Hit by Irene? Suffered devastation from tornadoes in Missouri ? Or widespread flooding in the Midwest? You might have a tax deduction or an unexpected tax gain. Bill Bischoff explains your 2011 federal income tax implications if you’re unlucky enough to suffer a disaster-related casualty this year:
Deductions for Personal Casualty Losses
Theoretically, our beloved Internal Revenue Code allows you to claim an itemized deduction on your Form 1040 — for personal casualty losses that are not covered by insurance. Exactly what is a casualty loss? It’s when the fair market value of your property or asset is reduced or wiped out by a hurricane, flood, storm, fire, earthquake or volcanic eruption (not to mention sonic boom, theft, or vandalism).
In reality, however, many disaster victims won’t qualify for any personal casualty loss write-offs because of the following two rules. First you must reduce your loss by $100. Then you must further reduce the loss by an amount equal to 10% of your adjusted gross income (AGI) for the year. Say you incur a $10,000 personal casualty loss this year and have AGI of $80,000. Your write-off is a puny $1,900 ($10,000 – $100 – $8,000). You get absolutely no tax break if your loss is $8,100 or less, and you have no chance at all if you don’t itemize.
But let’s assume you do have a 2011 deductible personal casualty loss after the two reductions. If the loss was caused by a disaster in a federally declared disaster area (more on that later), a special rule allows you to claim your rightful deduction either this year or last year. For example, victims of Hurricane Irene can file amended 2010 returns and claim their losses last year. And if you extended your 2010 return to October 17, 2011, you can claim the loss on your original return for last year filed by that date. This rule allows you to get some immediate tax savings instead of having to wait until 2012 when you finally get around to filing your 2011 return. Remember: this special rule is only available for losses in federally declared disaster areas. You can find a by-state listing of these areas on the following link: FEMA: 2011 Federal Disaster Declarations.
Deductions for Business Casualty Losses
If you have disaster-related losses to business assets, you don’t have to worry about the $100 reduction rule or the 10%-of-AGI reduction rule. Instead, you can deduct the full amount of your uninsured loss as a business expense. As with personal casualty losses, you have the option of claiming 2010 deductions for 2011 losses that occur in a federally declared disaster area.
If you do turn out to have an involuntary conversion gain, it must be reported on your tax return unless you: (1) make sufficient expenditures to repair or replace the property and (2) make a special tax election to defer the gain. If you make the election (you generally should), you have a taxable gain only to the extent the insurance proceeds exceed what you spend to repair or replace the property. The expenditures for repairs or replacement generally must occur within the period beginning on the date the property was damaged or destroyed and ending two years after the close of the tax year in which you have the involuntary conversion gain.
Special favorable rules apply to involuntary conversion gains resulting from casualties in presidentially declared disaster areas (the rules are way too complicated to adequately explain here).
For more details on disaster-related casualties and your taxes, see IRS Publication 547 (2010) (Casualties, Disasters, and Thefts). If you have big losses or big insurance payments, consider hiring a tax pro to deal with the complicated rules and prepare your return. It could be money well-spent.