Businesses Have Options in Deducting Severe Weather Losses

Many businesses have suffered significant losses from the recent hurricanes and extreme weather events. As part of their financial recovery, these businesses face the question of how to account for the losses. The Internal Revenue Code allows businesses to treat repairs to weather-related damages as ordinary and necessary business expenses under IRC Section 162 or as casualty losses under IRC Section 165. Key factors in deciding which section to use are the timing of the deduction and the documentation requirements.

Losses as a Business Expense

Businesses can get immediate tax relief by deducting repairs to storm damaged property as an “ordinary and necessary” business expense under Section 162. Deducting these costs as ordinary expenses can lower the taxpayer’s taxable income, resulting in reduced tax liability. A taxpayer can also claim deductions immediately without taking into account outstanding insurance claims or other reimbursements that they reasonably expect to collect. These deductions, however, require analyzing the expenditures against the improvement standards in the Tangible Property Repair Regulations (TPR). The TPR, for example, requires businesses to capitalize costs that are a betterment, adaptation or restoration to a unit of property.

Casualty Losses

Alternatively, businesses can deduct casualty losses under Section 165. Section 165 allows taxpayers to deduct losses arising from fire, storm, shipwreck, or other casualties for property used in a trade or business or for a transaction entered into for profit. For losses in federally declared disaster areas, Section 165 offers the flexibility to take deductions in either the year of the loss or the year prior to the loss. Additionally, net qualified disaster-related casualty losses are not subject to the requirement in Section 165(h)(2) that they exceed 10 percent of adjusted gross income.

Taxpayers determine the amount of the deduction by comparing the fair market value (FMV) of the property immediately before and after the event that caused the loss. The regulations also permit the taxpayer to establish the amount of loss by using the cost of repairs, with some limitations. The deduction is limited to the adjusted basis in the property, leaving it greatly reduced if the taxpayer took bonus depreciation.

Deducting casualty losses under Section 165 requires businesses to meet specific criteria, such as proving the loss was sudden, unexpected, and not a result of normal wear and tear. Unlike in Section 162, businesses must also demonstrate that the loss was not covered by insurance or other reimbursements (reimbursements received at a later date would be recognized as income and reduce the loss). Failure to meet these requirements can result in disallowed deductions and potential penalties.

Additional Rules and Reminders

In determining how to account for their losses, businesses should be careful not to “double dip” by claiming losses under both sections. Once a business deducts repairs for the loss under Section 162, for example, it cannot then claim additional deductions on the same property under Section 165. Businesses should also take note that casualty loss rules for property used in a trade or business differ from those for personal property.

Regardless of the route chosen, businesses should remember that documentation is critical. The IRS may scrutinize these deductions more closely, so it is important to document the calculations and expenditures properly.

For more information on how to claim losses for severe weather events, contact us today. We’re here to help!

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