Tax Relief for Homeowners With Corrosive Drywall

IRS safe harbor offers clear method to claim deduction.

Some homeowners who have built or purchased new homes in recent years are experiencing the destructive effects of sulfur emissions from so-called corrosive gypsum plasterboard, or drywall. This drywall was manufactured in China in response to the mini-construction boom after the destruction from Gulf Coast hurricanes in the mid-2000s. Most of it was installed between 2005 and 2006. U.S. suppliers could not keep up with the increased demand, and imports of Chinese drywall increased 17 times. However, corrosive drywall had been installed as early as 2001. It has been found across the country, but mainly in Florida and Louisiana.


As of late January this year, the U.S. Consumer Product Safety Commission (CPSC) had received nearly 3,800 reports of corrosive drywall in buildings in more than 40 states, the District of Columbia, American Samoa and Puerto Rico (see The corrosive drywall emits hydrogen sulfide gas (which is what gives rotten eggs their distinctive odor) and, in buildings where it has been installed, causes blackening and corrosion of copper wiring, copper components of household appliances and copper air conditioning evaporator coils. Residents of homes where it is present say it also causes health problems that include headaches; itchy eyes; scratchy, burning throat; and skin irritations.


Homeowners in Florida, Mississippi, Alabama and Louisiana account for more than 87% of the CPSC’s reports, with a significant number (165) also reported in Virginia. The numbers increased during 2010, and more cases are likely to continue to come to light. The CPSC reports that in 2006 alone, more than 5.5 million sheets of drywall were imported from China, although only some brands were found to give off hydrogen sulfide gas (see


This article is intended to help CPAs guide their clients who have or think they may have a problem with corrosive drywall to take advantage of guidance and a safe harbor method of deducting a casualty loss outlined in Revenue Procedure 2010-36 (, which the IRS issued in September 2010 after numerous inquiries from taxpayers and their congressional representatives. Acknowledging the “unique circumstances” involved, the IRS provided the safe harbor and a formula for determining its amount. The revenue procedure is available to individuals who pay to repair damage to their personal residence or household appliances from the effects of corrosive drywall.



Section 4.01 of Revenue Procedure 2010- 36 states its special tax treatment is available for “problem drywall” as identified in two steps outlined by the CPSC and the Department of Housing and Urban Development in interim guidance from those agencies issued Jan. 28, 2010 ( On Aug. 27, 2010, the agencies revised this guidance (see


Step 1. An initial inspection finds blackening of copper electrical wiring or air conditioning evaporator coils and evidence the drywall was installed between 2001 and 2008.


Step 2. A further inspection finds corroborating evidence or characteristics, such as results of testing a sample of the drywall for sulfur content, metal corrosiveness and/or sulfide gas emission. Other possible corroborating evidence can be labeling or other marks indicating the drywall is of Chinese origin.



The revenue procedure clarified a number of problematic areas for homeowners seeking to claim a casualty loss deduction for damage caused by corrosive drywall and the cost to remove and replace it and repair or replace affected metal components or household appliances. One was the nature of the damage. For loss deduction purposes, a casualty is generally defined as partial or complete destruction of property resulting from an event “of a sudden, unexpected, and unusual nature” (Revenue Ruling 72-592). The effects of corrosive drywall could easily be described as unexpected and unusual, but they might be difficult or impossible to characterize as a sudden event. The damage from the drywall typically occurs over time; copper tubing does not corrode overnight. Yet Revenue Ruling 72-592 underscores the suddenness of a casualty as an event “that is swift and precipitous and not gradual or progressive.” The revenue procedure also cites Matheson v. Commissioner (54 F.2d 537 (2nd Cir. 1931)), in which the taxpayer was denied a casualty loss deduction related to a flawed design that allowed a home’s steel foundation reinforcement bars to corrode. Because a personal property casualty loss is defined as arising “from fire, storm, shipwreck, or other casualty” (section 165(c)(3)), courts have reasoned that by “other casualty,” Congress meant events as sudden as fire, storm and shipwreck. Courts have similarly ruled against taxpayers with respect to wood “dry rot” (Hoppe v. Commissioner, 42 TC 820, (aff’d, 9th Cir. 1965)) and termite damage (Fay v. Helvering, 120 F.2d 253 (2nd Cir. 1941)).


A second problem was also time-related. Section 165(a) provides that the loss is properly claimed in the tax year in which it is sustained. With respect to corrosive drywall damage, when exactly was the loss sustained? Was it the year the drywall was installed, or later, when the effects were discovered?


Third, how was the amount of loss to be determined? Under the existing regulations, the amount of a casualty loss generally is the decrease in the fair market value of the property as a result of the casualty, limited to the taxpayer’s adjusted basis in the property (Treas. Reg. § 1.165-7(b)). However, determining the fair market value before the loss, especially in the economic conditions existing at the time, could be problematic. To simplify the calculation of the loss, regulations also permit taxpayers to use the cost to repair damaged property as evidence of the decrease in the value of the property. Such repairs must be only those needed to restore the property to its condition immediately before the casualty, and their cost must not be excessive. They must not increase the property’s value beyond its value immediately before the casualty (Treas. Reg. § 1.165-7(a)(2)(ii)). The revenue procedure applies these requirements, stating that only amounts paid to restore the taxpayer’s personal residence to the condition existing immediately prior to damage qualify for loss treatment (section 4.03). Where a household appliance is replaced rather than repaired, the amount of the loss attributable to the appliance under the revenue procedure is the lesser of the current cost to replace the original appliance or the basis of the original appliance (generally its cost) (section 4.04).


Fourth, taxpayers generally must wait to claim a casualty loss until they are reasonably certain whether they will receive any insurance reimbursement or other recovery for any portion of it covered by a claim for reimbursement with respect to which there is a reasonable prospect of recovery (Treas. Reg. § 1.165-1(d)(2)).



The revenue procedure addresses the first three hurdles by stating that the Service will not challenge a casualty loss claim by an individual to repair damage to the individual’s personal residence or household appliances resulting from corrosive drywall (as defined in the revenue procedure) if the individual treats the amount paid to repair the damage as a casualty loss in the year of payment.


The fourth problem, reimbursement for the loss, is addressed in section 4.02 of the revenue procedure for taxpayers in each of the following circumstances:


No claim for reimbursement. A taxpayer who does not have a pending claim for reimbursement (and does not intend to pursue reimbursement) may claim as a loss all unreimbursed amounts paid during the taxable year to repair damage to the taxpayer’s personal residence and household appliances that results from corrosive drywall.


Pending claim for reimbursement. A taxpayer who has a pending claim for reimbursement (or intends to pursue reimbursement) may take advantage of the safe harbor method and claim a loss for 75% of the unreimbursed amounts paid during the tax year to repair damage to the taxpayer’s personal residence and household appliances that resulted from corrosive drywall. The taxpayer may have to include in gross income the amount of recovery previously deducted or have an additional deduction in subsequent tax years, depending on the actual amount of the reimbursement received (section 4.02 of the revenue procedure).


Reimbursement already received. A taxpayer who has been fully reimbursed before filing a return for the year the loss was sustained may not claim a loss.


The general floor for losses of personal-use property as an itemized deduction applies: $100 ($500 for 2009), plus 10% of the taxpayer’s adjusted gross income (AGI).



The main advantage of the revenue procedure is that a taxpayer does not need to substantiate that the loss was a casualty as defined under section 165. The main disadvantage is that, to fall under the safe harbor and avoid any possible IRS challenge, the taxpayer must pay for the required repairs. Thus, only those taxpayers able to pay for the cost of repairs will be allowed to claim the casualty loss under the safe harbor.


For casualty losses generally, Treas. Reg. § 1.165-7(b) allows the amount of loss to be based on the decrease in the property’s fair market value, but this would be open to challenge by the IRS, as it does not fall under the safe harbor method contained in the revenue procedure. In addition, the amount of loss may be difficult to prove if the difference in fair market value is used as the measurement of the amount of loss, especially considering the overall economic condition of the real estate market. As noted in Brandom v. U.S. (docket no. 76CV779-W-3 (W.D. Mo. 1978)), the casualty loss must recognize effects of any general market decline affecting undamaged property and exclude that decline in value. If there is not an accurate appraisal of the property prior to any damage from drywall, it could be difficult to determine just how much of the loss is attributable to corrosive drywall versus an overall decline in residential housing prices.


Under the safe harbor in the revenue procedure, a taxpayer may be able to take a deduction in the year that he or she pays for repairs, regardless of the prospects for a recovery or reimbursement for the damage; under Treas. Reg. § 1.165-1(d)(2)(i), a taxpayer attempting to take a loss outside the revenue procedure would be able to take a loss only in the year that no prospect for reimbursement exists. With many builders being insolvent and the supplier of the drywall difficult or impossible to determine (and possibly also insolvent), a reasonable prospect of recovery may not be likely. A taxpayer may be able to substantiate that recovery is unlikely if the taxpayer can track down these parties and execute a release (see Treas. Reg. § 1.165-1(d)(2)(i)). Absent such definitive proof, and since this is a question of fact (as stated in the regulations), opinions could vary on exactly when the likelihood of recovery is no longer reasonable.



A casualty loss is claimed as an itemized deduction on Schedule A of Form 1040 and Form 4684, Casualties and Thefts. The safe harbor provision of the revenue procedure requires the taxpayer to include the heading “Revenue Procedure 2010-36” at the top of Form 4684.


For corrosive drywall losses incurred in prior years, taxpayers may file an amended return.


For tax years before 2010, a taxpayer’s itemized deductions may be limited by the phaseout based on AGI. The casualty loss deduction should not increase the likelihood that the taxpayer will be subject to the alternative minimum tax. The casualty loss described in this article relates to personal property and is not a tax preference item. Taxpayers must reduce their basis in the home by the amount of the casualty loss deduction and any reimbursement from insurance or otherwise.


Example 1: Safe harbor without reimbursement claim. During the 2010 tax year, Taxpayer A incurred $12,500 to replace corrosive drywall and repair damaged appliances. Taxpayer A cannot seek reimbursement from any parties that contributed to the damages. Taxpayer A’s AGI in 2010 was $45,000.


Step 1. Since Taxpayer A does not have a pending claim for reimbursement and does not plan to seek reimbursement, his gross casualty loss is equal to the full amount of costs incurred in 2010, $12,500.


Step 2. Reduce casualty loss by $100 due to section 165(h)(1).


Step 3. Casualty loss is reduced by an additional 10% of Taxpayer A’s AGI ($45,000 x 10% = $4,500). Taxpayer A’s allowable casualty loss claim is $7,900 ($12,500 –100 – 4,500 = $7,900).


Example 2: Safe harbor with reimbursement claim. The facts are the same as Example 1, except that Taxpayer B has a claim pending for reimbursement by the builder.


Step 1. Since Taxpayer B has a pending claim for reimbursement, his gross casualty loss is equal to 75% of the amount of costs incurred in 2010, or $9,375 ($12,500 x 75%).


Step 2. Reduce casualty loss by $100 due to section 165(h)(1).


Step 3. Casualty loss is reduced by an additional 10% of Taxpayer B’s AGI ($45,000 x 10% = $4,500). Taxpayer B’s allowable casualty loss claim is $4,775 ($9,375 – 100 – 4,500 = $4,775).



Prior to Revenue Procedure 2010-36 there was much uncertainty about whether the damages caused by corrosive drywall qualified as a casualty loss. The revenue procedure provides taxpayers with a clear method to claim a deduction for the cost of repairs due to corrosive drywall. However, because it generally requires basing the amount of loss on amounts paid to repair damage, it may prevent taxpayers who are unable to pay for repairs from claiming a loss.





  Taxpayers may seek relief under IRS Revenue Procedure 2010-36, which addresses tax implications of corrosive drywall and the resulting economic loss. The procedure addresses what constitutes a deductible casualty loss, the tax year in which the loss is deductible, and how to compute the amount of the loss. It provides a safe harbor method for determining the amount of the loss.


  Under the safe harbor, a taxpayer who does not have a pending claim for reimbursement of damages and does not intend to pursue reimbursement may claim a loss of all unreimbursed amounts paid during the tax year to repair damage from corrosive drywall to the taxpayer’s personal residence and household appliances. If there is a pending claim for reimbursement or an intention to pursue reimbursement, a taxpayer may claim only 75% of the unreimbursed amounts paid to repair the damages. Income or an additional deduction may arise in a subsequent tax year, depending on the amount of any reimbursement actually received.


  The revenue procedure carries a drawback of basing the amount of the deduction on payment for repairs rather than a calculation of decrease in fair market value as a result of the casualty (limited to the taxpayer’s basis in the property), that is otherwise allowed as a method under Treas. Reg. § 1.165-7(b).


  However, the revenue procedure gives taxpayers certainty that the IRS will not challenge treatment of the repairs as a casualty loss under the requirement that a casualty is the result of an “identifiable event” that is “sudden, unexpected, and unusual” rather than the result of “progressive deterioration.”


Karl L. Fava ( is a principal with Business Financial Consultants Inc. in Dearborn, Mich. Ellen Weiss ( is a tax consultant in Canton, Mich. Robert E. Huber ( is a principal with Huber CPA PC, and a Ph.D. candidate at the University of Arizona, both in Tucson, Ariz.


To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at or 919-402-4434.





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