We seem to be living in an age of natural disasters. Floods, fires, hurricanes, tornados, and other disasters often dominate the news.
If a disaster strikes you, the tax law may help. It’s important to note that there are differences on how personal losses and business losses are treated and deducted under our current tax laws.
PERSONAL DISASTER LOSSES
You may qualify to deduct a tax code-defined disaster loss from your taxable income. The rules for personal losses are complex and far more restrictive than for business losses.
Only Casualty Losses Are Deductible
Damage to personal property caused by a disaster is deductible only if it qualifies as a casualty loss. A casualty is damage to, destruction of, or loss of property from events such as fires and floods that are sudden, unexpected, or unusual.
The disaster must result in physical damage to property, so economic losses do not qualify as a casualty loss.
Many, but not all, casualty losses are covered by insurance. You can’t deduct such losses to the extent they are insured. Moreover, suppose you have insured yourself against the loss. In that case, you must file a timely insurance claim, even if that insurance claim will result in the cancellation of your policy or an increase in premiums.
Your casualty loss (not your deduction) is equal to the lesser of
- the decrease in the property’s fair market value after the disaster, or
- the property’s adjusted basis before the disaster (usually its cost).
Subtract any insurance or other reimbursement from the lesser of (1) or (2).
To find the decline in the property’s fair market value, you can use appraisal or repair costs.
Limits on Casualty Losses
Unfortunately, you can’t deduct all your casualty losses. From 2018 through 2025 (under the Tax Cuts and Jobs Act), you can only deduct personal casualty losses due to a federally declared disaster or to the extent you have casualty gains.
For example, a homeowner can claim a casualty loss if a wildfire (declared a federal disaster) destroys his home. But he gets no deduction if a faulty fireplace caused the fire and destroys his home (no federal disaster).
The law imposes major limits on your casualty-loss deduction. The general rule says that you may not deduct the first $100 and then deduct your loss only to the extent that it exceeds 10 percent of your adjusted gross income. Your final hurdle is that you then deduct the loss as an itemized deduction. These rules significantly reduce or even eliminate many casualty loss deductions.
You have a choice for losses from a federal disaster: claim the loss in the year of the disaster or on the prior year’s return if it’s before October 15. This can result in a quick refund of all or part of the tax you paid that year.
Casualty Gains
If all this is not complicated enough, there’s one further wrinkle. A casualty such as a fire can result in a casualty gain instead of a casualty loss when the insurance proceeds you receive exceed the property’s adjusted basis (cost).
A casualty gain is taxable. But you may deduct casualty losses from the gains. Here, you don’t need a federal disaster.
Also, you can postpone tax on a casualty gain by buying replacement property.
BUSINESS DISASTER LOSSES
Disasters such as storms, fires, floods, and hurricanes damage or destroy property.
If property such as an office building, rental property, business vehicle, or business furniture is damaged or destroyed in a disaster, your business may qualify for a casualty loss deduction.
It’s easier to deduct business casualty losses than personal losses, but the rules are complex.
What Casualty Losses Are Deductible
Disasters such as fires and floods can result in a “casualty” because the damage, destruction, or property loss is from a sudden, unexpected, or unusual event.
Car accidents qualify as a casualty so long as they’re not caused by your willful act or willful negligence. Losses due to thefts and vandalism can also qualify.
Insurance covers many casualty losses. You must reduce your casualty loss by the amount of any insurance you receive or expect to receive. But unlike a personal loss, you are not required to file an insurance claim for a business casualty loss.
Amount of Casualty Loss
Your casualty loss can never exceed the adjusted basis of the property involved—usually its cost plus the value of any improvements, minus all deductions you took for the property, including depreciation or Section 179 expensing. If your adjusted basis is zero, you get no casualty loss deduction and could have a casualty gain.
The amount of your casualty loss for damaged property is equal to the smaller of
- the decrease in the property’s fair market value after the disaster, or
- the property’s adjusted basis before the disaster.
Subtract any insurance or other reimbursement received from the smaller of (1) and (2).
You can use an appraisal or repair costs to figure the decline in the property’s fair market value.
If a casualty destroys business property, the loss is equal to the property’s adjusted basis minus salvage value plus insurance proceeds, if any.
Unlike personal casualty losses, business casualty losses are not subject to a $100 floor and the 10 percent of adjusted gross income threshold to be deductible.
Casualty Losses Due to Federal Disasters
If your casualty loss is due to a federally declared disaster, you have the option of deducting it in the prior year. This way, you can get a refund of all or part of the tax you paid for that year.
Casualty Gains
You’ll have a casualty gain if the insurance proceeds you receive exceed the property’s adjusted basis (cost).
A casualty gain is taxable. But you can postpone tax on a casualty gain by buying replacement property of equal or greater value within two years (four years for federal disasters).
Repair Costs
Repairs of property damaged by a casualty are not part of the casualty loss deduction. You capitalize the cost of the repairs and add them to your basis in the damaged property. But then you may qualify to depreciate or Section 179 expense them.
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