Part 3: Claiming A Business Casualty Loss Deduction
By Steven Schlachter, CPA, MBA
This article is the third and final installment in a series discussing the federal casualty loss deduction. This deduction may be claimed on the income-tax return of many that have suffered damage from Hurricane Sandy. The first installment discussed the general rules of claiming such a casualty loss deduction. The second focused on the IRS-approved methods for establishing the loss sustained in the storm. This installment will address the rules for claiming the casualty loss for business property.
Hurricane Sandy caused major havoc to business owners, the cost of which is still being calculated. Damaged business property included buildings, equipment, motor vehicles, and inventory. To claim a business casualty loss, the property must have been used in a trade or business or in the production of income, such as rental property. In general, the amount of the casualty loss deduction is the lesser of the decline in the property’s fair market value as a result of the event and its adjusted basis in the hands of its owner (to be discussed later).
There are three important differences between business and personal casualty losses. First, the threshold amounts ($100 and 10% of adjusted gross income or AGI) described in the first installment do not apply to business property. Second, for real estate, any casualty loss must be calculated separately for each property. For example, if a storm damages both a building and the landscaping in front of the building, each property must be taken into account separately for purposes of calculating the casualty loss deduction. Finally, if the business property is completely destroyed (or stolen), and its adjusted basis is less than its fair market value immediately prior to the casualty, the loss is calculated solely by considering the adjusted basis of the property less insurance proceeds.
Adjusted basis. Typically basis is a measure of one’s investment in a particular property. Normally this is the cost of purchasing or creating the property. Property acquired in some other way (gift, inheritance, or non-taxable exchange) may have a different basis. A property’s basis then is adjusted periodically to arrive at the final basis amount. These adjustments include increases to reflect additions or permanent improvements to the property and decreases such as earlier losses taken on the property, as well as tax deductions for depreciation (which are not necessarily reflective of economic decrease in value). The final adjusted basis amount is important when calculating the available casualty loss deduction.
Inventory. Inventory is property held for sale to customers. This can include widgets in a warehouse, cars on a dealer’s lot, or condo units held for sale by a real-estate developer. Uninsured inventory losses may be taken into account in one of two ways. A loss on the inventory can be reflected in cost of goods sold as long as opening and closing inventories are properly maintained. The lost inventory (which was included in the beginning inventory prior to the casualty event) should not be included in the ending inventory figures of the business so that the enterprise’s cost of goods sold is higher and decreases gross profit. If this method is used, no casualty loss deduction is allowed. An alternative is to deduct the loss separately as a casualty loss deduction. Under this method, the lost inventory is removed from beginning inventory figures and then a corresponding casualty loss deduction may be claimed.
Rented property. If you have rented business property that was damaged or lost in the casualty event, you can claim a casualty loss deduction if you are in fact liable for that damage or the lost items. The cost of repair or replacement of the property, minus any insurance proceeds, is the amount of the casualty loss deduction. On the flip side, the owner of the rented property must reduce his or her casualty loss deduction by the amount paid by the renter to repair or replace the property.
Mixed-use property. Property used both for business and personal activities must have its basis allocated among all components in order to calculate a personal and then business casualty loss deduction. The rules pertaining to personal and business casualty loss deductions are then applied to each component of the property.
Reimbursement received after deducting a loss. Due to the slow response of many insurance carriers to the claims associated with Hurricane Sandy, it is likely there will be situations where final insurance settlements will take place after the casualty losses have been claimed and reported on income-tax returns. If the settlement amounts are different from the amounts used when claiming the deduction, there is no need to amend the tax return. Instead, an additional loss or income might have to be reported on the tax return in the year the final settlement is reached.
While the rules pertaining to casualty loss deductions are complex, the IRS has issued Publication 584‑B to help businesses to identify and evaluate properties damaged or destroyed by events such as Hurricane Sandy. This publication provides helpful guidance in calculating the casualty loss. Checklists included in the publication list possible property items included in various categories, including office furniture and fixtures; information systems; motor vehicles; office supplies; buildings, building components, and land; and equipment.
In conclusion, taxpayers affected by the recent storms should discuss the casualty loss deduction with their tax adviser as a possible way to receive some relief in the form of tax savings. v
Steven Schlachter is a senior tax manager at the accounting, tax, and business advisory firm of Margolin, Winer & Evens LLP. For comments or questions, Steven can be reached at firstname.lastname@example.org.