                        T.C. Memo. 2001-235



                      UNITED STATES TAX COURT



 ESTATE OF JAMES W. BOYLE, DECEASED, NANCY A. BOYLE AND JAMES H.
CASE, CO-PERSONAL REPRESENTATIVES AND NANCY A. BOYLE, Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 18586-98.                 Filed September 10, 2001.



     David W. K. Wong, for petitioners.

     Henry E. O’Neill, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION



     MARVEL, Judge:   Respondent determined a deficiency of

$60,820 in the Federal income tax of petitioner Nancy A. Boyle

(Mrs. Boyle) and her deceased husband, James W. Boyle (decedent),
                                - 2 -

for 1995.    The only issue1 for decision is whether, under section

165,2 the decedent and Mrs. Boyle properly deducted a casualty

loss of $173,833 on their Federal income tax return for 1995.

                          FINDINGS OF FACT

     The facts of this case have been fully stipulated pursuant

to Rule 122.    We incorporate the stipulation of facts into our

findings by this reference.

     Petitioners are the Estate of James W. Boyle, Deceased, Mrs.

Boyle and James H. Case, Co-Personal Representatives, and Mrs.

Boyle, the surviving spouse of decedent.     Decedent, who died on

October 24, 1998, and Mrs. Boyle (together, the Boyles) were

husband and wife during 1995 and timely filed a joint Federal

income tax return for 1995.    Mrs. Boyle and James H. Case are the

duly appointed personal representatives of decedent’s estate.

Petitioners resided in Honolulu, Hawaii, on the date the petition

was filed.

     In June 1979, the Boyles purchased a commercial warehouse

building (old warehouse) located in Honolulu, Hawaii.    The Boyles

owned the old warehouse as joint tenants at all relevant times.

Their cost basis in the old warehouse as of June 1979 was


     1
       The only other issues raised in the notice of deficiency
are computational or were conceded by petitioners.
     2
       All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
                                - 3 -

$148,479.    The Boyles depreciated the old warehouse using the

straight-line method and a 20-year useful life, beginning in

1979, claiming annual depreciation deductions of $7,424.3    On

January 1, 1993, the Boyles’ adjusted basis in the old warehouse

was $48,255.

     On December 13, 1993, the old warehouse was completely

destroyed by fire.    Immediately prior to the fire, the fair

market value of the old warehouse was between $600,000 and

$700,000.    Immediately after the fire, the fair market value of

the old warehouse was zero.    As of the date of the fire, the

Boyles’ adjusted basis in the old warehouse was $40,831.

     When the fire occurred, the old warehouse was covered by a

replacement cost fire insurance policy (insurance policy) issued

by Pacific Insurance Co. (Pacific).     The Boyles anticipated that

the insurance policy would cover all the costs of constructing a

new warehouse to replace the old warehouse and submitted a claim

to Pacific.    A dispute, however, arose between the Boyles and

Pacific as to whether the insurance policy would cover that part

of the construction costs associated with changes in building

code requirements that occurred between the time the old

warehouse originally was constructed and the date of the fire.

As a result of that dispute, the amount of insurance

reimbursement the Boyles reasonably expected to receive under the


     3
         In 1979, the Boyles deducted only $3,712.
                                 - 4 -

insurance policy was uncertain until 1995, when the Boyles and

Pacific settled the claim.     Pursuant to the settlement, Pacific

paid $553,793 to reimburse the Boyles for the destruction of the

old warehouse, and the Boyles constructed a new warehouse at a

total cost of $698,935 to replace the old warehouse.4

     On their 1995 Form 1040, U.S. Individual Income Tax Return,

the Boyles claimed a depreciation deduction of $7,424 and a

casualty loss in the amount of $173,833 with respect to the old

warehouse.     The parties stipulated that the casualty loss was

computed as follows:5




     4
      The Boyles’ net out-of-pocket investment to construct the
new warehouse was only $145,142 after application of the
insurance proceeds.
     5
      The computation made by the Boyles on their 1995 return as
reflected on Form 4684, Casualties and Thefts, differs from the
stipulated computation and was as follows:

         Cost or adjusted basis of property         $727,626
         Insurance or other reimbursement            553,793

         Fair market value before casualty           750,000
         Fair market value after casualty               NONE

         Difference                                  750,000

         Enter the smaller of the adjusted
         basis or the difference in fair market
         value before and after the casualty as
         the casualty loss claimed                   173,833
                                 - 5 -

          Original cost of
                 old warehouse (June 1979)        $148,479
          Cost of reconstruction                   698,935
          Amortizable costs                        112,360

          Total Costs                              959,774

          Less:
                                              1
          Depreciation claimed                 (122,495)
          Insurance Proceeds                   (553,793)
          Amortization claimed                 (109,653)

          Casualty Loss Claimed                    173,833
     1
      This figure includes $7,424 in depreciation for 1995.

The Boyles did not report any gain realized from the destruction

of the old warehouse on their 1995 return.

     In his notice of deficiency, respondent disallowed the

claimed casualty loss because the insurance proceeds exceeded the

Boyles’ allowable loss.   Respondent also disallowed the

depreciation deduction claimed for 1995, and petitioners have

conceded this adjustment.

                              OPINION

     Section 165(a) and (c) allows a deduction for losses arising

from fire or other qualifying casualty sustained during the

taxable year and not compensated for by insurance or otherwise

(casualty loss).   See also sec. 1.165-7(a)(1), Income Tax Regs.

A casualty loss is “treated as sustained during the taxable year

in which the loss occurs as evidenced by closed and completed

transactions and as fixed by identifiable events occurring in
                               - 6 -

such taxable year.”   Sec. 1.165-1(d)(1), Income Tax Regs.; see

also sec. 1.165-1(b), Income Tax Regs.

     There is no dispute in this case as to the year in which the

Boyles’ casualty loss, if any, was sustained for purposes of

section 165.   Although the fire that destroyed the warehouse

occurred in December 1993, the Boyles had a claim for insurance

reimbursement which their insurer disputed.   That claim was not

settled until 1995.   Because the amount of the insurance

reimbursement could not reasonably be ascertained until the

dispute was settled in 1995, the parties agree that the casualty

loss in question, if any, was sustained in 1995.6

     The issue we must decide focuses, instead, on the

calculation of the Boyles’ adjusted basis, an essential component

of the casualty loss calculation.   Section 1.165-7(b)(1), Income

Tax Regs., provides that the amount of loss to be taken into

account for purposes of section 165(a) is the lesser of either

(i) the amount which is equal to the fair market value of the

     6
      Even though a casualty occurs in an earlier year, any loss
resulting from that casualty is not considered to be sustained
under sec. 165 until it can be determined with reasonable
certainty whether reimbursement for all or part of the loss will
be received and in what amount. Gale v. Commissioner, 41 T.C.
269, 275 (1963); sec. 1.165-1(d)(2)(i), Income Tax Regs. When a
reasonable prospect of recovery on a reimbursement claim exists
but the amount of the reimbursement cannot be determined with
reasonable certainty, a casualty loss is not sustained until the
claim is settled, adjudicated or abandoned, thus enabling the
taxpayer to calculate the amount of the loss, if any. Licht v.
Commissioner, 37 B.T.A. 1096, 1100 (1938); Allied Furriers Corp.
v. Commissioner, 24 B.T.A. 457, 460 (1931).
                               - 7 -

property immediately before the casualty reduced by the fair

market value of the property immediately after the casualty or

(ii) the amount of the taxpayer’s adjusted basis prescribed in

section 1.1011-1, Income Tax Regs., for determining the loss from

the sale or disposition of the property involved.   The amount

determined is then reduced by any insurance or other compensation

received to arrive at the deduction allowable.   Sec. 165(a); sec.

1.165-1(c)(4), Income Tax Regs.; see also Helvering v. Owens, 305

U.S. 468 (1939); Pfalzgraf v. Commissioner, 67 T.C. 784 (1977);

Millsap v. Commissioner, 46 T.C. 751 (1966), affd. on other

issues 387 F.2d 420 (8th Cir. 1968); sec. 1.165-7(b)(3), Income

Tax Regs.

     The parties agree that the difference between the fair

market value of the old warehouse before and after the fire is

between $600,000 to $700,000 and that the Boyles received

insurance reimbursement of $553,793.   The parties disagree,

however, regarding the calculation of the Boyles’ adjusted basis

in the old warehouse.   Respondent contends that the Boyles’

adjusted basis must be calculated as of December 13, 1993, the

date the fire occurred, citing sections 1.165-7(b)(1) and 1.165-

1(c)(4), Income Tax Regs., in support of his position.

Petitioners reject respondent’s argument, pointing out that the

regulations cited by respondent do not state whether a taxpayer’s

adjusted basis is calculated as of the date the casualty occurred
                                - 8 -

or the date the casualty loss, if any, was deemed sustained.

Petitioners urge us to conclude that (i) the Boyles’ adjusted

basis in the old warehouse must be calculated as of 1995, the

year the casualty loss, if any, was sustained in this case and

that (ii) the adjusted basis so calculated must include the cost

of rebuilding the warehouse.

     We agree with petitioners that neither section 1.165-1(c)(4)

nor section 1.165-7(b)(1), Income Tax Regs., clearly states that

a taxpayer’s adjusted basis in property damaged or destroyed by

casualty must be calculated as of the date of the casualty.    The

pertinent part of section 1.165-1(c)(4), Income Tax Regs.,

provides simply that, in determining the amount of loss actually

sustained under section 165(a), proper adjustment must be made

for any insurance received.    The pertinent part of section 1.165-

7(b)(1), Income Tax Regs., provides that the amount of the

casualty loss to be taken into account under section 165(a) is

the lesser of either (i) the amount equal to the fair market

value of the property immediately before the casualty reduced by

the fair market value immediately after the casualty or (ii) the

amount of the adjusted basis prescribed in section 1.1011-1,

Income Tax Regs., for determining the loss from the sale or other

disposition of the property involved.7

     7
      Sec. 1.1011-1, Income Tax Regs., provides that a taxpayer’s
basis in property shall be its cost, adjusted to the extent
                                                   (continued...)
                               - 9 -

     We disagree with petitioners, however, that the failure of

the above-cited regulations to specify when the adjusted basis of

the property involved must be calculated means that petitioners

are free to calculate the adjusted basis of the old warehouse by

adding to it the cost of constructing the new warehouse.

Although the above-cited regulations do not explicitly address

the timing question posed by petitioners, the answer, we believe,

flows from section 1.165-7(b)(1), Income Tax Regs.

     Petitioners’ calculation of the Boyles’ adjusted basis in

the old warehouse as of 1995 assumes that the new warehouse is

merely an improvement of the old warehouse and that the cost of

that improvement increases the Boyles’ adjusted basis in the old

warehouse for purposes of calculating their casualty loss under

section 165(a).   This assumption, which is critical to the

success of petitioners’ position, is incorrect because the record

in this case clearly establishes that the old warehouse and the

new warehouse were separate and distinct properties.   Only the

old warehouse was involved in the casualty on December 13, 1993,

and it was completely destroyed before the new warehouse was even

in existence.



     7
      (...continued)
provided by sec. 1016. Secs. 1.1016-2 and 1.1016-3, Income Tax
Regs., provide that a taxpayer’s cost basis must be increased by
the cost of improvements and betterments made to property, and
decreased by amortization, depreciation, and obsolescence.
                               - 10 -

     Section 1.165-7(b)(1), Income Tax Regs., limits a deductible

casualty loss under section 165(a) to the lesser of the decrease

in value of property before and after the casualty or the

adjusted basis of the “involved” property.    The reference to

“involved” property contained in section 1.165-7(b)(1), Income

Tax Regs., must refer to the property damaged or destroyed by the

casualty, i.e., the old warehouse, and the Boyles’ adjusted basis

in the old warehouse for purposes of calculating the casualty

loss, if any, under section 165(a) must be its basis as of the

date of the casualty.

     Our conclusion is consistent with section 1033, which

provides rules for determining whether gain realized upon the

involuntary conversion of property must be recognized for Federal

income tax purposes.    A casualty is treated for Federal income

tax purposes as an involuntary conversion of property.    Sec.

1033(a); secs. 1.1033(a)-1 and 1.1033(a)-2(c), Income Tax Regs.

Under section 1033(a)(2), if damaged or destroyed property is

converted into money (e.g., through insurance), that conversion

is treated as a sale or exchange of the damaged or destroyed

property (the converted property), and the amount of gain, if

any, realized on the conversion must be recognized except to the

extent provided in section 1033(a)(2).    If, however, the taxpayer

reinvests the money received for the converted property to

acquire qualified replacement property (i.e., property similar or
                                - 11 -

related in service or use to the converted property, section

1033(a)(2)(A)) within the period provided in section

1033(a)(2)(B), gain is recognized, if the taxpayer so elects,

only to the extent the amount realized from the involuntary

conversion of the converted property exceeds the cost of the

qualified replacement property.8    Sec. 1033(a)(2)(A).   The basis

of the replacement property acquired as a result of an

involuntary conversion of the property into money is its cost,

decreased by the amount of gain not recognized upon conversion.

Sec. 1033(b).

     An example used in section 1.1033(b)-1(b), Income Tax Regs.,

to illustrate the operation of section 1033(a)(2)(A) and (b) is

consistent with our analysis:

          Example. A taxpayer realizes $22,000 from the
     involuntary conversion of his barn in 1955; the
     adjusted basis of the barn to him was $10,000, and he
     spent in the same year $20,000 for a new barn which
     resulted in the nonrecognition of $10,000 of the
     $12,000 gain on the conversion. The basis of the new
     barn to the taxpayer would be $10,000–-the cost of the

     8
      When an involuntary conversion results in the realization
of gain, the details of the involuntary conversion, including
those relating to the replacement of the converted property, must
be reported in the return for the taxable year in which any of
the gain is realized. An election to defer the recognition of
gain from the conversion under sec. 1033(a)(2) and sec.
1.1033(a)-2(c)(1), Income Tax Regs., is made by including such
gain in gross income, but only to the extent required by sec.
1033, on the taxpayer’s Federal income tax return for the first
year the taxpayer is required to recognize the gain. Sec.
1.1033(a)-2(c)(2), Income Tax Regs. If sec. 1033 does not
require a taxpayer to recognize any of the gain, the election is
made simply by not including the gain in gross income.
                             - 12 -

     new barn ($20,000) less the amount of the gain not
     recognized on the conversion * * *[9]

Our conclusion is also reinforced by section 1.1033(a)-2(c)(12),

Income Tax Regs., which states that “An amount expended for

replacement of an asset, in excess of the recovery for loss,

represents a capital expenditure and is not a deductible loss for

income tax purposes.”

     When we treat the old warehouse and the new warehouse as

different properties, as sections 165 and 1033 require, the

determination of adjusted basis for purposes of calculating a

casualty loss under section 165(a) is straightforward.    The

Boyles’ adjusted basis in the old warehouse for purposes of

     9
      In the notice of deficiency, respondent applied a similar
analysis to calculate the Boyles’ gain from the involuntary
conversion of the old warehouse and the Boyles’ adjusted basis in
the new warehouse in accordance with sec. 1033(a)(2) and (b) as
follows:

         Gain realized on the involuntary conversion of
         the old warehouse:

         Amount realized from the involuntary
            conversion of the old warehouse     $553,793
         Less:
            Adjusted basis                        33,408
         Gain realized                           520,385


         The Boyles’ adjusted basis in the new warehouse

         Total Cost of new warehouse            $702,702
         Less:
            Gain realized but not
            recognized under sec.
            1033(b)                              520,385
         Adjusted basis                          182,317
                              - 13 -

calculating gain or loss on its disposition, calculated in

accordance with sections 1.1011-1, 1.1016-2, and 1.1016-3, Income

Tax Regs., was their adjusted basis in the old warehouse as of

the date of the casualty or $40,831.10

Summary

     A taxpayer cannot deduct a casualty loss under section

165(a) unless his adjusted basis in the converted property

exceeds the reimbursement received.    United States v. Koshland,

208 F.2d 636, 639 (9th Cir. 1953); LaFavre v. Commissioner, T.C.

Memo. 2000-297; Elliston v. Commissioner, T.C. Memo. 1973-4; sec.

1.165-7(b)(3), Examples (1) through (3), Income Tax Regs.

Despite this well-established principle, petitioners urge us, in

effect, to permit them to deduct as a casualty loss their entire

unrecovered investment in both the old and new warehouses.    This

we cannot do for the reasons discussed herein.   We hold that the

cost of constructing the new warehouse does not increase the

Boyles’ adjusted basis in the old warehouse for purposes of

section 165, and, therefore, the Boyles’ adjusted basis in the


     10
      In his opening brief, respondent notes that the revenue
agent’s calculation of the allowable casualty loss showed the
Boyles’ adjusted basis as $33,408. This figure was calculated
(with a $1 discrepancy) by subtracting the 1994 depreciation
deduction of $7,424 from $40,831, the Boyles’ adjusted basis in
the old warehouse as of the date of the fire. Respondent states
that he does not concede that the 1994 depreciation deduction was
proper, but he takes the position that the issue is immaterial
because the insurance proceeds received exceed both $40,831 and
$33,408.
                               - 14 -

old warehouse did not exceed the insurance recovery of

$553,793.11   Accordingly, we sustain respondent’s determination

disallowing the Boyles’ 1995 casualty loss.

     We have carefully considered all remaining arguments made by

petitioners for contrary holdings, and, to the extent not

discussed, we find them to be irrelevant, moot, or without merit.

     To reflect the foregoing,



                                         Decision will be entered

                                    for respondent.




     11
      Petitioners failed to offer any evidence regarding the
starting and completion dates of the reconstruction.
Petitioners’ position regarding the Boyles’ adjusted basis for
purposes of sec. 165 assumes that both the insurance recovery and
the construction of the new warehouse occurred in 1995. This
assumption seems questionable, but we need not examine it further
under the circumstances.
