Opinion: Tax treatment of casualty losses
April 10, 2014
Last fall a freak early snow storm killed thousands of livestock and horses in South Dakota. Ranchers suffered a tremendous monetary loss of prized livestock and horses. More recently in Kentucky, eight horses were killed in a fire, four of which were yearlings slated for the Keeneland September sale. Three of the four were uninsured.
The financial impact of casualties is significant in that it wipes out potential sales income, and sets back breeding, racing and showing efforts, not to mention the personal trauma of the tragedy.
Under Federal tax law, if you are engaged in a horse or livestock activity as a trade or business, a casualty loss is important to account for. Sometimes a major part of your breeding program can be interrupted by a casualty such as an aborted foal. When the IRS asks for an explanation of why there were several years of losses, sometimes the casualty issue needs to be clarified in detail. Sometimes if there are several casualties the IRS agent might get suspicious of insurance fraud, which requires further explanation. If there is no insurance, the amount claimed in the casualty might be substantial, and will require proof. In other cases, the IRS agent might need to be educated as to the economics of your venture and why the loss of an aborted foal, for example, can really throw a monkey wrench into your profit plans.
Another kind of setback involves illness of owners, resulting in loss of time expended in the activity due to medical treatment and recuperation. While this does not result in a casualty loss as does the death of an animal, nonetheless it impacts one's ability to carry forward business plans, and needs to be explained to the IRS if there is a history of losses.
Under the Tax Code, a casualty loss deduction is available when property is damaged, destroyed or lost due to a sudden, unexpected, or unusual event. IRS Form 4684 ("Casualties and Thefts") is submitted along with other tax forms. A sudden event is one that is swift, not gradual, such as a sudden storm, a racehorse casualty, a fire, flood, highway accident, or other misfortune.
A loss of horses or livestock in a casualty is allowed only if the animals are part of a horse or ranching business. Livestock bought for resale are deductible, for example, but casualties affecting hobby horses are not.
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The amount of the casualty loss depends mainly on the cost basis of the animals in question. To compute a loss, the IRS will look to your adjusted basis in the animals minus any insurance or other reimbursement you receive or expect to receive. Generally, if a single casualty involves multiple animals, you must compute your loss separately for each animal, and then combine the losses to determine your total loss for tax purposes.
If you receive insurance proceeds for the loss, but incurred legal expenses to collect that insurance, the legal costs are deducted from the amount of insurance reimbursement in calculating the amount to report.
Losses of horses or livestock from disease are considered involuntary conversions. This is the case if you need to sell more than the usual number of livestock because of drought. The sale of animals above the normal volume is treated as an involuntary conversion. Involuntary conversions are reported on Form 4797 along with sales and exchanges of horses or livestock.
There are complications and grey areas in determining the scope of a casualty loss or involuntary conversion, and therefore you should seek the advice of your tax professional regarding the application of these rules to insure accurate reporting on your tax return.
John Alan Cohan is a lawyer who has served the horse, farming and ranching industries since l98l. He can be reached at: (3l0) 278-0203, by e-mail at firstname.lastname@example.org, or you can see more at his website: http://www.johnalancohan.com.