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IRS Restricts Disaster Writeoff for Married People

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Although the IRS permits certain tax deductions for victims of natural disasters, the allowances come with restrictions. For instance, only the rightful owner of a residential property can claim the write-off. So, how does this affect people who are married? Julian Block addresses this question and more.

Oct 28th 2021
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Just joining us? To better understand part three, go to parts one and two for their discussions of basic rules on deductions for casualty losses available to property owner Hester (Internal Revenue Code Section 165).

To qualify personal-use property for write-offs, Hester has to satisfy two stipulations. First, her losses for damaged or destroyed property are deductible only to the extent that they’re attributable to natural disasters, such as floods and wildfires. Second, those losses occur in disaster areas that, as determined by the President, deserve federal assistance. Part three will focus on other highlights of deductions for disaster victims.

There are additional wrinkles for Hester and other victims of natural disasters to consider as well. For example, husband Hannibal and wife Clarice plan to claim a disaster loss and are aware of Internal Revenue Service guidelines that allow only the owner of the property to claim the deduction. 

Therefore, the spouses need to weigh whether they’re joint or separate owners of the damaged property (Code Section 165 (h) (4) (E)), and whether one of them will declare more income than the other, circumstances that bear on their decision to file joint or separate returns. The only way to determine the best strategy: crunch the numbers both ways.

Let’s say a disaster destroys an auto owned solely by Hannibal. The spouses file separate returns. 

Who, ordains the IRS, gets to deduct the loss on a separate return? Only owner Hannibal. 

Why won’t the IRS allow Clarice to claim it? She doesn’t have any ownership interest. 

How does the agency respond when they’re joint owners? They’re able to deduct the entire loss on a joint return.

What does it require them to do if they file separately? Hannibal deducts his share of the loss on his separate return. Clarice deducts her share of the loss on her separate return. 

Back to Hester. Suppose she’s unable to deduct a disaster loss on the return for the year of the loss, because of a disagreement with her insurer on the amount of the loss. 

In that case, it might be better for Hester to settle the matter in a later year, if her income will be lower, as more of her loss will exceed the 10 percent floor and, therefore, qualify as a tax deduction.

How much is deductible? The Stepford response of the IRS: Hester has to prove that her deductions take into account what the missing or damaged items originally cost and what they were worth just before and after the incident. In the case of theft, she counts the value of stolen property as zero.

Why does the IRS compel her to provide this kind of substantiation? Because the deductible amount for an uninsured loss isn’t the property’s replacement value, contrary to what many clients mistakenly assume. Instead, her allowable deduction is the lesser of:

  • The property’s decrease in value; or 
  • The property’s “adjusted basis.” Usually, where what’s involved are homes, furniture, clothing and other property used solely for personal purposes, adjusted basis is simply what Hester originally paid, plus any improvements.

What’s ahead in part four. More highlights of write-offs available for individuals who suffer casualty losses in disaster areas declared by the president to be eligible for federal assistance.

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