Casualty Losses and Insurance Reimbursement

Due to yesterday's wildfires, many of which are still burning as I write this, a large number of people have been evacuated from their homes and sadly a few people have lost their homes. Therefore, today I will be writing about the tax consequences of casualty losses and insurance reimbursement. 

However, I would first like to encourage everyone to begin to prepare now for future disasters by talking to an insurance agent about renter's insurance, home owner's insurance (which covers fires), earthquake insurance, and flood insurance.  Hopefully you will never need it, but I would urge everyone to at least consider it just in case.

A casualty loss, for tax purposes, is the damage, destruction, or loss of property resulting from an identifiable event (such as a fire) that is sudden, unexpected, or unusual.

Deductible Casualty Losses

The deductible portion of your casualty loss equals the lesser of:

• The adjusted basis in the property before the casualty or theft; or
• The decrease in the fair market value of the property as a result of the casualty or theft,
  Minus  any insurance or other reimbursement received or that is expected to be received.

Personal Use Property

For personal use property, like your home, there are 2 limitations applied to your deductible casualty loss.

1. There is a $100 reduction applied to each event that causes the casualty or theft.  This means that if your house and two cars are damaged in an earthquake, there would be a $100 reduction to the deductible casualty loss (not $300 because it was only one event).  However, if you were having a bad day and you got into a car accident and later there was an earthquake damaging your home, there would be two events so the reduction would be $200.
2. The aggregate of all your casualty losses must be reduced by 10% of your Adjusted Gross Income.  This reduction is applied after the $100 per casualty reduction.

Business and Income-Producing Property

Business and income-producing property does not have the same limitations placed on it that personal use property does.  If business property is completely destroyed, the deductible casualty loss is generally the cost of the property minus any accumulated depreciation.  If the property is damaged but not destroyed, then the loss is generally the decrease in the property's fair market value.

Employee Business-Use Property

An employee's business use property, such as an employee's personal laptop that is used exclusively for business purposes, may be deducted without any of the personal-use property limitations listed above, but it is only deductible as a miscellaneous itemized deduction.

Insurance Reimbursement

Any deductible casualty loss is reduced by the amount of actual insurance reimbursements received and any expected reimbursements.  If the property is covered by insurance, an insurance claim must be filed or the casualty loss will not be allowed.  If the insurance reimbursement exceeds the casualty amount, then the profit is taxable income unless the insurance reimbursement is reinvested in similar-use property.  Reinvestment generally must occur by the end of the second year following the insurance reimbursement.  However, taxpayers have 4 years to replace a principal residence in a federally declared disaster area.

Because the casualty losses are reduced both by the amount of actual insurance reimbursements and any expected reimbursements, occasionally there is a need to made adjustments in the following year.

If the actual reimbursement received was greater than the expected reimbursement, the excess amount is treated as ordinary income in the year received unless the prior year's casualty loss deduction did not reduce the taxpayer's tax liability.

If the actual reimbursement was less than expected, the difference is treated as a casualty loss in the year the taxpayer can reasonably expect no more reimbursement.

Federally Declared Disasters

There are special tax provisions that apply if the President declares a disaster to be eligible for federal assistance under the Disaster Relief and Emergency Assistance Act.  Those provisions are outside the scope of this blog, but be sure to ask your tax preparer about them if you are ever affected by a federally declared disaster.

So as you can see, the federal government does provide some support through the form of tax deductions if you are affected by a disaster.  However, it should also be clear to you that the tax relief that you would be eligible for generally does not compare to what you would receive through an adequate insurance policy.

If you have any questions about deducting casualty losses, please do not hesitate to contact me.

Also, please feel free to contact me if you would like a referral to a great insurance agent.

As always, I appreciate your feedback in the comments section below.