A disaster loss is actually a casualty loss that occurs in a geographic area that the President of the United States declares eligible for Federal disaster assistance. Disaster losses are also eligible for special tax benefits, which are discussed in this brochure. Note: Tax reform no longer allows a federal deduction for personal casualty losses other than in disaster areas. Some states continue to allow non-disaster area casualty loss deductions. What is a Casualty Loss?A casualty loss occurs when there is property damage from a sudden, unanticipated event. Some examples of qualifying events are: hurricanes, earthquakes, tornadoes, floods, storms, fire and volcanic eruptions. Why Are Disaster Losses Different?Taxpayers within a federally declared disaster area may elect to claim their loss: In the year it occurs, or On the preceding year’s return. Example: A taxpayer in a federally declared disaster area can claim a casualty loss either on their return for the year of the loss or on their return for the previous year. If the previous year’s return has already been filed, as is generally the case, it can be amended by filing a Form 1040X. In contrast, someone who suffered an individual casualty (a car accident, a house fire caused by a cooking mishap, etc.) who is eligible to claim a casualty loss may only do so on the return for the year that the casualty occurred. The return on which to claim a disaster loss deduction depends upon a number of factors and should be carefully analyzed to determine which year is the most beneficial for the taxpayer. The tax brackets for each year – Each year should be carefully examined as to which will provide the greatest overall tax advantage without wasting other tax benefits. The need for immediate cash – The primary purpose of the special rules allowing the casualty loss to be claimed on the prior year’s return is to provide a taxpayer access to a tax refund without the need to wait – often many months - to file their return for the year of the loss. Self-employment tax – Self-employed taxpayers will also need to consider whether to take a business casualty loss that affects inventory in the current or prior year since the loss can offset self-employment tax as well as income taxes. Whether the loss will be used up – If the casualty loss is not fully used up in the year it is first deducted, it can create what is called a net operating loss (NOL). For losses claimed on a 2018 or later year return, the NOL is carried forward as a deduction on the next and future years until used up. If the loss is claimed on the 2017 or an earlier year return, the NOL is first taken back to the second prior year return; any excess carries forward. NOLs occurring in 2018 and subsequent years can only offset 80% of a subsequent year’s taxable income. Values the Loss is Based UponGenerally, for each item lost in the casualty the deductible loss is the lesser of: The cost or adjusted basis(1) or The decrease in fair market value(2) (FMV) Once the loss is determined for each individual item, then those amounts are added together to determine the total loss for the casualty event. For real property, the loss is figured on the whole property (buildings, plants, trees, etc.), not item-by-item. (1) Generally, the measure of a taxpayer’s basis in a property is its cost. When property is inherited, received as a gift, or acquired in a nontaxable exchange, the basis will be determined in some other manner. Certain events can take place after acquiring the property that can increase or decrease the basis; thus the term “adjusted basis”. Examples would be improvements to the property, depreciation and casualty loss deductions. (2) Fair market value (FMV) is the price that a willing seller would accept from a willing buyer when the seller does not need to sell nor must the buyer purchase and both are aware of all the relevant facts.Business or Personal CasualtyThose that are business casualty losses are fully deductible without limitations. Personal casualty losses, on the other hand, are first reduced: by $100 for each event, and then the total of all events for the year is reduced by 10%of the taxpayer’s annual income (Adjusted Gross Income). In addition, for personal casualty losses, deductions must be itemized in order to take advantage of the loss. Example: Claiming a Personal Loss – The taxpayer’s principal residence was damaged in a flood in a federally declared disaster area. The damage amounted to $12,000 and the taxpayer had no flood insurance. His AGI for the year was $57,000. His casualty loss for the year is determined as follows: Casualty loss $ 12,000 “Per-event” amount -100 10% of AGI -5,700 Casualty loss $ 6,200 Since the loss occurred in a federally declared disaster, the taxpayer can elect to take the casualty in the prior tax year.Figuuring a LossTo determine the deduction for a casualty or theft loss, figure out the loss first. Amount of loss: Figure the amount of the loss using the following steps. Determine the adjusted basis in the property before the casualty or theft. Determine the decrease in fair market value (FMV) of the property as a result of the casualty or theft. Subtract any insurance proceeds or other reimbursement received (or expected to be received) from the smaller of the amounts determined in (1) and (2). If the property is covered by insurance, the taxpayer must file a timely insurance claim for reimbursement of the loss. Otherwise, a casualty or theft loss deduction cannot be claimed for that property. However, the part of the loss usually not covered by insurance (for example, a deductible) is not subject to this rule. Gain From ReimbursementIt is possible to incur a gain from a casualty event. If a taxpayer’s reimbursement is more than the adjusted basis in the property, there is a gain. This is true even if the decrease in the FMV of the property is smaller than the adjusted basis. If there is a gain, taxes may have to be paid on it, or reporting the gain may be postponed (as discussed later). If the gain is from a taxpayer’s primary residence and the taxpayer has owned and used the residence as the main home for 2 out of the prior 5 years, the taxpayer can exclude $250,000 ($500,000 on a joint return) of gain. Example: Assume an individual purchased his home for $50,000 fifteen years ago and the home is destroyed by a hurricane. The insurance company decides the home is a total loss and pays the single homeowner $200,000 as the settlement for the loss. He decides not to rebuild and sells the lot where the house once stood for $40,000. If the taxpayer elects to use his $250,000 home gain exclusion to offset the gain from the casualty, he would have no taxable gain.