As wildfires, hurricanes and other natural disasters continue to grab headlines, advisors say clients should be aware of tax relief and insurance breaks they might be entitled to if they lose property to a disaster.
“The IRS has provided extensions on tax filing and payment extensions in areas that experienced a natural disaster. They also may give tax credits for rebuilding efforts for certain disasters,” said Jesica Ray, lead advisor at Brighton Jones in Washington, D.C.
But “complexities surrounding the deductibility of losses, calculation methods, insurance reimbursement, and differences between personal-use and business-use properties often lead to significant misunderstandings,” said Kelly Morgan Gillette, a partner at Armanino LLP in Dallas. “One of the largest misconceptions among clients, especially those in higher-income brackets, is that casualty losses are fully deductible.”
For individuals, since 2018 only losses attributable to federally declared disasters are deductible. Disasters must be officially defined by the Federal Emergency Management Agency (FEMA). Fire-related claims are the most expensive and severe claims, Ray said, and floods are the leading natural disaster.
There are three types of casualty losses:
• Federal casualty: a loss of personal-use property attributable to a federally declared disaster.
• Disaster: a loss attributable to a federally declared disaster that occurs in an area eligible for assistance pursuant to presidential declaration.
• Qualified disaster: a loss of personal-use property attributable to a major disaster declared by the president under section 401 of the Stafford Act in 2016.
“If you suffer a qualified disaster loss, you can claim a casualty loss deduction, claim the loss in the preceding tax year and deduct the loss without itemizing other deductions on Schedule A,” said Cindy Chase, managing director at Callan Family Office in Penngrove, Calif. “You may not deduct casualty losses covered by insurance unless you file a timely claim for reimbursement and you reduce the loss by the amount of reimbursement. If the amount you receive from insurance or any other reimbursements is more than the cost or adjusted basis of the property, you may have a reportable capital gain.”
Clients must use the lesser of the decrease in value (the difference between the FMV before and after the disaster) or the property’s adjusted basis to calculate the starting point for the deductible amount. “Valuing the property, especially high-value properties, properties that have not been valued recently, collectibles or unique assets, may require appraisals,” Gillette said.
After a client figures their casualty or theft loss on personal-use property, they reduce that loss $100 and then their total federal casualty losses by 10% of their AGI. (The 10% rule doesn’t apply to qualified disaster losses.) “Depending on the level of AGI, the calculation may result in no available tax deduction,” said Jave Ragan, CPA and senior wealth advisor with Bordeaux Wealth Advisors in Kirkland, Wash. That loss can be taken in the tax year immediately preceding the actual event or in the year the event occurred. “Beneficial if the AGI was much lower in one year,” Ragan added.
“Wealthy clients with a high AGI often find the 10% rule surprising,” said Richard Pianoforte, managing director of tax at Fiduciary Trust International in New York. “When a casualty loss is decreased by 10% of their AGI, there are many instances where the casualty loss falls below 10%, rendering it non-deductible."
Gillette added, “Business casualty losses are fully deductible in the year the loss occurs and aren’t subject to the same limitations as personal-use losses."
The most complicated aspect of property-casualty losses? “Making sure the loss is properly insured in the first place,” said Craig Cartmill, director of private client with Golsan Scruggs in Lake Oswego, Ore. “Dramatic variability between various insurance company policy contracts” could mean that a personal liability umbrella won’t necessarily provide complete coverage, he said.
Cartmill added that high-value homes are seeing dramatic rate increases, coupled with policy contract limitations and amendments, as headline disasters increase.
Advisors say it's important to evaluate clients' policies before disasters strike.
“Events such as natural disasters may not be covered in certain circumstances. Losses not covered by insurance may also not result in a tax deduction,” Ragan said.