Casualty Loss

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Reviewed by :

Personal casualty loss refers to a type of tax-deductible loss that can be caused due to any damage or destruction to a taxpayer’s property. Such a loss must be unforeseen, unusual, and so sudden that the individual could have done nothing in their power to avoid it.

It is also necessary that one has not received full insurance coverage on the property. All federally declared disasters qualify for a casualty loss. However, depreciation or gradual deterioration does not count. Further, there should be the sustenance of loss during the particular taxable year to be eligible for deductions.

What Is a Casualty Loss?

Casualty loss refers to property loss resulting from unforeseen, unusual, and sudden events.
Such a loss is eligible for tax deductions if the taxpayer does not get complete coverage and sustains the losses in the taxable year.
A deductible casualty loss is subject to specific rules and complex calculations. However, by following the correct procedure, taxpayers can avail of some benefits, especially if the insurance does not fully cover the losses and the net value exceeds 10% of the adjusted gross income.

Casualty Loss On Rental Property Explained

A casualty loss is specified by Section 165 of the United States Code under Title 26 A. In addition, the Internal Revenue Service (IRS) clearly outlines the requirements and circumstances under which taxpayers become eligible for a tax deduction based on casualty or theft losses.

There are three types of IRS casualty loss – federal, disaster, and qualified disaster losses. Federal loss applies if the taxpayer and their property belong to the state receiving a federal disaster declaration and there was subsequent property damage.

A disaster loss can be claimed when the taxpayer belongs to an area (county) eligible for tax assistance following a federal disaster declaration. It is applicable for personal and business properties. A qualified disaster is a major natural calamity, a large-scale one, declared by the government; for example, Hurricane Harvey.

How To Claim?

Let us look at the steps involved in claiming the casualty loss:

1. Tax Deduction

Taxpayers should first report their losses in IRS Form 4684. This form is specially designed to report casualty and theft losses. Then, they can claim their losses as an itemized deduction (that help reduce the net tax) on Schedule A (Form 1040). It is not mandatory to itemize the loss. However, it can help increase the net deductions. After this, the taxpayer can fill up form 1040-X to determine the refund.

The deductions claim will be in strict compliance with the $100 rule and the 10% rule of the IRS. According to the $100 rule, taxpayers should deduct $100 from each casualty loss event in the taxable year. The 10% rule, on the other hand, states that 10% of a taxpayer’s adjusted gross income (AGI) should be deducted from the total loss.

The taxpayer should show proof of loss while claiming deductions. They should first show that they are the legal owner of the property, the casualty was an unforeseen one and out of the owner’s control, and that the loss to a property directly arose from the casualty. They should also show if there is another means of reimbursement (insurance, etc.) which can provide a reasonable recovery.

2. Calculation

The following steps can help calculate the net deduction:

Step 1: First, determine the amount of casualty loss. If there are multiple events, determine the individual amounts.
Step 2: Deduct $100 from each amount and add the resulting values. Let’s call the sum ‘V.’
Step 3: Now, calculate the adjusted gross income.
Step 4: Determine 10% of the AGI. Call this value ‘X.’
Step 5: Next, subtract X from V. This is the deduction amount.

Points To Remember

The loss should be reported as the total casualty loss due to an event. The $100 deduction should be made to the total loss from an event and not to each property destroyed.
For qualified disaster losses, a $500 deduction should be made instead of the $100 deduction.
Qualified disaster losses are not subject to the 10% rule.
If there are multiple property owners, they can use each file separately. However, married couples filing a joint return should only deduct the loss for a single person. If they file separate returns, each can claim deductions.

Examples of Casualty Loss

Let’s discuss a few examples of a casualty loss.

Example #1

Steve lives in California. In 2018, his house was destroyed in the Camp Fire on November 9. His car was also lost to the fires that year. Later that year, in December, his wife Dana’s car was totaled when it was parked on the side of the road, and another car collided with it. Thus, the couple decided to claim joint tax deductions that year. Let’s see how it went.

House = $120,000
Insurance coverage = $100,000
Steve’s car = $3000
Insurance on Steve’s car = $2000
Dana’s car = $8000
Insurance on Dana’s car = $7500
Adjusted gross income of the couple = $ 70,000
Loss from Event 1 = $123,000
Insurance reimbursement = $102,000
Total loss = $21,000
Applying the $100 rule, Claim $20,900

The 10% rule doesn’t apply to the 2018 Camp Fire as it is a qualified disaster.

Therefore, deductions from Event 1 loss = $20,900

Loss from Event 2 = $8000
Insurance reimbursement = $7500
Total loss = $500
Applying the $100 rule, claim $400
Further applying the 10% rule,
10% of AGI = $7000

Since a net loss of $400 is less than 10% of the AGI, Steve cannot claim the deduction.

However, the loss of Dana’s car became eligible for deductions in the first place since it was not Dana’s fault, and the car was parked.

Example #2

Winter home fires are common in many U.S. states, especially in December, January, and February. However, casualty losses cannot be claimed on home fires and subsequent property losses. The only reimbursement is the home insurance coverage. But until 2017, it was possible to claim some tax relief. In 2017, the government decided to provide deductions for personal property losses due to federally declared disasters. The move came after 72,323 claims of casualty and theft losses were made in 2015. The limitation was initiated on January 2018 and is likely to expire in 2025.

Limitations

IRS casualty loss is subject to the following limitations to deduction:

Probably the most constraining limitation is the exception of damage to property from non-federal disasters. In such a case, the maximum insurance coverage will be helpful. However, the limitation is set to expire in 2025. Also, a personal casualty loss on deposits can be deducted, which can be favorable.
The taxpayer will have no deduction if the net loss value after the subsequent deductions is less than 10% of the AGI. Hence, if a person sustains a loss of $1000 but they have an AGI of $11000, they will not receive any deductions.
Deductible losses that are recovered later should be included as income in the year of recovery.

Frequently Asked Questions (FAQs)

1. Are insurance proceeds from a casualty loss taxable?

No. Generally, insurance proceeds from any event, not just deductible casualty loss, are not taxable. Again, it is because insurance proceeds are not considered income.

2. Are casualty losses deductible?

Yes. Casualty and theft losses are deductible. However, there are some prerequisites. Firstly, the casualty should be sudden and unforeseen. It should not be caused due to progressive decline. And the insurance coverage should not realize the full losses.

3. How to claim a casualty loss on taxes?

First, the taxpayer has to report their losses on Form 4684. Then, they have to file Form 1040. Itemizing deductions can be advantageous to taxpayers. They have to input the amount of loss and insurance coverage and apply the $100 rule and 10% rule while determining the deduction. Finally, they can file Form 1040-X to determine their tax refund. They will also have to submit proof of loss.