In a Revenue Procedure, IRS has provided a safe harbor method 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 (2017 Hurricanes).
Background on casualty loss deductions. Taxpayers generally are allowed to deduct losses sustained during the tax year that are not compensated by insurance or otherwise. (Code Sec. 165) For personal-use property (such as a taxpayer’s personal residence and household appliances), Code Sec. 165 limits an individual’s deduction to losses arising from fire, storm, shipwreck, or other casualty, or from theft.
A casualty loss is generally allowed as a deduction only for the tax year in which the loss is sustained. However, if the taxpayer has a claim for reimbursement of the loss (from insurance or otherwise) for which there is a reasonable prospect of recovery, no portion of the loss is deductible until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. (Reg. § 1.165-1(c)(4)) And, under Code Sec. 165(i)(1), an individual who suffered a loss occurring in a disaster area and attributable to a Federally declared disaster is allowed to take the loss into account for the tax year immediately preceding the tax year in which the disaster occurred.
Two limitations apply to casualty loss deductions for personal use property. (Code Sec. 165(h)) First, a casualty loss deduction is allowable only for the amount of the loss that exceeds $100 per casualty. Second, the net amount of all of a taxpayer’s casualty losses (in excess of casualty gains, if any) is allowable only for the amount of the losses that exceed 10% of the taxpayer’s adjusted gross income (AGI) for the year.
The amount of a taxpayer’s casualty loss generally is the decrease in the fair market value (FMV) of the property as a result of the casualty, limited to the taxpayer’s adjusted basis in the property. (Reg. § 1.165-7(b))
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.Reg. § 1.165-7(a)(2)(ii) provides that the cost of repairs to the property damaged is acceptable as evidence of the decrease in value of the property if the taxpayer shows that: (1) the repairs are necessary to restore the property to its condition immediately before the casualty; (2) the amount spent for such repairs is not excessive; (3) the repairs do not care for more than the damage suffered; and (4) the value of the property after the repairs does not, as a result of the repairs, exceed the value of the property immediately before the casualty.
In order to use the above cost-of-repairs method to determine the decrease in FMV, the taxpayer must actually make the repairs rather than rely on estimates of repairs that will be performed in the future or not at all. (Lamphere, (1978) 70 TC 39170 TC 391)
Due to the widespread devastation from the 2017 Hurricanes, IRS is providing a method in additional to the safe harbor method in Rev Proc 2018-8 (¶ 31) 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 that was damaged or destroyed as a result of the 2017 Hurricanes.
IRS provides safe harbor. An individual with a U.S. income tax filing requirement who suffered a casualty loss to the individual’s personal-use residential real property located in the “2017 Disaster Area” as a result of the 2017 Hurricanes may use the safe harbor method provided in Rev Proc 2018-9 (the “Cost Indexes Safe Harbor Method”) in determining the amount of the individual’s casualty loss under Code Sec. 165. The term “2017 Disaster Area” means the entire states of Texas, Louisiana, Florida, Georgia, and South Carolina, the Commonwealth of Puerto Rico, and the territory of the U.S. Virgin Islands. Rev Proc 2018-9 applies to bona fide residents of Puerto Rico and the U.S. Virgin Islands only where these individuals otherwise have a U.S. income tax filing requirement.
For purpose of Rev Proc 2018-9, 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. 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 consists of the total enclosed square footage of the residence or single unit, including any enclosed structures attached to the residence or single unit. For example, a personal residence includes a basement and an attached garage, but does not include a deck or screened-in porch.
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.
If an individual owns two or more parcels of personal-use residential real property, the use of the Cost Indexes Safe Harbor Method for one parcel does not require the individual to use the Cost Indexes Safe Harbor Method, or any safe harbor method, for any other parcel.
Under the Cost Indexes Safe Harbor Method, an individual may use one or more of the cost indexes, as applicable, to determine the decrease in the FMV of personal-use residential real property, including the personal residence, detached structures, and decking. Cost indexes are provided for three size categories of personal residences based on the square footage of the personal residence and for seven geographic areas. Rev Proc 2018-9, Sec. 4, provides the following tables:
… Table 1. Total Loss. A total loss of a personal residence occurs if, as a result of one of the 2017 Hurricanes, any one of the following occurred: (a) the personal residence either collapsed or is structurally unsound; (b) the government has ordered that the personal residence be demolished or relocated; (c) the individual has sold the personal residence to an unrelated party for a price that reflects the FMV solely of the land on which the personal residence is situated; or (d) the personal residence sustained damage that satisfies the definition of near total loss (see below), and the individual has demolished the personal residence.
… Table 2. Near Total Loss. The near total loss of a personal residence occurs if, as a result of one or more of the 2017 Hurricanes, the personal residence sustained severe damage necessitating the removal and disposal of substantially all interior wall frame coverings (including drywall and other wall frame coverings), floorings, electrical lines, ducts, plumbing, and other fixtures. For a personal residence sustaining near total loss, only the wood frame, rafters, and outside façade of the personal residence remain structurally sound and reusable.
… Table 3. Interior Flooding Over 1 Foot. Interior flooding over one foot occurs if a personal residence was flooded with water to a height of more than one foot as a result of one or more of the 2017 Hurricanes, but did not sustain damage that falls within the definition of total loss or near total loss.
… Table 4. Structural Damage From Wind, Rain, or Debris. Structural damage from wind, rain, or debris occurs if a personal residence sustained major structural damage to the roof and/or outside wall(s) as a result of wind or windblown debris from one or more of the 2017 Hurricanes that exposed part or all of the interior of the personal residence to rain or debris, requiring substantial renovation of the damaged areas. Substantial renovation requires the removal and replacement of drywall or other wall frame coverings, replacement of trim, and repair and painting of the damaged interior areas of the personal residence.
… Table 5. Roof Covering Damage From Wind, Rain, or Debris. Roof covering damage from wind, rain, or debris occurs if a personal residence sustains damage from wind, rain, or windblown debris to roofing felt, shingles, flashings, fascia, or soffit as a result of one or more of the 2017 Hurricanes.
… Table 6. Damage to a Detached Structure. Damage to a detached structure occurs if, as a result of one or more of the 2017 Hurricanes, the detached structure requires either complete or major rebuilding. A detached structure is an enclosed structure of wood-frame construction that has some electrical capabilities, but little or no interior finishing. A detached structure is located on personal-use residential real property and includes a shed, shop, or detached garage that is not used in connection with a trade or business and that is not equipped with heating or air conditioning.
… Table 7. Damage to Decking. Damage to decking occurs if, as a result of one or more of the 2017 Hurricanes, the decking attached to a personal residence was damaged or destroyed.
The computation of cost per square foot is relatively simple. For example, in using Tables 1, 2, or 6, the taxpayer (1) determines the total square footage; (2) determines the size of the personal residence (or detached structure) based on the total square footage; (3) determines which column in the Table that applies based on the geographic location; (4) multiplies the total square footage (from step 1) by the applicable cost index based on the appropriate column of the Table. Special rules may apply in using the tables, such as a personal residence may not be subject to more than one of the following tables: Table 1 (Total Loss); Table 2 (Near Total Loss); or Table 3 (Interior Flooding Over 1 Foot).
In computing the decrease in FMV under the Cost Indexes Safe Harbor Method, an individual must take into account the value of any no-cost repairs (i.e., repairs to, or rebuilding of, the individual’s personal-use residential real property provided by another party at no cost to the individual, such as by volunteers).
If the Cost Indexes Safe Harbor Method is used, the amount determined is the full amount of the decrease in FMV of that personal-use residential real property and may not be increased by amounts related to items such as landscaping, debris removal, demolition, etc.
The Cost Indexes Safe Harbor Method applies only to the following three types of improvements on an individual’s personal-use residential real property: a personal residence, a detached structure, and a deck. If there is any other type of improvement on an individual’s personal-use residential real property, the individual may use the Cost Indexes Safe Harbor Method to determine the decrease in FMV of the personal-use residential real property, but may not add any amount for the other type of improvements. The decrease in FMV of the other type of improvement may be determined by another applicable method. For example, under the Cost Indexes Safe Harbor Method, no amount may be added to the decrease in FMV of the personal-use residential real property for a residence that contains a home office, a residence in a structure that contains five or more residential units, or a detached structure equipped with heating or air conditioning.
Effective date. Rev Proc 2018-9 is effective for losses that are attributable to the 2017 Hurricanes and that arose in the 2017 Disaster Area after Aug. 22, 2017.
References: For casualty losses, see FTC 2d/FIN ¶ C-7214; United States Tax Reporter ¶ 1654.300.
Rev Proc 2018-9, 2018-2 IRB