At the federal level, there are some key provisions that you need to be aware of such as what qualifies as a disaster area loss, a casualty loss, and qualified disaster relief payments.
Disaster Area Losses
A federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for federal assistance. Review the IRS’ Around the Nation page for news specific to local areas, primarily disaster relief or tax provisions that affect certain states. The IRS has also provided resources for disaster situations that focuses on the most recent disasters.
A casualty loss can result from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. If your property is personal-use property or isn’t completely destroyed, the amount of your casualty loss is the lesser of:
- The adjusted basis of your property, or
- The decrease in the fair market value of your property as a result of the casualty
If your property is business or income-producing property, such as rental property, and is completely destroyed, then the amount of your loss is your adjusted basis. You must reduce the loss, whether it’s a casualty or theft loss, by any salvage value and by any insurance or other reimbursements you receive or expect to receive. The adjusted basis of your property is usually your cost, increased or decreased by certain events such as improvements or depreciation.
Individuals and businesses that suffer losses in a federally declared disaster area may elect to deduct the loss either in the tax year in which it occurred or in the immediately preceding tax year.
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.”
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 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.
Net Operating Loss (NOL)
If your loss deduction is more than your income, you may have a net operating loss (NOL). You don’t have to be in business to have an NOL from a casualty.
A NOL is the amount by which a taxpayer’s business losses exceed its income. For tax years beginning before January 1, 2018, NOLs were able to offset 100% of taxable income and allowed to be carried back two years and carried forward for twenty years. However, TCJA eliminated net operating loss carrybacks while providing indefinite net operating loss carryforwards, limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017.
Generally, you may deduct casualty and theft losses relating to your home, household items and vehicles on your federal income tax return. You may not deduct casualty and theft losses covered by insurance unless you file a timely claim for reimbursement and you reduce the loss by the amount of any reimbursement or expected reimbursement.
The IRS has supplied a Disaster Resource Guide for Individuals and Businesses which provides information for individuals and businesses affected by a disaster. It also covers the help available for disaster victims. The guide can help taxpayers claim unreimbursed casualty losses on property that was damaged or destroyed.
Qualified Disaster Relief Payments
Qualified disaster relief payments include payments from any source to or for an individual paid as a result of a qualified disaster:
- to pay or reimburse reasonable and necessary personal, family, living, or funeral expenses, including personal property expenses;
- to pay or reimburse necessary expenses incurred for the repair of a personal residence, including one that is rented, or its contents;
- including payments made by a common carrier on account of death or personal physical injury; and
- including amounts paid by a federal, state, or local government to promote the general welfare.
Taxpayers may also obtain audit relief. It has been reported that IRS agents have been informally telling tax professionals that audit and collection activities in disaster areas will be delayed. This is not a formal policy. However, if a taxpayer would like to keep their case going to obtain closure sooner, they can contact the IRS.
Guidance for Those Affected by Disasters
The IRS has provided taxpayers with links to several different pages of Frequently Asked Questions (FAQs). Each set of FAQs is about a specific topic to help people after a disaster. To read more, visit FAQs for Disaster Victims.