In recent years, we have witnessed tremendous devastation caused by a wide variety of natural disasters.  For residents here in New Hampshire we've faced flooding and ice storms that have caused millions in damages to both personal and business property.  Although it may be a small consolation if you've experienced property damage, you may be able to deduct a casualty loss on your 2008 tax return.

The tax regulations say that you can qualify for a casualty loss deduction if damage is caused by an event that is sudden, unexpected or unusual, such as fire, tornado, earthquake, hurricane or even volcanic eruption.  Note that the tax rules arent limited to damages resulting from natural disasters. For example, you may be able to claim losses caused by automobile collisions, frozen pipes bursting or even theft. However, you are not entitled to any tax relief for damage occurring over a long period of time such as a severe drought or deterioration caused by termites.

The amount of your deduction depends on whether the property damaged is personal property or business property. For personal property, the deduction is limited to the excess above 10% of your annual adjusted gross income (AGI) after subtracting $100 for each casualty event.

For example, if your AGI for 2008 is $80,000 and you suffered a loss to your home of $20,000, your deduction is limited to $11,900 ([$20,000 - $100] - [10% of $80,000]). In contrast, there are no such limits for business property. The full amount of the eligible loss can be deducted on the companys return.

The amount that is eligible for the deduction is the lesser of (1) the difference in the property's value before and after the casualty or (2) the adjusted basis in the property. Of course, you must reduce the deductible amount by any insurance proceeds you receive.

Going back to the previous example, let's say that you receive $10,000 in insurance proceeds for the damage to your home. In that case, your deduction is reduced to $1,900 ([$20,000 - $100 - $10,000] - [10% of $80,000]).

If your property is located in an area that is formally declared by the President to be a federal disaster area, you could be entitled to a quick tax refund. In that case, you can elect to deduct your casualty loss on the tax return for the prior year.  You also have the choice to deduct the loss on your tax return for the year immediately preceding the year of the casualty.  If you have already filed your return for the preceding year, the loss may be claimed in the preceding year by filing an amended return, (Form 1040X) for Individuals or Form 1120X for Corporations. Generally, you must make the choice to use the preceding year by the due date of the current year's return, without extensions.

A Word of Caution

The IRS often challenges casualty loss deductions, so make sure you can prove the loss. The best method is to prepare documentation before a tragedy occurs by videotaping or taking photos of your property as it currently exists. The visual proof can be compelling when coupled with snapshots of the property immediately after a casualty occurs.

To further support your position, obtain an independent appraisal of the damage. The appraisal itself is deductible as a miscellaneous itemized deduction subject to the usual limits. (Miscellaneous expenses are deductible only to the extent the annual total exceeds 2% of your AGI.)

Professional tax advisers can help maximize the casualty loss deductions you claim on your return. If you're still unclear if recent disasters can be used as a deduction, contact your tax adviser. 

Steven A. Feinberg, CPA - www.AppletreeBusiness.com