Taxing Lessons Case Summaries

Case — Theft Loss Deduction Based on Replacement Cost

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TL Case Summ

THE QUESTION

Can a taxpayer use estimated replacement cost to establish the amount of a theft loss deduction?

THE DISPUTE

Taxpayer Says: An appraisal from 1980 should suffice as credible substantiation of both the basis and the current market value for a theft loss deduction, and the deduction should be allowed based on the market value.

Internal Revenue Service Says: Taxpayer failed to substantiate either basis or fair market value immediately before the theft, and no deduction is allowed.

THE LAW

From Internal Revenue Code Section 165(a): Allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise.

From Internal Revenue Code Section 165(c)(3): Allows an individual taxpayer to deduct a loss from theft.

From Internal Revenue Code Section 165(h)(1) and (2): The deduction is only allowed to the extent the loss exceeds $100 and to the extent the net loss exceeds 10 percent of adjusted gross income.

From Federal Tax Regulation 1.165-7(b), 1.165-8(c): The amount allowed as a deduction is the lesser of: (1) The difference between the fair market value of the property immediately before and after the theft, and (2) the adjusted basis in the property. In the case of theft, the fair market value of the property immediately after the theft is zero.

THE CAUSE OF THE DISPUTE

To determine an amount for a theft loss deduction, you first have to establish your basis in the property stolen, as well as the property’s current fair market value.

As a general rule, your basis is what you paid for the property, plus any improvements, less any depreciation (different rules apply when calculating basis if you acquired the property by gift). Fair market value is the amount a willing buyer would pay for your property.

In this case (involving stolen jewelry), the taxpayer believes a 1980 appraisal, plus an estimate of twenty-two years of appreciation, establishes both basis and the current value of the jewelry and the current value is the amount that should be used in computing the deduction. The IRS says the taxpayer has not substantiated either the basis or the fair market value, and the theft loss deduction is denied.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 16KB)

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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.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. The current value estimated by the taxpayer is replacement cost, which is not the same as fair market value. Taxpayer failed to establish either a fair market value or a credible basis. NOTE: The Court did estimate a basis figure and allow a small theft loss deduction.
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