Rev. Rul. 71-161

Advice has been requested concerning the Federal income tax treatment of reimbursements for debris removal made to victims of casualties under provisions of section 14 of the Disaster Relief Act of 1969, Public Law 91-79, 83 Stat. 130, 42 U.S.C. 1855 mmm.

As a result of a hurricane in 1970 the taxpayer sustained business property damage deductible as a casualty loss under section 165 of the Internal Revenue Code of 1954. The property had a basis of 25,000x dollars and a fair market value of the same amount immediately before the hurricane. Immediately after the hurricane the fair market value was 20,000x dollars because of damage to the property and debris scattered thereon. The taxpayer subsequently paid 1,000x dollars in 1970 for removal of such debris. He also paid 4,000x dollars for repair of the damaged property. These expenditures restored the property to its condition prior to the casualty. Pursuant to section 14 of the Disaster Relief Act of 1969, the taxpayer made application for reimbursement of the debris removal expenditures. He received 700x dollars reimbursement in 1970 and was told by appropriate authorities there were not enough funds to reimburse him for the other 300x dollars. However, in 1971 funds became available and he received the 300x dollars.

The specific questions concern the income tax consequences of the reimbursement of the debris removal expenses that (1) was made in the taxable year of the casualty loss and (2) was made in a year subsequent to the casualty loss.

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 1.165-7(b)(1) of the Income Tax Regulations provides in part:

In the case of any casualty loss whether or not incurred in a trade or business or in any transaction entered into for profit, the amount of loss to be taken into account for purposes of section 165(a) shall be the lesser of either--

(i) The amount which is equal to the fair market value of the property immediately before the casualty reduced by the fair market value of the property immediately after the casualty; or (ii) The amount of the adjusted basis prescribed in sec. 1.1011-1 for determining the loss from the sale or other disposition of the property involved.

Section 1.165-7(a)(2)(ii) of the Income Tax Regulations provides:

The cost of repairs to the property damaged is acceptable as evidence of the loss of value if the taxpayer shows that (a) the repairs are necessary to restore the property to its condition immediately before the casualty, (b) the amount spent for such repairs is not excessive, (c) the repairs do not care for more than the damage suffered, and (d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty.

The presence of debris on the property contributes to the loss in the fair market value of the property immediately after the casualty. Thus, the cost of debris removal may be used, like the cost of repairs, as evidence of the amount of the casualty loss sustained, if the conditions of section 1.165-7(a)(2)(ii) of the regulations are satisfied. Accordingly, in the instant case the amount of the casualty loss sustained is 5000x dollars.

Since the taxpayer received reimbursement for debris removal costs under the Disaster Relief Act of 1969 in the year of the casualty, the casualty loss sustained was to the extent of the reimbursement "compensated for" within the meaning of section 165(a) of the Code. Accordingly, the taxpayer must reduce his casualty loss sustained by 700x dollars in arriving at his casualty loss deduction for 1970.

Sections 1.165-1(d)(2)(i) and (ii) of the regulations provide that loss deductions for the taxable year are to be reduced by the amount of anticipated recovery with respect to the loss. Accordingly, since the taxpayer in 1970 had no reasonable prospect of recovering the 300x dollars, it was not necessary for him to reduce his casualty loss sustained for 1970 in that amount in computing the allowable casualty loss deduction. Therefore, the allowable casualty loss deduction for 1970 is 4,300x dollars.

Section 1.165-1(d)(2)(iii) of the regulations provides:

If the taxpayer deducted a loss in accordance with the provisions of this paragraph and in a subsequent taxable year receives reimbursement for such loss, he does not recompute the tax for the taxable year in which the deduction was taken but includes the amount of such reimbursement in his gross income for the taxable year in which received, subject to the provisions of section 111, relating to recovery of amounts previously deducted.

Pursuant to section 111 of the Code and the regulations thereunder, the taxpayer may exclude from his gross income in 1971 that part of the 300x dollars reimbursement which does not exceed the amount of the casualty loss sustained in 1970 which did not result in a tax benefit.

The taxpayer's basis in property damaged or destroyed by a casualty must be reduced by the amount of the allowable loss deduction under section 165 of the Code. His basis is also reduced by the amount of insurance or other compensation received or recoverable (i.e., there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery) in the year the casualty loss was sustained. See section 1.1016-6(a) of the regulations which provides that "Adjustments must always be made to eliminate double deductions or their equivalent." Because the taxpayer did not, in 1970, have a claim for reimbursement of the 300x dollars received in 1971, such amounts do not give rise to an adjustment in basis.

In the instant case, the cost of debris removal and repair of casualty damage is in the nature of replacement of the part of the property that was damaged. Accordingly, these costs should be capitalized and added to the taxpayer's basis in the property. See section 1016(a)(1) of the Code. Thus, the adjusted basis of the taxpayer's property is computed as follows:

 Adjusted basis before casualty loss____________________  $25,000x