A 70-foot retaining wall that was part of a large co-op on Manhattan's Upper West Side suddenly collapsed onto the Henry Hudson Parkway below, causing millions of dollars in damage. The co-op ended up paying a substantial sum out of its own pocket to fix the damage because the dollar amount exceeded the limits of the property insurance coverage. Can the co-op owners deduct their share of this uninsured expense from their income taxes? If the retaining wall collapsed due to a storm, they could. But if it collapsed due to gradual soil erosion, they could not.
Welcome to the wonderful world of casualty losses.
Homeowners can deduct uninsured losses they suffer when their property is damaged or destroyed by an event--but only if such event is a "casualty." A “casualty” is damage, destruction, or loss of property due to an event that is sudden, unexpected, or unusual. Examples include:
One thing all the events in the list above have in common is that they are sudden—they happen quickly. Suddenness is the hallmark of a casualty loss. Thus, loss of property due to slow, progressive deterioration is not deductible as a casualty loss. Thus, if the retaining wall discussed above collapsed due to soil erosion occurring over a period years, the loss is not a deductible casualty. But if it collapsed all at once due to a violent storm, it is a deductible casualty.
Many legal disputes have occurred over whether an event was sufficiently sudden to cause a deductible casualty loss. Here are some examples from real court cases. See if you can tell which are deducible casualty losses and which are not.
1. Damage to shoreline buildings due to sudden erosion caused by wave or wind action during a storm (Rev. Rul. 76-134)
2. Termite damage occurring in a single year (Rosenberg v. Comm’r., 198 F.2d 46)
3. Destruction of barn caused by high winds during a storm (Stein v. Comm’r., T.C. Memo 1955-57)
4. Termite damage occurring over three-year period (Dodge v. Comm’r., 25 T.C. 1022)
5. Destruction of trees caused by Dutch elm disease (Burns v. United States, 174 F. Supp. 203 (D. Ohio 1959))
6. Collapse of patio roof caused by dry rot (Chipman v. Comm’r., T.C. Memo 1981-194).
Examples 1-3 were found to be deducible casualty losses, examples 4-6 were not.