New refund opportunities for prior casualty and theft losses.

• Author: Adkins, Nell

Changes made by the Tax and Trade Relief Extension Act of 1998, the Internal Revenue Service Restructuring and Reform Act of 1998 and Taxpayer Relief Act of 1997 may trigger refund opportunities for casualty and theft deductions taken or limited in prior open years. This article explains all of these legislative amendments and offers examples.

Taxpayers incurring casualty or theft losses in the current or a previous tax year may have new opportunities to maximize the tax benefits resulting therefrom. Substantial changes to these provisions were made by the Tax and Trade Relief Extension Act of 1998 (TTREA '98), the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) and the Taxpayer Relief Act of 1997 (TRA '97); however, official guidance was not released until the 1999 tax season was well under way.(1) Thus, tax advisers may have overlooked certain provisions and been unaware of retroactive effective dates. Accordingly, any previously filed tax return containing a casualty or theft loss, for which the statute of limitations remains open, should be examined for possible application of these changes.

While the TTREA '98 contained numerous technical corrections (discussed below) that affect a wide range of taxpayers, the TRA '97 contained only two major provisions affecting casualty and theft losses. First, under TRA '97 Section 1082(b), amending Sec. 172(b)(1)(F), any part of a net operating loss (NOL) arising from a casualty or theft occurring after Aug. 5, 1997, was made eligible for a three-year carryback period.(2) Second, under TRA '97 Section 915, if an individual located in an area Presidentially declared a disaster after 1996 was granted an extension to file under Sec. 6081 and to pay under Sec. 6161, the Service will abate, for the extension period, any interest assessed under Sec. 6601. IRSRRA '98 Section 3309, amending Sec. 6404(h), broadened this interest abatement to other taxpayers and to Presidentially declared disaster areas in years after 1997.

These provisions are a complex web. This article attempts to unravel the recent statutory changes to the casualty and theft loss provisions made by the TTREA '98, IRSRRA '98 and TRA '97, and proffer tax savings opportunities.

General Provisions

To fully comprehend the effect of the technical amendments, an examination of the statutory provisions is required. Sec. 165(a) allows a deduction for losses sustained during the tax year not compensated for by insurance or otherwise; for individuals, Sec. 165(c)(1)-(3) limits the deduction to:

1. Losses incurred in a trade or business.

2. Losses incurred in any transaction entered into for profit, though not connected with a trade or business.

3. Except as provided in Sec. 165(h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck or other casualty, or from theft.

   Thus, Sec. 165(c)(1) and (2) generally allow a deduction for a variety of losses in the trade or business and for-profit transaction contexts. However, deduction of losses on personal-use property is restricted to the events noted in #3 above. Exhibit 1 on p. 184 summarizes the general treatment of casualty and theft losses.

   Exhibit 1: Casualty and Theft Loss Deduction Summary Type Code Incurred in a trade or business Sec. 165(c)(1) Incurred in a transaction entered Sec. 165(c)(2) into for profit (rent or royalty property) Incurred in a transaction entered Sec. 165(c)(2) into for profit (property other than rent or royalty property) Incurred on employee property Sec. 67(a) Incurred on personal-use property Sec. 165(c)(3) Type Deduction restrictions/ limits Incurred in a trade or business Deductible for AGI Incurred in a transaction entered Deductible for AGI into for profit (rent or royalty property) Incurred in a transaction entered Deductible from AGI as a into for profit (property other miscellaneous itemized than rent or royalty property) deduction Incurred on employee property Deductible from AGI as miscellaneous itemized deduction subject to the 2% floor Incurred on personal-use property Deductible from AGI, subject to $100 and 10% of AGI limits Type Examples Incurred in a trade or business Depreciable personal...