Tax Memo

Explanation When Can a Taxpayer Deduct Casualty Losses? Taxpayers may generally deduct losses resulting from damage to, or destruction of, property. However, several limits apply to deductions claimed by individuals, as well estates and trusts[1] for personal casualty and theft losses related to property that is not used in the taxpayer’s trade or business or in a transaction entered into for profit.

Generally, the deduction for personal casualty losses is limited to losses arising from fire, storm, shipwreck, or other casualty, or theft[2] (see Explanation: §165(c)). However, for tax years beginning in 2018 through 2025[3]

, the deduction for personal casualty and theft losses is limited only to losses attributable to federally declared disasters. A taxpayer may still claim personal casualty and theft losses not attributable federally declared disasters to the extent of any personal casualty and theft gains during 2018 through 2025.

The amount of the deduction for personal casualty losses is also subject to the following limits:

• the first $100[4] of each casualty or theft loss is not deductible, and • the personal casualty losses that exceed personal casualty gains are deductible only to the extent that

they also exceed 10 percent of adjusted gross income (AGI)[5] .

These limits apply only to nonbusiness property. Damage to business or income-producing property need not result from a casualty, theft, or disaster, and loss deductions are not subject to any floors.

A casualty loss is generally deductible only for the tax year in which the loss is sustained (see Explanation: §165(h)). However, a taxpayer that sustains a loss attributable to a federally declared disaster in a tax year may elect to deduct the disaster loss[6] in the preceding tax year. The amount of the loss taken in the preceding year cannot exceed the uncompensated amount of the loss. Thus, if the taxpayer is reimbursed from insurance or otherwise, or has a reasonable prospect of receiving reimbursement, then the amount of the loss claimed must be reduced (see Explanation: §165(i)).

A taxpayer may not deduct a loss unless the damaged property belongs to the taxpayer. For example, a taxpayer cannot deduct the amount paid to another individual for damage caused by the taxpayer's pleasure boat to another vessel[7] . A similar rule applies to automobile damages.

Passive Activities

The deduction of casualty losses generally is not limited by the passive activity loss rules[8] , even if the losses are sustained in a passive trade or business or rental activity. Instead, losses similar in cause and severity to those that recur regularly in the conduct of the passive activity are treated as passive activity deductions subject to limitations. See Explanation: §469.

Since a casualty loss incurred in a passive activity is not a personal casualty loss, it is not subject to the deduction limitations of IRC §165(h)[9] . Rather, it is treated in the same way as any other theft or casualty loss incurred in a trade or business or transaction entered into for profit. Also, the election to advance a disaster loss to the tax year preceding the loss year may apply to a casualty loss incurred in a passive activity. See Explanation: §165(i).

Citations

1. REVRUL62-197 2. §165(c)(3) 3. §165(h)(5) 4. §165(h)(1)

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When Can a Taxpayer Deduct Casualty Losses?

5. §165(h)(2) 6. §165(i) 7. DEC15351(M) 8. NOTICE90-21 9. §165(h)

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