Virtually everyone has suffered a loss, whether it's an accident, which may be covered by accident insurance, or theft.
Tornadoes, earthquakes, wildfires, hurricanes, and other natural disasters cost taxpayers and insurers billions of dollars in losses every year.
Thefts, particularly car and personal home thefts, fall into a separate category and cost taxpayers and policyholders billions of dollars annually.
This article will describe what types of accidental loss and theft are deductible when the loss can be deducted and who can deduct a loss.
The Sudden Event Test
To be deductible, a loss must meet the sudden event test criteria, which require the following:
The event must be a one-time event, so to speak, like a car accident, and cannot occur over an extended period.
The loss must occur due to a sudden, unforeseeable, unpredictable, or unusual event.
There must be some element of chance or natural force involved.
According to this definition, losses encountered due to the following events would qualify for the deduction:
Natural disasters such as hurricanes, typhoons, earthquakes, tornadoes, floods, fires, and avalanches.
Losses due to civil unrest, such as riots
However, several types of losses do not give rise to the deduction:
Losses incurred due to long-term processes such as drought, wood rot, erosion, or termite damage.
Any loss resulting from what the Internal Revenue Service (IRS) considers a "foreseeable" event.
Note:
A theft loss is only deductible if the taxpayer can prove with strong evidence that the theft caused the loss.
For a loss to be deductible, it must meet specific criteria for sudden events.
Any loss related to these greens must meet the sudden event test criteria if you have trees and shrubs on your property.
Not all theft losses and casualties are deductible. It depends on the events and the eligibility of the loss.
Example of non-deductible loss
A couple owns a house on a cliff with the rest of the neighborhood. Unfortunately, over time erosion causes several properties bordering their property to collapse and fall. However, their property, by some luck, remains intact, and the city's construction officials allow them to continue living there.
When they tried to sell their home three years later, they found out that the value of the house had dropped by $150,000 due to buyer hesitation resulting from the negative public perception of the property due to the disaster. They are forced to sell their home for $175,000 less than they paid for it. Neither this loss nor the losses incurred by homeowners whose houses collapsed are tax deductible.
Who can deduct a loss, and when?
Only the owner of the lost property can deduct the loss, within certain limits, in the year in which the loss occurred. Losses related to theft are deductible in the year the owner discovers that the property was stolen.
If you rent a property that was lost or destroyed by an unforeseeable event that qualifies for the deduction, you may be able to deduct payments made to the lessor that makes up for the loss.
On the other hand, if the taxpayer expects to be fully reimbursed for the loss in a subsequent year, the loss should not be deducted in the year that the loss is incurred. If the refund is never paid, the loss must still be claimed in the year it occurred by filing an amended return for that year.
For example, if a taxpayer's home was destroyed by fire in 2021 and the taxpayer expects to receive insurance proceeds in 2022, the taxpayer is not required to report a loss on the income tax return for 2021. However, if the insurer denies liability in 2022, the taxpayer is expected to file an amended return for 2021 to report the loss.
Losses from insolvent banks and other savings institutions
When a financial institution that offers overnight deposit accounts becomes insolvent, its customers can deduct uninsured losses, such as damages or non-trade debts. If no loss was insured, you could claim the loss of the investment.
However, losses from investment are limited to $20,000 per institution and are subject to the 2% AGI (Adjusted Gross Income) limit.
Trees and Shrubs Losses
Any loss related to trees and shrubs must pass the sudden event test, although in this case, it could include destruction from insects if a sudden infestation occurs and lasts only a few days.
Greenery losses on personal property are calculated by comparing the total value of the property before and after the damage. Structures, soils, and growth are grouped together for this purpose. However, trees and shrubs are assessed separately for business property.
Losses Due To Theft
For a theft loss to be eligible to be deductible, the taxpayer must verify that the loss was due to theft; mere suspicion of theft will not suffice. If the asset has simply disappeared, no theft loss can be claimed.
For example, if you leave the house and find that the empty kiddie pool you left in the yard the day before is gone, you are not eligible to claim a deduction for your loss because it may have been blown away. But if you left a bike and came out to find out it is gone, that would be deemed a loss due to theft since there is no other reason why the bike shouldn't be there.
Admissible evidence of theft may include the following:
Statements from witnesses who saw your property being taken.
Police reports.
Newspaper articles about the theft.
Calculating and filing casualty and theft loss
Casualty and theft are -miscellaneous itemized deductions that are reported on Form 4684, which carries over to Schedule A, and then Form 1040. Therefore, for a claim or theft to be deductible, the individual must be able to itemize the deductions. If the taxpayer cannot, then no loss can be claimed.
Also, there are other conditions that must be met. Generally, the amount must be greater than $500 and meet the 10% adjusted gross income threshold.
Disaster Losses
Taxpayers who experience disaster losses in a President-declared disaster area can report their loss on their previous year's tax return, allowing them to amend their tax return and receive an immediate refund for relief.
The Federal Emergency Management Agency maintains a list of all qualified disaster areas and the years for which they are eligible. Those who do not do this will be required to provide a statement outlining their choices to take the deduction and provide basic information on the disaster's time, place, and nature.
The deadline for this choice is the standard filing deadline for the current fiscal year or the extended deadline for the previous fiscal year. Individuals who elect to claim a prior year's loss and then change their mind have 90 days to rescind the election and return any refund made.
Victims in these areas are not required to meet the AGI 10% threshold rule if they suffered a net catastrophe loss. Also, they do not have to itemize the deductions; in this scenario, they would report the loss on IRS Form 4684 of the standard deduction worksheet. Those who do not itemize will report it on Schedule A.
The Bottom Line
The IRS allows limited deductions for casualty and losses from theft as a relief measure for those who are victims of theft or natural disasters. There are many rules and regulations regarding claims and theft that are beyond the scope of this article. This is where consulting a tax professional comes in.
FOR MORE INFORMATION ON HOW JIM McCLAFLIN, EA, NTPI FELLOW, CTRC CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLICK THE BLUE TAB ON THIS PAGE.
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Jim McClaflin, EA, NTPI Fellow, CTRC