Sales Tax Deduction for a Casulty Loss

[jerome]

Client’s home is destroyed by fire. Insurance pays to rebuild house, plus buy new furnishings. No casualty loss since insurance pays for everything. No gain on the insurance reimbursements since nothing exceeds basis and replacement property is purchased within the time limit.

Fine. No problem.

Now the client wants to deduct the actual sales tax paid on Schedule A, which exceeds the state income tax paid, and the sales tax using the tables. Most of the sales tax was paid using insurance proceeds due to the casualty.

My first impression is that it is not deductible since it is tax free money (the insurance proceeds) being used to purchase these items. However, The Tax Book page 4-21 explains how under a business casualty, you get a double deduction – the cost of repairs plus the casualty loss – when there are no insurance proceeds. Assuming you had insurance proceeds, you would lose the casualty loss deduction but still get the cost of repairs.

Wouldn’t the sales tax deduction for personal property replaced in a casualty work on the same principal? You deduct the sales tax paid and reduce basis in the replacement property accordingly?

[GIMoe]

Double dipping

Client’s home is destroyed by fire. Insurance pays to rebuild house, plus buy new furnishings. No casualty loss since insurance pays for everything. No gain on the insurance reimbursements since nothing exceeds basis and replacement property is purchased within the time limit.

Fine. No problem.

Now the client wants to deduct the actual sales tax paid on Schedule A, which exceeds the state income tax paid, and the sales tax using the tables. Most of the sales tax was paid using insurance proceeds due to the casualty.

My first impression is that it is not deductible since it is tax free money (the insurance proceeds) being used to purchase these items. However, The Tax Book page 4-21 explains how under a business casualty, you get a double deduction – the cost of repairs plus the casualty loss – when there are no insurance proceeds. Assuming you had insurance proceeds, you would lose the casualty loss deduction but still get the cost of repairs.

Wouldn’t the sales tax deduction for personal property replaced in a casualty work on the same principal? You deduct the sales tax paid and reduce basis in the replacement property accordingly?

I don't think it's the same thing. In the example, the T/P repaired the home to pre-casualty condition without materially improving the value of the property and paid all expenses out-of-pocket. In your client's case, the home was rebuilt and paid for with insurance proceeds.

You stated that "most" of the sales tax was paid with insurance proceeds which would indicate that your client actually paid some out-of-pocket, correct? I would think that anything paid out-of-pocket could be deducted. The sales tax paid for a home or materials used to build a home can be taken in addition to the amount from the optional Sales Tax Tables (TTB 4-9).

[jainen]

Suppose I inherit $57,868

>>the home was rebuilt and paid for with insurance proceeds<<

Suppose I inherit $57,868. Tax-free, natch. If I decide to spend $53,335 for a 2007 Corvette convertible, are you saying I can't deduct the $4533 sales tax (8.5%) because I got the money tax-free?

[GIMoe]

I don't believe that is what I said...

>>the home was rebuilt and paid for with insurance proceeds<<

Suppose I inherit $57,868. Tax-free, natch. If I decide to spend $53,335 for a 2007 Corvette convertible, are you saying I can't deduct the $4533 sales tax (8.5%) because I got the money tax-free?

...I think there is a huge difference between inheriting money that you then decide to spend on a car vs having your home rebuilt from insurance proceeds after a casualty loss. But that's just me, I could be missing something. It wouldn't be the first time.

[Brad Imsdahl]

Here is my take.

The example in TTB, based upon TAM 199903030, illustrates that a casualty loss is based upon the reduction in the fair market value of property destroyed, and that if the reduction in FMV is equivalent to the cost of repairs, you could get a double deduction. The rental property went down in value by $10,000 due to the casualty. Without insurance to reimburse the taxpayer, the $10,000 casualty loss is deductible even if the taxpayer decides not to repair the property. That is why the taxpayer deducts $20,000 even though it only cost him $10,000 out of pocket: $10,000 for the reduction in FMV, and $10,000 for the cost of repairs. The amount taken as a casualty loss reduces the cost basis in the property. The amount taken as a repair does not reduce the cost basis.

The only time replacement property is required to be purchased is if insurance or other reimbursement for the casualty exceeds the basis in the property. Thus, in the above example, if the taxpayer received $10,000 in insurance proceeds but the basis in the property was only $5,000, to exclude the gain on the insurance proceeds, the taxpayer would be forced to replace the damaged property within the time limit.

Lets assume insurance proceeds do not exceed basis.

In the above example, had the taxpayer received a check from insurance for the $10,000 casualty loss, there would no longer be a casualty loss to deduct, since the reduction in FMV is offset by the insurance reimbursement. However, the taxpayer would still get to deduct $10,000 in repairs to the property. In effect, the taxpayer is using tax free insurance proceeds to repair his property while at the same time deducting the cost of those repairs on Schedule E. And since the deduction is based upon the cost of repairs and is not a deduction for a casualty loss, there would be no reduction in basis of the property.

Now lets change the above example to a non-business property. Again, $10,000 casualty loss, $10,000 cost of repairs, no insurance.

The $10,000 casualty loss is allowed, reducing basis in the property. However, because it is personal use property, no deduction for repairs. Exception: The amount in that $10,000 that represents sales tax could be deducted on Schedule A as a sales tax deduction.

Now lets say there is $10,000 in insurance reimbursements. The $10,000 casualty loss is no longer allowed. The cost of repairs is not allowed. However, the amount representing sales tax could still be deducted on Schedule A.

There is no requirement that says you have to use after tax money to pay for something in order for it to be deductible.

That is my take on the issue, based loosely on the theory behind TAM 199903030. I could be wrong as there is no specific example that is identical to your situation. However, I think the theory is sound.