Casualty Loss Deductions

Miscellaneous

Houston Tax Attorney

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Hurricane Harvey & IRS Casualty Loss Deduction

As Houston recovers from what some consider to be a 1 in 1,000 year event, only 15% of Houston residents are protected by flood insurance. Undoubtedly, there will be massive personal and business losses. A casualty loss deduction on your tax return can help offset some the cost of repairs. The first few weeks after a natural disaster are very important in properly documenting a casualty loss claim and here are some important things you need to know for tax purposes.

Casualty Loss Deduction – an Overview

There are special casualty loss rules for those located in federally declared disaster areas. FEMA has declared Hurricane Harvey a federal disaster and designated the following counties as disaster areas: Aransas, Bee, Brazoria, Calhoun, Chambers, Fort Bend, Galveston, Goliad, Harris, Jackson, Kleberg, Liberty, Matagorda, Nueces, Refugio, San Patricio, Victoria, and Wharton.

Residents of these counties who have experienced a casualty loss may deduct the loss in either the tax period in which the loss occurred or the tax period immediately preceding the disaster year. In this case, casualty losses caused by Hurricane Harvey can be deducted on the 2017 return (filed next year) or on the 2016 return. If the 2016 return has already been filed, you have until October 15, 2018 to file an amended return to claim the casualty loss deduction. If you’ve already paid your 2016 taxes, you may be able to get a refund by amending it.

Figuring out the Amount of the Loss

Step 1: Determine the lower of (A) the adjusted basis in the property before the loss and (B) the decrease in Fair Market Value after the casualty loss. The adjusted basis is the cost of the property plus the cost of any improvements. The Fair Market Value can be proven through an appraisal or the cost of repairs.

Step 2: Subtract the lower of the two amounts in Step 1 and subtract any insurance proceeds received or expected to be received. The net is the amount of your casualty loss.

Business Property

The process is slightly different for casualty loss incurred to business property. The amount of loss is the adjusted basis minus salvage value minus insurance reimbursement.

If there is loss in business inventory, the taxpayer can claim the loss through by either taking a casualty loss deduction or by an adjustment to the cost of goods sold.

Things you Should do Immediately after a Casualty for Tax Purposes

Obviously taxes are not a priority after a natural disaster. But sometime in the days following the incident you should take the following steps to ensure that your casualty loss claim is successful.

1. Begin Reconstructing your Records

Personal Residence/Real Property

  • Be sure to take photographs as quickly as possible after the casualty to establish the extent of the damage. Take photos of specific valuable items if possible, rather than just a general picture of the damage. This will help establish the extent of damage to your personal items.
  • Contact the Title Company, Escrow Company, or bank that handled the purchase to obtain copies of escrow papers. Your real estate broker may also be able to help.
  • Use the current property tax statement for land vs. building ratios, if available; if not available, get copies from the county assessor’s office.
  • Check with appraisal companies to locate a library of old multiple listing books. These can be used for “comps” to establish a basis or fair market value. “Comps” are comparable sales within the same neighborhood.
  • Check with your mortgage company for copies of any appraisals or other information they may have about cost or fair market value.
  • Tax records – Immediately after the casualty, file Form 4506, Request for Copy of Tax Return, to request copies of the previous four years of federal income tax returns. To obtain copies of the previous four years of transcripts you may file a Form 4506‐T, Request for Transcripts of a Tax Return. Write the appropriate disaster designation, such as “HURRICANE HARVEY,” in red letters across the top of the forms to expedite processing and to waive the normal user fee.
  • Improvements – Call the contractor(s) to see if records are available. If possible get statements from the contractors verifying their work and cost.
  • If a home improvement loan was obtained, obtain paperwork from the institution issuing the The amount of the loan may help establish the cost of the improvements.
  • Inherited Property – Check court records for probate values. If a trust or estate existed, contact the attorney who handled the estate or trust.
  • No other records are available – Check at the county assessor’s office for old records about the property. Look for assessed value and ask for the percentage of assessment to value at the time of purchase. This is a rough guess, but better than no records at all.

Vehicles

Kelly’s Blue Book, NADA, and Edmunds are available on‐line and at most libraries. They are good sources for the current fair market value of most vehicles on the road.

  • Call the dealer and ask for a copy of the contract. If not available, give the dealer all the facts and details and ask for a comparable price figure.
  • Use newspaper ads for the period in which the vehicle was purchased to determine cost basis. Use ads for the period when it was destroyed for fair market value. Be sure to keep copies of the ads.
  • If you are still making payments, check with your lien holder.

Personal Property

The number and types of personal property may make it difficult to reconstruct records. One of the best methods is to draw pictures of each room. Draw a floor plan showing where each piece of furniture was placed. Then show pictures of the room looking toward any shelves or tables. These do not have to be professionally drawn, just functional. Take time to draw shelves with memorabilia on them. Do the same with kitchens and bedrooms.

Reconstruct what was there, especially furniture that would have held items — drawers, dressers, and shelves. Be sure to include garages, attics, and basements. Here are some examples of ways that you can prove the value of your personal property:

  • Get old catalogs. These catalogs are a great way to establish cost basis and fair market value. Check the prices on similar items in your local thrift stores to establish fair market value. Walk through the stores and look at comparable items, especially items such as kitchen gadgets. Look for odds and ends you may have had but forgotten because of infrequent use.
  • Use your local “advertiser” as a source for fair market value. Keep copies of the issues handy and copy pages used for specific items to put with your tax records file on the disaster.
  • Check local newspaper want ads for similar items. Again keep a copy of any you use for comparison with the tax
  • If you bought items using a credit card, contact your credit card company.
  • Check with your local library for back issues of newspapers. Most libraries keep old issues on microfilm. The sale sections of these back issues may help establish original costs on items such as appliances.
  • Go to a used bookstore with a tape measure and the diagram of the destroyed property. Measure several rows of used books and count the number of books per shelf. Add up the prices of those books and determine an average cost per shelf. Then count the number of shelves you had in your home and multiply by the average cost per shelf. This will help determine the value of your books before the loss.

Business Records

  • Inventories – Get copies of invoices from suppliers. Whenever possible, the invoices should date back at least one calendar year.
  • Income – Get copies of bank statements. The deposits should closely reflect what the sales were for any given time period.
  • Obtain copies of last year’s federal, state, and local tax returns including sales tax reports, payroll tax returns and business licenses (from city or county). These will reflect gross sales for a given time period.
  • Furniture and fixtures – Sketch an outline of the inside and outside of the business location. Then start to fill in the details of the sketches. (Inside the building — what equipment was where; if a store, where were the products/inventory located. Outside the building — shrubs, parking, signs, awnings, etc.)
  • If you purchased an existing business, go back to the broker for a copy of the purchase agreement. This should detail what was acquired.
  • If the building was constructed for you, contact the contractor for building plans or the county/city planning commissions for copies of any plans.

2. File an Insurance Claim

The IRS requires you to file a timely insurance claim first and then take a casualty loss deduction for any loss that is not covered. The IRS will disallow your casualty loss deduction if you fail to make a timely insurance claim.

3. Begin Documenting your Casualty Losses

If you try to compile all of this information during tax time next year, it will be extremely difficult. You should begin documenting your losses through a worksheet or other method as soon as possible after the loss.

Worksheet for Personal Use Property (courtesy of IRS)

Worksheet Business Property (courtesy of IRS)


Sources:

IRS Publication 547

IRS Publication 2194

IRS FAQs for Natural Disaster Victims