A “perfect storm” for damage loss deductions

Despite common perception, the Tax Cuts and Jobs Act (TCJA) did not permanently eliminate the personal injury and theft loss deduction. On the one hand, the TCJA’s crackdown is temporary, extending from 2018 to 2025. On the other hand, it does not apply to losses incurred in a federally designated disaster area.

So you may be able to recover a disaster deduction. The damage in these areas is often significant. However, in order to be able to deduct a loss in a disaster area, you must still follow the usual rules for losses in the event of a disaster.

Background: Under the previous law, you could deduct losses of personal property caused by a “sudden, unexpected or unusual” event. Typically, this included damage or destruction caused by natural disasters, but also applied, for example, to a motor vehicle collision or the bursting of water pipes during a winter freeze.

The amount of the deductible loss has been reduced by any insurance reimbursement you received. In addition, two main limitations applied to the deductions.

  1. You can only deduct the excess over 10% of your Adjusted Gross Income (AGI).
  2. The amount of the loss was to be reduced by $100 for each occurrence.

Let’s say your AGI was $100,000 and you suffered an unreimbursed loss of $20,000. In this case, your deduction was $9,900.

For these purposes, the deductible amount is equal to the lesser of your adjusted asset base and the decrease in the fair market value of your assets resulting from the loss. If an income-producing property (for example, a rental property) is completely destroyed, the amount of the loss is limited to your adjusted base in the property.

The result : If you incur a loss deduction in a federally designated disaster area in 2022, you can deduct the loss, subject to applicable limits. (Although Congress has changed these rules in recent years, the 10% AGI limit and $100 per event discount are still in place for this year.)

Normally, an accident loss is claimed on the tax return for the year in which the accident occurred. However, a special election is available for losses in a federal disaster area. Specifically, you can choose to deduct the loss on the tax return for the year before the actual event.

For example, if you suffer a loss during hurricane season in 2022, you don’t have to wait to file your 2022 return. Instead, you can get faster relief by filing an amended 2021 return or, if you have an automatic filing extension, the 2021 return which is due no later than October 15, 2022.

Caution: Be aware that the IRS often disputes loss deductions. The best evidence you can offer is to take photos or videotape the property in its current condition. In other words, getting documentation before an accident occurs. Visual evidence can be compelling when paired with snapshots of the property immediately after a loss occurs. Keep these records in a safe place.

Finally, remember that the above rules only apply to personal losses. Your small business can deduct all qualified losses regardless of dollar or percentage limits.