Bad things can happen to good business property. Fires, floods, freezes, and other disasters can damage or destroy the personal or real property you use to keep your business up and running.
Disasters are always bad news. But you may be able to deduct your losses. And you are not subject to many of the restrictions that apply to deductions for disaster losses to personal property such as your home, personal car, or personal belongings.
What is a Business Disaster Loss?
A business disaster loss is a damage, destruction, or loss of property used in a trade or business due to a “casualty”. For this reason, the terms “disaster loss” and “casualty loss” are often used interchangeably.
A casualty is a sudden, unexpected, and unusual event such as a fire, flood, freeze, earthquake, storm, hurricane, tornado, landslide, government-ordered demolition or relocation, or terrorist attack.
Events that would not be classified as “disasters” can also be casualties. For example, a car accident qualifies as a casualty so long as it’s not caused by your willful act or willful negligence. Losses due to thefts and vandalism can also qualify.
Unlike the individual’s loss deduction, the business does not need a presidential declared disaster to claim a tax deduction for its loss to business property. As explained in Deducting Disaster Losses for Individuals, for the tax years 2018-2025, the individual taxpayer may deduct a casualty loss only if it’s due to a presidentially-declared. disaster.
For example, you can deduct business property losses from a localized, accidental fire in an office building. But personal property losses due to a fire in your home are deductible only if the fire is declared a federal disaster — something certainly not likely for a small house fire.
Calculating a Business Disaster Loss
The casualty loss deduction permits you to deduct an amount equal to the decline in the property’s value due to a casualty, up to the amount of your investment you have not already deducted through depreciation or otherwise reduced by insurance or other reimbursements.
The amount of a disaster loss depends on the property’s adjusted basis, whether the loss is covered by insurance, and whether the property was totally destroyed or only damaged by the casualty event.
You can use IRS Publication 584-B, Business Casualty, Disaster, and Theft Loss Workbook, to calculate your loss.
Adjusted basis. The basic rule for your loss deduction is that you can deduct the amount of the property’s decline in value up to its adjusted basis. You always face an adjusted basis as the ceiling for the deduction.
Your adjusted basis is usually the property’s original cost; plus the value of any improvements; minus all deductions you took for the property, including depreciation and Section 179 dispensing.
You determine the basis for a building, land improvements, and landscaping separately. Basis is reduced by the amount of claimed disaster losses and insurance recoveries.
Business personal property (computers and other equipment, for example) often have a zero adjusted basis because 100 percent of the cost can be deducted in the year of purchase with 100 percent bonus depreciation (through 2022) or Section 179 expensing. In this event, the disaster loss reduction is zero.
But your repair costs may be currently deductible (as explained later in this article).
Example. Sara purchased a computer for $2,000 two years ago for her home business. She deducted the entire cost that year with bonus depreciation. Her adjusted basis in the computer is zero. A fire destroyed the computer. Sara’s disaster loss deduction is zero.
Bonus depreciation and Section 179 expensing are not available for business real property such as your office building, and the tax code limits those deductions for business passenger vehicles. You are less likely to have a zero basis in this type of property.
Insurance and other reimbursements. In addition to the adjusted basis ceiling, you must reduce your disaster loss deduction by the amount of any insurance proceeds or other reimbursement you actually receive or reasonably expect to receive. Other reimbursements could include a court award of damages based on the event, the forgiveness of a federal disaster loan, or payment of repairs by a lessee.
If the reimbursement turns out to be less than you expected, you can claim a loss in the year you determine you’ll receive no further reimbursement. Don’t amend your original return for the prior year.
Suppose you’re uncertain about the amount of reimbursement you’ll likely receive. In that case, the IRS advises waiting to deduct the amount about which you’re uncertain until the year you’re reasonably certain about the reimbursement if any.
Unlike with personal casualty losses, where you have to file the insurance claim if you want a loss deduction, you don’t have to file an insurance claim to qualify for the business disaster loss deduction. In some cases, you could be better off not filing a claim if the claim will result in substantial increases in your insurance premiums or cancellation of your policy.
Multiple assets. When the business property is involved, you must calculate your loss separately for each single, identifiable item of damaged, destroyed, or stolen property. For example, if a building and its landscaping are damaged in the storm, calculate the loss separately for the building and landscaping.
Property a total loss. If the property is completely destroyed or stolen, your deduction is calculated as follows:
Adjusted Basis – Salvage Value – Insurance Proceeds = Deductible Loss
“Salvage value” is the value of what remains after the property is destroyed. This is often nothing.
Example. Sean, a 1099 worker, suffers a fire that ravages his apartment and destroys his business computer. He paid $2,000 for the computer. Sean has taken no tax deductions for it because he purchased it only two months ago, so his adjusted basis is $2,000. Sean is a renter and has no insurance covering the loss. Sean’s casualty loss is $2,000 ($2,000 Adjusted Basis – $0 Salvage Value – $0 Insurance Proceeds = $2,000).
Partial loss. If the property is only partially destroyed, your casualty loss deduction is the lesser of:
- the decrease in the property’s fair market value immediately after the event, or
- its adjusted basis.
You must reduce both fair market value and adjusted basis by any insurance proceeds you receive or expect to receive.
Example. The chimney in Sally’s rental home collapses during an earthquake. She has no earthquake insurance coverage. She pays $5,000 to a building contractor to restore the chimney to the condition it was in before the earthquake. She figures her casualty loss deduction as follows:
|Adjusted basis of the home before the earthquake||$96,000|
|Fair market value before the earthquake||$225,000|
|Fair market valueafter the earthquake||$220,000|
|Decrease in fair market value (based on cost of repair)||$5,000|
|Amount of loss (lesser of adjusted basis or decrease in value)||$5,000|
Mixed-use property. If you use property such as a car for both business and personal purposes, treat it as two separate assets — one business, one personal — to calculate a disaster or theft loss. Allocate the total basis, fair market value before and after the loss, and insurance or other reimbursement between the business and personal use of the property. Then calculate the disaster loss separately for the business portion and the personal portion.
This is necessary because casualty losses for business and personal uses are figured differently. Personal casualty losses are deductible only for federally declared disasters and are generally subject to a $100 floor and 10 percent of adjusted gross income threshold. See Deducting Disaster Losses for Individuals for details.
Example. Ron uses his Tesla 60 percent for his real estate brokerage business and 40 percent for personal commuting and other personal use. He paid $100,000 for the Tesla. The car is badly managed in 2021 when the battery accidentally catches fire. He paid $20,000 to repair the damage, and his insurance reimbursed him $10,000 (Ron had a $10,000 deductible on his insurance policy).
Here’s how Ron calculates his loss deductions:
|Original cost||$ 40,000||$ 60,000|
|Adjusted basis||$ 40,000||$ 35,000|
|Repair as decline in value||$ 8,000||$ 12,000|
|Insurance reimbursement||$ 4,000||$ 6,000|
|Loss||$ 4,000||$ 6,000|
|Deductible Loss||$0||$ 6,000|
Ron measures his lost based on the cost of repair, less the insurance reimbursement. He has no deduction for the personal part of the Tesla because a federally-declared disaster did not cause the loss.
Determining Decline in Property Fair Market Value
There are two ways to determine how much a disaster reduced your property’s fair market value:
- An appraisal by a qualified appraiser
- The cost of repair
The appraiser should determine the fair market value of the property just before and just after the event. The decline in fair market value does not include any general decline of property values in the area due to the disaster.
You can use the cost of repairing the property instead of an appraisal only if
- the repairs are actually completed by the due date for your business tax return,
- the repairs are necessary to bring the property back to its condition before the casualty,
- the amount spent for repairs is not excessive,
- the repairs take care of the damage only, and
- the value of the property after the repairs is not greater than before the casualty.
Note that the cost of repairs is not the casualty loss. It is used only as evidence of the decline in property’s fair market value. If you obtain an appraisal, you don’t have to repair or replace the property to claim a casualty loss deduction.
There are two ways you can deduct a loss of inventory due to a disaster:
- Treat the loss as part of your cost of goods sold for the year. Don’t claim this loss again as a casualty or a theft loss. Include any insurance or other reimbursement you receive for a loss in gross income.
- Deduct the loss as a casualty loss. Eliminate the affected inventory items from the cost of goods sold by making a downward adjustment to opening inventory or purchases. Reduce the loss by any reimbursement you receive. Don’t include the reimbursement in gross income.
A casualty loss for business property you lease is deductible by you if the lease makes you liable for the damage, as leases ordinarily do. Your loss is the amount you must pay to repair the property minus any insurance or other reimbursement you receive or expect to receive.
When to Deduct Disaster Losses
You may claim a disaster loss in the year it is sustained. But if the loss was caused by a federally-declared disaster, you have the otion of claiming it for the prior year. This can provide a quick refund of tax you paid for the prior year. Federally-declared disasters are listed on the Federal Emergency Management Agency (FEMA) website.
You must make an election to claim the loss for the preceding year on IRS Form 4684, and attached it to your amended or original return for that prior year. You figure the loss and the exchange in taxes as if the loss had occured in the preceding year.
The election must be made within six months after the regular due date for filing your original return for the disaster year. For example, if you’re a calendar-year taxpayer, you have until October 15, 2021, to amend your 2019 return to claim a disaster loss that occured during 2020.
If you make this election, it applies to the entire loss sustained as a result of the disaster.
If you claim an inventory loss for the prior year, you must reduce the opening inventory for the year the disaster actually occured by the amount of loss. Otherwise, you’ll get an improper double deduction.
Net Operating Loss
If your casualty loss deduction exceeds your income for the year (before considering the casualty loss), you’ll have a net operating loss (NOL) for the year.
You can carry back for five years an NOL for 2018, 2019, or 2020 and obtain a refund of tax paid for those years. You then carry forward any unused amount indefinetly. NOL’s occuring in 2021 and later can be carried forward only, but indefinitely.
If the total insurance compensation and other reimbursements you receive are more than the adjusted basis in the destroyed or damaged property, you’ll have a casualty gain, not a loss. This is common with business personal property such as computer equipment that is fully expensed or depriciated.
Example. Sara purchased a $5,000 computer system for her business two years ago. She deducted the entire cost that year with bonus depreciation, so her adjusted basis in the system is zero. A fire destroys the system, and she receives $4,000 in insurance proceeds. Sara gets no casualty loss deduction since her adjusted basis is zero.
Instead, she has a $4,000 casualty gain. Sara reports her basis, insurance payment, and gain on IRS Form 4684. Because the computer system is Section 1245 property, the rules deem the casualty a sale of the computer that Sara reports on Form 4797, Sale of Business Property. This is reported as ordinary income, not subject to self-employment tax if Sara chooses to recognize the gain.
Under the involuntary conversion rules, Sara can defer the gain by purchasing replacement property of equal or greater value. Her basis in the replacement property is its cost reduced by the amount of unrecognized casualty gain.
Example. Sara purchases a new computer system for $6,000 three months after the fire. Her basis in the new system $2,000 ($6,000 cost – $4,000 gain).
If the cost of the replacement property is less than the reimbursement received, Sara must recognize the gain to the extent the reimbursement exceeds the cost of the replacement property.
Loss not due to a federal disaster. If the casualty loss is not due to a federal disaster, the replacement property must similar or related in service or use to the property destroyed.
Alternatively, you may purchase a controlling interest (at least 80 percent) in a corporation owning such property.
You must replace the damaged property within two years after the close of the first taxable year in which any part of the gain is realized.
Loss due to a federal disaster. If the property was damaged or destroyed in a federal disaster, you have four years to purchase the replacement property. Additionally, any business-use property will qualify.
Deducting Repairs for Damaged Property
As mentioned above, repair costs are not part of the property loss deduction. They are merely used to measure the decline in fair market value due to a casualty. Can you take a casualty loss and then deduct your repair costs as an ordinary and necessary business expense?
No. The IRS repair regulations provide that the cost of restoring property damaged by a casualty for which a reduction of basis is required must be capitalized (depreciated) and added to the property’s basis.
Example. Jason owns an apartment building with a $500,000 adjusted basis that suffers extensive uninsured damage due to a flood. An appraiser determines that the decline in the building’s fair market value is $50,000, and Jason deducts this amount as a casualty loss. He then hires a contractor and pays $50,000 to repair the damage to the building. The repair costs must be separately depreciated over 39 years as an improvement and added to the building’s basis.
The only exception to the capitalization requirement is where the amount of otherwise deductible repair expenses exceed the property’s adjusted basis before the loss. In other words, the amount of repair costs in excess of the casualty loss deduction and/or insurance recovery can be deductible, but repair costs equal to or less than the casualty loss/insurance must be capitalized.
Example. Assume Jason fully depreciated his building, and its adjusted basis is zero. He also received zero insurance proceeds. He may currently deduct his entire $50,000 cost to restore the property to its pre-flood condition. He reduces the building basis by $50,000.
Even if the IRS repair regulations require capitalization, if personal business property is involved, you may be able to deduct the repair costs in one year anyway through 100 percent bonus depreciation, Section 179 expensing, or the de minimis safe-harbor deduction (limited to $2,500 per item, or $5,000 with an applicable financial statement).
Example. Linda, a physician, owns radiation therapy equipment with a $100,000 adjusted basis. She claims a $10,000 casualty loss when the property is damaged in a hurricane, which reduces the property’s adjusted basis to $90,000.
She then spends $15,000 to restore the property to working condition. Under the IRS repair regulations, the $15,000 repair costs must be capitalized over the property’s seven-year class life since they are less than the property’s $90,000 adjusted basis. But since the repair costs are treated as newly acquire property, they may be deducted in one year with 100 percent bonus depreciation or Section 179 expensing.
Reporting a Casualty Loss
If you’re a sole proprietor or an owner of a one-member LLC taxed as a sole proprietorship, complete of Section B of Form 4684, Casualties and Thefts. Use a separate Form 4684 for each casualty. Losses are netted against gains and transferred to Form 4797, Sales of Business Property. The net loss or gain is entered on Schedule 1 of Form 1040.
Note for the self-employed. The net loss does not go on Schedule C, and thus does not reduce or increase self-employment taxes.
Multimember LLC’s, partnerships, S corporations, and C corporations report casualty loss or gain on Form 4797. The net gain or loss is entered on a specific line on Form 1065 (LLC’s and partnerships), Form 1120-S (S corporations), or Form 1120 (C corporations) It thereby reduces or increases the total business income of the entity.
Here are six things to know from this article:
- Physical damage to business property due to a disaster such as a fire or a flood is deductible as a casualty loss.
- If the property is totally destroyed, your loss is the property’s adjusted basis minus insurance and other reimbursements and salvage value. If the property is partially destroyed, your loss is lesser of the property’s decline in fair market value or adjusted basis. You may determine the decrease in fair market value with an appraisal or use the cost of repairs.
- You must reduce your casualty loss by any insurance proceeds you receive or expect to receive. But unlike for a personal casualty loss deduction, you are not required to file an insurance claim to deduct a business casualty loss.
- If the casualty loss was from a federally-declared disaster, you may deduct the loss the prior year and obtain a refund of tax paid that year.
- A casualty may result in a taxable gain if the insurance proceeds you’re paid exceed your adjusted basis in the damaged or destroyed property. You can postpone the tax on this gain by buying replacement property.
- Repairs of property damaged by a casualty not part of the casualty loss deduction. You deduct the casualty loss separately. The cost of the repairs ordinarily is capitalized and added to the taxpayer’s tax basis in the damaged property.