Rev. Rul. 71-160

Advice has been requested as to the Federal income tax consequences of a cancellation under the Disaster Relief Act of 1969 of certain indebtedness in the circumstances described below.

The taxpayer, an individual, suffered an uninsured property loss in the amount of $10,000 in June 1968, when Hurricane Candy damaged his property. Shortly thereafter, the taxpayer was granted a ten year, three percent disaster loan of $10,000 by the Small Business Administration in accordance with section 7(b) of the Small Business Act (15 U.S.C. 636(b)). On his income tax return for 1968 the taxpayer claimed a casualty loss under the provisions of section 165(c)(3) of the Internal Revenue Code of 1954.

Congress subsequently enacted the Disaster Relief Act of 1969 (Act of October 1, 1969, Public Law 91-79, 83 Stat. 125 42 U.S.C. 1855aaa), dealing with property loss or damage resulting from a major disaster. In accordance with section 6(1)(A) of the Disaster Relief Act of 1969 (83 Stat. 127, 42 U.S.C. 1855eee), the Small Business Administration in 1969 cancelled $1,800 of the disaster loan made to the taxpayer in 1968.

Section 165(a) of the Code allows as a deduction any loss sustained during the taxable year and "not compensated for by insurance or otherwise."

Section 6(1)(A) of the Disaster Relief Act of 1969 provided that, to the extent the loss or damage is not compensated for by insurance or otherwise, the Small Business Administration shall cancel the part of the disaster loan over $500, with a limit of $1,800 on the amount cancellable. The borrower was given the option of allocating the amount cancellable between principal and interest. Section 7(1)(A) of the Act (83 Stat. 127, 42 U.S.C. 1855fff) made the same provisions for emergency loans under subtitle C of the Consolidated Farmers Home Administration Act of 1961 (7 U.S.C. 1961-1967), administered by the Department of Agriculture. These provisions are similar in operation to an insurance policy with a $500 deductible clause. Since the purpose of these provisions is to compensate disaster victims for certain property losses by means of cancelling portions of certain Federal loans, it is concluded that the portions of debts cancelled under the Act are "compensation" within the meaning of section 165(a) of the Code. The amount of the forgiveness of debt (including forgiveness of interest) will therefore reduce the casualty loss deduction otherwise allowable under section 165.

Section 1.165-1(d)(2)(i) and (ii) of the Income Tax Regulations provide that casualty loss deduction claims for the taxable year are to be reduced by the amount of anticipated recovery with respect to the loss. When a taxpayer suffers a casualty loss and in the same year he is granted a disaster loan subject to the debt cancellation provisions of the Disaster Relief Act of 1969, he is entitled by law to a recovery under the provisions of the Act. If the loan was made after the enactment of the Act or during the taxable year in which the Act was enacted, the taxpayer must reduce his casualty loss deduction claim under section 165 of the Code accordingly.

However, since the taxpayer described earlier suffered a casualty loss in 1968 and received a disaster loan before the enactment of the Disaster Relief Act of 1969 and its debt cancellation provisions, he could not have anticipated the recovery in 1968. He therefore properly deducted his loss in 1968 without reduction. Section 1.165-1(d)(2)(iii) of the regulations provides that if a taxpayer deducts a loss in one year and in a subsequent year he receives reimbursement for the loss, he must include the amount of the reimbursement in his gross income for the year it was received, subject to the provisions of section 111 of the Code, relating to recovery of amounts previously deducted.

Accordingly, the taxpayer is entitled to a casualty loss deduction in 1968, but is required to include in gross income for 1969 the cancelled amount of the disaster loan, subject to the provisions of section III of the Code.

The Disaster Relief Act of 1969 was repealed by the Disaster Relief Act of 1970 (Act of December 31, 1970, Public Law 91-606, 84 Stat. 1744) [page 532, this Bulletin]. The 1970 Act increased the amount cancellable under the 1969 Act to $2,500, and removed the option to allocate the amount cancelled between principal and interest. Since, aside from these changes, the debt cancellation provisions of the 1970 Act are similar to the corresponding provisions of the 1969 Act, the tax results under section 165 of the Code are the same. ¹ Also released as News Release IR-1113, dated March 9, 1971.