Tax Court: Ongoing Litigation Precludes Deduction of Casualty Loss from House Fire.

(Parker Tax Publishing June 3, 2015)

The Tax Court held that because a taxpayer was actively seeking reimbursement from his landlord for personal property damages incurred in a house fire, he could not claim casualty loss deductions under Code Sec. 165. Hyler v. Comm'r, T.C. Summary 2015-34.

Background

Fletcher Hyler worked as a self-employed marketing consultant. Hyler and his wife resided in a single-family house they rented in California. In 2012, while the couple was away, a fire destroyed the house and its contents. Hyler and his wife's personal property was insured through a policy with State Farm Insurance. Hyler had declared bankruptcy in 2004 as a result of a downturn in the economy, and had received an appraisal report of the home's contents, which reflected a total value of $99,380. However, the insurance policy's limit on recovery was only $60,000.

After the fire, Hyler and his wife made a claim against the landlord's insurance company seeking to recoup losses from the house fire not covered by his State Farm policy. The claim was denied, and Hyler filed a lawsuit against the landlord and his insurance company. In 2015, the parties scheduled meetings to mediate the claim.

On his 2012 return Hyler claimed a casualty loss of $1,164,547. Hyler believed the bankruptcy appraiser's valuations did not represent the fair market value of certain items and presented documents to the IRS in which he valued artwork, furnishings, and other personal property at approximately $2 million. The IRS disallowed the claimed casualty losses and determined a deficiency of $18,160 in Hyler's 2010 return.

Analysis

Generally, an individual can deduct losses not compensated for by insurance or otherwise, if the losses are of property not connected with a trade or business or with a transaction entered into for profit if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. (Code Sec. 165(c)).

However, if there is a claim for reimbursement in which there is a reasonable prospect of recovery, the taxpayer is not treated as having sustained a deductible loss from the casualty until it can be ascertained with reasonable certainty whether or not the taxpayer will receive the reimbursement (Reg. Sec. 1.165-1(d)(2)(i)). A loss is treated as sustained during the year in which the loss occurs, as evidenced by closed and completed transactions (Reg. Sec. 1.165-1(d)(1)).

The Tax Court observed that Hyler had made clear during trial in 2015 that legal proceedings were ongoing against the landlord and the landlord's insurance company. Thus, the court stated, Hyler's claim for reimbursement from the fire was not resolved in 2012 and in fact, at the time of trial in early 2015, there existed a claim for reimbursement which Hyler was actively pursuing. The court noted a casualty loss is not recognized in the year of actual occurrence if there exists at that time a reasonable prospect of recovery on a claim for reimbursement.

Additionally, the court stated that the Code and the regulations are clear that a loss is not considered "sustained" while a claim for reimbursement is pending. Citing Hudock v. Comm'r, 65 T.C. 351 (1975), the Court noted that settlement, adjudication, or abandonment of a claim would be considered an event sufficient to render the loss "sustained" within the meaning of Code Sec. 165.

The Tax Court determined that because Hyler's claim against his landlord was ongoing, there was no "closed and completed transaction" required by Reg. Sec. 1.165-1(d)(1) to support a sustained loss. Because Hyler had not sustained a loss from the 2012 fire within the meaning of Code Sec. 165, the tax court held that he was not entitled to the casualty loss deduction, and upheld the IRS's assessed deficiencies.

For a discussion of casualty losses, see Parker Tax ¶84,540. (Staff Editor Parker Tax Publishing)

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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