How Can You Get the Most Value When You Deduct Casualty Losses?
If you or your business gets hit with a theft, disaster, or other major casualty or loss, you can generally claim a deduction on your income tax return.
This applies to any of the casualties or losses described in Section 165(i)of the U.S. tax code, including:
- Property damaged by a storm, fire, car accident, or other similar events
- Loss on deposits, such as when your financial institution becomes insolvent or bankrupt (which, while not hurricane related, is included in this section of tax code)
In the case of a natural disaster, you have the option to deduct your losses for the tax year BEFORE the loss happened. Special rules also apply if your casualty loss exceeds your taxable income.
So, for example, if you were affected by Hurricane Matthew, you may be able to claim your losses in the year they happened (2016). Or, you could choose to file an amended return and claim the losses for 2015 – the year before the hurricane happened.
You have six months after the tax filing due date for the year of your loss to decide what year you want to claim the deduction in.
How Does This Work?
The first step is to add up the amount of your losses. You must determine the value of your losses not just for tax purposes but to file insurance and FEMA claims, too. Once you have valued your losses, then you can start to calculate the amount that is deductible on your tax return. That amount is generally calculated by figuring out the decrease in fair market value or your adjusted basis in the lost or damaged property (whichever is less), minus any recovery amount you expect to receive from insurance, FEMA, or other similar reimbursement sources.
Your deductible loss on personal use property, such as a home, boat or car not used in a business, is treated as an itemized deduction. These losses are subject to various limitations, which are generally based on your income.
The next step is to determine if you or your business is in a federally declared disaster area, as declared by the President of the United States. If you are within the designated disaster area, then you can start looking at your options for deducting your disaster losses.
If you are in a federally declared disaster area, then you want to compare what your tax returns will look like depending on whether you claim your losses in the year before or the year of the disaster. Whichever year you choose, you must claim your entire loss in one year. You can’t divide up your expected loss and apply it across both years. But if the loss eliminates your taxable income for either year, make sure to consider any refunds you can get from carrying back a net operating loss.
If the amount you recover from insurance, FEMA and other sources is ultimately different from the amount you anticipated, you generally must report the difference either as income or as an expense in the year when the amount of reimbursement is finally determined.
Net Operating Losses
If your losses completely eliminate your taxable income for a given year, you may have a net operating loss (“NOL”). An NOL can generally reduce your income tax liability for other years.
The normal rule is that NOLs are carried back to the second year prior to the year of loss. If the loss is bigger than your income was in that year, you may be able to claim the loss on your return for up to 20 years after the year of loss.
A special rule applies to NOLs caused by casualties, including storms such as Hurricane Matthew. These losses are carried back three years instead of the two-year carry-back period that normally applies.
Making Your Disaster Election
When you file your tax return, you have to include an election statement, so the Internal Revenue Service (“IRS”) knows which disaster caused your damage and can verify your property location.
Your election statement must include:
- The words “Section 165(i) Election” (this would normally go at the top of a Form 4684, which you file for casualties and thefts)
- The name or a description of the disaster that caused the loss(es) you’re claiming
- The date(s) of the disaster
- The address (including city, town, county, parish, state and zip code) where the damaged or destroyed property was located at the time of the disaster
If you’re filing electronically, your statement may be attached as a PDF. If you’re filing by paper, your statement could be as simple as writing the name of the disaster and the date on the top of your return.
If you claim your disaster loss in one year, but then you change your mind and want to claim it for a different year, you have to file an amended return to remove the previously deducted loss. That amended return has to be filed on or before the date when you file the new return on which you want to claim the disaster election. (In other words, whichever way you’re moving the loss – to the preceding year or the actual year of the disaster – you have to correct the first return you filed before you can proceed.)
Finally, you have six months after the due date of your federal income tax return for the disaster year (regardless of any other extension to file) to make your election. If you want to revoke a disaster election, you have 90 days from the due date for making the election, in case you change your mind about when you want to claim your loss.
Part of claiming a disaster casualty is determining the value of what you lost and tracking quotes and claims. For questions about how to value your loss and guidance on the claims and recovery process, call our Litigation Support team and ask for Insurance Recovery Services.
When you know the value of your losses and are ready to crunch some numbers, reach out to your Cherry Bekaert rep or your local service team. They can help you compare scenarios and help with filing.
Whether you need help with part of the process or the whole thing, we have