The IRS allows individuals to deduct certain Disaster-Area Casualty Losses on their Form 1040 Income Tax Return as they relate to the taxpayer’s home, household goods, and vehicles (not loss of income/profit). *Keep in mind that in reading this, different rules may apply for businesses and investment properties. Casualty losses in general are those losses from damage or destruction caused by a sudden, unexpected, and unusual event (such as flooding). To qualify for deductions under the more specific Disaster-Area provisions, the taxpayer’s residence must be in an area declared by the President as a disaster area and eligible for federal assistance.
Generally, the rule regarding casualty loss deductions requires that the taxpayer claim the loss in the year it occurred. However, if the casualty loss is from a federally-declared disaster, the taxpayer CAN choose to deduct the loss for the year immediately preceding the disaster year. One of the biggest benefits found by amending the previous year’s return is that the amendment typically results in a lower tax owed, often resulting in a refund, but the extent of the benefit depends largely on income. In making a decision regarding which year to claim the loss in, we always suggest consulting a tax professional, as there are many important factors to evaluate (most important is in which year higher income is reported) to ensure that the loss is claimed in the year that benefits the taxpayer most. Once it’s decided that carrying back the loss is best, here are a few suggested tips to doing so:
- File a Form 4684 and Schedule A attach it to the Form 1040 Income Tax Return. The IRS advises taxpayers to designate “Louisiana, Severe Storms and Flooding” on the form in order to expedite processing
- If electing to claim the loss on the prior-year return, enclose a separate letter explaining the circumstances (the date of disaster, address of damaged/destroyed property, etc.) with the original/amended return
- File/Amend the prior-year return by the later of either the date (without extensions) for filing the return for the tax year in which the disaster occurred OR the due date (with extensions) for filing the return the preceding year
- If the original return has been lost in the disaster and is needed for an amended return, request a copy via IRS Form 4506. The IRS is offering fee waivers and expedited processing for this service Calculate the loss under the normal rules for casualty losses
- The lesser of either the adjusted basis of property or the decrease in fair market value after the casualty
- Ensure the $100 and 10% rules on deduction limits are followed: the loss must be reduced by $100 and then further reduced by 10% of AGI
- Ensure there are records to support the loss deduction; if records were lost in the flood, the taxpayer should do what they can NOW to reconstruct the information; it should be much easier to collect the information now vs. later in the event of an audit
- See IRS Publication 2194: Disaster Resource Guide for IRS guidance on how to reconstruct records lost
- Keep in mind that the burden of proof to prove losses/deductions remains with the taxpayer
- Decrease the amount of loss by any insurance payments or certain government payments received or expected to be received
- Not filing an insurance claim is not beneficial- the IRS can subtract amounts that could have been received had the taxpayer properly filed an insurance claim
- FEMA payments to compensate for property loss/damage should be deducted from the amount of loss. FEMA payments for food, temporary housing, etc. should not
- If the total amount of loss exceeds total income, the taxpayer may have a Net Operating Loss (NOL) that could be carried forward or backward for several years. Taxpayers do not have to be in business to have a NOL from a casualty
While we pray that everyone who was affected by the flooding has received enough financial assistance through insurance and government payments that claiming a casualty loss is not applicable, we hope this information offers some relief to those who HAVE suffered such out-of-pocket loss and further relief is provided through tax savings.