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 deduction 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 $100. Section 165(h)(2) provides that if personal casualty and theft losses for any taxable year exceed personal casualty and theft gains for the taxable year, the losses are allowed only to the extent of the sum of the amount of the gains, plus so much of the excess as exceeds ten percent of the adjusted gross income of the individual.

.03 Section 165(h)(4)(E) provides that to the extent an individual’s casualty or theft loss is covered by insurance, such loss shall be taken into account only if the individual files a timely insurance claim with respect to such loss.

.04 Section 165(i)(1) allows an individual who suffered a loss occurring in a disaster area and attributable to a Federally declared disaster to take the loss into account for the taxable year immediately preceding the taxable year in which the disaster occurred.

.05 Section 165(i)(4) authorizes the Treasury Department and the IRS to prescribe guidance under which an appraisal for the purpose of obtaining a loan of Federal funds or a loan guarantee from the Federal Government as a result of a Federally declared disaster may be used to establish the amount of any loss described in § 165(i)(1) or (2).

.06 Section 165(i)(5)(A) defines “Federally declared disaster” as any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the

Robert T. Stafford Disaster Relief and Emergency Assistance Act. Section 165(i) (5)(B) defines “disaster area” as the area so determined to warrant such assistance. For areas with respect to which Federally declared disasters have been determined, see www.fema.gov/disasters .

.07 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.

.08 Section 1.165–1(d)(2)(iii) provides that if a taxpayer deducted a loss and in a subsequent taxable year receives reimbursement for such loss, the taxpayer does not recompute the tax for the taxable year in which the deduction was taken but includes the amount of such reimbursement in gross income for the taxable year in which received, subject to the provisions of section 111, relating to recovery of amounts previously deducted.

.09 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.

.10 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

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dure provides safe harbor methods that individuals may use under § 1.165–7(a)(2) to measure the decrease in the fair market value of their personal-use residential real property following a casualty and to determine the pre-casualty or theft fair market value of personal belongings.

The Treasury Department and the IRS also are aware of the unique circumstances surrounding a Federally declared disaster area and the difficulties individuals encounter in determining the amount of their losses in those areas. Accordingly, this revenue procedure provides those individuals with additional safe harbor methods to use in determining the amount of their casualty and theft losses for property damaged, destroyed, or stolen as a result of any Federally declared disaster.