There are three limits that apply on deductions for casualty and theft losses of personal-use property: the 2% rule, the $100 rule, and the 10% rule. Losses on business, or income-producing property, such as rental property, are not subject to these rules.
2% Rule
Casualty and theft losses calculated on Form 4684 are transferred to Schedule A and taken as a miscellaneous itemized deduction. These losses are deductible to the extent they exceed 2% of your adjusted gross income.
$100 Rule
The first $100 of each casualty or theft event is not deductible. So the amount of the loss you can take for each event must be reduced by $100. This is included as a separate line on Form 4684. This $100 rule applies to each event, and not to each item of property. You may have more than one item of property involved in a casualty, and the $100 rule applies only once for the entire casualty. But if you had more than one casualty or theft event in the same year, the $100 rule would be applied to each event.
If two or more individuals, other than a husband and wife filing jointly, had losses from the same casualty or theft event, the $100 rule applies to each individual. If you are married filing jointly, the $100 rule applies once; if you are married filing separately, it applies to each person.
10% Rule
The total of all your casualty and theft losses for the year must be reduced by 10% of your adjusted gross income, after applying the $100 rule for each event. This is also included as a separate line on Form 4684. If you are married filing jointly, the 10% rule applies once; if you file separately, it applies to each return.
Gains and Losses
If you have both gains and losses from casualties and thefts, after applying the $100 rule per event, you will need to net the gains against the losses to determine if you have an overall gain or loss from casualties and thefts for the year. Any gains you choose to postpone, as discussed below, do not enter into this calculation.
If the net result is an overall loss, you must apply the 10% rule to reduce your loss, and the difference is your taxable deduction (to be included in itemized deductions subject to the 2% rule).
If the net result is an overall gain, it is reported as a capital gain on Schedule D and is not subject to the 10% rule.
Form 4684 is designed to lead you through these calculations and by following the indications on the form, you will see how the result should be handled.
Property Used for Both Personal and Business Purposes
When you have a casualty or theft loss on property that is used partly for personal purposes and partly for business purposes, you need to figure the deduction separately for the personal and business portions. The personal portion is subject to the $100 rule and the 10% rule, while the business portion is not subject to these rules. Allocate the adjusted basis in the property, the decrease in fair market value, and any insurance or other reimbursement between the personal portion and business portion of the property and figure the gain or loss on each portion separately.