Hurricane season is winding down and it looks like those of us in South Florida might be in the clear until 2020. But recently a client asked the following question: “If we do have a major storm, are hurricane losses tax-deductible?”
The answer is to this question is technically “yes” but practically “no”. In other words, while it is possible to get a tax break from hurricane losses, there are so many hurdles to overcome that the chances of receiving a tax benefit are very low.
What is the IRS definition of a casualty loss?
The IRS defines a casualty as “damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.” Casualty losses cannot be the result of regular, day-to-day events, nor do they happen gradually over time. They are unexpected and unanticipated.
Under the 2017 tax reform, the definition of a deductible casualty loss was narrowed to only include casualty losses that are a direct result of a federally declared disaster. This means that losses due to a break-in, a water leak, or a lightning strike are not deductible unless these events can be tied to a federal disaster.
Calculating the casualty loss deduction
The amount of casualty loss is generally defined as the decrease in the fair market value of the home1 due to the disaster (limited to the adjusted cost basis of the property), less any insurance proceeds collected. In most cases, this turns out to be homeowner’s hurricane deductible, which in Florida is usually 2% of the value of the dwelling.
Next, to calculate the casualty loss deduction, the casualty loss is reduced by $100 AND 10% of the taxpayers Adjusted Gross Income (AGI). Only the amount in excess of the $100 and 10% of AGI is deductible.
The casualty loss deduction is then included in the taxpayer’s itemized deduction calculation on Schedule A. If the total itemized deductions do not exceed the standard deduction, then the taxpayer will claim the standard deduction, effectively making the casualty loss deduction worthless.
Therefore, for a taxpayer to receive a tax benefit from a casualty loss, the loss must have been produced by a federally declared disaster, the loss must be in excess of $100 and 10% of AGI AND the taxpayer must itemize. Only about 10-15% of taxpayers itemize, and those who do itemize are likely to have higher AGI’s. As you can see, the chances of receiving much of a tax benefit from a casualty loss are small.
Congress and IRS are aware of this, however, which is why for certain high-profile disasters, they have waived the 10 percent of AGI floor reduction AND the requirement to itemize.2 Examples have included Hurricane Harvey, the California wildfires and Hurricanes Irma and Maria.
If you have questions about deducting a casualty loss, please contact our office and we’ll help you sort through the requirements.
- Because appraisals before and after a disaster are unlikely, the IRS has provided several safe harbor methods for determining the amount of the casualty loss. Under the contractor safe harbor, the casualty loss is the cost for repairs under a binding contract with a contractor. Another method is the insurance method, which is based on estimated loss reports from your insurance company. In most cases, the loss equals the amount of the hurricane deductible.
- For these disasters, instead of subtracting $100 per casualty loss from the casualty loss, $500 is subtracted.