IRS Provides Relief for Corrosive Drywall Dilemma
October 7, 2010
The IRS will allow individuals who have used corrosive drywall building materials to treat related losses as a deductible casualty loss. Revenue Procedure 2010-36, 2010-42 IRB provides the guidance.
Many homeowners have experienced problems with certain imported drywall installed in their homes between 2001 and 2008. Homeowners have reported blackening or corrosion of copper electrical wiring and copper components of household appliances, as well as sulfur gas odors. In November 2009, the Consumer Product Safety Commission (CPSC) reported that an indoor air study of a sample of fifty-one homes found a strong association between the problem drywall and levels of hydrogen sulfide in those homes, as well as corrosion of metals.
The IRS has received many inquiries about whether a loss from corrosive drywall constitutes a deductible casualty loss under IRC Section 165; the taxable year any such loss would be deductible; and how the amount of the loss would be computed.
Claiming a Casualty Loss Deduction
Individuals generally may deduct losses incurred during the taxable year that are not compensated by insurance or otherwise. For personal-use property (such as a personal residence and household appliances), the deduction is normally limited to losses from fire, storm, shipwreck, or other casualty, or from theft. A casualty is damage, destruction, or loss of property that results from an identifiable event that is sudden, unexpected, and unusual. Damage or loss resulting from progressive deterioration of property is not a casualty loss.
A casualty loss normally may be deducted only for the taxable year in which the loss is sustained. However, if the taxpayer has a claim for reimbursement of the loss (from insurance or otherwise) for which there is a reasonable prospect of recovery, no portion of the loss is deductible until it can be determined with reasonable certainty whether such reimbursement will be received.
The amount of a taxpayer's casualty loss generally is the decrease in the fair market value of the property as a result of the casualty, limited to the taxpayer's adjusted basis in the property. To simplify the computation of a casualty loss deduction, IRS regulations permit taxpayers to use the cost to repair the damaged property as evidence of the decrease in value of the property. See Treasury Reg. Section 1.165-7(b).
IRC Section 165(h) imposes two limitations on casualty loss deductions for personal use property such as a personal residence. First, a casualty loss deduction is allowable only for the amount of the loss that exceeds $100 per casualty ($500 for taxable years beginning in 2009 only). Second, the net amount of all of a taxpayer's casualty losses (in excess of casualty gains, if any) is allowable only for the amount of the losses that exceed ten percent of the taxpayer's adjusted gross income (AGI) for the year.
IRS Offers Relief
Although losses incurred from corrosive drywall is not “sudden” as normally required, in view of the unique circumstances surrounding such damage, the IRS will provide a “safe harbor method” (or a special tax break) that treats certain damage resulting from corrosive drywall as a casualty loss. The IRS also provided a formula for determining the amount of the loss. To qualify, specific procedures must be followed:
· An individual who pays to repair damage to that individual's personal residence or household appliances that results from corrosive drywall may treat the amount paid as a casualty loss in the year of payment. Note that prior year returns may be amended. The term “corrosive drywall” means drywall that is identified as problem drywall under the two-step identification method published by the CPSC and the Department of Housing and Urban Development in their interim guidance dated January 28, 2010.
·The amount of a loss resulting from corrosive drywall may be limited depending on whether the taxpayer has a pending claim for reimbursement (or intends to pursue reimbursement) of the loss through property insurance, litigation, or otherwise. A taxpayer who does not have a pending claim for reimbursement (and does not intend to pursue reimbursement) may claim as a loss all unreimbursed amounts paid during the taxable year to repair damage to the taxpayer's personal residence and household appliances. A taxpayer who has a pending claim for reimbursement (or intends to pursue reimbursement) may claim a loss for 75 percent of the unreimbursed amounts paid during the taxable year to repair damage to the taxpayer's personal residence and household appliances that resulted from corrosive drywall. A taxpayer who has been fully reimbursed before filing a return for the year the loss was sustained may not claim a loss. A taxpayer who has a pending claim for reimbursement (or intends to pursue reimbursement) may have income or an additional deduction in later taxable years depending on the amount of reimbursement received.
·Amounts paid for improvements or additions that increase the value of the taxpayer's personal residence above its preloss value are not allowed as a casualty loss. Only amounts paid to restore the taxpayer's personal residence to the condition existing immediately prior to the damage qualify for loss treatment.
·If a household appliance is replaced rather than repaired, the amount of the loss attributable to the appliance is the lesser of the current cost to replace the original appliance or the basis of the original appliance (generally its cost).
Individuals claiming such a casualty loss must report the loss amount on Form 4684 (Casualties and Thefts) and mark “Revenue Procedure 2010-36” at the top of the form. Taxpayers are still subject to the $100 ($500 for taxable years beginning in 2009 only) limitation, and the 10-percent-of-AGI limitation.
And, those who choose not to apply the safe harbor treatment are subject to all of the generally applicable provisions concerning deductibility of losses under IRC Section 165. These taxpayers must establish that the damage, destruction, or loss of property resulted from an identifiable event that is sudden, unexpected, and unusual, and was not the result of progressive deterioration. These taxpayers also must prove that the loss is properly deductible in the taxable year claimed by the taxpayer and not in some other year. Further, these taxpayers must prove the amount of the claimed loss, and must prove that no claim for reimbursement of any portion of the loss exists for which there is a reasonable prospect of recovery.