Analyzing the new personal casualty loss tax rules: Recent legislative and administrative measures transform this common deduction.

Author:Tierney, Kristie N.
 
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Over the past decade, the United States has been plagued with myriad natural disasters. The National Oceanic and Atmospheric Administration reports that in 2017 alone, the country experienced 16 weather- and climate-related disasters costing more than $1 billion apiece and, in total, exceeding $306 billion, which far surpassed the previous record of $215 billion set in 2005. Many scientists are predicting more extreme weather-related events in the future.

Congress has responded to the most devastating of these natural disasters with tax relief for victims. Through the passage of the Disaster Tax Relief and Airport and Airway Extension Act of 2017, RL. 115-63, and the Bipartisan Budget Act of 2018, RL. 115-123, Congress eased the traditional personal casualty loss rules for the victims of hurricanes Harvey, Irma, and Maria, as well as those of the California wildfires. Additionally, with its issuance of Rev. Procs. 2018-8 and 2018-9, the Treasury Department introduced numerous safe-harbor methods that alleviate the netdesome burden of determining personal casualty loss amounts.

Conversely, however, with the enactment of P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA), Congress charted a new course, essentially eliminating the personal casualty loss deduction for tax years 2018 through 2025, except for major disasters deemed to require federal assistance.

TRADITIONAL PERSONAL CASUALTY LOSS RULES

Before the TCJA imposed new limits, Sec. 165(c)(3) granted authority to individual taxpayers to deduct uncompensated personal casualty losses. Personal casualty losses are defined as those not incurred in a trade or business or in any transaction entered into for profit, and arising from "fire, storm, shipwreck, or other casualty, or from theft." While neither the Code nor the Treasury regulations define a "casualty," the IRS has interpreted it to be "an identifiable event of a sudden, unexpected, or unusual nature" (Rev. Rul. 79-174). No doubt, weather-related phenomena such as tornadoes, hurricanes, mudslides, and wildfires meet this definition; likewise, events such as car accidents, vandalism, and incidents of civil unrest would fall within its scope. Losses arising from progressive deterioration through a steadily operating cause, however, are not deemed to be casualties (e.g., termite damage or normal seasonal variations in levels of a body of water; see Rev. Ruls. 63-232 and 76-134).

Once a taxpayer ascertains the availability of a personal casualty loss, the next task is to determine the amount allowed. The Treasury regulations provide that personal casualty losses are equal to the lesser of (1) the adjusted basis for determining a loss on the sale of the damaged property, or (2) the decrease in the property's fair market value (FMV) (Regs. Sec. 1.165-7(b)). A property's FMV, both before and after the casualty, must be established by a "competent appraisal," or its decrease can be evidenced by repair costs meeting the requirements of Regs. Sec. 1.165-7(a)(2)(ii). Once this determination is made, an adjustment must be made for "any salvage value and for any insurance or other compensation received" (Regs. Sec. 1.165-1(c)(4)).

There are three pivotal limitations to the allowance of personal casualty losses. First, the loss from each casualty is allowed only to the extent it exceeds $100 (Sec. 165(h)(1)). Second, aggregate losses for a tax year are allowed only to the extent they exceed the sum of (1) casualty gains and (2) 10% of the taxpayer's adjusted gross income (AGI) (Sec. 165(h)(2)). Third, no deduction is permitted in a tax year for the loss, or any portion of it, when a claim for compensation is outstanding for which there is a "reasonable prospect" of recovery (Regs. Sec. 1.165-1(d)(2)).

Taxpayers report these net personal casualty losses as itemized deductions and can use them to offset ordinary income.

The Code generally requires a taxpayer to take a loss deduction in the year in which it is sustained. However, an election may be made to deduct losses incurred within a disaster area determined to warrant federal assistance and attributable to a federally declared disaster in the tax year immediately preceding the year in which the disaster occurred (Sec. 165(i)). The Treasury regulations state that an election made under Sec. 165(i) applies to all the losses suffered by the taxpayer as a result of the disaster to which the election...

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