Well, if you had an account with FTX, you very well might be in some financial difficulty. To a certain segment of our Western Illinois clients, this is a BIG deal. As such, I’ll have more thoughts in the following weeks as things become more clear.
But the “good” news is that we might be able to harvest some serious tax losses and make a big dent in your tax liabilities.
I know, cold comfort.
Speaking of a different sort of disaster, let’s talk hurricanes and suchlike (e.g. Hurricane Ian, and recently, Nicole).
When the Federal government marks unfortunate events like these as federal disasters, it almost always equals some form of tax relief for the taxpayer. Even if your tax preparer lives in an affected area and you do not (there’s a little extra leg work required here).
And this includes things like flooding seen in Alaska and Missouri earlier this year, wildfires like are often seen in California and Colorado, and others as well.
The IRS has a list of federal disaster situations with ongoing tax relief updates as well as a disaster tax relief FAQ page to help guide you through commonly asked questions – you can always call my office for answers, too.
But not only do disaster-affected taxpayers get IRS relief in the form of extended deadlines, but you can also capitalize on a casualty loss deduction, which I’d like to talk about today.
Now, on a brief side note, the student loan forgiveness situation I discussed recently has encountered some roadblocks. Though the moratorium on payments extends until the end of the year, payments (interest and principal balance) are still something to keep in the forefront and plan for. And of course, there are tax implications to that as well, which I’d be happy to sit down and discuss:
Now, to keep you in the know on all things tax, especially in times of disaster, let’s jump into today’s topic…
When Disaster Strikes Western Illinois Taxpayers: Casualty Loss Deduction
“Any disaster is a learning process.” – Julia Child
Disasters (natural and otherwise) are in the news more than ever these days, and preparing for them involves a lot more than just stocking your canned food above the flood line. Certain tax deductions, for instance, become available if you suffer property losses due to weather and other causes.
But these tax breaks come with conditions.
Here’s what to know.
Taking a casualty loss deduction was easier before the Tax Cuts and Jobs Act (TCJA) in 2017. Additional restrictions now make a claim harder, though far from impossible.
The first prerequisite for filing for a casualty loss is that the disaster must be federally declared, involving the Federal Emergency Management Agency (FEMA). Recent examples include wildfires, hurricanes Ian and Fiona, and major storms and flooding like those that hit Alaska in September and Missouri last summer.
Among conditions: A casualty loss can result from the damage, destruction, or loss of property from what the IRS terms “any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption.” A casualty loss is not from normal wear and tear. Casualty and theft losses must be directly from a FEMA-declared disaster. You can’t claim any loss that your insurance covered completely – and you have to subtract from the deduction any partial insurance or other reimbursement.
Doing the math
Calculating a casualty loss, frankly, isn’t easy. The IRS defines the amount of the loss as your adjusted basis in the destroyed property and the decline in fair market value that the disaster caused.
Your basis is usually the price you gave originally, “adjusted” up for improvements or down for claimed depreciation over time. (Inherited or gifted property is a special animal – check with us.)
Fair market value (FMV), or how much you would’ve gotten for your property before the disaster from an informed buyer, is tricky (except in the case of theft, when FMV of property immediately after a theft is zero because you don’t have the property anymore – if it’s recovered and returned to you, that’s still another formula). Finding the FMV generally starts with a qualified appraisal or, for a vehicle, book value.
The IRS says you can use the cost of the clean-up or repairs as a measure of the decrease in FMV if the repairs are actually made and were necessary to bring the property back to its condition before the casualty, the amount you spent isn’t “excessive,” the repairs take care of only the damage, and the value of your property after the repairs isn’t more than the value of the property before the disaster. The IRS also has some safe-harbor figures to calculate the loss that they claim they won’t question. (We can walk you through using these numbers.)
Some things you can’t consider when figuring the FMA: costs of protection, from insurance to boarding up your windows; personal incidentals like medical bills, a motel, or a rental car; sentimental value; or the drop in the value of your undamaged property because it’s in or near a disaster, among others.
Again, you must reduce the loss (whether a casualty or theft loss) by any salvage value, insurance payout, or other reimbursement you receive or expect to receive.
(If your loss deduction exceeds your income, you may have what’s called a net operating loss – and that opens a host of other tax-planning opportunities …)
You can claim these losses as an itemized deduction on Schedule A of your tax return. You may have to subtract an additional small amount and 10% of your adjusted gross income from the total to calculate your allowable casualty and theft losses for the year.
If you have a qualified disaster loss, you can deduct the loss without itemizing your deductions. Your net casualty loss doesn’t need to exceed 10% of your adjusted gross income to qualify for the deduction, but you would reduce each casualty loss by $500 after any salvage value and any other reimbursement.
You report casualty and theft losses on Form 4684, “Casualties and Thefts.” (We can help with this, of course.) If you have a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), you can treat the loss as having occurred in the year immediately preceding the tax year in which you sustained the disaster loss, and you can deduct the loss on your return or amended return for that preceding tax year.
Here’s the thing: The TCJA raised the standard tax deduction for most people, meaning the total of all your itemized deductions would have to exceed the deduction for your tax-filing status to make itemizing worth anything.
We would never wish disaster on you or anyone, but we would wish that if it happens, you are able to get any tax relief you can when it does.
And that’s something we’re here to keep you and all of our Western Illinois friends in the know about.
Keeping you afloat in hard times,