Table 3. When To Deduct a Loss
Basis of replacement property. You must
reduce the basis of your replacement property
IF you have a loss...
THEN deduct it in the year...
(its cost) by the amount of postponed gain. In
this way, tax on the gain is postponed until you
From a casualty
The loss occurred.
dispose of the replacement property.
In a Presidentially declared
The disaster occurred or the year immediately
Example. A fire destroyed your rental home
disaster area
before the disaster.
that you never lived in. The insurance company
From a theft
The theft was discovered.
reimbursed you $67,000 for the property, which
had an adjusted basis of $62,000. You had a
On a deposit treated as a:
• Casualty
• A reasonable estimate can be made.
gain of $5,000 from the casualty. If you have
• Bad debt
• Deposits are totally worthless.
another rental home constructed for $110,000
• Ordinary loss
• A reasonable estimate can be made.
within the replacement period, you can post-
pone reporting the gain. You will have rein-
vested all the reimbursement (including your
entire gain) in the new rental home. Your basis
Owner-user. If you are an owner-user, simi-
any business is treated as similar or related in
for the new rental home will be $105,000
lar or related in service or use means that re-
service or use to the destroyed property. For
($110,000 cost − $5,000 postponed gain).
placement property must function in the same
more information, see Disaster Area Losses,
way as the property it replaces.
later.
Replacement Period
Example. Your home was destroyed by fire
Controlling interest in a corporation. You
and you invested the insurance proceeds in a
can replace property by acquiring a controlling
To postpone reporting your gain, you must buy
grocery store. Your replacement property is not
interest in a corporation that owns property simi-
replacement property within a specified period
similar or related in service or use to the de-
lar or related in service or use to your damaged,
of time. This is the replacement period.
stroyed property. To be similar or related in
destroyed, or stolen property. You can postpone
The replacement period begins on the date
service or use, your replacement property must
reporting your entire gain if the cost of the stock
your property was damaged, destroyed, or sto-
also be used by you as your home.
that gives you a controlling interest is at least as
len.
much as the amount received (reimbursement)
Main home in disaster area. Special rules
The replacement period ends 2 years after
for your property. You have a controlling interest
apply to replacement property related to the
the close of the first tax year in which any part of
if you own stock having at least 80% of the
damage or destruction of your main home (or its
your gain is realized.
combined voting power of all classes of voting
contents) if located in a federally declared disas-
stock and at least 80% of the total number of
ter area. For more information, see Gains Real-
Example. You are a calendar year tax-
shares of all other classes of stock.
ized on Homes in Disaster Areas in the
payer. While you were on vacation, a valuable
instructions for Form 4684.
piece of antique furniture that cost $2,200 was
Basis adjustment to corporation’s prop-
stolen from your home. You discovered the theft
erty. The basis of property held by the corpo-
Owner-investor. If you are an owner-inves-
when you return home on August 11, 2002. Your
ration at the time you acquired control must be
tor, similar or related in service or use means
insurance company investigated the theft and
reduced by the amount of your postponed gain,
that any replacement property must have a simi-
did not settle your claim until January 3, 2003,
if any. You are not required to reduce the ad-
lar relationship of services or uses to you as the
when they paid you $3,000. You first realized a
justed bases of the corporation’s properties be-
property it replaces. You decide this by deter-
gain from the reimbursement for the theft during
low your adjusted basis in the corporation’s
mining all the following.
2003, so you have until December 31, 2005, to
stock (determined after reduction by the amount
•
of your postponed gain).
replace the property.
Whether the properties are of similar serv-
Allocate this reduction to the following clas-
ice to you.
ses of property in the order shown below.
Main home in disaster area. For your main
•
The nature of the business risks con-
home (or its contents) located in a Presidentially
nected with the properties.
1) Property that is similar or related in service
declared disaster area, the replacement period
or use to the destroyed or stolen property.
•
What the properties demand of you in the
ends 4 years after the close of the first tax year in
way of management, service, and rela-
which any part of your gain is realized. See
2) Depreciable property not reduced in (1).
tions to your tenants.
Disaster Area Losses, later.
3) All other property.
Example. You are a calendar year tax-
If two or more properties fall in the same class,
Example. You owned land and a building
payer. A hurricane destroyed your home in Sep-
allocate the reduction to each property in pro-
you rented to a manufacturing company. The
tember 2002. In December 2002, the insurance
portion to the adjusted bases of all the properties
building was destroyed by fire. During the re-
company paid you $3,000 more than the ad-
in that class. The reduced basis of any single
placement period, you had a new building con-
justed basis of your home. The area in which
property cannot be less than zero.
structed. You rented out the new building for use
your home is located is not a Presidentially de-
as a wholesale grocery warehouse. Because
clared disaster area. You first realized a gain
Main home replaced. If your gain from the
the replacement property is also rental property,
from the reimbursement for the casualty in 2002,
reimbursement you receive because of the de-
the two properties are considered similar or re-
so you have until December 31, 2004, to replace
struction of your main home is more than the
lated in service or use if there is a similarity in all
the property. If your home had been in a Pre-
amount you can exclude from your income (see
the following areas.
sidentially declared disaster area, you would
Main home destroyed under Figuring a Gain,
•
have until December 31, 2006, to replace the
earlier), you can postpone reporting the excess
Your management activities.
property.
gain by buying replacement property that is simi-
•
The amount and kind of services you pro-
lar or related in service or use. To postpone
vide to your tenants.
reporting all the excess gain, the replacement
Property in the New York Liberty Zone. For
•
property must cost at least as much as the
property located in the New York Liberty Zone
The nature of your business risks con-
amount you received because of the destruction
that was damaged or destroyed as a result of the
nected with the properties.
minus the excluded gain.
September 11, 2001, terrorist attacks, the re-
Also, if you postpone reporting any part of
placement period ends 5 years after the close of
Business or income-producing property
located in a Presidentially declared disaster
your gain under these rules, you are treated as
the first tax year in which any part of your gain is
area.
If your destroyed business or
having owned and used the replacement prop-
realized. This 5-year replacement period applies
income-producing property was located in a
erty as your main home for the period you
only if substantially all of the use of the replace-
Presidentially declared disaster area, any tangi-
owned and used the destroyed property as your
ment property is in the City of New York, New
ble replacement property you acquire for use in
main home.
York.
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