Planning Reminder

If your property is damaged, you must reduce the basis of the damaged property by the casualty loss deduction and compensation received for the loss (5.20). When you later sell the property, gain or loss is the difference between the selling price and the reduced basis.

Connor claimed that the market value of his house dropped $93,000 after it was damaged by fire. His $52,000 cash outlay in repairing the house was reimbursed by insurance. He claimed a casualty loss of approximately $40,000, the uncompensated drop in market value. The IRS barred the deduction. The house was restored to pre-casualty condition. The cost of the repairs is a realistic measure of the loss, and, as the expense was fully compensated by insurance, Connor suffered no loss. A federal appeals court disagreed. The house dropped $70,000 in market value, of which $20,000 was uncompensated by insurance. The deduction is measured by the uncompensated difference in value before and after the casualty. It is not limited to the cost of repairs, even where the repair expense is less than the difference in fair market values. Had the repairs cost more than this difference, the IRS would not have allowed a larger deduction.

Caution

If you are insured for your full loss and do not file a claim because you do not want to risk cancellation of liability coverage, you may not claim a deduction. If you do not file an insurance claim but your loss exceeds the coverage, the noncovered loss may be deductible. For example, if you have a $2,500 deductible on your personal automobile insurance policy, a loss of up to $2,500 would be reduced by the $100 floor and the balance would be deductible only to the extent the 10% of adjusted gross income floor was exceeded; see Step 5 (18.13).