The Tax Cuts and Jobs Act (TCJA) suspends deductions for garden-variety casualty losses from 2018 through 2025, but still permits write-offs for losses incurred in areas designated as federal disaster areas.
In a new case involving a pre-TCJA casualty loss, Taylor, TC Memo 2019-102, 8/19/19, a taxpayer could not deduct a loss based on his property’s decline in value after a hurricane, rather than physical damage.
To qualify for a casualty loss deduction for personal property, the damage or destruction must result from a “sudden, unexpected or unusual” event. Typically, this includes damage or destruction caused by natural disasters such as hurricanes, tornadoes, fires, earthquakes or floods. Conversely, you can’t claim a loss for damage sustained due to normal wear and tear or progressive deterioration.
For personal property that is partially or completely destroyed, the amount of eligible for the casualty loss is the lesser of (1) your adjusted basis of your property, and (2) the decrease in fair market value of your property as a result of the casualty.
The adjusted basis of property is usually its cost, increased or decreased by certain events such as improvements or depreciation. In addition, the deductible loss must be reduced by any insurance or salvage reimbursements.
Finally, the tax law limits deductions to the excess of this amount above 10 percent of your adjusted gross income (AGI), after subtracting $100 per casualty event.
In the new case, the taxpayer acquired property in a swanky Houston suburb for $9.25 million in 1998. He bought it in an “as-is condition.” The property included a house, three-car garage, cabana, guardhouse and a large wine cellar where the taxpayer stored close to 7,000 bottles of wine. The taxpayer listed the property for sale at $18.5 million in 2007.
However, in 2008, the property sustained significant damage from Hurricane Ike, including tree and fence damage, broken windows and water damage inside the house. The basement wine cellar was flooded and mold formed because of the standing water. Also, the ducts and pipes in the basement, which were wrapped in asbestos, began to deteriorate.
The taxpayer spent months repairing the property and cleaning the wine bottles. After the wine was removed, the basement was remediated for asbestos and mold.
The taxpayer filed an insurance claim for the damage. A salvage agent determined that the wine was a total loss, but the taxpayer kept 21 bottles. He received about $2.39 million in insurance proceeds, including $1.57 million for the value of the wine. Eventually, he sold the property in 2014 for $12 million.
On his 2008 tax return, the taxpayer claimed a casualty loss deduction of more than $888,000, reflecting a pre-hurricane value of about $15.44 million and a post-hurricane value of $12.25 million.
After the IRS denied the casualty loss deduction, the taxpayer obtained a retrospective appraisal from a licensed real estate appraiser. The appraiser determined that the property's fair market value was almost $18.5 million before the hurricane and $11 million after it. At trial, the appraiser testified that the property was "stigmatized" as a result of the flood, due in part to the discovery of asbestos during the post-flood remediation process.
But the Tax Court wasn’t swayed. It said that the appraisal wasn’t a reliable measure of the loss because the post-hurricane valuation relied heavily on the stigmatization of the property due to the flooded basement. The Court noted that physical damage to property is required to deduct a casualty loss. A loss isn’t allowed based on a temporary decline in market value.
Furthermore, the decline in value was partly attributable to the discovery of asbestos. The asbestos was present when the taxpayer bought the property in as is condition and didn’t cause “sudden, unusual or unexpected” damage.
Finally, the court cited previous decisions where deductions were denied for supposed buyer resistance in areas damaged by floods without proof of any post-flood sales of comparable properties.
Moral of the story: As is shown by this particular case, the stakes for casualty loss deductions are often quite high. Have your clients obtain the documentation needed to support claims for write-offs.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...