Should you consider a casualty loss provision for your business?

IRC section 165(i) is a loss provision allowing eligible taxpayers to accelerate current-year casualty and disaster losses into the immediately preceding tax year. This is basically a timing provision in which taxpayers can accelerate loss recognition and obtain the tax benefits a year earlier. The president’s national emergency declarations in March may present an opportunity for taxpayers to make a section 165(i) election in applicable situations to claim a deduction in 2019 for COVID-19-related disaster losses occurring in 2020.

Section 165(i)(1) provides that “any loss occurring in a disaster area and attributable to a federally declared disaster may, at the election of the taxpayer, be taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred.” Our research has not identified any authorities that applied section 165(i) (or its predecessor version) to losses attributable to a pandemic or widespread health problem.

For example, a restaurant having to discard food inventory due to state-mandated closures could potentially prove this type of disaster loss. On the other hand, that same restaurant selling equipment at a loss could have difficulty proving the decline in value was exclusively attributable to COVID-19.

The following are examples of losses that could arise in 2020 but be accelerated and deducted in 2019. Again, facts and circumstances will dictate and the taxpayer must establish a direct causal relationship to the national emergency.

• Inventory discarded due to government-ordered shutdown
• Permanent closure of a location(s)
• Complete abandonment of leasehold improvements.

Caution

Section 165(i) has never been used during a pandemic. Instead, it is more typically applied to casualty events, such as a hurricane, where cause and effect of the loss are more readily traceable. Application of this provision to the current pandemic is an evolving area. The Treasury Department and the IRS are looking at this and indications are that guidance will be issued in the coming weeks. Each of the loss examples described above is highly dependent upon facts and circumstances. Direct attribution to the COVID-19 pandemic must be thoroughly documented. We urge you to discuss your particular fact pattern with your Baker Tilly tax advisor if you believe you have an opportunity in this area. In addition, consider extending your return if you believe section 165(i) may be applicable.

View more insights from our guide to tax planning during and after COVID-19

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.