For tax years 2018 through 2025, individuals can claim a deduction for casualty losses attributable to a federally declared disaster on their personal return in the year the loss occurred or may elect to claim the deduction on their prior year return. These individuals may also benefit from an exemption to the additional tax on early distributions from retirement accounts to use as financial support to repair property after the disaster. However, the amount of casualty losses an individual can be deducted and the benefit an individual can receive from the additional tax exemption are both subject to limitations.
I. Calculating Personal Casualty Loss
Taxpayer’s personal casualty loss for damaged or destroyed property is equal to the lesser of: (i) the taxpayers adjusted basis in the property before the casualty or (ii) the decrease in fair market value from the casualty; minus any insurance or other reimbursement received or expected to receive for the property.
Generally, if a casualty single event results in the damage or destruction of more than one item of property, taxpayers must calculate the loss on each item individually and then combine all losses to determine the total loss from that casualty event. However, when determining a casualty loss on personal-use real property, the entire property (including any improvements, such as buildings, trees, and shrubs) is treated as one item for calculating casualty loss. Thus, when determining the casualty loss on a taxpayer’s personal home, the amount of loss will be calculated using the lesser of the fair market value or the adjusted basis of the entire property.
The decrease in fair market value used to figure the amount of a casualty loss is the difference between the property’s fair market value immediately before and immediately after the casualty. Determining the decrease in fair market value as a result of a casualty event generally requires a competent appraisal; however, the IRS has identified alternative methods available to taxpayers.
a. Cost of Repairs or Cleaning. The cost of cleaning up or making repairs to a property after a casualty event may be used as a measure of the decrease in the fair market value of the property if the following conditions are satisfied: (i) the repairs are actually made; (ii) the repairs are necessary to put the property back to its condition before the casualty; (iii) the amount spent for repairs is not excessive; (iv) the repairs only take care of the damage caused by the casualty event; (v) the repairs do not cause the value of the property to be more than it’s value before the casualty event.
(b) Personal-Use Residence Safe Harbor Methods. The IRS has provided some safe harbor methods for calculating the decrease in fair market value to personal-use residential real property from a casualty event. However, a residence will not qualify as personal-use residential real property if any part of the property contains a home office used in a trade or business or is used as a rental property.
(i) Estimated Repair Cost Method. The estimated repair cost safe harbor method allows taxpayers to determine the decrease in the fair market value of their personal-use residential real property using the lesser of two repair estimates prepared by separate and independent licensed contractors. The estimates must detail the itemized costs to restore the property to its condition immediately before the casualty. However, this method is limited to casualty losses of $20,000 or less.
(ii) Insurance Method. The insurance safe harbor method allows taxpayers to determine the decrease in the fair market value of their personal-use residential real property based upon the estimated loss in reports prepared by their homeowners or flood insurance company. These reports must set forth the estimated loss sustained from the damage to or the destruction of the property.
(c) Federal Disaster Personal-Use Residence Safe Harbor Methods. The IRS has provided additional safe harbor methods for calculating the decrease in fair market value to personal-use residential real property from a casualty event that can only be used if the event has been declared a federal disaster and the loss occurred in a federally declared disaster area.
(i) Contractor Method. Under the contractor safe harbor method, a taxpayer may use the contract price for the repairs specified in a contract prepared by an independent and licensed contractor to determine the decrease in the fair market value of their personal-use residential real property. However, this safe harbor method doesn’t apply unless the taxpayer is subject to a binding contract signed by them and the contractor setting forth the itemized costs to restore the personal-use residential real property to its condition immediately before the casualty.
(ii) Disaster Loan Appraisal Method. Under the disaster loan appraisal safe harbor method, a taxpayer may use an appraisal prepared to obtain a loan of federal funds or a loan guarantee from the federal government that identifies their estimated loss from a federally declared disaster to determine the decrease in the fair market value of their personal-use residential real property.
(d) Personal Belongings Safe Harbor Method. The IRS has provided a safe harbor method for calculating the decrease in fair market value to personal belongings (tangible personal property that does not maintain or increase in value and is not used in a trade or business) from a casualty event. Under the De Minimis safe harbor method, a taxpayer can use a good-faith estimate to determine the decrease in he fair market value of their personal belongings from a casualty event if they maintain records describing their affected property as well as their methodology for estimating the loss. However, this method is limited to casualty losses of $5,000 or less.
(e) Federal Disaster Personal Belongings Safe Harbor Method. The IRS similarly has additional safe harbor methods for calculating the decrease in fair market value to personal belongings from a casualty event that can only be used if the event has been declared a federal disaster and the loss occurred in a federally declared disaster area. Under the Replacement Cost safe harbor method, a taxpayer can
determine the decrease in fair market value of their personal belongings by taking the current cost of replacing the item with a new one and reducing that value by 10% for each year the taxpayer has owned the item.
The loss determined through any safe harbor method must be reduced by the value of any repairs provided by a third party at no cost (for example, work done by volunteers or via donations) to the taxpayer and by the amount of any insurance, reimbursements, or other compensation received by the taxpayer for the property. Note that all these safe harbor methods are subject to additional rules and exceptions under Revenue Procedure 2018-08.
II. Calculating Personal Casualty Loss Allowable Deduction
Although individuals are allowed to claim a deduction for personal casualty losses in 2018 through 2025, the amount of loss that they are allowed to deduct is subject to several limitations. With the exception of Qualified Disaster Losses , the amount of casualty losses an individual can deduct is limited by the $100 Rule and 10% Rule.
$100 Rule. The taxpayer’s total casualty loss from all items of personal-use property affected by a single casualty event must be reduced by $100.
10% Rule. An individual taxpayer can only claim a deduction for the amount their total casualty loss after application of the $100 Rule exceeds 10% of their adjusted gross income (“AGI”) for the year the loss was sustained.
Example. In September, X’s house was damaged by a tropical storm that was a federally declared disaster. X’s total personal-use casualty loss from the storm was $2,000. X did not receive any reimbursement from insurance. X’s AGI for the year the loss was sustained was $29,500. X’s casualty loss deduction calculation is as follows:
Total Casualty Loss $2,000
$100 Rule ($100)
Loss after $100 Rule $1,900
10% Rule ($2,950)
Casualty loss deduction $ -0-
X cannot claim a casualty loss deduction because their total loss after the $100 Rule ($1,900) is less than 10% of X’s AGI ($2,950).
III. Tax Implications of Using Retirement Funds to Repair Home
Qualified Disaster Recovery Distributions. Under the general rule, early distributions from a retirement plan are included in the taxpayer’s income and subject to additional tax. However, there is a limited exception for qualified disaster recovery distributions.
A qualified disaster recovery distribution is (i) a distribution made from an eligible retirement plan (ii) to an individual whose principal residence was located in a federally declared disaster area and sustained an economic loss, such as damage or destruction of real or personal property, by reason of said disaster, (iii) and was made on within 180 days of the FEMA declared incident period. Eligible retirement plans include qualified pensions, profit-sharing, 401(k), SEP IRA, Simple IRA and Roth IRA.
Qualified disaster recovery distributions are included in the taxpayer’s income but are not subject to any additional tax for early distributions up to $22,000 total from all retirement plans. Any distributions received in excess of $22,000 limitation may be subject to additional tax depending on the conditions of the specific retirement account. Taxpayers receiving a qualified disaster recovery distribution can elect to report the full value of the distribution as income in the year received or can elect to report the distribution as income in equal portions over the next three years. Taxpayers are generally allowed to repay any portion of the distribution within three years of receiving it and the amounts repaid are not included income.
1 https://www.irs.gov/publications/p547#en_US_2023_publink1000225230 Deduction Limits.
https://www.irs.gov/newsroom/irs-provides-relief-for-helene-various-deadlines-postponed-to-may-1-2025-part-or-all-of-7-states-qualify Additional Tax Relief
2 https://www.irs.gov/publications/p547#en_US_2023_publink100014701 Figuring Decrease in FMV—Items To Consider
3 Cash Gifts: If you receive excludable cash gifts as a disaster victim and there are no limits on how you can use the money, you don’t reduce your casualty loss by these excludable cash gifts. This applies even if you use the money to pay for repairs to property damaged in the disaster https://www.irs.gov/publications/p547#en_US_2023_publink100014701
4 Qualified Disaster Losses are individual casualty losses attributable to A major disaster declared by the President under section 401 of the Stafford Act in 2016; Hurricane Harvey; Tropical Storm Harvey; Hurricane Irma; Hurricane Maria; The California wildfires in 2017 and January 2018; A major disaster that was declared by the President under section 401 of the Stafford Act and that occurred in 2018 and before December 21, 2019, and continued no later than January 19, 2020 (except those attributable to the California wildfires in January 2018 that received prior relief); and A major disaster that was declared by the President during the period between January 1, 2020, and February 25, 2021. Also, this disaster must have an incident period that began on or after December 28, 2019, and on or before December 27, 2020, and must have ended no later than January 26, 2021. The definition of a qualified disaster loss does not extend to any major disaster that has been declared only by reason of COVID-19 (because the incident period for COVID-19 extended beyond January 26, 2021). Thus, given that the incident period for COVID-19 generally ran from January 20, 2020, to May 11, 2023, a loss due to COVID-19 is not a qualified disaster loss. https://www.irs.gov/publications/p547#en_US_2023_publink100014701
5 https://www.irs.gov/publications/p590b#idm139792480117456
