T.C. Summary Opinion 2001-27
UNITED STATES TAX COURT
TRACY M. COLTER AND ROBERT N. COLTER, Jr., Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20771-98S. Filed March 9, 2001.
Tracy M. Colter and Robert N. Colter, Jr. pro sese.
Andrew M. Winkler, for respondent.
CARLUZZO, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority. Unless otherwise indicated,
subsequent section references are to the Internal Revenue Code in
effect for 1995. Rule references are to the Tax Court Rules of
Practice and Procedure.
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Respondent determined a $2,741 deficiency in petitioners’
1995 Federal income tax and a $548.20 penalty under section 6662.
The issue for decision is whether petitioners are entitled to a
casualty loss deduction in excess of the amount allowed by
respondent.
Some of the facts have been stipulated and are so found.
Petitioners are, and were during all relevant periods, married to
each other. At the time the petition was filed, they resided in
Fredonia, Kentucky.
Sometime in early 1993, petitioners and their children moved
from a rented house in Nashville, Tennessee, into a 3-bedroom,
2-bath, ranch-style brick house that they purchased in
Hendersonville, Tennessee (the Hendersonville residence). On
July 7, 1995, one of petitioners’ daughters plugged a vacuum
cleaner into an electrical outlet located in petitioners’
bedroom. Through some fault in either the vacuum cleaner or the
outlet, a fire started in that bedroom that caused substantial
damage to the Hendersonville residence and destroyed or badly
damaged most of the personal property located in the house.
At the time, petitioners were insured against fire losses
by the Westfield Companies (Westfield). Under the terms of
their insurance coverage, subject to various conditions and
limitations, petitioners were entitled to recover the replacement
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cost of personal property damaged or destroyed by fire. As a
result of the fire, petitioners received $118,970.92 (less the
$250 deductible attributable to personal property losses) from
Westfield. This amount includes $49,686.02 for damages to the
Hendersonville residence, $11,909.90 for additional living
expenses, and the policy limits of $57,375 (less the deductible)
for damages to or loss of personal property. Of the amount
petitioners received for loss of personal property, $11,642.94
was attributable to dry cleaning expenses, and the balance,
$45,732.06, was attributable to the replacement costs of various
items of personal property typically found in a family residence.
After an investigation, Westfield paid petitioners the policy
limits for their personal property losses because, according to
the insurance company, “the ACV [actual cash value] of the UPP
[unscheduled personal property] exceeded the limits and they were
not made whole”.
Westfield’s decision to pay policy limits for personal
property loss was based at least in part upon a document entitled
“Personal Property Inventory” prepared by petitioners within days
after the fire occurred (the inventory). The inventory consists
of 38 pages that itemizes and describes hundreds of items of
personal property destroyed by the fire. Some descriptions are
specific, e.g., “Magnavox 19 inch color television with VCR”,
others are more general, e.g., “belts”. For each item (or
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category of items) listed on the inventory, petitioners made
entries in designated columns for: (1) Number of items
destroyed; (2) date and place of purchase; (3) “original cost”;
and (4) replacement cost at or about the time of the fire.
For a few items, there is a variance between the entries
made for original cost and the replacement cost. For most, if
not all, of those few items, the replacement cost is higher than
petitioners’ estimated original cost for that item.
For most items, either the amounts entered for original cost
and the replacement cost are identical, or, if more than one item
was destroyed, the replacement cost listed is the product of the
number of items multiplied by the amount listed as the original
cost of the items. It appears that for these items, amounts
entered in the “original cost” column do not, as the name
suggests, represent petitioners’ costs of the items, but instead
duplicate petitioners’ estimate of the replacement costs of those
items.
From the information supplied by petitioners, Westfield
computed the “actual cash value” of each item listed on the
inventory by applying a depreciation factor, ranging from 20
percent to 70 percent, to the replacement cost of each item. The
total of the amounts listed as original cost cannot be determined
from the copy of the inventory placed into the record because
relevant portions of the document are obscured by overlays.
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Replacement costs for all of the items total $83,830.66; actual
cash values (replacement cost minus depreciation) of all of the
items total $51,711.17.
Some of the personal property located in the house at the
time of the fire appeared to be salvageable. Petitioners hired
MasterCraft and MasterClean to clean and/or refurbish these
items. After removing these items from the Hendersonville
residence, the cleaning company determined that some of them
could not be cleaned or otherwise salvaged. The items that could
not be cleaned were not returned to petitioners and were not
included on the inventory. Petitioners estimated the value of
these items to total $4,562.
Petitioners filed a timely joint 1995 Federal income tax
return. It was prepared by a professional income tax return
preparer. They reported adjusted gross income of $42,802.
Taking into account itemized deductions totaling $29,516 and
personal exemption deductions claimed for themselves and their
four children, they reported no taxable income or Federal income
tax liability on that return.
Relevant here, on the Schedule A, Itemized Deductions,
included with their 1995 return, petitioners claimed a $21,610
casualty loss deduction, computed as follows:
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Cost or other basis of each property $139,647
Insurance or other reimbursement 107,022
Fair market value before casualty 133,012
Fair market value after casualty - 0 -
Amount of loss 133,012
Amount of loss not reimbursed 25,990
Less $100 floor 100
Less 10 percent of adjusted gross income 4,280
Casualty loss claimed 21,610
In the notice of deficiency, respondent disallowed, at least
mathematically, $20,011.04 of the casualty loss deduction here in
dispute. A fair reading of the explanation for this adjustment
suggests that respondent intended to disallow the entire amount.
Nevertheless, we proceed as though petitioners are entitled to a
casualty loss deduction of at least $1,598.96 for 1995. In the
notice of deficiency respondent also determined that petitioners
are liable for a section 6662(a) penalty, but respondent now
agrees that they are not.
Discussion
Subject to certain limitations, an individual is entitled to
a deduction for “any loss[es] sustained during the taxable year
and not compensated for by insurance or otherwise” that “arise
from fire * * * or other casualty”. Sec. 165(a), (c)(3), (h)(1)
and (2).
To properly compute a casualty loss deduction, the following
values of the damaged or destroyed property must be established:
(1) Fair market value before the casualty; (2) fair market value
after the casualty; and (3) the taxpayer’s basis in the property.
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See Millsap v. Commissioner, 46 T.C. 751, 759 (1966), affd. 387
F.2d 420 (8th Cir. 1968). The reduction in the fair market value
of the property caused by the casualty must be compared to the
adjusted basis of the property. The lesser of the two amounts
equals the amount of the casualty loss for purposes of computing
the deduction allowed under section 165. See Helvering v. Owens,
305 U.S. 468 (1939); Pfalzgraf v. Commissioner, 67 T.C. 784
(1977); Cornelius v. Commissioner, 56 T.C. 976 (1971); Millsap v.
Commissioner, supra; sec. 1.165-7(b)(1), Income Tax Regs.
Subject to numerous exceptions, the general rule is that a
taxpayer’s basis in property equals the taxpayer’s cost of the
property. See secs. 1011 and 1012. Fair market value is defined
in countless cases as “the price at which the property would
change hands between a willing buyer and a willing seller,
neither being under any compulsion to buy or sell and both having
reasonable knowledge of relevant facts.” United States v.
Cartwright, 411 U.S. 546, 551 (1973); Gresham v. Commissioner, 79
T.C. 322, 326 (1982), affd. 752 F.2d 518 (10th Cir. 1985); sec.
1.170A-1(c)(2), Income Tax Regs.
Although less than clear from the manner in which the
casualty loss deduction was computed on petitioners’ return, the
relevant “property” over which the controversy centers in this
case is the personal property damaged or destroyed in the fire.
Reciting the well-established general principles that control
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situations such as the one presently before us is relatively
simple and straightforward. Applying those principles to
hundreds of personal household items that would typically be
damaged or destroyed in a residential fire is more problematic,
not only because of the number of items involved, but also
because of the nature of those items.
Establishing the fair market values of used household items
is not only difficult, but also not enough for purposes of
section 165(a). The taxpayer’s cost, or basis, in each item of
property must also be established, often long after the item was
acquired. Furthermore, the utility, economic, and sentimental
values of a particular piece of personal property to a particular
owner are not necessarily reflected in either the fair market
value of, or the taxpayer’s basis in, that item. Consequently,
it is not unusual for a taxpayer who suffers the loss of property
due to some casualty to sense a loss greater than that allowable
as a deduction pursuant to section 165(a).
Petitioners could not explain the manner in which the
casualty loss deduction is computed on their return, and we
cannot find any support for the computation in the record. The
amount of insurance reimbursement listed is obviously incorrect,
at least in the aggregate, and does not correspond to the
recovery of any of the component amounts. Furthermore, the
amounts listed for “cost or basis” and “fair market value before
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casualty” do not appear to be based upon information contained on
the inventory.
At trial, petitioners more or less ignored the computation
of the casualty loss deduction set forth in their return.
Instead, they relied almost exclusively on the inventory, a
document prepared not with reference to the amount of any
potential casualty loss deduction to which they might be
entitled, but rather in connection with an insurance claim under
a policy that allowed recovery based upon replacement cost. For
insurance purposes, the original cost of personal property
damaged or destroyed in the fire was not particularly important.
Consequently, the inventory does not provide sufficient
information to allow for the proper computation of the amount of
petitioners’ casualty loss deduction. Nevertheless, respondent,
in apparent recognition of the practical difficulties confronting
petitioners in establishing the information technically required
to support a casualty loss deduction, relies, at least in part,
upon the information reported on the inventory, even though that
document might not contain all of the information necessary to
properly compute the allowable deduction. In an apparent attempt
to simplify the matter, respondent now accepts petitioners’
estimate of replacement costs and Westfield’s estimate of actual
cash value (replacement cost less depreciation) of the destroyed
property as the measure of that property’s fair market value
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before the fire.1 Respondent argues that petitioners’ casualty
loss deduction should be computed as follows:
Fair market value of personal property
before fire $51,711.17
Less amount reimbursed 45,732.06
Less $100 (sec. 165(h)(1)) 100.00
Less 10 percent of adjusted gross income
(sec. 165(h)(2)) 4,280.00
Allowable casualty loss deduction 1,599.11
In effect, in the above computation, respondent considers the
property damaged or destroyed in the fire to have had no fair
market value after the fire. Furthermore, to petitioners’
benefit, respondent treats the property’s fair market value prior
to the fire and petitioner’s basis in the property as equal,
which is highly unlikely.
We consider respondent’s computation to be reasonable under
the circumstances, and note that, if only by coincidence, it
provides support for the adjustment made in the notice of
deficiency. The computation, however, does not take into account
the value of those items removed from the Hendersonville
residence by the cleaning company, determined to be
unsalvageable, and never returned to petitioners. We accept
petitioners’ $4,562 estimate of value of those items, adopt
respondent’s approach as to the significance of that estimate,
1
Subtracting depreciation from replacement cost can be an
acceptable method of determining the fair market value of an item
of personal property. See Cornelius v. Commissioner, 56 T.C. 976
(1971).
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and find that petitioners are entitled to a casualty loss
deduction for 1995 computed as follows:
Fair market value of personal property
listed on inventory, plus fair market
value of personal property not listed
on inventory, (values before fire) $56,273.17
Fair market value of personal property
after fire - 0 -
Less insurance reimbursement 45,732.06
Less $100 (sec. 165(h)(1)) 100.00
Less 10% of AGI (sec. 165(h)(2)) 4,280.00
Allowable casualty loss deduction 6,161.11
Reviewed and adopted as the report of the Small Tax Case
Division.
Based on the foregoing,
Decision will be
entered under Rule 155.