Taxing Lessons From Court Decisions

Decisions — Out of the ordinary

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Ordinary

When claiming a casualty loss, the difference between ordinary and extraordinary is more than five letters.

Revenue Ruling 72-592 spells out requirements for qualifying as a casualty loss under code section 165. The loss you suffer must result from some event that is (1) identifiable, (2) damaging to property, and (3) sudden, unexpected, and unusual in nature.

“Sudden” means the event is swift and precipitous and not gradual or progressive.

“Unexpected” means you did not anticipate the event and it occurred without your intent.

“Unusual” means the event is extraordinary and nonrecurring. These types of events do not commonly occur during the activity in which you were engaged when the destruction or damage occurred and one that does not commonly occur in the ordinary course of your day-to-day living.

The third requirement was the question in chief counsel memorandum 201529008. The taxpayer, a car rental company, asked whether collision damages to rental vehicles arose from a casualty in cases where the rental agency’s customers had purchased a waiver and the taxpayer could not seek recovery from the customer.

The taxpayer offered customers a collision damage waiver. Under the terms of the waiver, the taxpayer could not seek recovery from the customer or the customer’s insurer if the vehicle was damaged during the customer’s rental period.

If a customer declined the waiver and the vehicle was damaged, the taxpayer obtained a third-party estimate of the cost to repair the damage and sought recovery for the damage from the customer or the customer’s insurance company.

If one of the vehicles was damaged and the customer purchased a waiver, the taxpayer estimated the cost to repair the vehicle damage and determined, based on the estimate, whether to repair the vehicle or to sell it in damaged condition.

The taxpayer only repaired vehicles it intended to keep in its fleet. The taxpayer did not repair damage to vehicles it determined should be disposed of. If the cost to repair the vehicle was too high, the taxpayer did not generally repair the vehicle. For the years in question, the taxpayer claimed a casualty loss in the amount of its own estimate of the cost to repair the damage to these vehicles.

The IRS agreed the damages met the first two requirements of revenue ruling 72-592. At issue was whether collision damages commonly occurred during the activity in which the taxpayer was engaged and if they commonly occurred in the ordinary course of the day-to-day-living of the taxpayer.

Here’s the relevant tax law.

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

From Treasury Regulation 1.165-7(a)(1): Provides that any loss arising from fire, storm, shipwreck, or other casualty is allowable as a deduction under section 165(a) for the taxable year in which the loss is sustained.

From Treasury Regulation 1.165-7(a)(3): Discusses casualty losses for damage to automobiles. Provides, in part, that an automobile owned by the taxpayer, whether used for business purposes or maintained for recreation or pleasure, may be the subject of a casualty loss, including losses arising from fire, storm, or other casualty. In addition, a casualty loss occurs when an automobile owned by the taxpayer is damaged and if: (i) The damage results from the faulty driving of the taxpayer or other person operating the automobile but is not due to the willful act or willful negligence of the taxpayer or of one acting in the taxpayer’s behalf, or (ii) The damage results from the faulty driving of the operator of the vehicle with which the automobile of the taxpayer collides.

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Right answer!
The losses commonly occur in the ordinary course of the day-to-day business of the taxpayer.

The taxpayer operates a business in which it rents a large number of vehicles. The number of vehicles damaged, just in the subset at issue, remained relatively consistent. When considered in the context of the overall approximate annual cost to repair damage to the vehicles, it is clear accidents are not unusual and nonrecurring items and that they are an ordinary and necessary expense of engaging in the taxpayer’s line of business.

(Note: The taxpayer cannot deduct the cost of the vehicle repairs under section 162 as it did not pay or incur any costs to make the repairs for the subset of vehicles at issue.)

The amount of the overall repair costs for damaged vehicles is large. The taxpayer did not suffer unusual casualty or an abnormal loss because it is normal and expected that its vehicles will be damaged when it rents such vehicles to numerous customers to be operated over public highways.
Accordingly, we conclude the collision damages do not arise from a casualty for purposes of section 165 because they are not unusual in the context of the taxpayer’s business of renting large numbers of vehicles per year. Crashes and collisions involving the taxpayer’s vehicles are common and are neither extraordinary nor nonrecurring.

Editorial Note: This decision addresses only damaged vehicles in situations where the customer purchases a waiver, the rental agency disposes of the vehicle, and the agency claims a casualty loss.

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