Almost everyone has experienced a loss at some point due to a casualty disturbance of some kind, which may be covered by casualty insurance, or outright theft.
Tornadoes, earthquakes, fires, hurricanes, and other natural catastrophes cause billions of dollars in damages each year for both taxpayers and insurance companies.
Theft, notably auto theft and residential burglaries, is a distinct category that costs governments and insurers billions of dollars each year.
This article will explain which forms of casualty and theft losses are deductible, who qualifies for a loss deduction, and when the loss may be deducted.
The Sudden-Event Test
A casualty loss must fulfill the requirements for the sudden-event test, which requires the following:
- The loss must be the outcome of a sudden, unexpected, or uncommon incident.
- The incident must occur at a single occurrence, such as a vehicle collision, and cannot have occurred over a lengthy period of time.
- There must be some element of chance or natural force involved.
Losses incurred as a result of the following incidents would be deductible under this definition:
- Earthquakes, hurricanes, typhoons, tornadoes, floods, fires, and avalanches are examples of natural catastrophes.
- Losses caused by civil unrest, such as riots
However, there are some sorts of losses that are not deductible:
- Those caused by long-term processes like as erosion, drought, wood breakdown, or termite damage.
- Any loss caused by what the Internal Revenue Service (IRS) calls a “foreseeable” incident.
- Not all theft and casualty losses are deductible. It is determined by the circumstances of the loss and its eligibility.
- A casualty loss must fulfill specified conditions for the sudden-event test in order to be tax-deductible.
- If you have trees and shrubs on your property, any loss involving these greens must fulfill the sudden-event test standards.
- A theft loss is only deductible if the taxpayer can show that the loss was caused by theft with strong proof.
Example of a Loss That Is Not Deductible
A couple owns a home that, like the rest of the neighborhood, is situated on a cliff overlooking the city. Unfortunately, erosion causes other buildings nearby to crumble and tumble over the cliff. Their property, however, is intact, and municipal building inspectors allow them to stay.
When they attempt to sell their home three years later, they find that the value has decreased by a stunning $150,000 owing to buyer apprehension caused by the public’s poor opinion of the property as a result of the disaster. They are compelled to sell their home for $175,000 less than the amount they paid for it. This loss, as well as the losses suffered by the homeowners whose homes fell, are not deductible.
Who Can Deduct a Loss—and When?
Only the owner of the lost item may deduct the loss in the year it occurred, subject to certain conditions. Theft losses are deductible the year the owner finds the property has been taken.
If you are leasing property and it is lost or destroyed due to a sudden and unanticipated occurrence that qualifies for a deduction, you may be eligible to deduct the payments you make to the lessor to compensate for the loss.
If, on the other hand, the taxpayer expects to be fully compensated for the loss in a later year, the loss (or at least the portion of the loss for which the taxpayer reasonably anticipates reimbursement) should not be deducted in the year the loss is incurred. If the reimbursement is never received, the loss must still be claimed in the year in which it occurred by submitting an amended return for that year.
For example, if a taxpayer’s home is damaged by fire in 2019, and the taxpayer anticipates receiving insurance payments in 2020, the person should not record a loss on the 2019 return. If the insurance company declines the claim in 2020, the taxpayer must submit an amended 2019 return to reflect the loss.
Losses From Insolvent Banks and Other Savings Institutions
When a financial institution that provides demand-deposit accounts goes bankrupt, its clients may deduct any uninsured losses as either casualty losses or non-business bad debts. If none of the losses were covered, an investment loss might be claimed in their place.
Investment losses, on the other hand, are restricted to $20,000 per institution and are subject to a 2% adjusted gross income (AGI) requirement. To be deductible, the institution must be subject to federal and/or state jurisdiction.
Tree and Shrub Losses
Any loss of trees and shrubs must fulfill the sudden-event requirement, which in this instance might include insect devastation if there is a sudden pandemic that lasts just a few days.
Greenery losses on personal property are calculated by comparing the entire worth of the property before and after the damage. For this reason, structures, land, and growth are grouped together. Trees and plants, on the other hand, are evaluated separately for company property.
To deduct a theft loss, the taxpayer must demonstrate that the loss was caused by theft; mere suspicion of theft will not enough. A theft loss cannot be claimed if the property is just missing.
For example, if you walk out of your home one morning to discover that the empty kiddie pool that had been in your yard the night before has vanished, you cannot claim a deduction for its loss since it may have blown away. However, if you go out to receive your mail and find that your mailbox has been uprooted from its post, this is deemed a loss due to theft since there is no other reason why your mailbox would be gone.
Statements from witnesses who witnessed your item being stolen, police records, and media stories of the burglary are all acceptable forms of evidence of theft.
Calculating and Filing Casualty and Theft Losses
Casualty and theft losses are miscellaneous itemized deductions recorded on IRS Form 4684, which subsequently transfers to Schedule A and finally to the 1040 form. As a result, in order for a loss caused by a catastrophe or theft to be deductible, the taxpayer must be able to itemize deductions. If this is not practicable, no claim may be made.
There are other requirements that must be completed. In general, the sum must be more than $500 and fulfill the 10% AGI threshold.
When Carl’s automobile is wrecked, he suffers a $2,500 loss to satisfy the deductible on his car insurance. Later that year, his residence is again broken into, and $3,000 in valuables is taken. Last year, his adjusted gross income was $40,000, and he is entitled to itemize deductions.
His losses can be calculated as follows:
|$2,500 – $500||$2,000|
|$3,000 – $500||$2,500|
|10% AGI limitation||$4,000|
|Actual deductible amount||$500|
Each loss is subject to a $500 floor, beyond which the remaining sums are tallied. The IRS has arbitrarily decreed that any sum above the 10% AGI limit is deductible. Any sum paid by insurance is not deductible, and any amount reimbursed by insurance later in the year must be reported as income.
Only personal property losses may be claimed on Form 4684. Business losses are subtracted in other places. Losses from casualties and theft may be carried back three years or forward for up to 20 years. Any excess losses may be carried as a net operating loss in either direction.
Taxpayers who suffer losses as a consequence of a catastrophe in a presidentially designated disaster region may disclose their losses on their previous year’s tax return, enabling them to amend the return and obtain an immediate refund as a measure of assistance.
The Federal Emergency Management Agency maintains an up-to-date list of all disaster locations and the years in which they are eligible. Those that do so must produce a statement describing their decision to claim the deduction the prior year, as well as basic details on the time, location, and nature of the catastrophe.
This election must be made before the usual filing date for the current tax year or by the deadline with extensions for the prior tax year. Those who choose to record a loss in a prior year and then change their minds have 90 days to reverse their decision and return any refund received.
Victims in these places are exempt from the 10% AGI requirement if they suffered a net catastrophe loss (meaning that the loss exceeded any amount of insurance or other remuneration).They are also not required to itemize deductions; in this scenario, the loss would be reported on Form 4684 of the standard deduction worksheet. Those who do itemize will report it on Schedule A as usual.
The Bottom Line
As a measure of assistance for persons who have been victims of theft or natural catastrophe, the IRS provides for limited casualty and theft loss deductions. Many restrictions and regulations apply to casualty and theft losses that are beyond the scope of this article. Visit the IRS website or read IRS Publication 547 for additional details.
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