Disaster loss can be tax-deductible
If your home or other property was damaged or destroyed last year by the wildfires in Southern California or by a tornado or flood elsewhere, you might be able to recover a portion of your loss from Uncle Sam. But doing so isn’t easy.
Federal tax law allows you to deduct from your taxable income a substantial economic loss caused by a “sudden, unexpected or unusual event.” A natural disaster is the most likely cause of such a setback, known as a casualty loss. But there are cases in which taxpayers have successfully claimed casualty losses for diamonds lost in a garbage disposal or a car that was impounded and prematurely crushed by the city.
Claiming the write-off, however, is a challenge.
“There are a lot of pitfalls,” said Jackie Perlman, tax researcher for H&R; Block Inc. in Kansas City. “It’s not something that I would suggest that you attempt to calculate on your own.”
What makes it so difficult?
First, there’s a high threshold to get over. Casualty losses can be claimed only to the extent that they exceed 10% of your adjusted gross income plus $100. For example, if your adjusted gross income is $100,000, you can claim only that part of your casualty loss that exceeds $10,100.
And the amount you can deduct is reduced by any insurance proceeds you received to compensate for the loss.
Before you even get to that point, you have to determine the size of your loss.
There are two methods. One is to add up how much you spent to replace or repair the property, then subtract any insurance reimbursements. The other method is to compare the appraised value of the property before the loss with the appraised value of the property after. You can choose the method that gives you the bigger loss.
Then it gets really complicated.
Under the tax law, the amount you deduct for a casualty loss can’t exceed your “adjusted cost basis” in the property, said Mark Luscombe, a federal tax analyst at publisher CCH Inc.
So what’s your adjusted cost basis? To start with, it’s how much you paid for the property plus the amount you spent on “permanent” improvements. (Cosmetic enhancements, such as paint and wallpaper, don’t count.)
Let’s say you bought your home in Malibu for $50,000 in 1970 and you spent another $50,000 on improvements, such as a new roof and air conditioning. Over the years, the value of the property rose to $1 million. You then sustained a $200,000 uninsured loss in the wildfires.
But because your cost in the property is just the $50,000 purchase price plus the $50,000 in permanent improvements, the most you could claim as a casualty loss would be $100,000.
That’s not all. If you bought your house more than 11 years ago, there may be an added complication.
Before 1997, if you sold your house for a profit, you could indefinitely defer paying tax on the gain by buying another home of equal or greater value. But any gains you deferred that way reduce your cost basis in your current home, potentially reducing your casualty deduction by the amount of gains you deferred more than a decade ago.
In addition, if you lost a home that included a home office, an additional set of rules would apply, Perlman said.
And one last complication: Taxpayers who suffer a loss in a location declared a disaster area by the president can claim the loss on their tax return for the year in which the loss occurred or for the previous year. If you claim it in the earlier year, you might not have to wait as long for the tax refund generated by your casualty deduction. But if your income was lower in the year of the loss, you might be able to claim a bigger loss for that year’s taxes.
“The smartest thing to do is calculate the loss both ways to see what comes up with the better result,” Perlman said. “It is not a simple subject.’
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