A disaster loss is a loss attributed to a casualty occurring in an area declared by the President of the United States to be a disaster area entitled to federal assistance. Thus, in order to qualify as a disaster loss, the loss must also qualify as a casualty. On the flip-side, however, a disaster loss is not a prerequisite to “casualty” status.
Taxpayers who incur losses as a result of a disaster in a presidentially declared disaster area have the option of declaring their loss on their prior year's tax return, thus allowing them to amend the return and receive an immediate refund as a measure of relief. (See “UPDATE” below.) The Federal Emergency Management Agency (“FEMA”) keeps an updated list of all eligible disaster areas and the years for which they qualify. See the updated listing at the FEMA website. Note that during the three year period ending in 2015 there were 258 disaster declarations!
As noted by FEMA, to be tax-deductible, a casualty loss (and disaster loss) must meet the criteria for the “sudden-event” test, which mandates the following:
- The loss must occur as a result of a sudden and unpredictable or unusual event.
- The event must be one that happens in a single instance, so to speak, such as a car accident, and cannot have happened over an extended period of time.
- There must be an element of chance or some sort of natural force involved.
Under this definition, losses due to the following events would qualify for deduction:
- Natural disasters, such as earthquakes, hurricanes, typhoons, tornadoes, floods, fires and avalanches.
- Losses from civil disturbances, such as riots.
However, there are several types of losses that would not qualify for deduction:
- Those incurred due to long-term processes, such as erosion, drought, decomposition of wood or termite damage.
- Any loss that arises from what the Internal Revenue Agency (IRS) considers to be a "foreseeable" event.
- Losses that arise from negative public perception.
UPDATE - IRS Releases Rules for Deducting Disaster Losses:
On October 13, 2016, Accounting Today reported that in the wake of Hurricane Matthew, the Internal Revenue Service has released new rules and procedures for deducting disaster losses, as follows:
Revenue Procedure 2016-53 contains rules and procedures for the election under Section 165(i) of the Tax Code to deduct a disaster loss for the taxable year immediately preceding the taxable year in which the disaster occurred. The revenue procedure provides the procedures and requirements for making and revoking an election under Section 165(i).
Along with the revenue procedure, the Treasury Department and the IRS issued temporary regulations to extend the date by which a taxpayer must make a Section 165(i) election to six months after the due date of the taxpayer’s federal income tax return for the disaster year (without regard to any extension of time to file).The temporary regulations also extend the time for revoking a Section 165(i) election to 90 days after the due date for making the election.
There are two key elements needed when qualifying an event as a disaster. First, the event must satisfy the definition of what is a casualty. Second, once the casualty loss definition is satisfied then there needs to be a Presidential declaration that the effected location is entitled to federal assistance.