Countless families and businesses have been impacted by wildfires, floods and tornados this season. In many cases, property has been damaged or completely destroyed, resulting in widespread casualty losses. The tax treatment of these losses is certainly far from anyone’s mind at the moment, but with tax filing season just beginning, it’s important to understand what amounts taxpayers may be entitled to deduct.
Individual taxpayers face certain hurdles when it comes to casualty losses, which for federal income tax purposes are defined by the Internal Revenue Service as losses that “result from the damage, destruction or loss of property from any sudden, unexpected event,” such as wildfires.
The first major hurdle is determining the amount of the loss. IRS Form 4684, Section A, walks through the calculation process step by step, but generally speaking, the loss is:
- The lesser of the property’s adjusted basis (typically original cost, adjusted for improvements and in certain cases, depreciation) prior to the casualty or the decrease in fair market value as a result of the casualty.
- Reduced by the amount of any insurance, salvage value or other reimbursements that have been received or are expected to be received.
- Further reduced by $100 for each casualty loss (for example, loss due to wildfires would count as one casualty loss).
The second hurdle, and perhaps the greatest, is that casualty losses for individuals are reported on Schedule A of Form 1040 as an itemized deduction and are subject to a very specific limitation. Only those losses that are greater than 10 percent of a taxpayer’s adjusted gross income (AGI) (line 37 of Form 1040) may be deducted. This limitation is applied after the loss calculation and $100 reduction noted above.
The standard deduction for single filers in 2016 is $6,300, and for married couples filing jointly it is $12,600. This means that a taxpayer’s total itemized deduction amount, including the casualty loss, must be greater than the standard deduction to make it worth claiming. If the amount is not, it is better to stick with the standard deduction.
The guidelines are less stringent for individuals with casualty losses to income-producing property (rental property, for example) and for businesses with casualty losses, as the amounts are not subject to the $100 reduction per casualty and 10 percent AGI limitation. These types of losses are reported on IRS Form 4684, Section B, and then on IRS Form 4797. They generally follow the calculation above, except that if the property is completely destroyed, the fair market value computation is not considered.
Last month, Sevier County was officially declared a “Presidential Disaster Area.” As a result, taxpayers who suffered casualty losses will have the option of claiming those losses on the current or previous year’s tax return. Typically, this option allows taxpayers to expedite an anticipated refund. The IRS has issued guidance stating that taxpayers choosing to claim losses on an amended 2015 return should put the disaster designation “Tennessee, Wildfires” at the top of the form so that those returns can be prioritized. Since the wildfires occurred so close to the end of the year, this treatment may or may not make sense depending on specific circumstances.
While these are some of the points to consider related to casualty losses, there are other caveats and reporting requirements that are beyond the scope of this article. Contact your tax advisor for more information.