Casualty
losses: limitations for personal-use property, and how they're claimed
Taxpayers who experience certain types of
major personal casualties may be able to recoup some of their losses through
tax savings. This article explains the mechanics of casualty losses, as well as
how and when they are claimed.
Background on casualty loss deductions. Taxpayers generally are allowed to deduct
losses sustained during the tax year that are not compensated by insurance or
otherwise. (Code Sec. 165) The deduction
is limited to taxpayers who itemize their deductions. For personal-use property
(such as a taxpayer's personal residence and household appliances), Code Sec. 165 limits an individual's deduction to losses
arising from fire, storm, shipwreck, or other casualty, or from theft. A
casualty is damage, destruction, or loss of property that results from an
identifiable event that is sudden, unexpected, and unusual. Damage or loss
resulting from progressive deterioration of property through a steadily
operating cause is not a casualty loss.
A casualty loss is generally allowed as a
deduction only for the tax year in which the loss is sustained, with an
exception for certain disaster losses (see below). However, if the taxpayer has
a claim for reimbursement of the loss (from insurance or otherwise) for which
there is a reasonable prospect of recovery, no portion of the loss is
deductible until it can be ascertained with reasonable certainty whether or not
such reimbursement will be received. (Reg. § 1.165-1(c)(4))
The amount of a taxpayer's casualty loss
generally is the decrease in the fair market value (FMV) of the property as a
result of the casualty, limited to the taxpayer's adjusted basis in the
property. (Reg. § 1.165-7(b))
Two limitations apply to casualty loss
deductions for personal use property. (Code Sec. 165(h)) First, a
casualty loss deduction is allowable only for the amount of the loss that
exceeds $100 per casualty. Second, the net amount of all of a taxpayer's
casualty losses (in excess of casualty gains, if any) is allowable only for the
amount of the losses that exceed 10% of the taxpayer's adjusted gross income
(AGI) for the year.
When to take the deduction. For casualty losses from a federally declared
disaster, a taxpayer can claim the loss in the year incurred or elect to take
the loss in the year before it was incurred. This may increase the tax savings
from the loss and may entitle the taxpayer to a refund earlier than waiting to
file the loss year's return.
How to claim. Casualty losses are reported on Schedule A to
Form 1040. The taxpayer must complete and attach a Form 4684, Casualties and Thefts, which contains entries including
descriptions of the property (or properties), their cost basis, and their FMV
before and after the casualty.
To claim the disaster loss on the prior year's
return, an election statement must be prepared and attached to the return. The
statement must include specific information about the time, place and nature of
the disaster that caused the loss.
Not every casualty results in a loss for tax
purposes. In certain situations, a taxpayer may have a “casualty gain.” For
instance, suppose a taxpayer buys a house for $100,000 (his tax basis) and it
increases in value to $300,000 over the years. If it's destroyed and the
taxpayer receives close to $300,000 in insurance, he will have a gain of close
to $200,000 since his basis was only $100,000. However, in certain cases, tax
on a casualty gain can be avoided or deferred.
Reg §1.165-7. Casualty losses.
Caution: The Treasury has not yet amended Reg § 1.165-7 to
reflect changes made by P.L. 97-248
Effective: Reg.
§1.165-7 has not been updated to reflect subsequent legislation.
(a) In general.
(1) Allowance of deduction. Except as otherwise provided in
paragraphs (b)(4) and (c) of this section, any loss arising from fire, storm,
shipwreck, or other casualty is allowable as a deduction under section 165(a)
for the taxable year in which the loss is sustained. However, see §1.165-6,
relating to farming losses, and §1.165-11, relating to an election by a
taxpayer to deduct disaster losses in the taxable year immediately preceding
the taxable year in which the disaster occurred. The manner of determining the
amount of a casualty loss allowable as a deduction in computing taxable income
under section 63 is the same whether the loss has been incurred in a trade or
business or in any transaction entered into for profit, or whether it has been
a loss of property not connected with a trade or business and not incurred in
any transaction entered into for profit. The amount of a casualty loss shall be
determined in accordance with paragraph (b) of this section. For other rules
relating to the treatment of deductible casualty losses, see §1.1231-1,
relating to the involuntary conversion of property.
(2) Method of valuation.
(i) In determining the amount of loss deductible under this
section, the fair market value of the property immediately before and
immediately after the casualty shall generally be ascertained by competent
appraisal. This appraisal must recognize the effects of any general market
decline affecting undamaged as well as damaged property which may occur
simultaneously with the casualty, in order that any deduction under this
section shall be limited to the actual loss resulting from damage to the
property.
(ii) The cost of repairs to the property damaged is
acceptable as evidence of the loss of value if the taxpayer shows that (a) the
repairs are necessary to restore the property to its condition immediately
before the casualty, (b) the amount spent for such repairs is not excessive,
(c) the repairs do not care for more than the damage suffered, and (d) the
value of the property after the repairs does not as a result of the repairs
exceed the value of the property immediately before the casualty.
(3) Damage to automobiles. An automobile owned by the
taxpayer, whether used for business purposes or maintained for recreation or
pleasure, may be the subject of a casualty loss, including those losses
specifically referred to in subparagraph (1) of this paragraph. In addition, a
casualty loss occurs when an automobile owned by the taxpayer is damaged and
when:
(i) The damage results from the faulty driving of the
taxpayer or other person operating the automobile but is not due to the willful
act or willful negligence of the taxpayer or of one acting in his behalf, or
(ii) The damage results from the faulty driving of the
operator of the vehicle with which the automobile of the taxpayer collides.
(4) Application to inventories. This section does not apply
to a casualty loss reflected in the inventories of the taxpayer. For provisions
relating to inventories, see section 471 and the regulations thereunder.
(5) Property converted from personal use. In the case of
property which originally was not used in the trade or business or for
income-producing purposes and which is thereafter converted to either of such
uses, the fair market value of the property on the date of conversion, if less
than the adjusted basis of the property at such time, shall be used, after
making proper adjustments in respect of basis, as the basis for determining the
amount of loss under paragraph (b)(1) of this section. See paragraph (b) of
§1.165-9, and §1.167(g)-1.
(6) Theft losses. A loss which arises from theft is not
considered a casualty loss for purposes of this section. See §1.165-8, relating
to theft losses.
(b) Amount deductible.
(1) General rule. In the case of any casualty loss whether
or not incurred in a trade or business or in any transaction entered into for
profit, the amount of loss to be taken into account for purposes of section
165(a) shall be the lesser of either—
(i) The amount which
is equal to the fair market value of the property immediately before the
casualty reduced by the fair market value of the property immediately after the
casualty; or
(ii) The amount of
the adjusted basis prescribed in §1.1011-1 for determining the loss from the
sale or other disposition of the property involved. However, if property used
in a trade or business or held for the production of income is totally
destroyed by casualty, and if the fair market value of such property
immediately before the casualty is less than the adjusted basis of such
property, the amount of the adjusted basis of such property shall be treated as
the amount of the loss for purposes of section 165(a).
(2) Aggregation of property for computing loss.
(i) A loss incurred in a trade or business or in any
transaction entered into for profit shall be determined under subparagraph (1)
of this paragraph by reference to the single, identifiable property damaged or
destroyed. Thus, for example, in determining the fair market value of the
property before and after the casualty in a case where damage by casualty has
occurred to a building and ornamental or fruit trees used in a trade or
business, the decrease in value shall be measured by taking the building and
trees into account separately, and not together as an integral part of the
realty, and separate losses shall be determined for such building and trees.
(ii) In determining a casualty loss involving real property
and improvements thereon not used in a trade or business or in any transaction
entered into for profit, the improvements (such as buildings and ornamental
trees and shrubbery) to the property damaged or destroyed shall be considered
an integral part of the property, for purposes of subparagraph (1) of this
paragraph, and no separate basis need be apportioned to such improvements.
(3) Examples. The application of this paragraph may be
illustrated by the following examples:
Example (1). In 1956 B purchases for $3,600 an automobile
which he uses for nonbusiness purposes. In 1959 the automobile is damaged in an
accidental collision with another automobile. The fair market value of B's
automobile is $2,000 immediately before the collision and $1,500 immediately
after the collision. B receives insurance proceeds of $300 to cover the loss.
The amount of the deduction allowable under section 165(a) for the taxable year
1959 is $200, computed as follows:
Value of
automobile immediately before casualty.......... $
2,000
Less: Value of
automobile immediately after casualty..... 1,500
_________
Value of property
actually destroyed..................... 500
=========
Loss to be taken
into account for purposes of section 165(a):
Lesser amount
of property actually destroyed ($500) or
adjusted basis
of property ($3,600)....................
$ 500
Less: Insurance
received................................. 300
_________
Deduction
allowable...................................... $
200
Example (2). In 1958 A purchases land containing an office
building for the lump sum of $90,000. The purchase price is allocated between
the land ($18,000) and the building ($72,000) for purposes of determining
basis. After the purchase A planted trees and ornamental shrubs on the grounds
surrounding the building. In 1961 the land, building, trees, and shrubs are
damaged by hurricane. At the time of the casualty the adjusted basis of the
land is $18,000 and the adjusted basis of the building is $66,000. At that time
the trees and shrubs have an adjusted basis of $1,200. The fair market value of
the land and building immediately before the casualty is $18,000 and $70,000,
respectively, and immediately after the casualty is $18,000 and $52,000,
respectively. The fair market value of the trees and shrubs immediately before
the casualty is $2,000 and immediately after the casualty is $400. In 1961
insurance of $5,000 is received to cover the loss to the building. A has no
other gains or losses in 1961 subject to section 1231 and §1.1231-1. The amount
of the deduction allowable under section 165(a) with respect to the building
for the taxable year 1961 is $13,000, computed as follows:
Value of property
immediately before casualty............
$ 70,000
Less: Value of
property immediately after casualty....... 52,000
_________
Value of property
actually destroyed.....................
18,000
=========
Loss to be taken
into account for purposes of section 165(a):
Lesser amount
of property actually destroyed ($18,000) or
adjusted basis
of property ($66,000)...................
$ 18,000
Less: Insurance
received................................. 5,000
_________
Deduction
allowable...................................... $
13,000
The amount of the deduction allowable under section 165(a)
with respect to the trees and shrubs for the taxable year 1961 is $1,200,
computed as follows:
Value of property
immediately before casualty............
$ 2,000
Less: Value of
property immediately after casualty....... 400
_________
Value of property
actually destroyed.....................
$ 1,600
=========
Loss to be taken
into account for purposes of section 165(a):
Lesser amount
of property actually destroyed ($1,600) or
adjusted basis
of property ($1,200)....................
$ 1,200
Example (3). Assume the same facts as in example (2) except
that A purchases land containing a house instead of an office building. The
house is used as his private residence. Since the property is used for personal
purposes, no allocation of the purchase price is necessary for the land and
house. Likewise, no individual determination of the fair market values of the
land, house, trees, and shrubs is necessary. The amount of the deduction
allowable under section 165(a) with respect to the land, house, trees, and
shrubs for the taxable year 1961 is $14,600, computed as follows:
Value of property
immediately before casualty............
$ 90,000
Less: Value of
property immediately after casualty....... 70,400
_________
Value of property
actually destroyed.....................
$ 19,600
=========
Loss to be taken
into account for purposes of section 165(a):
Lesser amount
of property actually destroyed ($19,600) or
adjusted basis
of property ($91,200)...................
$ 19,600
Less: Insurance
received................................. 5,000
________
Deduction
allowable...................................... $ 14,600
(4) Limitation on certain losses sustained by individuals
after December 31, 1963.
(i) Pursuant to section 165(c)(3), the deduction allowable
under section 165(a) in respect of a loss sustained—
(a) After December 31, 1963, in a taxable year ending after
such date,
(b) In respect of property not used in a trade or business
or for income producing purposes, and
(c) From a single casualty
shall be limited to that portion of the loss which is in
excess of $100. The nondeductibility of the first $100 of loss applies to a
loss sustained after December 31, 1963, without regard to when the casualty
occurred. Thus, if property not used in a trade or business or for income
producing purposes is damaged or destroyed by a casualty which occurred prior
to January 1, 1964, and loss resulting therefrom is sustained after December
31, 1963, the $100 limitation applies.
(ii) The $100 limitation applies separately in respect of
each casualty and applies to the entire loss sustained from each casualty.
Thus, if as a result of a particular casualty occurring in 1964, a taxpayer
sustains in 1964 a loss of $40 and in 1965 a loss of $250, no deduction is
allowable for the loss sustained in 1964 and the loss sustained in 1965 must be
reduced by $60 ($100 − $40). The determination of whether damage to, or
destruction of, property resulted from a single casualty or from two or more
separate casualties will be made upon the basis of the particular facts of each
case. However, events which are closely related in origin generally give rise
to a single casualty. For example, if a storm damages a taxpayer's residence
and his automobile parked in his driveway, any loss sustained results from a
single casualty. Similarly, if a hurricane causes high waves, all wind and
flood damage to a taxpayer's property caused by the hurricane and the waves
results from a single casualty.
(iii) Except as otherwise provided in this subdivision, the
$100 limitation applies separately to each individual taxpayer who sustains a
loss even though the property damaged or destroyed is owned by two or more
individuals. Thus, if a house occupied by two sisters and jointly owned by them
is damaged or destroyed, the $100 limitation applies separately to each sister
in respect of any loss sustained by her. However, for purposes of applying the
$100 limitation, a husband and wife who file a joint return for the first
taxable year in which the loss is allowable as a deduction are treated as one
individual taxpayer. Accordingly, if property jointly owned by a husband and
wife, or property separately owned by the husband or by the wife, is damaged or
destroyed by a single casualty in 1964, and a loss is sustained in that year by
either or both the husband or wife, only one $100 limitation applies of a joint
return is filed for 1964. If, however, the husband and wife file separate
returns for 1964, the $100 limitation applies separately in respect of any loss
sustained by the husband and in respect of any loss sustained by the wife.
Where losses from a single casualty are sustained in two or more separate tax
years, the husband and wife shall, for purposes of applying the $100 limitation
to such losses, be treated as one individual for all such years if they file a
joint return for the first year in which a loss is sustained from the casualty;
they shall be treated as separate individuals for all such years if they file
separate returns for the first such year. If a joint return is filed in the
first loss year but separate returns are filed in a subsequent year, any unused
portion of the $100 limitation shall be allocated equally between the husband
and wife in the latter year.
(iv) If a loss is sustained in respect of property used
partially for business and partially for nonbusiness purposes, the $100
limitation applies only to that portion of the loss properly attributable to
the nonbusiness use. For example, if a taxpayer sustains a $1,000 loss in
respect of an automobile which he uses 60 percent for business and 40 percent
for nonbusiness, the loss is allocated 60 percent to business use and 40
percent to nonbusiness use. The $100 limitation applies to the portion of the
loss allocable to the nonbusiness loss.
(c) Loss sustained by an estate. A casualty loss of property
not connected with a trade or business and not incurred in any transaction
entered into for profit which is sustained during the settlement of an estate
shall be allowed as a deduction under sections 165(a) and 641(b) in computing
the taxable income of the estate if the loss has not been allowed under section
2054 in computing the taxable estate of the decedent and if the statement has
been filed in accordance with § 1.642(g)-1. See section 165(c)(3).
(d) Loss treated as though attributable to a trade or
business. For the rule treating a casualty loss not connected with a trade or
business as though it were a deduction attributable to a trade or business for
purposes of computing a net operating loss, see paragraph (a)(3)(iii) of
§1.172-3.
(e) Effective date. The rules of this section are applicable
to any taxable year beginning after January 16, 1960. If, for any taxable year
beginning on or before such date, a taxpayer computed the amount of any
casualty loss in accordance with the rules then applicable, such taxpayer is
not required to change the amount of the casualty loss allowable for any such
prior taxable year. On the other hand, the taxpayer may, if he so desires,
amend his income tax return for such year to compute the amount of a casualty
loss in accordance with the provisions of this section, but no provision in
this section shall be construed as extending the period of limitations within
which a claim for credit or refund may be filed under section 6511.
T.D. 6445, 1/15/60, amendT.D. 6712, 3/23/64 ,T.D. 6735,
5/18/64 ,T.D. 6786, 12/28/64 ,T.D. 7522, 12/13/77 .
www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com
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