When you suffer a loss caused by theft, vandalism, fire, storm, or similar causes, or a car, boat, or other type of accident, you may be able to take an itemized deduction on your U.S. federal income tax return. You may also be able to deduct money you had in a financial institution but lost because of the insolvency or bankruptcy of the institution. The deduction of these types of losses is covered under the tax provisions for casualties, disasters, and thefts.
What Constitutes a Deductible Loss?
Casualties
A casualty, for federal income tax purposes, is defined as “the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.” A sudden event is one that is swift and does not include damage that is gradual or progressive over time. An unexpected event is one that you do not usually expect. But this does not rule out storms, such as tornados or hurricanes, for instance, that periodically occur. Unexpected also means unintended. If there is intent behind an accident or a fire, for example, the event is not surprising and therefore does not qualify as a casualty for tax purposes. Willful negligence that results in an accident can also disqualify an event from being a deductible casualty loss. Unusual refers to events that are not day-to-day occurrences and are not typical. Accidentally dropping and breaking glassware or China, for example, may be unexpected and unintended, but for tax purposes, it is not a deductible loss since it occurs in what would otherwise be considered normal circumstances.
Examples of non-deductible losses due to progressive deterioration include normal wear and tear, steady weakening of a building due to the usual effects of wind and weather, termite damage, and the destruction of trees or other plants by a fungus, disease, insects, or other pests.
Based on this definition, there are several different types of events that can result in a deductible casualty loss, including car accidents, earthquakes, fires, floods, storms, including hurricanes and tornadoes, vandalism, and government-ordered demolition or relocation of a home that is unsafe to use because of a disaster.
Thefts
Deductible theft losses include blackmail, burglary, embezzlement, extortion, theft and robbery. There must be criminal intent for the damage to be deductible. Misplacing or otherwise losing personal property will not qualify for a deduction. Also, theft losses do not include a decline in the market value of your investment in stocks as a result of disclosure of fraud or other illegal misconduct by the officers or directors of the corporation. But you may be able to deduct a capital loss when you sell or exchange the stock, or if the stock becomes worthless. You would take this capital loss on Schedule D, Capital Gains and Losses.
Loss on Deposits
If a bank, credit union, or other financial institution in which you have deposits goes bankrupt or becomes insolvent, you can deduct the damage when you can reasonably estimate how much of your deposits you have lost.
How To Deduct a Casualty or Theft Loss
Forms to File
When you have a casualty or theft loss, you will need to file Form 4684, Casualties and Thefts, and then transfer the result to Schedule A, to report the loss as an itemized deduction. You may need to file Form 4797 if the business property has been affected by the casualty or theft.
For a loss on deposits, you have three different ways to take the deduction:
- A casualty loss reported on Form 4684 and then on Schedule A as an itemized deduction.
- As an ordinary loss, reported as a miscellaneous itemized deduction on Schedule A. The maximum amount you can claim is $20,000 ($10,000 if married filing separately), less any proceeds from state insurance on deposits, If the deposit is federally insured, you cannot claim the loss as an ordinary loss. Miscellaneous itemized deductions are subject to the 2% of the adjusted gross income limit.
- As a non-business bad debt, on Schedule D. If you choose this option, you will have to wait until the actual loss is determined and deduct the loss as a bad debt in that year.
Proof of the Loss
To deduct a casualty or theft loss, you will need to be able to show that the casualty or theft occurred, that your loss was a result of the casualty or theft and that you were the owner of the property. For a casualty loss, if you are leasing the property, you will need to show that you are contractually liable for the damage. You will also need records of your cost or another basis in the property, and records of insurance claims filed, and the amount of reimbursement received or you are expecting to receive.
Determining the Amount of the Deduction
You can calculate the amount of your casualty or theft loss as follows:
- Determine the adjusted basis in the property before the casualty or theft.
- Determine the decrease in the fair market value of the property as a result of the casualty or theft.
- From the smaller of 1 or 2, subtract any insurance or other reimbursements.
Adjusted Basis
Your adjusted basis in the property before the casualty or theft might be your original cost, if you purchased the property, or maybe another base if you received the property as a gift, by inheritance, in an exchange, or in some other way. If you had rented out the property, your adjusted basis might be original cost less accumulated depreciation and other adjustments. You should refer to how basis for tax purposes. IRS Publication 551, Basis of Assets, provides guidance in this regard.
The decrease in Fair Market Value
Fair market value is defined as the price for which you could sell your property to a willing buyer when neither of you has to sell or buy, and both of you know all the relevant facts. The decrease in the fair market value is the difference between the property’s fair market value immediately before and immediately after the casualty or theft. In the case of a robbery, the fair market value after the theft is considered to be zero. In the case of an injury, you will generally need to get an appraisal. The cost of the appraisal is not a part of the loss, but can be taken as a miscellaneous itemized deduction on Schedule A.
In determining the amount of a casualty loss, the cost of cleaning up or making repairs is not part of the loss. But, aside from an appraisal, you may be able to use the cost of clean-up and restoration as a way of determining the decrease in fair market value if you take the repairs. The repairs are necessary to bring the property back to its condition before the casualty, the amount spent is not excessive and is only to repair the damages, and the value of the property after the repairs is not more than its value before the casualty.
Insurance Reimbursements
You reduce your loss by the amount of the insurance you expect to receive, even if you do not accept the insurance reimbursement until the following year. If your property is insured, you must file a timely insurance claim; otherwise, your loss is not deductible. But this does not apply to a deductible, which you would not be able to recover anyway. For example, if your car is damaged and you do not file an insurance claim, you could still claim a loss for the amount of the deductible.
If you receive insurance reimbursement the following year, and it turns out to be less than the expected amount of insurance reimbursement you reported when you initially claimed the deduction for the casualty loss, you can include the difference with any other casualty losses you may have for the year you received the reimbursement. If your insurance reimbursement was more than you reported as expected, you might have to include the excess in your income as a recovery in the year you receive it. But if the related casualty loss did not reduce your taxable income in the year the casualty occurred, you do not need to report the excess reimbursement. For example, if you had a casualty loss but did not itemize deductions that year, you had no tax benefit from the loss, and you do not need to report the insurance reimbursement.
If the total of all reimbursements you receive for the casualty loss, including insurance, is more than the adjusted basis of the property, you have a gain. If you had already taken a deduction for a casualty loss in a prior year, you would have ordinary income to report for the portion of the gain that corresponds to the amount you previously deducted. You may be able to postpone the remainder of the benefit if any. Postponement of benefits is below.
If the insurance reimbursement the following year is the same as what you reported as the expected reimbursement, you do not have any income or deduction to indicate when you receive the compensation.
Separate Items of Property
Form 4684 provides different columns for reporting different individual items of property involved in a casualty or theft. You determine the loss on each piece separately, and then combine them to determine the total loss from that casualty or theft. But if real property used for personal purposes was affected by the casualty, the entire property including buildings, trees, and landscaping is treated as one item. In this case, the loss is the lesser of the decrease in the fair market value of the entire property or the adjusted basis of the whole property.
If you have more than one casualty or theft to report, you should use a separate Form 4684 to report each event.
Leased Property
If the casualty damaged property that you are leasing, your loss is the amount you are contractually obligated to pay to repair the property, less any insurance or other reimbursements.
Business or Income-producing Property
If a casualty results in the complete loss of property you held in your business or for producing income, such as rental property, the decrease in the property’s fair market value not gets into consideration in calculating your loss. In this case, you calculate your loss by taking your adjusted basis in the property, subtracting any salvage value and any insurance or other reimbursements.
If the casualty affects inventory you hold for your business, you can deduct the loss as part of your cost of goods sold calculation. Or you can deduct the loss separately as a casualty loss; In the latter case, you would need to remove the affected items from your cost of goods sold calculation by adjusting to reduce opening inventory or purchases.
Deduction Limits
Three limits apply to 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. It is on 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 piece of the 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. If you are married filing jointly, the $100 rule applies once; if you are married filing separately, it refers 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. It is also on a separate line on Form 4684. If you are married filing jointly, the 10% rule applies once; if you file separately, it refers 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 benefits 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 you should handle the result.
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 individual and business portions. The individual part 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 reimbursements between the personal portion and business portion of the property and figure the gain or loss on each piece separately.
Gain from Reimbursement
It may turn out that you have a benefit if your insurance reimbursement is more than your adjusted basis in the property. If the net result on Form 4684 is a gain, then this amount needs to transfer to Schedule D, Capital Gains, and Losses.
In addition to insurance payments, reimbursements include money and the value of any property you receive, including an amount to pay off a mortgage or other lien on the damaged, destroyed, or stolen property.
If a storm destroys your primary home, and you have a gain from the casualty, then you can exclude the gain the same as if you had sold or exchanged your home. You can eliminate up to $250,000 ($500,000 if married filing jointly). If the gain exceeds the exclusion amount, you may be able to postpone the remainder of the benefit.
Postponement of Gain
If you received reimbursement for the casualty in the form of property similar to, or related in service and use to the property that was destroyed or stolen, you do not need to report any gain. Your basis in the property you receive is generally the same as your basis in the property replaced.
If you receive money or other property that is not similar, you may be able to postpone any gain you had on the casualty or theft if you purchase property identical to that which was destroyed or stolen within a specified replacement period. If you have a gain on property that was damaged, you can postpone the benefit if you spend the reimbursement on restoring the property.
If you spend all the reimbursement on replacement property or on restoring damaged property, you can postpone the entire gain you may have had. If you pay less than the total compensation, you will have to report the unspent amount as a gain.
You must purchase the replacement property for the specific purpose of replacing the property that was destroyed or stolen. You do not necessarily have to use the same funds you received as reimbursement. You could use these funds for another purpose, and borrow money to replace the property and still qualify to postpone the gain.
You effectively postpone the gain by reducing the basis in the replacement property. Any benefit you are delaying gets subtracted from the cost of the replacement property, and you would therefore generally not owe any tax on this gain until you sell or dispose of the replacement property.
The replacement period starts on the date your property was damaged, destroyed, or stolen, and ends two years after the close of the first tax year in which any part of your gain gets realized (generally the year in which you receive the insurance or other reimbursements).
If your loss was your main home and the casualty occurred in an area declared a disaster area by the President, the replacement period gets extended to four years after the first tax year in which you realized any gain.
How to Postpone a Gain
You postpone a gain by attaching a statement to your tax return for the year in which you have a benefit, indicating that you choose to delay it. This statement should show:
- date and details of the casualty or theft
- insurance or other reimbursements you received
- how you calculated the gain
If you acquire replacement property before you file your return, this statement should also include detailed information about:
- the replacement property
- the postponed gain
- the basis adjustment in the replacement property that reflects the delayed gain
- any gain you are reporting as income.
If you have not yet acquired replacement property by the time you file your return, the statement should indicate your intention of obtaining replacement property within the period allowed.