HOW DO YOU ELECT TO CLAIM LOSS IN YEAR
PRECEDING “DISASTER YEAR”
After
a Disaster taxpayers may elect to claim a casualty loss on the tax return for
the “prior year”. The rules have changed!
GENERAL RULES
Internal Revenue Code §165(a) states:
There shall be
allowed as a deduction any loss sustained
during the taxable year and not
compensated for by insurance or otherwise.
This
blog post is a two part discussion of the rules for claiming a disaster loss on
a tax return for the tax year prior to the loss year. This discussion involves
several words and phrases that have exact meanings within the context of this
material. Please be careful to understand each of these words and phrases
within the context of a disaster loss. Do not interchange any of the words and
phrases that seem similar.
First
is a discussion of the rules under §1.165-11 that has been replace by a temporary regulation. Second, temporary
regulation §1.165-11T, issued in
October 2016, is discussed under the heading:
“TEMPORARY REGULATION §1.165-11T,
and REV. PROC. 2016-53”
To
understand the temporary regulation §1.165-11T
the original regulation is discussed first to demonstrate the significance of
the changes. The new regulation is slated to expire October 13, 2019. While it
would be very useful for taxpayers if the temporary regulation is made
permanent, a three year window for it creates a narrow window where it can be
used as explained in an example.
As delineated
in §165(a), taxpayers who
experience a disaster, claim the loss in the year it is “sustained.” The Internal Revenue Code permits claiming the loss on
the tax return for the year preceding the actual loss year under §165(i). When claiming it in the
preceding year, all the rules, including carryback rules, apply as if the loss claim
year is the loss event year. This election, previously under §1.165-11,
must be made on or before the later of:
(1)
the due date for filing the income
tax return (determined without regard to any extension of
time) for the taxable year in which the
disaster actually occurred, or
(2)
the due date for filing the income tax return (determined with regard to any
extension) for the taxable year immediately preceding the taxable year in which the disaster actually occurred.
(Generally,
the first rule will be the operative date limitation.)
NO EXTENSION OF TIME TO MAKE THIS DECISION – 90
DAY LIMITATION TO REVOKE ELECTION INVALIDATED BY COURT
The
Regulation, §1.165-11, is
specific regarding when the election must be made to take the deduction on the
return for the year preceding the year
of the actual loss. However, sometimes the circumstances make it difficult
to comply with the rule in time to file the return, generally by April 15 of
the year following the year of the event.
Under very
limited and restrictive conditions, it has been possible to request an
extension of time to make the election to take the loss in a prior year. (PLR’s 9752056, 9732012, 9622020, 9603023, 9603024, 9534016, 9218022, 9120002, and 9145009)
The fact patterns in most of the PLR’s are similar. The taxpayer’s accountant
made a mistake and the taxpayer wished to be given the opportunity to make the
late election. In PLR 9145009, the
IRS granted an extension of time to take the loss in the year preceding the year
of the event when the accountant failed to notify the taxpayers of the election requirements and the disaster
(freezing of crops) occurred at the end of the year, not providing
sufficient time to determine the amount of the damage to the property by the
due date of the return. Based on these facts, the Service granted an extension
of time to elect to take the disaster loss in a preceding year. While there are
a number of private letter rulings on this topic where the taxpayer was given
the opportunity to make the late election to take the loss on the return for
the year preceding the loss, they are concentrated in a seven year time period;
they do not appear to be present before or afterward.
For the 2005
Hurricane Katrina and the 2013 Colorado Floods, the IRS issued blanket
extensions to October 15th of the year following the years of the
events (October 15, 2006 and 2014, respectively) to file for the losses on the
tax returns for the respective preceding years of these events.
Regulation 1.165-11,
Election in respect of losses attributable to a disaster,
in part states, “(e) Time and manner of making election.”
ü Election to claim a
deduction for a disaster loss … must be made by filing
(1)
a return, (2) an
amended return, or (3) a claim for
refund
ü Clearly showing the
election provided by §165(h) has
been made.
ü Specify the date or
dates of the disaster,
ü The city, town,
county, and State in which the property which was damaged or destroyed was
located at the time of the disaster.
ü An election must be
made on or before the later of
(1) the
due date for filing the income tax return (determined without regard to any
extension of time granted the taxpayer for filing such return) for the taxable
year in which the disaster actually
occurred, or
(2) the
due date for filing the income tax return (determined with regard to any
extension of time granted the taxpayer for filing such return) for the taxable
year immediately preceding the taxable year in which the disaster actually
occurred.
ü Such election shall be
irrevocable after the later of … 90 days after the date on which the election
was made
ü No revocation of such
election shall be effective unless the amount of any credit or refund which
resulted from such election is paid to the Internal Revenue Service within the
revocation period.
ü In the case of a
revocation made before receipt by the taxpayer of a refund claimed pursuant to
such election, the revocation shall be effective if the refund is repaid within
30 calendar days after such receipt.
Revocking the
Election:
The IRS, in
Publication 547 (2013 Edition), asserts that taxpayers have 90 days after making
the election to revoke it. Regulation §1.165-11(e) states that the taxpayer has 90 days in which
to revoke the election. The Tax Court in MATHESON (74 TC 836, July 24, 1980 (Acq.)) ruled the regulation invalid. The Court held that the intent of the
legislation was to give taxpayers immediate help, but a comparison of the
relative tax benefits might not be possible until the time for filing their
returns for the year of the loss. If a §165(i)
election is made, it applies to the entire loss sustained by the taxpayer
(§1.165-11(d)).
The facts of
the MATHESON case are summarized below:
Petitioners
suffered a disaster loss in September, 1976. On October 28, 1976, they filed an
amended Federal income tax return for 1975 electing under §165(h) (predecessor to §165(i))
to treat the disaster loss as if it had occurred in 1975 and, thereby, claiming
itemized deductions of $29,558 attributable to that loss.
Ninety-five
days later, on January 31, 1977, petitioners filed a second amended Federal
income tax return for 1975 attempting to revoke the election made pursuant to section 165(h). The return was
accompanied by a check payable to the Internal Revenue Service in the amount of
$6,286, representing the refund of $5,986 received from the first amended
return plus $300 in estimated interest accrued on the funds received.
Petitioners
claimed a disaster loss of $29,558 in their 1976 joint Federal income tax
return.
The Tax Court
concluded:
Held,
that part of §1.165-11(e), Income
Tax Regs., which imposes a 90-day time limitation for revoking an election is
invalid because a time limitation for revoking an election which is shorter
than the time limitation for making an election under §165(h), I.R.C. 1954, as amended, effectively frustrates the
purpose of the statute.
While the IRS acquiesced to the decision, the regulation was not
withdrawn and the simple language in Pub. 547 was not modified to conform with
the court decision.
TEMPORARY REGULATION §1.165-11T
and
REV. PROC. 2016-53
In October 2016 the IRS issued 2Temporary
Regulation §1.165-11T and the
companion Rev. Proc. 2016-53. These
materials change the following:
·
the applicable dates
for claiming a disaster loss on a tax return for the preceding year,
·
the “90 day
revocation” limitation rule, and
·
most significantly, (without
discussion, clarifies) the definition of the year of the “actual loss.”
(The Code section, “165(i)(1) ELECTION TO TAKE DEDUCTION FOR
PRECEDING YEAR” refers
to:
“[A]ny loss
occurring in a disaster area and attributable to a federally declared disaster
may, at the election of the taxpayer, be taken into account for the taxable
year immediately preceding the taxable year
in which the disaster occurred.”
The temporary regulation provides for the
following:
[A]pplies to elections, revocations, and any other related actions that can be made or taken on or after October 13, 2016 and
expiring October 13, 2019.
In
the temporary rules discussed below, the Service refers to “sustained” instead of “occurred”. These temporary rules are in
effect for a specified period of, October 13, 2016 to October 13, 2019. Because
of the limited three year period for this temporary regulation there may be
confusion determining how to apply this regulation once the expiration date is
close at hand. The importance of the use of the word “sustained” is part of the discussion below.
The important
word appearing in §165(i) is “occurred,” which generally
refers to the actual loss experience, corresponding to the federal
disaster declaration incident period. In the temporary regulation “sustained” is used to effectively
replace “occurred.”
§1.165-11T(a) In general. Section 165(i) allows a taxpayer who has sustained a loss attributable to a federally declared
disaster in a taxable year to elect to deduct that disaster loss in the
preceding year.
The actual law is always a
good place to start to understand the IRS regulations.
Internal Revenue Code §165(i) DISASTER LOSSES
states:
165(i)(1)
ELECTION TO TAKE DEDUCTION FOR PRECEDING YEAR.— Notwithstanding
the provisions of subsection (a), any loss occurring in a disaster area and attributable to a federally
declared disaster may, at the election of the taxpayer, be taken into account
for the taxable year immediately preceding the taxable year in which the
disaster occurred.
165(i)(2)
YEAR OF LOSS.— If an election is made under this
subsection, the casualty resulting in the loss shall be treated for purposes
of this title as having occurred in
the taxable year for which the deduction is claimed.
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The temporary regulation takes a position
that in §1.165-11T(b) (4) defining the
term “disaster Year” for the first time. It is the year the deduction is properly claimed. This is consistent with the last
sentence of the Code section quoted above. Until now “disaster Year” was not specifically
defined.
§1.165-11T(b) (4) the disaster year
is the taxable year in which a taxpayer sustains
a loss attributable to a federally declared disaster.
The “disaster
year” is no longer defined as the year the
event "happens." The “disaster year”
is the year the claims are “settled.”
In order for a claim to be “sustained”
as required by §1.165-11T(b) (4), it must have both “occurred” and is “settled.”
§1.165-11T(c) Scope and effect of election. An election made pursuant to section 165(i) for a disaster loss
attributable to a particular disaster applies to the entire loss sustained by the taxpayer from that
disaster during the disaster year.
If the taxpayer makes a section 165(i) election with respect to a
particular disaster occurring
during the disaster year, the disaster to which the
election relates is deemed to have occurred,
and the disaster loss to which the election applies is deemed to have been sustained, in the preceding year.
Once the loss is “sustained,” that defines the “disaster year” and thus
since one part of “sustaining” is “occurred,” using the word “occurring” above is not inconsistent. It
appears that “sustained” is the
operative word not “occurred.”
Generally, “sustained” is a
combination of both “occurred” and “settled.” Without “settlement,” the loss is not “sustained.”
It does not
appear to be a casual use of the word “sustain”
in the temporary regulation instead of “occur,”
the word that was used in the regulation being replaced and §165(i). Understandably, Congress may
not have been precise while the IRS has the time to get into the details and
understand the impact of these words. The IRS is using a new term, “disaster year”, to bring in
“sustain” as the critical event. This is a welcomed clarification.
What is the
importance of the substitution? “Occurs”
is simple; it is when the event “happened,”
the fire, flood, or earthquake. To be “sustained,”
claims for compensation must be “settled.”
It must be a “closed transaction,” no longer is there any “reasonable prospect of recovery” for any additional
compensation. All claims to be “closed”
must be finalized with those who are responsible for payment, including, if
necessary, final adjudication, or actual abandonment of any remaining claim, or
closure of an applicable statute of limitation for pursuing a claim. It might
take years for the taxpayer to finalize or “settle” all the claims for compensation.
The problem
with the old regulation was its emphasis on occurred; that designated a point in time that might not correspond
with the period in which the loss was sustained.
As a result, if the loss was not a closed
transaction by the short due date
for filing the loss on the tax return for the prior year the taxpayer would be
precluded from any choice once the loss is settled
in a subsequent year.
The “actual experience
of the disaster event” is no longer tied to the year when it happens. The “disaster year” is now the year that the
loss is “sustained,” not the year
the disaster event actually created the damage. When the disaster loss is “sustained” is the year that is the
basis for determining how to compute the “preceding
year.” Once the year the disaster loss is “sustained” is determined, establishing the “disaster year,” the “year
preceding” that year is the year to
elect under §165(i) as the loss year. It is no longer necessarily a fixed
date for all taxpayers experiencing the same disaster event.
Most
taxpayers rely on IRS Pub. 547 when preparing a disaster income tax return. Taxpayers
do not read the law or the regulations. Pub. 547, understandably, is written
in language that might be less technical than the law and regulations. The
Pub. refers to “happened” and does
not discuss “sustain” or “settled.” “Occurred” does appear in the Pub., that seems to be a drafting
alternative to continuing to use “happened.”
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Example:
· The
disaster event “happens” in 2016,
the year the damage is done.
· It
is “settled,” “closed” in November 2018.
Under the
temporary regulation the year 2018 is the “disaster
year,” the year the loss is “sustained,”
the year it was “settled.” The “disaster year” is the year it is allowed
as a casualty loss deduction without regard to §165(i).
By electing
the §1.165-11T benefits, the loss deduction
is allowed to be claimed in the 2017 tax return. Under the old rule the
critical word was “occurred” and the
“preceding year” would have been 2015. Because the loss was not fully
determined (closed) and “settled” until 2018, under the old
regulation, the taxpayer would have lost the flexibility of choosing a year to
deduct the loss.
Finally, two additional
changes need to be attended to. First, how long does the taxpayer have to make
the election? Second is a change in how to revoke that election. In the above example,
the disaster year is 2018, the taxable year in which a taxpayer
sustains the loss. By definition in
the regulation, “the preceding year is the
taxable year immediately prior to the
disaster year.”
§1.165-11T(f) Due date for making election.— The due date for making the section 165(i) election is six months after the due date for filing
the taxpayer's federal income tax return for the disaster year (determined
without regard to any extension of time to file). The taxpayer could have filed
the tax return for the disaster year timely by April 15, 2018 and yet would
have until October 15, 2018 to elect to take the loss on the 2016 tax return.
Making the election
requires disclosures that are delineated in accompanying Rev. Proc. 2016-53:
.02 The election statement must contain the following
information:
(1) The
name or a description of the disaster and date or dates of the disaster which
gave rise to the loss.
(2) The
address, including the city, town, county, parish, State, and zip code, where
the damaged or destroyed property was located at the time of the disaster.
.03 For an election made on
an original federal tax return, a taxpayer must provide the information
required by section 3.02 of this revenue procedure on Lines 1 or 19 (as
applicable) of Form 4684 (Casualties and Thefts). A taxpayer filing an
original federal tax return electronically may attach a statement as a PDF
document if there is insufficient space on Lines 1 or 19 of the Form 4684 to
provide the information required by section 3.02. For an election made on an
amended federal tax return, a taxpayer may provide the information required
by section 3.02 by any reasonable means. Reasonable means include, but are
not limited to, writing the name or a description of the disaster, the State
in which the damaged or destroyed property was located at the time of the
disaster, and “ Section 165(i) Election” on
the top of the Form 4684 and providing the rest of the information required
by section 3.02 in either the Explanation of Changes in the applicable
amended Form.
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The last date for filing an
election is October 13, 2019, (the expiration of the temporary regulation §1.165-11T) and it appears that the
period for revoking the election under the new rule also expires on October 13,
2019. This is different for an election
that would have had an October 15, 2018 filing date limitation. For the October
15, 2018 election, the taxpayer has an additional 90 days to revoke the
election.
The
October 13, 2019 date presents restrictions that the latest disaster year would
be 2018 where the new regulation could be used and possibly the latest year of
a disaster actually happening might be 2017 if the taxpayer needs to make a
distinction between “occurred” and “sustained.”
Under §1.165-11T, the revocation rule is defined clearly and more liberally
in terms of the decision period that is allowed compared to the prior rule.
(g) “…
a section 165(i) election may be
revoked on or before the date that is ninety (90) days after the due date for
making the election.
These new
rules mean that the taxpayer is no longer under pressure to make an election
that involves one of the most important decisions that the taxpayer will have
to make during their recovery process. It also allows taxpayers who might have
been restricted from using the amended return option because the loss is not “sustained” in the year it occurs to now use the benefit in the
year prior to the year it is “sustained.”
We
can only hope that the temporary regulation is made permanent. Unfortunately
the IRS may not have enough time to gather statistics on tits actual use to
make a final determination prior to its expiration.
The definition of “Occur,” “settled,” and “Sustained” are based on §1.165-1 (d) Year of deduction (2). That subparagraph
also mentions “reasonable prospect of recovery.”
JOHN
TRAPANI, CPA 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.
© 2017, John Trapani,
CPA,
All rights to reproduce or quoting any part of
the entry in any other publication is reserved by the author. Republication
rights limited by the author regarding this material.
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
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Website:
www.TrapaniCPA.com
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It All Adds Up For You
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DISCLAIMER
The contents of this blog
entry represent only the understanding of the author.
Any accounting, business or
tax advice contained in this entry is of a general nature and does not have any
legal weight, it is not aa authoritative analysis of a specific issue, nor a
substitute for a formal analysis of a specific fact situation. It cannot be
considered sufficient to avoid tax-related penalties that might be assessed by
a tax authority.
If desired, John Trapani,
CPA would be pleased to perform a complete research and analysis of a
taxpayer’s situation.
This material was completed on the date of the posting
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