Taxing Lessons From Court Decisions

Decision – Scoping the casualty

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One exception to the rules prohibiting a deduction for non-business casualty losses for years 2018 through 2025 is when the loss occurs in a federally declared disaster area.

The IRS answers two questions about the new rules in Program Managers Tax Advice Memo 2019-08.

Here is the relevant tax law.

From section 165(a) of the internal revenue code: Provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

From section 165(c) of the internal revenue code: Provides that in the case of an individual, the deduction under subsection (a) shall be limited to–

(1) losses incurred in a trade or business;

(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and

(3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

From section 165(h) of the internal revenue code: Provides a limitation for taxable years 2018 through 2025. Provides that in the case of an individual, any personal casualty loss which (but for this paragraph) would be deductible in a taxable year beginning after December 31, 2017, and before January 1, 2026, shall be allowed as a deduction under subsection (a) only to the extent it is attributable to a Federally declared disaster (as defined in subsection (i)(5)).

From section 1.165-1(b) of the income tax regulations: Provides that to be allowable as a deduction under section 165(a), a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and, except as otherwise provided in section 165(h) and § 1.165-11, relating to disaster losses, actually sustained during the taxable year.

From section 1.165-1(d) of the income tax regulations: Provides that a loss shall be allowed as a deduction under section 165(a) only for the taxable year in which the loss is sustained. For this purpose, a loss shall be treated as sustained during the taxable year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such taxable year. Also provides that if a casualty or other event occurs which may result in a loss and, in the year of such casualty or event, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of section 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received.

Think you know the new rules? Test your skill with these two scenarios.

1

On May 1, 2017, a flood damaged a taxpayer’s house, resulting in a personal casualty loss. The flood did not constitute a federally declared disaster. The taxpayer filed an insurance claim and had a reasonable prospect of recovering the entire amount claimed.

In February 2018, the insurance company paid 70% of the amount claimed. Also in February 2018, it became reasonably certain that the taxpayer would not be able to recover the unreimbursed amount. The taxpayer did not suffer any additional personal casualty losses in 2018.

If a personal non-federally declared disaster loss occurred prior to December 31, 2017, but was not sustained until after December 31, 2017, is the loss deductible?

or

2

On September 1, 2018, a severe storm damaged a taxpayer’s house in Kansas, resulting in a personal casualty loss.

On September 7, 2018, the president issued a major disaster declaration for the state of Kansas relating to the storm. The declaration authorized the Federal Emergency Management Agency (FEMA) to provide individual assistance and public assistance. FEMA determined that five counties in Kansas were eligible for the assistance.

The taxpayer’s personal casualty loss is attributable to the federally declared disaster. The taxpayer’s house is not located in one of the counties designated as eligible for individual assistance and public assistance.

For taxable years 2018-2025, personal casualty losses are limited to losses attributable to a federally declared disaster. Must the personal casualty loss also occur in a “disaster area” to be deductible?

or

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions and IRS documents. The full documentation may include facts and issues not presented here. Please use the link provided in the post to read the entire document.

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.

***

Sorry, wrong answer :(
✓ Right answer!

No, a personal non-federally declared disaster loss that occurred prior to December 31, 2017, but was not sustained until after December 31, 2017, is not deductible. The personal non-federally declared disaster loss must have been sustained prior to December 31, 2017, to be deductible.

In the example above, while the loss occurred on May 1, 2017, the loss was not sustained on May 1, 2017, because the taxpayer had a claim for reimbursement with respect to which there was a reasonable prospect of recovery.

Rather, the loss was sustained in February 2018 when it could be ascertained with reasonable certainty whether the taxpayer would receive reimbursement.

Accordingly, because the personal casualty loss was not sustained until February 2018, the new casualty loss limitation provided in section 165(h)(5) applies, and the taxpayer may not claim a casualty loss deduction for the unreimbursed flood damage.
Sorry, wrong answer :(
✓ Right answer!

No, the personal casualty loss does not have to occur in a "disaster area" to be deductible. The personal casualty loss must occur in the state receiving the federal disaster declaration.

In the scenario above, the taxpayer suffered a personal casualty loss on September 1, 2018, when the taxpayer's house located in Kansas was damaged by a severe storm.

On September 7, 2018, the president issued a major disaster declaration for the state of Kansas. Even though the taxpayer's house is not located in one of the counties FEMA designated as eligible for individual assistance and/or public assistance, the taxpayer is not precluded from claiming a casualty loss deduction. Section 165(h)(5) does not require the loss to occur in a disaster area and be attributable to a federally declared disaster.

Rather, section 165(h)(5) only requires the loss to be attributable to a federally declared disaster. Since federally declared disasters are issued on a state-wide basis, the loss must occur in the state receiving the federal disaster declaration.

Accordingly, because the taxpayer's personal casualty loss occurred in Kansas and was attributable to the federally declared disaster in Kansas, the taxpayer is eligible to claim a casualty loss deduction so long as all other requirements under section 165 and the regulations are satisfied.
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