By: Emily D. Cokeley, Ph.D., CPA, and Shelby Follis, CPA
Recent events in middle and east Tennessee have prompted the president to declare federal disasters. Such disasters could arise from fires, floods, storms, and other natural or man-made disasters, but at the time of publication, Tennessee has had two federally declared disasters in 2024: severe weather and tornadoes in middle Tennessee in May and Tropical Storm Helene in east Tennessee in September. In addition to receiving donations from their communities and other relief, disaster-affected individuals and business owners may be eligible to claim a casualty loss deduction for losses of their real and personal property – and come seeking advice on the tax implications.
Being able to claim a casualty loss deduction on a taxpayer’s federal income tax return can result in a decreased tax liability, offering a potentially significant benefit to the taxpayer at a time when they are struggling to recover from a disaster loss. IRS Publication 547 discusses the treatment of Casualties, Disasters, and Thefts, and highlights special rules for losses resulting from federally declared disasters.
What Can Be Claimed?
For tax year 2024, individuals may deduct casualty losses of personal-use property (including both real property and personal property) only if the loss is the result of a federally declared disaster. A federally declared disaster must be either a “major disaster declaration” or an “emergency declaration” made by the president under the Stafford Act. A searchable list of federally declared disaster areas and the associated declaration numbers can be found at fema.gov/disaster. Casualty losses of personal-use property resulting from storms, accidents or other events that are not federally declared disasters are no longer deductible on an individual’s federal income tax return.
A casualty loss includes the destruction of real property, personal-use property, business or income-producing property, and business inventory. What cannot be claimed, however, are the costs of repairs to damaged property and the costs of cleaning up after the disaster, although these costs may be used to measure the decrease in fair market value (FMV) of the property under certain conditions.
While the IRS does allow for a deduction based on the value of the losses incurred, the deduction is limited in two ways. The loss is first reduced by $100 and then additionally reduced by 10% of the individual taxpayer’s AGI. Any remaining casualty loss may be claimed as a deduction on IRS Form 4684: Casualties and Thefts. Section A relates to personal use property, Section B relates to business and income-producing property, and Section D allows for the election to deduct a federally declared disaster loss in the preceding tax year or to revoke a prior such election. Section C is unrelated to disaster losses.
Calculation of the Loss
To calculate a casualty loss, the adjusted basis of the property before the disaster must be determined. For purchased property, the adjusted basis is often the amount the taxpayer paid for the property. For property acquired in other ways, the adjusted basis must be calculated (see IRS Publication 551). Next, the decrease in the property’s FMV as a result of the disaster must be determined. This is often accomplished through an appraisal or using the cost of actual repairs made to the property. In some circumstances, safe harbor methods may be used to determine the decrease in FMV of personal-use residential real property (see Revenue Procedure 2018-08). Finally, from the smaller of the adjusted basis or the decrease in FMV, subtract any insurance or other reimbursements (i.e., cash from an employer’s emergency disaster fund that is stipulated to be used to repair or replace the property) received or expected. The resulting figure is the amount of the casualty loss.
Calculation of the Deduction
After all losses of personal-use property are determined, the losses must be totaled and then reduced for the $100 rule, which requires that the total of all losses resulting from this casualty event be reduced by $100. Additionally, the loss total must then be reduced for the 10% rule, which requires that the total of all losses from this casualty event be reduced by 10% of the taxpayer’s AGI. If the resulting figure is $0 or less, no casualty loss deduction can be claimed. Any remaining loss greater than $0 should be entered on Schedule A, line 15 (Itemized Deductions). The taxpayer must itemize their deductions to claim a casualty loss.
Example
To fully understand the calculation, one can refer to the following example of an individual who suffered the complete destruction of their home during a flood in a region of Tennessee that was a federally declared disaster area. The individual purchased the home, which they used as their primary residence, four years ago for $200,000. Since then, the FMV of the home increased to $250,000. With the destruction of their home, the taxpayer also lost all personal property contents of the home, purchased for $60,000. After the flood, the FMV of the real property was $25,000 for the value of the land. The taxpayer received an insurance check for $190,000 ($150,000 for the real property and $40,000 for the personal property). The taxpayer’s AGI for the year was $120,000.
Completing Section A of Form 4684, the taxpayer would list the real property and the personal property separately, as follows:
The taxpayer will first determine the casualty losses of the assets separately, as shown with separate columns for Real Property and unscheduled Personal Property. To determine the losses, the decrease in FMV before versus after the disaster is calculated and compared to the cost or other basis of the property. The smaller of the FMV loss or the adjusted basis in the property is selected. In this example, the decrease in FMV of the real property was $225,000, and the adjusted basis of the real property was $200,000, so the smaller amount of $200,000 was selected.
Next, any insurance reimbursements expected and/or received must be factored in, reducing the potential loss. In this example, the taxpayer received insurance reimbursement of $150,000 for the real property, reducing the potential loss on the real property from $200,000 to $50,000. The insurance reimbursement of $40,000 for the personal property reduced the potential loss on those assets from $60,000 to $20,000.
Then, to determine the casualty loss deduction, the losses for both assets are added together before being reduced by $100 and then further reduced by 10% of the taxpayer’s AGI. The casualty loss of $50,000 for the real property combined with the casualty loss of $20,000 for the personal property sums to $70,000, which is then reduced by $100, and then further reduced by 10% of the taxpayer’s AGI (10% of $120,000).
Finally, the casualty loss deduction in this example is determined to be $57,900. This deduction amount is transferred to Schedule A (Form 1040), line 15.
Business-Related Disaster Losses
The method for calculating a casualty loss deduction for business property is similar to that of personal-use property; however, in the event of the complete destruction of business or income-producing property, the decrease in FMV isn’t considered when calculating the loss. Instead, the loss would be calculated as the adjusted basis in the property less any salvage value, any insurance, or other reimbursement received or expected.
If inventory is destroyed, the loss can be deducted either by increasing the cost of goods sold or by deducting the loss separately. If the business elects to increase the cost of goods sold, opening and closing inventories should be reported accurately, and any insurance or other reimbursement should be included in gross income. If the business elects to deduct the loss separately, the business will need to decrease the opening inventory or purchases. The loss should be reduced by any insurance or other reimbursement, but such reimbursements should not be included in gross income.
Documentation Requirements
As with all tax return claim items, proper documentation of casualty losses must be maintained. The documentation must show that a casualty was incurred and must support the amount of the loss. Documentation should be able to support the following assertions, as required by the IRS:
- The taxpayer was the owner of the property or leased the property and is liable to the owner for the loss
- The type of casualty loss and when it occurred (the FEMA declaration number will be required)
- The casualty loss was a direct result of the federally declared disaster noted above
- Whether an insurance claim for reimbursement has or could be made for which there is a reasonable expectation of recovery
When To Claim a Loss
Special rules apply to federally declared disaster area losses, offering flexibility in the timing of when a disaster area loss is claimed. The first option is for the taxpayer to claim the loss in the year of the disaster; however, the special rules provide a second option allowing for the taxpayer to claim the loss in the year immediately preceding the disaster loss. Electing to claim the disaster loss in the preceding year may be beneficial to a taxpayer with a lower AGI in the preceding year than in the year of the disaster loss, resulting in a larger loss deduction.
If electing to claim the loss deduction in the preceding year, the election must be made within six months of the due date of the tax return of the disaster year. For example, if a disaster loss occurs in 2024 and the due date of the 2024 tax return is April 15, 2025, the election to claim a disaster loss in tax year 2023 must be made by Oct. 15, 2025. In other words, the deadline to amend the 2023 income tax return to claim a casualty loss that occurred in 2024 is Oct. 15, 2025. To make this election, the taxpayer must complete Part I of Section D of Form 4684: Electing to Deduct Federally Declared Disaster Loss in Preceding Tax Year and attach it to the return for the year preceding the disaster loss.
IRS Assistance for Taxpayers in a Disaster Area
If the taxpayer’s main home, principal place of business, or tax records are located within a federally declared disaster area, the IRS will waive the fee for furnishing copies of prior-year tax returns. When filing Form 4506 to request these copies, simply write the name of the disaster in the top margin of the form.
Finally, the IRS may extend due dates for tax filings and payments for taxpayers impacted by a federally declared disaster. When made, such announcements and details can be found at irs.gov/newsroom.
Conclusion
While this article presents the basics of casualty loss deductions, tax preparers will benefit from examining more detailed situations and examples noted in IRS Publication 547. Tennessee and surrounding states endure a variety of disasters each year, and keeping up
to date with the intricacies of claiming casualty loss deductions resulting from these disasters will enable tax preparers to offer exceptional service to their clients.
FEMA Contact Information
www.DisasterAssistance.gov
800-621-3362
About the Authors
Emily Cokeley, Ph.D., CPA, is an assistant professor at East Tennessee State University. She can be reached at cokeley@etsu.edu.
Shelby Follis, CPA, is a tax manager at LBMC. She can be reached at shelby.follis@lbmc.com.
References
Internal Revenue Service. (2024, January 10). Publication 547: Casualties, Disasters, and Thefts.
Internal Revenue Service. (2019, February 26). Publication 584 and 584- B: (Business) Casualty, Disaster, and Theft Loss Workbook.
Internal Revenue Service. (2023, January 17). Publication 551: Basis of Assets.
Internal Revenue Service. (2023). Form 4684: Casualties and Thefts. Retrievable from https://bit.ly/form4684
Internal Revenue Service. Revenue Procedure 2018-08. Retrievable from https://bit.ly/irb201808
www.fema.gov/disaster
www.irs.gov/newsroom
This article was originally published in the November/December 2024 Tennessee CPA Journal.
