Determing $ of Casualty Loss

[equinecpa]

I have a client whose rental property was ruined by a flood last year. They have stripped it down to the studs and are reconstructing it. They have already spent just about as much as their ACB in the property and are not yet finished.

I know the calculation is FMV before loss -FMV after loss -but how is FMV after loss determined? They didn't have it appraised. Am I safe to assume that a house that is torn down to the studs is basically a 100% write-off? They had to install new wiring, carpets, drywall, woodwork etc.

Carolyn

[erchess]

My two cents

I think I would pay a real estate expert for a written opinion. Let them see the house asap. You also might be able to get some useful information from the insurance company. I personally think the house stripped down to the studs has to have some economic value unless there were non economic reasons why they did not tear down what was left after the flood and build a new house. I do not find it surprising that the cost of rebuilding exceeds previous basis. The cost of everything is going up and has been basically since at least the end of WWII.

[equinecpa]

We're way too far into the reconstruction for that. Client is a real estate agent though...

The way I look at it is: If I were looking for a property I'd much rather buy raw real estate than a lot with a foundation and studs -because then I'd be stuck building on what was there rather than from scratch. I guess the foundation might have value? I imagine demolishing the foundation would have been an even bigger chore than building on what was there.

If the client chooses to say complete write-off, how is this best substantiated? (This was in a federal disaster zone)

[erchess]

OK I re read the thread and I am stilll puzzled

I'm looking at this the way I believe an auditor and the Tax Court would because it is well known that we as TPs risk trouble for ourselves when we write a return with less than a 50 50 shot of surviving an audit with no change. The obvious reason to rebuild from what could be salvaged instead of carting it away with the rest and starting over would be that what was done was the cheapest way to end up with the house the owner wanted to have. In that scenario the house was not a total loss. There has to be some value to what was left. And if there was no appraisal done you need to err on the side of giving it a greater value rather than a lesser value. Your client is a Realtor and presumably saw the house after the taking away was complete and before any of the rebuilding had been done. If the house had been being built from scratch, how much would she have been into the contractor for at that point? What could she have sold the house and the land for at that point and what could she have sold the bare land for with no part of a house? The value she cannot write off is somewhere in that ballpark. If client insists on total write off I think I would get a lawyer for my E and O Carrier to write a special engagement letter specifying that you are not liable if client cannot substantiate that or failing that send the client elsewhere. And it goes without saying that I would use the dreaded disclosure form to protect myself. If there was some non economic reason for doing what was done, I think that's irrelevant for tax purposes unless the motive can be well substantiated. For example if the house was an ancestral home she could argue that keeping all that could be kept meant more than money and claiming a total loss might fly..

[FEDUKE404]

Curiosity

You did not mention any insurance reimbursements, especially in relation to the anticipated "total loss."

That might help in determining the value of anything left behind.

[DTS]

I guess the foundation might have value? I imagine demolishing the foundation would have been an even bigger chore than building on what was there.

Carolyn,

In the late 80's, studs (2X6) for a 2000 sq. ft., two story home would be around $12,000. Pella windows, $17,000, rough plumbing, a few thousand and then the foundation...

If you have a contractor contact, maybe see how this compares??

[equinecpa]

This is a "cheap rental" property -lot and house cost $35,000. No flood insurance carried so no insurance proceeds. I'll discuss further with the client perhaps she'll assign a "token" value to the shell...pretty tough though when the real estate values really aren't very high in the area, and she has already spent over $25,000 on rebuilding and is not close to being done.

[erchess]

This is a "cheap rental" property -lot and house cost $35,000. No flood insurance carried so no insurance proceeds. I'll discuss further with the client perhaps she'll assign a "token" value to the shell...pretty tough though when the real estate values really aren't very high in the area, and she has already spent over $25,000 on rebuilding and is not close to being done.

If she wanted me to sign the return she would either assign a value to what was left that was more than a token relative to what she spent on reconstruction or she could let me do the dreaded disclosure or of course she could take her business elsewhere. Builders don't put up part of a house for free and any work the builder didn't have to do saved her on construction costs.

[DTS]

Carolyn

Sounds like the FMV will be close to zero, as you state most of the finish cost is so low. When you find out, please post it.

Curious.

[CinSee]

FMV Before Loss

A client's house burned down in December 2007. Suggestions on how the FMV before the fire can be determined for the household goods? For example, he is stating that the replacement cost for his clothes is approximately $271,000. (He has expensive taste). Most of the clothes are less than a year old. He believes that a suit he paid $5,000 will have a FMV of $5,000, even though it is a few months old.

Same situation with computers. He has some that is "approximately" 2 years old and shows a replacement cost of $2,000. With the way technology grows I would think the FMV would be lower.

I realize you use FMV and I am trying to explain to him that replacement cost can not be used for casualty loss calculations but he deals with real estate and just can't seem to comprehend.

Any assistance would be greatly appreciated!

[AuditorTurnedGood]

I would approach it this way

First off, what did his insurance pay for the clothing lost? I had a case exactly like this back in the day, and the insurance company produced a line item list of the items destroyed, the value they threw at them, and the amount of reimbursement. That might be a way to start.

As for the clothing and computers, I'd ask him what he'd pay for used suits and a 2 year old computer. He might say "well, 5K and 2K" but I doubt it if you show him the logic. Also, if possible, take a look on e-bay (I'm assuming here a 5K suit is Armani or Zenga or something similar) and there is a secondary market for these items. Also, ask him for the reciepts for the purchases. I have a 2K Oscar de la Renta suit in the closet I paid about 400 for on clearance, but you ask me what it's worth - 2,000!

Having audited returns like this, the first thing I would be looking to cut is the value on the clothing and the computers, using the techniques above. Does he have an income to support 271K in clothing? I would expect someone with that kind of budget for clothing to be pulling down 2-3 million a year at a bare minimum.

Also, you said he's in real estate? Depending on the market you're in, pull up a listing that is selling for far less than its replacement cost (I looked at a home here in the twin cities on the market at 349,000 which, according to a contractor I spoke to, would cost about 800,000 to build on a similar lot in the same neighborhood). Then ask him what he'd pay for it, replacement cost or list price.

Just a few thoughts. Best of luck!

[FEDUKE404]

Tax issues vs insurance claim issues

I assume we are talking about tax issues here, therefore:

The "replacement costs" have virtually nothing to do with the amount of casualty loss that can be claimed on his tax return. That is between him and the insurance company, and is closely related to the level of coverage he had AND the records he can reproduce for the insurance company (and the IRS!) showing his real cost basis and the proveable loss.

Generally speaking the IRS will look at an insurance settlement as representative of a "fair" settlement, which negates a lot of the "it was really worth such and such" discussions.

Since this guy obviously has an extremely large income to pay for the expensive wardrobe in the first place, the 10% of AGI reduction of the IRS allowable casualty loss may simply leave him little to show on his tax return.

As for replacement cost values, just look around the GoodWill stores to see how "well" items hold their original value. The "but I only buy expensive clothes" argument falls flat when those clothes sell just like the WalMart jeans at the GW store. (There is a secondary market for true designer clothes, but even then buyer #1 pays a LOT more than buyers #later.) Used computers are (almost) a dime a dozen, and a $2k computer these days must have a lot of bells & whistles.

For my 2¢ worth, the $271,000 value seems a little absurd. (You know, more than one hundred $2k suits, etc.) If I were an insurance agent, I might be scratching my head and saying something like "Show me those receipts!"

Good luck.

FE

[OtisMozzetti]

Costs of Cleanup & Repair May be a Measure of the decrease

It says that the "costs of cleanup and repairs" might be a useful "measure of the decrease in value", if certain conditions are met. See IRS Publication 547, p. 4.

[taxea]

Aren't you all making this more difficult than it needs to be. Pub 17 is very clear on how to determine FMV. His loss on the rental is his total cost less depreciation already declared. He is not responsible for renter's personal property so that does not enter into the loss.
The fair market value after is zero...and the rebuilding is expenses or depreciation depending on the replaced item/s. taxea