On October 29, Superstorm Sandy caused havoc on the East Coast of the United States and resulted in approximately $81 billion in property losses in New York and New Jersey alone. It has also created massive disruptions in the day-to-day family lives and business routines of those affected.
Taxpayers should be aware that under current law, relief is available to those who suffered property damage. Both individuals and businesses may claim a casualty-loss deduction on their federal income tax returns to recoup some of that loss. This article will focus on the individual and business aspects of the casualty-loss deduction.
Under federal law, an individual may claim on his or her tax return a casualty loss on Form 4684 which carries over to Schedule A as an itemized deduction. The casualty loss is deductible for both regular tax and alternative minimum tax (AMT) purposes. A casualty loss is defined as “damages, destruction or loss of property resulting from an identifiable event that is sudden, unexpected and unusual in nature.” Clearly, Sandy meets all of these aspects.
The total casualty loss is defined as the difference in the fair market value (FMV) of the property immediately before the casualty and the FMV after the casualty. In many cases, full appraisals or market studies are necessary to determine FMV. However, money spent to restore the property to its pre-storm condition may be sufficient to show the difference in fair market value before and after the casualty.
The deductible amount is the lesser of 1) the decrease in the FMV of the entire property, or 2) the adjusted basis of the entire property. The lesser amount is then reduced further by 10 percent of adjusted gross income (AGI) and $100 to arrive at the casualty loss deduction.
- Individual reports AGI of $100,000
- Owns property with an adjusted basis of $200,000
- FMV before the loss is $250,000
- FMV after the loss is $100,000
- Individual receives $75,000 insurance settlement
The computation of the casualty loss deduction is as follows:
|Line 1 – Adjusted basis of the entire property||$200,000|
|Line 2 – FMV of the entire property before Sandy||$250,000|
|Line 3 – FMV of entire property after Sandy||$100,000|
|Line 4 – Decrease in FMV of entire property (Line 2 less Line 3)||$150,000|
|Line 5 – Loss (smaller of Line 1 or Line 4)||$150,000|
|Less: Insurance reimbursement||$75,000|
|Loss after reimbursement||$75,000|
|Less: 10% of AGI||($10,000)|
|Casualty loss deduction on Schedule A||*$64,900|
|*Not subject to 2% floor|
Ordinarily, the loss is deducted in the year the disaster occurred. In the case of Sandy, the year would be 2012. However, if the loss occurred in a federally declared disaster area, such as is the case for New York and New Jersey, the taxpayer may choose to deduct the loss in the first preceding year (in this case, the 2011 income tax year). This can be accomplished by filing an amended tax return for 2011 and applying the casualty loss in 2012 to 2011. The purpose of this application is to accelerate the claim and the receipt of the tax refund.
There are several more items worth noting. The federal government has in the past waived both the 10 percent and $100 limitations on the loss. For instance, victims of Hurricane Katrina were allowed to deduct 100 percent of the loss on their income tax returns. In the above example, the allowed loss would be $75,000 if the government waives the limits for Sandy. The Treasury has not issued any guidance regarding the waiver of the 10% and $100 limits to date, but we can remain hopeful.
Business casualty losses are treated slightly different than personal casualty losses. When computing a business casualty loss deduction, there is no 10 percent of AGI or $100 limitations and the loss is not reported as an itemized deduction. The full loss after insurance reimbursement is deductible as an ordinary business expense.
For example, Sandy caused damage to a taxpayer’s business property that reduced its FMV by $25,000. The adjusted cost basis of the property is $85,000, and the insurance company reimbursed the owner $20,000 for the loss. Since the loss in FMV is less than the adjusted basis, the $20,000 insurance payment is subtracted from $25,000 for a tentative casualty loss of $5,000. If the property was used in a business, the entire $5,000 is deductible.
Supporting Your Loss Claim
Taxpayers must obtain proper proof to support the loss suffered as a result of Sandy. To prove the FMV of the property after the storm, it is recommended that taxpayers obtain an appraisal of such property from a licensed and competent appraiser. Also, taxpayers should determine the FMV of a house’s contents after the loss. Photos of the damaged and destroyed furnishings and personal items represent viable documentation for this area. To prove the FMV before the loss, the appraiser should also prepare a similar report. Purchase records and comparable values of similar homes in proximity are helpful. In a similar fashion, the FMV of the house’s contents should be documented from photos and receipts if available. It should be noted that a decrease in value of a property because it is in or near the disaster area is not an allowable casualty loss by the Internal Revenue Service. The loss can only be taken for actual casualty damage to the property in the disaster area.
The casualty loss deduction requires the taxpayer to avail herself/himself of all avenues of reimbursement, such as insurance and all federal, state and local aid programs such as the Federal Emergency Management Agency (FEMA). Until such steps are taken, no casualty deduction can be taken. If a claim is initially denied or a refund is received at a later date in an amount greater than expected, any such proceeds are includable in income in the year of receipt.
Mr. Horan is an adjunct professor for SJC’s School of Professional and Graduate Studies, and is a CPA and senior manager for PKF O’Connor Davies, a division of O’Connor Davies LLP. This article was co-written by O’Connor Davies partner Leo Parmegiani.