Tax Time: How to Treat Your Property and Casualty Losses

In the aftermath of a disaster, it may be comforting to know that tax laws may offer some financial relief for those who are affected. In most instances, a portion of unreimbursed casualty losses counts as an itemized deduction, according to certain guidelines.

On a broad scale, the federal government declared 59 disasters in 30 different states and U.S. territories in 2009.¹ Many other families suffered property and casualty losses resulting from isolated incidents that were just as devastating.

The IRS defines a casualty loss as one that results from the damage or destruction of property from any sudden, unexpected, or unusual event. It recognizes both man-made and natural disasters such as fires, vandalism, severe storms, floods, tornadoes, earthquakes, and volcanic eruptions, but not ordinary wear and tear or avoidable conditions such as termite damage.

Here’s a look at the guidelines for allowable deductions and how additional legislation may provide more tax relief for victims of federally declared disasters.

Qualifying Losses

For casualty events outside of a federal disaster area, losses typically need to be large enough to qualify for the itemized deduction and must be taken for the year in which the casualty occurred. However, if taxpayers were underinsured or their claims were subject to a large catastrophe deductible, they could have incurred a big unreimbursed loss that might generate a deduction.

Taxpayers may deduct an allowable loss to the extent that it exceeds 10 percent of adjusted gross income (AGI), minus $100 for each event. For example, if a family suffers $10,000 in losses over and above their insurance reimbursement and their AGI is $80,000, they can claim a deduction of $1,900 ($10,000 minus $8,000 minus $100 = $1,900). In this case, if their AGI was $95,000 or more, they would not qualify for any deduction.

Losses are limited to the decrease in value of the property caused by the casualty or its adjusted basis (usually the cost), whichever is smaller. Taxpayers may determine the decrease in fair market value either by appraisal or, in some cases, by the cost of repairs.

Declared Disasters

Congress may pass tax-relief laws for victims of specific disasters that affect certain regions. Following a number of serious events in 2008, Congress passed the National Disaster Relief Act of 2008 to provide even more favorable tax treatment for those who suffered losses in federally declared disaster areas throughout 2008 and 2009.

The Act removed the 10 percent AGI limitation for net disaster losses, but taxpayers had to reduce their stated loss by $500 for each event (in 2009 only; this reduction returns to $100 after 2009). Also, these filers do not have to itemize in order to take advantage of the tax deduction.

Another potential benefit was that taxpayers could choose to take the deduction in 2009 or to file an amended return for 2008. Each individual’s personal tax situation, including AGI for each year, determines which option is more valuable. Also, taxpayers who received aid or grants from state programs, charities, or employers to cover disaster-related costs do not have to include these funds in their gross income.

If you think you might qualify for this special deduction, you will need to keep good records and file an additional form with your tax return. You may want to consult your tax professional and provide him or her with all receipts, insurance statements, and other items when it’s time to file your taxes.

Of course, it’s better to avoid uninsured losses whenever possible. Therefore, you should review your insurance coverage on a regular basis and carefully document your personal belongings. But for those who become a victim of a major disaster, a tax deduction from Uncle Sam is better than nothing.

1) FEMA, 2010

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.