Casualty losses are losses that result from sudden, catastrophic events such as floods, earthquakes and fires, which cause damage to or loss of a person’s home, household possessions or vehicles. Normal wear and tear does not qualify as a casualty loss for income tax purposes. Theft is the criminal deprivation of a person’s money or property. In order to deduct a theft loss on one’s income taxes, the theft would have to be proven. In addition, it must be illegal under the law of the state in which it occurs, which means that criminal intent must be shown.
Most importantly, however, beginning in 2018, after the passage of the Tax Cuts and Jobs Act, a person can deduct casualty and theft losses on their income taxes only if they are directly related to an event declared a disaster by the President of the U.S.
Furthermore, a theft loss must have occurred as a direct result of an event in an area that has been declared a disaster area by the U.S. President. Property that has been mislaid or lost is not property loss related to theft in a disaster area. Thus, the Tax Cuts and Jobs Act has drastically reduced the scope of the individual casualty and theft loss deduction.
Before 2018 a person was required to itemize deductions on their personal income tax return in order to claim a casualty or theft loss. This has now changed and a person can claim the deduction even if they do not itemize deductions but take the standard deduction instead. In addition the amount of the loss does not need to exceed 10% of a person’s adjusted gross income, as it did previously. Another change is that the $100 per-casualty exclusion has now increased to $500.
However, just to add to the confusion, these changes are only temporary. The Tax Cuts and Jobs Act applies the changes it effected only to tax years beginning after December 31, 2017 and ending before January 1, 2026. In addition, the new limitations on the deduction apply only to personal casualty losses, not casualty losses experienced by a business.
The Federal Emergency Management Agency (FEMA) publishes a list of disasters. It can be searched by type of incident, type of declaration and date of the incident. Some examples of federally declared disaster areas based on events that happened in 2018 are as follows:
- The state of Alaska because of an earthquake;
- Areas of California because of wildfires;
- The states of Alabama, Georgia and Florida because of Hurricane Michael;
- The state of Virginia because of Hurricane Florence;
- The state of Hawaii because of Tropical Storm Olivia;
- The states of North Carolina and South Carolina because of Hurricane Florence.
FEMA supervises the process for declaring a federal disaster area. The process begins with an affected state or tribal government asking FEMA to perform a preliminary damage assessment. Certain tribal governments can also request a declaration directly from the president.
Declarations fall into two categories:
- Emergency declarations: An emergency declaration may be issued by the president when it is determined that an affected region requires federal assistance;
- Major disaster declarations: Before an emergency can be declared a major disaster, the president must determine that the event has caused damage so severe that state or local governments would not be able to respond.
Again, FEMA is the source of information about areas that have been declared disaster areas for income tax purposes.
What is the Process for Deducting Casualty or Theft Losses on a Tax Return?
This process comprises the following steps:
- A person needs to calculate the decrease in the property’s fair market value, which is the amount equal to the difference in value of the property immediately before and immediately after the loss;
- Then a person should subtract $500 from the property’s fair market value after the loss.
- Any amount received from insurance or any other source as compensation for the loss must be subtracted from the value also.
- The amount remaining is the value used as a casualty loss deduction on the person’s tax return.
For example, suppose a person’s uninsured laptop worth $1500 is stolen as a direct result of an event in a disaster area. They must subtract $500 from the value of the computer, so the value of the loss is now $1000 and that is the value of the deduction.
Or, suppose this person’s $500,000 house suffers a loss in value of $50,000 in a forest fire. After the $500 exclusion is applied, the loss is $49,500. Of course, if the person were to be compensated by their homeowner’s insurance policy for the loss, the amount of the payment received from insurance must be subtracted from the amount of the deduction. The remaining amount is the value of the casualty loss deduction that the person can claim on their income tax return. Tax Form 4684 is used to report casualty and theft losses.
If property that has been lost or destroyed is business or income-producing property, such as rental property, and its destruction is complete, then the amount of the loss is the adjusted basis of the property.
How Do I Figure Out the Adjusted Basis of My Property?
Adjusted basis is usually the amount a person paid for the property, plus any improvements the person has made to it while they owned it.
In addition, any depreciation in value that happened since the person bought the property must be subtracted. And, finally, any insurance reimbursements a person receives to compensate for a loss must be subtracted from the amount of the loss.
I Live in an Area Once Declared a Disaster Area. How Does this Affect my Tax Deductions?
Of course any casualty or theft loss must be directly related to a disaster in a federal disaster area to be deductible on a person’s income tax return.
If a person has a tax deductible casualty loss from a disaster in an area officially designated by the President as eligible for federal disaster assistance, they can choose to deduct that casualty loss on their tax return for the tax year immediately preceding the tax year of the loss.
So the person might want to revise the previous year’s tax return and claim the deduction for that year. Of course, one would want to calculate the effect of the deduction on each year’s tax liability and see how the deduction could be claimed to the best effect.
What if the Disaster Affected my Ability to Pay My Taxes on Time?
If a person has been affected by a disaster in a presidentially declared disaster area, the person can ask the IRS to delay collection of tax they owe and not apply tax penalties and interest.
Do I Need an Attorney’s Assistance with Deducting Casualty or Theft Losses?
The casualty and theft loss provisions of the Internal Revenue code were changed significantly by the Tax Cuts and Jobs Act of 2018. In some ways, the calculations required to specify the value of a qualified loss are complicated. Moreover, just determining if your losses qualify under the new rules regarding federally declared disaster areas can be a bit of a headache.
An experienced tax attorney can help you understand current law and how it affects your situation. If you have questions regarding the deductibility of your losses, or if you need to go to tax court, an attorney can represent you and help minimize your income tax bill. You are most likely to get the best possible outcome in your situation with an experienced tax attorney representing your interests.