Casualty Losses With Business Property
Casualty losses are damage to property caused by fire, theft, vandalism, earthquake, storm, floods, terrorism, or some other “sudden, unexpected, or unusual event.” There must be some external force involved for a loss to be a casualty loss. Thus, you get no deduction if you simply lose or misplace property or it breaks or wears out over time.
You may take a deduction for casualty losses to business property if, and only to the extent that, the loss is not covered by insurance. Thus, if the loss is fully covered, you’ll get no deduction.
Amount of Deduction
How much you may deduct depends on whether the property involved was stolen or completely destroyed or only partially destroyed. However, you must always reduce your casualty losses by the amount of any insurance proceeds you actually receive or reasonably expect to receive. If more than one item was stolen or wholly or partly destroyed, you must figure your deduction separately for each and then add them all together.
If the property is stolen or completely destroyed, your deduction is figured as follows: Adjusted Basis – Salvage Value – Insurance Proceeds = Casualty Loss. (Your adjusted basis is the property’s original cost, plus the value of any improvements, minus any deductions you took for depreciation or Section 179 expensing.) Obviously, if an item is stolen, there will be no salvage value.
Example: Sean’s business computer is stolen from his apartment by a burglar. The computer cost $2,000. 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.)
If the property is only partly destroyed, your casualty loss deduction is the lesser of the decrease in the property’s fair market value or its adjusted basis, reduced by any insurance you receive or expect to receive.
Example: Assume that Sean’s computer from the example above is partly destroyed due to a small fire in his home. Its fair market value in its partly damaged state is $500. Since he spent $2,000 for it, the decrease in its fair market value is $1,500. The computer’s adjusted basis is $2,000. He received no insurance proceeds. Thus, his casualty loss is $1,500.
Special Rules for Federally Declared Disasters
Special rules apply to damage or destruction to business property caused by a federally declared disaster during 2008 and 2009. Under those circumstances, you can currently deduct costs related to the repair of business property damaged by the disaster; the abatement or control of hazardous substances released due to the disaster; or the removal of debris from, or the demolition of structures on, real property damaged or destroyed by the disaster (IRC § 198A). You can currently deduct these expenses, even though normally you would have to depreciate these costs under the regular tax rules.
You don’t have to treat damage to or loss of inventory as a casualty loss. Instead, you may deduct it on your Schedule C as part of your cost of goods sold. This is advantageous because it reduces your income for self-employment tax purposes, which casualty losses do not. However, if you do this, you must include any insurance proceeds you receive for the inventory loss in your gross income for the year.
Excerpted from Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).