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Natural disasters come in different shapes and sizes and have a considerable impact on households and their assets all across the country.
Homeowners and rental property owners often have insurance policies that protect them against these tragedies. But in the grand scheme of things, these policies are not enough.
It might benefit you to know of the advantages of a casualty loss as provided to you by the Internal Revenue Service (IRS). As per the regulator’s provisions, casualty losses as a result of these disasters are tax deductible.
Nevertheless, there is more to be learned about casualty loss. In this article, the team from SGI Property Management breaks down the subject topic and also details the different factors that may affect deduction for casualty losses.
A Casualty
It would be ideal for us to first define what a casualty is. This is a sudden and unexpected loss of life or in this case damage of property.
While the source of the casualty may differ, we are concerned with natural causes and the ones outlined by the IRS. These include floods, sonic booms, fires, earthquakes, storms, landslides, and volcanic eruptions.
Another form of casualty that is provided is man-made causes. For example, if the government orders the demolition of a building as a result of hazardous elements but there is more damage to surrounding properties.
A common factor that you will appreciate in all or the above causes mentioned above is the unpredictability and suddenness of the act.
These are not progressive weakening or damage that can be predicted and acted upon. By that definition, damage as a result of normal wear and tear or deterioration is not considered.
What is considered casualty loss is exact by its definition. Here are some of the elements to be considered:
A casualty loss is still deductible should the event still occur to a damaged property in a federally declared disaster zone.
For personal residences, a casualty loss is only considered when there is a presidential declaration deeming the natural event to be a disaster.
An error in your personal residence that results in unprecedented damage cannot be considered a disaster.
The judgment on whether an unprecedented loss results in the deduction of casualty loss depends on the severity of the damage.
How Much is Deductible?
As a rental property owner, this is a question that you should know the answer to. The casualty loss deductible wholly depends on the severity of damage on the property i.e. partial or complete destruction. In addition, if insurance is in play, the casualty loss deductible also varies.
Landlords must know the deduction for each of the items destroyed or damaged. This statement applies most to rental property owners. However, the rule doesn’t apply if the damaged goods are personal. This refers to items like stoves and refrigerators.
To be able to calculate the amount of money to be deducted, there are two elements to be considered:
1. Property to Total Loss
Given a situation where the property is stolen or destroyed, the landlord calculates the deduction based on: the insurance proceeds, the adjusted basis, and the salvage value.
Adjusted basis refers to the property’s original cost plus the improvements on it subtracting the depreciation and other related expenses as per Section 179 of the IRS code. The adjusted basis is calculated separately for the different elements i.e. for the building, landscaping, etc.
Salvage value as the name implies refers to the value of the property after the damage. For example, after a fire, there would be some building materials left behind. That would be the salvage value.
The deductible loss will be equal to:
Deductible loss: Adjusted basis – Salvage rules – Insurance proceeds
2. Partial Loss
In the case of partial damage to the property, the casualty loss is calculated as:
Adjusted basis – Decrease in the property’s fair market value – Salvage rules – Insurance proceeds
Will Insurance Affect Tax Deductions?
As mentioned above, the casualty loss is tax deductible. By virtue of your property being insured, you will be receiving an amount from the insurer. You can reduce the casualty loss amount by the reimbursements received.
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As a business or individual operating an income-producing property, you don’t have to file an insurance claim for you to meet the requirements for a casualty loss deduction. This is the typical method of operation for most landlords.
Insurers tend to increase the premium upon filing of the claim. Some even go to the lengths of canceling the policy.
Other elements that will affect your tax deduction for the casualty loss. This includes:
Restoration and repair costs received from any relief agency. A good example is the Red Cross.
Court award for property damages (subtracting related expenses)
Forgiven Federal disaster loan (either in part of whole)
Repair and replacement costs from the tenant
Filing for Casualty Losses
Typically, all casualty losses are deductible in the year that they occur. There are exceptions to this rule in disaster areas.
If an event occurred in a federally declared disaster area, a property owner has the option of deducting the loss from the previous year.
And what about if the returns had already been filed? In such a scenario, the landlord can claim against the current year’s returns using an amended one. However, this applies if the amendment is done within six months.
Conclusion
Feeling a bit lost with the overload of information? You are not alone in the process. The property industry tends to be quite technical and requires one to be ready to consume and interpret a plethora of information.
Property owners in Phoenix and its environs rely on the expertise of the team from SGI Property Management Phoenix.
We take away the risk, frustration, and time wasted with rental property ownership and leasing. With over 500 units in our portfolio, we are the partner that you need by your side. Get in touch with us today and receive a quote for our services.
