Natural Disaster Casualty Losses

9/26/2022 - By Brett Snyder, JD, LL.M

This blog has been updated on 9/26/2022 from its original publishing on 12/14/2020.

Did you know that losses of property due to natural disasters are deductible as personal casualty losses on your tax return? This means if you suffered damage from a hurricane that resulted in your property losing value, you might be entitled to a tax deduction for that loss. As with any tax deduction, this is subject to a handful of limitations. Here are a few things you need to know:

Deducting Personal Casualty Losses

For your loss to be deductible, the 2017 Tax Cuts and Jobs Act requires that it must have occurred in and be attributable to a federally declared disaster.
The amount of the loss is generally the lesser of the adjusted basis of the property—what you paid for the property plus any improvements made thereafter—before the casualty event or the decrease in fair market value due to the casualty. The adjusted basis of the property does not include any amounts spent to replace, clean up, or repair the property.

The decrease in fair market value can be ascertained in different ways. The most reliable method would be obtaining a qualified appraisal of the property to measure the decrease in fair market value. If that is an expense you do not want to undertake, the cost of cleaning up or making repairs to restore the property to its original condition can be used as a measure of the decrease in fair market value of the property, in lieu of using a qualified appraisal. Keep in mind, to use the “cost-of-repairs” method to substantiate the amount of the loss, the repair expenditures must be made, the repairs must be necessary to bring the property back to its original condition, the amount spent for repairs must not be excessive, the repairs must take care of the damage only, and the value of the property after the repairs must not—due to the repairs—be more than the value of the property before the casualty.

Certain items cannot be considered as part of the loss when calculating the decrease in the fair market value of the property. For example, the cost of protecting the property against further (or another) casualty is not part of the loss—that is, the amount spent to board up a house, or to construct a retaining wall to prevent flooding. Also, incidental expenses incurred due to a casualty, such as expenses for temporary housing or travel, are also not part of the casualty loss.
Once the amount of your casualty loss is determined, it must be reduced by expected insurance or other reimbursements. “Other reimbursements” would include, for example, certain qualified disaster relief payments and lawsuit settlement payment. If the property is covered by insurance but a timely insurance claim is not filed, no deduction is allowed for the portion of the loss that would otherwise be covered by insurance. However, this does not apply if the loss is less than the amount of your insurance deductible.

If insurance reimbursement is expected but has not been received when you file your return, you must consider the expected reimbursement in determining the amount of loss. Should your eventual reimbursement turn out to be less than expected, a loss can be claimed in the year it is determined you cannot reasonably expect any additional reimbursement. If, on the other hand, your eventual reimbursement is larger than expected, the additional amount is included in income to the extent it was deducted in a prior year.

Reimbursement Payments

Any amount you receive as a “qualified disaster relief payment” is excluded from gross income. A qualified disaster relief payment is any amount paid to or for the benefit of an individual:

To reimburse or pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a disaster;
To reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for the repair, rehabilitation, or replacement is attributable to a qualified disaster;
By a person engaged in the furnishing or sale of transportation as a common carrier by reason of death or personal physical injuries incurred because of a qualified disaster; or
If a federal, state or local government or agency pays such amount, in connection with a qualified disaster to promote general welfare.

However, this exclusion does not apply to payments made by a governmental agency with respect to income replacement, such as lost wages, unemployment compensation insurance, or business income replacement payments.
There are two other limitations on the casualty loss deduction: First, once the loss is calculated, it must be reduced by $100.

Generally, casualty losses are deductible in the year incurred (it does not matter when the property is replaced or repaired). You can also elect to deduct the loss on the return for the immediately preceding year. If that return has been filed, you can amend it for a refund of taxes already paid. Deciding when to file is based on several factors, the two most important are the loss’s maximum deduction based on your adjusted gross income level, and your cash flow situation (that is, if the refund is needed immediately to offset the economic loss).

If you suffered damage from Hurricane Sally and have any questions regarding your potential casualty loss deduction, we’re here to help guide you through the process. Contact a member of our team today.

About the Author | Brett Snyder, JD, LL.M
Brett is a manager in the Tax & Accounting Services Department of Saltmarsh, Cleaveland & Gund. Prior to joining Saltmarsh in January 2013, he worked as a litigation assistant and completed a five-month externship with the Mississippi Office of the Attorney General and also worked as a staff accountant for an accounting firm in Birmingham, Alabama prior to attending law school. Brett’s primary areas of experience include tax research, planning and consulting.