CASUALTIES PRODUCE LOSSES, RIGHT?
As in all things related to the tax laws, whether or not a casualty produces a deductible
loss (or gain), depends! I am sure it would not surprise any of our readers if we told you
that you could have a gain from a casualty. A casualty must first meet several tests to
determine that it is a “casualty” for which a loss may be taken. Since I want to talk about
the calculations, we will skip those definitions.
It matters whether you own the property or lease it. In a lease situation, the calculation is
simple: the amount of your cost to repair or replace less any reimbursement is the loss. If
you own the property it depends on whether it is business use property or personal use
property. The business use property calculation is: Adjusted Basis minus Salvage Value
minus Reimbursement. If it is personal use property the calculation is: (the lesser of
Adjusted Basis or Decrease in Fair Market Value) minus Reimbursement (due or
received). Adjusted Basis is a term of art, with different meanings for business use
property and personal use property. It is pretty much what you have on your books less
depreciation for business use property, but for personal use property it is original cost or
transferor basis if gift property, plus improvements, less any earlier losses or
“depreciation” (but that is not the same as what applies in business use property and is
not defined for personal use property). But remember the lesser of Adjusted Basis or
Decrease in Fair Market Value is the important top number, before reimbursements. IRS
gives an example of a chair destroyed in a fire. Before the fire the value was $500 to
replace, but it could not have been sold for more than $100 just before the fire. The cost
of the chair 4 years before was $300. IRS says your loss is $100. IRS Publication 547
(2006), p 4. Since your Adjusted Basis was $300 and that is larger than the Decrease in
Fair Market Value ($100 FMV before fire less $0 FMV after the fire = $100 Decrease),
the loss is $100. If you got replacement value reimbursement at 80% of the cost to
replace ($500 * 80% = $400), then you have a $300 gain on that loss property ($100 loss
less $400 = ($300)). To complicate things further, costs to determine values are not
additions to basis, but may be deducted as “Other Itemized Expenses” – subject to 2% of
AGI limitations. If this loss is caused in a federally declared disaster area, these
calculations may favor the taxpayer significantly.
Thus, it will be important in the event of a casualty loss for you to be able to determine
values before and after the loss, and your original basis. The calculations will have to
take into account many things which you may not recognize immediately as being
applicable to your loss, and things such as living expense reimbursements may create
taxable income (except in a federally declared disaster area) to the extent that they exceed
your normal living expenses.
by Charles H. Moses, III, Esq.