MUDSLIDE
– IS THIS A CASUALTY LOSS?
When is a mudslide a casualty, and if it is a casualty, then how is the casualty loss computed?
We
have to start with the general rules for a personal casualty loss. Did the loss
arise from a “fire, storm, shipwreck, or other casualty?” If it falls within an
“other casualty” category, does it qualify? To qualify it must be the result of
an action that is “sudden, unexpected or unusual.” Meeting all three is good,
but apparently only one is necessary. The IRS made an argument in a 1988 Tax
Court case Tax Court Memoranda Decision, (Radding 55 T.C.M. 1029,
T.C. Memo. 1988-250, (Jun. 7, 1988)). In that case another principle was
interjected into the mix by the IRS. The IRS argued the concept of
“foreseeability.” The IRS argued that if the loss is foreseeable, maybe it
should be barred from being a casualty as it is not sudden, unexpected or
unusual. The Court responded that in that case damage from events such as
hurricanes or earthquakes would be barred as they are certainly foreseeable in
specific areas of the country.
In the Radding case the taxpayers experienced
four mudslides, one each in 1977, 1978, 1982 and 1983. The Tax Court was only
addressing the last two events. The taxpayers sued the developer and included
in their causes of action were two allegations that apparently were the impetus
for the IRS to argue the concept of foreseeability:
“2. A
foreseeable amount of rain would cause the hillside to crack, slide and
collapse.”
“3. A
foreseeable amount of rain would cause substantive quantities of water and dirt
to slide down the hillside and to Cross-Complainants' home.”
The Court rejected
the IRS argument.
The
computation of the loss involves determining the physical aspects of the loss
and then the manner of determining the amount of the loss. Two ways are
permitted by the Internal Revenue Code to determine the amount of a loss. The
usual method that is preferred is called the Appraisal Method. The Appraisal
Method requires two appraisals, generally embodied in one report prepared by a
competent appraiser. The two appraisals are geared to determining the decrease
in value as a result of the event. The Court also made an important point in
differentiating the change in values before and after the event:
"This appraisal must recognize the effects of any general
market decline affecting undamaged as well as damaged property which may occur
simultaneously with the casualty, in order that any deduction under this
section shall be limited to the actual loss resulting from damage to the
property.”
But the
Court was concerned with the valuations as seen from the following taken from
the decision:
Appraisal dated March 31, 1982 (Third mudslide)
Fair market value of residence, without adjustment due to slides
in the year of appraisal, i.e., 1982, was
|
$615,000
|
The net value of residence after adjustment for slides is
|
$565,000
|
Diminution in value due to 1982 slides of
|
$50,000
|
Appraisal dated August 15, 1983 (Last mudslide)
Fair market value of the residence on that date, without
adjustments for slides in 1983
|
$628,000
|
Value after the 1983 slides
|
$563,000
|
diminution in value for 1983
|
$65,000
|
The Court noted:
“ [H]ad the 1983 slides not occurred, the fair market value of
petitioners' residence would have increased from $565,000 on March 31, 1982, to
$628,000 on August 15, 1983. This represents an increase in value of $63,000
(or approximately 10 percent) in only 161/2 months. Furthermore, the house would
have increased in value from $200,000 (the purchase price in 1977) to $628,000
in 6 years despite alleged “permanent diminutions” in value due to the 1977,
1979, and 1982 slides.”
As
you can guess, the Court was troubled by the outcome of the appraisal process.
Again, we note the Court’s findings as to the diminution in value:
“With regard to the 1983 mudslide, the insurance recovery in 1984
was directly connected to losses claimed for the fourth slide which occurred in
1983…”
No loss was
allowed for the fourth mudslide. But the loss for the third mudslide was
allowed.
Many
mudslides are not serial in nature as the ones in the Radding case. The taxpayers did document their losses properly in
the Radding case, unfortunately, the
conclusions of the appraisals fork against the taxpayers in this situation.
But, yes mudslides can be a casualty, but the circumstances and individual
facts will have an impact on the manner in which it can be deducted on a tax
return.
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
October 2011.
© 2011, John Trapani, CPA,
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.
JOHN TRAPANI
Certified
Public Accountant
2975
E. Hillcrest Drive #403
Thousand
Oaks, CA 91362
(805)
497-4411 E-mail John@TrapaniCPA.com
Website:
www.TrapaniCPA.com
Blog:
www.AccountantForDisasteRrecovery.com
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