Court Relies on Owner's Opinion of Property's Value to Determine Casualty Loss

(Parker Tax Publishing November 2016)

The Tax Court held that a couple was entitled to a casualty loss deduction for one tract of property damaged by a tornado, but not for a different tract for which the couple could not prove the adjusted basis of the property. In determining the amount of the loss, the court relied on the land owners' opinion as to the before-and-after values, saying such deference was appropriate because the owner has unique knowledge of the land. Coates v. Comm'r, T.C. Memo. 2016-197.

Background

In 2010, Howard Coates and his wife owned a large amount of land in Seminole County, Oklahoma. One tract was 700 acres that consisted of three adjacent areas: (1) Property A, which consisted of 80 acres and included the couple's home and two barns; (2) Property B, which consisted of 440 acres of undeveloped woodlands; and (3) 180 other acres. The woodland was populated by wild turkeys, deer, wild boars, rabbits, and squirrels. The Coateses and others used the land recreationally to hunt, fish, and hike. They did not charge anyone for use of the land.

Coates is experienced in working with timberland, farmland, and pastureland. For 30 years, he has been handling tasks on his properties and has also bought and sold various properties in Seminole County. Some of the land Coates bought had been damaged by fire or was overgrown. In those instances, he had to restore the land to workable farmland or grazing land before reselling it.

On May 10, 2010, a tornado hit Seminole County, Oklahoma. The tornado cut through the couple's property, significantly damaging Property A and flattening the woodland of Property B. The center of the tornado leveled a roughly mile-wide path, and the accompanying high winds uprooted trees as far as an additional half mile on either side of the tornado's path. On Property A, the tornado damaged the house and barns, tore down fences, and knocked down trees. On Property B, the tornado demolished 80 to 90 percent of the oak trees. Without the tree canopy cover, Property B became covered in dense, impassable scrub. The land no longer provided a suitable habitat for the wild turkeys, deer, and wild boars. Only the squirrels and rabbits remained after the tornado.

The taxpayers received an insurance reimbursement for the damage to Property A of $168,000 after spending $20,000 to hire a professional firm to estimate the amount of damage. Because the Coateses did not insure Property B, no insurance reimbursements were received for the damage to that property. The couple reported the net reimbursement of $148,000 on their 2010 tax return and reported a casualty loss of approximately $128,000 for the damage to Property A and Property B. The IRS disallowed the casualty loss and assessed an accuracy-related penalty of more than $6,000.

Analysis

Before the Tax Court, the taxpayers argued that the pre-tornado and post-tornado values of Property A were $660,000 and $450,000, respectively, and the pre-tornado and post-tornado values of Property B were $528,000 and $440,000, respectively. Thus, before the insurance reimbursement and the statutory limitations on casualty losses, Coates contended that the couple had a decline in the value of Property A of $210,000 and a decline in the value of Property B of $88,000. The IRS rejected those values, saying that Coates' valuation should be accorded little weight because he was not a certified appraiser and he did not exhaustively explain his method for determining the values.

Under Reg. Sec. 1.165-7(b)(1), the amount of a casualty loss cannot exceed the adjusted basis of the damaged property. The couple reported that their adjusted basis in Property A was $500,000. In an effort to establish their adjusted basis in Property B, the taxpayers introduced deeds to various properties. However, the deeds did not state the purchase prices and certain notations on the deeds suggested to the Tax Court that the deeded land was transferred by gift.

The Tax Court agreed with the taxpayers that they suffered a $210,000 decline in the value of Property A as a result of the tornado. Because this amount was less than the property's adjusted basis, the court used this amount as the starting point for calculating the casualty loss deduction. After subtracting the net insurance reimbursement of $148,268, the court determined a casualty loss of $61,732. From that amount, the court subtracted the statutory limitations on casualty losses of $100 and 10 percent of adjusted gross income to arrive at a total casualty loss of $39,731. Because the couple did not satisfy their burden of proving their adjusted basis in Property B, the court did not allow any casualty loss with respect to that property.

In arriving at the casualty loss deduction for Property A, the court relied on Coates' testimony of the pre- and post-tornado value. The court found him to be credible and knowledgeable about the before-and-after values of Property A. It is permissible, the court said, to consider the opinion of a landowner as to the value of land because the owner has unique knowledge of the land. According to the court, although Reg. Sec. 1.165-7(a)(2)(i) provides that the relevant fair market values before and after a casualty must generally be ascertained by a competent appraisal, this does not mean that the appraisal must be done by a professional appraiser. It is therefore permissible, the court said, for the before-and-after values in a casualty-loss situation to be determined by a court on the basis of the landowner's opinion of these values.

The court said that Coates's views on the valuation of the property deserved special weight because (1) he owned Property A before and after the tornado; (2) he has substantial experience working with timberland, farmland, and pastureland; (3) for 30 years, he has been handling various tasks on the ranch; and (4) he has also bought and sold various properties in Seminole County, some of which had been damaged by fire or was overgrown and had to be restored to workable farmland or grazing land before reselling it. As a result, the court concluded that Coates was credible and knowledgeable about the before-and-after values of Property A.

Finally, the court rejected the imposition of an accuracy-related penalty saying that the taxpayers prepared their 2010 tax return in good faith and had reasonable cause for claiming an excessive casualty-loss deduction.

For a discussion of the calculation of casualty losses, see Parker ¶84,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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