Tax Information: What Is Irs Section 165?

An overview of Section 165 and how it can reduce your tax liability.

One of the best means of reducing your federal tax bill is to carefully review all your deduction options. By properly accounting for your deductions, you may be able to reduce or eliminate your tax payment.

One such option is the Section 165 election, which deals with unusual losses such as fire, natural disaster, or theft.

There are three basic limitations to qualifying for this deduction:

1. Losses incurred in a trade or business.

2. Losses incurred in any transaction entered into for profit, though no necessarily connected with a trade or business.

3. In most circumstances, losses of properties that are not part of a trade or business or part of a transaction entered into for the purpose of making a profit, if such losses are due to a fire, storm, shipwreck, or like casualty, or from a theft.

Casualty basic losses are covered under this election:

Capital Losses

Certain specific losses suffered from the sale or exchange of capital assets are deductible. This includes any security that is a capital asset that becomes worthless during the tax year. For the purpose of this discussion, securities means: a share of stock in a corporation; a right to receive a share of stock in a corporation; or a bond, debenture, note or certificate, or other evidence of debt, issue by a corporation or a government agency, with interest coupons or registered form.

Personal or Business Casualty Losses

If your casualty losses outweigh your gains, you may take the difference as a deduction, provided the loss is more than $100 per incident and and a 10 percent of adjusted gross income (AGI) limit. In other words, after the first $100 is subtracted, you can only deduct the portion of the remaining loss that exceeds 10 percent of your AGI. Neither of these limits apply to casualty losses on business property. Casualty losses or gains mean the recognition of a gain or loss from an involuntary conversion of property.

There is a special rule that applies to personal casualty losses. The deduction for personal casualty losses cannot exceed the personal casualty gains.

Disaster Losses

Losses attributable to a disaster that is subsequently determined to qualify for assistance by the federal government under the Disaster Relief and Emergency Assistance Act, at the election of the taxpayer, may be deducted on the preceding year tax return or for the tax year in which the loss occurred.

Gambling Losses

You may deduct your gambling losses to the extent of your gambling winnings. For example, if you reported gambling income of $10,000, and you had documentation to substantiate $15,000 in losses, you could deduct $10,000 in losses.

Losses in Insolvent Financial Institutions

If you can reasonably estimate the loss on a qualified individual's deposit in a qualified financial institution, such as a bank, credit union, or savings and loan, due to the bankruptcy or insolvency of the institution, the taxpayer can elect to treat the amount as a loss for that tax year. Insolvency means the inability to meet debts or discharge liabilities.

There are three criteria for determining whether you are a disqualified individual: 1.) you own at least 1 percent of the outstanding stock in the institution in question; 2.) you are an officer of said financial; 3.) you are a sibling, spouse, aunt, uncle, niece, nephew, ancestor, lineal descendent, or otherwise related to someone meeting criteria 1.) or 2.).

Theft Losses

Any losses through theft are deductible in the year in which the taxpayer discovered the loss.

As always, if you think you qualify for a Section 165 deduction, consult with a professional to assure you take full advantage of your options.

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