Tudyman v. Commissioner

T.C. Memo. 1996-215

UNITED STATES TAX COURT

BARBARA ANN TUDYMAN, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent

Docket No. 9883-93. Filed May 2, 1996.

Sandra G. Scott and Stephen M. Moskowitz, for petitioner.

Margaret S. Rigg, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined deficiencies in

petitioner’s Federal income tax and additions to tax as follows:
 - 2 -

Accuracy-Related
Additions to Tax Penalty
Year Deficiency Sec. 6653(a)1 Sec. 6661 Sec. 66622
1985 $10,985 $549 $2,746 --
1986 8,076 404 2,019 --
1987 13,083 654 3,271 --
1988 1,961 98 -- --
1989 3,406 -- -- $578
1
Respondent determined that petitioner is liable for
additions to tax for 1986 and 1987 under sec. 6653(a)(1)(A)
and (B).
2
Respondent determined that petitioner is liable for
negligence under sec. 6662(a), not substantial understatement
or valuation misstatement. See sec. 6662(b), (c), (d), and (e).
Thus, we do not consider whether petitioner is liable under
sec. 6662(d) or (e).

The issues for decision are:

1. Whether petitioner had a deductible casualty loss of

$270,265 from the Loma Prieta earthquake in 1989 as petitioner

contends, zero as respondent contends, or some other amount. We

hold that her deductible casualty loss was $108,000 for 1988,

after reducing the amount of her loss by an insurance

reimbursement of $42,000.

2. Whether petitioner is liable for: (a) Additions to

tax for negligence under section 6653(a) for 1985 to 1988, (b)

additions to tax for substantial understatement under section

6661 for 1985 to 1987, and (c) the accuracy-related penalty under

section 6662 for 1989. We hold that she is not.

Section references are to the Internal Revenue Code in

effect for the years in issue. Rule references are to the Tax

Court Rules of Practice and Procedure.
 - 3 -

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

A. Petitioner

Petitioner resided in San Carlos, California, when she filed

her petition. She is a special education teacher for San Mateo

County. She has taken no tax or accounting courses.

B. Petitioner’s Home

Petitioner bought her home at 11 Buttercup Lane, San Carlos,

California, on November 4, 1988, for $324,000. Petitioner’s unit

is one of 277 condominiums in Crestview Park. Petitioner is a

member of the Crestview Park Condominium Homeowners’ Association

(Homeowners’ Association).

Petitioner’s home was built in 1982. It is the center of

three attached units. She owns one-third of the building,

including the roof, the foundation, and the supporting walls.

Petitioner owns: (1) The interior of her unit; (2) an undivided

one-third interest in the common areas, such as outside perimeter

walls, balconies, bearing walls, subfloors, unfinished floors,

pipes, plumbing, wires, and other utilities except the outlets

thereof in each unit; and (3) a membership in the Homeowners'

Association which owns the pool, tennis courts, and recreation

room.

Petitioner insures her home with the USAA Casualty Insurance

Co. (USAA).
 - 4 -

The Homeowners’ Association is responsible for repairing,

maintaining, and insuring the common areas, including individual

units from the interior paint out. If proceeds from the

Homeowners’ Association insurance policy are insufficient to

repair damage, the Homeowners' Association may use its own funds

or specially assess its members. The Homeowners’ Association was

short on funds in 1989 and 1990.

Before she bought her home, petitioner contracted with J.D.

Hise (Hise) to inspect it. Hise is a licensed general contractor

who inspected homes for home buyers. He has worked in the

building industry since 1963. Hise inspected the property on

October 25, 1988. At that time, the foundation had no cracks,

the floors were level, the doors fit, 25 roof tiles were broken,

the garage slab had minor cracks, the master bath carpet had

water damage, the master bath vanity had settled away from

the tile splash, and the living room windows leaked. Hise

recommended no structural repairs for the house.

C. The Loma Prieta Earthquake

The Loma Prieta earthquake (the earthquake) occurred on

October 17, 1989. Petitioner was at home during the earthquake.

The earthquake damaged petitioner’s home and personal property.

During the earthquake, petitioner’s house shook, articles fell

from the wall and cabinets, tile cracked, and the front door

sprang open and would not reclose. The earthquake measured 7.1

on the Richter scale. The earthquake area, including the area
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where petitioner lived, was declared a national disaster area.

Notice 89-108, 1989-2 C.B. 445.

Petitioner continued to live in her home after the

earthquake.

D. Structural Damage

1. The Foundation

a. Description

Each of the three units in petitioner's building has a

garage. Petitioner's garage is built on flat land. Part of the

foundation of each unit is separate from the garage on a steep

slope. Petitioner's unit has a pier and grade beam foundation

other than for the garage. The grade beams rest on piers. The

piers are 18 inches in diameter and 18 feet deep.

The foundation of petitioner’s home was weakened by the

earthquake. The earthquake caused about 25 cracks in the

foundation, including several under the main supports for

the house.

b. Inspection by Bob Cook

Shortly after the earthquake, petitioner hired a contractor,

Bob Cook (Cook), to inspect her home. Cook made two estimates of

the cost of structural repairs to petitioner’s home. He made a

preliminary estimate on December 5, 1989, of $37,900, and a final

estimate on December 20, 1989, of $48,100. Cook had engineers

consider whether the foundation needed to be replaced or could be

salvaged using chemical adhesive injection (i.e., epoxy). On
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December 5, 1989, he estimated that replacing the foundation

would cost from $90,000 to $130,000, and that chemical adhesive

injection would cost about $30,000. On December 20, 1989, Cook

estimated that foundation repairs would cost from $30,000 to

$150,000. Petitioner submitted Cook’s estimate to USAA.

c. Construction Management Associates and Frank Lewis

The Homeowners’ Association hired Construction Management

Associates (CMA) to oversee the repair of damage caused by the

earthquake. Frank Lewis (Lewis) worked for CMA. Lewis is a

civil engineer and a land surveyor. He has extensive knowledge

of earthquake damage. He examined 40 to 50 homes damaged by the

Loma Prieta earthquake.

Lewis first inspected petitioner's unit on December 8, 1989.

He investigated whether the house was safe after the earthquake.

At trial, he said that a foundation has serious problems if it

has 20 or more cracks. He said that the foundation for

petitioner’s home had 4 cracks wider than three thirty-seconds of

an inch (about the width of a nickel), and at least 25 hairline

cracks. On February 5, 1990, he said that the earthquake caused

petitioner’s home to appear to be rotating off its foundation.

Graham & Kellam were structural engineers who reviewed the

structural adequacy of the Crestview Park units for CMA in 1990.

After inspecting petitioner’s home with Lewis on April 19, 1990,

Leslie Graham (Graham) of Graham & Kellam said that the

foundation was stable.
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After further inspection in April 1990, Lewis said that

the foundation was sound. He recommended that the Homeowners’

Association inject epoxy into the large cracks in petitioner’s

foundation. The hairline cracks were too small to inject.

d. Philip Barrett

Petitioner hired a contractor, Philip Barrett (Barrett), to

repair her home shortly after the earthquake. Barrett remodeled

petitioner’s bathrooms, fixed the living room fireplace, and

rehung several doors that were out of plumb. He saw stress

cracks and apparent movement in the foundation.

e. Gary Halpin

Petitioner hired Gary Halpin (Halpin) to estimate the value

of her home after the earthquake. Halpin inspected many

buildings damaged by the Loma Prieta earthquake. Halpin first

saw petitioner's unit on August 25, 1994, nearly 5 years after

the earthquake. He also inspected her unit on November 20, 1994.

Halpin thought that there were too many cracks to be

repaired with epoxy injection. Halpin concluded that the

foundation should be replaced to restore it to its pre-earthquake

condition.

f. Foundation Repairs

In November 1990, the Homeowners' Association hired Hensley

Homes (Hensley) to retrofit the foundation of petitioner’s home
 - 8 -

(to bring the foundation into compliance with the building code)

and do drainage work for petitioner’s home. The contract was for

$7,381. Hensley injected epoxy in the foundation and installed

plywood shear walls in the crawl space under petitioner’s home.

Hensley also added studs, shearwall, and tie-downs to the

foundation of petitioner's unit. Petitioner did not have any

other foundation repairs done.

2. The Roof

The roof of petitioner’s home was defective when petitioner

bought the unit. The earthquake did not damage the roof.

At the time of the earthquake, the Homeowners’ Association

was involved in litigation with the developers of Crestview Park.

The Homeowners’ Association alleged that construction was

substandard. In 1992, the developers and the Homeowners’

Association agreed to a settlement for faulty roof design. The

Homeowners’ Association repaired the roofs on the three units in

petitioner’s building for about $7,500.

3. The Garage

The crack in petitioner's garage floor was larger after

the earthquake than when petitioner bought her home, and it was

heaving. Cook estimated that it would cost $8,000 to replace the

garage floor.

4. Floors

The earthquake caused the first and second floors of

petitioner’s home not to be level. On April 19, 1990, Graham
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observed that the first and second floors of petitioner’s home

were not level.

In 1990, petitioner hired Jack Santangelo (Santangelo) to

install marble tile in the entryway, master bathroom, fireplace,

upstairs bathroom vanity, bar in the den, and dining room, and on

the stairs from the living room to the dining room. He leveled

the floors where he installed new tile. The marble tile he

installed cost a few hundred dollars more than the tile that was

there previously. The only areas that are level are those that

Santangelo leveled: The entryway, the dining room, the stairs

to the living room and den, the downstairs half bath, and the

upstairs second bath and master bath.

Halpin and Lewis recommended that petitioner’s unit be

jacked up to level the floors. Halpin also recommended that the

roof be renailed to prevent stress in the roof line. However,

jacking up the building could cause several problems and might

not result in restoring petitioner’s home to its pre-earthquake

condition. Jacking up the middle unit could damage the

connections at the party walls and at the roof line. Jacking up

the building would force the plumb components (such as the second

floor walls) out of plumb. Finally, jacking up the unit would

put the part of the first floor that Santangelo had already

leveled out of level. Petitioner wanted a guaranty that the work

would not damage her marble tile. The Homeowners' Association

would not make that guaranty.
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5. Doors

The doors to the hallway closet and the master bath were out

of plumb and did not hang properly after the earthquake. Barrett

rehung them and used better quality hardware. Other doors did

not stay open and some stuck. Petitioner replaced several doors

after the earthquake.

6. The Fireplace and Chimney

The earthquake caused the fireplace mantle to separate from

the wall. Some stucco cracked and fell from the chimney and had

to be patched.

7. Kitchen Floor/Linoleum

The earthquake caused a bump in the linoleum on the kitchen

floor. Petitioner has not replaced the linoleum.

8. Other Structural Damage

There were cracks in the plaster in areas not specified in

the record. The bathroom tile cracked at the tile splash. Grout

joints separated from the tub, vanities, and floors. Tiles in

the entryway cracked, and some did not adhere to the floor after

the earthquake. The stairs were not level, and the stair

railings were loose. An upstairs toilet cracked. An upstairs

bathroom (not the master bath) carpet, not reported by Hise as

damaged when he inspected petitioner’s house before the

earthquake, was damaged by water which splashed from the toilet

during the earthquake.

9. Halpin’s Estimate of Damages to Petitioner’s Residence
 - 11 -

Halpin estimated the casualty loss to petitioner’s home by

comparing its fair market value before and after the earthquake.

He concluded that the fair market value of petitioner’s home was

$324,000 before and $116,700 after the earthquake, for a $207,300

loss in value. He estimated the loss in value by considering the

cost of restoring petitioner’s home to its pre-earthquake

condition.

Halpin estimated that it would cost $157,364.02 to restore

petitioner’s home to its pre-earthquake condition. He estimated

that it would cost $50,000 for a pier foundation retrofit

required by the 1988 State building code. There was an existing

pier foundation, but the earthquake made it inadequate.

Halpin estimated the cost of repairs as follows:

General Items

Project management $7,340.10
Progressive/postconstruction
cleanup 2,264.80
Architectural/engineering
services 3,500.00
Soils report/engineering 2,250.00
General labor (materials and
equipment handling) 4,320.00
Interior/exterior
scaffolding 2,050.00
Content move-out/packing 4,250.00
Content move-back/unpacking 4,250.00
Content storage 250.00
Permit fees 665.00
Detach/reset window treatment
for all rooms 445.00
General repair allowance
(e.g., rafters, joists) 1,100.00

Subtotal 32,684.90
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Other Items

Substructure 51,498.40
Garage 5,146.35
Kitchen 2,767.46
Dining room 957.22
Entry 3,215.24
Hall bath 1,347.19
Living room 4,134.28
Den 1,671.98
Stairways 1,208.28
Bath #2 2,966.21
Bedroom #2 1,478.35
Master bedroom 2,398.68
Master bath 4,328.13
Front elevation 1,500.00
Rear elevation 1,425.00
Roof 7,163.55
Subtotal 125,891.22

Overhead @ 10% 12,589.12
Profit @ 10% 12,589.12
Contingency @ 5% 6,294.56
Total cost of repairs 157,364.02

Retrofit 50,000.00
Total diminution in value 207,364.02

E. Personal Property Damage

The earthquake destroyed or damaged personal property in

petitioner’s home, such as rugs, mirrors, and a chandelier in

the entryway; the fireplace mantle and mirrors in the living

room; vases, china, crystal, and a chandelier in the dining room;

dishes, glasses, a clock, and some appliances in the kitchen;

books, vases, a clock, and a statue in the den; a mirror and

figurines in the bedroom; clocks, pictures, and stained glass

in the bathrooms; and clothing and various other personal items.
 - 13 -

Petitioner inventoried and estimated the value of her

damaged personal property shortly after the earthquake.

Petitioner’s accountant, Robert Kern, gave her an Internal

Revenue Service worksheet to complete before he prepared her

amended 1988 return. On the worksheet, petitioner estimated the

cost and fair market value of her damaged personal property

items. She spent 50 to 100 hours researching the cost and fair

market value of the damaged items. She called stores to get the

cost of items for which she did not have receipts.

The earthquake destroyed some of petitioner’s personal

property, such as mirrors, statues, vases, and figurines. It

damaged other items such as bookcases, tables, chairs, a

grandfather clock, rugs, and appliances. Petitioner had to have

some of the damaged items repaired. For example, petitioner had

the buffet server, table, and chairs repaired.

Petitioner asked an appraiser, Mervyn Cohn (Cohn), to verify

the cost and fair market value of the damaged items. He checked

price guides, called retailers, and concluded that petitioner’s

estimates were reasonable. He discounted the pre-earthquake cost

or fair market value by 40 percent. He estimated that the value

of petitioner's personal property was $86,398 before the

earthquake. He assumed that the personal property listed by

petitioner as damaged by the earthquake had no salvage value.

He did not separately estimate the salvage value of each item.
 - 14 -

Cohn did not see petitioner’s personal property or

photographs of it. Cohn relied on information from petitioner

consisting of an attachment to her tax return, some handwritten

schedules, and a few receipts.

Petitioner had received some of the personal property that

was damaged by the earthquake as gifts. Her grandmother gave her

some leather-bound books, a magazine rack, and some stemware.

Petitioner did not establish the donor's basis in any of the

gifts. Petitioner inherited some items, including the dining

room chandelier and books, from her aunt.

F. Property Tax Assessment

In January 1990, petitioner applied for a reduction in the

property tax assessment of her home because of the earthquake

damage. San Mateo County reduced the property tax assessment of

her home by $202,200 from $317,000 to $114,800 based on repair

estimates by Cook ($150,000 for foundation repair and $47,600

for other structural repairs) and Arbor Electrical ($4,593 for

electrical repairs) and a telephone conversation with

petitioner’s realtor, Clare Box (Box). Box estimated that the

value of petitioner's home was $389,000 before the earthquake and

$188,057 after the earthquake, for a loss in value of $200,943.

In March 1991, in response to a questionnaire from San Mateo

County, petitioner said that the foundation had been reinforced

to prevent future damage but that the floors had not been

leveled. In March 1993, in response to a questionnaire from San
 - 15 -

Mateo County, petitioner said that she had repaired the damage to

her property. The County reappraised the property at $350,705.

G. Petitioner's Insurance Claim

Petitioner was insured for earthquake damage up to $42,000

by USAA. Petitioner submitted a claim to USAA for personal

property damage of $59,967.99.

A USAA inspector estimated that petitioner’s real property

damage was $40,000 to $60,000, which exceeded the $30,000 policy

limit. Lentom General, a building contractor, estimated that it

would cost $50,000 to $55,000 to jack up the building to level

the floors. Lentom General sent its estimate to USAA.

On February 16, 1990, USAA paid $12,000 to petitioner for

personal property damage and $30,000 for real property damage

caused by the earthquake. This amount ($42,000) was the maximum

allowed by her policy.

H. Homeowners’ Association Insurance

The Homeowners’ Association insured the condominium complex

with Aetna Life & Casualty (Aetna). On April 10, 1990, Aetna

denied coverage for the earthquake damage. Aetna concluded that

petitioner’s damage was less than the deductible (5 percent of

the cost of her building). The policy excluded damage to the

foundation. Aetna did not consider foundation damage in

concluding that the damage was less than the deductible.

I. Petitioner’s Tax Returns
 - 16 -

Petitioner timely filed a Federal income tax return for

1988. Petitioner properly elected under section 165(i) to claim

a loss deduction in the immediately preceding tax year. She

filed an amended 1988 return on April 9, 1990, to claim a

casualty loss of $290,262,1 for the damage caused by the

earthquake.

The Homeowners’ Association had made minimal repairs to

her home when she filed her amended 1988 return. Aetna denied

coverage under the Homeowners’ Association policy for the

earthquake damage to petitioner’s home on April 10, 1990.

Petitioner filed amended returns for 1985, 1986, and 1987 on

June 6, 1990. She carried back net operating losses of $250,661

to 1985, $208,242 to 1986, and $172,919 to 1987 from the unused

1988 casualty loss. She carried forward $121,814 of the unused

casualty loss to 1989.

Petitioner filed her 1989 return around April 15, 1990.

1
Petitioner calculated her casualty loss deduction as
follows:

Personal property damage $134,411
Real property damage 202,200
Subtotal 336,611
Less:
Insurance proceeds 42,000
Sec. 165(h)(1) limit 100
Sec. 165(h)(2) limit 4,247
46,347

Casualty loss 290,264

Petitioner deducted $290,262 as a casualty loss deduction.
There is no explanation in the record for the $2 discrepancy.
 - 17 -

By notices of deficiency issued on February 19, 1993,

respondent disallowed all of petitioner's casualty loss deduction

and associated carrybacks and carryforward.

OPINION

A. Casualty Loss Deduction

1. Contentions of the Parties

Petitioner argues that she may deduct her losses from the

earthquake as a casualty loss. She contends that she offered

evidence showing the difference between the fair market values of

her home and personal property before and after the earthquake

and the adjusted bases of the property, and that respondent

offered no evidence that the earthquake did not cause the damage.

Respondent contends that petitioner has not proven that her

losses exceeded the amount of insurance proceeds she received, or

that the fair market value of the property was less after the

earthquake than before.

As discussed below, we conclude that petitioner’s losses

were greater than her insurance reimbursement but less than the

amount she deducted.

2. Eligibility for a Casualty Loss Deduction

Individuals generally may deduct losses to property caused

by casualties such as earthquakes. Sec. 165(c)(3). The loss

must exceed $100 and 10 percent of the individual’s adjusted

gross income. Sec. 165(h)(1) and (2)(A)(ii). Taxpayers may not
 - 18 -

deduct amounts compensated by “insurance or otherwise.” Sec.

165(a).

Taxpayers who suffer disaster losses in an area declared a

disaster area by the President may elect to deduct the loss in

the tax year immediately preceding the year in which the disaster

occurred. Sec. 165(i)(1).

To be eligible for a casualty loss deduction based on the

decrease in the fair market value, petitioner must prove: (a)

The fair market value of the property immediately before and

immediately after the earthquake, (b) the amount of insurance

reimbursement, and (c) the adjusted basis in the property.

Helvering v. Owens, 305 U.S. 468 (1939); Lamphere v.

Commissioner, 70 T.C. 391, 395-396 (1978); Cornelius v.

Commissioner, 56 T.C. 976, 979 (1971); sec. 1.165-7(a)(2), Income

Tax Regs.2

2
Sec. 1.165-7(a)(2), Income Tax Regs., provides:

(2) Method of valuation. (i) In determining the
amount of loss deductible under this section, the fair
market value of the property immediately before and
immediately after the casualty shall generally be
ascertained by competent appraisal. This appraisal
must recognize the effects of any general market
decline affecting undamaged as well as damaged property
which may occur simultaneously with the casualty, in
order that any deduction under this section shall be
limited to the actual loss resulting from damage to
the property.

(ii) The cost of repairs to the property damaged
is acceptable as evidence of the loss of value if the
taxpayer shows that (a) the repairs are necessary to
(continued...)
 - 19 -

The cost of repairs may be considered if the taxpayer shows

that: (a) The repairs are necessary to restore the property to

its condition immediately before the casualty, (b) the amount

spent for the repairs is not excessive, (c) the repairs are made

only to the damaged portion of the property, and (d) the repairs

do not cause the value of the property to exceed the value of

the property immediately before the casualty. Lamphere v.

Commissioner, supra; Farber v. Commissioner, 57 T.C. 714, 719

(1972); sec. 1.165-7(a)(2)(ii), Income Tax Regs.

Respondent's determination is presumed to be correct. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

3. Structural Damage to Petitioner’s House

The fair market value of petitioner’s house before the

earthquake was $324,000, the amount petitioner had paid for it

about 11 months earlier.

The parties each called expert witnesses to give their

opinions about the structural damage to petitioner's house caused

by the earthquake. Expert witnesses' opinions can help the Court

to understand subjects requiring specialized training, knowledge,

or judgment. However, the Court is not bound by the experts'

2
(...continued)
restore the property to its condition immediately
before the casualty, (b) the amount spent for such
repairs is not excessive, (c) the repairs do not care
for more than the damage suffered, and (d) the value
of the property after the repairs does not as a result
of the repairs exceed the value of the property
immediately before the casualty.
 - 20 -

opinions. Helvering v. National Grocery Co., 304 U.S. 282, 295

(1938). We weigh the opinions of expert witnesses according to

their qualifications and other relevant evidence. Anderson v.

Commissioner, 250 F.2d 242, 249 (5th Cir. 1957), affg. in part

and remanding in part T.C. Memo. 1956-178; Johnson v.

Commissioner, 85 T.C. 469, 477 (1985).

Respondent’s expert, Lewis, gave no opinion about the fair

market value of petitioner’s house after the earthquake.

Petitioner’s expert, Halpin, estimated that the postearthquake

value was $116,700.

a. Halpin’s Valuation

Halpin inspected petitioner’s home on August 25 and

November 20, 1994. He reviewed various documents that petitioner

gave him, including Cook’s December 5, 1989, estimate; memos from

CMA to Graham & Kellam; Lewis’ written report dated January 31,

1990, describing his findings and recommendations concerning the

postearthquake damage to petitioner’s home after on-site

inspections on December 8, 1989, and January 19, 1990 (Exhibit

12-L); a May 11, 1990, letter from Graham reviewing the condition

of petitioner’s home; and a November 15, 1990, letter and

application from CMA for a permit to retrofit petitioner’s home.

Halpin prepared a report describing the damages to petitioner's

home caused by the earthquake and the repairs needed to restore

the house to its pre-earthquake condition. He subtracted his

estimate of the cost of repairs and his estimate of the cost of
 - 21 -

retrofitting the foundation to get the postearthquake loss in

value of petitioner's home.

Respondent argues that Halpin improperly used a cost-of-

repair method. We disagree. Halpin valued petitioner's home by

comparing its fair market value before and after the earthquake.

An appraiser may consider repair cost estimates in deciding

postcasualty fair market value. Pfalzgraf v. Commissioner, 67

T.C. 784, 788 (1977); Abrams v. Commissioner, T.C. Memo.

1981-231. In Abrams, an appraiser used repair estimates to

confirm his estimate of postearthquake fair market value, which

he based on the market method. In Pfalzgraf, we held that, in

estimating the amount of a casualty loss, an appraiser may

consider the cost of repairing property to restore it to its

precasualty status. 67 T.C. at 788. We rejected the taxpayers’

method of estimating their loss based on the difference between

the prefire fair market value and the postfire fair market value

because the taxpayers’ method included losses or expenses not

caused by the fire. Id. at 789-791.

Respondent contends that Abrams and Pfalzgraf do not stand

for the proposition that repair estimates may be used to

calculate a casualty loss. We disagree. The taxpayer's expert

in Abrams concluded that a prospective buyer would discount the

value of the damaged building by the cost of needed repairs. He

subtracted the estimated cost of repairs from the precasualty

fair market value. Similarly, Halpin estimated the loss in value
 - 22 -

of petitioner’s home by subtracting the estimated cost of repairs

from its pre-earthquake fair market value.

In Pfalzgraf, we approved an appraiser’s estimate of the

cost of repairing property as a measure of the taxpayers’

casualty loss. 67 T.C. at 788. Here, Halpin figured

petitioner’s casualty loss by estimating the cost of restoring

petitioner's home to its pre-earthquake condition.

Respondent argues that Halpin’s testimony should be given

little weight because he is not an engineer. We disagree.

Halpin was a credible and knowledgeable witness.

Respondent argues that we should give Halpin’s report less

weight because Halpin first saw petitioner's property 5 years

after the earthquake. We agree. We give Halpin’s report less

weight because some of the property damage could have occurred

during those 5 years.

Respondent pointed out that Halpin testified that the second

floor was sloped, yet Halpin did not measure the second floor and

did not note that it was sloped on his diagram of that floor. In

his diagram of the first floor, he noted that it was sloped. We

do not think Halpin’s failure to measure the second floor is

significant. He testified that he could feel the slope by

walking across the floor, and that he did not take measurements

because it would be expensive to do so and because he thought it

was sufficient to measure the first floor. Santangelo testified

that he had to level the second floor before he retiled it.
 - 23 -

Graham wrote to Lewis on May 11, 1990, that the second floor was

out of level.

Respondent argues that the earthquake did not worsen the

crack in the concrete garage slab. We disagree. Cook viewed

the garage shortly after the earthquake. He concluded that the

earthquake worsened the crack in the garage floor and that the

garage floor should be replaced.

There are defects in Halpin's valuation. He used 1994 labor

and materials cost estimates instead of 1989 costs. He included

repairs that may have been required by wear and tear on the

property during the 5 years between the earthquake and his

survey, such as interior and exterior painting. He estimated

that it would cost $50,000 to retrofit the foundation of

petitioner's home although the Homeowners' Association had paid

Hensley $7,381 in November 1990 to retrofit the foundation of her

home. He double-counted a $2,600 estimate to perform certain

electrical work in the foundation. He incorrectly included in

his estimate $8,750 for petitioner to vacate her unit and store

her belongings during repairs. Millsap v. Commissioner, 46 T.C.

751 (1966), affd. 387 F.2d 420 (8th Cir. 1968) (additional living

expenses, e.g., moving expenses and temporary accommodations

expenses, resulting from a casualty are not deductible as part of

a casualty loss).
 - 24 -

b. Respondent’s Expert--Frank Lewis

i. Admissibility of Respondent’s Expert’s Report

Respondent’s expert at trial was Frank Lewis.

Rule 143(f) provides that, unless otherwise permitted by the

Court upon timely request, any party who calls an expert witness

shall cause that witness to prepare a written report to submit to

the Court and the opposing party not later than 30 days before

the calendar call. Rule 143(f)(1). We will exclude expert

witness testimony for failure to comply with the provisions of

Rule 143(f) unless the failure is due to good cause, and the

failure to comply with the Rule does not unduly prejudice the

opposing party. Id.

The Court granted respondent’s request at trial to designate

Exhibits 12-L, T (pages 26-27), and Z as Lewis’ expert report.

Exhibit 12-L is Lewis’ report dated January 31, 1990, describing

his findings and recommendations concerning the earthquake damage

to petitioner’s home after inspections on December 8, 1989, and

January 19, 1990. The report includes about 25 photographs of

the foundation of petitioner’s home. Pages 26 and 27 of Exhibit

T are a letter dated June 13, 1990, from Lewis to Graham &

Kellam, recommending that the floors of petitioner’s unit be

leveled by removing, reconstructing, and stabilizing the pony

walls and without jacking up her unit. Exhibit Z is Lewis’

curriculum vitae.
 - 25 -

Petitioner contends that we should not have allowed

respondent to designate those exhibits as Lewis’ expert report

because respondent failed to do so 30 days before the calendar

call. Petitioner also contends that we should strike Lewis’

testimony because respondent listed Lewis in the pretrial

memorandum as a fact witness, not as an expert. Petitioner

argues that she was prejudiced because Halpin did not fully

respond to Lewis’ report in his report and because petitioner’s

counsel could not adequately prepare for cross-examination of

Lewis.

We disagree. Petitioner was not prejudiced in any way by

the admission into evidence of Lewis’ expert report and expert

testimony. Halpin referred to and relied on Exhibit 12-L (Lewis’

report) in preparing his own expert report. Halpin had Exhibit

12-L and petitioner’s counsel had pages 26-27 of Exhibit T

several months before trial. Halpin became thoroughly familiar

with these items before he testified at trial. Our consideration

of the points made by Lewis in those exhibits was identical

whether or not we treated the exhibits as Lewis’ expert report.

Respondent listed Lewis as a fact witness for this trial session

and one the year before. His expert testimony directly related

to his factual knowledge gained from his investigation of

petitioner’s residence after the earthquake. Petitioner had

every opportunity at trial to have Halpin respond to Lewis’
 - 26 -

testimony, and petitioner’s counsel used this opportunity

effectively. Permitting Lewis to testify as an expert did not

prejudice petitioner in any way. Cf. Chagra v. Commissioner,

T.C. Memo. 1991-366 (taxpayers' motion to strike expert testimony

was granted because taxpayers did not have access to the

Commissioner's expert's conclusions and their underlying bases

before trial), affd. without published opinion 990 F.2d 1250 (2d

Cir. 1993).

Petitioner cites Smith v. Ford Motor Co., 626 F.2d 784 (10th

Cir. 1980), in which the U.S. Court of Appeals for the Tenth

Circuit concluded that the defendant had been prejudiced by

expert testimony. In Smith, the plaintiff failed to provide

adequate advance information about proposed testimony of a

medical expert witness, and the plaintiff elicited testimony from

the witness that was outside the scope of the plaintiff's

description of his proposed testimony. Defendant's counsel had

only 11 minutes to prepare for cross-examination of the expert

witness. Id. at 791 n.3. In contrast, as discussed above, long

before trial, petitioner’s expert and petitioner’s counsel were

thoroughly familiar with the items that we treated as Lewis’

expert report, and petitioner was not prejudiced by the admission

of Lewis' expert testimony or expert report.

ii. Lewis’ Conclusions

Lewis and Graham said that the foundation of petitioner's

house was structurally sound and could be repaired by injecting
 - 27 -

epoxy into the cracks. Respondent attempts to minimize the fact

that Lewis said that the foundation was not sound, that the house

appeared to be rolling off its foundation, and that a foundation

should be replaced if it has more than 20 cracks. The foundation

in petitioner's home had 25 cracks after the earthquake.

Petitioner points out that Lewis worked for CMA, which had been

retained by the Homeowners' Association. These facts lead us to

give Lewis’ opinion less weight.

Lewis and Graham said that the first floor of petitioner's

home was not level when it was built. We disagree. Hise

testified that the floors were level when he inspected the house.

Barrett had to rehang several of the doors, which shows that the

Graham & Kellam report erred in stating that all of the doors fit

and were plumb. Halpin concluded that the earthquake caused

petitioner's floors to be out of level. We agree.

Halpin believed that an epoxy injection would be

insufficient and that the foundation needed to be replaced.

Graham is a structural engineer and is better qualified to

evaluate the foundation than Halpin. While Halpin’s overall

testimony was credible, he is not an engineer and is less

knowledgeable about foundations than Graham.

Respondent questions whether Hise did a thorough

investigation for his $200 fee. Respondent says that Hise failed

to adequately inspect the foundation and report on its condition.

Respondent’s criticism of Hise is at best speculative.
 - 28 -

Respondent did not raise these criticisms when Hise testified at

trial and thus did not give Hise a chance to respond to them.

Hise is a licensed general contractor. He prepared a detailed

report on the condition of petitioner’s home. His testimony

appeared to be credible. We accept Hise’s report as a fair

representation of the condition of petitioner’s house before the

earthquake.

Respondent argues that the fact that petitioner lived in

her home after the earthquake but did not repair the foundation

shows that she believed that the building was safe. However,

respondent has not shown or even argued that a house must be

uninhabitable to lose value to the extent that petitioner

contends.

c. Improvements to Petitioner’s Home

A taxpayer must show that the repairs do not improve the

property more than the damage suffered, and that the value of the

property after the repairs does not, as a result of the repairs,

exceed the value of the property immediately before the casualty.

Sec. 1.165-7(a)(2)(ii), Income Tax Regs. Respondent points out

that some of petitioner's expenses were for improvements to her

home. For example, petitioner installed marble tile worth a

couple of hundred dollars more than the tile that was there

previously, and she upgraded some fixtures and door hardware.
 - 29 -

d. Conclusion

We conclude that the earthquake caused the foundation to

crack in 25 places and the floors to slope. We also conclude,

based primarily on the Graham & Kellam report, that the

foundation of petitioner's home could be repaired. However, we

believe a buyer would pay much less for a home in that condition

than he or she would pay for the same property undamaged. Even

though the Homeowners’ Association was liable for making some of

the repairs, we believe a prospective buyer would pay less for

this property than for identical property where no repairs were

required because of the possibility that it would take effort to

ensure that the work was done. We conclude that petitioner’s

home lost $115,000 in value because of the earthquake.

4. Personal Property

Petitioner’s personal property was also damaged by the

earthquake. She deducted $134,411 on her 1988 return for loss

to her personal property. She attached an appendix to her brief

showing that she had a personal property loss of $110,065. We

treat the appendix as petitioner's position in this case relating

to her personal property loss.

Petitioner compiled a detailed inventory of her personal

property that was damaged or destroyed as a result of the

earthquake. She spent 50 to 100 hours researching the cost of

the damaged items. Cohn said that the values petitioner used

were reasonable. Petitioner contends that, although she did not
 - 30 -

testify about or have notes on each item on her list, based on

her testimony, notes and receipts, and Cohn’s testimony, we

should conclude that she prepared an honest inventory of her

damaged property.

Respondent argues that we should not consider Cohn's

appraisal because he did not see petitioner’s personal property

or photographs of property, and he lacked information about some

of the items. We agree in part and disagree in part. Cohn

appeared to be knowledgeable, and he readily disclosed the limits

inherent in the methodology he used. On the other hand, Cohn

lacked necessary information, such as the age, original cost, or

pre-earthquake fair market value of some of petitioner’s items.

He incorrectly assumed that none of the property had salvage

value. Cohn did not know the size of or the number of lights in

the chandeliers, or the amount of crystal in them. He did not

know the height, type, quality, or condition of the grandfather

clock. He did not know the size or quality of the antique bells

or whether they were made of metal. Cohn valued 20 books at $20

per book without knowing their titles, age, or condition.

Petitioner’s estimates of the amount of her personal

property damage were flawed in part. She used the wrong year

of purchase for a few of the items. The refrigerator, stove,

carpeting, and the entrance hall chandelier had all been in the

unit since it was built in 1982, yet petitioner listed the date

of purchase as 1988, the year she bought the condominium.
 - 31 -

Appliances and carpeting are worth much less after 7 years than

after 1 year.

For a few items that had lost value before the earthquake,

petitioner deducted cost rather than the fair market value. She

did not consider depreciation in estimating the precasualty fair

market value of her clothes that were damaged.

Petitioner had some items repaired that had been damaged by

the earthquake, such as the buffet server and the dining room

table and chairs. If a taxpayer has repaired property damaged by

a casualty, the cost of repairs may be a better measure of the

loss than an appraisal. Clapp v. Commissioner, 321 F.2d 12 (9th

Cir. 1963), affg. 36 T.C. 905 (1961); Pfalzgraf v. Commissioner,

67 T.C. at 791; Keith v. Commissioner, 52 T.C. 41, 49 (1969).

Petitioner incorrectly used a diminution in value method rather

than the actual repair cost to measure her loss for these items.

Petitioner claims that things fell on and scratched her

refrigerator and stove. She also claims that heavy things fell

on and bent and scratched her knives and forks. We think

petitioner overestimated the extent of damage to these items.

We are not convinced that the earthquake extensively damaged her

refrigerator, oven, blender, electric iron, kitchen sink, ladder,

utensils, telephone, rack, and all clocks, or that it destroyed

napkins, tablecloths, towels, and a bath mat. We are not

convinced that she lost $520 of canned goods, $4,000 of plumbing

fixtures, 400 pieces of china, and 122 pieces of stemware.
 - 32 -

As discussed at paragraph A-2 above (p. 17), petitioner

must prove her adjusted basis in property for which she claims

a casualty loss. A taxpayer who acquires property by gift takes

a basis in the property equal to the lesser of the donor's basis

or the fair market value at the time of the gift. Sec. 1015. A

taxpayer who inherits property takes a basis in the property

equal to its fair market value at the date of the decedent's

death. Sec. 1014(a). Petitioner did not establish the basis she

had in property that she received by gift or inheritance. For

example, she did not show that the fair market value she provided

was determined at the time of the earthquake or at the time of

her aunt's death. She said that the chandelier, which she valued

at $14,500, was not listed as an asset in her aunt's estate tax

return. Petitioner did not show what her basis is for these

items.

Petitioner’s personal property was damaged by the

earthquake, but we think she overestimated the amount of damage.

We conclude that petitioner had personal property loss of

$35,000.

5. Insurance Payment

We conclude that the decrease in fair market value of

petitioner’s home due to the earthquake exceeded her insurance

recovery.

Petitioner received $42,000 ($30,000 plus $12,000) as

insurance reimbursement, the maximum allowed under her policy.
 - 33 -

As discussed above, petitioner sustained losses of $115,000 to

the structure of her home and $35,000 to her personal property.

This exceeds her insurance recovery by $108,000.

6. Year of Loss

a. Reasonable Prospect of Recovery

Petitioner may deduct her casualty loss only to the extent

it is not compensated by “insurance or otherwise”, e.g., by the

Homeowners' Association. Sec. 165(a). Respondent argues that

petitioner did not have an uncompensated loss because the

prospects of repair by the Homeowners’ Association were very high

in 1990 when petitioner filed her amended 1988 return. Whether

there is a reasonable prospect of recovery is decided based on

all the facts known in the taxable year. Coastal Terminals, Inc.

v. Commissioner, 25 T.C. 1053 (1956); sec. 1.165-1(d)(2)(i),

Income Tax Regs.3 Petitioner filed her amended 1988 return

3
Sec. 1.165-1(d)(2)(i), Income Tax Regs., provides:

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 section 165, until it can be ascertained
with reasonable certainty whether or not such
reimbursement will be received. Whether a reasonable
prospect of recovery exists with respect to a claim for
reimbursement of a loss is a question of fact to be
determined upon an examination of all facts and
circumstances. Whether or not such reimbursement will
be received may be ascertained with reasonable
certainty, for example, by a settlement of the claim,
by an adjudication of the claim, or by abandonment of
(continued...)
 - 34 -

shortly before Aetna denied her claim for damage under the

Homeowners’ Association policy.4 Respondent argues that

petitioner had a reasonable prospect of recovery when she filed

her return because Aetna had not yet denied her claim. We

disagree. The Homeowners’ Association was short on funds in 1990

and had made only minimal repairs to petitioner's home in April

1990 when she filed her amended 1988 return. It was uncertain

whether it could afford to make all of the repairs for which it

was responsible. Notwithstanding the fact that the Homeowners’

Association could have specially assessed its members to pay for

repairs, there is no evidence that it did so in 1990.5 The fact

that it could have done so did not give petitioner a reasonable

prospect of recovery in 1990. We conclude that petitioner had

losses from the earthquake for which she had no reasonable

prospect of recovery from insurance or otherwise and which she

properly deducted on her amended 1988 return.

b. Role of the Homeowners’ Association

3
(...continued)
the claim. * * *
4
Petitioner contends that she filed her amended 1988 return
on Apr. 14, 1990, after Aetna Life & Casualty (Aetna) denied her
claim for damage under the Crestview Park Condominium Homeowners'
Association (Homeowners' Association) policy. The record clearly
shows, however, that she filed her return on Apr. 9, 1990, before
Aetna denied her claim.
5
Petitioner said that the Homeowners' Association made a
special assessment equal to 6 months of dues, but it appears that
was in 1991 or later.
 - 35 -

Respondent contends that the Homeowners’ Association was

responsible for making various repairs to petitioner's home.

However, petitioner did not have a reasonable prospect of

recovery from the Homeowners’ Association when she filed her

amended 1988 return. Thus, she may deduct as a casualty loss

her real property loss even if the Homeowners’ Association was

responsible for making repairs to her home.6

B. Additions to Tax

1. Negligence

Negligence is a lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances. Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th

Cir. 1984), affg. 79 T.C. 714 (1982); Marcello v. Commissioner,

380 F.2d 499, 506 (5th Cir. 1967), affg. in part and remanding

in part 43 T.C. 168 (1964) and T.C. Memo. 1964-299; Neely v.

Commissioner, 85 T.C. 934, 947 (1985). Petitioner must show that

she acted reasonably and prudently and exercised due care. Neely

v. Commissioner, supra.

Respondent argues that petitioner did not use reasonable

care in assessing her casualty loss from the earthquake. We

disagree.

6
Respondent does not contend that petitioner may not (as a
matter of law) deduct a casualty loss for damage to the common
areas.
 - 36 -

Petitioner has no tax or accounting background. She used a

competent contractor to contemporaneously estimate the amount of

damage to her home. She was reasonably careful in preparing her

loss estimate, and she reasonably relied on her accountant to

prepare her return. She gave her accountant all necessary

information to prepare her return. She attached to Form 4684,

Casualties and Thefts, a detailed inventory of her personal

property loss and the $202,200 reduction in the value of her real

property by the San Mateo County tax assessor's office. She

hired a personal property appraiser to verify her estimates of

her personal property loss. Petitioner made a reasonable attempt

to figure the amount of her casualty loss. We hold that she was

not negligent.

2. Substantial Understatement

The next issue for decision is whether petitioner is liable

for the addition to tax for substantial understatement of income

tax under section 6661(a) for tax years 1985-87. Section 6661(a)

provides for an addition to tax in the amount of 25 percent of

the amount of any underpayment attributable to a substantial

understatement of income tax.

An understatement is the amount by which the correct tax

exceeds the tax reported on the return. Sec. 6661(b)(2)(A). An

understatement is substantial if it exceeds the greater of 10

percent of the tax required to be shown on the return or $5,000.
 - 37 -

Sec. 6661(b)(1)(A). Petitioner bears the burden of proving

that imposition of the addition to tax under section 6661 is

erroneous. Rule 142(a); Tweeddale v. Commissioner, 92 T.C. 501,

506 (1989).

If a taxpayer has substantial authority for the

tax treatment of any item on the return, the understatement

is reduced by the amount attributable to it. Sec.

6661(b)(2)(B)(i). Similarly, the amount of the understatement

is reduced for any item adequately disclosed either on the

taxpayer's return or in a statement attached to the return.

Sec. 6661(b)(2)(B)(ii). A taxpayer’s position may be adequately

disclosed either in a statement attached to the tax return, or

on the tax return itself. Id. Respondent contends that

petitioner did not have substantial authority for her position

but does not deny that she adequately disclosed the casualty loss

on her 1985, 1986, and 1987 returns. We consider whether

petitioner adequately disclosed her position on her 1985, 1986,

and 1987 returns.

Disclosure can be accomplished under section 6661 by

providing sufficient information on the tax return to enable the

Commissioner to identify the potential controversy. Schirmer v.

Commissioner, 89 T.C. 277, 285-286 (1987).

The Commissioner may promulgate revenue procedures which

prescribe the circumstances in which information provided on a
 - 38 -

tax return is adequate disclosure under section 6661. Sec.

1.6661-4(c), Income Tax Regs. Section 4(a)(5) of Rev. Proc. 89-

11, 1989-1 C.B. 797, 798, provides that to adequately disclose a

casualty loss for purposes of section 6661, the taxpayer must

complete Form 4684 and attach it to the return.

Petitioner attached Forms 4684 to the amended returns she

filed for 1985, 1986, and 1987. In them, she described her real

and personal property loss from the earthquake. She included a

detailed inventory of her personal property that was damaged

or destroyed by the earthquake. We conclude that petitioner

adequately disclosed her casualty loss on her 1985, 1986,

and 1987 returns. Rev. Proc. 89-11, sec. 4(a)(5). Thus, we

hold that petitioner is not liable for the addition to tax under

section 6661 for 1985, 1986, and 1987.

3. Accuracy-Related Penalty

Taxpayers are liable for a penalty equal to 20 percent

of the part of the underpayment attributable to negligence or

disregard of rules or regulations. Sec. 6662(a) and (b)(1).

Negligence includes a failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws or to

exercise ordinary and reasonable care in the preparation of a

tax return. Sec. 6662(c).

Petitioner bears the burden of proving that she is

not liable for the accuracy-related penalty. Rule 142(a).
 - 39 -

For the reasons stated at paragraph B-1, above (pp. 34-35),

we hold that petitioner is not liable for the accuracy-related

penalty for 1989.

To reflect the foregoing,

Decision will be entered

under Rule 155.