Casualty Losses & the IRS
© by Greta P. Hicks, CPA
The Internal Revenue Code is filled with general rules, exceptions,
and sometimes requires detail beyond the convenient. The IRS definition
of a casualty loss is a sudden, unexpected, or unusual event, such as flood,
fire, tornado, earth quake, or hurricane. If your records meet all the
general rules and exceptions, you may have a deductible loss on your federal
income tax return.
In determining your deductible casualty loss, two basic problems
- How much is deductible?
- When is it deductible?
The general rule for year deductible, is that the loss is a deduction
in the year of the casualty, however, there is an exception for a casualty
loss suffered in an area determine by the President of the United States
to warrant assistance by the federal government under the Disaster Relief
and Emergency Assistance Act. Instead of claiming the loss in the casualty
year, the loss may be claimed in the year immediately preceding the year
in which the casualty occurred. The benefit to you is that you receive
any accompanying tax refunds a year earlier which will provide you additional
funds to re-build after the casualty.
The amount of the deductible casualty loss depends upon whether your
suffered a total or partial loss.
Total loss of business property. If
your business property is completely destroyed (becomes totally worthless),
your deductible loss is the adjusted basis of the property (cost less depreciation
taken), minus any salvage value and any insurance or other reimbursement
you receive or expect.
Partial loss of business property. In
a partial destruction, the deductible loss is the decrease in fair market
value of the property or the adjusted basis of the property, which ever
is less. Reduce this amount by any insurance or other reimbursement you
receive or expect.
Tax Treatment Of Selected Items
Related Expenses. The related expenses
you have due to a casualty or theft, such as for the treatment of personal
injures, temporary house, or a rental car, are not deductible as casualty
or theft losses. However, they may be deductible as business expenses.
Disaster unemployment pay. Disaster
unemployment assistance payments are taxable unemployment benefits.
Income or Loss. A loss of future profits
is not deductible.
Insurance and other reimbursements.
If you receive insurance or another type of reimbursement for your loss,
subtract it from the loss when you figure your deduction. You cannot deduct
the reimbursement part of a casualty or theft.
Grants. Do not include grants you receive
under the Disaster Relief Act in your gross income. Also, do not deduct
a casualty loss or medical expense with the grant specifically reimburses
Lump-sum reimbursement. If you have
a casualty or theft loss of several assets a the same time, divide the
lump sum reimbursement amount the assets according to the fair market value
of each at the time of the loss. Figure the gain or loss separately for
each asset that has a separate basis.
Postponement Of Gain
Do not report the gain on condemned, damaged, destroyed, or stolen
property if you replace the lost property with property that is similar.
Your tax basis for the new property is the same as your basis for the old
You can choose to postpone reporting the gain, if, within a specified
period of time, you purchase:
- Property similar or related in service or use to the lost property,
- A controlling interest (at least 80’s) in a corporation owing such
To postpone all the gain, the cost of your replacement property must
be equal to or more than the amount realized (reimbursement) for your property.
To postpone reporting your gain from condemnation, casualty, or theft,
you must buy replacement property within a specified period of time. The
replacement period for a casualty or theft begins on the date the property
was damaged, destroyed, or stolen. The replacement period ends two years
after the close of the first tax year in which you realize any part of
the gain on the casualty or theft.
Casualty losses are a red flag for an IRS audit and you will need
to produce documents supporting the values, basis, and depreciation. The
IRS auditor is not sympathetic to a "I lost my records" excuse.
They’ve heard it all before . First, you will need to prove that you owned
each and every asset. Secondly, you have to show that each individual asset
was lost or destroyed.
The information you need to support the amount of your loss is very
voluminous and detailed. You should have available the following:
- Contracts or purchase receipts for the original cost basis plus
- Copies of old tax returns complete with detailed depreciation taken
on each asset.
- Fair market value of each asset before the casualty
- Fair market value of each asset after the casualty
- Salvage value of surviving assets.
Records, Records, Records
Protecting your records (accounting, financial, contracts, and computer
data) before a casualty occurs is often overlooked by business owners.
A fireproof filing cabinet or safe on location is preferable to leaving
records in exposed areas. The storing of tape backup of computerize data
off site is advisable.. Documents such as your original purchase receipt
or contract should be preserved for at least three years after you dispose
of the property. As in so many other areas of life, prevention of lost
records is more preferable over discovering too late that accidents do
The success or failure of your casualty loss standing up under an
IRS audit will be determined by the quality and reliability of your records.
Example Of Forms
Forms which you may need to attached to your tax return include:
Form 8824. If you exchange property in a like-kind transaction, you
must file Form 8824 in addition to Schedule D or Form 4797.
Form 4797. A sale, exchange, or involuntary conversion of property
used in your trade or business or held for the production of rents or royalties
sometimes results in either a capital gain or loss, or an ordinary gain
or loss. All or part of any gain from the disposition of such property
may be ordinary gain from depreciation.
Form 4684. Use Form 4684 to figure and report casualty and theft
losses and gains. If you had more than one casualty or theft during the
year, use a separate form for each casualty or theft.
|1. Adjusted basis of building before flood (no land value)
|2. Value before flood
|3. Value after the flood
|4. Decrease in value
|5. Amount of loss (line 1 or line 4, which ever is less)
|6. Minus: Insurance
|7. Loss after reimbursement
A casualty or theft loss of inventory, including items you hold for
sale to customers, is automatically claimed through the increase in the
cost of goods sold by properly reporting your opening and closing inventory.
Do not claim this loss again as a casualty or theft loss.
|1. Value before flood
|2. Value after the flood
|3. Decrease in value
|4. Cost basis
|6. Adjusted basis (book value
|7. Amount of loss (line 1 or line 4, which ever
|8. Minus: Insurance
|9. Loss after reimbursement
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List of Articles by Greta P. Hicks, CPA
GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies
and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing
educational materials and programs on solutions to IRS problems and is
a nationally known speaker and writer on solutions to IRS problems. To
arrange for consultation contact:
Greta's web site: http://www.gretahicks.com
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