                          T.C. Memo. 2000-297



                        UNITED STATES TAX COURT



         SCOTT L. LAFAVRE AND SHARI L. LAFAVRE, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 1132-99.                   Filed September 25, 2000.


     Jeffrey W. Starbird, for petitioners.

     Eric W. Johnson, for respondent.



                          MEMORANDUM OPINION


     LARO, Judge:    This case is before the Court fully

stipulated.    See Rule 1221.   Respondent determined a deficiency

in petitioners' 1994 Federal income tax in the amount of $43,938

and a penalty of $8,788 pursuant to section 6662(a).     After


     1
       Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise indicated, section references are to
the Internal Revenue Code in effect for the year in issue.
                                - 2 -

concessions2 the sole issue we must decide is whether petitioners

are entitled to the $455,720 casualty loss claimed on their 1994

Federal income tax return.

     The stipulation of facts and attached exhibits are

incorporated herein.    The stipulated facts are hereby found.

                             Background

     When the petition was filed, petitioners resided in

Lakeville, Minnesota.    In 1994, petitioners were the only

partners in the Chateau Deville Partnership.

     The Chateau Deville Partnership owned a group of apartment

buildings located in Slidell, Louisiana.      The apartment buildings

were damaged by flooding in 1995.3      Before the flood, the

apartment buildings' basis was $672,093.      The fair market value

of the apartment buildings immediately prior to the flood was $2

million.   The fair market value of the apartment buildings

immediately after the flood was $750,000.

     Petitioners received insurance proceeds of $767,000 as

compensation for the flooding damage to the apartment buildings.


     2
       Respondent has conceded that petitioners are not liable
for the sec. 6662(a) accuracy-related penalty and are entitled to
a reduction of capital gains of $28,682, as opposed to the amount
of $14,828 stated in the notice of deficiency.
     3
       We note that the property suffered damage in 1995;
however, petitioners assert on brief that the surrounding area
was subsequently declared a disaster area by President Clinton
allowing the deduction to be taken in 1994 under sec. 165(i).
Respondent does not dispute this assertion in his brief, reply
brief or mention the issue in the notice of deficiency.
                                 - 3 -

These insurance proceeds were reinvested in the reconstruction of

the apartment buildings.     Additionally petitioners invested

$483,000 in the reconstruction of the damaged apartments.

     On their income tax return for 1994 the petitioners claimed

a casualty loss of $455,720.     This loss was calculated by

subtracting an after casualty fair market value of $1,544,280

from a precasualty fair market value of $2 million.

                              Discussion

     Respondent determined that petitioners are not entitled to

the casualty loss claimed on their 1994 Federal income tax return

because petitioners’ adjusted basis in the property was less than

the insurance proceeds received by petitioners for the loss.

Petitioners argue that since the insurance proceeds were

reinvested in qualifying property under section 1033 the full

amount of the economic loss should be deductible.         Petitioners

calculate their loss as follows:

       Fair market value prior to casualty   $2,000,000
       Fair market value after casualty        -750,000
       Gross casualty loss                    1,250,000
       Less insurance proceeds                 -767,000
       Net casualty loss                        483,000
       (Casualty loss less than basis)

     Section 165 provides for the deduction of a loss and in

pertinent part provides:
                                - 4 -

     (a) General Rule.--There shall be allowed as a deduction any
loss sustained during the taxable year and not compensated for by
insurance or otherwise.

        *        *       *        *       *       *       *

     (i) Disaster Losses.--

          (1) Election to take deduction for preceding
     year.--Notwithstanding the provisions of subsection
     (a), any loss attributable to a disaster occurring in
     an area subsequently determined by the President of the
     United States to warrant assistance by the Federal
     Government under the Disaster Relief and Emergency
     Assistance Act may, at the election of the taxpayer, be
     taken into account for the taxable year immediately
     preceding the taxable year in which the disaster
     occurred.

     For casualty losses, the calculation of the amount of the

loss is defined in section 1.165-7(b)(1), Income Tax Regs., as

follows:

            (b) Amount deductible.--

          (1) General Rule.--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 loss to be taken into account for purposes of
     section 165(a) shall be the lesser of either--

          (i) The amount which is equal to the fair market
     value of the property immediately before the casualty
     reduced by the fair market value of the property
     immediately after the casualty; or

          (ii) The amount of the adjusted basis prescribed
     in section 1.1011-1 for determining the loss from the
     sale or other disposition of the property involved. * *
     * [Emphasis added.]

     The calculation of a casualty deduction under section 165(a)

proceeds as follows.    First, the "loss" is determined as the

lesser of (1) the difference between the fair market value of the
                                - 5 -

property before the casualty and the fair market value of the

property after the casualty (without consideration of insurance

received) and (2) the adjusted basis of the property before the

casualty.   In this case the difference in fair market values is

$1,250,000 and the adjusted basis was $672,093.     The lesser

amount of $672,093 is the amount of petitioners’ loss.

     Second, the amount of the loss deductible under section

165(a) is the loss "not compensated for by insurance"; i.e.,

reduced by the insurance received.      See sec. 1.165.7(b)(3),

Examples (1) through (3), Income Tax Regs.      In this case the

insurance received exceeds the loss (adjusted basis of the

property prior to the casualty), and therefore there is no

allowable casualty deduction.

     We hold that petitioners are not entitled to the $455,720

casualty loss claimed on their 1994 Federal income tax return.

     Accordingly,



                                             Decision will be entered

                                          under Rule 155.
