Who can take a casualty-loss tax deduction?

When a storm damages your home or a burglar steals valuables from your home or vehicle, you probably turn to insurance to reimburse you for your loss.

Insurance companies pay out billions of dollars every year to cover such expenses — known as casualty losses. In fact, insured losses due to natural disasters in the U.S. totaled $78 billion in 2017, according to the Insurance Information Institute. That number increased to $91 billion in 2018, the National Oceanic and Atmospheric Administration reports.

But sometimes the insurance you have doesn’t cover an entire loss. Or worse, you may not have insurance coverage at all. If either is the case, you might be able to take a casualty-loss deduction on your federal income tax return, provided you meet some specific criteria.

• What is a casualty loss?
• What is the casualty-loss deduction?
• Changes due to tax reform
• Federally declared disaster areas
• How to claim the casualty-loss tax deduction
• Casualty loss gains

What is a casualty loss?

It’s important to understand what constitutes a casualty loss and what doesn’t.

Normal wear and tear or progressive deterioration over time doesn’t add up to a casualty loss. To qualify as a casualty loss, the damage, destruction or loss of property must arise from a sudden, unexpected and unusual event, like a flood, hurricane, tornado, fire, earthquake or volcanic eruption.

For example, if your home’s roof needs to be replaced because it’s 30 years old and your insurance doesn’t cover the replacement, that wouldn’t be considered a casualty loss. But if the roof is damaged in a storm, that could be a casualty loss.

Causes of casualty losses can include (but aren’t limited to, and there are exceptions) …

• Earthquakes
• Fires
• Floods
• Demolition or relocation of a home, at the government’s order, because a disaster has rendered the home unsafe
• Sonic booms
• Storms, including hurricanes and tornadoes
• Vandalism
• Volcanic eruptions

What is the casualty-loss deduction?

When your home or personal property is damaged in a disaster, you might be eligible to take a casualty-loss tax deduction — but there are specific rules for who can take this deduction.

Prior to tax reform, any taxpayer who experienced a casualty loss, and who qualified for a casualty-loss tax deduction, could take the deduction by itemizing on Schedule A. To deduct casualty losses for property for personal or family use, you had to reduce each casualty loss by $100 and the total had to be more than 10% of your adjusted gross income.

Taxpayers could also deduct casualty losses due to theft. The theft must have been considered illegal in the state where it occurred and done with criminal intent. You may only deduct the theft in the year that your property was stolen.

If you met the criteria for the casualty-loss tax deduction, you could take the deduction regardless of where the loss occurred. But the Tax Cuts and Jobs Act of 2017 changed the criteria for the deduction, and now where your loss occurs helps determine if it’s deductible or not.

Changes due to tax reform

Tax reform drastically limited who can claim the casualty-loss tax deduction for personal losses.

Now, only taxpayers whose personal losses occur in a federally declared disaster area may be eligible to claim a casualty-loss tax deduction. So the president must declare the region a disaster area in order for losses in that area to be deductible.

This provision effectively excludes many events that previously could have been the cause of deductible losses.

For example, if you had property damage due to a severe summer storm, prior to tax reform you might have been able to take a casualty-loss deduction for that damage (provided you met all the other criteria for taking the deduction). But not every summer storm will warrant a federal declaration of a disaster — and unless that occurs, storm victims in the area won’t be able to claim a casualty-loss tax deduction.

And theft losses are only deductible if they can be attributed to a federally declared disaster as well.

But if you do live in a federally declared disaster area, there’s good news from tax reform. If you’re eligible for the casualty-loss tax deduction, you can claim it without having to itemize your deductions. The amount of your loss no longer needs to exceed 10% of your AGI, but the $100 per-casualty limit has now increased to $500 per casualty.

These changes are temporary, though: The tax reform bill applied the changes only to tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. It’s also important to note that the limitations only apply to personal casualty losses, not casualty losses experienced by a business.

Federally declared disaster areas

How do you know if your area is considered a federally declared disaster area? The Federal Emergency Management Agency, or FEMA, maintains a list of disasters that’s searchable by incident type, declaration type and date of incident.

Here’s a partial list of federally declared disaster areas from events that occurred in 2018.

• Alaska earthquake
• California wildfires
• Alabama, Georgia and Florida (Hurricane Michael)
• Virginia (Hurricane Florence)
• Hawaii (Tropical Storm Olivia)
• North Carolina and South Carolina (Hurricane Florence)
• Hawaii (Hurricane Lane)

FEMA oversees the process for declaring a federal disaster area. It starts with an affected state or tribal government asking FEMA to conduct a preliminary damage assessment. Certain tribal governments can also request a declaration directly from the president.

There are two types of declarations.

• Emergency declarations — The president may issue an emergency declaration when he or she determines the affected region requires federal assistance.
• Major disaster declarations — For an emergency to be declared a major disaster, the president must determine the event has caused damage so severe that the state or local governments wouldn’t be able to respond.

How to claim the casualty-loss tax deduction

Calculating a casualty-loss deduction isn’t as straightforward as submitting receipts or repair estimates and asking for reimbursement. It takes a bit of work — beginning with determining your actual loss.

Calculating actual loss

For personal-use property like a home or car, or for other property that is only partially destroyed (the roof is gone but the walls are still standing), your casualty loss is either the adjusted basis of the property or the decrease in fair market value of the property as a result of the damage, whichever is less.

For business or income-producing property that is completely destroyed, your casualty loss is the adjusted basis of the property, and for theft, the casualty loss is typically the adjusted basis of the property.

Figuring in insurance reimbursement

Once you know the amount of your loss, you must deduct any insurance or other reimbursement you received for the damaged property to arrive at your loss after reimbursement. From that amount, you would subtract $500 (the per-casualty limit). The final product of your calculations should be your casualty-loss tax deduction.

Let’s look at an example. Joe’s personal car gets caught in flooding in a federally declared disaster area and is totaled as a result. His adjusted basis for the vehicle is $12,000 (he uses adjusted basis because it’s less than the decrease in the fair market value of his vehicle). Insurance pays him $7,000 for his loss.

Here’s the calculation for Joe’s casualty loss tax deduction.

$12,000 (Joe’s loss) – $7,000 (insurance payout) = $5,000

$5,000 – $500 (per-casualty limit) = $4,500 (Joe’s casualty-loss deduction)

When to report

Generally, you must deduct a disaster loss on your tax return for the same year the disaster occurred. But if your loss occurs from a federally declared disaster, you may be able to apply your casualty-loss tax deduction to your tax return for the year before the disaster happened.

IRS Publication 547 has detailed information on casualty losses.

Casualty loss gains

If you experience a casualty loss and receive insurance reimbursement for more than the adjusted basis of the damaged, destroyed or stolen property, you may have a casualty gain that you’ll have to report as income.

The adjusted basis of property is generally how much you paid to buy the property, plus anything you did to improve the property and increase its value, and minus anything that happened to decrease its value.

You may not have to report the gain as income if it came about because your main home was destroyed. If you meet the qualifications, you may be able to exclude up to $250,000 of your gain ($500,000 if married filing jointly) from your income.

There are detailed rules for how to report gains from different kinds of casualty losses. Again, check out IRS Publication 547 to learn more.

Bottom line

Insurance to cover valuable property can be expensive, but going without it can be even more costly if disaster strikes — especially since you can’t deduct casualty losses that occur outside a federally declared disaster area.

If you do suffer losses as a result of a federally declared disaster, it’s important to understand how the casualty-loss tax deduction works and when you can take the deduction. You’ll need to reduce your loss amount by any reimbursement you receive for the loss, plus the $500 limit. But with the suspension of the 10% AGI requirement, you may be able to recoup more of your uninsured, unreimbursed losses.

A senior product specialist with Credit Karma, Janet Murphy is a CPA candidate with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.