Tax deductions can be silver lining behind storm clouds

The Southeast was plagued in 2016 and at the beginning of 2017 with natural disasters that resulted in the loss of business and property. Hurricane Matthew struck the East Coast in early October, impacting the coasts of Florida, Georgia, South Carolina and North Carolina. Throughout November, wildfires raged in North Carolina and in north Georgia.  At the end of that month, wildfire in the Great Smokey Mountains National Park destroyed thousands of homes and businesses, killing 14 people and bringing the city of Gatlinburg to a standstill. In January, tornadoes ripped through parts of south Georgia and Mississippi, resulting in President Donald Trump declaring the areas to be federal disaster areas.

Business and property owners in the paths of these disaster – and others – have the opportunity to deduct losses not compensated by insurance they suffered either through loss of property or loss of business as a direct result of these events.

  • What is a ‘casualty event?’

A “casualty event” involves a loss of property caused by fire, storm, shipwreck or other casualty or by theft. According to the IRS, the loss or damage to property must be “sudden, unexpected and unusual in nature.”

In other words, the event causing the loss must have happened quickly – not a gradual or progressive decline, such deterioration over time  or a home destroyed as a result of termite infestation – must be one that does not commonly occur in the ordinary day-to-day activities of the business owner or individual.

  • How is the deduction calculated?

In many of those instances, the taxpayer can claim a deduction on the loss. The amount of the casualty loss is the lesser of the difference in the fair market value of the property immediately before the event and its fair market value immediately afterward, or the adjusted basis of the property immediately before the casualty.  It should be noted that if the property owner expects to fully recover financially, then no casualty loss deduction is allowed.

To qualify, the taxpayer must be able to show:

  • The nature of the event;
  • When the event occurred; and
  • That the loss occurred as a direct result of the casualty.

The taxpayer must also produce the following:

  • Descriptions and locations of the damaged property;
  • Evidence of the adjusted basis of the property (such as purchase contracts, checks, receipts, etc.);
  • Depreciation allowed or allowable;
  • An appraisal supporting the fair market value immediately before and after the event;
  • Salvage value, if any;
  • Received or expected insurance reimbursements or other compensation.

If the damaged property is business property, the casualty losses are deductions for adjusted gross income.

It’s a bit more complicated for individuals whose personal-use property has been damaged in a casualty event. They must reduce their loss by what are referred to as two “floors.”

The first is a $100 per occurrence floor. The total of all personal property casualty losses are then subject to a second “floor,” which is 10 percent of the taxpayer’s adjusted gross income.

Consider this example of a property owner with $100,000 AGI who suffers a $15,000 loss and received $6,000 in insurance payout.

$15,000 (total loss)

– $6,000 (insurance proceeds)

= $9,000 (loss after proceeds)

– $100 (loss after IRS per occurrence fee)

-$10,000 (10 percent of AGI nondeductible)

= -$1,100 (nondeductible due to floor limitation)

  • When should a deduction for casualty loss be claimed?

Generally, a casualty loss is deducted in the year the loss occurs, regardless of when the damaged property is repaired or replaced. Any loss that occurs in an area declared a disaster area by the president of the United States can either be deducted in the year the loss occurs or in the tax year immediately preceding the tax year the disaster occurred.

There are some special rules for deducting losses incurred as a result of disasters:

  • If a taxpayer deducts the loss in the tax year immediately preceding the tax year in which the disaster occurred, the loss is treated as “sustained” in that preceding tax year.
  • Homes that are made unsafe by a disaster and are required by the state or local government to be torn down or moved are treated as a disaster loss and the loss of value is deductible.
  • If, as the result of a presidentially declared disaster, the property owner receives disaster relief payments that reimburse or pay for the cost of repairing a personal residence or replacing its contents, those payments are not taxable.
  • Relief provisions may be available if the insurance proceeds received for one’s principal residence exceeds one’s basis in that residence.
  • Those people and businesses who have a loss have 60 days from the date a presidential declaration state of emergency was announced to register with FEMA to be eligible to receive a maximum of $31,900 in disaster aid.
  • What about other kinds of loss?

Not all disasters to befall a business or individual are a result of a natural occurrence. Thefts, bankruptcy of a financial institution or falling victim to a Ponzi scheme are all ways individuals and businesses can suffer serious financial loss.

The deduction allowed for a theft loss is computed the same way as any casualty loss allowable for deduction. The following are some rules regarding deductions from loss as a result of theft:

  • A theft loss is deductible in the year the theft is discovered
  • A police report should be filed.
  • If there is a reasonable possibility of restitution or reimbursement for the theft, the loss should not be claimed.
  • A theft loss may not be claimed for theft of insured property unless a timely insurance claim is filed.
  • If a taxpayer deducts a theft loss in one taxable and receives a reimbursement in a later year, the amount of the reimbursement should be included in the taxpayer’s income for the year received.
  • If the theft loss is discovered during the settlement of an estate, it is deductible the year it is discovered, even if it relates to and occurred during a taxable year during which the decedent was alive – so long as it was not claimed for federal estate tax purposes.

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