Home Office Casualty Losses

If you qualify for the home office deduction and your home office is damaged or destroyed by a burglary or a disaster such as a hurricane, flood, fire, accident, riot, or vandalism, you may be able to deduct some of your losses as part of the home office deduction.

Casualty losses imply a sudden, accidental, or unusual loss and do not include damage from pets or progressive losses to property such as damage from erosion, termites or other insects, wood rot, etc.

If the loss occurs only to the home office, treat it as a "direct" expense that is fully deductible. If it applies to the entire home (such as storm damage to your roof), you can deduct a proportionate part of it as a business expense (based on your business use percentage), and the remainder as a personal expense. If the loss occurred only to the personal part of the home, you may not deduct any of it as a business expense, although you may be able to deduct it as a personal expense.

Insurance reimbursement. To claim a casualty loss you must file a timely claim for any insurance you have on the property, and you can only deduct the portion of the loss that is not reimbursed by insurance.

If the reimbursable amount has not been determined by the time you need to file your tax return, compute your losses using the amount that you reasonably expect to eventually recover from the insurance company. If your estimate is incorrect, you can treat any additional reimbursement as income in the year you actually receive it, or file an amended return for the year of the loss if you don't recover as much as you expected.

Warning If you recover more insurance money than your adjusted basis in the property at the time of the loss, you may actually have a taxable gain unless you purchase replacement property within two years, or within four years if the loss occurred to your main home located in a federally declared disaster area. See IRS Publication 547, Casualties, Disasters, and Thefts, for more details.

Business vs. personal loss. The rules for deducting casualty losses are more favorable for business property than for personal property.

For one thing, losses on personal property are generally subject to two thresholds: a $100 per occurrence threshold (the first $100 is not deductible at all) and a 10 percent of adjusted gross income (AGI) threshold. In other words, after the first $100 is subtracted, you must subtract 10 percent of your adjusted gross income (AGI) to determine the amount you can deduct. Neither of these limits apply to casualty losses on business property.

Secondly, business casualty losses are measured using slightly different rules. For both kinds of losses, if the property is only damaged, you must take the lower of the decrease in the property's fair market value (FMV) as a result of the loss, or the property's adjusted basis before the casualty loss. From this you subtract any insurance reimbursement, to arrive at the amount of loss. If personal property is completely destroyed, start with the lower of the property's FMV or adjusted basis before the loss. But if business property is completely destroyed, start with the adjusted basis before the loss minus any salvage value; the property's FMV is not considered.

In order to claim a casualty loss on your home office, you must compute the loss both ways. First, compute the amount of loss that you'd be allowed to deduct if the office was not used for business, using the $100 and 10 percent-of-AGI thresholds described above. Then, compute the amount of loss on the home office as a business expense. The easiest way to compute these two amounts is to use IRS Form 4684, Casualties and Thefts, as a worksheet. Complete Part A as if the loss were on personal property, and then complete Part B as if the property were business.

While the amount that would be deductible as a personal loss (as shown on Part A) is always deductible as an itemized deduction, the difference between the personal loss and the business loss will only be deductible this year if your business income is sufficient to cover all your business expenses. If not, you can carry over the excess and deduct it next year.

Adjustments to basis. Your deductible casualty losses must be used to reduce your tax basis in the business portion of the home. For the year of the loss and for subsequent years, you will need to use this new basis in calculating your depreciation deductions. For more information, see IRS Publication 946, How To Depreciate Property.