To claim a casualty loss, taxpayers must determine what the deduction will be by starting with the amount their insurance does not cover. Under Code Sec 165, taxpayers must reduce each personal casualty loss by $100 and then reduce that total personal casualty and theft losses by 10 percent of their adjusted gross income. They may only deduct the part of the loss that exceeds the 10 percent of adjusted gross income limit. As an alternative, the safe harbor methods described in Rev. Proc. 2018-08 and Rev. Proc. 2018-09 can provide additional relief. More on that shortly.
In addition, if the loss is due to Hurricane Harvey, Irma, or Maria, The Disaster Tax Relief and Airport and Airway Extension Act of 2017 allows the entire portion of the disaster loss not covered by insurance to be reduced by $500 (instead of the $100) and the excess over the $500 will not be reduced by the 10% adjusted gross income limitation. For individuals, casualty and theft losses are generally reported on Schedule A “Itemized Deductions” and deducted on the taxpayer’s personal income tax return. However, if the taxpayer does not itemize, the standard deduction can be increased by the qualified net hurricane disaster loss.
Let’s review the two Revenue Procedures that provide safe harbor methods that individual taxpayers may use in determining the amount of their casualty and theft losses for their homes and personal belongings. Revenue Procedure 2018-08 provides four safe harbor methods that may be used for any qualifying casualty or theft loss and three that are specifically applicable to losses occurring as a result of a federally declared disaster. The three safe harbors methods that are specific to federally declared disaster areas are the Contractor Safe Harbor Method, the Disaster Loan Appraisal Safe Harbor Method for personal-use residential property and the Replacement Cost Safe Harbor for personal belongings. Revenue Procedure 2018-09 provides a safe harbor method, the Cost Indexes method, which may only be used for losses resulting from Hurricane Harvey, Hurricane Irma, and Hurricane Maria.
It is important to note that if any portion of your personal residence is used for business purposes (for example, contains a home office used in a trade or business or is used as rental property) the safe harbor provisions described below may not be available.
Personal-Use Residential Property
- Estimated Repair Cost Safe Harbor Method – For casualty losses less than $20,000, individuals may use the lesser of two separate and independent repair estimates to determine the decrease in fair market value of the individual’s personal-use residential real property.
- De Minimis Safe Harbor Method – An individual may estimate the cost of repairs required to restore the individual’s residence to the condition existing immediately prior to the casualty. This method is available for casualty losses of $5,000 or less.
- Insurance Safe Harbor Method – An individual may determine the decrease in fair market value by using the estimated loss determined in reports prepared by the taxpayer’s insurance company.
- Contractor Safe Harbor Method – If the loss occurred in an area declared a federal disaster area, an individual may use the contract price for repairs to the residence as determined in an itemized contract prepared by a licensed contractor. This safe harbor method does not apply unless there is binding contract signed by the individual and the contractor setting forth the itemized costs to restore the real property.
- Disaster Loan Appraisal Safe Harbor Method – An individual may use an appraisal prepared for the purpose of obtaining a loan of federal funds or a loan guarantee from the federal government setting forth the estimated loss the individual sustained as a result of the damage to the individual’s residence from a federally declared disaster.
- De Minimis Safe Harbor Method – An individual must make a good faith estimate describing the affected personal belongings as well as the methodology for estimating the loss. This method is limited to losses of $5,000.
- Replacement Cost Safe Harbor – this method is for those losses in a federally declared disaster area. To use this method the individual must first determine the current cost to replace the item with new property and then reduce that amount by 10 percent for every year the item was owned. This calculated decrease in fair market value is then compared to the original basis of the property. Whichever is the lesser of the two will be the casualty loss amount.
Personal belongings do not include a boat, aircraft, mobile home, trailer, or vehicle.
If any of the above safe harbor methods are used the IRS will not challenge an individual’s determination of the decrease in fair market value of personal-use residential real property or personal belongings. Use of any one of the methods is not mandatory but if the individual decides to use the actual decrease in fair market value (as opposed to one of the safe harbors) they must be diligent about providing proper substantiation of the costs.
Under the cost indexes safe harbor method, individuals may use one or more cost indexes to determine the amount of loss to their personal use residential real property as a result of Hurricane and Tropical Storm Harvey, Hurricane Irma and Hurricane Maria. This revenue procedure cannot be used for losses pertaining to any other disaster other than these three storms. Losses to personal belongings are not covered under this safe harbor method. The cost indexes method may be used if you suffered any of the following:
- A total loss of a personal residence.
- A near total loss of a personal residence.
- Interior flooding over one foot in a personal residence.
- Structural damage from wind, rain, or debris to a personal residence.
- Roof damage from wind, rain, or debris to a personal residence.
- Damage to a detached structure.
- Damage to decking.
The cost indexes safe harbor method provides seven tables, respective of each category above, with cost per square foot for Texas, Louisiana, Florida, Georgia, South Carolina, Puerto Rico, and the U.S. Virgin Islands. The computation of cost per square foot is relatively simple. The individual must determine the total square footage of the residence, the size of the residence (small, medium, large), the geographic location of the residence and then multiply the total square footage by the applicable cost index.
Each of the safe harbor methods above require quite a bit of legwork but they are excellent answers to the natural disaster losses experienced in 2017. Calvetti Ferguson can assist taxpayers with navigating and choosing which safe harbor is best for them. We can also calculate the casualty loss that will be reported on the tax return.