You can claim the out-of-pocket expenses you incurred to restore the property. If you were partially reimbursed by the insurance company, you subtract the amount of reimbursement from the expenses paid. When you are renting a property, repairs (modifications required due to deterioration or, in this case, vandalism, but which restore the property to essentially the original condition) are fully deductible (minus tax-free reimbursements). Improvements (that is to say, a modification that increases the value of the property, such as an addition or a room remodel), must be capitalized and depreciated.
Since repair work related to vandalism restores the property to its original condition, and does not increase the property value, you may claim the expenses above what the insurance covered as repairs expenses on Schedule E.
You can use this treatment because rental income is a form of business income, and casualties can be directly deducted from business income. If it was purely personal loss, you would be limited to the treatment described above.
You do not get any deduction for loss of property value, however. Loss of property value works itself out at the time the rental property is eventually sold. The loss of value will result in a reduced price of sale, reducing the amount of gain you will end up reporting on the sale. While capital loss on the sale of a primary home is not deductible, capital loss on a rental home can be deductible if the rental home is not being treated as a primary residence for tax purposes. Usually, however, rental homes sales create gain because depreciation taken or allowable is factored into your original basis, lowering that basis and usually creating a gain as a result.
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