8711 / How do the rules governing theft and casualty losses interact with the rules governing involuntary conversions of property?

Editor’s Note: Under the 2017 tax reform legislation, individuals are no longer entitled to deduct casualty and theft loss expenses as itemized deductions for 2018-2025 (when those losses are not related to property used in a trade or business). An exception exists for losses that occur in federally declared disaster areas.¹

The rules governing theft losses frequently intersect with the IRC Section 1033 provisions governing involuntary conversions (see Q 8670 to Q 8673). The rules on involuntary conversions govern the treatment of any reimbursement that a taxpayer receives as a result of a loss, such as a casualty or theft loss.

Therefore, if a taxpayer receives insurance proceeds, for example, that exceed the amount lost as a result of a casualty or theft, the taxpayer would look to the rules on involuntary conversions for determining whether the gain must be recognized.² In these circumstances, the gain is characterized as stemming from an involuntary conversion because the casualty in effect causes the damaged property to suddenly be converted into cash from the insurance proceeds. The rules for determining what gain is or is not subject to taxation in involuntary conversions may differ for federally declared disasters.³