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’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 $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 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)(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 (“Stafford Act”). Section 165(i)(5)(B) defines “disaster area” as the area so determined to warrant such assistance.

.06 The Disaster Tax Relief and Airport and Airway Extension Act of 2017 (“Disaster Tax Relief Act”), Pub. L. No. 115–63, 131 Stat. 1168, 1182–1183 (Sept. 29, 2017), modifies some of the general rules under § 165 for losses in certain geographic areas. Section 504(b) of the Disaster Tax Relief Act increases the § 165(h)(1) dollar limitation from $100 to $500, waives the § 165(h)(2) ten percent

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of adjusted gross income limitation, increases the § 63 standard deduction, and provides that such increase in the standard deduction is allowed in computing the alternative minimum tax. Section 504(b) of the Disaster Tax Relief Act applies only to net disaster losses, which are the excess of losses attributable to Hurricanes Harvey, Irma, and Maria and that arose in the Hurricane Harvey disaster area, Hurricane Irma disaster area, or Hurricane Maria disaster area after particular dates, over personal casualty gains.

.07 Under § 501(a)(2) of the Disaster Tax Relief Act, “Hurricane Harvey disaster area,” “Hurricane Irma disaster area,” and “Hurricane Maria disaster area” are areas with respect to which a major disaster has been declared by the President under § 401 of the Stafford Act by reason of Hurricane Harvey, Hurricane Irma, and Hurricane Maria, respectively. For areas with respect to which a major disaster has been declared by the President under § 401 of the Stafford Act, see www.fema.gov/disasters .

.08 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.

.09 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.

.10 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.

.11 Section 1.165–7(a)(2)(i) provides that to determine the amount of the de

ductible 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; Far- ber v. Commissioner, 57 T.C. 714, 719 (1972), acq., 1972–2 C.B. 2. But see § 4.02 of Rev. Proc. 2018–08 (providing an estimated repair cost safe harbor method).

.12 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.

.13 Taxpayers report gains and losses from casualties on Form 4684 according to the Form 4684 instructions, as updated at www.irs.gov/form4684 . See special instructions at www.irs.gov/form4684 for taxpayers electing under § 165(i) to report their casualty losses calculated under this revenue procedure on an original or amended 2016 tax return.

.14 Rev. Proc. 2018–08, provides safe harbor methods that individuals may use in determining the amount of their casualty and theft losses under § 165 for personal-use residential real property and personal belongings. Due to the widespread devastation from the 2017 Hurricanes, the Treasury Department and the

IRS are providing an additional safe harbor method 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 that was damaged or destroyed as a result of the 2017 Hurricanes.