Lessons on Casualty Losses From the O.J. Case and Others

But the courts don't exist to play "good cop" to the IRS' "bad cop," and they frequently hold up IRS decisions. Neighbors of O.J. Simpson claimed that the double murder and ensuing media frenzy permanently decreased their property value, lowering the value of their home by at least $400,000. The Ninth Circuit appellate court ruled that a casualty loss requires actual physical damage caused by a fire, storm or other sudden unusual event, and not merely buyer resistance. The Tax Court issued a similar decision to O.J.'s next-door neighbors, who also claimed their homes were permanently devalued.

When to Deduct

Generally, casualty losses are deducted in the year the casualty occurs -- even if you don't repair or replace the property in the same year. Casualty and theft losses are claimed on Form 4684 (use a separate form for each claim). Figuring a casualty loss takes a few steps. First, calculate the loss itself -- generally the difference between the fair market value of the property before the casualty and the fair market value of the property after the casualty. You'll need appraisals to back up your claim; sentimental value doesn't count.

If your basis in the property -- what you paid to acquire and/or improve it -- is less than the loss amount, then that's the figure that becomes the figure used to determine your deductible casualty loss.

You're only allowed to deduct losses that are not covered by insurance, so subtract any insurance payments from your loss amount. Now, subtract $100 from the remainder. (I know, this is starting to sound like a joke.) You're only able to deduct the balance to the extent it exceeds 10% of your adjusted gross income. And unlike medical expenses, married couples can't file separately in order to "bunch" the deductions and reach the 10% threshold with greater ease -- only an owner can claim a casualty or theft loss. (For more on this strategy, see Deductions for Your Health and Wealth.)