Tax considerations for property damaged in federal disaster areas: PwC

August 30, 2024

Updated January 14, 2025

In brief

Update: The IRS on January 10 issued IR-2025-10, providing relief to individuals and businesses in southern California affected by wildfires that began on January 7 and have caused significant property damage across southern California, with emergencies declared by the Federal Emergency Management Agency (FEMA) in Los Angeles County. Currently, individuals and businesses that reside or have a business in Los Angeles County qualify for the relief. The same relief will be available to any other counties added later to the disaster area.

Observation: The tax relief provided in IR-2025-10 postpones various tax filing and payment deadlines that would otherwise be due between January 7, 2025, and October 15, 2025. Affected individuals and businesses now have until October 15 to file various individual and business tax returns and make tax payments that originally were due during this period.

What happened?

Hurricanes Debby and Ernesto caused significant property damage across the southeastern United States and Puerto Rico, with emergencies declared in multiple states and a state of disaster declared in Florida. The IRS has postponed various tax filing and payment deadlines for these taxpayers, as well as taxpayers affected by Hurricanes Helene and Milton. For deadlines falling on or after October 5, 2024, and before May 1, 2025, taxpayers located in Alabama, Florida, Georgia, North Carolina, South Carolina, Tennessee and Virginia generally have until May 1, 2025, to file various federal individual and business tax returns and make quarterly tax payments.

Why is it relevant?

Federal tax provisions allow a casualty loss deduction for partial destruction of property and for certain disaster losses to be claimed in the preceding year, favorably modify the rules for involuntary conversions resulting from certain disasters and provide an enhanced deduction for charitable contributions of inventory used to assist disaster victims. The IRS also regularly provides relief to taxpayers in federally declared disaster areas by, for example, extending filing and payment deadlines and abating certain penalties.

Action to consider

Taxpayers affected by hurricanes, floods, tornadoes, wildfires, or similar occurrences should check whether their location is declared a federal disaster area and be aware of the tax relief that may be available to alleviate the economic burden of the disaster. Careful planning is necessary to accurately report losses, recoveries, reinvestments, and charitable contributions of inventory and to evaluate potentially available tax benefits.

In detail

Definition of federally declared disaster area

Federally declared disasters most commonly are natural disasters such as hurricanes, tornadoes, severe storms, and floods. A federally declared disaster area is an area determined by the President to warrant assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. A ‘federally declared disaster’ includes both a major disaster declared under Section 401 of the Stafford Act and an emergency declared under Section 501 of the Stafford Act.

Areas that have been declared disaster areas and receive tax relief are identified on the irs.gov disaster relief page.

Disaster loss deduction

Although a deduction is allowed for a loss sustained during the tax year that is not compensated for by insurance or otherwise, the loss generally cannot be recognized until the property is completely worthless. However, taxpayers may be eligible to claim a casualty loss for partial destruction or the reduction in value of the damaged property resulting from an identifiable event of a sudden, unexpected, or unusual nature, measured by comparing the value immediately before the casualty with the value immediately after the casualty, with the amount of the loss limited to the property’s adjusted basis.

Generally, personal casualty losses of individuals are subject to certain limitations. The 2017 tax reform act (Act) disallows personal casualty loss deductions for individuals for losses incurred in tax years beginning after 2017 and before 2026, except (1) to the extent the taxpayer has personal casualty gains or (2) if the loss is attributable to a federally declared disaster.

An individual or business taxpayer in a federally declared disaster area also may elect to deduct a loss attributable to the disaster in the tax year immediately preceding the tax year the loss is sustained (the ‘preceding year’ and the ‘disaster year’, respectively). For example, a calendar-year taxpayer that resides or has a business in Los Angeles County may claim a disaster loss sustained from wildfires and straight-line winds on the taxpayer’s 2024 federal income tax return, although the loss occurred in 2025. A loss for which a taxpayer makes the election is treated for all federal income tax purposes as occurring in the preceding year (the tax year the taxpayer claims the deduction). Regulations provide that a taxpayer must make the election on an original or amended return for the preceding year in the manner specified by other guidance.

Regulations under Section 165 provide that a taxpayer must make the election on an original or amended return for the preceding year in the manner specified by other guidance. Thus, for example, Rev. Proc. 2016-53 provides that a taxpayer makes or revokes the election by attaching a statement to an original or amended return providing certain specified information. Taxpayers may submit the required statement by completing Section D of IRS Form 4684, Casualties and Thefts.

A taxpayer must make the election no later than six months after the unextended due date for filing the taxpayer’s return for the disaster year. A taxpayer may revoke an election within 90 days after the due date for making the election. A taxpayer revokes the election by filing an amended return for the preceding year on or before the date the taxpayer files its return (or amended return) for the disaster year and claims the loss. A taxpayer that claims the loss on its return for the disaster year and wishes to make the election to claim the loss in the preceding year must file an amended return for the disaster year on or before the date the taxpayer files an amended return making the election for the preceding year.

Example 1. In 2025, individual taxpayer J sustains a disaster loss in a federally declared disaster area. J makes the election to claim the loss in 2024 by filing an amended return for the 2024 tax year on August 17, 2026, which is within the six months following J’s unextended filing due date for filing her 2025 return. J files her 2025 return on September 15, 2026.

Example 2. J decides to revoke her election to claim the loss in 2024 and to claim the loss on her 2025 return instead. J may file an amended return for 2024 revoking the election and an amended return for 2025 claiming the loss. J must file the 2024 amended return revoking the election by January 15, 2027 (within 90 days after October 15, 2026), and on or before the date J files a 2025 amended return claiming the loss.

Example 3. In 2025, individual taxpayer K sustains a disaster loss in a federally declared disaster area. K claims the loss on his 2025 return filed on April 15, 2026. K then decides to elect to claim the loss on his 2024 return. K may make the election on or before October 15, 2026, by filing a 2024 amended return claiming the loss deduction. K must file a 2025 amended return omitting the loss deduction on or before the date of filing the 2024 amended return.

Costs to repair or improve damaged business property

The costs of restoring damaged business property generally must be capitalized, rather than deducted as a casualty loss. A taxpayer must capitalize amounts paid to restore a unit of property (UOP) if the restoration relates to damage to the UOP for which the taxpayer has properly taken a basis adjustment attributable to a casualty loss.

However, the costs required to be capitalized as a restoration under the casualty loss rule are limited to (1) the excess of the adjusted basis of the UOP damaged in the casualty over (2) the amounts paid to restore damage to the UOP that also constitute a restoration under the restoration standards (excluding the casualty loss rule). Expenditures related to casualties in excess of the limitation are not treated as restoration costs and may be deducted if they otherwise constitute ordinary and necessary business expenses.

Observation: These rules require a taxpayer to (1) capitalize amounts as a restoration only to the extent of the adjusted basis of the property destroyed in the casualty (generally, the amount that also would be recognized as a loss), and (2) claim a deduction for excess expenditures not otherwise required to be capitalized (i.e., not a betterment and not adapting property to a new or different use). That is, a taxpayer effectively may claim a full deduction to remediate the damage by claiming the casualty loss and deducting any expenditures in excess of the adjusted basis.

Insurance and similar recoveries

In general, insurance proceeds and other payments received by a business due to a casualty are characterized as either payments for lost profits or payments for lost property. Compensation for lost profits is taxable in the current year, while compensation for loss of the use of property or for property damage generally is treated as a recovery of capital, generally taxable only to the extent that the amounts received exceed the property’s basis (without regard to possible involuntary conversion treatment discussed below).

Under certain insurance policies (e.g., business interruption), whether payments are intended to compensate for lost profits or for lost property (or a combination of both) may be unclear. The courts have considered factors such as (1) the existence of additional policies with specific coverage, (2) the nature of the casualty triggering the insurance recovery (i.e., suspension of business or loss of property), (3) how the amount of the insurance recovery is computed, and (4) whether the payment is approximately equivalent to the replacement cost of property.

Involuntary conversions

When property is involuntarily converted into money (e.g., insurance proceeds) as a result of its complete or partial destruction, a taxpayer may elect to recognize gain only to the extent the amount realized on the conversion exceeds the cost of purchasing property ‘similar or related in service or use’ to the damaged property (replacement property). The taxpayer must purchase the replacement property within two years after the close of the first tax year the taxpayer realizes any part of the gain.

Special rules apply to property damaged by federally declared disasters. Tangible property a taxpayer holds for productive use in a trade or business is treated as property similar or related in service or use to involuntarily converted property that was held for productive use in a trade or business or investment and located in a federally declared disaster area. The IRS applied this rule in a 2011 technical advice memorandum (TAM 201111004) to allow a taxpayer to replace inventory destroyed in a federally declared disaster with real property held for productive use in the trade or business.

Observation: Taxpayers that recently recognized gain as a result of an involuntary conversion of property in a federally declared disaster but did not elect to defer the gain may wish to consider filing a claim for credit or refund.

Enhanced deduction for charitable contributions of inventory

Many businesses assist disaster victims by donating inventory such as food, clothing, toiletries, and medical supplies to charities. Section 170(e)(3) provides a special enhanced deduction for inventory a C corporation contributes to a qualified tax-exempt charity that uses the inventory solely to care for the ill, infants, or needy (e.g., disaster victims) in a manner related to the recipient organization’s charitable purpose. The charity may not transfer the inventory in exchange for money, other property, or services; the taxpayer must obtain a written statement from the charity that includes certain required representations; and any inventory subject to regulation under the federal Food, Drug, and Cosmetics Act must fully satisfy the applicable requirements of that act and related regulations for 180 days before the date of transfer.

In general, the amount of a charitable contribution of property is the fair market value (FMV) of the property, subject to certain reductions. For ordinary income property (e.g., inventory), the reduction generally is the difference between the FMV and the basis of the property. Therefore, the charitable contribution deduction is equal to the basis of the inventory. However, the amount of the enhanced deduction for qualified contributions of inventory equals the lower of (1) FMV of the inventory less 50% of the difference between the FMV and the basis of the inventory or (2) twice the basis of the inventory. Thus, C corporations making qualified donations of inventory to charities that will use the inventory to care for disaster victims may take a charitable contribution deduction equal to the basis of the inventory plus 50% of the gain, limited to twice the basis of the inventory.

Note: In general, the total charitable contribution deduction for a C corporation is limited to 10% of the corporation’s taxable income (as defined under Section 170 for purposes of charitable contributions).

Trades or businesses that are not C corporations (e.g., S corporations, partnerships, or sole proprietors) may claim the enhanced deduction only for charitable contributions of food inventory. Thus, farmers, retail grocers, and restaurants that do not do business as C corporations have an opportunity to claim the enhanced deduction for qualified charitable contributions of food inventory.

The total deduction for charitable contributions of food inventory generally is limited to 15% of taxable income for C corporations and, for taxpayers that are not C corporations, to 15% of the taxpayer’s aggregate net income for the tax year from all trades or businesses from which the contributions are made.

Other considerations

Qualified disaster relief payments

Employees and other individual taxpayers who incur expenses or suffer losses or hardship as a result of a federally declared disaster may receive benefits or assistance from their employers or other parties that are excludable from income under Section 139 as ‘qualified disaster relief payments.’ Qualified disaster relief payments include amounts paid to or for the benefit of an individual for reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster, but do not include expenses paid for by insurance or other reimbursement or income replacement payments. An employer may deduct a qualified disaster relief payment to an employee as a trade or business expense.

Uniform capitalization (UNICAP) under Section 263A

Taxpayers that are subject to the UNICAP rules under Section 263A are not required to capitalize certain indirect costs they incur in connection with a natural disaster, including casualty losses under Section 165 and depreciation on temporarily idle equipment and facilities.

Extension of filing and other deadlines

Following a federal disaster declaration, the IRS commonly extends the time for taxpayers in the affected areas to perform certain acts. Rev. Proc. 2018-58 describes the acts for which the IRS may provide an extension of time. After a federal disaster declaration, the IRS generally provides the specifics of the relief in a notice or news release. As noted earlier, IRS news releases recently extended certain filing and payment deadlines to October 15, 2025, for individuals and businesses that reside or have a business in Los Angeles County and have been affected by the wildfires that began on January 7 in southern California.

The Taxpayer Certainty and Disaster Tax Relief Act of 2019 provided for a mandatory 60-day extension period for certain taxpayers, but did not specify the deadlines to be extended. Regulations under Section 7508A apply this extension to deadlines for certain acts related to retirement contributions.