Casualty and theft losses on personal property are itemized deductions that reduce taxable income. You use Form 4684 to calculate your losses, and you report them on Schedule A (Form 1040).
It’s not easy to qualify for this deduction, though:
Only an uninsured loss is deductible.
Each uninsured loss of personal property must be reduced by $100.
The total of all your casualty and theft losses on personal property for the year must exceed 10% of your adjusted gross income (AGI) to claim a deduction for that portion of the loss above the threshold.
Example: A burglar breaks into your apartment and steals $10,000 worth of cash and uninsured valuables. Your AGI for the year is $50,000, and this is the only loss you suffered during the year.
Before claiming a deduction for this theft, you must first reduce the loss by $100, and then subtract 10% of your AGI ($50,000 X .10, or $5,000) from the remaining $9,900. This leaves you with a deductible loss of $4,900. If your AGI had been $99,000 or more, the 10% rule would have wiped out your deductible loss completely.
A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual:
A sudden event 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 it isn’t typical of the activity in which you are engaged.
Deductible casualty losses can result from a number of different causes, including:
Car accidents (see Nondeductible Losses for exceptions)
Earthquakes
Fires (see Nondeductible Losses for exceptions)
Floods
Government-ordered demolition or the relocation of a home that’s unsafe to use because of a disaster. A disaster is an event that occurred in an area declared by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.
Mine cave-ins
Shipwrecks
Sonic booms
Storms, including hurricanes and tornadoes
Terrorist attacks
Vandalism
Volcanic eruptions
A loss on deposits can also be considered a casualty loss. Such a loss can occur when a bank, credit union, or other financial institution becomes insolvent or bankrupt. If you incurred this type of loss, you can choose to deduct it as a casualty loss, an ordinary loss, or a nonbusiness bad debt. Once you make the choice, though, you can’t change it without the permission of the Internal Revenue Service. For more information on claiming a loss on deposits, see Publication 547, Casualties, Disasters and Thefts.
The special casualty and theft loss rules for Hurricane Katrina, Rita, and Wilma victims expired on 12/31/2006. These rules don’t apply in 2007.
A casualty loss isn’t deductible if the damage or destruction is caused by any of the following:
Accidentally breaking articles such as glassware or china under normal conditions
A family pet—You can’t deduct damage done by a family pet unless the casualty requirements are met.
Example: Your antique Oriental rug was damaged by your new puppy before it was housebroken. Because the damage isn’t unexpected or unusual, you can’t deduct the loss.
A fire that you willfully set or that you paid someone else to set.
A car accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone acting for you caused the accident.
Progressive deterioration—You can’t deduct damage due to progressive deterioration. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. Examples of damage due to progressive deterioration include:
The steady weakening of a building due to normal wind and weather conditions.
The deterioration and damage to a water heater that bursts. However, the rust and water damage to rugs and drapes caused by the bursting of a water heater does qualify as a casualty.
Most losses of property caused by droughts. To be deductible, a drought-related loss generally must be incurred in a trade or business or in a transaction entered into for profit.
Termite or moth damage.
The damage or destruction of trees, shrubs, or other plants by a fungus, disease, insects, worms, or similar pests. However, a sudden destruction due to an unexpected or unusual infestation of beetles or other insects may result in a casualty loss.
If your property is covered by insurance, you must file a timely insurance claim for reimbursement of your loss. Otherwise, you can’t deduct the loss as a casualty or theft. However, the portion of the loss usually not covered by insurance (for example, a deductible) isn’t subject to this rule. For more information on insurance reimbursements, see Publication 547, Casualties, Disasters and Thefts.
Example: You have a car insurance policy with a $500 deductible. Since your policy doesn’t cover the first $500 of damages due to a car accident, you can deduct the $500, although it’s subject to the $100 reduction and 10% of AGI rules. This is true whether or not you file an insurance claim because your insurance carrier won’t reimburse you for the deductible.
A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the law of the state where it occurred and it must have been done with criminal intent.
Theft includes the taking of money or property by the following means:
Blackmail
Burglary
Embezzlement
Extortion
Kidnapping for ransom
Larceny
Robbery
Fraud or misrepresentation
To determine your deduction for a casualty or theft loss, you must first figure the amount of your loss.
To calculate the amount of your loss:
Determine your adjusted basis in the property before the casualty or theft.
Determine the decrease in fair market value (FMV) of the property as a result of the casualty or theft.
From the smaller of the amounts that you determined in (1) and (2), subtract any insurance or other reimbursement you received or expect to receive.
Example: A sofa that you bought 10 years ago for $1,000 is destroyed in a fire. Before it was destroyed, you could have sold the sofa for $500. Now, to replace the sofa you lost with a comparable sofa, you’ll have to pay $1,800. What’s your casualty loss? It’s not the replacement cost ($1,800). It’s the decrease in fair market value caused by the fire—$500.
ITo prove your loss was caused by a casualty, it’s a good idea to keep newspaper accounts and other proof showing the type of casualty that struck your area and the amount of damage it did in general. To prove the amount of your loss, you should have receipts for its purchase and any improvements made to it, as well as pre- and post-casualty appraisals for the affected property. For more information on proving your loss, see Publication 547, Casualties, Disasters and Thefts.
There are special rules if you suffer a loss as the result of a Presidentially declared disaster. Usually, you deduct a casualty loss in the year that the loss occurs. However, if your loss is the result of a Presidentially declared disaster, you can choose to deduct the loss on your previous year’s return instead. If you’ve already filed your previous year’s return, you can file an amended return to claim the deduction.
Tip: Claiming a qualifying disaster loss on your previous year’s return could result in a lower tax for that year, and it often produces or increases a cash refund. It also means that you’ll get your money months earlier than you will if you wait to claim your loss on your current year’s return.
Example: A tornado badly damages your home in July 2007, and causes $100,000 of uninsured damage. Because the tornado caused a considerable amount of property damage in your town, the President declares the area a federal disaster area. Because your loss occurred in a Presidentially declared disaster area, you can choose to deduct the loss on your home on the 2006 tax return that you filed in April, or you can wait and deduct the loss on your 2007 return, which you won’t be filing until April 2008. If you claim the loss by amending your 2006 return, you’ll put much needed cash in your hands to help you get back on your feet.
Believe it or not, it’s possible to have a gain from a casualty or theft loss according to tax law. And if you do, it’s considered taxable income. You have a gain if you receive an insurance payment or other reimbursement that’s more than your adjusted basis in the destroyed, damaged, or stolen property.
To calculate your gain, you subtract the amount you receive from the adjusted basis of the property at the time of the casualty or theft. Even if the decrease in the fair market value (FMV) of your property is smaller than the adjusted basis of your property, you must use the adjusted basis to figure the gain.
Example: A flood destroyed personal property in the basement of your home. Under a replacement value rider attached to your homeowner’s insurance policy, the replacement value paid by your insurance company is $25,000. After the flood, it’s determined that your adjusted basis in the personal property is only $15,000. Your taxable gain from the insurance reimbursement is $10,000.
The amount you receive includes the payment you received plus the value of any property you received minus any expenses you incurred while pursuing reimbursement. It also includes any reimbursement used to pay off a mortgage or other lien on the damaged, destroyed, or stolen property.
Example: A hurricane destroyed your personal residence and the insurance company awarded you $145,000. You received $140,000 in cash. The remaining $5,000 was paid directly to the holder of the mortgage on the property. The amount you received includes the $5,000 reimbursement paid on the mortgage.
Generally, you must report your gain as income in the year that you receive the reimbursement. However, there is a valuable exception to this rule. You don’t have to report your gain if you meet certain requirements and you choose to postpone reporting the gain by buying replacement property. For more information, see the "Postponement of Gain" chapter in Publication 547, Casualties, Disasters and Thefts.
If you suffer a casualty or theft loss to property used in a business, such as a vehicle or rental property, you can deduct your full loss in Part II of Form 4684. The $100 reduction and 10% of AGI rules don’t apply.