This article is a follow-up to my previous article “Casualties” on casualty loss deductions in which I set forth the nature of a casualty, qualifying events, how to determine the amount of the loss, and the allowable deduction.
[This case was reported in J.K. Lasser’s Monthly Tax Letter, February, 2014].
Taxpayers built two homes but did not obtain the necessary building permits because they wanted to live without government interference. Several years later, the homes were destroyed by a fire and the taxpayers claimed a casualty loss in the year of destruction. [Note: the article did not say when this occurred].
The IRS disallowed the loss on the grounds that the taxpayers did not comply with state and county laws. The IRS said if the deduction were allowed, this would “severely and completely frustrate the State policy of obtaining permits before building a home.” The IRS further said “it would make the federal government the insurer of the last resort for unpermitted, illegal homes.”
Occasionally, in prior years, the courts have disallowed deductions where the taxpayers actions would “severely and immediately frustrate national or state policy.” One court disallowed a theft loss deduction for money stolen from a taxpayer who participated in a counterfeiting scheme. Whether a court allows deductions for these kind of casualties depends on the facts of each case, such as whether the taxpayers actions directly the loss-e.g., arson.
The taxpayers appealed the IRS disallowance to the Tax Court. The court held there was no direct link between the taxpayers failure to obtain a building permit and the fire loss. Failure to obtain required building permits was not a sufficient reason for the IRS to deny their casualty loss deduction. But the loss was denied because the taxpayers failed to provide sufficient evidence of the loss and the amount claimed [Chief Counsel Memorandum ILM, 201346009]