IRC 165 Casualty Loss, Theft Loss, and the OBBBA 2026 State-Declared Disaster Expansion: Practitioner Guide

1. Introduction: What IRC 165 Does and Why 2026 Is a Pivotal Year

IRC Section 165 is the statutory backbone for loss deductions across the tax code. It permits taxpayers to deduct losses sustained during the tax year and not compensated by insurance or otherwise, subject to a hierarchy of rules that vary by property type, taxpayer status, and the nature of the loss event. For practitioners, IRC 165 sits at the intersection of property law, insurance, and disaster response -- a three-way complexity that makes accurate planning and filing unusually consequential.

2026 is the most significant year for IRC 165 practitioner planning since the Tax Cuts and Jobs Act of 2017 (TCJA). The One Big Beautiful Budget Act (OBBBA, P.L. 119-21), signed in 2025, added a new category of deductible personal casualty loss through Section 70106: losses occurring in areas covered by a state-declared disaster, effective for tax years beginning after December 31, 2025. This is a structural change to the law, not a temporary relief measure, and it carries a novel dual-certification requirement that has no direct precedent in the existing federally declared disaster framework.

Practitioners advising clients who experienced property losses in 2026 must now assess two parallel eligibility tracks: the pre-existing federal disaster track and the new state disaster track. The IRC 165(h) floors and AGI thresholds remain in place for both. Implementation details for the state-disaster track are pending formal IRS guidance; verify all requirements at IRS.gov before advising clients on 2026 returns.

2. IRC 165(a)-(c) Framework: The Deductibility Hierarchy

IRC 165(a) states the general rule: a deduction is allowed for any loss sustained during the tax year and not compensated by insurance or otherwise. But 165(a) alone is not a grant of deductibility for individuals; it is filtered through the limitations in IRC 165(b) and 165(c).

The IRC 165(c) Three-Category Structure

For individuals, IRC 165(c) limits deductible losses to three categories:

IRC 165(c)(1): Losses Incurred in a Trade or Business

Losses attributable to trade or business property are deductible without a disaster-area restriction. There is no federal or state disaster declaration requirement, no per-casualty floor, and no AGI threshold for these losses. The loss amount is generally the lesser of the adjusted basis in the property or the decline in fair market value, reduced by any insurance proceeds received. For total destruction, the adjusted basis is the ceiling.

IRC 165(c)(2): Losses Incurred in a Transaction Entered Into for Profit

Losses on income-producing property (rental property, investment property, and similar assets not held in a trade or business) are deductible under 165(c)(2). Like 165(c)(1) losses, the 165(c)(2) category carries no disaster-declaration requirement. The $100 per-casualty floor and 10%-of-AGI threshold in 165(h) do not apply to 165(c)(2) losses -- those limitations are expressly keyed to personal-use property.

IRC 165(c)(3): Personal Casualty Losses

Losses of personal-use property arising from fire, storm, shipwreck, theft, or other sudden, unexpected, or unusual event fall under IRC 165(c)(3). This is the most restricted category. TCJA 2017 overlaid a federal disaster-declaration gate, and OBBBA 2026 added a parallel state-disaster gate. The IRC 165(h) limitations apply in full.

IRC 165(b): Amount of Loss

The deductible amount is the adjusted basis of the property, subject to limitations. For personal-use property, the deduction is limited to the lesser of the adjusted basis or the decrease in fair market value attributable to the casualty, reduced by insurance reimbursement. For totally destroyed property, basis is the ceiling and no fair-market-value comparison is required. Appraisals are the standard method for establishing fair market value before and after the casualty; practitioners should obtain and retain qualified appraisals for all significant claims.

3. Pre-OBBBA Personal Casualty Loss Rules (TCJA 2017)

The Tax Cuts and Jobs Act of 2017 fundamentally restricted personal casualty loss deductions for tax years 2018 through 2025. Understanding the TCJA baseline is essential for advising clients whose losses span multiple years or who are considering amended returns.

The Federal Disaster-Declaration Requirement

Under TCJA, personal casualty losses under IRC 165(c)(3) are deductible only if the loss occurs in an area designated as a federally declared disaster area by the President under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Losses from fires, floods, storms, or other casualties outside a federally declared area are not deductible as personal casualty losses under TCJA rules, even if the casualty is sudden and devastating. This rule applied for 2018 through 2025 returns (verify applicability at IRS.gov).

IRC 165(h)(1): The Per-Casualty Floor

Each casualty loss is reduced by $100 per event before any other limitation applies (verify the current statutory amount at IRS.gov). This floor applies per casualty, not per asset. A single storm that damages a car and a home is one casualty; a subsequent earthquake is a separate casualty with its own $100 reduction.

IRC 165(h)(2): The 10%-of-AGI Threshold

After applying the per-casualty floor, net personal casualty losses are deductible only to the extent they exceed 10% of the taxpayer's adjusted gross income. This is not a flat deduction of 10% -- it is a threshold below which no deduction is available. A taxpayer with $120,000 AGI and $14,000 of net casualty losses (after the $100 floor) can deduct only $2,000 (the excess over $12,000, which is 10% of AGI). Verify the current threshold calculation method at IRS.gov.

Form 4684: The Computational Vehicle

Personal casualty losses are computed on Form 4684 (Casualties and Thefts), Section A. Practitioners must identify each casualty event by date and type, establish fair market value before and after, determine the adjusted basis, reduce for insurance reimbursements, apply the $100 per-event floor, and then aggregate for the 10%-of-AGI threshold. The net deductible loss transfers to Schedule A as an itemized deduction. Taxpayers who do not itemize receive no benefit from personal casualty losses. Verify form instructions at IRS.gov.

4. OBBBA 2026 Expansion: Section 70106 and the State-Declared Disaster Category

OBBBA Section 70106 (P.L. 119-21) is the most significant amendment to the IRC 165 personal casualty loss framework since TCJA. Effective for tax years beginning after December 31, 2025, it adds a second eligible category of personal casualty loss: losses occurring in areas covered by a state-declared disaster that meets the statutory dual-certification criteria.

The Dual-Certification Requirement

For a state-declared disaster to qualify under the OBBBA expansion (verify at IRS.gov), two certifications must be present:

• Governor's declaration: The governor of the affected state must issue a formal disaster declaration for the area in which the property is located.
• Secretary of Treasury certification: The Secretary of the Treasury (or a delegate) must separately certify that the disaster meets the criteria specified in OBBBA Section 70106. The statute creates this certification role without specifying the form or timing of the certification, leaving those mechanics to IRS guidance.

Both certifications are required. A governor's declaration alone does not qualify a loss under the OBBBA expansion. Practitioners should document both certifications for each client's file and monitor IRS.gov and the Federal Register for guidance specifying the Treasury certification process.

Interaction with TCJA Limits

The OBBBA state-disaster expansion does not eliminate or modify the IRC 165(h) limitations. The $100 per-casualty floor under IRC 165(h)(1) and the 10%-of-AGI threshold under IRC 165(h)(2) remain in place for state-declared disaster losses, exactly as they apply to federally declared disaster losses. The OBBBA change is a gate-removal on the eligibility requirement, not a relaxation of the computational limits.

What Qualifies as a Qualifying Loss Under the OBBBA Expansion

The underlying loss must still satisfy the IRC 165(c)(3) casualty definition: a loss to personal-use property arising from a fire, storm, shipwreck, theft, or other sudden, unexpected, or unusual event. The OBBBA expansion does not broaden the definition of what constitutes a casualty. A loss that would not qualify as a casualty loss under 165(c)(3) under the pre-OBBBA rules (for example, a loss from a slow geological process or progressive deterioration) does not become deductible simply because a governor has declared a disaster. Verify qualifying event criteria at IRS.gov.

Practical 2026 Filing Implications

• Identify all clients who sustained property losses in 2026 and assess whether those losses occurred in areas subject to either a federal or a state disaster declaration.
• For state-declared disaster areas, verify whether the Treasury certification has been issued and document that verification in the client file.
• Compute the loss on Form 4684 Section A, applying the $100 floor and 10%-of-AGI threshold, regardless of whether the qualifying declaration is federal or state.
• Evaluate whether the client will itemize. If not, the casualty loss deduction produces no tax benefit on the current-year return, but the IRC 165(i) lookback election may apply to a prior year.
• Monitor IRS guidance actively. The Treasury certification process, any IRS list of qualifying state declarations, and potential safe harbors are all open items as of July 2026.

5. IRC 165(i) Lookback Election: Accelerating the Deduction

IRC 165(i) gives taxpayers who sustain a loss in a federally declared disaster area the option to elect to treat the loss as having occurred in the immediately preceding tax year. This lookback election is made by filing (or amending) the prior year's return and claiming the casualty loss deduction there, rather than waiting for the current-year return.

How the Election Works

The taxpayer makes the election on a timely filed original return for the preceding year or on an amended return filed no later than six months after the due date of the current-year return (without extensions), subject to IRC 6511 refund claim limitations. Once made, the election is irrevocable for the specific loss. Practitioners must weigh the prior-year tax rate against the current-year rate, the prior-year itemization status, and the prior-year AGI for the 10%-of-AGI threshold calculation.

2026 Planning Value

The OBBBA expansion makes the IRC 165(i) lookback planning analysis more complex and more valuable. If the state-declared disaster expansion is available for 2026 losses, practitioners must determine whether IRC 165(i) also extends to state-declared disaster losses -- or whether the lookback remains limited to federally declared disasters. This is an open statutory interpretation question pending IRS guidance. Verify the scope of IRC 165(i) under the OBBBA at IRS.gov before advising clients to file amended 2025 returns for 2026 state-disaster losses.

Even where IRC 165(i) is clearly available (federal disaster), 2026 presents particular planning value because the OBBBA may affect marginal rates and standard deduction amounts in ways that make the prior year (2025) a more favorable year for the deduction. Run a comparative tax calculation for both years before recommending the election.

Interaction with Amended Returns

An IRC 165(i) election for a 2026 loss on a 2025 amended return must comply with the general amended-return procedures under IRC 6511 and applicable regulations. The six-month extended deadline runs from the due date (without extensions) of the 2026 return, which for calendar-year individual taxpayers is April 15, 2027 (verify the applicable deadline at IRS.gov). Ensure that the amended return is clearly labeled as an IRC 165(i) election return.

6. Theft Loss Rules Under IRC 165(e)

IRC 165(e) provides a specialized rule for theft losses: the loss is treated as sustained in the tax year in which the taxpayer discovers the theft, not the year in which the theft actually occurred. This discovery-year rule is a departure from the general rule that losses are deducted in the year sustained.

Defining Theft Under IRC 165

The IRS and courts construe "theft" broadly to include larceny, embezzlement, robbery, extortion, blackmail, and other acts involving the taking of property with criminal intent. The taxpayer must be able to demonstrate that a theft occurred under state law. Verify the definition applicable in the client's jurisdiction; not every financial loss involving another party qualifies as theft for federal tax purposes.

TCJA Impact on Personal Theft Losses

Under TCJA, personal-use theft losses are deductible only if they occur in a federally declared disaster area. In practice, this makes most personal theft losses nondeductible for 2018-2025 returns. Business and investment theft losses retain full deductibility without a disaster requirement. Whether the OBBBA 2026 state-disaster expansion extends to personal theft losses occurring in state-declared disaster areas is an open question; the text of Section 70106 addresses casualty losses broadly, but practitioners should confirm applicability of the OBBBA expansion to theft losses at IRS.gov before claiming a deduction on that basis.

Ponzi Scheme Losses: Rev. Proc. 2009-20

Rev. Proc. 2009-20 provides a theft-loss safe harbor for investors in fraudulent investment arrangements (Ponzi schemes). A "qualified investor" who suffers a loss in a "qualified investment" can elect to deduct a specified percentage (generally 95% for taxpayers without potential third-party recovery claims, or 75% for taxpayers with such claims -- verify current percentages at IRS.gov) of the qualified investment in the year of discovery. Because Ponzi losses are investment losses rather than personal-use losses, they are classified under IRC 165(c)(2) and are not subject to the TCJA personal-use disaster restriction or the IRC 165(h) limitations. Practitioners with clients who suffered investment losses in fraudulent schemes should evaluate Rev. Proc. 2009-20 carefully and document the scheme's criminal referral or conviction status.

7. Business vs. Personal Property: Different Rules, Different Forms

The distinction between business/income-producing property and personal-use property determines not only the applicable deduction rules but also the tax form on which the loss is reported. Mixing these categories is one of the most common errors in casualty loss reporting.

Business Property (IRC 165(c)(1))

Losses on property held in a trade or business are computed on Form 4684, Section B. The net loss from Section B flows to Form 4797 (Sales of Business Property) for property subject to depreciation recapture, or directly to Schedule C, E, or F for assets not subject to Form 4797 treatment. No disaster declaration is required, no per-casualty floor applies, and no AGI threshold limits the deduction. However, insurance reimbursements reduce the deductible loss, and any gain from insurance proceeds in excess of basis is recognized and may be eligible for deferral under IRC 1033 (see the IRC 1033 Involuntary Conversion guide linked below).

Income-Producing Property (IRC 165(c)(2))

Rental property and other income-producing property not held in a trade or business is also reported on Form 4684 Section B. The loss flows from Section B to Schedule E for rental property or Schedule D for investment property, depending on the nature of the asset. No disaster requirement applies. The interaction with passive activity loss rules under IRC 469 is critical: a rental property loss that is already suspended under the passive activity rules adds complexity to the casualty loss computation (see the IRC 469 guide linked below).

Personal-Use Property (IRC 165(c)(3))

Personal-use property losses are reported on Form 4684 Section A. Section A calculates the deductible loss after applying the $100 per-event floor and produces a net amount that is carried to Schedule A, line 15 (or the applicable line on the current form -- verify at IRS.gov). The 10%-of-AGI threshold is applied on Schedule A. Only taxpayers who itemize receive a tax benefit.

Mixed-Use Property

A home office, vacation rental, or other property used partly for business and partly personally requires the casualty loss to be allocated between the business and personal portions. The business portion is deducted under IRC 165(c)(1) with no disaster restriction; the personal portion is subject to all IRC 165(h) limitations. Practitioners must use a reasonable and consistent allocation method and document it in the client file.

8. Quick-Reference Table: IRC 165 Loss Type Matrix

The table below summarizes the key rules by loss type. Verify all statutory thresholds, forms, and disaster requirements at IRS.gov; the OBBBA columns reflect law as enacted in P.L. 119-21 and are subject to forthcoming IRS guidance.

All figures and requirements should be verified at IRS.gov. OBBBA columns reflect enacted law (P.L. 119-21) and are subject to IRS implementation guidance.

9. Frequently Asked Questions

• What is a casualty loss under IRC 165 and who can deduct it?

  A casualty loss under IRC 165 is a loss arising from fire, storm, shipwreck, theft, or another sudden, unexpected, or unusual event. Deductibility depends on the property category: trade or business property (IRC 165(c)(1)), income-producing property (IRC 165(c)(2)), or personal-use property (IRC 165(c)(3)). Business and income-producing losses carry no disaster-declaration requirement. Personal-use losses face the TCJA federal disaster restriction plus the IRC 165(h) per-event floor and AGI threshold. Always verify current rules at IRS.gov.

• What did OBBBA Section 70106 change for personal casualty losses in 2026?

  OBBBA Section 70106 (P.L. 119-21) added a new deductible category: personal casualty losses in state-declared disaster areas, effective for tax years beginning after December 31, 2025. Under prior TCJA rules, only federally declared disasters qualified. The OBBBA expansion requires dual certification -- a governor's declaration and a separate Treasury Secretary certification. Implementation details are pending IRS guidance; verify all requirements at IRS.gov before advising clients.

• What is the dual-certification requirement under OBBBA Section 70106?

  For a state-declared disaster to qualify under the OBBBA expansion, two certifications must be present: (1) a formal disaster declaration by the governor of the affected state, and (2) a certification by the Secretary of the Treasury (or delegate) confirming the disaster meets the statutory criteria. Until the IRS issues guidance specifying the Treasury certification process, practitioners should treat this requirement as pending. Document the governor's declaration date and monitor IRS.gov and the Federal Register for Treasury certification notices.

• How does the IRC 165(h) floor and threshold apply to personal casualty losses?

  Under IRC 165(h), two reductions apply to personal casualty losses. First, the per-casualty floor under IRC 165(h)(1) reduces each casualty event by $100 (verify the current amount at IRS.gov). Second, the AGI threshold under IRC 165(h)(2) allows only the portion of net casualty losses exceeding 10% of adjusted gross income. Both limitations apply to OBBBA state-declared disaster losses -- the expansion removes the eligibility gate but does not eliminate these thresholds. Verify the calculation method at IRS.gov.

• What is the IRC 165(i) lookback election and when should practitioners use it?

  IRC 165(i) allows a taxpayer who sustains a casualty loss in a presidentially declared disaster area to elect to treat the loss as occurring in the preceding tax year, deducting it on an amended prior-year return. This accelerates the cash-flow benefit and may produce a larger deduction if the prior year had lower AGI or a higher marginal rate. Whether IRC 165(i) extends to OBBBA state-declared disaster losses is an open question pending IRS guidance. Verify the scope of IRC 165(i) under the OBBBA at IRS.gov before filing amended 2025 returns for 2026 state-disaster losses.

• How are theft losses deducted under IRC 165 after TCJA?

  IRC 165(e) allows theft losses in the year the theft is discovered. For personal-use property, TCJA suspended the theft loss deduction except for federally declared disaster theft losses -- a narrow category. Business and investment theft losses remain fully deductible without a disaster requirement. Ponzi scheme losses are treated as theft losses in the year of discovery, with a safe-harbor deduction percentage available to qualified investors under Rev. Proc. 2009-20. Verify the current status of all theft-loss rules at IRS.gov.

• What is the difference between Form 4684 and Schedule C for casualty losses?

  Form 4684 (Casualties and Thefts) is the primary vehicle for computing both personal and business casualty losses. Section A covers personal-use property; losses transfer to Schedule A as an itemized deduction. Section B covers business and income-producing property; losses transfer to Form 4797 for depreciation-recapture property or directly to Schedule C, E, or F depending on the asset type and entity. Schedule C does not replace Form 4684 -- it receives the net loss after Form 4684 Section B computations are complete. Verify form instructions at IRS.gov.

• Can a taxpayer deduct both a state-declared and a federally declared disaster loss in the same 2026 tax year?

  If a taxpayer sustains losses from two separate events in 2026 -- one in a federally declared disaster area and one in a qualifying OBBBA state-declared disaster area -- each event is analyzed separately. The $100 per-event floor under IRC 165(h)(1) applies per casualty. The 10%-of-AGI threshold under IRC 165(h)(2) applies to net losses in aggregate. Report each event separately on Form 4684 Section A, identify the applicable declaration for each event, and aggregate the results for the Schedule A deduction. Verify the multi-event calculation method and OBBBA coordination rules at IRS.gov.

10. Related Practitioner Guides

Casualty and disaster loss planning frequently intersects with involuntary conversion elections, passive activity loss limitations, and depreciation recapture. The guides below address those adjacent issues in depth.

• IRC 1033: Involuntary Conversion and Replacement Period -- How insurance proceeds and condemnation awards can be deferred through a replacement property election, coordinating directly with casualty loss computations.
• IRC 469: Passive Activity Loss Rules -- How suspended passive losses interact with rental property casualty losses and the real estate professional election.
• IRC 183: Hobby Loss Rules -- Understanding at-risk and profit-motive requirements that can affect loss deductibility for income-producing property.
• IRC 263A: UNICAP Uniform Capitalization Rules -- Capitalization versus expensing decisions that affect the adjusted basis used to compute casualty loss amounts.
• IRC 1245/1250: Depreciation Recapture and Form 4797 -- How depreciation taken on business property affects the casualty loss amount and the recapture rules triggered when insurance proceeds exceed adjusted basis.