Industry Directory Directive #1 on Examination of IRC Section 165 Casualty Losses
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
Large and Mid-Size Business Division
Impacted IRM 4.51.2
April 27, 2007
MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB
DIRECTOR, FIELD SPECIALISTS, LMSB
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB
DIRECTOR, INTERNATIONAL COMPLIANCE
STRATEGY AND POLICY
FROM: Keith M. Jones /s/ Keith M. Jones
Natural Resources and Construction
SUBJECT: LMSB Tier II Issue - Field Directive on the Examination
of IRC Section 165 Casualty Losses #1
This memorandum provides direction for this Large and Mid-Sized Business division (LMSB) Tier II Issue to effectively utilize resources in the classification and examination of Internal Revenue Code (IRC) Section 165 casualty loss deductions.
LMSB Technical Advisors and field teams have discovered a growing trend in the utilities and telecommunications industry whereby taxpayers are deducting casualty losses under IRC Section 165 and then deducting the cost of restoring the damaged property as repair expenses under Section 162.
A corollary issue relates to the adjusted basis of the assets used in calculating the allowable casualty loss amount. In applying Regulation Section 1.165-7, which limits the deduction to the taxpayer's basis in the "single identifiable property" (SIP) damaged or destroyed, taxpayers are designating as the SIP their entire utilities transmission and distribution system or their entire telecommunication system.
As to the first issue, the Service's position is that the taxpayer cannot take both a casualty loss deduction and a business repair expense deduction as a result of one casualty. Rather, the casualty loss is deductible under IRC Section 165 and the cost of restoring the property to its pre-casualty condition must be capitalized under IRC Section 263. See Revenue Ruling 71-161, 1971-1Consolidated Bulletin 76. The reasoning and authorities cited in General Legal Advice Memorandum 2006-006 www.irs.gov/pub/irs-utl/am2006006.pdf support this position. This is true whether the amount of the loss deduction is determined by appraisal or by the cost of repairs.1
1 On August 21, 2006, a notice of proposed rulemaking, Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property, REG-168745-03; 71 Fed. Reg. 48590-48623, was issued. Proposed regulation § 1.263(a)-3(f)(iv), "Restoration after a casualty loss," contains a rule consistent with this position. Although the regulations, when finalized, will apply prospectively, proposed § 1.263(a)-3(f)(iv) essentially reflects current law.
The corollary issue concerning what assets comprise the SIP is currently being developed in the field, with assistance from Chief Counsel. Business casualty loss deductions are limited to the lesser of (a) the difference between the fair market value (FMV) of the property before and after the casualty or (b) the adjusted tax basis of the property immediately before the casualty; if the property is destroyed, in effect only the basis limit applies. Treas. Reg. Section 1.165-7. The deduction limits are determined by reference to the value and basis of the SIP damaged or destroyed. Because taxpayers’ damaged or destroyed properties have been subject to accelerated write-offs and may have been in service for significant periods of time, taxpayers often have a low tax basis in these assets. By defining as the SIP their entire transmission and distribution system or telecommunications system, not the specific assets damaged or destroyed, the taxpayers have a larger cost basis in computing their casualty loss deduction.2
2 The Field must ensure that taxpayers have adjusted their basis in property to account for casualty losses previously deducted.
NRC has established an Emerging Issue Team to determine the impact of these losses and develop examination guidance for consistency in issue resolutions.
Any cases having this issue should use the following Uniform Issue List (UIL) and Standard Audit Index Number (SAIN) codes:
Capitalization versus Repair: 00162.16-04
Casualty Losses: 00165.07-00
Capitalization versus Repair
Primary SAIN:110: 2nd Tier: Casualty Loss 390
Primary SAIN: 409: 2nd Tier: Single Identifiable Property 391
Planning and Examination Guidance
This issue is considered a Tier II issue for LMSB examiners. This issue is required to be addressed in examinations if claimed. If this issue is present on your case, please complete Attachment I and forward it to Marge Lopez, Utility Technical Advisor ( Marge.M.Lopez@irs.gov).
Examination guidelines will be forthcoming as the issue is being developed. Until guidelines are issued, it is recommended that audit teams contact their respective Technical Advisors for guidance. All 5701s must be approved by the Utility or Telecommunication Technical Advisors prior to issuance.
Effect on Other Directives
This directive does not amend or obsolete any other directive on the subject.
If you have any questions, please contact Marge Lopez, Utilities Technical Advisor at 619-557-6125 or Marge.M.Lopez@irs.gov or Kathy Follis, Telecommunication Technical Advisor at 610-992-5160 ext. 302 or Kathleen.G.Follis@irs.gov or Emile Robertson, NRC Territory Manager at 504-558-3039 or Emile.Robertson@irs.gov.
This LMSB Directive is not an official pronouncement of the law and cannot be used, cited, or relied upon as such.
cc: Commissioner, LMSB
Deputy Commissioner, LMSB Operations
Deputy Commissioner, LMSB International
Division Counsel, LMSB
Directors, LMSB Field Operations
Director, LMSB Performance, Quality and Audit Assistance