Seeking Tax Relief for Casualty Losses

What a year it has been. In 2011, we have witnessed devastation caused by a wide variety of natural disasters, ranging from tornadoes to floods to wildfires. Although it is a small consolation if your home or other property is damaged as a result, at least you may be able to deduct a casualty loss on your tax return.

Basic rules: You may qualify for a casualty loss deduction if damage is caused by an event that is “sudden, unexpected or unusual.” This not only includes natural disasters already mentioned but also automobile collisions and frozen pipes bursting. The same basic rules apply to thefts of your property. However, you are not entitled to any tax relief for damage occurring over a long period of time, such as damage from a drought.

How much is deductible? It depends on whether the property damaged is personal or business property. For personal property, the deduction is limited to the excess above 10% of your annual AGI after subtracting $100 per casualty event. (This $100 “floor” was temporarily raised to $500 for 2009 only.) For example, if your AGI for 2011 is $100,000 and you suffer a loss to your home of $20,000, your deduction is limited to $9,900 ([$20,000 – $100] – [10% of $100,000]).

In contrast, there are no such limits for business property. The full amount of the eligible loss can be deducted on the company’s return.

The amount eligible for the deduction is the lesser of (1) the difference in the property’s value before and after the casualty or (2) the adjusted basis in the property.

But you must reduce the deductible amount by any insurance proceeds you receive.

Special tax break: If you own damaged property located in an area that is officially declared to be a “federal disaster area,” you could be entitled to a quick tax refund. In that case, you can elect to deduct your casualty loss on the tax return for the prior year. In other words, if you suffered a loss in a federally designated disaster area in 2011, you may file an amended return for 2010.

Be aware, however, that the IRS often challenges casualty loss deductions. The best proof you can offer is photographs or videotapes of your property as it currently exists. In other words, obtain documentation before a casualty occurs. The visual proof can be compelling when coupled with snapshots of the property immediately after a casualty occurs.

To further support your position, you should obtain an independent appraisal of the damage. The appraisal itself is deductible as a miscellaneous itemized deduction (subject to a 2%-of-AGI floor).

In summary: Your professional tax advisers can help you maximize the casualty loss deductions claimed on your return. Obtain assistance when appropriate.