Taxpayers’ valuation of land accepted; inability to establish basis limits casualty loss

The Tax Court accepted a married couple’s self-prepared valuations and repair estimates for property damaged by a tornado but limited their casualty loss deduction because they could not establish their basis for part of the property.

Facts: In 2010, Howard Bruce Coates and his wife, Tandi Coates, owned 700 acres on which they lived in Seminole, Okla. “Property A” consisted of 80 acres, which included the Coateses’ dwelling and two barns. “Property B” consisted of 440 acres of undeveloped woodland.

In May 2010, a tornado significantly damaged property A and flattened most of the trees on property B. The Coateses timely filed their Form 1040, U.S. Individual Income Tax Return, for 2010, attaching Form 4684, Casualties and Thefts, and reporting a casualty loss deduction of $127,731 as a result of the tornado. The couple based their loss largely on Howard Coates’s own estimates of the property’s fair market value (FMV) before and after the tornado, subtracting insurance reimbursements from the difference in FMV. Earlier in 2010, the Coateses had commissioned an appraisal of 120 acres that included property A that assigned it an FMV of $676,900. After the tornado, they hired a “loss-recovery advocacy” firm that estimated the cost of repairing the house and barns on property A at $189,248.

Howard Coates estimated an FMV before the tornado for property A of $660,000 and an FMV of $450,000 after the tornado, a difference of $210,000. For property B, he estimated a pre-tornado FMV of $528,000 and an after-tornado FMV of $440,000, a difference of $88,000. In 2013, he commissioned an appraisal of property B that determined it would cost $149,700 to return it to its pre-tornado condition for its best use, hunting (as it had been used before the tornado). The Coateses reported an adjusted basis for property B of $247,000.

The IRS issued a notice of deficiency to the Coateses disallowing the entire casualty loss and determining a deficiency and accuracy-related penalty under Sec. 6662(a). The couple timely filed a petition for review of the deficiency.

Issues: Sec. 165(a) allows a deduction for any loss sustained during the tax year and not compensated for by insurance or otherwise. For individual taxpayers, Sec. 165(c) limits deductions under Sec. 165(a) to three categories of losses, one of which is a casualty loss. The amount of a casualty loss is the difference between the FMV of the property before and after the casualty, according to Regs. Sec. 1.165-7(a)(2)(i). As a general rule, values must be determined by competent appraisals. The amount of the casualty loss cannot exceed the adjusted basis of the property.

With regard to property A, the IRS argued that the valuation provided by Howard Coates should be accorded little weight because his views were self-interested. Furthermore, the IRS pointed out that Coates was not a certified appraiser.

One week before trial, IRS counsel notified the Coateses that the IRS challenged their adjusted basis of both properties.

Holding: The Tax Court accepted Howard Coates’s valuations and upheld the amount of the casualty deduction with respect to property A. However, it held that the taxpayers did not establish they had any basis in property B and so were not entitled to a casualty loss deduction with respect to it.

The court cited Howard Coates’s unique knowledge of the land, his ownership of property before and after the tornado, and his substantial experience working the land. He also had bought and sold other property in Seminole County, some of it fire-damaged or overgrown, that he had restored to productive use. In all, the court considered him a knowledgeable and credible source of before-and-after valuations, and any apparent inconsistencies with the 2010 appraisal and insurance reimbursement amount were reasonably explained by other facts in the record. The adjusted basis of property A, reported by the Coateses as $500,000, was accepted by the court upon the failure of the IRS to challenge it in its opening brief filed after trial.

With respect to property B, the basis of which the IRS did challenge in its brief, the court noted that some deeds bore tax stamp notations indicating the property was given by Howard Coates’s parents as a gift. Although the Coateses testified that they had bought the property from Howard Coates’s parents, they were unable to provide any proof as to an amount paid for it, or its basis in the hands of the parents. Accordingly, the court held any amount of casualty loss attributable to property B exceeded its basis and was disallowed.

The Tax Court held that the Coateses were entitled to a casualty loss deduction for the 2010 tax year on property A of $39,731, which was the reduction in the property’s value, less the insurance reimbursement they received and the statutory reduction of $100 and 10% of adjusted gross income. Additionally, the Sec. 6662(a) penalty was not upheld.

• Coates, T.C. Memo. 2016-197

—By Maria M. Pirrone, CPA, LL.M., assistant professor of accounting and taxation, St. John’s University, New York City.