18.1 Sudden Event Test for Casualty Losses
To be a deductible casualty loss, property must be damaged or destroyed as the result of a sudden, unexpected, or unusual event. A sudden event is one that is swift, not gradual or progressive. An unexpected event is one that is ordinarily unanticipated and unintended. An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged. Chance or a natural phenomenon must be present. Examples include earthquakes, hurricanes, tornadoes, floods, severe storms, landslides, and fires. Loss due to vandalism during riots or civil disorders also is treated as a casualty loss. Damage to your car from an accident is generally deductible (18.7). Courts have allowed deductions for other types of accidents; see Example 2 below. The requirement of suddenness is designed to bar deductions for damage caused by a natural action such as erosion, corrosion, and termite infestation occurring over a period of time.
The IRS and the courts have generally disallowed casualty deductions based on a loss in property value due to permanent buyer resistance rather than actual physical damage; see Examples 4 and 5 below.
EXAMPLES
1. A homeowner claimed a loss for water damage to wallpaper and plaster. The water entered through the window frame. The loss was disallowed. He gave no evidence that the damage came from a sudden or destructive force, such as a storm. The damage may have been caused by progressive deterioration.
2. Mr. White accidentally slammed the car door on his wife’s hand. In pain, she shook her hand vigorously. A diamond flew out of her ring’s setting, which was loosened by the impact. The diamond was never found. The IRS disallowed the deduction, contending that a casualty loss requires a cataclysmic event. The Tax Court disagreed. A deductible casualty loss occurs whenever an accidental force is exerted against property, and its owner is powerless to prevent the damage because of the suddenness. The IRS has accepted the decision.
3. A boat, which was in a poor state of repair, was equipped with a pump that automatically began operating when the water in the hull rose above a certain level. One day, the dockside power source failed, and the boat sank at its mooring within four hours. The IRS claimed that no deductible casualty occurred because the leakage was a chronic problem. The Tax Court allowed the deduction. The sinking was not a direct result of the boat’s leaking hull, but of the failure of the on-board water pump.
4. A Brentwood couple, whose home was near the O.J. Simpson house, filed for a refund in federal district court to claim a $400,000 casualty loss deduction. The couple claimed that the double murder and the media frenzy surrounding the Simpson trial caused permanent buyer resistance in their neighborhood, lowering the value of their home by at least $400,000. The district court denied the refund. The couple relied on a 1986 case in which the Eleventh Circuit appeals court allowed Finkbohner a casualty loss deduction based on permanent buyer resistance when 12 nearby homes were razed by local authorities following severe floods and the lots were required to be kept as open space. However, the Brentwood couple’s case was appealable to the Ninth Circuit, and the Ninth Circuit requires that a casualty loss be based on actual physical damage caused by a fire, storm, or other sudden unusual event and not merely buyer resistance. Therefore, the claim for a casualty loss deduction for the Brentwood home was denied.
In a similar case, the Tax Court denied a casualty loss deduction to O.J. Simpson’s next-door neighbors, who claimed they had suffered a permanent devaluation of their home’s value due to the trial publicity. The Tax Court holds that actual physical damage is required for a deduction.
5. A 1983 avalanche caused $9,000 of physical damage to the Lunds’ vacation home in Sundance, Utah, but they claimed a $221,000 deduction. They argued that there was a permanent loss in property value due to the avalanche risk in the area. Local authorities blocked road access during heavy snowfalls and some neighbors had decided not to rebuild destroyed homes. A federal district court agreed with the IRS that their loss could not exceed the actual physical damage. There may have been temporary buyer resistance following the avalanche, but not a permanent change in the area itself as there was in the Eleventh Circuit Finkbohner case mentioned above in Example 4.
Is drought damage deductible?
The IRS does not generally allow deductions for drought damage. An agent may argue that the loss resulted from progressive deterioration, which does not fit the legal definition of a personal casualty loss. Courts have allowed deductions for severe drought where the damages occur in the same year as the drought.
If the damage becomes noticeable a year later, a court will view this as evidence of progressive deterioration that does not qualify as a deductible casualty. Where there are drought conditions, inspect your property for damage before the end of the year and claim a deduction for the damage in that year to negate an IRS argument that damage was caused by progressive deterioration.
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Caution
Loss Prevention Measures
The cost of preventive measures, such as burglar alarms or smoke detectors, or the cost of boarding up property against a storm, is not deductible.
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Special IRS procedure for repairs of Chinese corrosive drywall.
A casualty loss is generally deductible only in the year that the casualty occurs (18.2), but a special IRS procedure (Revenue Procedure 2010-36) allows you to treat the amount paid to repair corrosive drywall damage to your home or household appliances as a casualty loss in the year of payment. You can claim a deduction for drywall damage without using the Revenue Procedure 2010-36 rules, but in that case the regular casualty rules apply: the deduction will be allowed only if you can prove that the damage was sudden rather than progressive, or the result of an unusual or unexpected event, and the deduction may be claimed only for the year the damage occurs and only to the extent there is no reasonable prospect of reimbursement.
To be eligible under Revenue Procedure 2010-36, the repair must be for drywall that has been identified as “problem drywall” under the two-step method used by the Consumer Product Safety Commission and the Department of Housing and Urban Development. The agency guidelines are at www.cpsc.gov/info/drywall/index.html.
If you are not pursuing reimbursement, Revenue Procedure 2010-36 allows you to claim all unreimbursed repairs paid during the year as a casualty loss, subject to the $100 per event floor and the 10% of AGI floor for net casualty losses of personal-use assets (18.2). A deduction is only allowed for drywall repair costs that restore the home to its pre-damage value. The cost of improvements that increase the value of your home above its pre-damage value may not be included. If there is a pending or a planned claim for reimbursement, an IRS safe harbor allows you to claim 75% of the unreimbursed repair costs paid during the year as a casualty loss, subject to the $100 and 10% of AGI floors. If you use the 75% safe harbor and in a later year you are reimbursed for the expenses, some or all of the recovery may have to be reported as income (11.6), or you may be entitled to an additional deduction for unrecovered repair costs. When claiming the deduction on Form 4684, write “Revenue Procedure 2010-36” at the top of the form; see the Form 4684 instructions for further details.
Damage to surrounding property.
Loss due to buyer resistance because of damage to surrounding property is generally not deductible. However, the Eleventh Circuit allowed a deduction. See Example 4 above.
Damage to trees.
The destruction of trees by southern pine beetles over a period of 5 to 10 days was held by the IRS to be a casualty. One court decided similarly where the destruction occurred over a 30-day period. For figuring the casualty deduction for tree and shrub damage (18.6).
Deduction despite faulty construction.
A plumber stepped on a pipe that was improperly installed. Resulting underground flooding caused damage of over $20,000. The IRS argued that this was caused by a construction fault and thus was not a casualty loss. The Tax Court disagreed. The plumber caused the damage. Improper construction was only an element in the causative chain.
Foreseeable events and preventable accidents.
The IRS may disallow a deduction by claiming that the loss was foreseeable and therefore not a deductible casualty loss; see the following Examples.
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Caution
Loss From Termites
Termite damage is generally nondeductible since it often results from long periods of termite infestation. Proving a sudden action in the sense of fixing the approximate moment of the termite invasion is difficult. Some courts have allowed a deduction, but the IRS will bar deductions for termite damage under any conditions based on a study that found that serious termite damage results only after an infestation of three to eight years. See examples of other nondeductible casualty losses later in this chapter (18.11).
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EXAMPLES
1. Heyn owned a hillside lot on which he contracted for the building of a home. A soil test showed a high proportion of fine-grain dense sandstone, which is unstable. His construction contract called for appropriate shoring up and support. But, because of the contractor’s negligence, a landslide occurred. The IRS disallowed the loss on the ground that it was not a “casualty” because the danger was known before Heyn undertook the project and because of the negligence involved. The Tax Court disagreed. The contractor’s negligence is not a decisive factor in determining whether there was a casualty. For example, an automobile collision is considered a casualty, even if caused by negligent driving (but not willful misconduct). Foreseeability is also not a conclusive factor. A weather report may warn property owners to take protective steps against an approaching hurricane, but losses caused by the hurricane are deductible. The IRS has agreed to accept the decision.
2. Mrs. Kane placed her dirty ring in a glass of ammonia. Not knowing the contents of the glass, her husband emptied it into the sink and started the automatic garbage disposal, crushing the ring. The court allowed a full deduction for the loss, which it said resulted from a destructive force. That Mr. Kane was negligent has no bearing on whether the event was a casualty.
3. At Christmastime in 1982, Hananel left his 1974 Plymouth Valiant in Chicago in an area in which the city was towing away cars to make room for construction work. When he returned a week later, he found that his car was missing and reported it stolen. A month later, he learned that the city pound had towed the car away and then crushed it because its ownership could not be determined. He claimed a casualty loss for the car. The IRS disallowed the deduction, claiming that the towing and crushing were not an unforeseeable event, and thus did not qualify as a casualty.
The Tax Court agreed that Hananel could have foreseen that leaving the car on the street subjected it to being towed. He was negligent. However, the penalty for this is a towing charge. He could not have foreseen its destruction. Therefore, the destruction occurred from an unusual and unexpected event, and he was allowed to claim a casualty loss deduction.
4. Destruction of a lawn through the careless use of weed killer was held by the Tax Court to be a casualty.
