Prior to 2018, taxpayers could take a deduction for personal casualty losses experienced during the tax year. Personal casualty losses are defined as losses of property not connected with a trade or business or in a transaction entered for profit if such losses arise from fire, storms, shipwreck, theft, or other casualties. In determining the deductible amount of the casualty loss, the total loss is reduced by $100 and a deduction for the net casualty loss is allowed only to the extent it exceeds 10% of adjusted gross income. Furthermore, losses are allowable to the extent of the personal casualty gains plus the excess as it exceeds 10% of the adjusted gross income (AGI).
Under the 2017 Tax Cuts and Jobs Act, the personal casualty loss deduction is suspended for taxable years beginning January 1, 2018 through December 31, 2025, in which a deduction will be allowed to the extent the loss is due to a federally declared disaster such as hurricanes, earthquakes, and major wild fires. Personal casualty losses not attributable to a federally declared disaster are still deductible, but only to the extent of personal casualty gains.
For disaster losses, taxpayers may elect to claim the loss deduction in the tax year immediately preceding the taxable year in which the disaster occurred. The amount of loss that is considered in the preceding taxable year cannot exceed the uncompensated amount determined at the date the taxpayer claims the loss. A casualty loss deduction may create or increase a net operating loss for the taxable year in which it is taken.
Considering recent major disasters, Congress provided special relief in the Disaster Tax Relief Act of 2017 for individuals with casualty losses that occurred from hurricanes Harvey, Irma, and Maria. The result of this act increased the $100 floor per casualty loss to $500 and the requirement to reduce the net casualty loss deduction by 10% of AGI was waived. A taxpayer’s standard deduction is increased for the net casualty loss resulting from hurricanes Harvey, Irma, or Maria disaster areas. Due to this increase in the standard deduction, a taxpayer may realize a greater benefit by taking the standard deduction versus itemizing.
It can be challenging to determine the amount of a casualty loss since records are often destroyed in a disaster and existing records may be hard to locate. In many cases, the amount of the casualty loss can be documented by reporting the total repair costs, but only if those repairs have actually been made. The Internal Revenue Service (IRS) recently issued two Revenue Procedures which contain safe harbors to help taxpayers in determining the amount of deductible casualty losses. A taxpayer may choose to use a safe-harbor method or compute the actual loss. A safe-harbor method simplifies the computing of a loss deduction. Rev. Proc. 2018-08 provides five different safe-harbor methods for a loss of “personal-use residential real property.” Rev. Proc. 2018-09 was created by the IRS due to the extensive hurricanes that occurred during 2017 and includes seven additional safe-harbor methods available for computing casualty losses in the “2017 disaster area.” These safe harbors only apply to losses from hurricanes Harvey, Irma, and Maria.
Personal casualty losses are unfortunate and determining the rules and regulations for properly deducting a casualty loss can be complicated.