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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 exist.

  1. How much is deductible?
  2. 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 you.

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 property.

You can choose to postpone reporting the gain, if, within a specified period of time, you purchase:

  1. Property similar or related in service or use to the lost property, or
  2. A controlling interest (at least 80’s) in a corporation owing such property.

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.


The Audit

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:

  1. Contracts or purchase receipts for the original cost basis plus any improvements.
  2. Copies of old tax returns complete with detailed depreciation taken on each asset.
  3. Fair market value of each asset before the casualty
  4. Fair market value of each asset after the casualty
  5. 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 happen..

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


The 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.


Example Buildings

1.  Adjusted basis of building before flood (no land value) $84,933
2.  Value before flood $88,667
3.  Value after the flood $80,000
4.  Decrease in value $8,667
5.  Amount of loss (line 1 or line 4, which ever is less) $8,667
6.  Minus: Insurance $6,000
7.  Loss after reimbursement $2,667


Example Inventory

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.


Example Equipment

1.  Value before flood $15,000
2.  Value after the flood 3,000
3.  Decrease in value $12,000
4.  Cost basis $12,000
5.  Depreciation ( 2,000)
6.  Adjusted basis (book value $10,000
7.  Amount of loss (line 1 or line 4, which ever is less) $10,000
8.  Minus: Insurance -0-
9.  Loss after reimbursement $10,000

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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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