What Is Disaster Loss?
A disaster loss is a special type of tax-deductible loss, similar to a casualty loss, where a loss has been incurred by taxpayers who reside in an area in the U.S. that has been designated as a federal disaster area by the president. Disaster losses can arise from such phenomena as floods, forest fires, and earthquakes.
- Taxpayers who live in an area that has been designated as a qualified federal disaster area by the president and have suffered a loss are eligible to take the disaster loss deduction.
- The types of disasters that have typically applied to disaster loss are natural disasters such as floods, hurricanes, tornadoes, fires, and earthquakes.
- Taxpayers can deduct losses related to the home, household items, and vehicles but cannot deduct losses covered by insurance.
Understanding Disaster Loss
A federally declared disaster area is eligible for federal assistance once it is declared a disaster by the president. This is stated under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, which was signed into law in 1988, and authorizes the federal government to provide various means of assistance to states and localities in the case of a declared disaster. The Federal Emergency Management Agency (FEMA) keeps a list of declared disaster areas.
On March 13, 2020, President Trump declared the coronavirus pandemic a national emergency and invoked the powers under the Stafford Act to provide disaster relief to states and cities.
A qualified disaster loss is similar to a casualty loss but may provide more favorable tax deductions. Not every federally declared disaster is known as a qualified declared disaster. Examples of declared disasters that were qualified include Hurricane Harvey, Hurricane Irma, and the California wildfires. Those qualified disasters had special tax relief options.
On March 27, President Trump signed a $2 trillion coronavirus emergency stimulus package, called the CARES Act, into law. The package includes a host of measures that provide tax relief to individuals and businesses who have been impacted by COVID-19.
How to Claim Disaster Loss
Typically, disaster losses may be deducted either in the year that the loss is incurred or the previous year if it is more beneficial to the taxpayer and depending on the type of disaster. A tax professional is best-suited to distinguish which year is most beneficial for the taxpayer.
Many people will take the deduction on the previous year because it provides them with an immediate refund on sudden losses. Homeowners who must relocate due to damage in a disaster area can often claim a loss even though the damage sustained does not meet the sudden event test. The sudden event test dictates that the loss must occur as a result of a sudden and unpredictable or unusual event. Disaster loss rules are the same for renters and commercial property owners as they are for homeowners.
FEMA provides a list of all eligible disaster areas and the years for which they qualify. Disaster victims in these areas do not have to itemize deductions—they would report the loss on Form 4684 of the standard deduction worksheet. Taxpayers who itemize, report it on Schedule A.
How to Calculate Disaster Loss
Taxpayers can deduct losses related to the home, household items, and vehicles but cannot deduct losses covered by insurance. If the homeowner files an insurance claim right away, they can subtract the loss from the amount of reimbursement and deduct the remainder. The homeowner would take the adjusted basis of the property (or the decrease in the fair market value of the property because of the disaster) and subtract the insurance reimbursement.
For example, if the adjusted basis of a property was $100,000, and the insurance reimbursement was $80,000, the tax deduction would be $20,000.
What Types of Disasters Apply to Disaster Loss?
The types of disasters that have applied to disaster loss have typically been natural disasters including floods, hurricanes, tornadoes, fires, and earthquakes. As mentioned above, only taxpayers who live in an area in the U.S. that has been designated as a qualified federal disaster area by the president and have suffered a loss are eligible to take the disaster loss deduction.