                        T.C. Memo. 2000-56



                      UNITED STATES TAX COURT



       MIGUEL MARTIN AND CLAUDIA P. PALOS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5871-98.                  Filed February 22, 2000.



     Miguel Martin and Claudia P. Palos, pro sese.

     Linette B. Angelastro, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined a $20,244 deficiency

in petitioners’ 1994 income tax.   After concessions by

petitioners, the issue remaining for our consideration is whether

petitioners are entitled to a casualty loss for earthquake damage

caused to a residence owned by them.
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                         FINDINGS OF FACT

     Petitioners resided at Monrovia, California, at the time

their petition was filed.   Petitioners, from 1989 through early

1999, owned real property located at 3748 Military Avenue, Los

Angeles, California (Military property).    The Military property

was first listed for sale on October 1, 1993.   Petitioners had

been using the Military property as their personal residence up

to the time they began their attempt to sell the property.

Petitioners began moving their furniture out of the Military

property shortly after the October 1993 listing for sale.

Petitioners moved in with Mr. Palos’ mother at some time prior to

the January 17, 1994, earthquake, and, subsequent to the

earthquake, moved into a newly purchased residence other than the

Military property.

     During 1993, petitioners commenced making improvements and

repairs to the Military property in order to enhance its

appearance and value for purposes of sale.   The Northridge

Earthquake occurred on January 17, 1994, and caused damage to

petitioners’ Military property.   After the earthquake,

petitioners continued to make improvements to the Military

property and also began to repair the damage caused by the

earthquake.   The improvements, as opposed to repairs from

earthquake damage, appear to represent the significantly greater

portion of more than $60,000 in expenditures involving the
                               - 3 -

Military property.   About 4 days after the Northridge earthquake,

petitioners rented the Military property.

     Petitioners filed a claim with their property insurance

carrier with respect to the earthquake.    The insurance adjuster

estimated that the repair necessary to address the earthquake

damage was $9,221, an amount that was less than petitioners’

$9,530 policy deductible for earthquake damage.    Petitioners

consulted with a real estate company, seeking an opinion as to

the decrease in fair market value, if any, due to the earthquake.

The real estate company opined that the Military property lost

approximately $30,000 in value due to the earthquake.    The

reduction in value was attributable to the actual damage and also

to the safety issues that may be perceived by potential buyers of

damaged older homes in areas prone to earthquake damage.

     On their 1994 joint income tax return, petitioners, on

advice of their return preparer, claimed a $25,000 business

casualty loss on the premise that the Military property was held

for business or other income-producing purposes; i.e., for rental

or sale at the time of the earthquake.    Respondent determined

that petitioners were not entitled to a casualty loss.
                               - 4 -

                              OPINION

     Section 165(a)1 allows a deduction for “any loss sustained

during the taxable year and not compensated for by insurance or

otherwise.”   Although an individual taxpayer’s business and

personal casualty losses are deductible under section 165(c),

there is a distinction between them.    Casualty losses incurred in

a business or other profit-seeking activity can be fully

deductible, whereas personal casualty losses are subjected to a

$100 exclusion and must exceed 10 percent of a taxpayer’s

adjusted gross income.   See sec. 165(h)(1) and (2).   That

distinction is critical to petitioners because the limitations on

personal losses may reduce or eliminate petitioners’ ability to

deduct a casualty loss deduction.   There is no dispute about the

occurrence of the earthquake, and respondent seems to agree that

petitioners had some loss; however, respondent contends that the

loss was personal and was of an amount that would not have

exceeded the threshold limitations.

     First, we consider the amount of petitioners’ loss.      A

casualty loss is the difference between the fair market value of

the property immediately before and immediately after the

casualty.   See sec. 1.165-7(a)(2)(i), Income Tax Regs.


     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the tax year under
consideration, and Rule references are to this Court’s Rules of
Practice and Procedure.
                                - 5 -

Deductions under the above-cited regulation are, however,

“limited to the actual loss resulting from damage to the

property.”   Id.   An alternative approach to valuing a loss from

damage to property is for a taxpayer to present evidence of

repairs to the subject property.   See sec. 1.165-7(a)(2)(ii),

Income Tax Regs.   In that regard, a taxpayer must show that the

repairs were made to restore the property to its precasualty

condition and not to improve the property.    See id.

     In this case, petitioners provided evidence in an attempt to

show the effect of earthquake damage on the fair market value of

their property.    The real estate agent’s opinion that the value

decreased by about $30,000 is in line with the $25,000 claim

petitioners made on their 1994 income tax return.    The opinion,

however, was based on actual damage and also on the safety issues

that may be perceived by potential buyers of damaged older homes

in areas prone to earthquake damage.    Under the above-quoted

regulation, however, petitioners’ claim would be limited to the

amount of actual damage.   See id.; see also Kamanski v.

Commissioner, 477 F.2d 452 (9th Cir. 1973), affg. T.C. Memo.

1970-352; Pulvers v. Commissioner, 407 F.2d 838, 839 (9th Cir.

1969), affg. 48 T.C. 245 (1967); Chamales v. Commissioner, T.C.

Memo. 2000-33.

     Petitioners also attempted to show that the damage exceeded

$25,000 by showing the extensive expense incurred in connection
                               - 6 -

with their Military property during the period preceding and

following the earthquake.   Petitioners’ evidence of actual

repairs, however, falls short of showing losses from earthquake

damage in excess of $9,221, the amount determined by petitioners’

insurance company.   It is difficult to delineate between amounts

that were being used to renovate and improve and those that were

directly attributable to the earthquake.   In addition, the

insurance company’s estimate that actual repairs attributable to

earthquake damage were $9,221 militates against petitioners’

claims.   We hold that petitioners have not shown that more than

$9,221 damage occurred from the earthquake.

     Finally, we must decide whether petitioners’ property had

been converted from a personal residence to business or income-

producing property prior to the time that earthquake damage was

incurred.   Respondent contends that the record contradicts

petitioners’ claim that the property had been converted to

business (rental) or income-producing property.   We agree.   The

parties have addressed this aspect of the case in two parts.

They disagree as to whether petitioners no longer resided in the

property and whether the property had been converted to business

or income-producing property as of the occurrence of the January

17, 1994, earthquake.

     The record reflects that petitioners started to move

furnishings out of the Military property beginning in October
                               - 7 -

1993 and that substantial improvements and repairs were begun and

remained ongoing after that time and through the time of the

earthquake.   Petitioners’ evidence was sufficient to establish

that the Military property was no longer used as their personal

residence as of January 17, 1994.

     Respondent also relies on a statement that respondent’s

agent testified was made during the examination.   The testimony

of respondent’s agent is as follows:

          I’m not sure if it was the first interview or the
     second one. I did see * * * [petitioner] two times,
     once in his home and once in the office after hours.

          But I know we discussed the earthquake because I
     mentioned--I believe I mentioned to him what happened
     to us in my home, and I know he said his furniture was
     in the house and that he wasn’t out of the house yet.

Petitioners and Mr. Palos’ mother, however, testified under oath

that they were no longer using the Military property as a

residence by the time of the earthquake.   In addition, with

extensive repairs underway at the Military property beginning

around October 1993, it is unlikely that petitioners remained in

the house when other and better choices were available to them.

Accordingly, we find that petitioners were not using the subject

property as their personal residence at the time of the

earthquake.

     Respondent also questions whether the Military property was

held for sale or rent in such a manner as to be considered

business or income-producing property within the meaning of
                                 - 8 -

section 165.   Property that is used as a taxpayer’s residence may

be converted to rental or other income-producing property within

the meaning of section 165(a).    See, e.g., section 1.165-9,

Income Tax Regs. (concerning the sale of residential property).

On that point, petitioners’ evidence did not show that the

property had definitively been converted to rental or other

income-producing property at the time of the earthquake.

     Generally, taxpayers must do more than merely list their

residential realty to convert its use from personal to one which

would permit a loss under section 165 that is not subject to the

limitation of section 165(h)(1) and (2).       See, e.g., Newcombe v.

Commissioner, 54 T.C. 1298, 1302-1303 (1970); Rogers v.

Commissioner, T.C. Memo. 1965-8.    Although petitioners had listed

the property for sale and were continuing to make repairs to

enhance the property, some of their furniture remained, and the

property was listed for sale rather than for rent.       Petitioners

were able to lease the property just 4 days after the earthquake

occurred, but these events are not sufficient to place them over

the threshold necessary to convert their personal residence into

property for which section 165(c)(1) or (c)(2) losses would be

available.   Accordingly, the $9,221 casualty loss is subject to

the limitations of section 165(h)(1) and (2).


                                         Decision will be entered under

                                 Rule 155.
