| Publication 225, Farmer's Tax Guide |
2006 Tax Year |
11.
Casualties, Thefts, and Condemnations
This is archived information that pertains only to the 2006 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
Limits on personal casualty or theft losses caused by Hurricanes Katrina, Rita, or Wilma. The following losses to personal-use property are not subject to the $100 rule or 10% rule. For more information, see Deduction Limits on
Losses of Personal-Use Property, later.
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Losses that arose in the Hurricane Katrina disaster area after August 24, 2005, and that were caused by Hurricane Katrina.
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Losses that arose in the Hurricane Rita disaster area after September 22, 2005, and that were caused by Hurricane Rita.
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Losses that arose in the Hurricane Wilma disaster area after October 22, 2005, and that were caused by Hurricane Wilma.
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:
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Casualties and thefts
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How to figure a loss or gain
-
Other involuntary conversions
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Postponing gain
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Disaster area losses
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Reporting gains and losses
Useful Items - You may want to see:
Publication
-
523
Selling Your Home
-
525
Taxable and Nontaxable Income
-
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 17 for information about getting publications and forms.
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.
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Airplane crashes.
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Car, truck, or farm equipment accidents not resulting from your willful act or willful negligence.
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Earthquakes.
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Fires (but see Nondeductible losses, next, for exceptions).
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Floods.
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Freezing.
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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.
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Lightning.
-
Storms, including hurricanes and tornadoes.
Nondeductible losses.
A casualty loss is not deductible if the damage or destruction is caused by the following.
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Accidentally breaking articles such as glassware or china under normal conditions.
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A family pet (explained below).
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A fire if you willfully set it, or pay someone else to set it.
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A car, truck, or farm equipment 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 below).
Family pet.
Loss of property due to damage by a family pet is not deductible as a casualty loss unless the requirements discussed
earlier under
Casualty are met.
Example.
The ornamental fruit trees in your yard were damaged when your horse stripped the bark from them. Some of the trees were completely
girdled and
died. Because the damage was not unexpected and unusual, the loss is not deductible.
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.
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Blackmail.
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Burglary.
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Embezzlement.
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Extortion.
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Kidnapping for ransom.
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Larceny.
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Robbery.
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Threats.
The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.
Decline in market value of stock.
You cannot deduct as a theft loss the decline in market value of stock acquired on the open market for investment
if the decline is caused by
disclosure of accounting fraud or other illegal misconduct by the officers or directors of the corporation that issued the
stock. However, you can
deduct as a capital loss the loss you sustain when you sell or exchange the stock or the stock becomes completely worthless.
You report a capital loss
on Schedule D (Form 1040). For more information about stock sales, worthless stock, and capital losses, see chapter 4 of Publication
550.
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.
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 bought for resale.
Casualty or theft losses of livestock or produce bought for resale 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 resale 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 6.
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 have a basis in the animal and therefore may be able to claim a deduction if either
of the following situations
applies to you.
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You use inventories to determine your income and you included the animals in your inventory.
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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 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.
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Determine your adjusted basis in the property before the casualty or theft.
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Determine the decrease in fair market value of the property as a result of the casualty or theft.
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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 6.
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 afterward.
FMV is defined in chapter 10 under Payments Received or Considered 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 afterward 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.
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The repairs are actually made.
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The repairs are necessary to bring the property back to its condition before the casualty.
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The amount spent for repairs is not excessive.
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The repairs fix the damage only.
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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)
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FMV after fire
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10,000
|
25,000
|
|
4)
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Decrease in FMV
(line 2 - line 3)
|
$18,000
|
$30,000
|
|
5)
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Loss (lesser of line 1 or line 4)
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$3,300
|
$28,000
|
|
6)
|
Minus: Insurance
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2,100
|
26,000
|
|
7)
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Deductible casualty loss
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$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.
Example.
You bought a farm in 1960 for $20,000. The adjusted basis of the residential part is now $16,000. In 2006, 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.
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.
Generally, disaster relief grants received under the Disaster Relief and Emergency Assistance Act are not included
in your income. See
Disaster relief grants, later, under Disaster Area Losses.
Qualified disaster relief payments 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 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 of the reimbursement
in your income and you cannot
deduct any additional 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 6 for more information.
Deduction Limits on Losses of Personal-Use Property
The $100 and 10% rules (defined below) do not apply if your loss arose in the Hurricane Katrina disaster area after August
24, 2005, the Hurricane
Rita disaster area after September 22, 2005, or the Hurricane Wilma disaster area after October 22, 2005, and your loss was
caused by that hurricane.
Casualty and theft losses of property held for personal use may be deductible if you itemize deductions on Schedule A (Form
1040).
There are two limits on the deduction for casualty or theft loss of personal-use property. You figure these limits on Form
4684.
$100 rule.
You must reduce each casualty or theft loss on personal-use property by $100. This rule applies after you have subtracted
any reimbursement.
10% rule.
You must further reduce the total of all your casualty or theft losses on personal-use property by 10% of your adjusted
gross income. Apply this
rule after you reduce each loss by $100. Adjusted gross income is on line 38 of Form 1040.
Example.
In June, you discovered that your house had been burglarized. Your loss after insurance reimbursement was $2,000. Your adjusted
gross income for
the year you discovered the burglary is $57,000. Figure your theft loss deduction as follows:
You do not have a theft loss deduction because your loss ($1,900) is less than 10% of your adjusted gross income ($5,700).
If you have a casualty or theft gain in addition to a loss, you will have to make a special computation before you figure
your 10% limit. See
10% Rule in Publication 547.
Generally, you can deduct casualty losses that are not reimbursable only in the tax year in which they occur. You generally
can deduct theft losses
that are not reimbursable only in the year you discover your property was stolen. However, losses in Presidentially declared
disaster areas are
subject to different rules. See Disaster Area Losses, later, for an exception.
If you are not sure whether part of your casualty or theft loss will be reimbursed, do not deduct that part until the tax
year when you become
reasonably certain that it will not be reimbursed.
Leased property.
If you lease property from someone else, you can deduct a loss on the property in the year your liability for the
loss is fixed. This is true even
if the loss occurred or the liability was paid in a different year. You are not entitled to a deduction until your liability
under the lease can be
determined with reasonable accuracy. Your liability can be determined when a claim for recovery is settled, adjudicated, or
abandoned.
Example.
Robert leased a tractor from First Implement, Inc., for use in his farm business. The tractor was destroyed by a tornado in
June 2006. The loss was
not insured. First Implement billed Robert for the fair market value of the tractor on the date of the loss. Robert disagreed
with the bill and
refused to pay it. First Implement later filed suit in court against Robert. In 2007, Robert and First Implement agreed to
settle the suit for
$20,000, and the court entered a judgment in favor of First Implement. Robert paid $20,000 in June 2007. He can claim the
$20,000 as a loss on his
2007 tax return.
Net operating loss (NOL).
If your deductions, including casualty or theft loss deductions, are more than your income for the year, you may have
an NOL. An NOL can be carried
back or carried forward and deducted from income in other years. See Publication 536 for more information on NOLs.
To deduct a casualty or theft loss, you must be able to prove that there was a casualty or theft. You must have records to
support the amount you
claim for the loss.
Casualty loss proof.
For a casualty loss, your records should show all the following information.
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The type of casualty (car accident, fire, storm, etc.) and when it occurred.
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That the loss was a direct result of the casualty.
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That you were the owner of the property or, if you leased the property from someone else, that you were contractually liable
to the owner
for the damage.
-
Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
Theft loss proof.
For a theft loss, your records should show all the following information.
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When you discovered your property was missing.
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That your property was stolen.
-
That you were the owner of the property.
-
Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
A casualty or theft may result in a taxable gain. If you receive an insurance payment or other reimbursement that is more
than your adjusted basis
in the destroyed, damaged, or stolen property, you have a gain from the casualty or theft. You generally report your gain
as income in the year you
receive the reimbursement. However, depending on the type of property you receive, you may not have to report your gain. See
Postponing Gain,
later.
Your gain is figured as follows:
-
The amount you receive, minus
-
Your adjusted basis in the property at the time of the casualty or theft.
Even if the decrease in FMV of your property is smaller than the adjusted basis of your property, use your adjusted basis
to figure the gain.
Amount you receive.
The amount you receive includes any money plus the value of any property you receive, minus any expenses you have
in obtaining reimbursement. It
also includes any reimbursement used to pay off a mortgage or other lien on the damaged, destroyed, or stolen property.
Example.
A tornado severely damaged your barn. The adjusted basis of the barn was $25,000. Your insurance company reimbursed you $40,000
for the damaged
barn. However, you had legal expenses of $2,000 to collect that insurance. Your insurance minus your expenses to collect the
insurance is more than
your adjusted basis in the barn, so you have a gain.
Other Involuntary Conversions
In addition to casualties and thefts, other events cause involuntary conversions of property. Some of these are discussed
in the following
paragraphs.
Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes. You report the gain or
deduct the loss on your
tax return for the year you realize it. However, depending on the type of property you receive, you may not have to report
your gain on the
involuntary conversion. See Postponing Gain, later.
Condemnation is the process by which private property is legally taken for public use without the owner's consent. The property
may be taken by the
federal government, a state government, a political subdivision, or a private organization that has the power to legally take
property. The owner
receives a condemnation award (money or property) in exchange for the property taken. A condemnation is a forced sale, the
owner being the seller and
the condemning authority being the buyer.
Threat of condemnation.
Treat the sale of your property under threat of condemnation as a condemnation, provided you have reasonable grounds
to believe that your property
will be condemned.
Main home condemned.
If you have a gain because your main home is condemned, you generally can exclude the gain from your income as if
you had sold or exchanged your
home. For information on this exclusion, see Publication 523. If your gain is more than the amount you can exclude, but you
buy replacement property,
you may be able to postpone reporting the excess gain. See Postponing Gain, later. (You cannot deduct a loss from the condemnation of your
main home.)
More information.
For information on how to figure the gain or loss on condemned property, see chapter 1 in Publication 544. Also see
Postponing Gain,
later, to find out if you can postpone reporting the gain.
The sale or other disposition of property located within an irrigation project to conform to the acreage limits of federal
reclamation laws is an
involuntary conversion.
Diseased livestock.
If your livestock die from disease, or are destroyed, sold, or exchanged because of disease, even though the disease
is not of epidemic
proportions, treat these occurrences as involuntary conversions. If the livestock was raised or purchased for resale, follow
the rules for livestock
discussed earlier under Farming Losses. Otherwise, figure the gain or loss from these conversions using the rules discussed under
Determining Gain or Loss in chapter 8. If you replace the livestock, you may be able to postpone reporting the gain. See Postponing
Gain, later.
Reporting dispositions of diseased livestock.
If you choose to postpone reporting gain on the disposition of diseased livestock, you must attach a statement to
your return explaining that the
livestock was disposed of because of disease. You must also include other information on this statement. See How To Postpone Gain, later,
under Postponing Gain.
Weather-related sales of livestock.
If you sell or exchange livestock (other than poultry) held for draft, breeding, or dairy purposes solely because
of drought, flood, or other
weather-related conditions, treat the sale or exchange as an involuntary conversion. Only livestock sold in excess of the
number you normally would
sell under usual business practice, in the absence of weather-related conditions, are considered involuntary conversions.
Figure the gain or loss
using the rules discussed under Determining Gain or Loss in chapter 8. If you replace the livestock, you may be able to postpone reporting
the gain. See Postponing Gain, later.
Example.
It is your usual business practice to sell five of your dairy animals during the year. This year you sold 20 dairy animals
because of drought. The
sale of 15 animals is treated as an involuntary conversion.
If you do not replace the livestock, you may be able to report the gain in the following year's income. This rule also applies
to other livestock
(including poultry). See Sales Caused by Weather-Related Conditions in chapter 3.
If, because of an abnormal drought, the failure of planted tree seedlings is greater than normally anticipated, you may have
a deductible loss.
Treat the loss as a loss from an involuntary conversion. The loss equals the previously capitalized reforestation costs you
had to duplicate on
replanting. You deduct the loss on the return for the year the seedlings died. If you took the investment credit for any of
these costs, you may have
to recapture all or part of the credit. See Form 4255, Recapture of Investment Credit.
Do not report a gain if you receive reimbursement in the form of property similar or related in service or use to the destroyed,
stolen, or other
involuntarily converted property. Your basis in the new property is generally the same as your adjusted basis in the property
it replaces.
You must ordinarily report the gain on your stolen, destroyed, or other involuntarily converted property if you receive money
or unlike property as
reimbursement. However, you can choose to postpone reporting the gain if you purchase replacement property similar or related
in service or use to
your destroyed, stolen, or other involuntarily converted property within a specific replacement period.
If you have a gain on damaged property, you can postpone reporting the gain if you spend the reimbursement to restore the
property.
To postpone reporting all the gain, the cost of your replacement property must be at least as much as the reimbursement you
receive. If the cost of
the replacement property is less than the reimbursement, you must include the gain in your income up to the amount of the
unspent reimbursement.
Example.
In 1970, you bought a cottage in the mountains for your personal use at a cost of $18,000. You made no further improvements
or additions to it.
When a storm destroyed the cottage this January, the cottage was worth $250,000. You received $146,000 from the insurance
company in March. You had a
gain of $128,000 ($146,000 - $18,000).
You spent $144,000 to rebuild the cottage. Since this is less than the insurance proceeds received, you must include $2,000
($146,000 -
$144,000) in your income.
Buying replacement property from a related person.
You cannot postpone reporting a gain from a casualty, theft, or other involuntary conversion if you buy the replacement
property from a related
person (discussed later). This rule applies to the following taxpayers.
-
C corporations.
-
Partnerships in which more than 50% of the capital or profits interest is owned by C corporations.
-
Individuals, partnerships (other than those in (2) above), and S corporations if the total realized gain for the tax year
on all
involuntarily converted properties on which there are realized gains is more than $100,000.
For involuntary conversions described in (3) above, gains cannot be offset by any losses when determining whether the total
gain is more than
$100,000. If the property is owned by a partnership, the $100,000 limit applies to the partnership and each partner. If the
property is owned by an S
corporation, the $100,000 limit applies to the S corporation and each shareholder.
Exception.
This rule does not apply if the related person acquired the property from an unrelated person within the period of
time allowed for replacing the
involuntarily converted property.
Related persons.
Under this rule, related persons include, for example, a corporation and an individual who owns more than 50% of its
outstanding stock, and two
partnerships in which the same C corporations own more than 50% of the capital or profits interests. For more information
on related persons, see
Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2 of Publication 544.
Death of a taxpayer.
If a taxpayer dies after having a gain, but before buying replacement property, the gain must be reported for the
year in which the decedent
realized the gain. The executor of the estate or the person succeeding to the funds from the involuntary conversion cannot
postpone reporting the gain
by buying replacement property.
You must buy replacement property for the specific purpose of replacing your property. Your replacement property must be similar
or related in
service or use to the property it replaces. You do not have to use the same funds you receive as reimbursement for your old
property to acquire the
replacement property. If you spend the money you receive for other purposes, and borrow money to buy replacement property,
you can still choose to
postpone reporting the gain if you meet the other requirements. Property you acquire by gift or inheritance does not qualify
as replacement property.
Owner-user.
If you are an owner-user, similar or related in service or use means that replacement property must function in the
same way as the property it
replaces. Examples of property that functions in the same way as the property it replaces are a home that replaces another
home, a dairy cow that
replaces another dairy cow, and farm land that replaces other farm land. A passenger automobile that replaces a tractor does
not qualify. Neither does
a breeding or draft animal that replaces a dairy cow.
Soil or other environmental contamination.
If, because of soil or other environmental contamination, it is not practical for you to reinvest your insurance money
from destroyed livestock in
property similar or related in service or use to the livestock, you can treat other property (including real property) used
for farming purposes, as
property similar or related in service or use to the destroyed livestock.
Weather-related sales of livestock.
If you sell or exchange livestock because of weather-related conditions (discussed earlier under Livestock Losses) and it is not
practical for you to reinvest the sales proceeds in property similar or related in service or use to the livestock, you can
treat other property
(excluding real property) used for farming purposes, as property similar or related in service or use to the livestock you
sold.
Standing crop destroyed by casualty.
If a storm or other casualty destroyed your standing crop and you use the insurance money to acquire either another
standing crop or a harvested
crop, this purchase qualifies as replacement property. The costs of planting and raising a new crop qualify as replacement
costs for the destroyed
crop only if you use the crop method of accounting (discussed in chapter 2). In that case, the costs of bringing the new crop
to the same level of
maturity as the destroyed crop qualify as replacement costs to the extent they are incurred during the replacement period.
Timber loss.
Standing timber you bought with the proceeds from the sale of timber downed as a result of a casualty, such as high
winds, earthquakes, or volcanic
eruptions, qualifies as replacement property. If you bought the standing timber within the replacement period, you can postpone
reporting the gain.
Business or income-producing property located in a Presidentially declared disaster area.
If your destroyed business or income-producing property was located in a Presidentially declared disaster area, any
tangible replacement property
you acquire for use in any business is treated as similar or related in service or use to the destroyed property. For more
information, see
Disaster Area Losses in Publication 547.
Substituting replacement property.
Once you have acquired qualified replacement property that you designate as replacement property in a statement attached
to your tax return, you
cannot substitute other qualified replacement property. This is true even if you acquire the other property within the replacement
period. However, if
you discover that the original replacement property was not qualified replacement property, you can, within the replacement
period, substitute the new
qualified replacement property.
Basis of replacement property.
You must reduce the basis of your replacement property (its cost) by the amount of postponed gain. In this way, tax
on the gain is postponed until
you dispose of the replacement property.
To postpone reporting your gain, you must buy replacement property within a specified period of time. This is the replacement
period.
The replacement period begins on the date your property was damaged, destroyed, stolen, sold, or exchanged. The replacement
period generally ends 2
years after the close of the first tax year in which you realize any part of your gain from the involuntary conversion.
Example.
You are a calendar year taxpayer. While you were on vacation, farm equipment that cost $2,200 was stolen from your farm. You
discovered the theft
when you returned to your farm on November 11, 2005. Your insurance company investigated the theft and did not settle your
claim until January 3,
2006, when they paid you $3,000. You first realized a gain from the reimbursement for the theft during 2006, so you have until
December 31, 2008, to
replace the property.
Main home in disaster area.
For your main home (or its contents) located in a Presidentially declared disaster area, the replacement period ends
4 years after the close of the
first tax year in which you realize any part of your gain from the involuntary conversion. See Disaster Area Losses, later.
Property in the Hurricane Katrina disaster area.
For property located in the Hurricane Katrina disaster area that was destroyed, damaged, stolen, or condemned after
August 24, 2005, as a result of
Hurricane Katrina, the replacement period ends 5 years after the close of the first tax year in which any part of your gain
is realized. This 5-year
replacement period applies only if substantially all of the use of the replacement property is in the Hurricane Katrina disaster
area.
Weather-related sales of livestock in an area eligible for federal assistance.
For the sale or exchange of livestock due to drought, flood, or other weather-related conditions in an area eligible
for federal assistance, the
replacement period ends 4 years after the close of the first tax year in which you realize any part of your gain from the
sale or exchange. The IRS
may extend the replacement period on a regional basis if the weather-related conditions continue for longer than 3 years.
For information on extensions of the replacement period because of persistent drought, see Notice 2006-82, available
at
www.irs.gov/irb/2006-39_IRB/ar01.html.
Condemnation.
The replacement period for a condemnation begins on the earlier of the following dates.
The replacement period generally ends 2 years after the close of the first tax year in which any part of the gain on the condemnation
is
realized. But see Property in the Hurricane Katrina disaster area earlier for an exception.
Business or investment real property.
If real property held for use in a trade or business or for investment (not including property held primarily for
sale) is condemned, the
replacement period ends 3 years after the close of the first tax year in which any part of the gain on the condemnation is
realized.
Extension.
You may get an extension of the replacement period if you apply to the IRS director for your area. Include all the
details about your need for an
extension. Make your application before the end of the replacement period. However, you can file an application within a reasonable
time after the
replacement period ends if you can show a good reason for the delay. You will get an extension of the replacement period if
you can show reasonable
cause for not making the replacement within the regular period.
You postpone reporting your gain by reporting your choice on your tax return for the year you have the gain. You have the
gain in the year you
receive insurance proceeds or other reimbursements that result in a gain.
Required statement.
You should attach a statement to your return for the year you have the gain. This statement should include all the
following information.
-
The date and details of the casualty, theft, or other involuntary conversion.
-
The insurance or other reimbursement you received.
-
How you figured the gain.
Replacement property acquired before return filed.
If you acquire replacement property before you file your return for the year you have the gain, your statement should
also include detailed
information about all the following items.
-
The replacement property.
-
The postponed gain.
-
The basis adjustment that reflects the postponed gain.
-
Any gain you are reporting as income.
Replacement property acquired after return filed.
If you intend to buy replacement property after you file your return for the year you realize gain, your statement
should also say that you are
choosing to replace the property within the required replacement period.
You should then attach another statement to your return for the year in which you buy the replacement property. This
statement should contain
detailed information on the replacement property. If you acquire part of your replacement property in one year and part in
another year, you must
attach a statement to each year's return. Include in the statement detailed information on the replacement property bought
in that year.
Reporting weather-related sales of livestock.
If you choose to postpone reporting the gain on weather-related sales or exchanges of livestock, show all the following
information on a statement
attached to your return for the tax year in which you first realize any of the gain.
-
Evidence of the weather-related conditions that forced the sale or exchange of the livestock.
-
The gain realized on the sale or exchange.
-
The number and kind of livestock sold or exchanged.
-
The number of livestock of each kind you would have sold or exchanged under your usual business practice.
Show all the following information and the preceding information on the return for the year in which you replace the
livestock.
-
The dates you bought the replacement property.
-
The cost of the replacement property.
-
Description of the replacement property (for example, the number and kind of the replacement livestock).
Amended return.
You must file an amended return (Form 1040X) for the tax year of the gain in either of the following situations.
-
You do not acquire replacement property within the replacement period, plus extensions. On this amended return, you must report
the gain and
pay any additional tax due.
-
You acquire replacement property within the required replacement period, plus extensions, but at a cost less than the amount
you receive
from the casualty, theft, or other involuntary conversion. On this amended return, you must report the part of the gain that
cannot be postponed and
pay any additional tax due.
Special rules apply to Presidentially declared disaster area losses. A Presidentially declared disaster is a disaster that
occurred in an area
declared by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency
Assistance Act.
A list of the areas warranting assistance under the Act is available at the Federal Emergency Management Agency (FEMA) web
site at
www.fema.gov .
This part discusses the special rules for when to deduct a disaster area loss and what tax deadlines may be postponed. For
other special rules, see
Publication 547.
When to deduct the loss.
If you have a deductible loss from a disaster that occurred in a Presidentially declared disaster area, you can choose
to deduct that loss on your
return or amended return for the tax year immediately preceding the tax year in which the disaster happened. If you make this
choice, the loss is
treated as having occurred in the preceding year.
Claiming a qualifying disaster loss on the previous year's return may result in a lower tax for that year, often producing
or increasing a cash
refund.
You must make this choice to take your casualty loss for the disaster in the preceding year by the later of the following
dates.
Disaster relief grants.
Do not include post-disaster relief grants received under the Robert T. Stafford Disaster Relief and Emergency Assistance
Act in your income if the
grant payments are made to help you meet necessary expenses or serious needs for medical, dental, housing, personal property,
transportation, or
funeral expenses. Do not deduct casualty losses or medical expenses to the extent they are specifically reimbursed by these
disaster relief grants.
Unemployment assistance payments under the Act are taxable unemployment compensation.
Qualified disaster relief payments.
Qualified disaster relief payments are not included in the income of individuals to the extent any expenses compensated
by these payments are not
otherwise compensated for by insurance or other reimbursement. These payments are not subject to income tax, self-employment
tax, or employment taxes
(social security, Medicare, and federal unemployment taxes). No withholding applies to these payments.
Qualified disaster relief payments include payments you receive (regardless of the source) for the following expenses.
-
Reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a Presidentially declared
disaster.
-
Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence due to a Presidentially
declared
disaster. (A personal residence can be a rented residence or one you own.)
-
Reasonable and necessary expenses incurred for the repair or replacement of the contents of a personal residence due to a
Presidentially
declared disaster.
Qualified disaster relief payments include amounts paid by a federal, state, or local government in connection with
a Presidentially declared
disaster to those affected by the disaster.
Qualified disaster relief payments do not include:
-
Payments for expenses otherwise paid for by insurance or other reimbursements, or
-
Income replacement payments, such as payments of lost wages, lost business income, or unemployment compensation.
Qualified disaster mitigation payments.
Qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency Assistance
Act or the National Flood
Insurance Act (as in effect on April 15, 2005) are not included in income. These are payments you, as a property owner, receive
to reduce the risk of
future damage to your property. You cannot increase your basis in property, or take a deduction or credit, for expenditures
made with respect to those
payments.
Sale of property under hazard mitigation program.
Generally, if you sell or otherwise transfer property, you must recognize any gain or loss for tax purposes unless
the property is your main home.
You report the gain or deduct the loss on your tax return for the year you realize it. (You cannot deduct a loss on personal-use
property unless the
loss resulted from a casualty, as discussed earlier.) However, if you sell or otherwise transfer property to the Federal Government,
a state or local
government, or an Indian tribal government under a hazard mitigation program, you can choose to postpone reporting the gain
if you buy qualifying
replacement property within a certain period of time. See Postponing Gain earlier for the rules that apply.
Postponed tax deadlines.
The IRS may postpone for up to 1 year certain tax deadlines of taxpayers who are affected by a Presidentially declared
disaster. The tax deadlines
the IRS may postpone include those for filing income, excise, and employment tax returns, paying income, excise, and employment
taxes, and making
contributions to a traditional IRA or Roth IRA.
If any tax deadline is postponed, the IRS will publicize the postponement in your area and publish a news release,
revenue ruling, revenue
procedure, notice, announcement, or other guidance in the Internal Revenue Bulletin (IRB).
Who is eligible.
If the IRS postpones a tax deadline, the following taxpayers are eligible for the postponement.
-
Any individual whose main home is located in a covered disaster area (defined next).
-
Any business entity or sole proprietor whose principal place of business is located in a covered disaster area.
-
Any individual who is a relief worker affiliated with a recognized government or philanthropic organization and who is assisting
in a
covered disaster area.
-
Any individual, business entity, or sole proprietor whose records are needed to meet a postponed deadline, provided those
records are
maintained in a covered disaster area. The main home or principal place of business does not have to be located in the covered
disaster
area.
-
Any estate or trust that has tax records necessary to meet a postponed tax deadline, provided those records are maintained
in a covered
disaster area.
-
The spouse on a joint return with a taxpayer who is eligible for postponements.
-
Any other person determined by the IRS to be affected by a Presidentially declared disaster.
Covered disaster area.
This is an area of a Presidentially declared disaster area in which the IRS has decided to postpone tax deadlines
for up to 1 year.
Abatement of interest and penalties.
The IRS may abate the interest and penalties on the underpaid income tax for the length of any postponement of tax
deadlines.
Reporting Gains and Losses
You will have to file one or more of the following forms to report your gains or losses from involuntary conversions.
Form 4684.
Use this form to report your gains and losses from casualties and thefts.
Form 4797.
Use this form to report involuntary conversions (other than from casualty or theft) of property used in your trade
or business and capital assets
held in connection with a trade or business or a transaction entered into for profit. Also use this form if you have a gain
from a casualty or theft
on trade, business or income-producing property held for more than 1 year and you have to recapture some or all of your gain
as ordinary income.
Schedule A (Form 1040).
Use this form to deduct your losses from casualties and thefts of personal-use property that you reported on Form
4684.
Schedule D (Form 1040).
Use this form to report gain from an involuntary conversion (other than from casualty or theft) of personal-use property.
Also, carry over the
following gains to Schedule D.
Schedule F (Form 1040).
Use this form to deduct your losses from casualty or theft of livestock or produce bought for sale under Other expenses in Part II, line
34, if you use the cash method of accounting and have not otherwise deducted these losses.
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