Today’s post is about the casualty loss deduction specific to individual taxpayers (not businesses) and how it works. Typical situations involve an expensive set of golf clubs getting stolen out of the back of a car or damage sustained from an event such as a tornado. When these things happen and the taxpayer isn’t reimbursed by insurance this is called a casualty loss.
The Internal Revenue Service (IRS) has the following definition for a casualty loss: Damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. The key thing to remember here is the event has to be sudden – not gradual. Termite damage is a common example. Termite damage can result in a big loss and taxpayers try to deduct it, only to have the IRS challenge the deduction because in the IRS’s eyes, termite damage is not a ‘sudden’ event. So in that fact pattern, generally taxpayers lose and the deduction gets thrown out.
Starting in 2018, when the new Trump tax law took effect, the casualty loss deduction is restricted to losses sustained in a presidentially declared disaster area. On May 28th areas around Lawrence, Eudora, Linwood, and Bonner Springs sustained damage due to a massive tornado.
On June 20th the President approved a Kansas Disaster Declaration. See the press release here: https://www.fema.gov/news-release/2019/06/21/president-donald-j-trump-approves-major-disaster-declaration-kansas. The tornado, among other very recent weather events, resulted in personal property damage. Damage sustained from any of these events is eligible for a casualty loss tax deduction.
Example 1: The taxpayer incurred damage from a tornado in 2018. The taxpayer’s house was just purchased for $250,000. The next day, before any personal effects were moved in, a tornado destroyed the house. The insurance company only reimbursed the taxpayer $220,000. This resulted in a $30,000 loss. The area was not declared a federal disaster area. The taxpayer is not eligible for any tax loss deduction.
Example 2: Assume the same facts except the area was declared a federal disaster area. In this case the $30k the taxpayer is out would be eligible for a tax deduction because of the declaration. Here’s the calculation:
$30,000 - Loss
($100) - Casualty loss floor per loss occurrence
($7,000) - 10% AGI limitation (this is 10% of your Adjusted Gross Income, assume AGI is $70,000)
$22,900 - Casualty loss deduction on 2019 tax return – Schedule A
Additionally, the tax code allows taxpayers the option to deduct the casualty loss in the prior year by amending the prior year return (2017 in the example). By deducting the loss in the prior year it gets cash in the taxpayer’s hands more quickly than waiting to file the current year’s return.
What about the golf clubs? Again, all casualty and theft losses are not deductible unless they occur in a presidentially declared disaster area. So if the clubs were destroyed in the tornado or were stolen in the declared disaster area the loss would then be deductible.
In conclusion, these sorts of events are rare but they do happen. Although congress has limited casualty losses to presidentially declared disaster areas, they are a last a remedy when the insurance company does not make the taxpayer whole after a catastrophic event. Message me with any questions.