Publication 225
Farmer's Tax Guide

For use in preparing 2002 Returns

Acknowledgment:

The valuable advice and assistance given us each year by the National Farm Income Tax Extension Committee is gratefully acknowledged.

13. Casualties, Thefts, and Condemnations

Important Reminders

Postponed tax deadlines in disaster areas.   The maximum period of time for which the IRS may postpone certain tax deadlines of taxpayers who are affected by a Presidentially declared disaster is increased from 120 days to 1 year. The tax deadlines the IRS may postpone include those for filing income and employment tax returns, paying income and employment taxes, and making contributions to a traditional IRA or Roth IRA. For more information, see Postponed tax deadlines, later, under Disaster Area Losses.

Qualified disaster relief payments.   Qualified disaster relief payments received in tax years ending after September 10, 2001, by an individual for certain expenses incurred because of a Presidentially declared disaster are not included in income. For more information, see Qualified disaster relief payments, later, under Disaster Area Losses.

Introduction

This chapter explains the tax treatment of casualties, thefts, and condemnations. A casualty occurs when property is damaged, destroyed, or lost due to a sudden, unexpected, or unusual event. A theft occurs when property is stolen. A condemnation occurs when private property is legally taken for public use without the owner's consent. A casualty, theft, or condemnation may result in a deductible loss or taxable gain on your federal income tax return. You may have a deductible loss or a taxable gain even if only a portion of your property was affected by a casualty, theft, or condemnation.

An involuntary conversion occurs when you receive money or other property as reimbursement for a casualty, theft, condemnation, disposition of property under threat of condemnation, or certain other events discussed in this chapter.

If an involuntary conversion results in a gain and you buy qualified replacement property within the specified replacement period, you can postpone reporting the gain on your income tax return. For more information, see Postponing Gain, later.

Topics

This chapter discusses:

• Casualties and thefts
• How to figure a loss or gain
• Other involuntary conversions
• Postponing gain
• Disaster area losses
• Reporting gains and losses

Useful Items

You may want to see:

Publication

• 536   Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
• 544   Sales and Other Dispositions of Assets
• 547   Casualties, Disasters, and Thefts
• 584   Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)
• 584-B   Business Casualty, Disaster, and Theft Loss Workbook

Form (and Instructions)

• Sch A (Form 1040)   Itemized
  Deductions
• Sch D (Form 1040)   Capital Gains and Losses
• Sch F (Form 1040)   Profit or Loss From Farming
• 4684   Casualties and Thefts
• 4797   Sales of Business Property

See chapter 21 for information about getting publications and forms.

Casualties and Thefts

If your property is destroyed, damaged, or stolen, you may have a deductible loss. If the insurance or other reimbursement is more than the adjusted basis of the destroyed, damaged, or stolen property, you may have a taxable gain.

Casualty.   A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

Deductible losses.   Deductible casualty losses can result from a number of different causes, including the following.

• Airplane crashes.
• Car or truck accidents not resulting from your willful act or willful negligence.
• Earthquakes.
• Fires (but see Nondeductible losses, next, for exceptions).
• Floods.
• Freezing.
• Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster as discussed under Disaster Area Losses, in Publication 547.
• Lightning.
• Storms, including hurricanes and tornadoes.

Nondeductible losses.   A casualty loss is not deductible if the damage or destruction is caused by the following.

• Accidentally breaking articles such as glassware or china under normal conditions.
• A family pet.
• A fire if you willfully set it, or pay someone else to set it.
• A car or truck accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone acting for you caused the accident.
• Progressive deterioration (explained next).

Progressive deterioration.   Loss of property due to progressive deterioration is not deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. Examples of damage due to progressive deterioration include damage from rust, corrosion, or termites. However, weather-related conditions or disease may cause another type of involuntary conversion. See Other Involuntary Conversions, later.

Theft.   A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the law of the state where it occurred and it must have been done with criminal intent.

Theft includes the taking of money or property by the following means.

• Blackmail.
• Burglary.
• Embezzlement.
• Extortion.
• Kidnapping for ransom.
• Larceny.
• Robbery.
• Threats.

The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.

Mislaid or lost property.   The simple disappearance of money or property is not a theft. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual.

Example.   A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.

Farming Losses

You can deduct certain casualty or theft losses that occur in the business of farming. The following is a discussion of some losses you can deduct and some you cannot deduct.

Livestock or produce purchased for sale.   Casualty or theft losses of livestock or produce bought for sale are deductible if you report your income on the cash method. If you report your income on an accrual method, take casualty and theft losses on property bought for sale by omitting the item from the closing inventory for the year of the loss. You cannot take a separate deduction.

Livestock, plants, produce, and crops raised for sale.   Losses of livestock, plants, produce, and crops raised for sale are generally not deductible if you report your income on the cash method. You have already deducted the cost of raising these items as farm expenses.

For plants with a preproductive period of more than 2 years, you may have a deductible loss if you have a tax basis in the plants. You usually have a tax basis if you capitalized the expenses associated with these plants under the uniform capitalization rules. The uniform capitalization rules are discussed in chapter 7.

If you report your income on an accrual method, casualty or theft losses are deductible only if you included the items in your inventory at the beginning of your tax year. You get the deduction by omitting the item from your inventory at the close of your tax year. You cannot take a separate casualty or theft deduction.

Income loss.   A loss of future income is not deductible.

Example.   A severe flood destroyed your crops. Because you are a cash method taxpayer and already deducted the cost of raising the crops as farm expenses, this loss is not deductible, as explained earlier under Livestock, plants, produce, and crops raised for sale. You estimate that the crop loss will reduce your farm income by $25,000. This loss of future income is also not deductible.

Loss of timber.   If you sell timber downed as a result of a casualty, treat the proceeds from the sale as a reimbursement. If you use the proceeds to buy qualified replacement property, you can postpone reporting the gain. See Postponing Gain, later.

Property used in farming.   Casualty and theft losses of property used in your farm business usually result in deductible losses. If a fire or storm destroyed your barn, or you lose by casualty or theft an animal you bought for draft, breeding, dairy, or sport, you may have a deductible loss. See How To Figure a Loss, later.

Raised draft, breeding, dairy, or sporting animals.   Generally, losses of raised, draft, breeding, dairy, or sporting animals do not result in deductible casualty or theft losses because you have no basis in the animals. However, you may be able to claim a deduction if either of the following situations applies to you.

• You use inventories to determine your income and you included the animals in your inventory.
• You capitalized the expenses associated with the animals under the uniform capitalization rules and therefore have a tax basis in the animals subject to a casualty or theft.

When you include livestock in inventory, its last inventory value is its basis. When you lose an inventoried animal held for draft, breeding, dairy, or sport by casualty or theft during the year, decrease ending inventory by the amount you included in inventory for the animal. You cannot take a separate deduction.

How To Figure a Loss

How you figure a deductible casualty or theft loss depends on whether the loss was to farm or personal-use property and whether the property was stolen or partly or completely destroyed.

Farm property.   Farm property is the property you use in your farming business. If your farm property was completely destroyed or stolen, your loss is figured as follows:

You can use the schedules in Publication 584-B to list your stolen, damaged, or destroyed business property and to figure your loss.

If your farm property was partially damaged, use the steps shown under Personal-use property, next, to figure your casualty loss. However, the deduction limits, discussed later, do not apply.

Personal-use property.   Personal-use property is property used by you or your family members for personal use. You figure the casualty or theft loss on this property by taking the following steps.

1. Determine your 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. From the smaller of the amounts you determined in (1) and (2), subtract any insurance or other reimbursement you receive or expect to receive.

You must apply the deduction limits, discussed later, to determine your deductible loss.

You can use Publication 584 to list your stolen or damaged personal-use property and figure your loss. It includes schedules to help you figure the loss on your home, its contents, and your motor vehicles.

Adjusted basis.   Adjusted basis is your basis (usually cost) increased or decreased by various events, such as improvements and casualty losses. For more information about adjusted basis, see chapter 7.

Decrease in fair market value (FMV).   The decrease in FMV is the difference between the property's value immediately before the casualty or theft and its value immediately afterwards. FMV is defined in chapter 12 under Payments Received.

Appraisal.   To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. But other measures, such as the cost of cleaning up or making repairs (discussed next) can be used to establish decreases in FMV.

An appraisal to determine the difference between the FMV of the property immediately before a casualty or theft and immediately afterwards should be made by a competent appraiser. The appraiser must recognize the effects of any general market decline that may occur along with the casualty. This information is needed to limit any deduction to the actual loss resulting from damage to the property.

Cost of cleaning up or making repairs.   The cost of cleaning up after a casualty is not part of a casualty loss. Neither is the cost of repairing damaged property after a casualty. But you can use the cost of cleaning up or making repairs after a casualty as a measure of the decrease in FMV if you meet all the following conditions.

• The repairs are actually made.
• The repairs are necessary to bring the property back to its condition before the casualty.
• The amount spent for repairs is not excessive.
• The repairs fix the damage only.
• The value of the property after the repairs is not, due to the repairs, more than the value of the property before the casualty.

Related expenses.   The incidental expenses due to a casualty or theft, such as expenses for the treatment of personal injuries, temporary housing, or a rental car, are not part of your casualty or theft loss. However, they may be deductible as farm business expenses if the damaged or stolen property is farm property.

Separate computations for more than one item of property.   Generally, if a single casualty or theft involves more than one item of property, you must figure your loss separately for each item of property. Then combine the losses to determine your total loss.

There is an exception to this rule for personal-use real property. See Exception for personal-use real property, later.

Example.   A fire on your farm damaged a tractor and the barn in which it was stored. The tractor had an adjusted basis of $3,300. Its FMV was $28,000 just before the fire and $10,000 immediately afterward. The barn had an adjusted basis of $28,000. Its FMV was $55,000 just before the fire and $25,000 immediately afterward. You received insurance reimbursements of $2,100 on the tractor and $26,000 on the barn. Figure your deductible casualty loss separately for the two items of property.