William and Carol Hagerty lived in a two-story wood-frame house in an exclusive part of South Bend, Ind.
Seven months after they bought the house, a fire destroyed the roof. This caused ceilings to collapse, opening most of the house to the elements. They repaired the house to the extent paid for by insurance.They said their damages exceeded their insurance coverage, so they took a tax deduction for this excess.
Hot under the collar, the IRS disallowed the deduction, saying there was no loss because the insurance paid for the repairs. The Tax Court disagreed.
Repairs are not always a measure of loss. Here repairs didn't restore the house to its prefire condition. The taxpayers could deduct the decrease in the value of their home not reimbursed by insurance.
THE MORAL: The taxman must take note when an insurance payment for damaged property is a drop in the bucket compared to the drop in value.
- Determining the reduction in value from a casualty is often a bone of contention in tax cases.
George Finkbohner Jr. and his wife, Beverly, learned about the dog-eat-dog world of taxes the hard way - through a tussle with the IRS.
A major flood in Mobile, Ala., damaged beyond repair seven of the 12 houses on a cul-de-sac near Three Mile Creek. The city bought the seven lots for permanent open space.
The Finkbohners owned one of the five remaining homes. Because they had no flood insurance, they paid the $1,200 it cost to repair their driveway and grounds. But they deducted more than that as a casualty. They claimed that the virtual destruction of their neighborhood lowered their property value: Their home would now be more susceptible to crime.
The IRS allowed only the $1,200.
The court increased the deduction to $13,700. The judge explained that the couple could deduct the decrease in market value. He criticized the IRS, saying it gives "service" to the market value rule while in "reality" it allows only the cost of repairs.
THE MORAL: What the market will bear is barely what the IRS will tolerate.
- Dr. Manouchehr Mozayeny of La Habra, Calif., watched his Mercury Marquis burn during the Iranian Revolution. He was there helping that government establish a health program when the revolution broke out.
Before leaving the United States, Mozayeny had paid $20,700 to ship the car to Iran and for custom duties once it got there. Not only did he deduct the price of the burned car on his tax return, he deducted these expenses also. The IRS operated on the doctor's return and removed the deductions. It said Mozayeny didn't prove he had a loss.
The court, however, accepted Mo-zayeny's proof of the loss but limited his deduction to what he paid for the car. The judge disallowed the transportation cost and the custom duties saying these were personal expenses and not part of the cost of the car.
THE MORAL: Even though taxpayers get burned about it, personal expenses go up in smoke.