IRC Section 165(i) Special Election to Deduct Current Year Disaster Losses in Preceding Tax Year

Company News | Edward P. Rigby | Jun 08, 2020

Existing tax law under IRC Section 165(i) allows a special election to deduct losses occurring in a federally declared disaster area in the tax year immediately preceding the tax year that the loss was incurred.  This election could create refund opportunities for taxpayers, who have suffered business casualty losses during the COVID-19 crisis, by allowing deductions for such losses incurred in 2020 on their 2019 tax returns.  Further, such losses claimed on 2019 tax returns could result in even further refund opportunities through carrybacks of net operating losses (NOLs) to the previous five years as the NOL rules were modified under the CARES Act.  The election to claim COVID-19 losses incurred in 2020 on the taxpayer’s 2019 tax returns is made on Form 4684.  Such election must generally be made on either an original or amended return for the preceding tax year.  The election must be made within six months of the due date of the loss year.

To claim a deductible casualty loss, a taxpayer must generally meet certain tests, including the requirement that the loss must be generated by a closed and completed transaction, (e.g., a sale of inventory at a loss, or a disposal or destruction of unsalable inventory).  Further, the loss must be generated by fixed and identifiable events, (e.g., due to COVID-19 related enforced closures, the taxpayer’s inventory was destroyed or became worthless).  The loss must have been sustained during the year of the disaster event.  Additionally, the taxpayer must consider insurance or other reimbursements in determining a casualty loss.  The taxpayer may not make the election to claim the loss in the preceding tax year if the  taxpayer claims a deduction in the tax year when the loss was incurred, (e.g., claiming a deduction through cost of goods sold for inventory or a Section 1231 loss for a loss on business property in 2020).

Losses to tangible personal property, such as inventory or leasehold improvements, are generally limited to the adjusted tax basis of such property.  Certain intangible assets, such as product rights or licenses, can be deducted as casualty losses (if completely worthless) if businesses are permanently closed.   Additionally, there could be opportunities to claim quick refunds of corporation estimated tax payments by filing Form 4466 on or before July 15, 2020.