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Small Business Tips

Tax Laws for Fire and Casualty Loss Tax Deduction

Justine Rabideau

Losing a home and personal belongings to a fire is everyone's worst nightmare. In the event of a fire on your property, your insurance policy will cover most of the damages. However, it likely will not include all the damages. Some expenses, such as any deductible associated with the insurance plan, will be up to you.  What about a fire loss tax deduction? Is that available to you to provide some relief after your devastating loss? If the fire occurred in 2018, it depends.  The Tax Cuts and Jobs Act of 2017, which takes effect this year, limits casualty losses you can claim on your taxes. Before, you could claim a house fire tax deduction, provided you did not set the fire yourself. Now you can only claim a casualty loss related to a federally declared natural disaster.

Casualty loss deduction before 2018

It may be helpful to first understand what generally qualifies as a casualty loss. An event qualifies as a casualty if it meets the following criteria:

  • Unusual
  • Unexpected
  • Sudden.

In other words, casualty losses are unanticipated and swift. Progressive damage that happens gradually over time does not qualify, nor do day-to-day occurrences. The loss cannot result from an event you could have foreseen, either.  Prior to 2018, you could claim fire losses not covered by insurance on your taxes and get a deduction. However, the new law prevents you from claiming these losses unless they occurred in a federal disaster area. This provision will be in place until 2025.  So if your house burns down due to faulty wiring and the only property affected was yours, you're out of luck. Anything that insurance doesn't cover, you have to pay out of pocket, with no tax deduction.

Casualty loss in federal disaster areas

In the past, homeowners with losses due to natural disasters had the option of applying the deduction to the previous year's taxes. By filing an amended tax return, homeowners could receive a tax refund right away. This quick refund provided ready cash for those struggling to put lives back together following the disaster. However, the TCJA involves some changes to this policy as well.  For example, assume you're a homeowner in California and the recent wildfires destroyed your home. You should be able to apply a house fire deduction to the previous year's taxes and get your refund, right?  Not necessarily. The current law extends previous-year filing only to those in counties federally declared as disaster areas. If the president doesn't declare the county you live in as a disaster area, your deduction applies to 2018 taxes only.

The flip side: Casualty gain after a fire

If your insurance company pays you more than the adjusted basis of the property, you may have a casualty gain. There is a formula for calculating adjusted basis of an asset:

  • The original purchase price
  • Minus any tax deductions you've claimed in the past
  • Plus the costs of any improvements you've made.

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Once you've calculated the adjusted basis, subtract it from the amount of insurance money you received. If the resulting amount is positive, you've had a taxable gain on your casualty. However, you may be able to defer or avoid taxes by purchasing replacement property using the reimbursement.

How to file a casualty loss on your taxes

The IRS requires anyone who's had one or more casualties during the year to file Form 4684. However, the changes to tax law have necessitated changes to the form itself. The revised form is still in its draft state, and the IRS has made it available for informational purposes only.  Some good news, however: you can deduct non-qualifying casualty losses from any casualty gains you report. This means the reported gains will be lower and have less impact on the losses from a qualified disaster.  Here's how it works:

  • Assume you report a casualty gain on line 13
  • Now assume you report a non-qualifying casualty loss on line 12
  • Further assume you also report a qualified disaster loss, also on line 12.

You will use Worksheet 1-1 to calculate your casualty loss deduction:

  • On line 1, enter your non-qualifying disaster losses in total
  • On line 2, enter your qualified disaster losses in total
  • Refer to line 13 of Form 4684, compare it to line 1 on Worksheet 1-1
  • Between Form 4684 line 13 and Worksheet 1-1 line 1, enter the smaller of the two on Worksheet 1-1 line 3
  • Add Worksheet 1-1 lines 2 and 3
  • Enter the total on Worksheet 1-1 line 4 and on Form 4684 line 14.

Now refer to Form 4684:

  • Compare lines 13 and 14
  • If line 13 is less than line 14, you have a net loss
  • From the amount on line 12, subtract the amount on line 13.
  • The result is your qualified disaster loss.

Keep in mind, this information comes from a draft form. Changes to the final version may occur between now and tax time. And if you don't like the changes to the tax laws, write to Congress.

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