The deduction for individual casualty losses has always been restricted, but at least taxpayers had a chance of partially deducting the loss of personal assets. After the passage of the Tax Cuts and Jobs Act (TCJA), however, the opportunity for a loss deduction is gone unless the taxpayer is in a federal disaster area. This rule is in effect for 2018-2025. The IRS is publicizing the new requirements through the release of a legal memorandum because of confusion about how the new law applies.
Two key elements of the new rules are that:
- deductible losses do not have to occur within the exact boundaries of the disaster area, and
- taxpayers do not sustain a loss until the amount of any other recovery is known.
Taxpayers also may be able to take a retroactive deduction.
Only Disaster Losses Qualify
Taxpayers now can only deduct casualty and theft losses on personal assets attributable to a federally declared disaster as designated by the President. A federally declared disaster is a disaster that occurs in an area declared by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. It includes a major disaster or emergency declaration under the Act. The IRS explains in its legal advice that taxpayers can still get the deduction even if their property is not in a designated county as long as the loss is attributable to the Federally declared disaster within the taxpayer’s state. Here’s an example:
Example: Dorothy in Kansas
On September 1, 2018, a tornado damaged Dorothy’s house in Kansas resulting in a personal casualty loss. On September 7, 2018, the President issued a disaster declaration for the State of Kansas. FEMA determined that five counties in Kansas were eligible for assistance. Dorothy’s house is not located in one of the designated counties. Even though Dorothy’s house is not located in one of those counties, her personal casualty loss is attributable to the Federally declared disaster and is deductible. The point is, the TCJA rules do not require the loss to occur within a disaster area but only require the loss to be “attributable to a Federally declared disaster” and to be a state receiving the federal disaster declaration.
Timing of Deduction
The general rule is that casualty losses are deductible in the year the loss is sustained, which usually is the year in which the casualty occurred. Under the new TCJA rules, if a taxpayer has a casualty loss from a federally declared disaster, the taxpayer can choose to deduct the loss in the year it occurred or in the preceding tax year. Taxpayers can amend their returns for the preceding year, if necessary.
It is important to note that even if a loss occurs in one year, it cannot be deducted if there is a reasonable prospect of recovery. The loss cannot be considered to be sustained until it can be ascertained with reasonable certainty whether the taxpayer will receive reimbursement, according to the IRS memo. The IRS offers this timing example.
On May 1, 2017, a flood-damaged Ann’s house resulting in a personal casualty loss. The flood did not constitute a Federally declared disaster. Ann filed a claim with Insurance Company and had a reasonable prospect of recovering the entire amount claimed. In February 2018, Insurance Company paid Ann 70% of the amount she claimed. Also, in February 2018, it became reasonably certain that Ann would not be able to recover the unreimbursed amount. Ann did not suffer any additional personal casualty losses in 2018.
Under the timing rules, the loss was not sustained on May 1, 2017, because
Ann had a claim for reimbursement with a reasonable prospect of recovery. Rather, the loss was sustained in February 2018, when it could be ascertained with reasonable certainty whether she would receive reimbursement. As a result, Ann cannot take a casualty loss because the loss is treated as occurring in 2018 and was not in a Federally declared disaster area.
Deduction Dollar Limits
Losses are not deductible if they are covered by insurance, and taxpayers must make an insurance claim to get any deduction. Only the amount not covered by insurance is deductible. Two different dollar limits apply to the deduction, which is taken as an itemized deduction on Schedule A. The first $100 of loss on each casualty is not deductible. Also, the deduction is limited to losses which exceed 10% of a taxpayer’s adjusted gross income (AGI).
Note that business casualty losses are not subject to these restrictions and were preserved by the TCJA.
What’s a Casualty? You Would be Surprised
According to the IRS, a casualty loss can result from the damage, destruction, or loss of property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. A casualty doesn’t include normal wear and tear or progressive deterioration.
Taxpayers have tried to deduct many types of losses over the years. For example, O.J. Simpson’s neighbors tried to deduct the loss in the value of their home due to media attention and onlookers after Nicole Simpson’s death but were not successful in court. On the other hand, a taxpayer whose car was crushed by a city government that towed it was deductible as a casualty loss. A court also allowed a married couple to deduct a casualty loss when the husband inadvertently put his wife’s engagement ring down the disposal.
The TCJA rules on personal casualty losses have greatly restricted the scope of these deductions for the next 10 years, but taxpayers with sizable losses in Federal disaster areas still can get some relief—that is, if they can still itemize their deductions.