8713 / How is the amount of a taxpayer’s allowable casualty or theft loss deduction determined?

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

If a taxpayer has suffered a casualty (or theft) loss, regardless of whether the loss is personal in nature or is related to trade or business activities, the taxpayer may be entitled to deduct the lesser of the following amounts:

(1)  The fair market value immediately before the casualty minus the fair market value of the property immediately after the casualty; or

(2)  The adjusted basis of the property that would be used for determining the taxpayer’s gain or loss if the property was sold or otherwise disposed of.²

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Planning Point: Although the regulations use the term “immediately after” when referring to the post-casualty value, the IRS recognizes that taxpayers’ ability to determine the decrease in the fair market values of their properties, as a result of a disaster, may be restricted by lack of access to the properties and the need to remove water from flooded properties. Under these circumstances, the decrease in fair market value would take into account additional damage sustained to the property as a result of delays due to legal and physical restrictions to taxpayers’ access to their property and the need to remove standing water from the properties.³

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The fair market value of the property must be ascertained by appraisal, and this appraisal must consider the impact of any general market decline affecting undamaged property (as well as damaged property) that may have occurred at the same time as the casualty, so that the casualty loss is limited to the actual loss caused by the casualty.⁴

The taxpayer claiming the casualty loss may use the actual cost of repairs to the property as evidence of the amount of loss if the following conditions are met:

(1)  The repairs are necessary to restore the property to its condition immediately before the casualty;

(2)  The cost of the repairs is not excessive;

(3)  The repairs only fix the damage suffered as a result of the casualty; and

(4)  The repairs do not cause the value of the property to exceed the value of the property immediately before the casualty.⁵

The cost of repairs may, in certain cases, be used to measure the decline in fair market value, but it cannot be used by itself to determine the amount of the loss. When the cost of repairs is determined to be a fair measure of the decline in fair market value, then the fair market value of the property before the casualty is reduced by the cost of repairs to arrive at the fair market value after the casualty.⁶

If the property at issue was used in a trade or business (or otherwise held for the production of income) and was totally destroyed by the casualty, the taxpayer may use the adjusted basis to determine the amount of loss if the fair market value of the property immediately before the casualty is less than the adjusted basis.⁷

When property used in a taxpayer’s trade or business (or otherwise held for profit) is destroyed, each single, identifiable piece of property must be considered separately in computing the amount of loss.⁸

Example: Chase owns a marina comprised of a large storage building and a boat docking area. The marina is badly damaged in a hurricane. In determining the fair market value of the property for purposes of determining loss, Chase must measure the decrease in value by taking the building and the docks into account separately, rather than together as two integral pieces of the property as a whole. In other words, he must determine the losses separately for the building and the docks.

However, where separate property is considered to be an integral piece of the property as a whole (for example, ornamental trees and shrubs on residential property), no separate calculation is made.⁹