8721 / What is a qualified insolvent financial institution loss? Can a taxpayer treat such a loss as a casualty loss?

Prior to 2018, a taxpayer could choose to treat a qualified insolvent financial institution loss as a casualty loss if it could be ascertained with reasonable certainty that there was a loss on a qualified individual’s deposit in a qualified financial institution and that the loss was caused by the bankruptcy or insolvency of that institution.[1] “Deposit” for this purpose means any deposit, withdrawable account or withdrawable or repurchasable share.²

The term “qualified individual” is defined by exclusion as any individual other than an individual who:

(1)  owns at least 1 percent of the outstanding stock of the qualified institution;

(2)  is an officer of the qualified institution; or

(3)  is related to a person described in (1) or (2), above.³

A “qualified financial institution” is a bank, mutual savings bank, credit union (if its deposits are insured or protected under federal or state law) or any similar institution that is chartered and supervised under either federal or state law.⁴

If the taxpayer elects to treat a qualified insolvent financial institution loss as a casualty loss, the election applies to all losses in that same financial institution for the tax year. The election can only be revoked with the consent of the Secretary.⁵

In the alternative, and while the casualty loss rules are suspended from 2018-2025, a taxpayer may elect to treat the loss as an ordinary loss in order to avoid the limits on the casualty loss deduction discussed in Q 8714. However, with respect to each financial institution, the taxpayer is only permitted to elect an ordinary loss deduction of up to $20,000 ($10,000 for married taxpayers filing separately). The taxpayer may not elect ordinary loss treatment if the deposit in question was federally insured.⁶

An election to treat a qualified insolvent financial institution loss as a casualty loss precludes treating the loss as a bad debt.⁷