Natural Disasters and Taxes
Allyse Carter, CPA
Helping small businesses and individuals at every step of their financial journey.
Some people might think that climate change is a hoax, but meteorological and other natural disasters are very real.
I'm from Florida (yes, I'm well aware of the "Florida Man/Woman" jokes) and have survived my fair share of hurricanes. The 2004 and 2005 hurricane seasons were some of the most notorious I’ve experienced. As of this writing, Hurricane Milton is barreling across a highly populated section of the third-largest state in the Union.
Natural disasters cause billions of dollars in property damage and incalculable human and emotional loss. These disasters are inevitable, and Uncle Sam recognizes this, which is why he tries to help us out. For the purposes of this article, we will focus on casualty losses that occur in federally declared disaster areas. If the President, based on the Stafford Act, declares your area a disaster area, then you are in a federally declared disaster zone, and the casualty losses resulting from the disaster will likely be deductible.
You can find more information on the IRS and FEMA websites for updates on these areas. Check out the websites as some disasters make the news and others don’t, but they may be declared a federal disaster area. You can find more info here: https://www.irs.gov/newsroom/around-the-nation; https://www.fema.gov/locations
Before we dive into what qualifies as a loss, it’s important to understand its limits. Due to the Tax Cuts and Jobs Act (TCJA), casualty losses are only deductible if caused by a federally declared disaster. Losses not caused by a federally declared disaster are limited to the amount of casualty gain, effectively making them non-deductible. This provision is set to expire at the end of 2025, along with other parts of the TCJA. Before the TCJA, casualty losses could be deducted on Schedule A as an itemized deduction, regardless of whether they occurred in a federal disaster area.
IRC Sec. 165 defines ‘Losses’. We will focus on 165(c)(3), which pertains to individuals and their personal property, such as a personal residence or car.
I.R.C. § 165(c) Limitation On Losses Of Individuals
For individuals, the deduction under subsection (a) is limited to:
(For further reference: https://irc.bloombergtax.com/public/uscode/doc/irc/section_165)
Why is it so important that federal disaster area casualty losses are deductible? If they are deductible, they are treated as ordinary losses, offsetting your taxable income and potentially generating a net operating loss (NOL) that can be carried forward for several years, up to 80%. [Another feature of the TCJA that will sunset before the end of the decade. Before the TCJA, NOLs could be carried back for a few years and then forward.]
Casualty losses are offset by the amount of reimbursement received, usually through insurance. Keep in mind, that there could be a timing difference between when the insurance reimbursement is received and the year the loss is deductible. On the bright side, cash gifts do not offset casualty losses, even if they are used to help offset the loss. I guess there’s always a blessing in the storm.
Form 4684
Casualty losses are reported on Form 4684, which would be included when filing Form 1040. (https://www.irs.gov/pub/irs-pdf/f4684.pdf)
To deduct casualty losses in federally declared disaster areas on Form 4684, you’ll need a FEMA declaration number, which is entered at the top of Page 1. The declaration number begins with ‘DR’ or ‘EM.’
For fun, I searched my zip code and found that the FEMA declaration number I get to use is EM-3623-FL.
You can elect to deduct your casualty loss in the previous tax year. Why would you want to do this? If a disaster occurs in the current year, you may not have the same cash flow or property as you did in the previous year. Making this election can be beneficial if you not only suffered a significant loss in the current year but also had high income and a high tax bill in the previous year. You may be able to recoup some money.
Sometimes we survive the worst of the storms, and sometimes we don’t. As we’ve learned over the past few days, weeks, months, and years, anywhere can turn into a disaster area in the blink of an eye.
The IRS has a helpful guide on what to do if you need to recreate tax records after a natural disaster: https://www.irs.gov/newsroom/reconstructing-records-after-a-natural-disaster-or-casualty-loss.
Pub 536 Net Operating Losses: https://www.irs.gov/publications/p536
Pub 547 Casualties, Disasters, and Thefts: https://www.irs.gov/pub/irs-pdf/p544.pdf
Pub 584 Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property): https://www.irs.gov/pub/irs-pdf/p584.pdf
Pub 584 Business Casualty, Disaster, and Theft Loss Workbook: https://www.irs.gov/pub/irs-pdf/p584b.pdf
Pub 3067 IRS Disaster Assistance: https://www.irs.gov/pub/irs-pdf/p3067.pdf
IRC Section 165: https://irc.bloombergtax.com/public/uscode/doc/irc/section_165
Topic no. 515, Casualty, disaster, and theft losses: https://www.irs.gov/taxtopics/tc515
Form 4684 – Casualties and Thefts: https://www.irs.gov/pub/irs-pdf/f4684.pdf
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Form 4684 Instructions: https://www.irs.gov/instructions/i4684
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