A “Perfect Storm” of Tax Deductions

Disaster often strikes quickly, with little or no warning, as in the case of Hurricane Sandy last year. The occurrence of a “perfect storm” or some other event—such as a tornado, flood or fire—can cause severe damage to your personal or business property. Small consolation: At least you may be entitled to deduct a casualty loss on your tax return.

Current rules: A taxpayer qualifies for a casualty loss deduction if damage is caused by an event that is “sudden, unexpected or unusual.” This not only includes natural disasters like the ones already mentioned, but also automobile collisions and frozen pipes’ bursting. The same basic rules also apply to theft of property. However, you cannot claim a deduction for damage occurring over a long period of time, such as damage occurring from a drought.

The deductible amount depends on whether the property damaged is personal or business property. For personal property, the deduction is limited to the excess greater than 10% of your annual adjusted gross income (AGI) after subtracting $100 per each casualty event.

Example: Let’s say that your AGI for 2012 was $100,000 and you suffered a loss to your home of $20,100. In that case, your deduction is limited to $10,000 ([$20,100 – $100] – [10% of $100,000]). If your loss amounted to $10,100 or less, you are not entitled to any deduction.

In contrast, there are no such limits for business property. The full amount of the eligible loss may be deducted on your company’s 2012 tax return.

The amount of the loss eligible for the deduction is the lesser of (1) the difference in the property’s value before and after the casualty or (2) the adjusted basis in the property. But you must reduce the deductible amount by any proceeds you receive from your insurance or the government.

Special tax break: If you own damaged property located in an area that is officially declared to be a “federal disaster area,” like many areas on the eastern seaboard impacted by Hurricane Sandy, you could be entitled to a quick tax refund. In that case, you can elect to deduct your casualty loss on the tax return for the prior year.

In other words, if you suffered a loss in a federally designated disaster area last year, you can obtain tax relief by filing an amended return for 2011. If you have already filed your 2012 return without making the election, you can file an amended 2012 return to recoup your losses more quickly.

Be aware, however, that the IRS often challenges casualty loss deductions. The best proof you can offer is photographs or videotapes of your property as it currently exists. In other words, obtain documentation before a casualty occurs. The visual proof can be compelling when coupled with snapshots of the property immediately after a casualty occurs.

To further support your position, you should obtain an independent appraisal of the damage. The appraisal itself is deductible as a miscellaneous itemized deduction (subject to a 2%-of-AGI floor).

Final words: Your professional tax advisers can help you maximize the casualty loss deductions claimed on your 2012 return. Do not hesitate to ask for assistance.