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2017 Hurricane Relief: IRS provides safe harbor methods for determining nonbusiness casualty losses

In a Revenue Procedure, IRS has provided safe harbor methods that individual taxpayers may use in determining the amount of their casualty and theft losses for their personal-use residential real property and personal belongings.

For a safe harbor under which individuals may use one or more cost indexes to determine the amount of loss to their homes as a result of Hurricane and Tropical Storm Harvey, Hurricane Irma and Hurricane Maria, see ¶ 23.

Background. Code Sec. 165(a) generally provides that a taxpayer may deduct any loss sustained during the tax year and not compensated for by insurance or otherwise. With respect to property not connected with a trade or business or a transaction entered into for profit, Code Sec. 165(c)(3) limits an individual taxpayer’s deduction to losses arising from fire, storm, shipwreck, or other casualty, or from theft.

Reg. § 1.165-7(b) provides that the amount of a casualty loss is the lesser of (1) the difference between the fair market value (FMV) of the property immediately before the casualty and the FMV immediately after the casualty, or (2) the adjusted basis of the property.Reg. § 1.165-7(a)(2)(i) provides that to determine the amount of the deductible loss under Code Sec. 165(a), the FMV of the property immediately before and immediately after the casualty generally must be ascertained by competent appraisal.

Code Sec. 165(i)(1) allows an individual who suffered a loss occurring in a disaster area and attributable to a Federally declared disaster to take the loss into account for the tax year immediately preceding the tax year in which the disaster occurred.

Code Sec. 165(i)(5)(A) defines “Federally declared disaster” as any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.Code Sec. 165(i)(5)(B) defines “disaster area” as the area so determined to warrant such assistance.

New safe harbors for determining the amount of losses. IRS has become aware that taxpayers often have difficulty determining the amount of their losses under the methods provided in Reg. § 1.165-7(a)(2), which has resulted in time-consuming and expensive litigation. In order to provide certainty to both taxpayers and IRS, the Revenue Procedure provides safe harbor methods that individuals may use under Reg. § 1.165-7(a)(2) to measure the decrease in the FMV of their personal-use residential real property following a casualty and to determine the pre-casualty or theft FMV of personal belongings.

… Qualifying to use the safe harbors. An individual who suffered a casualty loss to the individual’s personal-use residential real property may use one of the first three safe harbor methods described at “Personal-use residential real property safe harbor methods” below, in determining the amount of the individual’s casualty loss under Code Sec. 165. An individual who suffered a casualty loss to the individual’s personal-use residential real property due to a Federally declared disaster may use any of the safe harbor methods described at “Personal-use residential real property safe harbor methods” below. An individual who suffered a casualty or theft loss to the individual’s personal belongings may use the first safe harbor method described at “Personal belongings safe harbor methods” below. An individual who suffered a casualty or theft loss to the individual’s personal belongings due to a Federally declared disaster may use either of the safe harbor methods described at “Personal belongings safe harbor methods” below.

Personal-use residential real property is real property, including improvements (such as buildings and ornamental trees and shrubbery), that is owned by the individual who suffered a casualty loss and that contains at least one personal residence. Personal-use residential real property does not include a personal residence if any part of the personal residence is used as rental property or contains a home office used in a trade or business or transaction entered into for profit.

For purposes of the Revenue Procedure, a personal residence is a single family residence, or a single unit within a contiguous group of attached residential units (for example, a townhouse or duplex), owned by the individual who suffered a casualty loss, and includes any structures attached to the residence or single unit. For purposes of the Revenue Procedure, a personal residence does not include a condominium or cooperative unit, or any other property for which the individual who suffered the casualty loss does not own the structural components of the building (such as the foundation, walls, and roof), or owns only a fractional interest in all of the structural components of the building, or a mobile home or trailer.

A personal belonging is an item of tangible personal property that is owned by the individual who suffered a casualty or theft loss and that is not used in a trade or business or in a transaction entered into for profit. Personal belongings do not include a boat, aircraft, mobile home, trailer, or vehicle, or an antique or other asset that maintains or increases its value over time.

… Personal-use residential real property safe harbor methods. The first three methods below may be used by any taxpayer who meets the requirements described above. The last two methods below may only be used by taxpayers who suffered a casualty loss in a disaster area and due to a Federally-declared disaster.

Under the Estimated Repair Cost Safe Harbor Method, to determine the decrease in the FMV of the individual’s personal-use residential real property, an individual may use the lesser of two repair estimates prepared by two separate and independent contractors, licensed or registered in accordance with State or local regs. The two repair estimates must set forth the itemized costs to restore the individual’s personal-use residential real property to the condition existing immediately prior to the casualty. However, the costs of any improvements or additions that increase the value of the personal-use residential real property above its pre-casualty value, such as the cost to elevate the personal residence to meet new construction requirements, must be excluded from the estimate for purposes of this safe harbor. The Estimated Repair Cost Safe Harbor Method is available for casualty losses of $20,000 or less.

Under the De Minimis Safe Harbor Method, to determine the decrease in the FMV of the individual’s personal-use residential real property, an individual may estimate the cost of repairs required to restore the individual’s personal-use residential real property to the condition existing immediately prior to the casualty. However, the costs of any improvements or additions that increase the value of the personal-use residential real property above its pre-casualty value, such as the cost to elevate the personal residence to meet new construction requirements, must be excluded from the estimate for purposes of this safe harbor. An individual’s estimate must be a good-faith estimate, and the individual must maintain records detailing the methodology used for estimating the loss. The De Minimis Safe Harbor Method is available for casualty losses of $5,000 or less.

Under the Insurance Safe Harbor Method, to determine the decrease in the FMV of the individual’s personal-use residential real property, an individual may use the estimated loss determined in reports prepared by the individual’s homeowners’ or flood insurance company setting forth the estimated loss the individual sustained as a result of the damage to or destruction of the individual’s personal-use residential real property.

Under the Contractor Safe Harbor Method, to determine the decrease in the FMV of the individual’s personal-use residential real property, an individual may use the contract price for the repairs specified in a contract prepared by an independent contractor, licensed or registered in accordance with State or local regs, setting forth the itemized costs to restore the individual’s personal-use residential real property to the condition existing immediately prior to the Federally declared disaster. However, the costs of any improvements or additions that increase the value of the personal-use residential real property above its pre-disaster value, such as the cost to elevate the personal residence to meet new construction requirements, must be excluded from the contract price for purposes of this safe harbor. To use the Contractor Safe Harbor Method, the contract must be a binding contract signed by the individual and the contractor.

Under the Disaster Loan Appraisal Safe Harbor Method, to determine the decrease in FMV of the individual’s personal-use residential real property, an individual may use an appraisal prepared for the purpose of obtaining a loan of Federal funds or a loan guarantee from the Federal Government setting forth the estimated loss the individual sustained as a result of the damage to or destruction of the individual’s personal-use residential real property from a Federally declared disaster.

… Personal belongings safe harbor methods. The first method below may be used by any taxpayer who meets the requirements described above. The other method below may only be used by taxpayers who suffered a casualty loss in a disaster area and due to a Federally-declared disaster.

Under the De Minimis Safe Harbor Method, an individual may make a good faith estimate of the decrease in the FMV of the individual’s personal belongings. An individual using the De Minimis Safe Harbor Method must maintain records describing the personal belongings affected and detailing the methodology used for estimating the loss. The De Minimis Safe Harbor Method is available for casualty or theft losses of $5,000 or less.

Under the Replacement Cost Safe Harbor Method, an individual determines the FMV before the casualty by determining the cost to replace the item and reducing that amount by 10% for each year the individual owned the personal belonging. He then subtracts the FMV of the personal belonging immediately after the federally declared disaster. He then compares that net amount with the basis of the personal belonging; his loss is the lower of those two amounts.

… Other rules. Under Code Sec. 165(a), a casualty loss must be reduced by insurance or other amounts received, such as amounts given to an individual to repair the damage to the individual’s property due to the casualty. This includes the value of repairs to, or rebuilding of, the individual’s personal-use residential real property provided by another party at no cost to the individual (“no-cost repairs”), such as the repair or rebuilding of an individual’s personal residence by volunteers. No-cost repairs include repairs made for a de minimis or token cost, donation, or gratuity.

An individual who uses any safe harbor method provided in the Revenue Procedure to determine the decrease in the FMV of or the amount of loss to the individual’s personal-use residential real property or personal belongings must reduce the loss by the value of any no-cost repairs.

IRS will not challenge an individual’s determination of the decrease in FMV of personal-use residential real property or personal belongings if the individual qualifies for and uses one of the safe harbor methods described the Revenue Procedure.

Use of a safe harbor method described in the Revenue Procedure is not mandatory. An individual may, instead, use the actual reduction in the FMV of personal-use residential real property or personal belongings, pursuant to Reg. § 1.165-7(a)(2), if the individual has proper substantiation.

Effective date. The Revenue Procedure is effective Dec. 13, 2017.

References: For casualty losses, see FTC 2d/FIN ¶  C-7214; United States Tax Reporter ¶  1654.300.

Rev Proc 2018-08, 2018-02 IRB; IR 2017-202