Rev. Rul. 73-51

Advice has been requested whether, under the circumstances described below, physical damage to surviving merchantable trees, arising from an ice storm, results in a deductible loss under section 165(a) of the Internal Revenue Code of 1954.

A taxpayer owns a large tract of timberland which it manages for the continuous production of wood for use in its business of manufacturing paper pulp. At the time of acquisition the total acquisition costs were allocated to the timber and land accounts, respectively.

An ice storm struck portions of the timberland causing physical damage to many of the "merchantable trees." "Merchantable trees" are those trees contributing to the quantity of timber determined according to section 1.611-3(e) of the Federal income tax regulations for the purpose of claiming a deduction for depletion.

The taxpayer claimed a casualty loss for the taxable year the damage occurred. The amount of the claimed loss was the estimated value of the "measurable damage" (physical damage) to the surviving merchantable trees. None of the claimed loss was compensated for by insurance or otherwise.

The taxpayer described the "measurable damage" as:

1. Broken top or limbs affecting at least 20 percent of the tree's crown, thereby slowing the tree's rate of growth.

2. Observable root damage that would probably weaken the tree, thereby reducing the rate of growth and leaving the tree more susceptible to attack from insects and disease.

3. Leaning or bending of the tree that will cause the formation of compression wood in subsequent timber increment, thereby reducing the quality of such increment.

Damaged areas were classified as heavy, medium, and light according to the percentage of surviving merchantable trees estimated to have suffered damage. For each class of damage the percent of the reduction in the rate of growth and the number of units of subsequent timber increment that would be downgraded in quality were estimated. From these estimates the projected economic loss at the time of future timber harvest was computed and discounted at six percent per annum to the date of the casualty. The amount determined in this manner was claimed as a casualty loss.

Section 1.165-7(b)(1) of the regulations provides that in the case of any casualty loss, whether or not incurred in a trade or business or in any transaction entered into for profit, the amount of such loss is the lesser of either (1) the difference in the fair market value of the property immediately before and immediately after the casualty, or (2) the property's adjusted basis. Section 1.165-7(b)(2) of the regulations provides that in the case of property used in a trade or business or in any transaction entered into for profit, the amount of such loss is the lesser of either (1) the difference in the fair market value of the property immediately before and immediately after the casualty, or (2) the property's adjusted basis. Section 1.165-7(b)(2) of the regulations further provides that in the case of such property, any casualty loss to such property must be determined by reference to the single, identifiable property damaged or destroyed.

Section 1.611-3(d)(3) of the regulations provides that the total value or total cost, as the case may be, of land and timber shall be equitably allocated to the timber and land accounts, respectively.

Section 1.611-3(e) of the regulations provides in pertinent part that each taxpayer claiming or expecting to claim a deduction for depletion is required to estimate with respect to each separate timber account the total units (feet board measure, log scale, cords, or other units) of timber reasonably known, or on good evidence believed to have existed on the ground on March 1, 1913, or on the date of acquisition of the property, whichever date is applicable in determining the basis for cost depletion.

Revenue Ruling 66-9, 1966-1 C.B. 39, provides that in the case of a casualty loss to timber the "property involved" and the "single, identifiable property" destroyed is the quantity of timber which is rendered unfit for use by reason of the casualty. Accord, Rosenthal v. Commissioner, 461 F.2d 491 (1969), affirming 48 T.C. 515 (1967); Harper v. United States, 396 F.2d 233 (1968), affirming per curiam, 274 F. Supp. 809 (D.S.C. 1967).

In denying a claim for the loss of future profits under section 165(a) of the Code the Tax Court of the United States held that it is vital to a loss that something of value be parted with. The Code contemplates only a loss of capital, or, in other words, actual loss of tangible or measurable property. This does not encompass a failure of profits or the loss of potential income. Squirt Company v. Commissioner, 51 T.C. 543 at 548 (1969), affirmed per curiam, 423 F.2d 710 (1970).

In the instant case the total quantity of timber on the tract was determined in accordance with section 1.611-3(e) of the regulations, and the total acquisition costs were allocated to the depletable timber account and the nondepreciable land account in accordance with section 1.611-3(d)(3) of the regulations. Therefore, there are two separately identifiable assets, timber and land, either of which may be the subject of a casualty loss. See Estate of Sam E. Broadhead v. Commissioner, T. C. Memo. 1966-26 (appealed on other issues).

The physical damage, described in 1, 2, and 3 above, suffered by the merchantable trees because of the ice storm did not result in any of the existing timber being damaged or rendered unfit for use, and therefore the damage was not measurable in units of timber destroyed. Any loss resulting from such physical damage would be in the nature of a contemplated loss of future profits or potential income due to a reduction in the rate of growth or the quality of subsequent timber increment. Therefore, such physical damage suffered by the merchantable trees is not a deductible loss. Revenue Ruling 66-9.

Since the existing timber suffered no physical damage and none was rendered unfit for use because of the casualty, if any deductible loss occurred it would have been the result of damage to the land. To determine if the land suffered a deductible loss it must be viewed as if devoid of merchantable trees because timber and land are separately identifiable accounts under section 1.611-3(d)(3) of the regulations.

Accordingly, under the facts of this case, it is held that physical damage to the surviving merchantable trees arising from an ice storm, does not result in a deductible loss under section 165(a) of the Code.