APPRAISERS ARE KEY TO DISASTER LOSS DEDUCTIONS
Often an essential part of the recovery from a catastrophic event is determining the amount of a deductible loss. Where adequate insurance coverage is in place the recovery focuses on collection of proceeds based on the policy provisions. But where insurance is not adequate or not available, the possible benefits of a tax deduction can be an important consideration. A properly prepared appraisal demonstrating the decrease in the value of the property resulting from the catastrophic event becomes essential.
In addition and integral to the appraisal process, it must be noted that the appraiser’s work product may be examined by an IRS agent who is reviewing the overall casualty loss deduction claimed on taxpayers’ income tax return. Most often at that meeting the appraiser will not be in attendance; only the report will be reviewed and the taxpayers’ representative, usually a CPA or EA will be the person defending the casualty loss claim. As such it is important that the tax professional be consulted before the appraisal report is issued final. It is not the tax professional’s responsibility to impact the conclusions of the appraiser, in fact that is the last thing that the tax professional should be a part of. But a knowledgeable tax professional should be able to review the appraisal report to see where the strengths and weaknesses are that will impact an IRS review. Clarity is important and that should be the only concern of the tax professional in any review of an appraisal.
In the end the tax professional and the professional appraiser are working together to assist the taxpayer report a casualty loss claim that is sustainable as a result of an IRS review.
After a physical catastrophic event strikes the recovery process starts immediately. One important task is the valuation of the loss. To complete that job it is often necessary to call on the expertise of a professional appraiser. The significance of the appraiser’s work in these situations brings to mind certain aspects of the appraiser that are very important and aspects of the situation that the appraiser cannot be called on to provide expertise about. For example, after a fire, the appraiser can provide a pre- and post- loss set of valuations; but the appraiser should not be called on to be a forensic analyst to determine what caused the fire.
There are many aspects of the professional appraisal process that are the subjects of the professional training an appraiser takes in addition to the material referred to in this article. This article is geared to the fact that, like other professionals that are called on in these situations, the appraiser may never have been called on to prepare one of these reports.
When the appraiser is called on to prepare a report of the pre- and post- loss valuations the appraiser needs to know what the report is going to be used for. A report for insurance or property tax assessment may be different from one that is going to be used to support an income tax report. There are specific aspects of an income tax casualty loss appraisal of loss that must be understood and adhered to in order for the appraisal to have any value to the taxpayer. Ignoring the special rules may be seen as correct by the appraiser, but the result will be a useless report. In order for the report to be useful to the client, the appraiser needs to know the unique rules that must be addressed. Additionally, it is important for the appraiser to be knowledgeable about how the appraisal report will be challenged by the IRS or will require testimony in a tax court hearing.
This article relies on income tax cases that taxpayers either have been successful 0or unsuccessful in securing a tax deduction for a casualty loss deductions. Most reports that meet the IRS requirements should be accepted without any questions, some will need to be vetted in an IRS examination and only a few will see the daylight of a tax case dissection. Since the results of the unquestioned tax returns and resolved tax examinations are not available to us, we have to rely on published court opinions and IRS rulings to understand the process used to resolve disputed tax loss deduction claims.
The IRS does have very specific rules for what qualifies as an appraisal for tax purposes, however, those rules are not set out in the casualty loss sections of the Internal Revenue Code, and the rules are part of the Code and Regulation for computing a charitable contribution of an object other than cash. These rules are not covered in this article. The user is referred to IRS Publication 561, “Determining the Value of Donated Property.” On the cover of Pub 561, the IRS notes: “This publication does not discuss how to figure the amount of your deduction for charitable contributions or written records and substantiation required. See Publication 526, Charitable Contributions, for this information.” Unfortunately, the publication does not provide the specialized assistance needed for a casualty loss valuation.
John Trapani has available a book (APPRAISER’S GUIDE TO INCOME TAX REQUIREMENTS IN A CATASTROPHIC LOSS APPRAISAL VALUATION) that discusses the unique issues of casualty loss appraisals in detail. More information can be found at: http://www.trapanicpa.com/disaster-recovery-blog/
The individual topics cover cases along with IRS rulings that support the conclusions and recommendations presented in the summary.
There are traditional necessities of a professional appraisal that are not covered in this article.
When it is necessary for taxpayers to “invest” in an appraisal to determine and support a casualty loss deduction, taxpayers and tax professionals need to have an understanding of what the appraisal report should include. In a real estate appraisal, the dollar amounts will likely be significant and the demands of the Internal Revenue Service (IRS) are not necessarily known by many appraisers. As a result the appraisers may issue a “normal appraisal” as they would for a refinancing or sale. It turns out that all that content is necessary, but there are specific requirements that may not be addressed but are required in order for the IRS to consider the appraisal valid. The requirements set out in this article are the result of reviewing and analyzing IRS publications and court cases. In court cases judges add additional points that they found the taxpayer’s documentation either included that swayed their conclusion or did not include that had a negative effect on the courts’ decision process. In some cases the court brings in a requirement that simply adds to the court’s weighing of conflicting appraisals.
Appraisals for disaster and “common” casualty losses are different from the normal real estate appraisal. The qualifications of the appraiser do not change, but the report has some unique features. There are specific qualifications of the appraiser that courts use to weigh the reports prepared for the taxpayer and those prepared for the IRS.
If the deduction becomes contested in an examination, the IRS may bring in their own “expert.” There may be a major difference between the appraisal prepared by the taxpayer’s professional and the one prepared by the IRS professional. The IRS professional may suffer from not being a local appraiser; that is often held against the government’s efforts as the non-local appraiser may miss unique local conditions. The taxpayer’s appraiser should emphasize his/her specific knowledge of the local area.
In the case where the IRS adds their expert into the mix, the relative weight of the work products will often hinge on a few details that may be remotely related to the actual appraisal. The taxpayer who has secured a quality appraisal soon after the damage occurs seems to have an edge over the expert that the IRS hires; the IRS expert will prepare a report two or more years after the event, the physical aspects of the site will be different. On the other hand, the market values of the property will have that time to mature and may be in conflict with the assumptions in the taxpayer’s commissioned appraisal.
Here is a list of critical points that are discussed in detail in the book.
The development of casualty loss deduction rules related to appraisals and appraisers have settled on some prerequisites including
a) “Hypothetical” appears a number of times in the literature and when it appears it is usually a problem for the taxpayer. The IRS sees “hypothetical” as an “imaginary thought exercise” and not real. In effect the presence of the word in the report diminishes the usefulness of the report. No one believes that the appraiser has actually examined the property immediately before or immediately after the flood, earthquake, mudslide, fire, storm or “other casualty” event when the debris is still ruining the “curb appeal.” Interestingly, the IRS recognizes the physical and psychological impact of debris,
b) “Buyer Resistance” is baked into the regulations as an adjustment that must be made to eliminate its impact on the diminished post-event value.
c) The presence of physical damage,
d) The damages result from "sudden, unexpected, and unusual" actions,
e) The appraiser must consider, as a separate amount, the possible impact of Buyer Resistance,
f) That the taxpayer was powerless to prevent the loss and within reason exerted appropriate effort to minimize the damage.
JOHN TRAPANI, CPA assists both taxpayers directly and
advises taxpayers’ tax professionals.
This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.
© 2017, John Trapani, CPA,
All rights to reproduce or quoting any part of the entry in any other publication is reserved by the author. Republication rights limited by the author regarding this material.
Certified Public Accountant
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Any accounting, business or tax advice contained in this entry is of a general nature and does not have any legal weight, it is not aa authoritative analysis of a specific issue, nor a substitute for a formal analysis of a specific fact situation. It cannot be considered sufficient to avoid tax-related penalties that might be assessed by a tax authority.
If desired, John Trapani, CPA would be pleased to perform a complete research and analysis of a taxpayer’s situation.
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