By Jennifer McNett, CPA
Manager, Tax Services Group
As residents in Texas, Florida and Puerto Rico recover from a trio of deadly hurricanes and the humanitarian crisis has started to ease, people’s thoughts have started to turn to practical matters. One question that has come up amongst those who own property in those regions is on the deductibility of losses due to hurricanes.
Hopefully, they carried property insurance, including a hurricane policy, to guard against damage from natural disasters. There are still bound to be some property losses that are unreimbursed, due to deductibles or because they fall outside the specific terms of an insurance policy. Is there any tax relief available for these losses?
The short answer is yes – but don’t expect it to be a simple process, or receive a huge amount of relief. Here is an overview.
In general, the federal tax code is not very generous when it comes to deductions for damages from disasters such as hurricanes, also known as casualty losses. In order to have a chance of recovering those unreimbursed losses through tax deductions, one usually must have low adjusted gross income (AGI), poor insurance coverage and be able to document the loss.
For personal use property, the loss is measured by the lesser of the adjusted-basis of the property or the economic loss. The adjusted-basis is usually the purchase price or value upon acquisition, adjusted by any subsequent capital improvements. The economic loss is calculated by the change in the property value immediately before and after the event.
From the lesser of those two values, we subtract the insurance payment or other reimbursement/mitigation. For personal use property losses, the IRS makes two reductions: first a flat $100, then a further 10 percent of the owner’s AGI. If there is still a loss after these reductions, it can be reported as an itemized deduction on the taxpayer’s federal return. Itemized deductions can also be limited depending on income, and on most state tax returns, including Indiana, federal itemized deductions are not allowed.
As an example, let us say Martha sustained $5,000 of post-insurance losses from a hurricane and has an AGI of $40,000. The IRS reductions of $100 and 10% of her AGI ($4,000) leaves her with a net casualty loss deduction of $900.
With for-profit business property, the casualty loss is similarly determined by computing the difference in fair market value immediately before and after the event. However, each identifiable property is treated separately, and the loss is not subject to the $100 or 10% of AGI reductions. For example, damages to a building, landscaping or vehicles parked there would be viewed and computed separately. Obviously, this makes the process more complex for businesses.
Inventory losses from hurricanes are not generally reported as casualty losses, but are deducted as a cost of goods sold expense under the general provisions relating to inventories.
The biggest challenge in claiming casualty loss tax deductions is being able to determine and document the pre-event value of the property and its diminishment as a result of the hurricane or other disaster. Usually a qualified appraiser is necessary who has knowledge of the region and type of property. In certain cases, the cost of repairs can be used to document the decline in value, but you are still required to start your calculation with the value before the loss.
The IRS and state taxing authorities do often give further concessions to taxpayers when the loss occurs in a federally declared disaster area – which is usually the case with severe hurricanes like Harvey, Irma and Maria. The primary concession is to allow the owner to obtain economic relief sooner than normal by permitting them to report the loss on the tax return for the year in which the loss occurred, or on an amended return for the immediately preceding tax year. In other words, if you are able to document a casualty loss from the 2017 hurricanes, you could file an amendment to your 2016 return right away.
If you want more information about casualty losses, you can visit the IRS webpage on that topic, or contact Jennifer McNett in our Tax Services department at (317) 608-6699 or email [email protected].