On Nov. 18, thousands of homes, offices and properties were threatened by a fire originating near Caughlin Ranch in Reno. The unusually dry autumn weather coupled with very strong winds created conditions which could have resulted in catastrophic losses. Although several homes were lost, the coordinated, diligent response by local fire protection agencies kept the losses from being far greater than they otherwise could have been.
Despite the wonderful efforts of many community members to protect and preserve one another's property, wrongdoers sought to prey on those affected by the fire. Just days after the fire, burglars targeted homes and vehicles in the disturbed neighborhoods. Officials warned residents to verify the credentials of those offering assistance. Scammers can cause additional harm by posing as insurance adjusters, carpet cleaners or contractors.
Based on the recent events, taxpayers should be mindful of helpful tax deductions arising from casualty, disaster and theft losses. A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Deductible casualty losses can result from a number of different causes, including fires, floods, storms, and vandalism.
A theft is the illegal taking of another's property. Theft includes the taking of money or property by burglary, larceny, looting, fraud and robbery.
To deduct a casualty or theft loss, the taxpayer must show that there was a casualty or theft and must support the amount taken as a deduction. Specifically, for a casualty loss the following must be established: 1. The type of casualty (fire, storm, etc.) and the date it occurred; 2. The loss directly resulted from the casualty; 3. The taxpayer owned the property, or leased and was contractually liable for the damage; and 4. Whether the taxpayer has a reasonable expectation of recovery on a claim for reimbursement.
For a theft loss, the taxpayer must establish the following: 1. Date it was discovered that the property was missing; 2. The property was stolen; 3. The taxpayer owned the property; 4. Whether the taxpayer had a reasonable expectation of recovery on a claim for reimbursement.
To determine the allowable deduction for a casualty or theft loss: 1. Determine the adjusted basis in the property before the casualty or theft. 2. Determine the decrease in fair market value of the property as a result of the casualty or theft. 3. Take the smaller of the amounts determined in the first two steps, and subtract any insurance or other reimbursement received or to be received.
For business or income-producing property, such as rental property, which is stolen or completely destroyed, the decrease in fair market value is not considered. The allowable loss equals the adjusted basis in the property, less any salvage value, less any insurance or other reimbursement received.
There are two ways to deduct a casualty or theft loss of inventory, including items held for sale to customers. One way is to simply deduct the loss through the increase in the cost of goods sold by properly reporting the opening and closing inventories. The loss cannot again be claimed as a casualty or theft loss. If this approach is followed, the taxpayer must include in gross income any insurance or other reimbursement received.
The other way is to deduct the casualty or theft loss separately. If deducted separately, the affected inventory items must be eliminated from the cost of goods sold by making a downward adjustment to opening inventory or purchases. The loss must be reduced by any reimbursement received. Do not include the reimbursement in gross income. If the reimbursement is not received by the end of the year, the loss must still be reduced by the amount of reimbursement for which there is a reasonable expectation of recovery.
If the taxpayer is liable for casualty damage to leased property, the loss is the cost to repair the property less any insurance or other reimbursement.
If insurance or other type of reimbursement is received, the loss is reduced to the extent of the reimbursement. A claim for insurance reimbursement must be filed in a timely fashion or the casualty or theft loss may be lost.
After the loss amount is determined, the taxpayer must next determine how much of the loss is deductible. The deduction for casualty and theft losses of employee property and personal-use property is limited. A loss on employee property is subject to the 2 percent rule. Employee property is property used in performing services as an employee. The casualty and theft loss deduction for employee property, when added to other miscellaneous itemized deductions, must be reduced by 2 percent of adjusted gross income.
A loss on personal use property is subject to the $100 and 10 percent rules. After determining the casualty or theft loss on personal-use property, the loss is reduced by $100. The total of all casualty or theft losses on personal-use property is reduced by 10 percent of the taxpayer's adjusted gross income. Losses on business property (other than employee property) and income-producing property are not subject to the 2 percent and 10 percent rules.
However, if the casualty or theft loss involved a home used for business or as a rental, the deductible loss may be limited. The casualty or theft loss deductions must be figured separately for property used for both personal and business or income-producing purposes. The taxpayer must allocate the total cost or basis, the fair market value before and after the casualty or theft loss, and the insurance or other reimbursement between the business and personal use of the property.
Just as property owners should seek qualified professionals in making repairs or improvements to damaged property, those looking to claim casualty and theft loss deductions should consult with a professional tax advisor.
Don L. Ross and Jason C. Morris are attorneys practicing in the areas of estate planning, taxation and probate at Woodburn and Wedge. Contact them at 688-3000 or dlross@woodburnandwedge.com and jmorris@woodburnandwedge.com.
