Breaking down the TCJA: The future of personal casualty losses
The TCJA suspended personal casualty and theft losses, except in federally declared disaster areas
Related resources for H&R Block tax professionals:
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- TCJA Quick Reference Card (TCJA QRC) (page 9)
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- How is a casualty loss calculated?
In the last 10 years, over 1,000 events caused U.S. Presidents to declare certain areas as federally disaster areas in the United States. The 2017 hurricanes Harvey, Irma, and Maria impacted over 25 million Americans.
The 2017 Tax Cuts and Jobs Act suspended itemized deductions for personal casualty and theft losses for tax years 2018-2025. However, the Act did not eliminate casualty losses completely. Taxpayers can still deduct casualty losses in federally-declared disaster areas. For this reason, tax professionals should brush up on the ins and outs of casualty losses and be prepared to help taxpayers when disaster strikes.
To qualify for deduction, the damage must be a “casualty loss”
Generally, a casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.
- A sudden even is one that is swift, not gradual or progressive;
- An unexpected event is one that is ordinarily unanticipated and unintended;
- An unusual event is one that:
- Isn’t a day-to-day occurrence, and
- Isn’t typical of the activity in which the taxpayer engages in.
The amount of a casualty loss deduction is rarely the amount spent to repair damage
After determining a casualty loss exists, the amount of the casualty loss deduction must be calculated. Many taxpayers mistakenly believe that the amount they spend to repair the damage is their deductible casualty loss. However, only under specific circumstances will the amounts that the taxpayer spends on repairs be used in the calculation of a casualty loss.
Generally, the amount of a casualty loss is the lesser of the following:
- The taxpayer's adjusted basis in the property before the casualty or theft; or
- The decrease in fair market value of the property as a result of the casualty or theft.
Insurance proceeds and other reimbursements are subtracted from the above amounts to determine the amount of the casualty loss.
Example – Albert purchased a home for $80,000. Over the years, Albert spent $20,000 on capital improvements in the house. Albert’s adjusted basis in the property is $100,000. Last year, Albert’s home was damaged by a hurricane in a federally declared disaster area. Due to the damage caused by the hurricane, Albert’s home decreased in fair market value by $85,000, determined by a qualified appraiser. Albert only received $40,000 from insurance proceeds. Albert has not spent any amounts to fix the damage on the house.
To determine his deductible casualty loss, Albert must use the lesser of the adjusted basis before the casualty ($100,000) and the decrease in the fair market value of the property as caused by the casualty ($85,000). Albert uses the $85,000 decrease in fair market value then reduces that by the insurance proceeds of $40,000 received. Thus, Albert has a potential deductible casualty loss of $45,000.
Decrease in fair market value requires an appraiser’s help
Determining the decrease in fair market value of the property can be both difficult and expensive to determine.
The fair market value is the price for which the taxpayer could sell their property to a willing buyer when:
- Neither the buyer or the seller must sell or buy, and
- Both the buyer and seller know all the relevant facts.
The decrease in fair market value used to figure the amount of a casualty is the difference between the property’s fair market value immediately before and immediately after a casualty. This determination must be made by a competent appraiser. The appraiser must recognize the effects of any general market decrease that may occur along with the casualty.
The national average cost for an appraisal by a licensed professional is between $300 and $400 and requires roughly two hours of inspection time to complete. For those who suffered a loss caused by a disaster, hiring an appraiser can be both time consuming and costly.
Certain taxpayers can use the cost of clean-up or making repairs to determine the decrease in FMV
Generally, the cost of repairing damaged property and cleanup aren’t part of a casualty loss. However, a taxpayer can use the cost of cleaning up or of making repairs after a casualty as a measure of the decrease in fair market value if the taxpayer meets all the following conditions.
- The repairs are actually made;
- The repairs are necessary to bring the property back to its condition before the casualty;
- The amount spent for repairs isn’t excessive;
- The repairs take care of the damage only;
- The value of the property after the repairs isn’t, due to the repairs, more than the value of the property before the casualty.
Meeting these requirements can prove difficult for taxpayers. Fortunately, the IRS recently published safe harbors for clients to use to measure the decrease in fair market value of personal property caused by damage in a federally declared disaster area.
New safe harbor methods simplify the process
Rev. Proc. 2018-08 provides new safe harbors for determining the decrease in fair market value to taxpayers who suffered a casualty loss in a federally declared disaster areas, without an appraisal. The IRS will not challenge an individual’s determination of the decrease in the fair market value if the taxpayer uses the safe harbors provided by the Revenue Procedure.
Keep in mind, this revenue procedure is only to be used for personal residence and belongings that have no business use, such as rental or a home office. Further, the personal belongings do not include boats, aircraft, mobile home, trailer, vehicles, antiques, or assets that maintain or increase their value over time.
Five Safe Harbor Methods for Personal-Use Residential Real Property
These safe harbor methods provide taxpayers with options to determine the decrease in fair market value for their personal-use residential real property.
- Estimated Repair Cost Safe Harbor Method
Taxpayers can use the lesser of two repair estimates prepared by two separate and independent contractors, licensed or registered, to determine the decrease in the fair market value. The two repair estimates must set forth the costs to restore the individual’s residential real property to the condition existing immediately prior to the casualty. However, the costs of any improvements or additions that increase the value of the residential real property above its pre-casualty value must be excluded from the estimate.
- De Minimis Safe Harbor Method
Taxpayers can use their own personal estimates of the costs to restore their residential real property to the condition immediately prior to the casualty as the decrease in the fair market value. The estimated costs must be under $5,000 and the estimated repair can’t increase the value of the property.
- Insurance Safe Harbor Method
Taxpayers can use the amount of estimated loss provided by the taxpayer’s homeowner’s or flood insurance company.
- Contractor Safe Harbor Method
The taxpayer can use the contract price for repairs specified in a contract prepared by an independent contractor, licensed or registered, as the decrease in the fair market value. The costs of any improvements or additions that increase the value of the residential real property above its pre-casualty value must be excluded from the contract price.
- Disaster Loan Appraisal Safe Harbor Method
The taxpayer can use the appraisal prepared for obtaining a loan of Federal funds or a loan guarantee from the Federal Government which sets forth the estimated loss.
Two Safe Harbor Methods for Personal Belongings
The taxpayer can also use one of the two safe harbor methods to help determine the casualty loss for the taxpayer’s personal use items.
- De Minimis Safe Harbor Method
The taxpayer can use their own personal estimate to determine the decrease in the fair market value of their personal belongings. The total estimated decrease in fair market value must be $5,000 or less. Further, the taxpayer must maintain records describing the personal belongings affected and detailing the methodology used for estimating the loss.
- Replacement Cost Safe Harbor Method
The taxpayer can use this method to determine the decrease in the fair market value of their personal belongings. First, the taxpayer determines their basis in the item based on the original cost. Then, the current cost to replace the property is decreased based on the number of years the taxpayer owned the property. Finally, the replacement cost is reduced by the value of the property after damage.
|Percentage of Replacement Cost to Use|
Example – Albert owns a couch that was damaged in a federally declared disaster area. Albert originally purchased the couch for $850. Albert looks up the price of a new version of the couch, which costs $800. Albert has owned the couch for two years. Thus, Albert multiplies $800 by 80% to give the fair market value of the property before the damage of $640.
After the disaster, the couch was so damaged that the couch was worthless. Thus, the decrease in fair market value is $640 ($640 was the fair market value of the property before the hurricane minus $0 which was the fair market value of the property after the hurricane). Albert has a deductible casualty loss of $640 as it is smaller than Albert’s basis of $850.
In a perfect world, disasters wouldn’t strike and damage people’s belongings. But in our imperfect world, taxpayers can ease the burden of calculating casualty losses in federally declared disaster areas by keeping diligent records of their damage and visiting a tax professional who is well-versed in the new casualty loss deduction safe harbors.