T.C. Memo. 2000-56
UNITED STATES TAX COURT
MIGUEL MARTIN AND CLAUDIA P. PALOS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5871-98. Filed February 22, 2000.
Miguel Martin and Claudia P. Palos, pro sese.
Linette B. Angelastro, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined a $20,244 deficiency
in petitioners’ 1994 income tax. After concessions by
petitioners, the issue remaining for our consideration is whether
petitioners are entitled to a casualty loss for earthquake damage
caused to a residence owned by them.
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FINDINGS OF FACT
Petitioners resided at Monrovia, California, at the time
their petition was filed. Petitioners, from 1989 through early
1999, owned real property located at 3748 Military Avenue, Los
Angeles, California (Military property). The Military property
was first listed for sale on October 1, 1993. Petitioners had
been using the Military property as their personal residence up
to the time they began their attempt to sell the property.
Petitioners began moving their furniture out of the Military
property shortly after the October 1993 listing for sale.
Petitioners moved in with Mr. Palos’ mother at some time prior to
the January 17, 1994, earthquake, and, subsequent to the
earthquake, moved into a newly purchased residence other than the
Military property.
During 1993, petitioners commenced making improvements and
repairs to the Military property in order to enhance its
appearance and value for purposes of sale. The Northridge
Earthquake occurred on January 17, 1994, and caused damage to
petitioners’ Military property. After the earthquake,
petitioners continued to make improvements to the Military
property and also began to repair the damage caused by the
earthquake. The improvements, as opposed to repairs from
earthquake damage, appear to represent the significantly greater
portion of more than $60,000 in expenditures involving the
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Military property. About 4 days after the Northridge earthquake,
petitioners rented the Military property.
Petitioners filed a claim with their property insurance
carrier with respect to the earthquake. The insurance adjuster
estimated that the repair necessary to address the earthquake
damage was $9,221, an amount that was less than petitioners’
$9,530 policy deductible for earthquake damage. Petitioners
consulted with a real estate company, seeking an opinion as to
the decrease in fair market value, if any, due to the earthquake.
The real estate company opined that the Military property lost
approximately $30,000 in value due to the earthquake. The
reduction in value was attributable to the actual damage and also
to the safety issues that may be perceived by potential buyers of
damaged older homes in areas prone to earthquake damage.
On their 1994 joint income tax return, petitioners, on
advice of their return preparer, claimed a $25,000 business
casualty loss on the premise that the Military property was held
for business or other income-producing purposes; i.e., for rental
or sale at the time of the earthquake. Respondent determined
that petitioners were not entitled to a casualty loss.
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OPINION
Section 165(a)1 allows a deduction for “any loss sustained
during the taxable year and not compensated for by insurance or
otherwise.” Although an individual taxpayer’s business and
personal casualty losses are deductible under section 165(c),
there is a distinction between them. Casualty losses incurred in
a business or other profit-seeking activity can be fully
deductible, whereas personal casualty losses are subjected to a
$100 exclusion and must exceed 10 percent of a taxpayer’s
adjusted gross income. See sec. 165(h)(1) and (2). That
distinction is critical to petitioners because the limitations on
personal losses may reduce or eliminate petitioners’ ability to
deduct a casualty loss deduction. There is no dispute about the
occurrence of the earthquake, and respondent seems to agree that
petitioners had some loss; however, respondent contends that the
loss was personal and was of an amount that would not have
exceeded the threshold limitations.
First, we consider the amount of petitioners’ loss. A
casualty loss is the difference between the fair market value of
the property immediately before and immediately after the
casualty. See sec. 1.165-7(a)(2)(i), Income Tax Regs.
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the tax year under
consideration, and Rule references are to this Court’s Rules of
Practice and Procedure.
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Deductions under the above-cited regulation are, however,
“limited to the actual loss resulting from damage to the
property.” Id. An alternative approach to valuing a loss from
damage to property is for a taxpayer to present evidence of
repairs to the subject property. See sec. 1.165-7(a)(2)(ii),
Income Tax Regs. In that regard, a taxpayer must show that the
repairs were made to restore the property to its precasualty
condition and not to improve the property. See id.
In this case, petitioners provided evidence in an attempt to
show the effect of earthquake damage on the fair market value of
their property. The real estate agent’s opinion that the value
decreased by about $30,000 is in line with the $25,000 claim
petitioners made on their 1994 income tax return. The opinion,
however, was based on actual damage and also on the safety issues
that may be perceived by potential buyers of damaged older homes
in areas prone to earthquake damage. Under the above-quoted
regulation, however, petitioners’ claim would be limited to the
amount of actual damage. See id.; see also Kamanski v.
Commissioner, 477 F.2d 452 (9th Cir. 1973), affg. T.C. Memo.
1970-352; Pulvers v. Commissioner, 407 F.2d 838, 839 (9th Cir.
1969), affg. 48 T.C. 245 (1967); Chamales v. Commissioner, T.C.
Memo. 2000-33.
Petitioners also attempted to show that the damage exceeded
$25,000 by showing the extensive expense incurred in connection
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with their Military property during the period preceding and
following the earthquake. Petitioners’ evidence of actual
repairs, however, falls short of showing losses from earthquake
damage in excess of $9,221, the amount determined by petitioners’
insurance company. It is difficult to delineate between amounts
that were being used to renovate and improve and those that were
directly attributable to the earthquake. In addition, the
insurance company’s estimate that actual repairs attributable to
earthquake damage were $9,221 militates against petitioners’
claims. We hold that petitioners have not shown that more than
$9,221 damage occurred from the earthquake.
Finally, we must decide whether petitioners’ property had
been converted from a personal residence to business or income-
producing property prior to the time that earthquake damage was
incurred. Respondent contends that the record contradicts
petitioners’ claim that the property had been converted to
business (rental) or income-producing property. We agree. The
parties have addressed this aspect of the case in two parts.
They disagree as to whether petitioners no longer resided in the
property and whether the property had been converted to business
or income-producing property as of the occurrence of the January
17, 1994, earthquake.
The record reflects that petitioners started to move
furnishings out of the Military property beginning in October
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1993 and that substantial improvements and repairs were begun and
remained ongoing after that time and through the time of the
earthquake. Petitioners’ evidence was sufficient to establish
that the Military property was no longer used as their personal
residence as of January 17, 1994.
Respondent also relies on a statement that respondent’s
agent testified was made during the examination. The testimony
of respondent’s agent is as follows:
I’m not sure if it was the first interview or the
second one. I did see * * * [petitioner] two times,
once in his home and once in the office after hours.
But I know we discussed the earthquake because I
mentioned--I believe I mentioned to him what happened
to us in my home, and I know he said his furniture was
in the house and that he wasn’t out of the house yet.
Petitioners and Mr. Palos’ mother, however, testified under oath
that they were no longer using the Military property as a
residence by the time of the earthquake. In addition, with
extensive repairs underway at the Military property beginning
around October 1993, it is unlikely that petitioners remained in
the house when other and better choices were available to them.
Accordingly, we find that petitioners were not using the subject
property as their personal residence at the time of the
earthquake.
Respondent also questions whether the Military property was
held for sale or rent in such a manner as to be considered
business or income-producing property within the meaning of
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section 165. Property that is used as a taxpayer’s residence may
be converted to rental or other income-producing property within
the meaning of section 165(a). See, e.g., section 1.165-9,
Income Tax Regs. (concerning the sale of residential property).
On that point, petitioners’ evidence did not show that the
property had definitively been converted to rental or other
income-producing property at the time of the earthquake.
Generally, taxpayers must do more than merely list their
residential realty to convert its use from personal to one which
would permit a loss under section 165 that is not subject to the
limitation of section 165(h)(1) and (2). See, e.g., Newcombe v.
Commissioner, 54 T.C. 1298, 1302-1303 (1970); Rogers v.
Commissioner, T.C. Memo. 1965-8. Although petitioners had listed
the property for sale and were continuing to make repairs to
enhance the property, some of their furniture remained, and the
property was listed for sale rather than for rent. Petitioners
were able to lease the property just 4 days after the earthquake
occurred, but these events are not sufficient to place them over
the threshold necessary to convert their personal residence into
property for which section 165(c)(1) or (c)(2) losses would be
available. Accordingly, the $9,221 casualty loss is subject to
the limitations of section 165(h)(1) and (2).
Decision will be entered under
Rule 155.