SECTION 2. BACKGROUND

.01 Section 165(a) generally provides that a taxpayer may deduct any loss sustained during the taxable year and not compensated for by insurance or otherwise. With respect to property not connected with a trade or business or a transaction entered into for profit, § 165(c)(3) limits an individual taxpayer’s deductions to losses arising from fire, storm, shipwreck, or other casualty, or from theft.

.02 Section 165(h) imposes two limitations on casualty and theft loss deductions for property not connected with a trade or business or transaction entered into for profit. Section 165(h)(1) provides that any loss to an individual described in § 165(c)(3) shall be allowed only to the extent that the amount of the loss arising from each casualty, or from each theft, exceeds

2006–28 I.R.B. 62 July 10, 2006

(such as buildings and ornamental trees and shrubbery) that is owned by the individual who suffered a casualty loss, that contains at least one personal residence, and that is not used in a trade or business or in a transaction entered into for profit. Personal-use residential real property does not include rental property. For purposes of this revenue procedure, a personal residence is a single family residence, or a single unit within a contiguous group of attached residential units (for example, a townhouse or duplex), owned by the individual who suffered a casualty loss, and consists of the total enclosed square footage of the residence or single unit, including any enclosed structures attached to the residence or single unit. For example, a personal residence includes a basement and an attached garage, but does not include a deck or screened-in porch. For purposes of this revenue procedure, a personal residence does not include a condominium or cooperative unit, or any other property for which the individual who suffered the casualty loss does not own the structural components of the building (such as the foundation, walls, and roof), or owns only a fractional interest in all of the structural components of the building, or a mobile home or trailer.

.03 Definition of personal belongings . For purposes of this revenue procedure, a personal belonging is an item of tangible personal property that is owned by the individual who suffered a casualty or theft loss and that is not used in a trade or business or in a transaction entered into for profit. For purposes of this revenue procedure, personal belongings do not include a boat, aircraft, mobile home, trailer, or vehicle (as defined in section 7.02 of this revenue procedure), or an antique or other asset that maintains or increases its value over time.

.04 Use of three personal-use residen- tial real property safe harbor methods . An individual described in section 3.01 of this revenue procedure may use any of the three safe harbor methods described in section 4 of this revenue procedure to determine the decrease in fair market value for personal-use residential real property located in the Hurricane Katrina disaster area, Hurricane Rita disaster area, or Hurricane Wilma disaster area (see section 2.03 of this revenue procedure) that was

ter area on or after September 23, 2005, or (3) Hurricane Wilma disaster area on or after October 23, 2005.

.05 Section 1.165–1(c)(4) provides that in determining the amount of loss sustained, adjustments must be made for any insurance or other compensation received.

.06 Section 1.165–7(b) provides that the amount of a casualty loss is the lesser of (1) the difference between the fair market value of the property immediately before the casualty and the fair market value immediately after the casualty, or (2) the adjusted basis of the property. Section 1012 and § 1.1012–1(a) provide that the basis of property generally is its cost. Section 1016(a)(1) and § 1.1016–2(a) provide that the basis of property is adjusted for any expenditure, receipt, loss, or other item, properly chargeable to capital account, including the cost of improvements and betterments made to the property.

.07 Section 1.165–7(a)(2)(i) provides that to determine the amount of the deductible loss under section 165(a), the fair market value of the property immediately before and immediately after the casualty generally shall be ascertained by competent appraisal. Section 1.165–7(a)(2)(ii) provides that the cost of repairs to the property damaged is acceptable as evidence of the decrease in value of the property if the taxpayer shows that: (1) the repairs are necessary to restore the property to its condition immediately before the casualty; (2) the amount spent for such repairs is not excessive; (3) the repairs do not care for more than the damage suffered; and (4) 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. In order to use the cost-of-repairs method to determine the decrease in fair market value, the taxpayer must actually make the repairs rather than rely on estimates of repairs that will be performed in the future or not at all. See Lamphere v. Commissioner, 70 T.C. 391, 396 (1978), acq ., 1978–2 C.B. 2; Farber v. Com- missioner, 57 T.C. 714, 719 (1972), acq ., 1972–2 C.B. 2. .08 Section 1.165–8(c) provides that the amount deductible in the case of a theft loss is determined consistently with the manner described in § 1.165–7 for determining the amount of a casualty loss. The fair market value of the property immediately after the theft is considered to be zero.

.09 Section 1.165–7(b)(2)(ii) provides that in determining a casualty loss involving real property and improvements thereon not used in a trade or business or in any transaction entered into for profit, the improvements (such as buildings and ornamental trees and shrubbery) to the property damaged or destroyed are considered an integral part of the property, and no separate basis need be apportioned to the improvements.

.10 Due to the widespread devastation from the 2005 Gulf hurricanes, it may be difficult for individuals to determine the decrease in the fair market value of damaged, destroyed, or stolen property using the methods provided in § 1.165–7(a)(2). The IRS and Treasury Department recognize that the statutory suspension of § 165(h) limitations on 2005 Gulf hurricane casualty loss deductions provided by § 1400S reflects Congressional intent to facilitate certain deductions. In view of these unique circumstances, the IRS and Treasury Department believe it is appropriate to provide safe harbor methods for use in determining the amount of casualty and theft loss deductions for certain property damaged, destroyed, or stolen as a result of the 2005 Gulf hurricanes. Therefore, this revenue procedure provides safe harbor methods that individuals may use under § 1.165–7(a)(2)(i) to measure the decrease in the fair market value of their personal-use residential real property that was damaged or destroyed and to determine the pre-hurricane fair market value of personal belongings that were damaged, destroyed, or stolen as a result of one of the 2005 Gulf hurricanes.