APPRAISAL
VALUATION ISSUES IN A CATASTROPHIC LOSS SITUATION
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
the policy provisions, but where insurance is not adequate or 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.
This material summarizes the unique
aspects of these specialized reports compared to traditional appraisal reports.
Summary
of Requirements
Appraisals for disaster and 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.
·
The
report will have two valuations.
o
The
first valuation will be a ‘routine’ type appraisal, valuing the real estate
“just before” the loss event. This one is based on normal conditions of recent
sales. If the loss is an isolated event that only had affects on the damaged
property, subsequent sales may also be used if they provide better evidence of
the value of the specific property.
o
The
second appraisal value is the one that can be a bit tricky. The extent of the
loss will affect the way the appraiser approaches the process.
§ The easiest
case is where the property improvements have been completely destroyed.
In
this case the land remains and it is a mess with the residue of the destroyed
improvements.
§ The more
complex situation is where there is partial destruction.
How
does the appraiser evaluate the affects of the partial destruction? The
appraiser may rely on other experts. In a Tax Court case involving a medical
building damaged in an earthquake. The appraiser noted that the rents were not
affected by the damages, but based on an engineer’s report the building’s value
had been impacted to the extent of the estimated cost of repairs computed by
the engineer. The taxpayer was successful in this position.
§ A final
possibility is where the type of damage triggers significant future building
restrictions and limitations that will have substantial impact on the
property’s salability.
We
have seen this situation in Louisiana and in the East Coast Region affected by
the 2012 hurricane and subsequent storm surge. As discussed in the text, in
these instances there may be permanent decline in values due to the financial
and architectural impact of building code modifications that imposes building
elevation above an anticipated surge level that might affect these properties
in the future.
·
There
are events that may occur as a result of the loss event that will have an
effect on the property’s value in the short-run but will diminish over a
relatively short period of time. These are referred to a buyer resistance. In
some events these will be temporary, such as in earthquakes in California;
initially no one wants to live in the perceived earthquakes zone. Over time
people realize that it is one of the risks of living in California and the
values equalize. These temporary reductions in value due to buyer resistance
are the hardest impact for an appraiser to contend with in the valuation
process. In a simple situation where the improvements have been destroyed, the
appraiser might simply find comparable unimproved properties that were sold
prior to the event as a basis for the destroyed real estate. Of course it may
become complicated where the comparables include significant, valuable
vegetation such as mature old growth trees and the target property only has
burnt trees and vegetation left. In most cases the appraiser may be able to
find other comparables with and without the vegetation features.
·
In
many cases, immediately after the damaged real property has suffered the
consequences of the fire, storm or other event, there is debris that must be
removed as part of the rehabilitation process. Obviously, that debris would
affect the immediate value of the property. The IRS recognizes this as a
valuation condition. Often the appraiser arrives after the debris has been
removed or in the case of massive flooding, the walls have been stripped to the
studs to keep mold from forming, making things worse. The appraiser should be
provided photos of the property that were taken before the mess was cleaned up
in order for the appraiser to make appropriate valuation reductions. If there
have been costs incurred to remove the debris, those should be provided to the
appraiser; they are possibly indication of the impact the debris had on the
value immediately after the loss event.
·
There
is only one Tax Court case where the IRS contested a permanent decline in value
due to the event. This is usually all buyer resistance. The taxpayer won, but
the amount was fairly small. We don’t know how many cases have been won by
taxpayers where the permanent decline in value was not contested by the IRS or
a negotiated amount was agreed to by the IRS and the taxpayer. In many
instances after the 1994 Northridge Earthquake unsafe fireplace chimneys were
ordered removed. Fireplaces were not banned, only the method or replacement. In
some cases the replacements may have been architecturally less imposing but in
most instances the owner was able to still have a working fireplace. In these
cases, it is unlikely that the values were permanently impacted. In cases such
as hurricanes where the municipal governments institute significant new
requirements for repairs in areas that have experienced a storm surge, the
repair requirements may add significant costs to the repair of the property.
These costs will certainly impact what a willing buyer would pay for such a
property, both in the cost of the repair and the possible physical appearance
impact of the additional building requirements. It would appear that these
newly required building modifications that can be traced directly back to the
reactions of the authorities to the loss event create a permanent affect on the
value of the property after the event, separate from temporary buyer
resistance. At a minimum, if the owner has a reasonably solid estimate of the
cost of complying with the new requirements that could be a starting point in
the valuation impact of the requirements.
·
The
appraisal should clearly state the valuation being made before the date of the
event and the date of the event along with the values as of those dates. In the
body of the report, at an appropriate place the appraiser should make a
statement as to how buyer resistance was incorporated into the valuation of the
post event amount and how debris impacted the report.
A lot depends on how the report is
written. No tax professional should impose any specific value conclusions on
the appraiser. However, as appraisers are not normally involved in the
preparation of these specialized reports, it is not unreasonable for the tax
professional to provide appropriate guidance to the appraiser on what will be
expected for purposes of preparing a report that will not be meaningless in a
later IRS audit.
An extensive discussion of this material is available for APPRAISERS. If you send JOHN TRAPANI an email at John@TrapaniCPA.com I will email you the PDF:
Request the
APPRAISAL REQUIREMENTS
report.
This blog,
“AccountantForDisasterRecovery.com” has been addressing taxpayer income tax
issues related to catastrophic losses for five years
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
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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
 (805) 497-4411 |
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Contact us
through our website at:
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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
© 2013, John Trapani, CPA,
1 comment:
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Reference:
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FlipThyHouse.com
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