The year 2011 was a tough one for natural disasters, with hurricanes
soaking the Atlantic coast, tornadoes wreaking havoc in Southern and Midwestern
states and wildfires hitting Texas, among other events. If you were affected by
a natural disaster this year, you should be aware of Internal Revenue Service
rules on casualty losses, as well as other financial considerations. The Minnesota
Society of Certified Public Accountants (MNCPA) provides some perspective.
What qualifies for a deduction?
Under
Internal Revenue Service rules, you are allowed to deduct a casualty loss that
is the result of a disaster, but some of the related rules serve to
significantly whittle down the amount you can deduct. First, consider what is
eligible for the deduction. A casualty loss is the damage, destruction or loss
of property resulting from an identifiable event that is unexpected, sudden or
unusual. Damages from natural disasters, such as hurricanes, floods, wildfires
and earthquakes are casualty losses. Damage to your home or other property
caused by something that is not unexpected, sudden, or unusual, such as
accidental breakage of items under normal conditions, progressive deterioration
occurring naturally over time, or due to the failure to maintain the property, does
not qualify as a casualty loss. If you have suffered a casualty loss to your
home, household goods or vehicle due to a disaster, you should be eligible to
deduct the amount of that loss on your tax return, less certain required
adjustments. (The same is true if you suffer a loss due to a theft.)
How does the deduction work?
According
to the IRS, "If your property is personal-use property, or is not
completely destroyed, the amount of your casualty or theft loss is the lesser
of: the adjusted basis of your property, or the decrease in the fair market
value (FMV) as a result of the casualty or theft.”
To
determine your adjusted basis, start with the basis of the property. Your basis
in the property you buy is usually how much it cost you. You then increase or
decrease the property’s basis to reflect any improvements you have made to the
property or depreciation deductions you have taken for the property. The
decrease in the FMV of the property used to determine the casualty loss is the difference
between the FMV of the property immediately before the casualty and the FMV of
the property immediately after the casualty. The FMV immediately after the
casualty frequently will be the salvage value of the property. From the lesser
of the adjusted basis of the property or the difference in its FMV, subtract
any insurance payment or other reimbursement (for example, compensation for the
loss from a government or employer relief program). This is your casualty loss.
For
example, suppose flooding heavily damaged your finished basement during a
recent hurricane. You have losses on several items that were destroyed by water
damage—a washer and dryer, hot water heater, furnace and some furnishings—as
well as to the basement walls. Your basis in these items—what you originally
spent on them—amounts to $10,000. The fair market value of these items was $9,500
before the disaster and $500 after, making the decrease in the FMV $9,000.
Because the decrease in the FMV of the items is less than your adjusted basis
in them, you must use the decrease in the FMV in your loss calculation. Your
insurance covers you for a maximum of $5,000 in damages, leaving you with a
$4,000 casualty loss.
Final steps in the calculation of the deduction
Before
deducting this personal property casualty loss on your tax return, there are a
couple of last steps you must take. First, you must subtract $100 from every
casualty or theft loss you report each year. That lowers the example amount to
$3,900. More significant, you must subtract 10 percent of your adjusted gross
income from the loss amount to arrive at your final deduction. If your adjusted
gross income was, say, $30,000 last year, you would subtract $3,000—10 percent—from
your loss amount to arrive at $900 as your allowable deduction. If your
adjusted gross income in the example was $39,000 or higher, that 10 percent would
wipe out your allowable deduction altogether.
Other sources of help
For
those seeking additional relief, it’s important to be aware that organizations
such as FEMA, the Federal Emergency Management Agency, often provide funds and
services to those affected by disaster. The agency’s guide, Help After a Disaster, offers an
overview of what’s available. In addition, Disaster Recovery: A Guide to Financial Issues—a joint project
of the American Institute of CPAs, the American Red Cross and the National Endowment
for Financial Education—answers questions on how to minimize the consequences
in the first days, weeks and months after a disaster.
Count on your local CPA
If you
have experienced casualty losses due to a disaster, or if you have questions on
preparing for or dealing with any financial issue, be sure to consult your
local CPA. He or she can provide valuable advice to help you address a range of
financial concerns.