Part 2: Calculating
A Casualty Loss Deduction
By Steven Schlachter, CPA, MBA
This is the second in a series of articles discussing the federal Casualty Loss Deduction. This deduction may be claimed on the income-tax return of many that have suffered damage from Hurricane Sandy. The first installment (5TJT, February 8, page 33) discussed the general rules of claiming such a casualty loss deduction. The focus here will be on the IRS-approved methods for establishing the loss sustained in the storm. More information and guidance is provided in IRS Publication 547.
As discussed in Part 1, the Casualty Loss Deduction is measured by the lesser of (a) reduction and fair market value of the property as a result of the event and (b) the purchase price of the property (plus any improvements and renovations to it subsequent to purchase). The key is to establish the decrease in the value of the property, and, for that, an appraisal is needed. In certain cases, other means may also be employed to establish a change in property value.
Use of an appraisal. The appraisal needed to establish the change in property value subsequent to the casualty or theft loss must be done by a qualified and competent appraiser familiar with market conditions relevant to the subject property. This is important in order to establish reduction in value of the property solely because of the event, rather than marketplace conditions. Under IRS guidelines, several important factors must be taken into account for the appraisal to be acceptable. These include the appraiser’s qualifications to do the appropriate research with respect to the property, and his or her knowledge of standard appraisal methodology. These methods include investigating comparable sales and evaluating conditions in the particular area where the casualty event occurred. In certain situations where the property was appraised for purposes of obtaining a federal loan (or a federal loan guarantee), it may be possible to rely on the appraisal to document the change in property value.
Cost of cleaning or repair. Many people that have sustained losses to personal property from Hurricane Sandy will not have appraisals of the property to attest to its value before the storm hit. It thus becomes difficult to prove diminution of property value. The IRS will allow a reasonable method to figure a loss in value by making reference to the cost of cleaning or repairing the damaged property. The cost of repairing damage is not, in and of itself, the measure of the casualty loss. However, what is permissible is the use of the cost of cleaning or repairing storm damage to measure the decrease in the value of the property, provided certain conditions are met. Among them are the requirements that the repairs have actually been made, such repairs were necessary to bring the property back to its condition immediately before the casualty, the amount spent for the repairs were not “excessive,” and the repairs only fixed the damage to the property, but did not improve it beyond its original condition.
Landscaping. The cost of restoring landscaping to its original condition may also indicate a decrease in property value. It may be possible to measure the loss in value by what is being spent on landscaping, which includes removing destroyed or damaged trees or shrubs, pruning, and other measures undertaken to preserve damaged trees and shrubs, and replanting, where necessary, to restore the property to its original condition.
Car value. Various available lists of automobile values may be a useful indicator of the decrease in value of a damaged or destroyed car. It is permissible to use the retail value listed for the automobile in question and modify such value by factors such as mileage on the car before its damage or destruction. These list prices are not official, but they are a useful indication of value and suggestive of comparables for a particular automobile. If the car in question is not listed in any of the published lists, other sources for determining value should be used. A dealer’s offer for the car as a trade-in for a new one is not necessarily a measure of true value.
Items not to consider. In accordance with IRS guidelines, there are a number of items that, in general, may not be used to establish a decrease in value of the casualty loss property. These items include the cost to protect the property against the casualty or theft, replacement costs to obtain new property, sentimental value, and the cost of photographs or appraisal of damaged property. Incidental expenses, such as from personal injury or the cost of temporary housing and car rental, are also not to be considered.
Further limitations. Once the value of the casualty loss has been measured, it may be further subject to limitations as discussed in the first installment of this series.
The next and last installment will focus on the casualty loss deduction for property used in a trade or business. v
(To be continued)
Steven Schlachter is a senior tax manager at the accounting, tax, and business advisory firm of Margolin, Winer & Evens LLP.