As the threat of severe winter storms replaced last summer’s natural disasters and the West Coast’s fires, many metals distributors discovered the Tax Cuts and Jobs Act
legislation passed in December 2017 eliminated, with a few exceptions, the casualty loss tax deduction as an itemized deduction on personal income tax returns. Fortunately, the tax deduction for business-related losses continues to provide some relief.
That’s right, the deduction has been eliminated for an individual’s personal casualty losses not connected with (1) a trade or business or (2) a transaction entered into for profit. Losses to business property arising from fire, storm, shipwreck or other casualty remain tax deductible for businesses or for transactions entered into for profit.
Between now and 2025, a personal casualty loss may only be claimed (1) to the extent of personal casualty gains, or (2) where the property loss was attributable to a “qualified disaster loss,” i.e. a “federally declared disaster.”
Business Casualty and Theft Loss Deductions
Although insurance may help defray some of the costs associated with restoring and replacing damaged property, several of the IRS’s special programs and provisions can provide added relief. Casualty losses are caused by fire, floods, earthquakes, hurricanes, tornadoes, terrorism or some other sudden unexpected or unusual event. Cyber fraud, robbery or theft losses and embezzlement are also casualty losses although they seem to be taking a backseat, publicity-wise.
Losses from earthquakes, floods or accidental fires are often treated separately from robbery, cyber fraud or theft losses. To be a tax-deductible loss, the theft-related event must be illegal under state or local laws, covering crimes such as embezzlement, burglary or robbery.
Tax deductible also means there must be some external force involved for a loss to be a casualty loss. What’s more, a casualty loss deduction can be claimed only to the extent that the loss is not covered by insurance or otherwise reimbursed. In other words, if the loss is fully covered, no tax deduction is available.
Under the current tax rules there are two ways that casualty or theft losses of inventory, including goods kept for resale, can be deducted. First, you can deduct the loss by adding the amount of the loss to the operation’s “cost of goods sold.” Using this method usually means a casualty loss deduction can’t be claimed. Naturally, if reimbursement is received for the loss, that amount must be included in gross income. You can also deduct the loss separately by removing damaged inventory from the “cost of goods sold” account by making a downward adjustment to opening inventory or purchases. Again, the amount of the loss will have to be reduced by any reimbursement, although this amount need not be included in gross income.
Disaster Business Losses
While casualty losses must usually be deducted in the year in which the loss event occurred, to help cushion losses suffered by businesses the tax laws allow deductions for disaster losses in an area subsequently determined by the president of the United States to warrant federal assistance. In those cases, the service center has the option of deducting the loss on the tax return for the year in which the loss occurred, or choosing to deduct the loss on the tax return for the preceding tax year. In other words, the operator has the option of deciding whether the loss would be most beneficial if used to offset the current year’s tax bill or better used to reduce the tax bill for the previous year -– generating a refund of previously paid taxes.
In order to accomplish this, an amended tax return for the preceding year can be filed, figuring the loss and the change in taxes exactly as if the loss actually occurred in that preceding year. While this choice must be made by the return’s due date (not including extensions) of the year the loss actually occurred, the resulting refund can go a long way to helping the damaged business or individual recover.
Too Much of a Good Thing
When all of an operation’s losses combined with its deductions exceed income, a so-called “net operating” loss results. The TCJA limited the amount of NOLs that can be utilized to only 80 percent of taxable income without the NOL. Even worse, the NOL carryback that formerly produced a refund of taxes paid in earlier years is gone. NOLs can now only be carried forward.
What’s more, for tax years ending before January 1, 2026, so-called “non-corporate” taxpayers can no longer claim a loss exceeding their Excess Business Loss. The new EBL rules create a limit on the amount non-corporate taxpayers, such as the recipients of pass-through income from S corporations, partnerships and sole proprietorships, can deduct.
Often, there are losses that can be controlled, such as when business property or assets are abandoned. If a depreciable business asset or income-producing asset loses its usefulness and is subsequently abandoned, the loss is equal to its adjusted basis. And, best of all, this type of loss applies to the abandonment of a business.
Far more common are those occasions when business property is taken, legally or illegally, and often as a result of a natural disaster. The government may, for example, legally take property by the act of "condemnation." The loss of any business property by actions outside the control of the metals distributor are usually labeled as “involuntary” conversions.
These actions are unusual in that they frequently result in a taxable gain. Fortunately, the rules governing involuntary conversions permit so-called “real property” to be replaced with property of a "like kind," eliminating the need to report and pay taxes on that gain.
Beginning with the 2018 tax year, like-kind or tax-deferred exchanges under the tax law’s Section 1031 are valid only for the buying and selling of real estate. Under the new rules, Section 1031 exchanges for “personal property,” such as tangible depreciable property, including vehicles, equipment and aircraft, or of intangible assets, will no longer be allowed.
The Proof is in the Records
For a deductible loss to be allowable it must be evidenced by a closed and completed transaction and fixed by an identifiable event. Many a deduction has been denied where there was a reasonable prospect of recovery.
Although the rules allow three years from the time an original return is filed until an amended return containing the claimed loss must be filed, bottom-line, the tax rules for casualty losses require proof, including:
- That the taxpayer owned the property;
- The amount of the basis or book value of the property;
- The pre-disaster value of the asset;
- The reduction in value caused by the disaster;
- The lack or insufficiency of reimbursement to cover the costs.
If records are missing, new IRS guidelines for reconstructing important records can help. For example, past bank or credit card statements, along with supplier’s invoices, are invaluable for determining what was paid for many assets. The Kelley Blue Book or Edmunds can be used to determine the current fair market value of lost or damaged business vehicles.
A metals distributor incurring a casualty loss of business property might prefer to claim the loss as an ordinary and necessary business expense under the tax law’s Section 162(a), Trade or Business Expenses. If property used in a trade or business suffers a casualty, the service center may claim the cost of repairs and maintenance as ordinary and necessary expenses. Naturally, if the expenditures result in an improvement or betterment of the property, the expenditure should be capitalized.
If the casualty is claimed under the tax law’s Section 165, Losses, the service center will not be able to claim amounts for loss reimbursement claims from insurance companies or claims against individuals or entities who may be responsible for the loss. If there is a reasonable prospect of recovery, no portion of the loss where reimbursement is on the horizon may be claimed until it can be ascertained with reasonable certainty whether such reimbursement will be received.
The rules have changed, but casualty losses suffered as a result of storms, fire, flooding, or the more common theft, burglary, embezzlement or cyber fraud, continue to be complex and often confusing. To achieve a full recovery, and to avoid running afoul of the ever-vigilant IRS, professional assistance is strongly recommended.Mark Battersby is a freelancer writer and consultant on tax and financial issues based in Ardmore, Pa. He can be reached at 610-789-2480 or by email at firstname.lastname@example.org.