Writing off losses after a catastrophe or theft

When a natural disaster or theft has destroyed or robbed you of your personal property, the last thing you’re likely to think about is taxes. You’re probably worrying about cleaning up, filing insurance claims, and getting your life back to normal.

In fact, the federal tax code allows deductions for casualty and theft victims. If you have insurance, the loss has to be fairly substantial to merit a deduction. Nevertheless, if you itemize, it might be worth investigating the issue with tax software or a professional.

What’s covered?

The Internal Revenue Service defines a casualty as the “damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.” That generally includes natural and man-made disasters such as earthquakes, fires, floods, car accidents, vandalism, and terrorist attacks. A loss that could have been prevented—such as some types of mold buildup—wouldn’t count.

Theft, in the IRS’s view, can include fraud or misrepresentation that’s deemed illegal under state or local laws. Lewis B. Kevelson, a partner in tax and business services at Rachlin LLP, an accounting firm in West Palm Beach, Fla., says victims of Ponzi schemes or other scams might be able to take a deduction under this definition. But a decline in stock value resulting from fraud committed at a legitimate corporation—think Enron—must be claimed as a capital loss.

Once you know what your insurer will pay, you can figure your casualty loss for tax purposes. For real estate, your casualty loss is your adjusted basis—purchase price plus documented improvements of the property before the loss—or the decrease in fair-market value of the property after the loss, whichever is less. From that, you subtract insurance and other payments.

For personal property, such as cars, furniture, and clothing, you must show the fair-market value of the items before and after the damage. You can document your loss with receipts and photographs or videos of your property, just as you would for your insurer. Report your totals on Form 4684, “Casualties and Thefts.”

Figuring your deduction

There’s still more to do to determine your deduction. First, subtract $100 from your estimated loss, then subtract 10 percent of your adjusted gross income. If the result is a positive number, that’s your deduction. “That $100 floor and the 10 percent rules really limit you to only taking the deduction when it’s a catastrophic-type loss,” says Lisa Workman, a CPA and director of tax services at BKD, an accounting firm in Springfield, Mo.

If your property is in a region declared a disaster area by the president, you can immediately claim a casualty loss on an amended federal return from last year. A tax pro can help you decide which approach will save you more. You also might be able to take advantage of extended tax-filing deadlines, which you can find by entering your state as a search term on the IRS Web site, at www.irs.gov. For more information, see IRS Publication 547, “Casualties, Disasters, and Thefts.”

This article was also published in Consumer Reports Money Adviser. Subscribe now to get more expert financial advice you can trust.