Rev. Rul. 76-134

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in Rev. Rul. 79, 1953-1 C.B. 41.

The questions presented are (1) whether losses from damage to property resulting from abnormally high water levels on bodies of water and (2) amounts expended for the construction of protective works or for moving homes back from their original locations to prevent probable losses from future storms are deductible as casualty losses under section 165 of the Internal Revenue Code of 1954.

Section 165(a) of the Code provides the general rule that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(c) provides, in part, that in the case of an individual, the deduction is limited to (1) losses incurred in a trade or business, (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business, and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. In respect of property not connected with a trade or business, a loss shall be allowed only to the extent that the amount of loss to such individual arising from each casualty, or from each theft, exceeds $100.

Section 263 of the Code provides that no deduction shall be allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.

Court decisions and revenue rulings have established standards for the application of the above provisions, and have developed the overall concept that the term "casualty" as used in such provisions refers to an identifiable event of a sudden, unexpected, or unusual nature and that damage or loss resulting from progressive deterioration of property through a steadily operating cause would not be a casualty loss. See Matheson v. Commissioner, 54 F.2d 537 (2d Cir. 1931), X1-2 C.B. 392 (1932); Fay v. Helvering, 120 F.2d 253 (2d Cir. 1941); and Getz, 24 CCH Tax Ct. Mem. 580 (1965); Rev. Rul. 63-232, 1963-2 C.B. 97; Rev. Rul. 71-560, 1971-2 C.B. 126.

Accordingly, losses due to physical damage to property, such as buildings, docks, seawalls, etc., as a result of wave action and wind during a storm are deductible as casualty losses under section 165 of the Code. Similarly, losses due to flooding of buildings and basements as a result of a storm and the complete destruction of buildings, occurring as a result of storm damage, are deductible casualty losses.

However, there are situations in which damage or expenditures may be incurred due to high water on bodies of water that may not be casualty losses under section 165 of the Code such as damage or loss of value due to gradual erosion or inundation occuring at still water levels. The term "still water levels" as used herein means normal seasonal variations in the water level of a body of water.

These variations are not such sudden and identifiable events that the gradual erosion resulting therefrom may be attributed to a specific period of time. The rise and fall of the water levels of a body of water is a normal process, and damage resulting from normal high water levels alone lacks the characteristics of a casualty loss under section 165. Thus, where the taxpayer's loss was due to progressive deterioration rather than some sudden, unexpected, or unusual cause, such loss is not a deductible casualty loss for Federal income tax purposes.

Another situation involves expenditures by taxpayers for the construction of protective works or for moving their homes back from their original locations to prevent probable losses from future storms. In such cases, no casualty loss deduction is allowable under section 165 of the Code because section 165(c) expressly limits a casualty loss deduction to losses of property. Such expenditures are within the purview of section 263, which provides that no deduction shall be allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of the property.

Where a casualty loss is allowed for the loss of property, the amount of loss deductible is measured by the excess of the value of the property just before the casualty over its value immediately after the casualty (but not more than the cost or other adjusted basis of the property), reduced by any insurance or compensation received. In the case of property not used in a trade or business, such amount is further reduced by $100 for each casualty.

Rev. Rul. 79 is superseded, since the position set forth therein is restated and amplified under current law in this Revenue Ruling.