In many areas of the country, almost everyone has incurred a loss at one time or another from a casualty disturbance of some sort. Tornadoes, earthquakes, fires, hurricanes and other natural disasters cost both taxpayers and insurance companies billions of dollars each year. As we know, Florida’s vulnerability to hurricanes is a major concern, and losses need to be accounted for properly. Here are circumstances under which casualty losses are tax-deductible.
The Sudden-Event Test
To be tax-deductible, a casualty loss must meet the criteria for the sudden-event test, which mandates the following:
Under this definition, losses due to the following events would qualify for deduction:
However, there are several types of losses that would not qualify for deduction:
Who Can Deduct a Loss – and When?
Only the owner of the property that is lost can deduct the loss, within certain limitations, in the year that the loss was incurred. If you are leasing property that is lost or destroyed by a sudden and unforeseeable event that qualifies for deduction, then you may be able to deduct the payments that you make to the lessor that make up for the loss.
If, on the other hand, the taxpayer expects to be reimbursed in full for the loss in a later year, then the loss (or at least the amount of the loss for which the taxpayer reasonably expects remuneration) should not be deducted in the year the loss is incurred. If the reimbursement is never paid, then the loss must still be claimed in the year that it was incurred by filing an amended return for that year. For example, if a taxpayer's house is destroyed by fire in 2016, and the taxpayer expects to receive the insurance proceeds in 2017, then the taxpayer should not declare a loss on the 2016 return. However, if the insurance company denies the claim in 2017, then the taxpayer must file an amended return for 2016 in order to declare the loss.
Taxpayers who incur losses as a result of a disaster in a presidentially declared disaster area have the option of declaring their loss on their prior year's tax return, thus allowing them to amend the return and receive an immediate refund as a measure of relief. The Federal Emergency Management Agency keeps an updated list of all eligible disaster areas and the years for which they qualify. Those who do this will need to provide a statement outlining their choice to take the deduction the previous year and provide basic information on the time, place and nature of the disaster. The deadline for this election falls either on the standard filing deadline for the current tax year or the deadline with extensions for the previous tax year. Those who elect to report the loss in a previous year and then change their minds have 90 days to reverse the election and send back any refund that was paid. Victims in these areas do not have to meet the 10% AGI threshold rule if they sustained a net disaster loss (meaning that the loss exceeded any amount of insurance or other remuneration). They also do not have to itemize deductions; in this case, they would report the loss on Form 4684 of the standard deduction worksheet. Those who do itemize will report it in the normal fashion on Schedule A.
The Bottom Line
The IRS allows limited casualty and theft loss deductions as a measure of relief for those who are victimized by theft or natural disaster. There are many rules and regulations pertaining to casualty and theft losses that lie beyond the scope of this article. For more information on this subject, visit the IRS website or see IRS Publication 547.
The following link provides information to those affected by Hurrican Irma.