Category: Deductions & Credits Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com The amount of the deduction for a casualty loss of property used in a trade or business or used in a transaction entered into for profit is limited to the lesser of: (1) the difference between the fair market value of the property immediately before and after the casualty; or (2) the adjusted basis of the property. Regulation Section 1.165-7(b)(1). Revenue Ruling 66-9, 66-1 CB 39. I gather the property was not completely destroyed. If it had been, and the fair market value before the casualty was less than its basis, then the deduction is the whole adjusted basis. The question for you is whether your client has at least $100,000 of basis in the property exclusive of his basis in the land. If so, then the proper deduction is in fact $100,000, assuming that the diminution in value relates solely to physical damage and not to something like buyer reluctance (see below). I have no idea what your agent means when he says the loss in this case is not an economic loss. It is clear that in order to claim a casualty loss, the taxpayer must bear the burden of showing that a real economic loss has occurred. There are quite a few cases and rulings in which a purported loss under Section 165 was disallowed on the grounds that there was no actual economic loss from a closed transaction. However, these cases involve genuine questions of whether the taxpayer actually suffered economically as a result of the alleged casualty or other loss event. Many of these cases involve sham losses of one sort or another. Some of them involve paper losses in connection with securities. The courts have pointed out that the measurement mechanism of Regulation Section 1.165-7 (i.e., measuring the deductible casualty loss in terms of the diminution in fair market value) means that the casualty loss of Section 165 is based on economic loss to the taxpayer. Carloate Industries, Inc. v. U.S., 354 F2d 814, 66-1 USTC ¶9159 (CA-5, 1966). In other words, if there is a diminution in the fair market value of property owned by the taxpayer as a result of a casualty, the taxpayer has met his burden of establishing that the loss in question is an economic loss. I cannot find a case involving an obvious casualty such as an earthquake, flood, fire, hurricane, etc. in which demonstrable damage to a structure was questioned as not being an economic loss. I just do not get where the agent is coming from in this case. There is only one thing in my mind that the agent could be referring to and that is buyer reluctance or buyer stigma. I urge you to pay close attention to the appraisal the taxpayer is using. What is the source of the decline in market value? Is it clear from the appraisal report that the decline is solely based on physical damage to the structure? It is extremely difficult to get the IRS and the courts to sustain a deduction based on "damage" to the fair market value of property resulting from buyer reluctance, lender resistance to lend in the area, or the stigma associated with an area as a result of the casualty. In other words, if the diminution in value is due to buyers being reluctant to live in an earthquake zone or because of unwillingness on the part of lenders to make loans in the area because of something like seismic faults, then there is a big problem with deducting the reduction in value due to this kind of thing. Look carefully at the appraisal report before preceding. For cases and rulings against the taxpayer on this issue, see Revenue Ruling 66-242, 1966-2 CB 56; Kendall v. Comr., 17 TCM 809 (1958); Pulvers v. Comr., 48 TC 245 (1967); For cases holding for the taxpayer, see Finkbohner v. Comr., 788 F. 2d 273 (11th Cir, 1986). |
