Casualties, Thefts, and Condemnations

Important Reminders

Postponed tax deadlines in disaster areas.   The maximum period of time for which the IRS may postpone certain tax deadlines of taxpayers who are affected by a Presidentially declared disaster is increased from 120 days to 1 year. The tax deadlines the IRS may postpone include those for filing income and employment tax returns, paying income and employment taxes, and making contributions to a traditional IRA or Roth IRA. For more information, see Postponed tax deadlines, later, under Disaster Area Losses.

Qualified disaster relief payments.   Qualified disaster relief payments received in tax years ending after September 10, 2001, by an individual for certain expenses incurred because of a Presidentially declared disaster are not included in income. For more information, see Qualified disaster relief payments, later, under Disaster Area Losses.

Introduction

This chapter explains the tax treatment of casualties, thefts, and condemnations. A casualty occurs when property is damaged, destroyed, or lost due to a sudden, unexpected, or unusual event. A theft occurs when property is stolen. A condemnation occurs when private property is legally taken for public use without the owner's consent. A casualty, theft, or condemnation may result in a deductible loss or taxable gain on your federal income tax return. You may have a deductible loss or a taxable gain even if only a portion of your property was affected by a casualty, theft, or condemnation.

An involuntary conversion occurs when you receive money or other property as reimbursement for a casualty, theft, condemnation, disposition of property under threat of condemnation, or certain other events discussed in this chapter.

If an involuntary conversion results in a gain and you buy qualified replacement property within the specified replacement period, you can postpone reporting the gain on your income tax return. For more information, see Postponing Gain, later.

Topics

This chapter discusses:

• Casualties and thefts
• How to figure a loss or gain
• Other involuntary conversions
• Postponing gain
• Disaster area losses
• Reporting gains and losses

Useful Items You may want to see:

Publication

• 536   Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
• 544   Sales and Other Dispositions of Assets
• 547   Casualties, Disasters, and Thefts
• 584   Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)
• 584-B   Business Casualty, Disaster, and Theft Loss Workbook

Form (and Instructions)

• Sch A (Form 1040)   Itemized
  Deductions
• Sch D (Form 1040)   Capital Gains and Losses
• Sch F (Form 1040)   Profit or Loss From Farming
• 4684   Casualties and Thefts
• 4797   Sales of Business Property

See chapter 21 for information about getting publications and forms.

Casualties and Thefts

If your property is destroyed, damaged, or stolen, you may have a deductible loss. If the insurance or other reimbursement is more than the adjusted basis of the destroyed, damaged, or stolen property, you may have a taxable gain.

Casualty.   A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

Deductible losses.   Deductible casualty losses can result from a number of different causes, including the following.

• Airplane crashes.
• Car or truck accidents not resulting from your willful act or willful negligence.
• Earthquakes.
• Fires (but see Nondeductible losses, next, for exceptions).
• Floods.
• Freezing.
• Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster as discussed under Disaster Area Losses, in Publication 547.
• Lightning.
• Storms, including hurricanes and tornadoes.

Nondeductible losses.   A casualty loss is not deductible if the damage or destruction is caused by the following.

• Accidentally breaking articles such as glassware or china under normal conditions.
• A family pet.
• A fire if you willfully set it, or pay someone else to set it.
• A car or truck accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone acting for you caused the accident.
• Progressive deterioration (explained next).

Progressive deterioration.   Loss of property due to progressive deterioration is not deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. Examples of damage due to progressive deterioration include damage from rust, corrosion, or termites. However, weather-related conditions or disease may cause another type of involuntary conversion. See Other Involuntary Conversions, later.

Theft.   A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the law of the state where it occurred and it must have been done with criminal intent.

Theft includes the taking of money or property by the following means.

• Blackmail.
• Burglary.
• Embezzlement.
• Extortion.
• Kidnapping for ransom.
• Larceny.
• Robbery.
• Threats.

The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.

Mislaid or lost property.   The simple disappearance of money or property is not a theft. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual.

Example.   A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.

Farming Losses

You can deduct certain casualty or theft losses that occur in the business of farming. The following is a discussion of some losses you can deduct and some you cannot deduct.

Livestock or produce purchased for sale.   Casualty or theft losses of livestock or produce bought for sale are deductible if you report your income on the cash method. If you report your income on an accrual method, take casualty and theft losses on property bought for sale by omitting the item from the closing inventory for the year of the loss. You cannot take a separate deduction.

Livestock, plants, produce, and crops raised for sale.   Losses of livestock, plants, produce, and crops raised for sale are generally not deductible if you report your income on the cash method. You have already deducted the cost of raising these items as farm expenses.

For plants with a preproductive period of more than 2 years, you may have a deductible loss if you have a tax basis in the plants. You usually have a tax basis if you capitalized the expenses associated with these plants under the uniform capitalization rules. The uniform capitalization rules are discussed in chapter 7.

If you report your income on an accrual method, casualty or theft losses are deductible only if you included the items in your inventory at the beginning of your tax year. You get the deduction by omitting the item from your inventory at the close of your tax year. You cannot take a separate casualty or theft deduction.

Income loss.   A loss of future income is not deductible.

Example.   A severe flood destroyed your crops. Because you are a cash method taxpayer and already deducted the cost of raising the crops as farm expenses, this loss is not deductible, as explained earlier under Livestock, plants, produce, and crops raised for sale. You estimate that the crop loss will reduce your farm income by $25,000. This loss of future income is also not deductible.

Loss of timber.   If you sell timber downed as a result of a casualty, treat the proceeds from the sale as a reimbursement. If you use the proceeds to buy qualified replacement property, you can postpone reporting the gain. See Postponing Gain, later.

Property used in farming.   Casualty and theft losses of property used in your farm business usually result in deductible losses. If a fire or storm destroyed your barn, or you lose by casualty or theft an animal you bought for draft, breeding, dairy, or sport, you may have a deductible loss. See How To Figure a Loss, later.

Raised draft, breeding, dairy, or sporting animals.   Generally, losses of raised, draft, breeding, dairy, or sporting animals do not result in deductible casualty or theft losses because you have no basis in the animals. However, you may be able to claim a deduction if either of the following situations applies to you.

• You use inventories to determine your income and you included the animals in your inventory.
• You capitalized the expenses associated with the animals under the uniform capitalization rules and therefore have a tax basis in the animals subject to a casualty or theft.

When you include livestock in inventory, its last inventory value is its basis. When you lose an inventoried animal held for draft, breeding, dairy, or sport by casualty or theft during the year, decrease ending inventory by the amount you included in inventory for the animal. You cannot take a separate deduction.

How To Figure a Loss

How you figure a deductible casualty or theft loss depends on whether the loss was to farm or personal-use property and whether the property was stolen or partly or completely destroyed.

Farm property.   Farm property is the property you use in your farming business. If your farm property was completely destroyed or stolen, your loss is figured as follows:

Your adjusted basis in the property

MINUS

Any salvage value

MINUS

Any insurance or other reimbursement you receive or expect to receive

You can use the schedules in Publication 584-B to list your stolen, damaged, or destroyed business property and to figure your loss.

If your farm property was partially damaged, use the steps shown under Personal-use property, next, to figure your casualty loss. However, the deduction limits, discussed later, do not apply.

Personal-use property.   Personal-use property is property used by you or your family members for personal use. You figure the casualty or theft loss on this property by taking the following steps.

1. Determine your adjusted basis in the property before the casualty or theft.
2. Determine the decrease in fair market value of the property as a result of the casualty or theft.
3. From the smaller of the amounts you determined in (1) and (2), subtract any insurance or other reimbursement you receive or expect to receive.

You must apply the deduction limits, discussed later, to determine your deductible loss.

You can use Publication 584 to list your stolen or damaged personal-use property and figure your loss. It includes schedules to help you figure the loss on your home, its contents, and your motor vehicles.

Adjusted basis.   Adjusted basis is your basis (usually cost) increased or decreased by various events, such as improvements and casualty losses. For more information about adjusted basis, see chapter 7.

Decrease in fair market value (FMV).   The decrease in FMV is the difference between the property's value immediately before the casualty or theft and its value immediately afterwards. FMV is defined in chapter 12 under Payments Received.

Appraisal.   To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. But other measures, such as the cost of cleaning up or making repairs (discussed next) can be used to establish decreases in FMV.

An appraisal to determine the difference between the FMV of the property immediately before a casualty or theft and immediately afterwards should be made by a competent appraiser. The appraiser must recognize the effects of any general market decline that may occur along with the casualty. This information is needed to limit any deduction to the actual loss resulting from damage to the property.

Cost of cleaning up or making repairs.   The cost of cleaning up after a casualty is not part of a casualty loss. Neither is the cost of repairing damaged property after a casualty. But you can use the cost of cleaning up or making repairs after a casualty as a measure of the decrease in FMV if you meet all the following conditions.

• The repairs are actually made.
• The repairs are necessary to bring the property back to its condition before the casualty.
• The amount spent for repairs is not excessive.
• The repairs fix the damage only.
• The value of the property after the repairs is not, due to the repairs, more than the value of the property before the casualty.

Related expenses.   The incidental expenses due to a casualty or theft, such as expenses for the treatment of personal injuries, temporary housing, or a rental car, are not part of your casualty or theft loss. However, they may be deductible as farm business expenses if the damaged or stolen property is farm property.

Separate computations for more than one item of property.   Generally, if a single casualty or theft involves more than one item of property, you must figure your loss separately for each item of property. Then combine the losses to determine your total loss.

There is an exception to this rule for personal-use real property. See Exception for personal-use real property, later.

Example.   A fire on your farm damaged a tractor and the barn in which it was stored. The tractor had an adjusted basis of $3,300. Its FMV was $28,000 just before the fire and $10,000 immediately afterward. The barn had an adjusted basis of $28,000. Its FMV was $55,000 just before the fire and $25,000 immediately afterward. You received insurance reimbursements of $2,100 on the tractor and $26,000 on the barn. Figure your deductible casualty loss separately for the two items of property.

		Tractor	Barn
1)	Adjusted basis	$3,300	$28,000
2)	FMV before fire	$28,000	$55,000
3)	FMV after fire	10,000	25,000
4)	Decrease in FMV (line 2 - line 3)	$18,000	$30,000
5)	Loss (lesser of line 1 or line 4)	$3,300	$28,000
6)	Minus: Insurance	2,100	26,000
7)	Deductible casualty loss	$1,200	$2,000
8)	Total deductible casualty loss		$3,200

Exception for personal-use real property.   In figuring a casualty loss on personal-use real property, the entire property (including any improvements, such as buildings, trees, and shrubs) is treated as one item. Figure the loss using the smaller of the following.

• The decrease in FMV of the entire property.
• The adjusted basis of the entire property.

Example.   You bought a farm in 1960 for $20,000. The adjusted basis of the residential part is $16,000. In 2002, a windstorm blew down shade trees and three ornamental trees planted at a cost of $600 on the residential part. The adjusted basis of the residential part includes the $600. The fair market value (FMV) of the residential part immediately before the storm was $130,000, and $126,000 immediately after the storm. The trees were not covered by insurance.

1)	Adjusted basis	$16,000
2)	FMV before the storm	$130,000
3)	FMV after the storm	126,000
4)	Decrease in FMV (line 2 - line 3)	$4,000
5)	Loss before insurance (lesser of line 1 or line 4)	$4,000
6)	Minus: Insurance	-0-
7)	Amount of loss	$4,000

Insurance and other reimbursements.   If you receive an insurance or other type of reimbursement, you must subtract the reimbursement when you figure your loss. You do not have a casualty or theft loss to the extent you are reimbursed.

If you expect to be reimbursed for part or all of your loss, you must subtract the expected reimbursement when you figure your loss. You must reduce your loss even if you do not receive payment until a later tax year.

Do not subtract from your loss any insurance payments you receive for living expenses if you lose the use of your main home or are denied access to it because of a casualty. You may have to include a portion of these payments in your income. See Publication 547 for details.

Disaster relief.   Food, medical supplies, and other forms of assistance you receive do not reduce your casualty loss, unless they are replacements for lost or destroyed property. Excludable cash gifts you receive also do not reduce your casualty loss if there are no limits on how you can use the money.

Qualified disaster relief payments you receive in tax years ending after September 10, 2001, for expenses you incurred as a result of a Presidentially declared disaster, are not taxable income to you. See Qualified disaster relief payments, later, under Disaster Area Losses.

Reimbursement received after deducting loss.   If you figure your casualty or theft loss using your expected reimbursement, you may have to adjust your tax return for the tax year in which you get your actual reimbursement.

Actual reimbursement less than expected.   If you later receive less reimbursement than you expected, include that difference as a loss with your other losses (if any) on your return for the year in which you can reasonably expect no more reimbursement.

Actual reimbursement more than expected.   If you later receive more reimbursement than you expected after you have claimed a deduction for the loss, you may have to include the extra reimbursement in your income for the year you receive it. However, if any part of your original deduction did not reduce your tax for the earlier year, do not include that part of the reimbursement in your income. Do not refigure your tax for the year you claimed the deduction. See Recoveries in Publication 525, Taxable and Nontaxable Income, to find out how much extra reimbursement to include in income.

If the total of all the reimbursements you receive is more than your adjusted basis in the destroyed or stolen property, you will have a gain on the casualty or theft. See Publication 547 for information on how to treat a gain from the reimbursement you receive because of a casualty or theft.

Actual reimbursement same as expected.   If you receive exactly the reimbursement you expected to receive, you do not have to include any amount in your income or deduct any loss.

Lump-sum reimbursement.   If you have a casualty or theft loss of several assets at the same time without an allocation of reimbursement to specific assets, divide the lump-sum reimbursement among the assets according to the fair market value of each asset at the time of the loss. Figure the gain or loss separately for each asset that has a separate basis.

Adjustments to basis.   If you have a casualty or theft loss, you must decrease your basis in the property by any insurance or other reimbursement you receive and by any deductible loss. The result is your adjusted basis in the property. Amounts you spend to restore your property after a casualty increase your adjusted basis. See Adjusted Basis in chapter 7 for more information.

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