Why is the Cost of Repairs Method of Loss Valuation not the one to use?

Why is the Cost of Repairs Method of Loss Valuation not the one to use?

In a July 16, 2008 post, updated in February 24, 2011, the author indicated that the methodology and reasons why is should not be used. Today I want ot bring to your attention a couple of big reasons why you don’t want to use this method.
The IRS posted an inquiry to it Frequently Asked Questions that adds additional fuel to the cause agains using the “Cost of Repairs” method:
“Q. According to Treas. Reg. 1.165-7(a)(2)(ii), the cost of making repairs to restore property to its original condition can be used as a measure of the decrease in the FMV of the property. If the repairs have not yet been made but the taxpayer received an estimated cost of the repairs, can the taxpayer report the estimated cost on the taxpayer’s return.”
“A: No. 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. “
The IRS response is no doubt based on a literal reading of its own Regualtion, §1.165–7(ii), which states:
“The cost of repairs to the property damaged is acceptable as evidence of the loss of value if the taxpayer shows that
“(a) the repairs are necessary to restore the property to its condition immediately before the casualty,
“(b) the amount spent for such repairs is not excessive,
“(c) the repairs do not care for more than the damage suffered, and
“(d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty.”

The key word in the regulation as it relates to this question is the word “spent” in sub-paragraph (b). “the amount spent for such repairs is not excessive.” Because the tense of the word “spent” is in the past, it seems to imply that the requirement of using the method is that the repairs are completed and the cost is known, therefore the loss has been established.

The IRS also holds that a loss to be deducted must be “sustained.” To be sustained, it must have “occurred” and is “settled.” As an additional aspect of the IRS position on the “Cost of Repairs” method, it might also be based on the idea that the loss is not “settled” until the costs of repairs are fully determined.

Unfortunately, another sub-paragraph makes it even harder to comply with this method: “(c) the repairs do not care for more than the damage suffered,”

In almost all repair endeavors, the property is changed from the original, pre-event condition. Some of the changes are by choice, to improve condition that long existed and now can be incorporated into the renovation. Others may be required by updated building codes. In either case these changes are not part of the “cost of repairs” that qualify for the use of this method.

In some small losses that are not covered by insurance, the “cost of repairs” method may by useful. The change in the fair market value due to the loss may not be easily determined and the damages are repaired to the original condition.

Regardless of the method that is used, a full understanding of the use and its implications should be understood.