Chief Counsel's Office Addresses Effective Date and Scope of Casualty Loss Limitation

(Parker Tax Publishing August 2019)

The Office of Chief Counsel advised that a personal non-federally declared disaster loss that occurred before December 31, 2017, but was not sustained until after December 31, 2017, is not deductible under Code Sec. 165(h)(5) because, under the changes made by the Tax Cuts and Jobs Act of 2017, such losses must have been sustained before December 31, 2017, to be deductible. The Chief Counsel's Office also advised that, for tax years 2018-2025, a personal casualty loss does not have to occur in a "disaster area" to be deductible, but must occur in the state receiving the federal disaster declaration. PMTA 2019-8.

Background

In PMTA 2019-8, the Office of Chief Counsel was asked to provide advice regarding the application of Code Sec. 165(h)(5), which for tax years 2018-2025 limits personal casualty losses to losses attributable to a federally declared disaster (as defined in Code Sec. 165(i)(5)). Specifically, advice was requested on the following two issues: (1) whether a personal non-federally declared disaster loss that occurred before December 31, 2017, but was not sustained until after December 31, 2017, is deductible; and (2) whether, for tax year 2018-2025, a personal casualty loss attributable to a federally declared disaster must also occur in a "disaster area" to be deductible. The Chief Counsel's Office addressed these issues based on the following two non-taxpayer specific scenarios.

Scenario 1

On May 1, 2017, a flood damaged a taxpayer's house resulting in a personal casualty loss. The flood did not constitute a federally declared disaster. The taxpayer filed an insurance claim and had a reasonable prospect of recovering the entire amount claimed. In February 2018, the insurance company paid the taxpayer 70 percent of the amount the taxpayer claimed. Also in February 2018, it became reasonably certain that the taxpayer would not be able to recover the unreimbursed amount. The taxpayer did not suffer any additional personal casualty losses in 2018.

Scenario 2

On September 1, 2018, a severe storm damaged a taxpayer's house in Kansas resulting in a personal casualty loss. On September 7, 2018, the President issued a major disaster declaration for the State of Kansas under the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the Stafford Act) relating to the storm. The declaration authorized the Federal Emergency Management Agency (FEMA) to provide individual assistance and/or public assistance. FEMA determined that five counties in Kansas were eligible for individual and/or public assistance. The taxpayer's personal casualty loss is attributable to the federally declared disaster, but the taxpayer's house is not located in one of the counties designated by FEMA as eligible for individual and/or public assistance.

Applicable Law

Code Sec. 165(a) allows a deduction for any loss sustained during the tax year and not compensated for by insurance or otherwise. For losses not incurred in a trade or business or a transaction entered into for profit, Code Sec. 165(c) limits the deduction under Code Sec. 165(a) to losses arising from fire, storm, shipwreck, or other casualty, or from theft (i.e., personal casualty losses).

Code Sec. 165(h)(5), as added by Section 11044 the Tax Cuts and Jobs Act of 2017 (TCJA), provides a limitation on the deduction of personal casualty losses for tax years 2018-2025. Under Code Sec. 165(h)(5)(A), in the case of an individual, any personal casualty loss which would otherwise be deductible in a tax year beginning after December 31, 2017, and before January 1, 2025, is allowed as a deduction only to the extent it is attributable to a federally declared disaster, as defined in Code Sec. 165(i)(5). The effective date of TCJA Section 11044 provides that the amendment to Code Sec. 165(h)(5) applies to losses incurred in tax years beginning after December 31, 2017.

Code Sec. 165(i)(5)(A) defines a federally declared disaster as any disaster subsequently determined by the President to warrant assistance by the federal government under the Stafford Act. Code Sec. 165(i)(5)(B) provides that the term "disaster area" means the area so determined to warrant such assistance. A federally declared disaster includes a major disaster declaration and an emergency declaration under the Stafford Act. The Stafford Act empowers the President to authorize FEMA to implement several different types of assistance in response to a disaster, based on the severity of the disaster. FEMA designates certain areas affected by the disaster as eligible for certain assistance, such as individual assistance and/or public assistance.

Reg. Sec. 1.165-1(b) provides that to be allowable as a deduction under Code Sec. 165(a), a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and, except as otherwise provided in Code Sec. 165(h) and Reg. Sec. 1.165-11, related to disaster losses actually sustained during the tax year.

Reg. Sec. 1.165-1(d)(1) provides that a loss is allowed as a deduction under Code Sec. 165(a) only for the tax year in which the loss is sustained. For this purpose, a loss is treated as sustained during the tax year in which the loss occurs, as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such tax year.

Reg. Sec. 1.165-1(d)(2)(i) provides that if a casualty or other event occurs which may result in a loss and, in the year of such casualty or event, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of Code Sec. 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received.

Chief Counsel's Analysis

The Chief Counsel's Office advised that the taxpayer in Scenario 1 suffered a personal casualty loss on May 1, 2017, when the taxpayer's house flooded, which did not constitute a federally declared disaster. According to the Chief Counsel's Office, while the loss occurred on May 1, 2017, the loss was not sustained at that time because the taxpayer had a claim for reimbursement with respect to which there was a reasonable prospect of recovery. The Chief Counsel's Office determined that the loss was sustained in February 2018 when it could be ascertained with reasonable certainty whether the taxpayer would receive reimbursement. Accordingly, the Chief Counsel's Office concluded that because the taxpayer's personal casualty loss was not sustained until February 2018, the new casualty loss limitation provided in Code Sec. 165(h)(5) applies, and the taxpayer cannot take a casualty loss deduction for the unreimbursed flood damage.

With respect to Scenario 2, the Chief Counsel's Office noted that the taxpayer suffered a personal casualty loss on September 1, 2018, when the taxpayer's house in Kansas was damaged by a severe storm. The Chief Counsel's Office advised that, even though the taxpayer's house is not located in one of the counties FEMA designated as eligible for assistance, the taxpayer is not precluded from claiming a casualty loss deduction. Code Sec. 165(h)(5), the Chief Counsel's Office observed, does not require the loss to occur in a disaster area and be attributable to a federally declared disaster. Rather, Code Sec. 165(h)(5) only requires the loss to be attributable to a federally declared disaster. Since federally declared disasters are declared on a statewide basis, the loss must occur in the state receiving the federal disaster declaration, the Chief Counsel's Office stated. Accordingly, the Chief Counsel's Office concluded that, because the taxpayer's personal casualty loss occurred in Kansas and was attributable to the federally declared disaster in Kansas, the taxpayer is eligible to claim a casualty loss deduction so long as the taxpayer satisfies all other requirements under Code Sec. 165 and the regulations.

For a discussion of the deduction for disaster area losses for tax years 2018-2025, see Parker Tax ¶84,545.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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