Casualty loss allowed for water damage from washing machine.

P purchased her home in 1985, where she continued to reside until sometime in 1995. The existing washing machine in the house was conveyed to P at the time of purchase.

When P arrived home on Aug. 26, 1994, she discovered that her home was flooded; the cause was identified as a split in the hose from the sink to the washing machine. As a result, the house (which is on a concrete slab) became water soaked; carpets and furniture were destroyed. Mold and mildew began to appear throughout the house within a few days. P and her daughter had to move temporarily. P, a collector, had many boxes and other items stored in her home; she incurred expenses to remove water-soaked items and for general cleanup and repair. The cleanup and repair process took many months and was delayed, at least in part, because of disputes between P and her insurance company.

In December 1994, P filed a claim for insurance loss; the cause and origin was described as "washing machine hose had a small split." On July 31, 1998, P received a payment of $12,500 in settlement of her lawsuit and claim.

On Form 4684, Casualties and Thefts, P reported a total casualty and theft loss of $138,479 and claimed a loss deduction of $130,851, as shown in Exhibit 1 on p. 118.

The IRS contends that (1) P has not established that the failure of the washing machine hose, and subsequent damage, constitute a casualty within the meaning of Sec. 165 and (2) even if a casualty occurred, P has not presented sufficient evidence to prove its amount.

What is a Casualty?

Sec. 165(a) and (c)(3) allow an individual a deduction for loss of property not connected with a trade or business or a transaction entered into for profit, if the loss arises from fire, storm, shipwreck or other casualty and is not compensated for by insurance or otherwise. "Other casualty" is defined as a loss proximately caused by a sudden, unexpected or unusual event, excluding the progressive deterioration of property through a steadily operating cause or by normal depreciation.

Whether damage qualifies as a casualty typically turns on whether the damage satisfies the suddenness requirement, which denotes an accident, a mishap or some sudden invasion by hostile agency, rather than progressive deterioration of property through steadily operating cause; Fay, 120 F2d 253 (2d Cir. 1941), aff'g 42 BTA 206 (1940). The "suddenness" of the loss itself (i.e., the lapse of time between the precipitating event and the loss proximately caused by that event) is a determining factor; John A. Maher, 76 TC 593 (1981), aff'd, 680 F2d 91 (11th Cir. 1982).

In this case, it is appropriate to separate (1) the damage to the washing machine hose from (2) the consequential water damage resulting from the hose's failure. The damage to the washing machine hose resulted from progressive deterioration over 9 years; thus, the failure of the hose does not constitute a casualty within the meaning of Sec. 165(c)(3).

However, the water damage to P's house and personal belongings was the result of an identifiable event, sudden in nature. The hose failure was the precipitating event, and the flooding immediately thereafter was proximately caused thereby. Thus, the damage resulting from the flood in the house is a casualty within the meaning of Sec. 165(c)(3).

Loss Amount

The amount of the casualty loss from partial destruction of property is the lesser of the taxpayer's adjusted basis of the property or the difference in the property's fair market value (FMV) immediately before and after the casualty; Regs. Sec. 1.165-7(b)(1). The loss is reduced by any insurance recovery and salvage value. To establish the amount of the loss, the relevant FMVs of the property "shall generally be ascertained by competent appraisal"; Kegs. Sec. 1.165-7(a)(2)(i). Alternatively, the taxpayer may use the cost of repairs to prove the casualty loss (the cost-of-repairs method); see Regs. Sec. 1.165-7(a)(2)(ii).

P is not allowed any loss for the house itself, because she did not present (1) an appraisal of the house to support the diminution in FMV or (2) the cost of actual repairs. The foreclosure sale for $100,000 (the same amount reflected as the cost basis in 1984) does not provide a means of determining the amount of any loss.

For personal property, P's schedule of loss in Exhibit 1 reflects the FMV of personal property before the casualty as $112,059 and after as $5,580. Exhibit 2 at left shows the loss actually allowed. The court accepts P's $5,580 figure, but approximates a reasonable value for the pre-casualty FMV under Cohan, 39 F2d 540, 544 (2d Cir. 1930). Also, P is not entitled to a deduction for moving or storage costs, because such expenditures do not represent a loss of property value. Thus, P is entitled to a casualty loss in the amount of $27,920.

Exhibit 1: loss claimed on Form 4684

                                         Real                  Personal
                                       property                property

Cost                                   $100,000                $216,330
Insurance reimbursement                  10,000                      --

FMV
  before casualty                       142,000                 112,059

FMV
  after casualty                        100,000                   5,580
                                       $42,000                 $106,479

Less: insurance                         (10,000)                     --
                                        $32,000                $106,419
Total                                              $138,479
  Less: $100                                           (100)
  Less: 10% of adjusted gross income                  7,528
  Claimed loss deduction                           $130,851

Exhibit 2: Loss allowed

                           FMV before
                        casualty or other
Item                      related cost

Personal items               $17,500
Furniture                     20,000
Miscellaneous                  3,000
Carpet                         5,500
Total                        $46,000

FMV
  before casualty            $46,000

FMV
  offer casualty               5,580
Balance                      $40,420
Less: insurance              (12,500)
Casualty loss allowed        $27,920

PAMELA S. COOPER, TC SUMM, OP, 2003-168