I just finished explaining to a potential client how a Form 4684, Casualties and Thefts worked and the information I would need from her to fill it out. After she left, I felt as if I had explained playing the children's game Chutes and Ladders.
The game, targeted at the very young player in all of us, goes by the different names but the game is the same. The players move there playing piece along the rows of tiles that zig zag from the bottom to the top of the board. At various points there are ladders and chutes on the tiles. Land on a tile with a ladder and you get to climb the ladder and skip tiles. But land on a chute tile and you go down and re-do tiles.
With Form 4684, you follow the form along. Occasionally you get a short ladder but at any time you can hit a long chute that takes you out of the game or worse. Lets assume a flood takes your home and contents. You start by figuring the basis in the property and the difference in Fair Market Value (FMV) before and after the incident. Then you take the lessor of the basis or FMV. Was there insurance on the house. If you got less insurance that what you have in the house you get a short ladder to the next step. If you received more insurance than you had in the house, BIG chute off to the 1040 by way of the Schedule D. While you have to finish the form, the extra money you received is taxable. At this stage of the game, you have what is left of your basis/FMV after insurance. Now take $100 off. (IRS deductible.) Then take 10% of you Adjusted Gross Income off. Is there anything left? If not, a chute will take you out of the form. If there is still a loss, you land on a ladder to the Schedule A. Can you itemize without the casualty loss? If yes, a ladder will take you a lower tax and the win. If you generally can't itemize, you will have to gather your state and local taxes, mortgage interest, charitable contributions and other itemize deductions and add them what you carried from Form 4684. Does that total more than your standard deduction? If not, you have hit a big chute that will take you out to the 1040(1040A) past all the time and energy your have wasted for no tax benefit. If you itemized deductions are more than your standard deduction you get a ladder to climb to lower tax. Of course, the benefit won't be as great as you envisioned but at least a chute didn't slide you out of the game.
This is a very simplified version of the 4684 Chutes and Ladders Game. Add several items going in the flood or add another casualty and the chutes and ladders pop up even more. And the business version has a different set of rules. Form 4684 is not the only example of Chutes and Ladders taxes but it is a great example. Taxpayers are targeted with everyone telling them they can "deduct a casualty or theft loss", "deduct mortgage interest", "claim a dependent", etc. But the reality is first they have to play the game and get pass the chutes.
A reader should seek advice from an independent tax adviser with respect to the information on this blog based on the reader’s particular circumstances. This advice is intended to be general information and cannot be used for the purpose of avoiding penalties that may be imposed by the IRS regarding the transaction or matters discussed here.