Recent law changes expand disaster loss deductions and offer disaster related tax-free relief payments, deadline extensions, and penalty-free retirement withdrawals:
- Recent changes to the law have expanded eligibility, allowing more disaster victims to claim these deductions.
- There’s nothing good about a disaster, but at least the tax law can help disaster victims in various ways. And recent changes in the law provide even more ways to get tax relief.
Deducting Disaster Losses for Individuals: Navigating the Rules
The federal tax law provides relief if a disaster—such as a fire, flood, or hurricane—damages your personal (non-business) property, including your home, belongings, and vehicle. You may be able to deduct these losses from your taxable income, but the rules are complex and often restrictive.
Recent changes to the law have expanded eligibility, allowing more disaster victims to claim these deductions.
Only Losses Due to Federal Disasters Are Deductible
Property losses are deductible only if the U.S. president declares the event a disaster. For example, the loss may be deductible if a wildfire destroys a homeowner’s property and the president designates the wildfire a federal disaster. But the loss is not deductible if the home burns down due to a faulty fireplace.
Only Unreimbursed Disaster Losses Are Deductible
Many, but not all, disaster losses are covered by insurance. You can’t deduct such losses to the extent they are insured. Moreover, if a loss is insured, you must file a timely claim, even if it will cancel your policy or increase premiums.
There’s a different rule for business owners. They can claim business casualty losses without filing an insurance claim.
The amount of your loss is equal to the smaller of (1) the decrease in the property’s fair market value after the disaster or (2) the property’s adjusted basis before the disaster (usually its cost). You then subtract any insurance or other reimbursement received from the smaller of (1) and (2).
You can use an appraisal or a repair cost to figure out the decline in the property’s fair market value.
Limits on Disaster Losses
There are strict limits on your deduction for disaster losses.
The general rule is that the first $100 is not deductible, and then you can deduct your loss only to the extent it exceeds 10% of your adjusted gross income (AGI). You may deduct the loss only if you itemize your deductions on IRS Schedule A.
Fortunately, thanks to the Federal Disaster Relief Act of 2023, enacted by Congress in December 2024, the general rule does not apply to federal “major” disaster losses from January 1, 2020, through January 11, 2025.
Instead, losses from such qualified disasters are subject to a $500 floor with no 10% AGI threshold. Taxpayers may claim the loss deduction without itemizing and then increase their standard deduction by the amount of their net disaster losses.
Note the January 1, 2020, date. You likely filed that return and others with no loss deduction. You can now file an amended return using the new rules for those wildfire and East Palestine train derailment casualty losses, and you can also exclude some of the disaster area payments you received.
Wildfires, Floods, Hurricanes: How the IRS Has Your Back
Disasters are all over the news these days. Severe calamities that cause widespread damage, such as large wildfires, floods, hurricanes, and earthquakes, ordinarily result in a disaster declaration by the U.S. president.
There’s nothing good about a disaster, but at least the tax law can help disaster victims in various ways. And recent changes in the law provide even more ways to get tax relief.
As discussed above, declared disaster victims can deduct the value of their uninsured losses from their tax returns, subject to limits. There are several other forms of tax relief for disaster victims, including those described below.
Postponement of tax deadlines. The government automatically extends tax deadlines for 60 days for those in federally declared disaster areas. But the IRS usually exercises its discretion to postpone such deadlines for up to one year. The IRS announces the extensions on its website.
Penalty-free withdrawals from retirement accounts. Taxpayers who suffer losses due to federally declared major disasters may withdraw up to $22,000 from their IRA, 401(k), or 403(b) account without penalty. And they can pay the regular income tax due on the withdrawals over three years.
Disaster relief payments are tax-free. Relief payments to disaster victims from federal, state, and local governments are tax-free. Disaster mitigation payments, which are made to lessen or avoid the effects of future disasters, are also tax-free. Payments that charitable organizations make to disaster victims are ordinarily tax-free gifts.
Qualified wildfire relief payments. Under new legislation passed in late 2024, most payments triggered from federally declared disasters caused by forest or range fires are tax-free. This relief applies to qualified wildfire relief payments received from January 1, 2020, through December 31, 2025.
Taxpayers who previously paid tax on wildfire receipts that are now tax-free may amend their tax returns for a refund, including from the years 2020 and 2021. The new law overrides the statute of limitations for these payments and allows amended returns until December 12, 2025.
Casualty gains can be tax-free or deferred. Disaster victims can end up owing income tax on casualty gains. These occur when the insurance received due to a disaster exceeds the adjusted basis of the property damaged or destroyed by the disaster or other casualty event.
But there are ways to avoid owing tax on casualty gains, such as the following:
Involuntary Conversion. You can treat the damage or destruction caused by a disaster as an involuntary conversion and postpone reporting the gain if you spend the insurance recovery funds to repair or replace the property within two years—four years for your main home if it was in a federally declared disaster area. If you use all of the insurance proceeds you receive to purchase replacement property within two or four years, your casualty gain will not be taxed.
Home Sale Exclusion. If the casualty completely destroyed your main home, you can treat the casualty gain as profit from the sale of your home. Then, if you qualify for the home sale exclusion, you can exclude from your income $250,000 of your gain if you are single or $500,000 if you are married and filing jointly. The destruction does not have to be from a federally declared disaster.
Contact your tax and financial advisors to determine the best moves for your situation.