 Hello and welcome to the session in which we'll discuss casualty and theft losses. Now bear in mind any losses incurred on personal use property. What's personal use property? Well, you might own a vehicle and you would use this vehicle to go to work every day to commute to your job To take your kids on vacation to go shopping for grocery to use it for your own enjoyment That's a personal use property any losses incurred on personal use property is not deductible however, if You incur a loss from that personal use property that's caused by fire storm a car accident Or by theft that is deductible and that's deductible from AGI from adjusted gross income Subject to a threshold and floor now bear in mind between 2018 and 2025 that type of losses personal casualty or theft losses are deductible only If related to a federally declared disaster area So if you lost a car in a federally declared disaster area Then it is deductible. If not, it's not deductible. Those losses are not deductible However, we're gonna have to learn about casualty and theft losses because they're gonna be deductible fairly soon Let's assume in June 20 X for a major thunderstorm cause river flood that damages Noah's basement leaving a $10,000 loss after insurance. Well, this loss is not deductible Assuming this is for personal use and assuming this is not a federally the disaster Declared area so that under storm was not federally declared disaster Now if the flooded property is Noah's rental home in other words, it's not for personal use It's for rental income or for business income. The loss becomes deductible However, if this is his if this is Noah's personal home, and this is what we're assuming None of the losses are deductible. Now. Let's talk a little bit more about a casualty losses What are casualty losses before we proceed any further? I have a public announcement about my company farhat lectures comm Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics My resources consist of lectures, multiple-choice questions, true-false questions as well as exercises Go ahead start your free trial today. An event must be identifiable. For example, a tornado occur You have it damaged the property. So because of the tornado the property was damaged and the damage was sudden sudden Surprisingly unexpected and unusual in nature usually active natures will Fit this definition. In other words the damage cannot be caused by the taxpayer Willful act or negligence. So so that's not that's not acceptable. For example an auto accident flood Hurricane tornado fire earthquake. Those are considered casualty losses Let's take a look at events that are not considered based on court cases So you might see this on your exam diseases and insect damages Those are not because they happen over time Termite damage that happens over time Decline in value of property as a result of landslide that destroyed neighborhood home that happened over time that is not Those are not sudden. Okay. Generally speaking active nature or Casualty losses. How about theft losses? Well for theft losses Well, we have we have to have the theft to have occur. Well, obviously Something must be stolen could be larceny embezzlement and robbery in other words It's not misplaced. So if you misplaced an item and you lost it, that's not really theft That's your negligence. When can you take the deduction timing of the deduction? The theft is the year of discovery because sometime you might have a theft in year one and you may not discover it in Unless year two and year three you will take it in the year of discovery Casualty loss year of loss occurs. So the for example now bear in mind For example, if the if the casualty loss occur in year one, you're not gonna file your return until year two You will file it in year two for year one. Okay now You should not file a Loss if you think you're gonna be getting the money back from the insurance If if insurance is expected to recover the loss, don't file. Don't claim the loss Okay, and if you do then you get the money then you have to use the tax benefit rule Now if the insurance does not fully recover you then whatever is left you can make a claim now casualty losses Bear in mind in a disaster area declared by the president. You can file in the same year So usually let's assume the now the casualty occur in year one And if the area is considered by the federal government a disaster area Then you will be able to file that same year and get a get some type of a relief alleviate the pain they allow you to do that Let's take a look at an example One of Adam's delivery vehicle was stolen from his garage April 20x3. He found out about the theft May 6 Which is next the following month And Adam filed an insurance claim which was settled February 15 20x4 if Adam believes Recovery is likely simply put if Adam believed he's gonna recover the whatever he lost No deduction should be permitted in 20x3 Because the insurance they're gonna get their money back if the insurance payout is less than the vehicle fair market value or adjusted basis a Partial deduction may be claimed so of the insurance that not cover everything then a partial deduction can be claimed However, if Adam used this vehicle for personal use no deduction applies Unless we are outside those years, you know in 26 27 that that type of Deduction is allowed again subject to certain limitation, which we'll talk about shortly, but again for now Casualty and theft losses. They are not allowed for personal use property unless it's a federally declared disaster area What is the amount of loss that you can deduct for casualty and theft losses? Well We compute this differently for business property or income producing property versus personal use Let's look at business or income producing property If the asset is completely destroyed, so if the asset is stolen, it's completely destroyed or if it's totally destroyed It's completely destroyed. What is the amount of the loss? The amount of the loss is your adjusted basis of the property Obviously minus any insurance. So if you receive any insurance, you have to reduce your loss If the asset was partially destroyed, it means you have a vehicle. It's destroyed, but not totally destroyed How much can you can you and again, this is a business Vehicle or income producing vehicle? How much is the loss? The loss is the lower the lesser of the adjusted basis Or the fair market value before and after which is The difference between those two it means what was the reduction in the fair market value? And obviously whatever the amount in one or two then you subtract the insurance because the insurance would lower your Losses because you are recovering your losses. Let's take a look at this example The flood totally damaged Adams and insurers business equipment. It was valued at eight thousand dollar. That's the fair market value It what it It means totally totally destroyed. It means the value of this is zero now So the reduction in fair market value equal to eight thousand the adjusted basis The adjusted basis is 12 000 Adam is entitled to an eight thousand dollar loss. Why because we're going to take the lower of The adjusted basis, which is 12 000 and the reduction in fair market value Which equal to eight thousand now, obviously If adam received any insurance proceeds, let's assume the insurance recovered three thousand dollar Then the losses will be what's left is five thousand and obviously since this is a business business business equipment the The deduction is for a gi Okay, let's look at another example Adams business car and insured was damaged in a crash. It was It has a pre accident market value of 13 000 Adjusted basis of 11 post accident fair market value of seven. Well the adjusted basis equal to 11 Before and after it went down the reduction in fair Market value equal to six thousand, which of the two we will Take the lower of the two is six thousand Adams deductible loss is six thousand, which is the smaller of The adjusted basis or fair market value decrease Considered as a deduction For a gi unless we have any insurance proceeds How about the amount of loss for personal use property? Remember personal use property is suspended between 2020 2018 and 2025 So it doesn't differentiate between complete and partially destroyed Okay, the loss is the lesser of the adjusted basis or the reduction in fair market value Now bear in mind You always have to reduce the with the insurance And here you have to reduce the insurance whether the insurance was recovered or could have been recovered What does that mean? Here's what happens sometimes you get into a car accident like usually a fender bender on the highway And the person that you know hits the car. They would say look, please don't claim file Don't claim an insurance against me. Okay, don't file a claim. I'm willing to pay For your damage. That's it. Don't now Obviously you did not file a claim but The assumption is you would have to reduce your losses as if you have filed the claim Why because the government don't don't want to subsidize your decision because you could have recovered some Of these losses, but you chose not to You would assume that you filed the claim and how much you would get from that claim. Okay? There's also a 100 dollar floor per event So so for so for something to be deductible. It has to be more than 100 dollars. Otherwise, there's a floor of 100 dollars So if the loss is less than 100 dollars, it's not even a loss. Okay, and also Your losses has to be greater than 10 percent of your adjusted gross income So the amount has to be decent to be deductible Okay, and this the reason for these floors and limitations is to do what? Is to avoid abuse by the taxpayer if that's not the case Then guess what any theft losses any theft losses that you will file a claim On your tax return. Well, it has to be large enough That's higher than 10 percent of your agi and the loss by itself. It has to be more than 100 dollars Let's take a look at an example to see how it works in 20x3 adam with an agi of 40 000 lost All his apartments furniture and flood within a federally declared disaster area. So here federally declared disaster area Yes, we're gonna have we're gonna be able to take the deduction The furniture has a fair market value of 15 and adjusted basis of 12 It was completely destroyed. So the fair market value went from 15 000 down to zero His insurance compensated him for six thousand dollar. How much is his deduction? Well, Let's see. How do we work this? problem, okay, it's It's a is it a casualty and theft loss. Yes, it's a flood That's the first thing Is it deductible? Yes in a federally disaster area. Here's what we're gonna do We're gonna take the lower of the the reduction in fair market value Or the adjusted basis adjusted basis equal to 12 The reduction in fair market value went from 15 to 0 equal to 15 000. What do we start with? We choose the lower of these two 12 000. Then the insurance Recovered half of that 12 000 minus 6 000 we're left with 6 000. Then this is one event. We're gonna deduct $100. We're left with 9 000 5 900 and losses Is this the amount deductible? No The amount deductible it's gonna be it's gonna have to exceed 10 percent of agi 10 percent of adjusted gross income is 4 000 So now what's the amount that exceed? 5 900 exceed 10 percent of agi by how much by 1 900? Therefore the loss is 1 900, okay So we're gonna choose the lesser of adjusted basis or the decrease in fair market value the adjusted basis We're gonna deduct the insurance because the insurance would Give us back 6 000 so we cannot claim the loss because we're getting the money back minus this $100 floor per event minus 10 of adjusted gross income, okay? Remember this deduction is From adjusted gross income. It's from agi not for agi. Okay, because this is a personal apartment furniture Personal casualty gains. Hold on a second. Do you have a gain with personal casualty? Yes, you could have a gain One with that gain happen is when your insurance proceeds are greater than your adjusted basis So an exception to the general rule allows a taxpayer to use personal use personal casualty losses Not tied to a federally declared disaster area to offset casualty gains So if you have casualty gains where the insurance proceeds were greater than the adjusted basis and this could happen If you have a gain Then you are allowed to take the gains and offset them against casualty losses because it's not fair Something happened. You are not expecting it and as a result you have a gain Well, it's taxable unless you have some other personal casualty losses You can offset them against each other. So what's gonna happen is you're gonna have a netting process So you're gonna net all personal casualty and theft gains or losses For the year you combine them and you're gonna either have a net gain or a net loss Either when you net them either have a net gain or a net loss if you have a net gain The net gain are treated as capital gain and included in the capital gain capital loss netting process If you have a net loss and assuming it's in it's it's not in federally declared disaster area Then the loss is not deductible Okay, so what why is why this special rule exists? This exception exists in case you have a gain It's unfair because you didn't you didn't want to you didn't want this event to happen It's outside your control now. You have to pay taxes on it. We'll say look If it happened you have a gain see if you have personal casualty losses Although it's it's not in a federally declared disaster area. You could still net them out Okay, but at the end if you have a gain you still have to treat the gain as a capital gain But at least you reduced it if you have a loss Assuming not federally declared disaster area not deductible What should you do now for casualty and theft losses? Go to far hat lectures and look at additional mcqs That's gonna help you understand this topic whether you are a cpa exam candidate Whether you are an accounting student or studying for your enrolled agent exam You need to understand this topic. Good luck study hard and of course stay safe