Last year, 2017, saw some of the most epic natural disasters of our time, effecting millions of people throughout the United States. Record setting fires, floods: even a hurricane massive enough to remove water from the shorelines made headlines just a few months ago. Millions have lost their homes from the high winds, tornadoes, and the immense flooding destroying billions in individual & business properties throughout many states.
Casualty is stated as a person or thing, destroyed, lost, or injured due to a disaster or other deemed mishap.Code Section 165 communicates those losses to the IRS where deemed necessary. There are some general rules of thumb:
- General rule: a deduction is permitted for any loss occuring during that tax year, but is not reimbursable by insurance or other means.
- Deduction Amount:the amount is determined based on section 1011 for deciding whether the loss was from the sale or other disposition of the property.
- Limitations on Losses:for an individual, under subsection(a) limits it to: 1) losses from a trade or business. 2)losses from any profitable transaction not connected with a business or trading. 3) the exception to the second. Subsection(h) provides it can be connected with a business or trading if the loss results from catastrophic damage(shipwreck, fire, theft, etc.).
Sec.165 casualty only applies if the loss was something unexpected or sudden. Its defined as an event swift/sudden, unexpected, & not intended. The main idea is Sec. 165 can be used when insurance will not cover the damage. Where car insurance, life insurance, homeowners, etc., exists to cover those expenses. The IRS has a deductible which applies called an exclusion. The algorithm used by the IRS is a little tricky. Schedule A(casualty deductions are painstakingly itemized. The taxpayer subtracts $100 per each lossed item, then subtract 10% of the taxpayer’s adjusted gross income. This ensures the unreimbursed losses are monetarily sizeable to gain the deduction. The IRS states you may not deduct any amount of loss for which there is a significant chance at recovering the loss. That stipulation makes it harder when claiming item loss due to theft where there is a potential chance at recovery. The taxpayer is also only allowed the tax year of the loss to claim the deduction, whereas when the President declares a “disaster area”, that proclamation allows for up to two years from when the loss was suffered.
- Where to deduct Casualty Losses: IRS Form 4684 is used for calculating the deductions & has three sections;
- 1) Section A: 10% AGI excluding applied before moving to Schedule A, line 20.
- 2) Section B: for casualty losses suffered through business and income generating properties not connected to business or trade. Section B is also where taxpayers subtract losses from theft if the cause does not meet the criteria for the third section, C.
- 3)Section C is new to Form 4684, was created after the “pyramid scheme” investing came to light. The IRS allows the taxpayer to deduct their losses suffered through a Ponzi scheme.This section was created to eliminate the question to deduct the taxpayers losses since there is a small potential for asset recovery.
The IRS states you must have a list of requirements to be substantiated, which is up to the taxpayer to ensure: Establish
- the loss was a direct result of theft
- activities that caused the loss are defined as theft under state law
- conduct showing criminal intent
- the victim was targeted
- confirm the date the client uncovered the theft.
- ownership of the property
- all opportunites for reimbursemtn were realized.
- document any future chance at asset recovery.
- estimate the value of what the future asset recovery might be.
- establish the tax basis for the property.
All of the above has been the culmination of several Tax Court cases, but there are three main concepts to keep in mind:
- determining if the loss is a theft
- the year it was discovered
- the reasonable prospect of asset recovery
It’s now 2018, a new year which will sadly bring new, frightening events & natural disasters, of which none of us are immune. We are here to help taxpayers navigate the system easier and be able to receive some form of compensation as they rebuild their lives.