If you’ve ever experienced an accident or weather emergency, you know how large a toll these casualties can take.
Not only do they impact you, but they can also damage your business’s financial health. Casualty losses are unexpected damages that can put your business between a rock and a hard place.
For this reason, the IRS allows you to deduct the value of your casualty losses from your taxable income.
However, to apply this deduction, you need to be sure that your casualty loss meets all the criteria. You also need to keep detailed records of how you catalogued the loss.
Here’s what you need to know to navigate a casualty loss in your rental business.
What is a Casualty Loss?
A casualty loss is any kind of damage to your property resulting from a sudden, unexpected event. This event could be a natural disaster (a storm, hurricane, flood), an accident, vandalism, or theft.
No landlord expects a casualty loss in their rental business. However, they do happen, and they often result in significant financial burdens for your business.
For this reason, the IRS allows you to deduct casualty losses if they meet certain criteria. However, keep in mind that casualty loss deductions are heavily scrutinized by the IRS. If a casualty occurs in your rental business, be sure to keep detailed documentation of the event and losses you claim.
Casualty Loss Criteria
Casualty losses are defined by a specific set of criteria. To qualify as a casualty loss, the event needs to meet the following requirements:
- The property damage must be sudden. Damage due to the slow deterioration of your property are not deductible. However, gradual wear and tear could lead to a sudden casualty loss.
- The loss must be caused by an external force. The accident or disaster can’t be directly caused by you. It can be caused by an outsider.
Here’s an example. Let’s say you’re concerned about the plumbing in your rental. General wear and tear on the plumbing isn’t enough to claim a casualty loss deduction. However, if wear and tear suddenly causes the pipes to burst one day, the damage caused is considered a casualty loss. You can also claim the loss if you called a plumber to fix the problem and their error leads to the pipes bursting.
Applying the Casualty Loss Deduction
To apply the casualty loss deduction, you’ll first need to file the loss with your insurance provider. Whatever portion of the loss isn’t covered by your insurance will the basis for your deduction.
Next, decide whether your loss was total or partial. For total losses, calculate your deduction using the following formula:
deduction = adjusted basis – salvage value – insurance proceedings
For partial losses, you will deduct the lesser of either the adjusted basis or the value of the decrease in your property’s fair market value:
deduction = decrease in fair market value – insurance proceedings
deduction = adjusted basis – insurance proceeds
What If You Have a Casualty Gain?
It’s possible that the reimbursement you receive from your insurance provider is more than the adjusted basis of your property. If this occurs, you have a casualty gain.
Casualty gains are common, and taxable. However, you can avoid this tax using something called the involuntary conversion rules. Essentially, you can eliminate your gain—and the tax—by buying replacement property of the same or higher value than your original property.
Casualty gains are more complex than we can cover here. Be sure to review the IRS guidelines and see a tax professional for clarification.
Other Deductions
You don’t have to wait for a casualty loss to take advantage of key tax deductions. You can save money on your taxes this year with a variety of deductions.
Here are a few to watch out for:
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- The home office deduction allows you to deduct expenses related to your home office if you manage your properties from home.
- The start-up expense deduction is for expenses you incur before your properties are officially in-service.
- Travel and transportation deductions are for vehicle and gas expenses related to your rental activities. However, you’ll need to ask yourself some key questions, such as what percentage of time you use your car for rental purposes and what is the standard mileage rate for 2022.
- The pass-through deduction helps you to deduct up to 20% of your net rental income from your income taxes.
- Rental loss deductions are used when your combined deductions exceed your rental revenue. If you have a rental loss at the end of the year, you can use the IRS’s rental real estate loss allowance. However, you must adhere to the passive loss rule. See the tax code for more information about this deduction.
Conclusion
Casualty losses are often unpredictable and unavoidable. When they do occur, it’s best to be prepared. Researching the deductions available to your rental business is the first step toward making the most of a bad situation in your business.
