Deductions Soothe Casualty Losses

(RIVERWOODS, ILL., January 2009) – As April 15 approaches, thousands of taxpayers can look forward to easing the pain of lost or damaged homes and property with a casualty loss deduction. Others, who suffered damage or loss to their property as a result of last year’s wildfires and floods, may already have received tax refunds that can help offset those losses, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).

There is normally a two-tier hierarchy of tax benefits to assuage losses, according to CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA.

“People who don’t live in presidentially declared disaster areas get help but not the most help or the quickest,” Luscombe noted. “Those in declared disaster areas get more help, quicker. Sometimes, as in the case of last year’s Midwest flooding, Congress authorizes specific additional tax-related breaks.”

The Casualty Loss Deduction

People whose losses aren’t a result of a presidentially declared disaster have to wait until they file their return for the year in which their loss occurred to get tax relief. However, if there is an action for reimbursement against another party, or an insurance claim, the year when the taxpayer can claim the deduction may be postponed.

In the case of non-business property, the deduction is limited to losses arising from theft, fire, storm, shipwreck or other casualty, such as tornadoes, hurricanes, earthquakes and abnormal flooding. In addition, after figuring their total non-business losses, taxpayers have to first subtract $100 and then subtract 10 percent of their adjusted gross income to calculate their allowable deduction. So a taxpayer with $50,000 of adjusted gross income who experienced a single $25,000 casualty loss would be able to claim $19,900. If someone has multiple incidents of loss in a year – say, a flood in April and a tornado in June – the $100 threshold is applied to each incident, while the 10-percent threshold is applied to the total of losses for the year.

“For individuals, this is an itemized deduction, and it will only benefit people whose total itemized deductions are greater than the standard deduction they’re entitled to,” Luscombe said.

Quicker Relief for Disaster Areas

Special rules come into play if losses occur in presidentially declared disaster areas. In this case, a property owner can elect to claim his or her losses in the year immediately before the tax year when the disaster occurs. This allowed taxpayers who suffered losses in last year’s floods and wildfires, for example, to get some quick relief by applying the loss to their 2007 tax bill. By filing an amended return, they had the opportunity to receive a refund of 2007 taxes in 2008.

“People should take a look at their overall tax situation before they decide to claim the loss in one year rather than another,” Luscombe noted. “Their tax bracket and their ability to reduce their adjusted gross income, and thereby increase the potential casualty deduction, are both factors to consider.”

For the 2008 and 2009 tax years, losses in federally declared disaster areas get additional favorable treatment. The losses people can claim are not limited to those in excess of 10 percent of their gross income and they do not have to itemize, adding the losses to their standard deduction, instead. On the other hand, in 2009, only losses in excess of $500 get this favorable treatment.

In addition, taxpayers in a presidentially declared disaster area who receive grants from state programs, charitable organizations or employers to cover medical, transportation or temporary housing expenses do not have to include these grants in gross income. These expenses include:

Personal, family, living or funeral expenses incurred as a result of the disaster;
Expenses incurred for the repair or rehabilitation of a personal residence, or for the repair or replacement of its contents to the extent attributable to the qualified disaster; and
Payments made by a federal, state or local government in connection with the disaster.

Qualified disaster relief payments do not include:

Payments for any expense compensated for by insurance or otherwise;
Payments in the nature of income replacement, such as payments to individuals of lost wages;
Unemployment compensation; and
Payments in the nature of business income replacement.

In addition to presidentially declared disaster areas, this exclusion from income is also available to victims of a disaster caused by terrorist or military action and other disasters as determined by the federal, state or local authority and the IRS.

“Taxpayers who live in areas most often affected by adverse weather – such as tornadoes, earthquakes and hurricanes – should be aware that they have a number of important options under the tax law should disaster strike and a disaster area be declared,” said Luscombe.

Midwestern Disaster Areas Get Special Treatment

Losses as a result of a number of federally declared disasters in the Midwest, primarily flooding, from May 20 to July 31, 2008, received special treatment from Congress. For these losses, both the $100 and 10-percent of gross income limitations were waived, making them fully deductible. But they can only be taken as itemized deductions.

“Congress ended up creating two types of treatment for casualty losses in federally declared disaster areas last year – one for the Midwest disasters and another for everything else,” Luscombe said.

Figuring the Deduction

To qualify for a casualty loss deduction, the taxpayer must prove to the IRS that a loss occurred and that the loss was caused by a casualty. To support a claim, the property owner needs to provide:

Proof of the nature of the casualty, when it occurred and that the loss was a direct result of the casualty;
In the case of depreciable property, the amount of depreciation allowed or allowable;
Proof he or she owns the damaged property or is legally responsible for it;
The fair market value of non-business property just before and after the loss;
A description of the damaged property and its location;
The salvage value of the property;
The cost or other adjusted basis of the property; and
The amount of insurance or other compensation received or expected to be received for property damage. This includes the value of repairs, cleanup and disaster relief provided without cost by agencies or others.

Taxpayers may also use the cost of repairs to the damaged property as evidence of the loss of value if they can prove that:

The repairs are necessary to restore the property to its pre-casualty condition;
The repairs do not cover more than the damage by the casualty;
The amount spent for such repairs is not excessive (estimates from several reputable companies are recommended); and
The repairs do not make the value of the property greater than it was before the loss occurred.

A taxpayer also can claim casualty losses for personal residences rendered unsafe by reason of certain disasters. The following criteria must be met:

The residence must be in a presidentially declared disaster area;
The residence must have been rendered unsafe as a residence because of the disaster; and
The owner is ordered to demolish or relocate the residence by the state or local government 120 days after the “disaster area” has been declared officially.

CCH also urges victims of disasters to consider property damage that is an indirect result of the casualty, such as destruction of doors, windows, plants and shrubbery.

What’s Not Deductible?

The following incidental expenses relating to a casualty are not part of casualty losses:

Treatment of personal injury;
Cleanup costs;
Temporary housing; and
Car rental.

Determining the Value of Property

Valuation of property is of the utmost importance when determining the amount of loss sustained in the casualty. When tax time arrives, taxpayers will need to be prepared to provide their tax preparer with evidence showing the value of the property’s pre-casualty value. Acceptable evidence includes:

Canceled checks, vouchers, receipts, purchase contracts and deeds.
If records have been destroyed, an appraiser’s opinion on the value of the property is needed.

Note that these losses claimed for the destruction of such things as portraits, heirlooms and keepsakes must be related to their market value, not the replacement or sentimental value.

IRS Resources

Taxpayers claiming a casualty loss should get a copy of IRS Publication 547, Casualties, Disasters and Thefts. Also useful is IRS Publication 584, Casualty, Disaster and Theft Loss Workbook for individuals. A similar workbook, Publication 584B, is used to figure the casualty loss for business and income-producing property.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem®, CCH® TeamMate, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com.

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