Monday, July 21, 2008

Personal Property Losses - Difficult Situation or No Problem?

Personal Property Losses - Difficult Situation or No Problem?

After the passage of a tax law in August 1993, the treatment of personal property losses in a disaster became less difficult to deal with on personal income tax returns.

(Unfortunately, these rules only apply to personal property losses for individuals and only for losses related to an individual’s principal residence that is damaged or lost in a Presidentially Declared Disaster.)

In the case where there is a “full” recovery of the loss related to personal property, the insurance proceeds do not have to be reported as taxable income and a detail computation of the loss of personal property does not have to be completed for tax purposes. The psychological impact as well as the need not to maintain detail records of the loss for a possible tax audit is a great benefit of this change.

This part of the law related to disaster situations has been in affect for over fifteen years. There is limited guidance from the IRS as to all of the property that is includable in this “pool” of assets for tax purposes.

Generally, it includes those items that would be found in “your” home. There might be items that you own that are not common, but are usual for your lifestyle. These will change over time. Twenty-five years ago, who would have thought that a computer would be a relatively common item found in a home? Today, there might be two or three in some homes.

Additionally, the fact that an item, generally associated with being in a residence is included even if, at the time of the loss, it was somewhere else that also was part of the disaster. If your gym clothes and equipment are at the office and both the office and the home are lost in a disaster, the gym clothes and equipment would be considered part of the personal property related to the residence.

If the taxpayer does not have insurance, the tax rules can be harsh in this area. The rules that are applied for tax purposes are quite different from those used for making a claim to an insurance company. The IRS position is that the computation of the loss related to personal items is computed based on the lower of your original cost or its lower fair market value (FMV) at the time of the loss (reflecting depreciation from use or obsolescence). Increases in fair market value (FMV) over the cost basis of antiques and other collectibles who’s FMV may increase will not affect the cost basis used for determining the amount of the loss for tax purposes.

This is the same rule that is applied to the dwelling, but in most cases, the dwelling has not decreased in value as of the date of the disaster compared to the purchase date.

In the case of the personal property, it is computed on each item individually. (For the dwelling it is computed on the structure as a whole.) Further, it is likely to be more difficult to determine the FMV of a five year old television set or a half used jar of jelly. As with the dwelling, the cost of repairs may assist in this determination for some items. The use of the lower of cost or FMV requires the determination of the decrease in FMV which may be difficult to determine. The method chosen must be used for all assets lost.

The IRS likes to apply "thrift store" values to personal property items. Many tax professionals believe this is not a fair method of valuation. The item had not been turned over to a thrift store because it had greater value to the taxpayer than the thrift store valuation. After the disaster, if the item was only damaged and not destroyed, it may be impossible to place a FMV on it in its damaged state.

In situations where the FMV has increased, the increase in one item cannot be used to offset the decrease in another item. Each item must stand on its own.

What about "sets" of items? What if three place settings of china out of twelve are destroyed? For insurance purposes it may have been possible to purchase a whole new set of twelve, if the pattern can no longer be found. But for tax purposes, the deduction might be limited to only that portion of the set actually lost. This is an area requiring judgment; however, taking an aggressive position in this area on a tax return can result in problems later if the return is audited by the IRS.

Another problem exists for those with insurance coverage on personal goods that are specifically itemized in their insurance policy. (Generally referred to as Scheduled Property) These are usually items that are covered on special floaters or scheduled in the insurance policy. Such scheduled property is treated in the same manner as the dwelling. In fact the tax law allows the scheduled property and the dwelling to be added together for purposes of reporting the “gain or loss” on the tax return. Thus if a taxpayer receives $200,000 for damage to the dwelling resulting from damages that occurred as part of a Presedentially Declared Disaster and $50,000 for a piece of scheduled property, all $250,000 may be used to repair the dwelling in order to qualify for deferral of any possible tax income arising from the receipt of the insurance money. If in addition to the $250,000 of insurance proceeds, the taxpayer receives $75,000 for unscheduled property, the taxpayer need not report any of these proceeds to the IRS on a tax return.

If the insurance proceeds are inadequate and a loss can be claimed, then the whole difficult process of reporting the loss, including identifying each item, its cost, fair market value before and after the event and the insurance proceeds must be calculated. If a loss results, it will be subject to other adjustments. Due to policy limits and restrictions some items may not be covered by the insurance claim.

The key is to carry insurance coverage that will compensate you adequately in the event of a loss.

In some cases the insurance company may actually replace the items. They may have access to sources that the general public is not aware of. If the items lost are simply replaced with items supplied by the insurance company, no tax reportable event has occurred as to these items because the items lost have not been converted into “cash.”

Friday, July 18, 2008

IRS Does Provide Help

 IRS Does Provide Help

Help from the IRS in the event of any casualty or disaster event is available at The IRS has assembled a number of their forms and publications into one publication – number 2194. It is available as a PDF download from their website.

IRS Publication 2194 includes a helpful set of informative publications and forms for taxpayers who have experienced a disaster all assembled into one easy to download PDF document.

The following publications and forms that will be useful to taxpayers in the event of a disaster or other casualty are included in the publication:

Publication 3932, Casualty Losses-Document List

Form 4506, Request for Copy of Tax Return (If your tax records have been lost or damaged in the casualty event, use this form to request copies of tax returns that you have previously filed with the IRS. You may also get copies from your accountant who will have both the federal and state copies of your return.)

Form 4506-T, Request for Transcript of Tax Return

Publication 584, Casualty, Disaster, and Theft Loss
Workbook (This booklet is very good for gathering the information that you will need to complete a tax return after a casualty event.)

Publication 547, Casualties, Disasters and Thefts
(This is a very useful booklet written in fairly plain language, it covers most of the basics.)

Form 4684, Casualties and Thefts (This is the form that is used to report a casualty or theft loss on a tax return. The details should be reviewed with a tax adviser. Having some understanding of the form will help you in determining what information should be brought to your accountant.)
Instructions 4684

Publication 551, Basis of Assets (This booklet helps explain how to compute the cost basis of your assets. If possible, before the event, discuss what is needed in your situation with your tax adviser. Your tax adviser may be able to keep a copy of the details of the cost basis of your major assets so that they are available after a casualty event.)

Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts

Form 1045, Application for Tentative Refund

Form 1040X, Amended U.S. Individual Income Tax Return
Instructions 1040X

Schedules A & B (Form 1040), Itemized Deductions and Interest and Dividend Income
Instructions 1040 Schedules A & B

Form 8822, Change of Address (The publication is available as a PDF download at the IRS website: www.IRS.GOV. It is a good idea to keep the IRS informed of any address change after a casualty event.)

The IRS also produces a “business” version of this assembly of materials. It is “2194 b.” it is also available at

Wednesday, July 16, 2008

Loss Valuation - Cost of Repairs Method

Loss Valuation - Cost of Repairs Method

Revised February 24, 2011, December 2012 and Jauary 18, 2013:
Author’s noteThis post continues to be the most popular post on this blog. When you read this post, also read the January 2013 post:


February 24, 2011: A number of viewers look at this entry, but few viewers look at a prior entry June 18, 2008, related entry “Figuring the Loss – Market Value Method.” Both should be reviewed. In fact the author generally believes that the “Market Value Method” is the preferred method. The preference is discussed in the June 18, 2008 entry.

The prior blog entry (Figuring the Loss – Market Value Method.) describes the manner of claiming a casualty loss using the market value method or Appraisal Method, requiring appraisals. There is an acceptable alternative, but it has certain pitfalls.

Instead of using an appraisal to compute the “economic loss” portion of the Form 4684, you can use the “Cost of Repairs” to compute the amount of the deductible loss. You are still limited to your cost basis for the asset lost, even if the cost of repairs exceeds your cost basis. As with the market value approach, if you decide to use the cost of repairs method, first, you must deduct any insurance recoveries for the loss from the both your cost basis of the asset lost and the computed total loss to determine if there is any deductible loss.

In fact, the IRS points out that it is not the estimated cost of repairs method, it is the cost of repairs method At:

 “FAQs [Frequently Asked Questions] for Disaster Victims - Casualty Loss (Valuations and Sections 165 (i)),”
(6/1/07) Q: A number of concerns have been raised by taxpayers and tax professionals about casualty loss valuations. While the IRS continues to research and develop specific answers to these issues, general guidance follows below.
the following response is noted: (12/15/09)
A: “…To be able to use the cost of repairs method to determine the decrease in FMV of a property, the repairs must have been made by the due date of the tax return.  If the repairs have not been made, the taxpayer should file the return without reporting the casualty loss informationAfter the repairs have been made, the taxpayer may file an amended return.” (Underlining added by author)

Because of the IRS position that the repair costs are not actually incurred, taxpayers must limit the deduction to the actual costs incurred if this method is used. An example of using this method follows:

Cost basis $100,000
Insurance recovery $ 95,000
Cost of repairs $120,000

Because the cost basis is less than the cost of repairs, the limit of deductibility is the cost basis of $100,000. Once you deduct the insurance recovery of $95,000, the deductible loss subject to other adjustments, is limited to only $5,000. In another example, the following facts are assumed:
Cost basis $150,000
Insurance recovery $ -0-
Cost of repairs $120,000

Without the insurance recovery and a cost basis in excess of the costs of repair, the deduction before other adjustments in this example is $120,000.

If a further assumption related to the above example is made that there was no insurance recovery and the homeowners did some of the repair work themselves, in order to save money, or decided against doing some of the repairs, there are additional reductions. If the homeowner actually only spent $85,000 to repair the damage, the IRS would adjust this loss down by $35,000: the difference between the cost using a contractor of $120,000 and the $85,000 that people actually spent.

The cost of repairs cannot include betterments or additions that were not part of the original asset that was damaged or lost.

Costs incurred are added to the cost basis of the asset lost regardless of those cost being repairs or betterments or additions.

Additionally, if the taxpayer decides to replace the property with another property and not repair the property, then the “Cost of Repairs Method” would not be used.

The two methods, “Cost of Repairs Method” and “Appraisal Method” will not likely result in the same economic loss amount. That is not a problem.

While the “Cost of Repairs Method” appears easier to apply, the restrictions place another type of burden on the asset owner that will most likely make it inappropriate for many major catastrophic loss situations.

All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author. Republication rights limited by the publisher of the book in which this chapter appears also apply.


Certified Public Accountant

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This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.  
Internal Revenue Service Circular 230 Disclosure
This is a general discussion of tax law. The application of the law to specific facts may involve aspects that are not identical to the situations presented in this material. Relying on this material does not qualify as tax advice for purpose of mounting a defense of a tax position with the taxing authorities
The analysis of the tax consequences of any event is based on tax laws in effect at the time of the event.
This material was completed on the date of the posting
© 2008, 2011 & 2012, John Trapani, CPA,