Taxpayers who experience certain types of major personal casualties may be able to recoup some of their losses through tax savings.
An itemized deduction may be available for personal losses from fires, storms, car accidents, and similar “sudden, unexpected, or unusual” events. Losses from theft are included as well. Individuals who don’t itemize deductions can’t deduct their casualty losses.
The deduction is only available for physical damage or loss to your property. Thus, if you are in an automobile accident and pay for the damage done to the other driver’s car, the cost does not qualify. Similarly, if you’re injured in the accident, your medical bills do not qualify as part of your casualty loss (although they may result in a medical expense deduction).
Figuring the loss. The loss is not always the decline in economic value you suffer. It’s measured as the lesser of (a) the drop in value and (b) your basis in the property (usually, your cost).
Example: Dan bought an antique vase for $500 which rose in value to $3,000. It was damaged in a fire, after which it was worth only $1,000. For tax purposes, the casualty loss is only $500, even though the economic loss was $2,000 ($3,000 − $1,000). The lesser of cost ($500) and drop in value ($2,000) is used.
It may be difficult to establish these elements. If you have your original receipt, you can show your cost. In some cases, appraisals will be needed to establish pre- and post-loss values. Sometimes, repair costs can be used as a measure of drop in value.
Limitations on the deduction. The loss figure must be reduced by three amounts. In many cases, these reductions result in no deduction being available.
First, to the extent you are insured, you must reduce your loss by your reimbursement. However, you shouldn’t fail to file an insurance claim in the hope of increasing your deduction. If you do, IRS will reduce your loss by the insurance reimbursement you could have received.
Next, for each casualty, you must reduce your loss amount by $100. Note that this reduction is per event, not per item damaged. Thus, if a storm knocks over a tree that damages your car and home, you have three property losses (tree, car, house) and only one reduction.
Third, after combining all your losses under the above guidelines, you must reduce them by 10% of adjusted gross income (AGI). Only the loss amount above this “floor” can be deducted.
This final limitation is often the one that wipes out the deduction. For example, if your AGI is $75,000, your losses (determined as described above) are only deductible to the extent they exceed $7,500 (10% of $75,000).
When to take the deduction. Except for “disaster losses,” the deduction is taken in the year the loss is incurred (or, for a theft, the year it’s discovered). If your loss is from a disaster in a federally declared disaster area, you can elect to take your loss in the year before it was incurred. This may increase the tax savings from the loss and may entitle you to a refund earlier than if you waited to file the loss year’s return.
Casualty gains. Also bear in mind that not every casualty results in a loss for tax purposes. There is such a thing as a “casualty gain.” For instance, suppose a taxpayer buys a house for $100,000 (his tax basis) and it increases in value over the years. If it’s destroyed and the taxpayer receives $300,000 in insurance, he will have a gain of $200,000 since his basis was only $100,000. In many cases, tax on a casualty gain can be avoided or deferred.
For additional information on these issues, please contact one of our tax professionals.
