Casualty losses and tax deductions
With Hurricane Matthew having caused over $200 million in insurance claims so far, many people will have opportunities to take a deduction on their 2016 individual income tax return and possibly even amend their 2015 return to get a current refund.
The two key items to keep in mind when it comes to deductible casualty losses are:
- Hurricane losses are considered a casualty. The deduction becomes limited to 10% of your adjusted gross income and the net loss after insurance proceeds.
- Hurricane Matthew caused a federally declared disaster area in Northeast Florida. Because of this, a great opportunity exists to take the deduction on either your 2016 tax return or to amend your 2015 tax return. Depending on your income in either year, you have the opportunity to maximize your refund between the two years.
The casualty loss deduction can be quite complicated. If you feel you have the opportunity to take the deduction, your tax preparer can help you with the calculation.
A casualty, for federal income tax purposes, is a sudden, unexpected, or unusual loss or damage to some property you own. Damage from a hurricane falls into this definition. So the next question would be, how do you measure your loss from the casualty? The IRS gives a “lesser of” scenario. It’s the lesser of either the property’s adjusted tax basis (ie what you paid for the property plus improvements and less other items such as depreciation taken) or the property’s decline in fair market value due to the casualty.
Remember the rule is the lesser of the two, so if you have had a large increase in the fair market value of the property then you might be stuck with the lower deduction of your adjusted tax basis.
Now that we know the amount of the loss you want to make sure you can prove it. Be prepared to have documentation of the following:
- That you owned the property
- The amount of your basis in the property
- The pre-storm value of the property
- The reduction in the value caused by the storm
- The lack of insurance or disaster relief funds reimbursement to cover the costs
The casualty loss deduction can be taken on one of two years. The deduction can be on the return for the year the storm happened. For losses related to Hurricane Matthew that would be the 2016 tax year (the return would be due April 15, 2017). A second option that might result in a quicker refund would be to amend your 2015 tax return to include the loss that incurred in 2016. By amending your 2015 return you elect to not deduct the loss in the year it was incurred. Since the 2015 return can be amended as soon as the loss is determined, you have the opportunity to get a refund faster. Having the option of filing for either year also gives the chance to determine which year would be more beneficial. The lower income year would possibly give more benefit since the 10% limit would be lower. You have until April 15, 2017 to amend your 2015 return and elect to claim the casualty loss on your 2015 tax return. If you chose to claim the loss on your 2016 tax return, that return is also due on April 15, 2017. With an option to extend the filing due date by 6 months. Just remember the tax is due on April 15th.
To report the loss you must complete Form 4684 and include that with your Form 1040 for whichever year you decide to deduct the loss. For personal property losses, such as your primary residence, Section A of the Form must be completed. You will also have two different reductions to your loss. For a married couple filing a joint return, a single $100 reduction applies for each event. After this first reduction you must reduce the deductible loss further by a full 10 percent of your adjusted gross income (Line 37 of your Form 1040). After applying the $100 reduction and the 10% reduction the loss is carried to Schedule A as an itemized deductions. You will then need to include this with your other itemized deductions (such as mortgage interest paid, charitable contributions, etc) and determine if your itemized deductions are more beneficial than the standard deduction. If the casualty loss is large, then the itemized deductions would be the most beneficial and would carry to your Form 1040 and reduce your income.
The other side to consider is reimbursements from your insurance company or other sources. These reimbursements would offset your initial loss. You must reduce either your adjusted tax basis or your change in fair market value, whichever was lower, by the reimbursements received. If the property was insured, you must file a timely claim for the reimbursement of your loss. If you don’t, you cannot deduct the casualty loss.
Insurance and other reimbursements could also potentially generate a gain from the casualty. If reimbursements exceed your adjusted tax basis then the difference should be recognized as a capital gain and reported on Schedule D.
While the casualty loss deduction presents opportunities for tax savings, there are many items to consider in the calculation. Your tax advisor can help to guide you through the calculation and arrive at the best tax benefit for your situation.
By Peter Reynolds, Managing Partner, The Griggs Group CPAs