Casualty Losses at Home Bring No Windfall From the IRS
The large oak tree in your backyard was felled by a massive storm, causing damage to your fence and your garage. Strong winds blew the shingles off your roof. And termites caused major damage in your basement.
Can you deduct your losses when you file your income tax return? The answer is "perhaps," but don't expect a windfall from the Internal Revenue Service. The law relating to casualty losses is complex and quite bizarre.
Recently, the IRS issued a Tax Tip listing 10 things taxpayers should know when considering whether their losses can be deducted for tax purposes. The first thing to understand is that unless your loss occurred in a federally declared disaster area (such as New Orleans after Hurricane Katrina or many Midwestern states after the severe storms last year), you cannot deduct a loss unless you itemize your tax deductions on IRS Form 1040, Schedule A. According to the Government Accountability Office, only 30 percent of taxpayers itemize, while approximately 70 percent claim the standard deduction.
Second, you are not permitted to deduct any casualty loss that is covered by insurance unless you are timely in filing a claim for reimbursement. And any money you receive from the insurance company will reduce the amount you can claim as a deduction.
The IRS defines a casualty as "damage, destruction or loss of property from an identifiable event that is sudden, unexpected, or unusual." Thus, the damage caused by a storm would be a casualty. However, termite damage is considered by the IRS to be "progressive deterioration" and not sudden, and will not be allowed as a deduction. It should be noted, however, that some courts have disagreed and allowed the deduction. If your tree is destroyed by disease or insects or worms, this is not a "sudden" event. If, however, the destruction is caused by an unexpected or unusual infestation of beetles or other insects, this may be considered a casualty loss.
There are limits on how much you can deduct.
Once you have determined that your loss can be deducted as a casualty, you must subtract $100 from the amount of the loss. For losses that occur this year, based on the Emergency Economic Stabilization Act of 2008, this floor is raised to $500 -- but only for the 2009 tax year.
Next, you have to apply the 10 percent rule. According to the IRS, "the total of all your casualty and theft losses of personal-use property usually must be further reduced by 10 percent of your adjusted gross income." Again, if your loss occurred in a federally declared disaster area, you can ignore this limitation.
There are special rules for damage to real estate. To determine your loss, the land and all improvements, such as buildings and landscaping, must be considered together. The IRS provides a helpful example for the 2009 tax year:
You bought your home a few years ago. You paid $150,000 ($10,000 for the land and $140,000 for the house). You spent an additional $2,000 for landscaping. This year a fire destroyed your home and damaged your shrubbery and trees. Appraisers valued the property as a whole at $175,000 before the fire, but at only $50,000 afterward. The insurance company paid you $95,00 for the loss. Your adjusted gross income for this year is $70,000.
Your adjusted basis (basically the purchase price plus the cost of improvements) in the home is $152,000. Fair market value before fire was $175,000; after fire it was $50,000, so the decrease in fair market value is $125,000. Subtract $95,000 of insurance proceeds, so the loss after insurance reimbursement is $30,000. Subtract $500 for the IRS's floor on losses, and that amount shrinks to $29,500. Then subtract 10 percent of your adjusted gross income, or $7,000. Finally you arrive at the amount you can claim as a casualty loss deduction: $22,500.
Why do you have to include the adjusted basis in this calculation? Because for tax purposes, your loss is based on whichever is smaller, your basis or the decrease in fair market value.
Thus, even though your real loss was $30,000, because of various rules, you are still going to lose at least $7,500 ($30,000 minus your tax deduction of $22,500) because of the fire. And remember, the $22,500 is a tax deduction, which means only that this will reduce your overall tax obligation. This does not even include the heartaches and headaches of restoring the family home.
There are different rules for business losses, and even more rules for losses on property used for business and personal purposes.
As you can see, the law is extremely complex. Hopefully, you will never suffer any loss, but should one occur, get a copy of IRS Publication 547, "Casualties, Disasters and Thefts" (http:/
File your insurance claim immediately, even if you do not know the full extent of the damage. And perhaps more importantly, consult your tax adviser to make sure you are on the right track.
Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http:/