Can a casualty loss deduction be claimed when faulty construction methods decrease property value and create unstable conditions?
Taxpayer Says: The damage to the property was sudden and unexpected, and should be allowed as a casualty loss.
Internal Revenue Service Says: The damage was the result of faulty construction methods, and does not meet the requirements to be claimed as a casualty loss.
From Internal Revenue Code Section 165(a): Deductions are allowable for losses not compensated for by insurance or otherwise.
From Internal Revenue Code Section 165(c)(3): Permits a nonbusiness casualty loss subject to the limitations of sections 165(h). Mentions losses arising from “fire, storm, shipwreck, or other casualty”.
From Internal Revenue Code Section 165(h): Sets forth dollar and percentage limitations or thresholds for claiming casualty losses. Permits an individual to deduct a casualty loss only to the extent each loss exceeds $100 and the aggregate of such casualty gains and losses exceeds 10% of adjusted gross income.
From Maher v. Commissioner, 76 T.C. 593, 596 (1981), affd. 680 F.2d 91 (11th Cir. 1982): In defining the term “other casualty” in section 165(c)(3), courts look for characteristics similar to those of a fire, storm, or shipwreck.
From Torre v. Commissioner, T.C. Memo. 2001-218, affd. 52 Fed. Appx. 965 (9th Cir. 2002): Courts have interpreted “other casualty” to require an undesigned, sudden and unexpected event, or a sudden, cataclysmic, and devastating loss.
THE CAUSE OF THE DISPUTE
When your property is damaged or destroyed by an identifiable event of a sudden, unexpected or unusual nature such as fire, car wreck or hurricane, you may be able to take a casualty deduction for the amount of your out-of-pocket loss. Vandalism, theft and damage caused by others may also qualify as casualty losses.
Disputes arise because the term “casualty” is not clearly defined in the Internal Revenue Code or income tax regulations.
In this case, a contractor caused the taxpayer’s property to lose most of its value by deviating from approved plans, removing vegetation, and negligently constructing a road. The errors created instability in the soil and resulted in denial of an occupancy permit.
The taxpayer says the damage happened over a short period of time and was not caused by gradual deterioration. In addition, the damage was unexpected because this type of damage does not usually occur during the construction on similarly situated properties.
The IRS says the damage was due to negligent construction, not a sudden unexpected event.
WHAT WOULD YOU DECIDE?
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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