08/18/09: No Windfall For Casualty Losses
Benny L. Kass
The large oak tree in your backyard was felled by a massive storm, causing damage to your fence and your garage. Strong winds blew the shingles off your roof. And termites caused major damage in your basement.
Can you deduct your losses when you file your income tax return? The answer is “perhaps”, but don’t expect a windfall from the IRS. The law relating to casualty losses is complex and quite bizarre.
Recently, the IRS issued a Tax Tip, listing ten things taxpayers should know when considering whether their losses can be deducted for tax purposes. First and foremost, unless your loss occurred in a federally-declared disaster area (such as New Orleans after Katrina or many midwestern states after the severe storms last year) you cannot deduct it unless you itemize deductions on IRS Form 1040, Schedule A. According to reports from the General Accounting Office, approximately 70 percent of taxpayers claim the standard deduction, while only 30 percent will itemize.
Next, you are not permitted to deduct any casualty loss that is covered by insurance unless you timely file a claim for reimbursement. And any moneys you actually receive from your insurance company will reduce the amount you can claim as a deduction.
The IRS defines a “casualty” as “damage, destruction or loss of property from an identifiable event that is sudden, unexpected, or unusual.” Thus, the damage caused by a storm would be a casualty. However, termite damage is considered by the IRS to be “progressive deterioration” and not sudden, and will be a disallowed deduction. It should be noted, however, that some courts have disagreed and allowed the deduction. If your tree is destroyed by disease or insects or worms, this is not a “sudden” event. If, however, the destruction is caused by an unexpected or unusual infestation of beetles or other insects, this may be considered a “casualty loss”.
Once you are satisfied that your loss can be deducted as a casualty, you must deduct $100 from the amount of the loss. For losses which occur this year, based on the Emergency Economic Stabilization Act of 2008, this floor is raised to $500 – but only for year 2009.
Next, you have to apply the 10 percent rule. According to the IRS, “the total of all your casualty and theft losses of personal-use property usually must be further reduced by 10 percent of your adjusted gross income.” Once again, if your loss occurred in a federally-declared disaster area, you can ignore this limitation.
There are special rules for damage to real estate. To determine your loss, all improvements – such as buildings, trees and the land must be considered together. The IRS provides a helpful example:
You bought your home a few years ago. You paid $150,000 ($10,000 for the land and $140,000 for the house). You also spent an additional $2,000 for landscaping. This year a fire destroyed your home. The fire also damaged the shrubbery and trees in your yard. ...Competent appraisers valued the property as a whole at $175,000 before the fire, but only $50,000 after the fire. ...the insurance company paid you $95,00 for the loss. Your adjusted gross income for this year is $70,000...
|FMV before fire:||175,000|
|FMV after fire:||50,000|
|Decrease in FMV:||125,000|
|Loss after Reimbursement:||30,000|
|Subtract $100||- 100|
|Loss after $100 rule:||29,900|
|Subtract 10% of $70,000||-7,000|
|Casualty Loss deduction:||$22,900|
Why do you have to include the adjusted basis in this calculation? Because for tax purposes, your loss is based on the smaller amount of the basis and the decrease in fair market value.
Thus, even though your real loss was $30,000, because of the various rules, you are still going to lose $7100 ($30,000 - 22,900) based on the fire. And this does not even include the heartaches and headaches of restoring the family home.
There are different rules for business losses, and even more rules for losses used for business and personal purposes.
As can be seen, the law is extremely complex. Hopefully, you will never suffer any loss, but should one occur, get a copy of IRS Publication 547, “Casualties, Disasters and Thefts” (www.irs.gov/publications) for a lot of helpful information.
File your insurance claim immediately, even though you do not know the full extent of the damage. And perhaps more important, consult your tax advisor to make sure you are on the right track.