Deduction Limits on Losses of Personal-Use Property
Casualty and theft losses of property held for personal use may be
deductible if you itemize deductions on Schedule A (Form 1040).
There are two limits on the deduction for casualty or theft loss of personal-use
property. You figure these limits on Form 4684.
$100 rule. You must reduce each casualty or theft loss on
personal-use property by $100. This rule applies after you have subtracted any
reimbursement.
10% rule. You must further reduce the total of all your casualty or
theft losses on personal-use property by 10% of your adjusted gross income. Apply this
rule after you reduce each loss by $100. Adjusted gross income is on line 35 of Form 1040.
Example. In June, you discovered that your house had been
burglarized. Your loss after insurance reimbursement was $2,000. Your adjusted gross
income for the year you discovered the burglary is $57,000. Figure your theft loss
deduction as follows:
| 1. |
Loss after insurance |
$2,000 |
| 2. |
Subtract $100 |
100 |
| 3. |
Loss after $100 rule |
$1,900 |
| 4. |
Subtract 10% × $57,000 AGI |
$5,700 |
| 5. |
Theft loss deduction |
-0- |
You do not have a theft loss deduction because your loss ($1,900) is less than 10% of
your adjusted gross income ($5,700).
 If you have a
casualty or theft gain in addition to a loss, you will have to make a special computation
before you figure your 10% limit. See 10% Rule in Publication 547.
When Loss Is Deductible
Casualty losses are generally deductible only in the year in which they occur. Theft
losses are generally deductible only in the year they are discovered. However, losses in
Presidentially declared disaster areas are subject to different rules. See Disaster
Area Losses, later, for an exception.
Leased property. If you lease
property from someone else, you can deduct a loss on the property in the year your
liability for the loss is fixed. This is true even if the loss occurred or the
liability was paid in a different year. You are not entitled to a deduction until your
liability under the lease can be determined with reasonable accuracy. Your liability can
be determined when a claim for recovery is settled, adjudicated, or abandoned.
Example. Robert leased a tractor from First Implement, Inc., for
use in his farm business. The tractor was destroyed by a tornado in June 2002. The loss
was not insured. First Implement billed Robert for the fair market value of the tractor on
the date of the loss. Robert disagreed with the bill and refused to pay it. First
Implement later filed suit in court against Robert. In 2003, Robert and First Implement
agreed to settle the suit for $20,000, and the court entered a judgement in favor of First
Implement. Robert paid $20,000 in June 2003. He can claim the $20,000 as a loss on his
2003 tax return.
Net operating loss (NOL). If your deductions, including casualty or
theft loss deductions, are more than your income for the year, you may have an NOL. An NOL
can be carried back or carried forward and deducted from income in other years. See
chapter 5 for more information on NOLs.
Proof of Loss
To deduct a casualty or theft loss, you must be able to prove that there was a casualty
or theft. You must have records to support the amount you claim for the loss.
Casualty loss proof. For a casualty loss, your records should show
all the following information.
- The type of casualty (car accident, fire, storm, etc.) and when it occurred.
- That the loss was a direct result of the casualty.
- That you were the owner of the property or, if you leased the property from someone
else, that you were contractually liable to the owner for the damage.
- Whether a claim for reimbursement exists for which there is a reasonable expectation of
recovery.
Theft loss proof. For a theft loss, your records should show all the
following information.
- When you discovered your property was missing.
- That your property was stolen.
- That you were the owner of the property.
- Whether a claim for reimbursement exists for which there is a reasonable expectation of
recovery.
Figuring a Gain
A casualty or theft may result in a taxable gain. If you
receive an insurance payment or other reimbursement that is more than your adjusted basis
in the destroyed, damaged, or stolen property, you have a gain from the casualty or theft.
You generally report your gain as income in the year you receive the reimbursement.
However, depending on the type of property you receive, you may not have to report your
gain. See Postponing Gain, later.
Your gain is figured as follows:
- The amount you receive, minus
- Your adjusted basis in the property at the time of the casualty or theft.
Even if the decrease in FMV of your property is smaller than the adjusted basis of your
property, use your adjusted basis to figure the gain.
Amount you receive. The amount you receive includes any money plus
the value of any property you receive, minus any expenses you have in obtaining
reimbursement. It also includes any reimbursement used to pay off a mortgage or other lien
on the damaged, destroyed, or stolen property.
Example. A tornado severely damaged your barn. The adjusted
basis of the barn was $25,000. Your insurance company reimbursed you $40,000 for the
damaged barn. However, you had legal expenses of $2,000 to collect that insurance. Your
insurance minus your expenses to collect the insurance is more than your adjusted basis in
the barn, so you have a gain.
| 1) |
Insurance reimbursement |
$40,000 |
| 2) |
Legal expenses |
2,000 |
| 3) |
Amount received (line 1 - line 2) |
$38,000 |
| 4) |
Adjusted basis |
25,000 |
| 5) |
Gain on casualty (line 3 - line 4) |
$13,000 |
Other Involuntary
Conversions
In addition to casualties and thefts, other events cause involuntary conversions of
property. Some of these are discussed in the following paragraphs.
Gain or loss from an involuntary conversion of your property is usually recognized for
tax purposes. You report the gain or deduct the loss on your tax return for the year you
realize it. However, depending on the type of property you receive, you may not have to
report your gain on the involuntary conversion. See Postponing Gain, later.
Condemnation
Condemnation is the process by which private property is legally
taken for public use without the owner's consent. The property may be taken by the
federal government, a state government, a political subdivision, or a private organization
that has the power to legally take property. The owner receives a condemnation award
(money or property) in exchange for the property taken. A condemnation is a forced sale,
the owner being the seller and the condemning authority being the buyer.
Threat of condemnation. Treat the sale of your property under threat
of condemnation as a condemnation, provided you have reasonable grounds to believe that
your property will be condemned.
Main home condemned. If you have a gain because your main home is
condemned, you generally can exclude the gain from your income as if you had sold or
exchanged your home. For information on this exclusion, see Publication 523, Selling
Your Home. If your gain is more than the amount you can exclude, but you buy
replacement property, you may be able to postpone reporting the excess gain. See Postponing
Gain, later. (You cannot deduct a loss from the condemnation of your main home.)
More information. For information on how to figure the gain or loss
on condemned property, see chapter 1 in Publication 544. Also see Postponing Gain, later,
to find out if you can postpone reporting the gain.
Irrigation Project
The sale or other disposition of property located within an
irrigation project to conform to the acreage limits of federal reclamation laws is an
involuntary conversion.
Livestock Losses
Diseased livestock. If your
livestock die from disease, or are destroyed, sold, or exchanged because of disease, even
though the disease is not of epidemic proportions, treat these occurrences as
involuntary conversions. If the livestock was raised or purchased for resale, follow the
rules for livestock discussed earlier under Farming Losses. Otherwise, figure the
gain or loss from these conversions using the rules discussed under Determining Gain
or Loss in chapter 10. If you replace the livestock, you may be able to postpone
reporting the gain. See Postponing Gain, later.
Reporting dispositions of diseased livestock. If you choose
to postpone reporting gain on the disposition of diseased livestock, you must attach a
statement to your return explaining that the livestock was disposed of because of disease.
You must also include other information on this statement. See How To Postpone Gain, later,
under Postponing Gain.
Weather-related sales of livestock. If you sell or exchange livestock (other than poultry) held for draft,
breeding, or dairy purposes solely because of drought, flood, or other
weather-related conditions, treat the sale or exchange as an involuntary conversion. Only
livestock sold in excess of the number you normally would sell under usual business
practice, in the absence of weather-related conditions, are considered involuntary
conversions. Figure the gain or loss using the rules discussed under Determining Gain
or Loss in chapter 10. If you replace the livestock, you may be able to postpone
reporting the gain. See Postponing Gain, later.
Example. It is your usual business practice to sell five of your
dairy animals during the year. This year you sold 20 dairy animals because of drought. The
sale of 15 animals is treated as an involuntary conversion.
 If you do not
replace the livestock, you may be able to report the gain in the following year's income.
This rule also applies to poultry. See Sales Caused by Weather-Related Conditions in
chapter 4.
Reporting weather-related sales of livestock. If you choose
to postpone reporting the gain on weather-related sales of livestock, show all the
following information on a statement attached to your return for the tax year in which you
first realize any of the gain.
- Evidence of the weather-related conditions that forced the sale or exchange of the
livestock.
- The gain realized on the sale or exchange.
- The number and kind of livestock sold or exchanged.
- The number of livestock of each kind you would have sold or exchanged under your usual
business practice.
Show all the following information on the return for the year in which you replace the
livestock.
- The date you bought replacement livestock.
- The cost of the replacement livestock.
- The number and kind of the replacement livestock.
Tree Seedlings
If, because of an abnormal drought, the failure of planted tree
seedlings is greater than normally anticipated, you may have a deductible loss.
Treat the loss as a loss from an involuntary conversion. The loss equals the previously
capitalized reforestation costs you had to duplicate on replanting. You deduct the loss on
the return for the year the seedlings died. If you took the investment credit for any of
these costs, you may have to recapture all or part of the credit. See Recapture of
Investment Credit in chapter 9.
Postponing Gain
Do not report a gain if you receive reimbursement in the form of
property similar or related in service or use to the destroyed, stolen, or other
involuntarily converted property. Your basis in the new property is generally the same as
your adjusted basis in the property it replaces.
You must ordinarily report the gain on your stolen, destroyed, or other involuntarily
converted property if you receive money or unlike property as reimbursement. However, you
can choose to postpone reporting the gain if you purchase replacement property similar or
related in service or use to your destroyed, stolen, or other involuntarily converted
property within a specific replacement period.
If you have a gain on damaged property, you can postpone reporting the gain if you
spend the reimbursement to restore the property.
To postpone reporting all the gain, the cost of your replacement property must be at
least as much as the reimbursement you receive. If the cost of the replacement property is
less than the reimbursement, you must include the gain in your income up to the amount of
the unspent reimbursement.
Example. In 1970, you bought a cottage in the mountains for your
personal use at a cost of $18,000. You made no further improvements or additions to it.
When a storm destroyed the cottage this January, the cottage was worth $250,000. You
received $146,000 from the insurance company in March. You had a gain of $128,000
($146,000 - $18,000).
You spent $144,000 to rebuild the cottage. Since this is less than the insurance
proceeds received, you must include $2,000 ($146,000 - $144,000) in your income.
Buying replacement property from a related person.
You cannot postpone reporting a gain from a casualty, theft, or other
involuntary conversion if you buy the replacement property from a related person
(discussed later). This rule applies to the following taxpayers.
- C corporations.
- Partnerships in which more than 50% of the capital or profits interest is owned by C
corporations.
- Individuals, partnerships (other than those in (2) above), and S corporations if the
total realized gain for the tax year on all involuntarily converted properties on which
there are realized gains is more than $100,000.
For involuntary conversions described in (3) above, gains cannot be offset by any
losses when determining whether the total gain is more than $100,000. If the property is
owned by a partnership, the $100,000 limit applies to the partnership and each partner. If
the property is owned by an S corporation, the $100,000 limit applies to the S corporation
and each shareholder.
Exception. This rule does not apply if the related person
acquired the property from an unrelated person within the period of time allowed for
replacing the involuntarily converted property.
Related persons. Under
this rule, related persons include, for example, a corporation and an individual who owns
more than 50% of its outstanding stock, and two partnerships in which the same C
corporations own more than 50% of the capital or profits interests. For more information
on related persons, see Nondeductible Loss under Sales and Exchanges Between
Related Persons in chapter 2 of Publication 544.
Death of a taxpayer. If a taxpayer dies after having a gain, but
before buying replacement property, the gain must be reported for the year in which the
decedent realized the gain. The executor of the estate or the person succeeding to the
funds from the involuntary conversion cannot postpone reporting the gain by buying
replacement property.
Replacement Property
You must buy replacement property for the specific purpose of
replacing your property. Your replacement property must be similar or related in
service or use to the property it replaces. You do not have to use the same funds you
receive as reimbursement for your old property to acquire the replacement property. If you
spend the money you receive for other purposes, and borrow money to buy replacement
property, you can still choose to postpone reporting the gain if you meet the other
requirements. Property you acquire by gift or inheritance does not qualify as replacement
property.
Owner-user. If you are an owner-user, similar or related in service
or use means that replacement property must function in the same way as the property it
replaces. Examples of property that functions in the same way as the property it replaces
are a home that replaces another home, a dairy cow that replaces another dairy cow, and
farm land that replaces other farm land. A passenger automobile that replaces a tractor
does not qualify. Neither does a breeding or draft animal that replaces a dairy cow.
Soil or other environmental contamination. If, because of soil or other environmental contamination, it is not practical
for you to reinvest your insurance money from destroyed livestock in property
similar or related in service or use to the livestock, you can treat other property
(including real property) used for farming purposes, as property similar or related in
service or use to the destroyed livestock.
Standing crop destroyed by casualty. If a storm or other casualty destroyed your standing crop and you use the
insurance money to acquire either another standing crop or a harvested crop, this
purchase qualifies as replacement property. The costs of planting and raising a new crop
qualify as replacement costs for the destroyed crop only if you use the crop method of
accounting (discussed in chapter 3). In that case, the costs of bringing the new crop to
the same level of maturity as the destroyed crop qualify as replacement costs to the
extent they are incurred during the replacement period.
Timber loss. Standing timber you bought with the proceeds from the
sale of timber downed as a result of a casualty, such as high winds, earthquakes, or
volcanic eruptions, qualifies as replacement property. If you bought the standing timber
within the replacement period, you can postpone reporting the gain.
Business or income-producing property located in a Presidentially declared disaster
area. If your destroyed business or income-producing property was located
in a Presidentially declared disaster area, any tangible replacement property you acquire
for use in any business is treated as similar or related in service or use to the
destroyed property. For more information, see Disaster Area Losses in Publication
547.
Substituting replacement property. Once you have acquired qualified
replacement property that you designate as replacement property in a statement attached to
your tax return, you cannot substitute other qualified replacement property. This is true
even if you acquire the other property within the replacement period. However, if you
discover that the original replacement property was not qualified replacement property,
you can, within the replacement period, substitute the new qualified replacement property.
Replacement Period
To postpone reporting your gain, you must buy replacement property
within a specified period of time. This is the replacement period.
The replacement period begins on the date your property was damaged, destroyed, stolen,
sold, or exchanged. The replacement period generally ends 2 years after the close of the
first tax year in which you realize any part of your gain from the involuntary conversion.
Example. You are a calendar year taxpayer. While you were on
vacation, a valuable piece of antique furniture that cost $2,200 was stolen from your
home. You discovered the theft when you returned home on November 11, 2001. Your insurance
company investigated the theft and did not settle your claim until January 3, 2003, when
they paid you $3,000. You first realized a gain from the reimbursement for the theft
during 2003, so you have until December 31, 2005, to replace the property.
Main home in disaster area. For your main home (or its contents)
located in a Presidentially declared disaster area, the replacement period ends 4 years
after the close of the first tax year in which you realize any part of your gain from the
involuntary conversion. See Disaster Area Losses, later.
Condemnation. The replacement period for a condemnation begins on
the earlier of the following dates.
- The date on which you disposed of the condemned property.
- The date on which the threat of condemnation began.
The replacement period generally ends 2 years after the close of the first tax year in
which any part of the gain on the condemnation is realized.
Business or investment real property. If real property held
for use in a trade or business or for investment (not including property held primarily
for sale) is condemned, the replacement period ends 3 years after the close of the first
tax year in which any part of the gain on the condemnation is realized.
Extension. You may get an extension of the replacement period if you
apply to the IRS director for your area. Include all the details about your need for an
extension. Make your application before the end of the replacement period. However, you
can file an application within a reasonable time after the replacement period ends if you
can show a good reason for the delay. You will get an extension of the replacement period
if you can show reasonable cause for not making the replacement within the regular period.
- Continue - |
