How to Report a Casualty Loss to the IRS

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If you're unfortunate enough to suffer damage to your property thanks to fire, flooding, or a similar disaster, you can at least take comfort in being able to claim the loss as a deduction on your tax return (and hopefully get a bit of a tax break for it). However, reporting such a loss isn't a simple matter.

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What is a casualty loss?

Not all property damage counts as a casualty loss. The IRS defines a casualty as "the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual." If termites eat your house to pieces or the family dog shreds your drywall, it won't count as a casualty and you can't deduct it. A loss also typically won't be deductible if you caused it -- for example, if you dropped and broke an expensive vase.

Common types of casualty losses include earthquakes, fires, car accidents, vandalism, and so on. Casualties like fires and car accidents aren't deductible if you caused them deliberately. Losses from theft are also deductible using the same method and rules as for a casualty loss.

Claiming a loss

You report a casualty or theft loss on Schedule A of that year's tax return. If the loss occurs as part of a federally declared disaster, you also have the option of reporting it on the previous year's tax return instead (which means filing an amended return for that year). Note that this means you have to itemize deductions in order to claim such a loss. You'll need to fill out Form 4684 to calculate how much of the loss you can deduct.

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Calculating loss or gain

In order to fill out Form 4684 (regrettably one of the more complicated individual tax forms), there are several numbers that you'll need to know. First, line 2 asks you for the "cost or other basis" of the property. Basis means the amount of money that you have invested in the damaged property. In most cases, this will be the amount you originally paid for it; however, if you spent money on improving the property later, your basis might be higher. For example, if you bought your house for $200,000 but then spent another $40,000 to add a second bathroom, your basis in the house would be $240,000.

Next, you'll need to fill in the amount of the reimbursement you received from your insurance coverage. If your reimbursement was greater than your basis in the property, then as far as the IRS is concerned, you had a gain rather than a loss. For example, if your basis in your house was $240,000 but the value of the house rose over time to $400,000, and the insurance company reimbursed you $350,000 after your house burned down in a fire, you would have not a loss of $50,000 but rather a gain of $110,000 (the amount of the insurance payment minus your basis).

If you do end up with a gain, you may have to pay taxes on that gain as though it was income that you'd earned that year. One way to avoid such a fate is to use the insurance reimbursement to either restore the damaged property or buy similar property. For example, if your car was stolen and you used all of the insurance money to buy yourself a new car, you wouldn't have to pay taxes on the gain. But if you instead spent the money on a vacation to Maui and resolved to take the bus in the future, you would have to pay taxes on any gain resulting from the reimbursement.

Making loss adjustments

Assuming that you have a loss rather than a gain, you'll next have to make some adjustments to this loss to come up with the amount you can deduct. First, you subtract $100 from the loss that you suffered (which means that if your loss is less than $100, you get no deduction at all). Next, you subtract 10% of your adjusted gross income (AGI) as calculated on your Form 1040.

For example, let's say that your loss after insurance reimbursement was $10,000 and your AGI for the year was $70,000. First, you'd subtract $100 from the $10,000 loss for a result of $9,900. Second, you'd subtract 10% of your AGI, or $7,000, which leaves you with $2,900. That's the amount of the loss that you can deduct and the number that you would report on your Schedule A.

Multiple losses

A severe disaster can result in more than one loss at a time. For example, if a major earthquake caused your house to collapse on top of your car, you'd have a loss for both your house and your car. In that case, you add up all the losses you suffered, then subtract $100 and 10% of your AGI from the total -- not from each individual loss.

Finally, in the case of such a large-scale disaster (especially one that's been declared a federal disaster), you can often get help both in dealing with the disaster itself and with filling out the associated paperwork, including your tax returns. The federal Disaster Assistance website has guidance for getting help, and your state may also have some resources available to help you out.

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