Fair Market Value is Fair Market Value (Unless Your Casualty Loss is in CA) – Franchise Tax Board Overturned
On February 24, 2015, Bewley, Lassleben & Miller SALT Group Attorney Joe Vinatieri successfully represented Larry G. Dighera (“Taxpayer”) in a personal income tax appeal before the California State Board of Equalization. The Board agreed (in a 3-2 vote) that the Taxpayer suffered a casualty loss deduction to his property that should include both the physical property damage as well as the non-physical property damage caused by the disaster.
In December, 2004, a series of rainstorms inundated the California coast, and in February 2005, President Bush determined that the severe damage was of a magnitude to declare Santa Barbara County a major disaster area under the Stafford Disaster Relief and Emergency Assistance Act. As a result of this disaster, Mr. Dighera claimed a casualty loss on his 2004 state income tax return for the diminution in value of his Santa Barbara County sea top bluff residence. The Franchise Tax Board (“FTB”) granted Mr. Dighera a loss of only $55,250 because under its interpretation of IRS Section 165(c), the casualty loss to the Taxpayer’s property should be limited to the damage of the physical property only caused by said catastrophe (or a loss of 10 ft x 85 ft of land into the ocean). Taxpayer, however, argued that the total casualty loss incurred should also be extended to include the decline in fair market value (“FMV”) of the overall property that was caused by the catastrophe as the owner would be permanently restricted from doing any future rebuilding/modifications to the residence because of the property’s County requirement mandating a 75 foot setback from the ocean bluff. Because of an anticipated gradual 18” per year geologic bluff erosion, the 75 foot setback was equivalent to a 50-year life. Taxpayer’s expert appraiser opined that the 10 foot loss decreased overnight the economic life to 35 years.
IRC Section 165, Casualty Loss, (and incorporated into the CA Revenue and Taxation Code) provides that generally, the allowable deduction is based on the difference of the FMV immediately before the catastrophe and the FMV immediately after the event as shown by a competent appraisal. FMV is not defined in the Section so the taxpayer cited Board Property Tax Rule 2 for the familiar willing buyer/willing seller definitional requirement. The question posed: would a willing buyer knowing of the setback requirement offer a lower purchase price for the property due to the loss in lifetime and utility? Intuitively, one would affirmatively assume so. Yet the FTB would not (and did not) agree.
FTB cited the 9th Circuit’s decision in Kamanski arguing that the Taxpayer cannot include the non-physical damages because there had been no actual “realization” event yet to help determine the value of the loss. Kamanski and its progeny hold that any diminution in value is “temporary” or a “mere fluctuation.”
In response, Taxpayer cited the 11th Circuit decision in Finkbohner which did allow for non-physical damages even though in both cases, the property owners suffered minimal physical damage. Taxpayer further argued that the substantial bluff loss suffered by Taxpayer was unique and could not be compared to Kamanski because the bluff loss affected only the Taxpayer’s property and there was no decline in the general market as was the case in Kamanski. Moreover, the burden of proof was met by the Taxpayer as the FMV of the property was determined by a competent MAI appraisal both before and after the disaster. Using sound appraisal methods, FMV of the property was shown to have been greatly reduced after the 2004 catastrophe as the utility of the property was severely diminished since the property could no longer be improved (in addition to the fact that the bluff loss shortened the property’s economic life). The FTB offered no appraisal or opinion of value. As such, Taxpayer suffered a much greater casualty loss than what the FTB conceded.
The Board agreed that the Taxpayer should be allowed the full casualty loss incurred. See the webcast of the SBE hearing here (B3.Larry G. Dighera): https://www.visualwebcaster.com/event.asp?id=101574.