THE TAX LAWS severely restricts deductions for losses claimed by individuals whose homes, household goods and other properties suffer damage or are destroyed due to events that, in IRS lingo, are “sudden, unexpected, or unusual.”
In many cases, the allowable write-offs turn out to be shockingly smaller than anticipated. Furthermore, those with high incomes and low losses will find they can’t claim any deductions. What follows are answers to some often-asked questions.
What are the usual restrictions on writing off casualty losses?
For starters, individuals who use the standard deduction forfeit write-offs for losses. To claim them, they must itemize. The big barrier: Losses (after they’re reduced for insurance reimbursements and $100 for each casualty) are allowable only to the extent that the total amount in any one year surpasses 10% of a taxpayer’s adjusted gross income.
Let’s say Tess Tracey anticipates a 2017 AGI of $100,000. After subtracting $100 and insurance recoveries for damage to her dwelling, she estimates a deduction of $11,000. But recall she can’t claim any deduction for the first $10,000 (10% of $100,000), thereby shrinking her allowable deduction to just $1,000. If her AGI surpasses $110,000, none of the $11,000 is deductible.
In which tax year are losses deductible?
While the IRS usually allows deductions only for the year in which losses occur, it authorizes an exception for losses occurring in disaster areas eligible for federal assistance. Qualifying taxpayers are able to apply their disaster deduction to either 2017, the current year, or 2016, the previous year, whichever is more advantageous. There’s a benefit to selecting the previous year: a quicker refund. That may provide needed cash for repairs or replacements. It’s a no-no to split a deduction between two tax years.
Legislation enacted in September relaxes the rules for deducting certain disaster-related losses. The new rules boost allowable write-offs for many millions of victims of August’s back-to-back hurricanes, Harvey and Irma.
The revisions permit those affected to claim their entire loss, not just the portion that exceeds 10% of AGI. The new rules include a minor tweaking that increases the $100 floor to $500. And no longer is tax relief available only for itemizers. Even those who opt for the standard deduction are able to claim disaster losses. In the run-up to the 2018 midterm elections, our lawmakers may decide to introduce similar solace for, among others, victims of fires in California.
Is there a tax break when disaster-related losses exceed income?
Yes. Filers need to familiarize themselves with the complex, often-overlooked rules for personal net operating losses (NOLs). These rules allow the application of unused excess deductions to recover or reduce taxes paid in other years.
This means it’s okay to take unused write-offs as additional deductions for the three prior years and for the following 20 taxable years (so-called carryback and carryforward in IRS speak). Alternatively, there’s the option to forego the entire carryback and just carry forward the excess amounts for up to 20 years, unless they’re used up sooner.
An example: Affluent Alice Adams abides in a pricey place that’s completely destroyed by hurricane Irma. Like her neighbors in their exclusive enclave, Alice has an insurance policy that specifically omits coverage for hurricanes. Accordingly, Alice’s six-figure loss exceeds her five-figure income.
Alice has IRS’s blessing to apply 2017’s unused excess deduction to reduce taxes for the years 2014 to 2016 or apply them to trim taxes for the next 20 years. The law permits her to avail herself of both options. She should seek the help of a qualified tax professional, as the rules are complicated, particularly the ones for carrybacks and carryforwards.
Is this the last hurrah for deducting casualty losses? The Republican House and Senate tax bills would repeal write-offs for most itemized deductions, including most casualty losses. If enacted, the repeal would take effect starting with returns for the 2018 tax year, which will be filed in 2019.
Julian Block writes and practices law in Larchmont, N.Y., and was formerly with the IRS as a special agent (criminal investigator). His previous blogs include Too Late, This Year or Next and A Year for Generosity. Follow Julian on Twitter @BlockJulian and learn more about him at JulianBlockTaxExpert.com.