In the aftermath of Hurricane Sandy, the Internal Revenue Service has recognized the effects the disaster has caused for many individuals and businesses that have sustained losses. These individuals and businesses will need to consider how to account for the losses by year end.
Taxpayers have the option to deduct casualty losses that occurred to property destroyed as a result of the disaster. Casualty losses are generally deductible in the year the casualty occurred. However, if the loss occurred within a federally declared disaster area, a taxpayer can choose to treat the loss as having occurred in the year immediately preceding the tax year of disaster. The loss can be deducted on either the current year tax return or an amended return for the preceding tax year. This option allows a taxpayer to receive an immediate refund, rather than waiting to file the 2012 tax return to claim the loss.
Individuals are required to claim casualty losses as an itemized deduction. To determine a casualty loss on an individual tax return, the taxpayer must first determine the cost basis in the property before the casualty and the decrease in fair market value of the property as a result of the casualty. From the smaller amount, the taxpayer must subtract any insurance or other reimbursement received or expected to receive. After figuring the amount of the loss net of insurance reimbursements, there are two further limitations on the amount that may be deductible. The first limit is known as the $100 rule, which reduces each total casualty by $100. Only a single $100 reduction applies. The next limit further reduces the total of all losses by 10% of the taxpayer’s adjusted gross income.
For business or income-producing property, such as rental property, the decrease in fair market value is not considered. To determine a casualty loss for business property, the taxpayer reduces his adjusted basis in the property by any salvage value and any insurance reimbursements received or expected to receive. Losses of business inventory can be treated as either a casualty loss, or by increasing the cost of goods sold. In the past, the IRS has modified the above limitations for large disasters such as last year’s Hurricane Irene. Should there be any modifications to the general rules due to Hurricane Sandy we will keep you posted.