Deducting Disaster Losses for Individuals

• We seem to be living in an age of natural disasters. Floods, fires, hurricanes, tornados, and other disasters often dominate the news.

  If a disaster strikes you, the tax law may help. When defined as such by the tax code, a disaster loss may qualify for deduction from your taxable income. The rules for personal losses are complex and far more restrictive than for business losses.

  Only Casualty Losses Are Deductible

  Damage to personal property caused by a disaster is deductible only if it qualifies as a casualty loss. A casualty is damage to, destruction of, or loss of property from events such as fires and floods that are sudden, unexpected, or unusual.

  The disaster must result in physical damage to property, so economic losses due to the COVID-19 pandemic do not qualify as a casualty loss.

  Many, but not all, casualty losses are covered by insurance. The insurance recovery reduces your tax-deductible loss and could result in a taxable gain.

  And here’s a possible nasty surprise. Say you have a deductible loss after reducing the loss by the insurance recovery. If you want to deduct the loss on your taxes, you must file a timely insurance claim, even if that insurance claim will result in the cancellation of your policy or an increase in premiums.

  Your casualty loss (not your deduction) is equal to the lesser of

  1. the decrease in the property’s fair market value after the disaster, or

  2. the property’s adjusted basis before the disaster (usually its cost).

  Subtract any insurance or other reimbursement from the lesser of these two options. To find the decline in the property’s fair market value, you can use an appraisal or the repair costs.

  Limits on Casualty Losses

  Unfortunately, you can’t deduct all your casualty losses. From 2018 through 2025, you can deduct personal casualty losses only due to a federally declared disaster or to the extent you have casualty gains.

  For example, a homeowner can claim a casualty loss if a wildfire (declared a federal disaster) destroys his home. But he gets no deduction if a faulty fireplace caused the fire and destroys his home (no federal disaster).

  The law imposes major limits on your casualty-loss deduction. The general rule says that you first reduce the loss by $100 and deduct the remaining loss only to the extent it exceeds 10 percent of your adjusted gross income (AGI). Your final hurdle is that claim the loss as an itemized deduction. These rules significantly reduce or even eliminate many casualty loss deductions.

  Fortunately, some casualty losses are not subject to these limits, including disaster losses sustained due to a federally declared major disaster from January 1, 2020, to February 25, 2021. Instead, losses from such disasters are subject to a $500 floor with no 10-percent-of-AGI reduction. Under this rule, you deduct the loss whether or not you itemize. If you don’t itemize, you add the deductible loss to your standard deduction.

  You have a choice for losses from a federal disaster: claim the loss in the year of the disaster or on the prior year’s return if it’s before October 15. This can result in a quick refund of all or part of the tax you paid that year.

  Casualty Gains

  If all this is not complicated enough, there’s one further wrinkle. A casualty such as a fire can result in a casualty gain instead of a casualty loss when the insurance proceeds you receive exceed the property’s adjusted basis (cost).

  A casualty gain is taxable. But you may deduct casualty losses from the gains. Here, you don’t need a federal disaster. Also, you can postpone tax on a casualty gain by buying replacement property.

  Deducting Disaster Losses for Businesses

  Disasters such as storms, fires, floods, and hurricanes damage or destroy property.

  If property such as an office building, rental property, a business vehicle, or business furniture is damaged or destroyed in a disaster, your business may qualify for a casualty loss deduction. It’s easier to deduct business casualty losses than personal losses, but the rules are complex.

  What Business Casualty Losses Are Deductible

  Disasters such as fires and floods can result in a “casualty” because the damage, destruction, or property loss is from a sudden, unexpected, or unusual event.

  Car accidents qualify as a casualty so long as they’re not caused by your willful act or willful negligence. Losses due to thefts and vandalism can also qualify.

  Insurance covers many casualty losses. You must reduce your casualty loss by the amount of any insurance you receive or expect to receive. But unlike with a personal loss, you are not required to file an insurance claim for a business casualty loss. You may wish not to do so if it will result in your policy’s cancellation or an increase in premiums.

  Amount of Business Casualty Loss

  Your casualty loss can never exceed the adjusted basis of the property involved—usually its cost plus the value of any improvements, minus all deductions you took for the property, including depreciation or Section 179 expensing. If your adjusted basis is zero, you get no casualty loss deduction and could have a casualty gain.

  The amount of your casualty loss for damaged property is equal to the smaller of

  1. the decrease in the property’s fair market value after the disaster, or

  2. the property’s adjusted basis before the disaster.

  Subtract any insurance or other reimbursement received from the smaller of these two options.

  You can use an appraisal or repair costs to figure the decline in the property’s fair market value. If a casualty destroys business property, the loss is equal to the property’s adjusted basis minus salvage value and insurance proceeds, if any.

  Unlike personal casualty losses, business casualty losses are not subject to either (a) the $100 floor or (b) the 10-percent-of-AGI threshold to be deductible.

  Business Casualty Losses Due to Federal Disasters

  If your casualty loss is due to a federally declared disaster, you have the option of deducting it in the prior year. This way, you can get a refund of all or part of the tax you paid for that year.

  Casualty Gains

  You’ll have a casualty gain if the insurance proceeds you receive exceed the property’s adjusted basis (cost).

  A casualty gain is taxable. But you can postpone tax on a casualty gain by buying replacement property of equal or greater value within two years (four years for federal disasters).

  Repair Costs

  Repairs of property damaged by a casualty are not part of the casualty loss deduction. You capitalize the cost of the repairs and add them to your basis in the damaged property. But then they may qualify for depreciation or Section 179 expensing.