Recovery after a natural disaster can bring difficult decisions at a time when your options may already be limited. The last thing anyone wants to do during this challenging time is to think about taxes.
When dealing with insurance claims, pets without backyard fences and what feels like yard work that will never end, taxes can feel like next year’s problem. However, knowledge can translate into potential tax savings, so being informed on how casualty losses work could save you some stress next April 15.
What Is a Casualty Loss?
Property that is damaged, destroyed or lost in a sudden, unexpected or unusual event may qualify as a casualty loss. These events can include fires, floods, hurricanes, tornadoes and other natural disasters, as long as the loss can be tied to an identifiable event.
How Are Casualty Losses Calculated?
To determine the amount of a casualty loss, compare:
- The property’s fair market value immediately before the casualty with its fair market value immediately after the casualty
- The property’s adjusted basis
The casualty loss is based on whichever amount is lower. From there, subtract any insurance proceeds, salvage value and related reimbursements that have been received or are reasonably expected to be received.
There are multiple safe harbor methods that can be used to calculate the drop in fair market value on personal property losses, including your principal residence, second home or contents.
Who Can Take a Casualty Loss?
If a loss is not related to business, it can be deducted as a personal casualty loss, but additional limitations apply. In order to take a personal casualty loss from 2018 until 2025, the loss must have occurred in a presidentially declared disaster area. Beginning in 2026, this rule was expanded to also include losses attributable to qualifying state-declared disasters.
Other limitations associated with a personal casualty loss include a $100 limitation per casualty and an overall limitation of 10% of the taxpayer’s adjusted gross income unless it is designated as “qualified disaster” by the president under §401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act.
If it is designated as a “qualified disaster,” then the limitation goes up to $500 per casualty, but there is no limitation for adjusted gross income. You may also add the casualty loss to your standard deduction if you do not itemize.
The president’s Stafford Act declaration and FEMA’s assistance-area designations can help define the affected area for disaster-loss rules. Congress may also separately expand tax relief by statute.
Can All the Yard Damage Be Included in a Casualty Loss Claim?
The IRS recognizes landscaping and trees as a part of your property, even if you purchased and planted them at a different time than when you purchased your property. However, the land, home and improvements, including plants and trees, are treated as one property when measuring the loss. Therefore, the loss of trees contributes to the overall decrease in fair market value of the entire property immediately before and after the casualty event.
What Should I Prepare or Know Now?
A few steps can help you prepare for a casualty loss claim:
Prioritize Documentation
Take pictures of everything that is a loss, especially high-end valuables, and keep receipts of items bought during recovery efforts. Obtain and keep all itemized estimates and contracts related to repairs to restore property to pre-casualty conditions. Don’t forget to gather documentation to establish your cost basis in the property.
Know Your Insurance Coverage
Be aware of deductibles. Does your policy reimburse hotel or rental home expenses if you are displaced? Does your policy provide replacement cost coverage or actual cash value?
Be aware that some insurance reimbursements and government agency funds are not required to be recognized as taxable income. Insurance payments received to cover living costs when displaced from your principal residence are excluded from income. Payments received from a government agency for the cost of moving as a result of the qualifying event are also not included in income.
Know the Disaster Area Specifications
Know that if you have a business or home in a qualifying federal or state disaster area, you may have a tax-deductible casualty loss. If you are outside of these counties, your deductible personal casualty loss is limited to the extent of personal casualty gains.
Understand Casualty Gains
Property that has increased in value since you acquired it can result in a casualty gain. If the insurance reimbursement exceeds the property’s adjusted basis, you may realize a gain.
You can defer recognizing that gain on your tax return by purchasing replacement property within the required time period. That period begins on the date of the casualty and ends two years after the close of the first tax year in which any portion of the gain is realized. For a principal residence or its contents in a qualifying federal disaster area, the period is extended to four years.
Understand Safe Harbor Methods
Be aware that using a safe harbor method to compute the casualty loss will not be challenged by the IRS as it relates to establishing the decline in fair market valuation methodology, eliminating the potential need for costly litigation.
Be sure to keep the records required for the particular valuation method:
- Estimated repair cost – limited to losses of $20,000 or less; requires itemized estimates from two separate, independent licensed or registered contractors.
- De Minimis estimate – limited to losses of $5,000 or less; requires documentation for a good-faith estimate.
- Insurance report – no limit; requires the insurer’s estimated loss report.
- Disaster contractor contract – no limit; requires a binding, signed contract by an independent, licensed or registered contractor. This applies to federal disaster areas only.
- Disaster-loan appraisal – no limit; requires an appraisal prepared to obtain a federal loan or loan guarantee that states the estimated loss. This applies to federal disaster areas only.
Connect With Your Tax Advisor
Talk with your tax advisors as soon as possible about the information they’ll need to calculate the loss, along with any elections you may need to make and the applicable timing for your tax return.
How Can I Learn More About Casualty Losses?
The details of a casualty loss claim will depend on your property, the damage and your specific tax situation.
The IRS has addressed common questions from disaster victims about casualty losses, including how losses are determined and calculated. You can review the IRS FAQs for disaster victims for additional information.
Your tax advisor can help you determine how the rules apply to your situation and what needs to be addressed on your tax return. If you have questions about a casualty loss, contact Warren Averett to connect with an advisor who can help.
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