When a hurricane destroys your home or a fire consumes your belongings, you expect a tax deduction. For decades, Section 165(c)(3) allowed a deduction for personal casualty losses not compensated by insurance, subject to a $100 floor per casualty and a 10%-of-AGI overall limit. But the Tax Cuts and Jobs Act of 2017 changed everything: from 2018 through 2025, personal casualty losses are deductible only if they are attributable to a federally declared disaster.
The Pre-2018 Rules
Before the TCJA, Section 165(c)(3) provided a deduction for “losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.”
The deduction was subject to two floors:
- A $100 floor per casualty (i.e., the first $100 of each loss was disallowed)
- A 10% of AGI floor for the aggregate of all casualty losses for the year (i.e., only the total exceeding 10% of AGI was deductible)
The term “casualty” was interpreted to mean “an identifiable event of a sudden, unexpected, or unusual nature.” The classic example: a diamond ring slipping off a finger into a garbage disposal was a casualty (sudden, unexpected). A ring simply lost (misplaced) was not a casualty – there was no identifiable event.
Cases like Dyer v. Commissioner, T.C. Memo. 1961-141, held that a cat knocking over a vase was not a casualty because the taxpayer assumed the risk by leaving the cat alone with the vase. Conversely, Blackmun v. Commissioner, 88 T.C. 677 (1987), aff’d, 867 F.2d 605 (1st Cir. 1988), held that a taxpayer who deliberately burned down a warehouse could not claim a casualty loss because the act was willful – public policy disallowed the deduction.
The Federally Declared Disaster Limitation
The TCJA added Section 165(h)(5), which provides that for tax years 2018 through 2025, “a personal casualty loss which is not attributable to a federally declared disaster shall not be allowed.” Only losses from federally declared disasters (FEMA-designated) are deductible.
Exceptions are made for losses that are “attributable to a federally declared disaster” – even if the taxpayer is not in the disaster area? The statute generally requires the loss to occur in an area declared a disaster by the President under the Stafford Act.
The Calculation of Deductible Loss
When a casualty does occur, the amount of the loss is the lesser of:
- The property’s adjusted basis, or
- The decline in fair market value (FMV before casualty minus FMV after casualty)
Reg. Section 1.165-7(b)(1). This rule prevents a taxpayer from claiming a loss based on market value that exceeds their investment (basis). For example, if a taxpayer bought a painting for $1,000 that appreciated to $10,000, and then it was destroyed, the loss is limited to $1,000 (the basis), not $10,000 (the decline in FMV).
If the property is totally destroyed, the loss is the adjusted basis (since FMV after is zero, but the basis limitation applies). The IRS takes the position that if the property is completely obliterated and had not previously been insured for its full value, the taxpayer may still be limited to basis.
The Role of Insurance
Casualty losses are reduced by any insurance reimbursement (or reimbursement that the taxpayer is entitled to receive). Section 165(a) provides that the deduction is for “losses not compensated for by insurance or otherwise.”
If a taxpayer has insurance but fails to file a claim, the loss is not deductible. In Kent v. Commissioner, T.C. Memo. 1979-431, the court held that a taxpayer who chose not to file an insurance claim (to avoid a premium increase) was not entitled to a casualty loss deduction – the loss was “compensable” even though not actually compensated.
Involuntary Conversions – Section 1033
When property is destroyed or condemned, the taxpayer may receive insurance proceeds or a government payment. Section 1033 allows the taxpayer to defer recognition of gain if they reinvest the proceeds in property “similar or related in service or use” within a specified period.
If the taxpayer’s adjusted basis in the destroyed property was $50,000 and they receive $70,000 insurance, they have a $20,000 gain. Under Section 1033, if they reinvest the full $70,000 in replacement property within two years, they can defer the gain – but only by reducing the basis of the replacement property to $50,000 (the original basis). The gain is deferred, not eliminated.
The Disaster Loss Election
Section 165(i) provides a special rule for disaster losses: a taxpayer may elect to treat a loss attributable to a federally declared disaster as having occurred in the tax year immediately preceding the year of the disaster. This allows the taxpayer to get a refund quickly (by filing an amended return for the prior year) rather than waiting until the end of the current year.
For example, a hurricane in September 2023 caused a loss. The taxpayer can elect to treat the loss as occurring in 2022, file an amended 2022 return, and receive a refund within months – instead of waiting until after the 2023 tax year ends.
The Casualty Gain Problem
If a taxpayer’s insurance proceeds exceed the property’s adjusted basis, they have a casualty gain. Section 165(h)(2)(B) provides that if personal casualty gains exceed personal casualty losses, the gains and losses are treated as capital assets (generally long-term if held more than one year). This means the gain may be taxed at favorable capital gain rates – but the loss is also limited as a capital loss.
For tax years 2018-2025, because personal casualty losses are deductible only for federally declared disasters, the netting rule still applies – but only disaster-related losses can offset disaster-related gains.
State Conformity Issues
Many states did not conform to the TCJA’s limitation on casualty losses. For state income tax purposes, taxpayers may still be able to deduct personal casualty losses that are not from a federally declared disaster. Taxpayers in those states should track losses for state purposes even if they are not deductible federally.
Practical Guidance
For losses that are not from a federally declared disaster (and thus not deductible federally), taxpayers should still document the loss for insurance purposes and for potential state deductions. If the loss is reimbursed by insurance, there’s no federal deduction anyway – but the insurance proceeds may be tax-free if they don’t exceed basis.
The key takeaway: for the next few years, personal casualty loss deductions are only for true disasters. A tree falling on your car during a thunderstorm? Not deductible unless the storm was a federally declared disaster. Theft of your jewelry? Not deductible unless the theft occurred in a disaster area (unlikely). The TCJA sharply curtailed this long-standing deduction, and it remains to be seen whether Congress will restore it in 2026 or later.
Disclaimer: This article provides general information for educational purposes only and does not constitute legal advice. Tax laws, judicial interpretations, and IRS guidance are subject to change at any time through legislation, regulation, or court decision. Readers should consult Alan Goldstein & Associates for advice regarding their specific factual situations.
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