Casualty Loss Deduction

A casualty loss deduction is a deduction under section 165 of the Internal Revenue Code for a loss of property caused by fire, storm, shipwreck, theft or another casualty, meaning damage from an identifiable event that is sudden, unexpected or unusual. For property held for personal use, the statute calls it a personal casualty loss and limits it heavily: for tax years after 2017 it is allowed only to the extent it is attributable to a federally declared disaster or, starting in 2026, a state declared disaster, or to the extent it offsets personal casualty gains in the same year. Losses of business or income-producing property, such as a rental, fall under different rules that carry no disaster limitation.

The IRS uses "casualty loss deduction" for the deduction and "casualty loss" for the loss being deducted; in everyday use the two mean the same thing. The related labels "disaster loss" and "qualified disaster loss" are not other names for it but categories within it, and they matter because each gets different arithmetic.

What counts as a casualty. The IRS's working test is an identifiable event that is sudden, unexpected or unusual: a flood, hurricane, tornado, wildfire, earthquake, a car accident. Damage from a steadily operating cause is progressive deterioration and does not qualify: termite or moth damage, a building weakened by normal weather, a water heater that wears out and bursts (though water damage to the rugs around it can be a casualty), and most drought losses. A theft requires a taking that is illegal under state law and done with criminal intent; simply misplacing money or property is not one, and a theft loss is generally your adjusted basis, because the property's value after it is gone is treated as zero.

The disaster limitation. Section 165(h)(5) allows a personal casualty loss in a tax year beginning after 2017 "only to the extent it is attributable to a Federally declared disaster ... or a State declared disaster." A federally declared disaster is one the President determines warrants federal assistance under the Stafford Act. The state branch, added by the One Big Beautiful Bill Act for tax years beginning after 2025, covers a natural catastrophe, or a fire, flood or explosion from any cause, that the governor and the Treasury both find severe enough. The same law made the limitation permanent; before it, the limitation was due to expire after 2025. So a kitchen fire, a burglary or a hailstorm that no government declares a disaster produces no deduction, with one exception: if the same year brings a personal casualty gain (an insurance payout above your basis in other damaged property), non-disaster losses can be deducted up to the amount of that gain.

Two tracks for a disaster loss. Public Law 119-108, signed September 11, 2026, reshaped the arithmetic for tax years beginning after 2024. A loss that arises in an area covered by a presidential major-disaster declaration, where the disaster's incident period began on or after December 28, 2019 and before January 1, 2027, is a qualified disaster-related personal casualty loss. That track reduces each event by $500, skips the 10%-of-adjusted-gross-income floor for the net amount (the qualified net disaster loss), and under section 63(b)(8) is available whether or not you itemize, alongside the standard deduction. Every other qualifying loss, including one from a state declared disaster or from a federal emergency declaration that is not a major disaster, follows the general track: $100 off each event, then 10% of adjusted gross income off the year's net total, deductible only on Schedule A. The measurement rules below apply on both tracks.

Insurance first. Under section 165(h)(4)(E), a loss covered by insurance counts only if you file a timely claim; skipping the claim to take the deduction instead does not work for the insured portion. You subtract any reimbursement you receive or expect, and if a claim with a reasonable prospect of recovery is still open at year end, the loss is not sustained until you know with reasonable certainty what it will pay. If insurance pays more than your adjusted basis, the result is a gain rather than a loss, which may be taxable or postponed under the involuntary-conversion rules.

Timing. A casualty loss is generally deducted in the year it happens and a theft loss in the year you discover it. Section 165(i) lets you deduct a loss from a federally declared disaster on the return for the year before the disaster instead, which can produce a refund months earlier; the IRS sets the election deadline at six months after the original due date, without extensions, of the return for the disaster year.

Wildfire relief payments. The same 2026 law added section 139M, which excludes from income qualified wildfire relief payments received in tax years beginning after 2025, for federally declared wildfire disasters declared after 2014 and before 2027. No deduction or credit is allowed for an expense to the extent an excluded payment covered it, and an excluded payment does not increase the property's basis.

1. Measure the loss for each item or event. For personal-use property, the loss before any limit is the smaller of (a) your adjusted basis, usually what you paid plus improvements, and (b) the decline in fair market value caused by the casualty, shown by an appraisal or, in some cases, by repair costs. Sentimental value does not count.

2. Subtract reimbursements. Insurance payouts, salvage value and other compensation, received or reasonably expected, come off.

3. Apply the per-event floor. $500 for a loss in a qualified major-disaster area, $100 for any other qualifying loss. Spouses filing jointly are one individual for this purpose.

4. Apply the 10% floor where it applies. For the general track, the net total for the year is reduced by 10% of adjusted gross income. The qualified net disaster loss is not.

5. Report it. The computation runs on Form 4684, Section A for personal-use property. A general-track loss is an itemized deduction; a qualified net disaster loss is deductible with or without itemizing.

Consider an example. Ines and Paul's house had an adjusted basis of $300,000. A flood in 2026, in a county covered by a presidential major-disaster declaration whose incident period began that year, lowers its value by $80,000, and their policy pays $50,000. Their loss is the smaller of $300,000 and $80,000, or $80,000, less the $50,000 payout: $30,000. On the qualified track they subtract $500 and deduct $29,500, without itemizing, and their $120,000 adjusted gross income does not reduce it.

Now suppose the same flood had been a state declared disaster only. The $30,000 loss would lose $100 to the per-event floor, leaving $29,900, and then 10% of their adjusted gross income, $12,000, leaving $17,900, deductible only if they itemize.

Pros

• A qualified major-disaster loss can be deducted without giving up the standard deduction, and without the 10%-of-AGI floor that erases small and mid-sized losses.
• The prior-year election can turn a disaster loss into a refund from the previous year's return, when cash matters most.
• From 2026, state declared disasters open the deduction to events that never receive a federal declaration.
• A loss larger than the year's income can create a net operating loss that carries forward.

Cons

• Most household losses get nothing: an undeclared fire, a burglary or a storm outside a declared area is not deductible unless personal casualty gains absorb it.
• The loss is capped at adjusted basis, so property that has risen in value since purchase can lose most of its decline to that cap.
• On the general track, the $100 and 10%-of-AGI floors leave little or nothing for a household with a moderate loss and a solid income.
• Measuring the loss takes appraisals or repair estimates, records of basis, and a closed insurance claim, and IRS publications have lagged the 2026 law.