APPRAISERS ARE KEY TO DISASTER LOSS
DEDUCTIONS
Often
an essential part of the recovery from a catastrophic event is determining the
amount of a deductible loss. Where adequate insurance coverage is in place the
recovery focuses on collection of proceeds based on the policy provisions. But
where insurance is not adequate or not available, the possible benefits of a
tax deduction can be an important consideration. A properly prepared appraisal
demonstrating the decrease in the value of the property resulting from the
catastrophic event becomes essential.
In
addition and integral to the appraisal process, it must be noted that the
appraiser’s work product may be examined by an IRS agent who is reviewing the
overall casualty loss deduction claimed on taxpayers’ income tax return. Most
often at that meeting the appraiser will not be in attendance; only the report
will be reviewed and the taxpayers’ representative, usually a CPA or EA will be
the person defending the casualty loss claim. As such it is important that the
tax professional be consulted before the appraisal report is issued final. It
is not the tax professional’s responsibility to impact the conclusions of the
appraiser, in fact that is the last thing that the tax professional should be a
part of. But a knowledgeable tax professional should be able to review the
appraisal report to see where the strengths and weaknesses are that will impact
an IRS review. Clarity is important and that should be the only concern of the
tax professional in any review of an appraisal.
In
the end the tax professional and the professional appraiser are working
together to assist the taxpayer report a casualty loss claim that is
sustainable as a result of an IRS review.
After
a physical catastrophic event strikes the recovery process starts immediately.
One important task is the valuation of the loss. To complete that job it is
often necessary to call on the expertise of a professional appraiser. The
significance of the appraiser’s work in these situations brings to mind certain
aspects of the appraiser that are very important and aspects of the situation
that the appraiser cannot be called on to provide expertise about. For example,
after a fire, the appraiser can provide a pre- and post- loss set of
valuations; but the appraiser should not be called on to be a forensic analyst
to determine what caused the fire.
There
are many aspects of the professional appraisal process that are the subjects of
the professional training an appraiser takes in addition to the material referred
to in this article. This article is geared to the fact that, like other
professionals that are called on in these situations, the appraiser may never have
been called on to prepare one of these reports.
When
the appraiser is called on to prepare a report of the pre- and post- loss
valuations the appraiser needs to know what the report is going to be used for.
A report for insurance or property tax assessment may be different from one
that is going to be used to support an income tax report. There are specific
aspects of an income tax casualty loss appraisal of loss that must be
understood and adhered to in order for the appraisal to have any value to the
taxpayer. Ignoring the special rules may be seen as correct by the appraiser,
but the result will be a useless report. In order for the report to be useful
to the client, the appraiser needs to know the unique rules that must be
addressed. Additionally, it is important for the appraiser to be knowledgeable
about how the appraisal report will be challenged by the IRS or will require
testimony in a tax court hearing.
This
article relies on income tax cases that taxpayers either have been successful 0or
unsuccessful in securing a tax deduction for a casualty loss deductions. Most
reports that meet the IRS requirements should be accepted without any questions,
some will need to be vetted in an IRS examination and only a few will see the
daylight of a tax case dissection. Since the results of the unquestioned tax
returns and resolved tax examinations are not available to us, we have to rely
on published court opinions and IRS rulings to understand the process used to
resolve disputed tax loss deduction claims.
The IRS does have very specific rules for what qualifies
as an appraisal for tax purposes, however, those rules are not set out in the
casualty loss sections of the Internal Revenue Code, and the rules are part of
the Code and Regulation for computing a charitable contribution of an object
other than cash. These rules are not covered in this article. The user is
referred to IRS Publication 561, “Determining
the Value of Donated Property.” On the cover of Pub 561, the IRS notes: “This
publication does not discuss how to figure the amount of your deduction for
charitable contributions or written records and substantiation required. See
Publication 526, Charitable Contributions, for this information.”
Unfortunately, the publication does not provide the specialized assistance
needed for a casualty loss valuation.
John Trapani has available a book (APPRAISER’S GUIDE TO
INCOME TAX REQUIREMENTS IN A CATASTROPHIC LOSS APPRAISAL VALUATION) that discusses the unique issues of casualty loss appraisals in detail.
The following is a list of topics contained in that book.
The
material is covered in the following topics.
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Table
of Topics
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Page
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Topic 1
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Role of Appraiser, Competence of
Appraiser
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6
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Topic 2
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Specific Notation in the Report by the
Appraiser
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7
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Topic 3
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Definition of a Qualifying Casualty
Loss Event
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9
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Topic 4
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Report Will Have Two Valuations. What
is Being Valued?
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12
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Topic 5
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Physical Damage / Identifiable Event
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17
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Topic 6
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"Sudden, Unexpected, and
Unusual"
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24
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Topic 7
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Debris Observed or Photographic
Evidence, Order to Demolish
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28
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Topic 8, 9 & 10
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The following three topics are related in many
ways, Obsolescence may be confused with “Market Stigma” or Buyer
Resistance”. For tax purposes,
they have individual issues and will be considered separately.They are split into these topics, but
should be read and understood as a single topic.
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Topic 8
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Obsolescence and Progressive
Deterioration
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30
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Topic 9
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Short-term vs. Long-term Value
Fluctuations (Buyer Resistance)
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31
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Topic 10
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Calculating the Amount of the Casualty
Loss, Post-event “Hypothetical” Costs
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42
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Topic 11
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Highest and Best Use of Property
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50
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Topic 12
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Recent Sales in the Area
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53
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Topic 13
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Real Estate Held for Personal Use
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54
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Topic 14
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Non-Personal Use Real Estate
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56
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Topic 15
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Landscaping, Trees, Shrubs
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59
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Topic 16
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“Cost of Repairs” IRS Successes in
Eliminating Credibility of Taxpayer’s Appraisal
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61
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Topic 17
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Disasters
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70
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Topic 18
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“Words Have Meanings”
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71
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CONCLUSION
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79
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EXAMPLES
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80
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The individual topics
cover cases along with IRS rulings that support the conclusions and
recommendations presented in the summary.
There
are traditional necessities of a professional appraisal that are not covered in
this article.
When
it is necessary for taxpayers to “invest” in an appraisal to determine and
support a casualty loss deduction, taxpayers and tax professionals need to have
an understanding of what the appraisal report should include. In a real estate
appraisal, the dollar amounts will likely be significant and the demands of the
Internal Revenue Service (IRS) are not necessarily known by many appraisers. As
a result the appraisers may issue a “normal appraisal” as they would for a
refinancing or sale. It turns out that all that content is necessary, but there
are specific requirements that may not be addressed but are required in order
for the IRS to consider the appraisal valid. The requirements set out in this article
are the result of reviewing and analyzing IRS publications and court cases. In
court cases judges add additional points that they found the taxpayer’s
documentation either included that swayed their conclusion or did not include
that had a negative effect on the courts’ decision process. In some cases the
court brings in a requirement that simply adds to the court’s weighing of
conflicting appraisals.
Appraisals for
disaster and “common” casualty losses are different from the normal real estate
appraisal. The qualifications of the appraiser do not change, but the report
has some unique features. There are specific qualifications of the appraiser
that courts use to weigh the reports prepared for the taxpayer and those
prepared for the IRS.
If the deduction becomes contested in an examination, the
IRS may bring in their own “expert.” There
may be a major difference between the appraisal prepared by the taxpayer’s professional
and the one prepared by the IRS professional. The IRS professional may suffer
from not being a local appraiser; that is often held against the government’s
efforts as the non-local appraiser may miss unique local conditions. The
taxpayer’s appraiser should emphasize his/her specific knowledge of the local
area.
In
the case where the IRS adds their expert into the mix, the relative weight of
the work products will often hinge on a few details that may be remotely
related to the actual appraisal. The taxpayer who has secured a quality
appraisal soon after the damage occurs seems to have an edge over the expert
that the IRS hires; the IRS expert will prepare a report two or more years
after the event, the physical aspects of the site will be different. On the
other hand, the market values of the property will have that time to mature and
may be in conflict with the assumptions in the taxpayer’s commissioned
appraisal.
Summary:
Here
is a list of critical points that are discussed in detail in the book.
The
development of casualty loss deduction rules related to appraisals and
appraisers have settled on some prerequisites including
a)
“Hypothetical”
appears a number of times in the literature and when it appears it is usually a
problem for the taxpayer. The IRS sees “hypothetical” as an
“imaginary thought exercise” and not real. In effect the presence of the word
in the report diminishes the usefulness of the report. No one believes that the
appraiser has actually examined the property immediately before or immediately
after the flood, earthquake, mudslide, fire, storm or “other casualty” event
when the debris is still ruining the “curb appeal.” Interestingly, the IRS
recognizes the physical and psychological impact of debris,
b)
“Buyer Resistance” is baked into the
regulations as an adjustment that must be made to eliminate its impact on the
diminished post-event value.
c)
The presence of
physical damage,
d)
The damages result
from "sudden,
unexpected, and unusual" actions,
e)
The appraiser must consider, as a
separate amount, the possible impact of Buyer Resistance,
f)
That the taxpayer was powerless to
prevent the loss and within reason exerted appropriate effort to minimize the
damage.
JOHN
TRAPANI, CPA assists both
taxpayers directly and
advises taxpayers’
tax professionals.
This material was
contributed by John Trapani. A Certified Public Accountant who has assisted
taxpayers since 1976, in analyzing and reporting transactions of the type
covered in this material.
© 2017, John Trapani,
CPA,
All rights to reproduce or quoting any part of
the entry in any other publication is reserved by the author. Republication
rights limited by the author regarding this material.
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JOHN TRAPANI
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Certified Public Accountant
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2975 E. Hillcrest Drive, #403
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Thousand Oaks, CA 91362
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(805) 497-4411
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It All Adds Up For You
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DISCLAIMER
The contents of this blog
entry represent only the understanding of the author.
Any accounting, business or
tax advice contained in this entry is of a general nature and does not have any
legal weight, it is not aa authoritative analysis of a specific issue, nor a
substitute for a formal analysis of a specific fact situation. It cannot be
considered sufficient to avoid tax-related penalties that might be assessed by
a tax authority.
If desired, John Trapani,
CPA would be pleased to perform a complete research and analysis of a
taxpayer’s situation.
This material was completed on the date of the posting
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