Tax

Tax Treatment of Storm & Flood Losses for Nonbusiness Property

June 2011
Author:  Brandon Davis

Brandon Davis

Senior Manager

Manufacturing & Distribution

3230 Hammons Boulevard
P.O. Box 1824
Joplin, MO 64802-1824 (64804)

Joplin
972.702.8262

& Mike Gray

Mike Gray

Partner

Manufacturing & Distribution

3230 Hammons Boulevard
P.O. Box 1824
Joplin, MO 64802-1824 (64804)

Joplin
972.702.8262

Individuals who suffer major personal losses from fires, storms or other casualties may be able to recover some of their losses through tax savings.

Importantly, a personal (nonbusiness) casualty loss deduction is allowed only for a loss to property you own. For example, after a flood, an individual cannot deduct as casualty loss expenses incurred for personal injuries, temporary lights, fuel, moving or rentals for temporary quarters.

Determining the Loss

For nonbusiness property, the casualty loss is the lesser of (1) the decrease in the fair market value of the property or (2) your adjusted basis in the property (normally, this is your cost). Determining the decline in fair market value (FMV) can be tricky. While obtaining appraisals of the property before and after the damage is ideal, this is rarely practical. As an alternative, the IRS will accept the cost of making repairs after a casualty as a measure of the decrease in FMV if you meet the following conditions:

  • The repairs are actually made.
  • The repairs are necessary to bring the property back to its condition before the casualty.
  • The amount spent for repairs isn't excessive.
  • The repairs take care of the damage only.
  • The value of the property after the repairs isn’t, due to the repairs, more than the value of the property before the casualty.

Deduction Limits

Once the loss is determined, the deductible amount is reduced by three items. (Keep in mind you also must itemize on your individual return to benefit.):

  1. 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, the IRS will reduce your loss by the insurance reimbursement you could have received.
  2. For each casualty, you must reduce your loss amount by $100. Note 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 and house) and only one reduction.
  3. After combining all your losses under the above guidelines, you must reduce them by 10 percent of adjusted gross income (AGI). Only the loss amount above this “floor” can be deducted.

To see an example of how a casualty loss deduction is calculated, click here.

If the casualty loss deduction is sufficient to completely offset your taxable income in the year of the loss, you may be able to receive tax refunds not only for the current year but also for prior years. To the extent the casualty loss results in a net operating loss, individuals may carry the loss back three years to offset taxable income, generating a cash refund of taxes paid previously that can now assist in recovery.

Insurance Payments for Living Expenses

Your casualty loss isn’t reduced by insurance payments received to cover living expenses in either of the following cases:

  • You lose the use of your main home because of a casualty.
  • Government authorities don not allow you access to your main home because of a casualty (or a threat of one).

If the insurance payments received exceed the temporary increase in living expenses, the excess is generally included in taxable income. However, if the casualty occurs in a federally declared disaster area, in general, none of the insurance payments for living expenses are taxable.

Federally Declared Disaster Areas

For major disasters, the president may designate a federally declared disaster area, and special rules apply. A list of federally declared disaster areas can be found at the Federal Emergency Management Agency website.

Individuals who suffer a casualty loss in a disaster area have the choice of (1) deducting the loss in the year the disaster occurred or (2) electing to claim the loss on an original or amended return for the prior year. By deducting the loss on the prior year’s return, the taxpayer may receive their refund sooner. Keep in mind that other factors, such as income levels, tax credits and effective tax rates, can affect the decision as to which year claiming the deduction will be most beneficial.

The IRS may postpone up to one year the filing deadlines of taxpayers who are affected by a federally declared disaster. The deadlines the IRS may extend include those for filing and paying federal income, excise and employment taxes.

Individuals in a federally declared disaster area also may exclude qualified disaster relief payments from their taxable income. In general, qualified disaster relief payments include payments (regardless of the source) for the reasonable and necessary expenses for:

  • Personal, family, living or funeral expenses incurred as a result of a federally declared disaster
  • Expenses incurred for the repair or rehabilitation of a personal residence or its contents due to a federally declared disaster

Individuals also may exclude from taxable income amounts paid by a federal, state or local government or an agency or instrumentality of those governments in connection with a qualified disaster to promote the general welfare.

Qualified disaster relief payments do not include payments for expenses otherwise reimbursed by insurance or income replacement payments, such as those for lost wages or unemployment compensation. These types of payments are normally taxable to the recipient.

Casualty Gains

While this article focuses on casualty losses, a disaster may sometimes result in a gain for tax purposes. This may occur where the insurance proceeds received exceed your tax basis in the damaged property. If that happens, there are several ways to exclude or postpone the tax on the gain. Please consult your BKD tax advisor for more details.