Disaster Losses Including Casualty and Theft IRS Publication 547 - IRS Form 4684 - John R. Dundon II, Enrolled Agent
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Disaster Losses Including Casualty and Theft IRS Publication 547 – IRS Form 4684

Disaster Losses Including Casualty and Theft IRS Publication 547 – IRS Form 4684

If you take one look at FEMA’s website, it’s clear that we are going to see a significant increase in the number of casualty losses going forward. Should you find yourself a victim of a disaster or a casualty or theft loss it is hugely important that you understand what you are entitled to from a tax perspective.

The best resource for this besides the US Tax Code is IRS Publication 547, Casualties, Disasters, and Thefts.  Be sure to review them before or as part of  preparing IRS Form 4684 when reporting to the IRS. Another good resource of course is the Instructions to the Casualty and Loss reporting form 4684.

Most people understand the proper tax treatment of what is often referred to as “standard” casualty and theft losses.

1. calculate the cost basis of the property before the loss

2. determine the decrease in the fair market value of the property as a result of the loss.

3. From the smaller of the two deduct any insurance or other reimbursement received.

4. Using IRS Form 4684 apply the deduction limits to determine the amount of our deductible loss.

Here is where it starts to get convoluted. Each loss must be reduced by $100. And you further reduce the total of all losses by ten percent of your adjusted gross income.

It’s also important to remember that the loss must be reported the year in which it occurred.

Before deducting the loss, you must be able to prove that there was a loss. If the loss is from theft for example

1. you should be able to identify when you discovered your property was missing,

2. that you were the owner,

3. that the property was actually stolen, and

4. whether an insurance claim was submitted.

This process is actually very easy if your front door is smashed when you get home from work. It’s obvious that someone has broken into your home. Obviously you call the police when you notice that your new flat-screen hi-definition television is missing. For tax purposes, you’ll have a dated police report, and since the TV was new, you most likely have a receipt that has information on the warranty. This will prove your ownership. How often does this happen though? In reality not all items are as easy to identify or value like antique inherited jewelry for example.

An annual inventory of the assets you keep at home is always a good thing to have on hand.

For a casualty loss you’ll need to show similar facts

1. the type of casualty be it auto, accident, fire, storm, etc.;

2. the date the casualty occurred;

3. that the loss was a direct result of the casualty;

4. that you were the owner of the property; and

5. whether an insurance claim has been filed.

However, a large part of the reporting process is determining the fair market value of your property after the loss. That’s pretty easy to do if it’s stolen. You have no property left to even have a fair market value (FMV).

But how do you calculate the FMV of damaged property? Often an insurance adjuster (auto, home, etc.) will assist in calculating the FMV.

It is often in your best interest to get an outside appraisal. If you go this path it’s important to have an appraiser who is familiar with your type of property. The appraiser should also have a good knowledge of the sales of comparable property in your geographical area.

For expensive items, the appraisal may be called into play should the IRS ever question the deduction, having a qualified professional preparing the appraisal is key.

Once you have established the fact that you do indeed have a casualty loss, you can prove when it happened, you can prove you owned the property, and you can prove the property’s value before and after the casualty. Now what should you do?

Here’s an example.

A tree has fallen on my son Hank’s fancy sports car, totaling it. The fair market value of the car before this happened was $60,000. The fair market value is now zero. The car’s basis is $75,000. Because Hank went with the cheapest insurance he only gets reimbursed $35,000.

His casualty loss would be $25,000 since he must take the lesser of the FMV or the cost basis ($60,000) and subtract the insurance reimbursement ($35,000).

To calculate the deductible amount of Hank’s loss he first subtracted the $100 limit, which left him with $24,900. His adjusted gross income is $100,000, so he must then subtract $10,000 (the equivalent of ten percent of his AGI). This provides him with a deductible loss of $14,900. In that he is a taxpayer in the 15 percent tax bracket he saw a tax savings of just over $2,000, just enough to buy a better car insurance policy.

If the loss has occurred to property owned by a business, the rules are almost the same and the loss is still reported on IRS Form 4684. 

Tax implications change when with federally declared disaster areas. If in a federally declared disaster area you can choose whether to claim the loss in the year of occurrence or on an amended return for the year immediately preceding the tax year in which the disaster happened. The idea behind this choice is that amending the previous year’s tax return may result in a lower tax for that year producing a refund. You can in theory receive the economic benefit of the deduction sooner by receiving an immediate refund on the preceding year’s return rather than waiting for the close of the current tax year.

For example, Amelia my daughter is a calendar year taxpayer living in San Francisco. In 2011, an earthquake severely damages her home and the President declares a federal disaster area.

Amelia could wait until April 2012 to file her tax return and claim the casualty loss in 2011. Or, she could amend her 2010 income tax return and claim a refund now. In so doing the additional funds would be helpful to ease the financial burden caused by the damage and subsequent cost of repairs to the home, especially for her Dad.

There’s a time limit for making the choice of which year to report the loss. If Amelia wants to take the loss in the preceding year, she must do it by the later of the following two dates:

• The due date (without extensions) for filing her tax return for the year in which the disaster actually occurred.

• The due date (with extensions) for filing the return for the preceding year.

One of the things to remember about amending the preceding year’s tax return is that you must follow that year’s tax law. For example purposes, assume that you had a loss in a federally declared disaster area in 2011, but are choosing to amend you 2010 income tax return to claim the refund.

As of the writing of this article there were no major tax law changes between 2010 and 2011 in the proper handling of deductions that I am aware of however be sure to familiarize yourself that with changes in tax law before you decide to amend the prior year tax return.

For example in 2009, the ten percent rule did not apply to losses sustained in federally declared disaster areas. And, there was a $500 rule, not a $100 rule. Here are some other rules of thumb:

$100 Rule 10% Rule General application

You must reduce each casualty or theft loss by $100 when figuring your deduction. Apply this rule to personal use property after you have figured the amount of your loss.

You must reduce your total casualty or theft loss by 10 percent of your adjusted gross income. Apply this rule to personal-use property after you reduce each loss by $100.

Single event

Apply this rule only once, even if many pieces of property are affected. Apply this rule only once, even if many pieces of property are affected.

More than one event

Apply to the loss from each event.

Apply to the total of all your losses from all events.

Married couple filing joint return with loss from the same event

Apply as if you were one person. Apply as if you were one person.

Married couple filing separate returns with loss from the same event

Apply separately to each spouse. Apply separately to each spouse.

More than one owner (other than a married couple filing jointly)

Apply separately to each owner or jointly owned property.

Apply separately to each owner of jointly owned property.