SECTION 5. COST INDEXES SAFE

HARBOR METHOD EXAMPLES

The following examples illustrate the application of the Cost Indexes Safe Harbor Method described in section 4.04 of this revenue procedure.

Example 1 . Prior to Hurricane Katrina, an individual purchased a personal residence for $300,000. The personal residence is 2,000 square feet and the personal-use residential real property does not contain any decking or detached structures. The personal residence was flooded by nine feet of salt water for over three weeks due to a breach in a levee, causing the structural connections in the personal residence to corrode to the extent they must be replaced. The personal residence is located in the Hurricane Katrina disaster area. Insurance and other reimbursements total $100,000. The individual obtained from the insurance company a report setting forth the estimated damage to the personal residence. The individual also obtained from a licensed contractor a binding contract signed by the contractor and the individual itemizing the contract price to repair the damage to the personal residence. The individual chooses to use the Cost Indexes Safe Harbor Method. Because the salt water corrosion damage to the personal residence falls within the definition of total loss, as defined in section 3.05(1) of this revenue procedure, the individual uses Table 1 of the Cost Indexes Safe Harbor Method to determine the decrease in fair market value of the personal-use residential real property. The individual multiplies the square footage of the personal residence by the cost index for a Medium Personal Residence in Table 1, as follows:

2,000 sq. ft. x $148/sq. ft. = $ 296,000

The individual compares the decrease in fair market value, $296,000, with the basis in the personaluse residential real property, $300,000, and from the smaller of these two amounts, $296,000, subtracts the insurance and other reimbursements of $100,000. The individual is entitled to a casualty loss deduction of $196,000 ($296,000 - $100,000).

Example 2 . Assume the same facts in Exam- ple 1, except that the individual purchased the personal-use residential real property twenty years ago for $120,000, and paid no additional amounts for improvements or remodeling. The individual compares the decrease in fair market value, calculated using the Cost Indexes Safe Harbor Method in Example 1, with the basis of the personal-use residential real property. Since the basis of $120,000 is less than the decrease in fair market value, $296,000, the individual’s casualty loss is limited to the basis of $120,000. Af

ter subtracting insurance and other reimbursements of $100,000 from the basis of $120,000, the individual is entitled to a casualty loss deduction of $20,000 ($120,000 - $100,000 = $20,000).

Example 3 . The individual’s personal residence is substantially damaged by a storm surge from Hurricane Katrina. The individual’s personal-use residential real property is located in the Hurricane Katrina disaster area. The damage falls within the definition of near total loss, as defined in section 3.05(2) of this revenue procedure, since all of the drywall, floorings, electrical lines, ducts, plumbing, and other fixtures need to be replaced. Prior to Hurricane Katrina, the individual purchased the personal-use residential real property for $190,000 and spent $10,000 for improvements to remodel the residence. Immediately prior to Hurricane Katrina, the adjusted basis of the property was $200,000 ($190,000 cost

• $10,000 improvements). The personal residence is 2,000 square feet and the personal-use residential real property does not contain any decking or detached structures. The individual paid $5,000 to have debris cleared from the personal-use residential real property. Insurance and other reimbursements total $100,000.

Because the damage to the personal residence falls within the definition of near total loss, the individual uses Table 2 of the Cost Indexes Safe Harbor Method to determine the decrease in fair market value of the personal-use residential real property. Using Table 2 of the Cost Indexes Safe Harbor Method, the decrease in fair market value of the personal-use residential real property is determined by multiplying the square footage of the personal residence by the cost index for a Medium Personal Residence as follows:

2,000 sq. ft. x $120/sq. ft. = $240,000

Because the individual chooses to use the Cost Index Safe Harbor Method for determining the decrease in fair market value, the $5,000 debris removal costs are not added to the safe harbor amount of $240,000. The individual compares the adjusted basis of the personal-use residential real property to the decrease in fair market value determined by using the Cost Indexes Safe Harbor Method. Since the adjusted basis of $200,000 is less than the decrease in fair market value, $240,000, the individual’s casualty loss is limited to the adjusted basis of $200,000. After subtracting $100,000, the amount of insurance and other reimbursements received, from the adjusted basis of $200,000, the individual is entitled to a casualty loss deduction of $100,000 ($200,000 - $100,000 = $100,000).

Example 4 . The first floor of an individual’s personal residence was flooded with 4 feet of salt water as a result of a storm surge during Hurricane Katrina. As a result of the flooding, all of the flooring and drywall on the first floor needs to be replaced. The second floor of the personal residence is not damaged. While the personal residence sustained flooding of more than 1 foot of salt water, it did not sustain damage that falls within the definition of total loss or near total loss in sections 3.05(1) and (2) of this revenue procedure. Therefore, the personal residence sustained interior flooding over 1 foot as described in section 3.05(3) of this revenue procedure. In addition, the pressure treated wood deck attached to the personal residence was completely

destroyed by Hurricane Katrina. The personal-use residential real property is located in the Hurricane Katrina disaster area. The personal residence is 2,000 square feet and the personal-use residential real property does not contain any detached structure. The total square footage of the flooded rooms on the first floor is 1,000 square feet. Prior to Hurricane Katrina, the individual purchased the personal-use residential real property for $200,000. Insurance and other reimbursements total $90,000. The individual chooses to use the Cost Indexes Safe Harbor Method.

To calculate the decrease in fair market value of the personal-use residential real property, the individual uses the first column of Table 3 to determine the size of the personal residence based on the total square footage of the personal residence. The individual multiplies the flooded square footage of the personal residence, 1,000 square feet, by $92, the cost index for a Medium Personal Residence in column 2 of Table 3.

1,000 sq. ft. x $92/sq. ft. = $92,000

The wood deck is 200 square feet. Using Table 7, the individual multiplies the square footage of the damaged area of the deck, 200 square feet, by the cost index of $15 in column 2 of Table 7.

200 sq. ft. x $15/sq. ft. = $3,000

To determine the total decrease in fair market value of the personal-use residential real property the individual adds $3,000 to $92,000.

$3,000 + $92,000 = $95,000

The individual then compares the adjusted basis of the personal-use residential real property, $200,000, to the decrease in fair market value determined by using the Cost Indexes Safe Harbor Method, $95,000. Since the decrease in fair market value of $95,000 is less than the basis of $200,000, the individual’s casualty loss is $95,000. After subtracting $90,000, the amount of insurance and other reimbursements, from $95,000, the individual is entitled to a casualty loss deduction of $5,000 ($95,000

• $90,000 = $5,000).

Example 5 . Prior to Hurricane Rita, an individual purchased personal-use residential real property for $200,000 and spent $5,000 for improvements to the personal-use residential real property. Two trees fell into the individual’s personal residence during Hurricane Rita, destroying a portion of the roof. Rain from the hurricane soaked the walls and flooring of two bedrooms and the living room, necessitating removal and replacement of drywall and wood paneling, roof panels, trusses, and flooring. The rest of the personal residence remains undamaged. The personal residence was not flooded by salt water. Therefore, the damage constitutes structural damage from wind, rain, or debris, as described in section 3.05(4) of this revenue procedure. The individual’s personaluse residential real property is located in the Hurricane Rita disaster area. The personal residence is 2,000 square feet and the personal-use residential real property does not contain any decking or detached structure. The damaged two bedrooms and living room total 1,000 square feet. Insurance and other reimbursements total $100,000.

July 10, 2006 69 2006–28 I.R.B.

The individual chooses to use the Cost Indexes Safe Harbor Method. Using Table 4, the percentage of square footage of the personal residence that was

damaged by the hurricane is determined by dividing the total square footage of the personal residence by

the square footage of the personal residence that was damaged as follows:

1,000 sq. ft. / 2,000 sq. ft. = 0.50 or 50% of the total square footage was damaged.

The individual uses the cost index in column 2 of Table 4 for 26% to 50% damage and multiplies it by the number of square feet that were damaged.

$132/sq. ft. x 1,000 sq. ft. = $132,000

The roof covering also sustained damage that necessitated replacement of all roof shingles, felt lining, and flashings. The total square footage of the ground floor of the personal residence is 2,000 square feet. The total square footage under the roof, including porches, patios, and overhangs, is 2,200 square feet. The individual multiplies the cost index for a Medium Personal Residence in Table 5 by 2,200 square feet, the total square footage under the roof.

2,200 sq. ft. x $5.75/sq. ft. = $12,650

The individual adds $12,650 to $132,000 to determine the total decrease in fair market value of the personal-use residential real property.

$12,650 + $132,000 = $144,650

The individual compares the decrease in fair market value, $144,650, with the adjusted basis, $205,000, and from the smaller of these two amounts, $144,650, subtracts insurance and other reimbursements of $100,000. The individual is entitled to a casualty loss deduction of $44,650 ($144,650 $100,000 = $44,650).

Example 6 . Winds from Hurricane Rita caused a tree to fall across a detached garage located on an individual’s personal-use residential real property. Prior to Hurricane Rita, the individual purchased the personal-use residential real property for $200,000. The personal residence is located in the Hurricane Rita disaster area. The personal residence is not damaged by Hurricane Rita. The personal-use residential real property does not contain any decking or other detached structure. The garage suffered significant damage and requires major rebuilding. The total square footage of the garage is 400 square feet. The garage was not insured.

The individual chooses to use the Cost Indexes Safe Harbor Method. Because the garage is a detached structure, as described in section 3.05(6) of this revenue procedure, the individual uses Table 6 to determine the decrease in fair market value of the personal-use residential real property. Using Table 6, the individual multiplies the total square footage of the garage, 400 square feet, by the cost index of $38 in column 2 of Table 6.

400 sq. ft. x $38/sq. ft. = $15,200

The individual’s basis in the personal-use residential real property is $200,000. The individual compares the decrease in fair market value, $15,200, with the basis, $200,000. Since the decrease in fair

market value is less than the basis, the individual is entitled to a casualty loss deduction of $15,200.

Example 7 . Winds from Hurricane Wilma blew down a pine tree that destroyed part of a pressure treated wooden deck attached to the back of an individual’s personal residence. The personal-use residential real property is located in the Hurricane Wilma disaster area. The individual’s basis in the personal-use residential real property is $200,000. Neither the personal residence nor any detached structure was damaged by the fallen tree. The deck is 450 square feet. It is necessary to rebuild one-half of the deck. The remaining half of the deck is not damaged, and remains structurally sound.

The individual chooses to use the Cost Indexes Safe Harbor Method. Because the deck is wood decking as described in section 3.05(7) of this revenue procedure, the individual uses Table 7 to determine the decrease in fair market value of the personal-use residential real property.

The square footage of the damaged area of the deck is one-half of 450 square feet, which is 225 square feet. Using Table 7, the individual multiplies the square footage of the damaged area of the deck, 225 square feet, by the cost index of $15 in column 2 of Table 7.

225 sq. ft. x $15/sq. ft. = $3,375

The individual compares the decrease in fair market value, $3,375, with the basis, $200,000. Since the decrease in fair market value is less than the basis, the individual is entitled to a casualty loss deduction of $3,375.