Casualty Loss                                     

   

Generally, you may deduct casualty and theft losses relating to your home, household items and vehicles on your federal income tax return. You may not deduct casualty and theft losses covered by insurance unless you file a timely claim for reimbursement, and you reduce the loss by the amount of any reimbursement or expected reimbursement.

A casualty loss can result from the damage, destruction or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake or even volcanic eruption. A casualty does not include normal wear and tear or progressive deterioration.

A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking must be illegal under the law of the state where it occurred and it must have been done with criminal intent.

If your property is personal-use property or is not completely destroyed, the amount of your casualty loss is the lesser of:

  • The adjusted basis of your property, or

  • The decrease in fair market value of your property as a result of the casualty

The amount of your theft loss is generally the adjusted basis of your property because the fair market value of your property immediately after the theft is considered to be zero.

If your property is business or income-producing property, such as rental property, and is completely destroyed, then the amount of your loss is your adjusted basis.

The loss, regardless of whether it is a casualty or theft loss, must be reduced by any salvage value and by any insurance or other reimbursement you receive or expect to receive. The adjusted basis of your property is usually your cost, increased or decreased by certain events such as improvements or depreciation. For more information about the basis of property, refer to Topic 703, Publication 547, Casualties, Disasters, and Thefts, and Publication 551, Basis of Assets. You may determine the decrease in fair market value by appraisal, or if certain conditions are met, by the cost of repairing the property. For more information, refer to Publication 547.

Individuals are required to claim their casualty and theft losses as an itemized deduction on Form 1040, Schedule A (PDF) (or Form 1040NR, Schedule A (PDF), if you are a nonresident alien). For property held by you for personal use, once you have subtracted any salvage value and any insurance or other reimbursement, you must subtract $100 from each casualty or theft event that occurred during the year. Then add up all those amounts and subtract 10% of your adjusted gross income from that total to calculate your allowable casualty and theft losses for the year.

Casualty and theft losses are reported on Form 4684 (PDF), Casualties and Thefts. Section A is used for personal-use property, and Section B is used for business or income-producing property. If personal-use property was damaged, destroyed or stolen, you may wish to refer to Publication 584, Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property). For losses involving business-use property, refer to Publication 584-B (PDF), Business Casualty, Disaster, and Theft Loss Workbook.

Casualty losses are generally deductible in the year the casualty occurred. However, if you have a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), you can choose to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. Review Disaster Assistance and Emergency Relief for Individuals and Businesses on IRS.gov, for information regarding timeframes and additional information to your specific qualifying event.

Theft losses are generally deductible in the year you discover the property was stolen unless you have a reasonable prospect of recovery through a claim for reimbursement. In that case, no deduction is available until the taxable year in which it can be determined with reasonable certainty whether or not such reimbursement will be received.  I will provide more information on this below.

Special rules may apply to theft losses from Ponzi-type investment schemes. For more information, see the Form 4684 (PDF) and the Form 4684 Instructions (PDF), Casualties and Thefts. Additionally, review Help for Victims of Ponzi Investment Schemes on IRS.gov.

If your loss deduction is more than your income, you may have a net operating loss. You do not have to be in business to have a net operating loss from a casualty. For more information, refer to Publication 536, Net Operating Losses for Individuals, Estates, and Trusts

 

Theft Losses

It appears with this lousy economy that theft losses are becoming more and more common these days. To help alleviate the burden of loss, taxpayers are allowed a theft loss deduction on their tax return in the year the theft is discovered (165). The catch is that taxpayers must prove a theft occurred under the relevant state statute and not their own judgment.   Here is an excerpt from a court case that illustrates this principal.

In October 2005, an Illinois couple, James and Gaetana Urtises, entered into a contract with Onyks Construction & Remodeling for an addition to their existing home. The addition required that part of the old home be destroyed and replaced with the new construction. Additionally, as standard with most construction contracts, Onyks requested that the couple make progress payments at various milestones.

Onyks began the project in November 2005. By January 2006 the project was progressing and payments were being made. However, in February 2006, the owner of Onyks, Dariusz Potok, began demanding progress payments prior to the completion of the milestones to avoid project delays. The Urtises agreed to make the early payments, but instead of paying Onyks or Potok, they paid the subcontractors and suppliers directly in an effort to protect their money. Throughout this time, Potok showed the Urtises the various stages of the project's progression. However, not being experts in the building industry, the Urtises did not realize Potok was lying about aspects of the construction he claimed were complete.

Construction began to run behind schedule, and in July 2006, Potok died suddenly. The Urtises subsequently discovered that Potok possibly had a drug problem that contributed to his financial problems and untimely death. In addition, the Urtises learned that Potok had used their payments for purposes unrelated to their construction project and that Onyks had damaged a portion of their original property because it failed to correctly protect the interior of the home. After Potok's death, the Urtises made significant payments to other companies to repair the damage and to complete the construction.

In 2007, the Urtises claimed a $188,070 theft loss deduction on their tax return for the funds paid to Onyks that were improperly used for purposes other than their construction project. The IRS disallowed the loss because it did not feel this was a theft as defined under Illinois state statue, and the year of the loss was actually 2006, not 2007. The Urtises contested and prevailed.

The Court determined Onyks/Potok committed the crime of home repair fraud under Illinois state law by inducing the Urtises into a contract using deception and misrepresentations, and later making false representations and statements regarding completed work and the need for payments more promptly than required in the contract. Consequently, the Urtises were in fact victims of a theft under their state statue and they were allowed the deduction.

Generally, no loss deduction is allowed in a year where there is a reasonable prospect of recovery. The IRS argued the Urtises were aware of the loss in 2006 and should have taken it then. However, in October 2006, the Urtises filed suit against Onyks. Providing the suit isn't speculative or without merit, the Court allows a lawsuit to be a relevant factor in determining whether a reasonable prospect of recovery exists. Given a valid lawsuit, a loss deduction should be postponed until the litigation is finalized. It was not until 2007 that the Urtises learned the Onyks's insurance policy had lapsed and that in April 2007, Onyks itself was involuntarily terminated. Hopes of any recovery were then gone. Consequently, the Court concurred with the Urtises and agreed that 2007 was the proper year to claim the deduction.

Because the Urtises prevailed in both issues, there was no underpayment and, therefore, no accuracy related penalty was imposed. In contrast to the Tax Court ruling above, it bears mentioning that the Court of Federal Claims Goeller v. U.S. It. al. rejected the IRS's position that the deductibility of a theft loss hinges on state law. Instead, not understanding why Congress would want state-by-state variability, the Court of Federal Claims yielded to Black's Law Dictionary for the definition of theft, citing that this well-accepted definition makes reference to state law unnecessary.

This just serves as a reminder that rules are not always consistent from one court to the next.  If you have suffered a casualty loss, let me know as soon as possible so that you can eliminate or minimize any adverse tax consequences.

 

 

 

 

 

 

 

 Revised 1/16/2014