Loss Valuation - Cost of Repairs
Method
Revised February
24, 2011, December 2012 and Jauary 18, 2013:
Author’s note, This post continues to be the most popular post on this blog. When you read this post, also read the January 2013 post:
"LOSS VALUATION - COST
OF REPAIRS METHOD FAQs"
February
24, 2011: A number of viewers look at this entry, but few viewers look at a
prior entry June 18, 2008, related entry “Figuring the
Loss – Market Value Method.” Both should be reviewed. In fact the author
generally believes that the “Market Value Method”
is the preferred method. The preference is discussed in the June 18, 2008
entry.
The prior blog entry (Figuring the Loss – Market
Value Method.) describes the manner of claiming a casualty loss
using the market value method or Appraisal Method, requiring appraisals. There
is an acceptable alternative, but it has certain pitfalls.
Instead of using an appraisal to compute the “economic loss” portion of the
Form 4684, you can use the “Cost of Repairs” to compute the amount of the
deductible loss. You are still limited to your cost basis for the asset lost,
even if the cost of repairs exceeds your cost basis. As with the market value
approach, if you decide to use the cost of repairs method, first, you must
deduct any insurance recoveries for the loss from the both your cost basis of
the asset lost and the computed total loss to determine if there is any
deductible loss.
In fact, the
IRS points out that it is not the estimated cost of repairs method, it is the
cost of repairs method At:
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/FAQs-for-Disaster-Victims-Casualty-Loss-%28Valuations-and-Sections-165-%28i%29%29
“FAQs [Frequently Asked Questions] for
Disaster Victims - Casualty Loss (Valuations and Sections 165 (i)),”
(6/1/07) Q: A number of concerns have been raised by
taxpayers and tax professionals about casualty loss valuations. While the IRS
continues to research and develop specific answers to these issues, general
guidance follows below.
the following
response is noted: (12/15/09)
A: “…To be able
to use the cost of repairs method to determine the decrease in FMV of a
property, the repairs must have been made by the due date of the tax return.
If the repairs have not been made, the taxpayer should file the return
without reporting the casualty loss information. After the repairs
have been made, the taxpayer may file an amended return.” (Underlining
added by author)
Because of the
IRS position that the repair costs are not actually incurred, taxpayers must
limit the deduction to the actual costs incurred if this method is used. An
example of using this method follows:
Cost
basis $100,000
Insurance
recovery $ 95,000
Cost
of repairs $120,000
Because the
cost basis is less than the cost of repairs, the limit of deductibility is the
cost basis of $100,000. Once you deduct the insurance recovery of $95,000, the
deductible loss subject to other adjustments, is limited to only $5,000. In
another example, the following facts are assumed:
Cost
basis $150,000
Insurance
recovery $ -0-
Cost
of repairs $120,000
Without the insurance recovery and a cost basis in excess of the costs of repair,
the deduction before other adjustments in this example is $120,000.
If a further
assumption related to the above example is made that there was no insurance
recovery and the homeowners did some of the repair work themselves, in order to
save money, or decided against doing some of the repairs, there are additional
reductions. If the homeowner actually only spent $85,000 to repair the damage,
the IRS would adjust this loss down by $35,000: the difference between the cost
using a contractor of $120,000 and the $85,000 that people actually spent.
The cost of
repairs cannot include betterments or additions that were not part of the
original asset that was damaged or lost.
Costs incurred
are added to the cost basis of the asset lost regardless of those cost being
repairs or betterments or additions.
Additionally,
if the taxpayer decides to replace the property with another property and not
repair the property, then the “Cost of Repairs Method” would not be used.
The two
methods, “Cost of Repairs Method” and “Appraisal Method” will not likely result
in the same economic loss amount. That is not a problem.
While the
“Cost of Repairs Method” appears easier to apply, the restrictions place
another type of burden on the asset owner that will most likely make it
inappropriate for many major catastrophic loss situations.
All rights to
reproduce or quote any part of the chapter in any other publication are
reserved by the author. Republication rights limited by the publisher of the
book in which this chapter appears also apply.
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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 E-mail John@TrapaniCPA.com
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Blog:
www.AccountantForDisasteRrecovery.com
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It All Adds Up For You
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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.
Internal Revenue Service Circular 230 Disclosure
This is a general discussion of tax law. The application of
the law to specific facts may involve aspects that are not identical to the
situations presented in this material. Relying on this material does not
qualify as tax advice for purpose of mounting a defense of a tax position with
the taxing authorities
The analysis of the tax consequences of any event is based
on tax laws in effect at the time of the event.
This material was completed on the date of the posting
© 2008, 2011 & 2012, John Trapani, CPA,
