“VALUING” A LOSS

WHEN A DISASTER STRIKES… BE CAREFUL… DON’T FORGET YOUR IRS REPORTING RESPONSIBILITIES

BEWARE OF THE PITFALLS

“VALUING” A LOSS

This article is part of a series of articles emphasizing several ways taxpayers can be trapped by problems in dealing with the tax reporting obligations resulting from a major casualty loss event.

Once it is determined there may be a loss, how is the loss computed? Two amounts are required for the calculation in addition to the cost basis of the asset lost or damaged. The value of the property immediately before and immediately after the loss event must be determined.

There are two acceptable methods of determining these values.

VALUATION METHODS TO DETERMINING A LOSS:

IRS regulations provide direction on the use of the two methods. Reg. §1.165–7 (a)(2) Method of valuation

The preferred method is using FAIR MARKET VALUES: (i) … the fair market value of the property … shall generally be ascertained by competent appraisal…

The alternative COST OF REPAIR has significant limitations: (ii) The cost of repairs to the property damaged is acceptable as evidence of the loss…

The appraisal method is the preferred method as described above, but the IRS often attempts to force taxpayers into the cost of repairs method.

Here is how these two methods are to be implemented.

APPRAISAL METHOD

Generally, all real estate needs to be appraised by a competent professional appraiser. There are both disclosure and methodology specifications that must be satisfied. These appraisals “look” very similar to the normal report that appraisers might prepare for a purchase or refinancing real property. However, there are additional requirements that must be met. If the appraisal was performed correctly and the additional IRS requirements are met, the IRS will have a very difficult time challenging the valuations. However, for each requirement that is ignored, the IRS gains a wedge into discrediting the report. Here is a summary of the requirements:

• Specific notation in the appraisal by appraiser:

“Appraisal is prepared for purposes of determining a possible casualty loss on a federal income tax return”

• Values before and after event must be clearly indicated.

ú  Debris observed or photographic evidence should be included and reduce post-event value.

• Competence of appraiser must be shown – A clear demonstration of qualifications including:

ú  Understanding of local market

ú  Understanding damages to property

• Physical damages must be present – (an obvious condition, but a specific requirement).

ú  Discussion of the damages must be included in the report and the appraiser must relate the damage to the applicable event. (If there was a fire and the damage appears to be the result of flooding, that would be a danger flag to the appraiser that there is problem.)

ú  If the property is not damaged physically, but is next door to a terrible physical loss that is impacting the taxpayer’s values, there is no loss.

• Short-term vs. Long-term value fluctuations

ú  Buyer resistance – temporary or long-term must be discussed in the report. Generally “buyer resistance” is a short-term condition and may not be included in the post-event valuation depreciation in value. “Buyer resistance” is the portion of the loss that the neighbor who had no physical damage realized and cannot deduct as a casualty loss. Thus, it must be eliminated from the casualty loss calculation.

ú  There is only one case that allowed “permanent buyer resistance.” That case goes back to 1986. The taxpayer was able to prove permanent buyer resistance.

• Valuation of property as a whole for personal use real estate:

ú  There are limitations regarding damages to landscaping and trees. Having a “tree appraiser” value trees alone (not as part of the whole property) that were damaged in a wind storm, for example, will not qualify for a valuation of personal use real estate.

• Methodology:

ú  Highest and best use of property – both before and after, recognizing actual limitations on possible changes in use

ú  Use of an estimate of repair costs of damages or even actual repair costs, if applicable and why they are used is acceptable in cases where it represents a reasonable method, but, must be done very carefully.

WHAT NEEDS TO BE APPRAISED?

Most household items (contents) can be based on “educated” valuations of the taxpayer. Significant items of personal property may need to have appraisals (expensive jewelry, art work and antiques). The problem with contents items is having enough information for a qualified appraiser to come to a valuation. In most cases other sources may be the best source. Retrieving credit card statements from the providers will help to some extent for large individual acquisitions made in recent years. Some vendors may have records going back further. A combination of original cost, even based on taxpayer’s recollection, photos, age and replacement cost for like-kind and quality can all be very useful for contents.

Artwork and antiques may be valued using published information in many cases for upper end valued properties.

Values of items of similar categories found in thrift stores is generally not applicable for valuing property lost or damaged in a casualty.

COST OF REPAIRS METHOD

• Fair Market Value before event is still required which requires an appraisal. In some cases where the cost basis is substantially greater that the amount of cost of repairs, the before appraisal is of lesser necessity.
• Taxpayer must Complete Repairs First

ú  If the repairs are not completed, this method cannot be used.

ú  The repairs must return the property to “pre-event status”

ú  The “after event value” may be Computed including

§  Reduction for debris removal

§  Eliminating code upgrades

§  Other improvements or betterments may not be included

• CLAIM THE LOSS ON THE TAX RETURN FOR YEAR REPAIRS ARE COMPLETED.

ú  In many cases this requirement eliminates the ability to deduct a disaster loss on the return for the prior year.

JOHN TRAPANI 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.  

© 2015, John Trapani, CPA,

All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author.

	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
	It All Adds Up For You

Tax Advice Disclaimer

Any implication of accounting, business or tax advice contained in this material is not intended as a thorough, in-depth analysis related to your specific issues. It is not a substitute for a formal opinion including a discussion or your specific situation. It is not sufficient to avoid tax-related penalties. If desired, John Trapani, CPA would be pleased to perform the requisite research, specific to your facts and circumstances and provide you with a detailed written analysis. Such an engagement would be the subject of a separate engagement letter letter that would define the scope and limits of the desired consultation services.

This material was completed on the date of the posting

A 450+ page text book is available for purchase:

DISASTER RECOVERY, Tax Benefits and Reporting Responsibilities

The book covers the tax reporting process from incident to resolution in disaster situations including descriptions of  how taxpayers can run into trouble.

An APPRAISER'S GUIDE (100 pages) is also available for purchase  to assist in evaluating appraisal reports and guiding appraisers in the tax law requirements to be addressed in an appraisal.