A column on personal finance prepared by the Virginia Society of Certified Public Accountants
WHEN DISASTER STRIKES: HOW TO DEAL WITH PROPERTY LOSS
(September 23, 2003) – With the West Coast at risk for earthquakes, the East prone to snowstorms and hurricanes, and tornadoes threatening much of the Midwest, few places are immune to the fury of Mother Nature. In fact, every year, millions of people face property damage from unexpected events. Although taxes are likely to be one of the last things on people’s minds when nature strikes, it’s good to know that Uncle Sam can help to relieve your financial burden. According to the Virginia Society of CPAs, a casualty loss deduction can help offset some of your loss.
Understanding What Qualifies as a Casualty Loss
The Internal Revenue Service classifies a casualty as the damage, destruction, or loss of property resulting from a sudden, unexpected, or unusual event. Casualties likely to qualify for deductions include auto accidents, civil disturbances, hurricanes, earthquakes, explosions, fires, floods, hail, ice and snow, vandalism, winds, and tornadoes. Loss from theft, including larceny, robbery and embezzlement also qualify as a casualty.
Gradual Damage Doesn’t Count
To qualify for a casualty deduction, the event that causes the damage or loss must be sudden and swift, not slow or progressive. For example, gradual damage caused by mildew and mold doesn’t qualify for a deduction. But if a pipe bursts and ruins your carpet and floor, your loss would qualify. Other examples of non-deductible losses include those caused by termites, dry rot, corrosion, and rust.
Determining Your Deduction
To determine the deductible amount of a casualty or theft loss, you will need to do several calculations. Start by determining the fair market value of the property before and after the damage. (Fair market value is the price for which you could sell the property to a knowledgeable buyer.) Next, establish your basis in the property (generally, your cost plus improvements, less any depreciation taken). Generally, your loss is the lesser of the two.
For example, the IRS cites the total destruction of a painting worth $100,000 that was purchased for $1,000. The decrease in fair market value is $100,000, but since the buyer’s basis is less, the loss is limited to $1,000, the buyer’s actual investment in the property.
After you determine the amount of your loss, you must deduct any insurance reimbursement you have received or an estimate of what you expect to receive. For losses of business property, the remainder is your deductible loss. For thefts or casualties of personal or family property, your deductible loss is much more limited. After subtracting your reimbursements, you must subtract $100 for each casualty, theft or accident suffered during the year. Then, you must again reduce your deductible loss by 10 percent of your adjusted gross income.
Be aware that you cannot deduct a loss unless you file a timely insurance claim. Homeowners who choose not to file can deduct only the portion of the loss that would not have been covered had a claim been filed.
Disaster Areas Qualify for Special Treatment
Usually a casualty or theft loss is deductible only in the year the event took place. However, when an area is declared a federal disaster by the President, you have the option of deducting the loss on the previous year’s tax return. This allows you to get an immediate tax benefit rather than wait to claim it.
Recordkeeping is Important
Declaring a casualty or theft deduction can help minimize the financial impact of a disaster. But since it might also attract the attention of the IRS, CPAs say it is important that your deduction can be substantiated. While it is not necessary to submit your documentation with your return, you should retain information that supports your calculated loss. Photos of the lost or damaged items, receipts and appraisals, and police reports are excellent proof of loss.
Establishing the deductibility of a casualty loss or theft can be complicated. If you have any questions, consult a CPA.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
Lifetime Financial Planning, LLC
Dean Knepper, CPA, CERTIFIED FINANCIAL PLANNER™ professional
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