Rev. Rul. 81-24
1981-1 C.B. 79, 1981-4 I.R.B. 10.
Internal Revenue Service
Revenue Ruling
LOSS; ARSON COMMITTED BY OWNER OF BUILDING
Published: January 26, 1981
26 CFR 1.165-1: Losses
(Also Sections 162, 212; 1.162-18, 1.212-1.)
Loss; arson committed by owner of building. No deduction is available to a taxpayer who burns down a building and collects no insurance proceeds because the arson is discovered.
ISSUE
Is a deduction available to a taxpayer who burns down a building if the insurance proceeds are not paid because the arson is discovered?
FACTS
Taxpayer, an individual, purchased a building in January 1977 for 90x dollars and the land on which the building was erected for 30x dollars. The building was insured against fire loss for 100x dollars, its fair market value. One month after purchasing the property, in order to collect the insurance proceeds, taxpayer set fire to the building and it was totally destroyed.
Before the first insurance claim was paid, the arson was discovered. The insurance proceeds were therefore not paid and taxpayer was convicted of arson. On taxpayer's federal income tax return for 1977, taxpayer claimed the 90x dollars paid for the building as a casualty loss.
Committing arson and making fraudulent insurance claims are illegal under applicable state laws and subject the violator to criminal penalties.
LAW AND ANALYSIS
Section 165(a) of the Internal Revenue Code allows a deduction for loss sustained during the taxable year and not compensated for by insurance or otherwise. Such a deduction is allowed, under section 165(b), only to the extent of taxpayer's adjusted basis as provided in section 1011 for determining the loss from the sale or other disposition of property. Section 165(c)(1), (2) and (3) provides that in the case of an individual, the deduction under section 165(a) shall be limited to losses incurred in a trade or business; losses incurred in any transaction entered into for profit, though not connected with a trade or business; and, with certain limitations, casualty losses sustained during the taxable year and not compensated for by insurance.
All ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business are deductible under section 162(a) of the Code.
All ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income are deductible by individual taxpayers under section 212(1) of the Code.
Rev. Rul. 77-126, 1977-1 C.B. 47, concerns the deductibility of losses incurred by a taxpayer upon the forfeiture of certain coin-operated gaming devices unlawfully held by the taxpayer. Rev. Rul. 77-126 states that for many years a court-created doctrine based on public policy has existed whereby ordinary and necessary business expenses otherwise allowable as deductions under section 162 of the Code are disallowed when the allowance of such deductions would severely and immediately frustrate sharply defined national or state governmental declarations of policy prohibiting particular forms of conduct. Rev. Rul. 77-126 concludes that although Congress codified and limited the public policy doctrine in the case of ordinary and necessary business expenses by amending section 162(c) and enacting sections 162(f) and (g), the rules for disallowing a deduction under section 165 on the grounds of public policy are not so limited.
The taxpayer sustained a loss of 90x dollars by the taxpayer's own knowing and willful act. Therefore, the loss would not qualify as a casualty within the meaning of section 165(c)(3) of the Code. White v. Commissioner, 48 T.C. 430 (1967), acq., 1969-1 C.B. 21.
Further, because the taxpayer violated applicable state laws against committing arson and making fraudulent insurance claims, it would severely frustrate sharply defined state governmental declarations of policy to allow the taxpayer to deduct this loss under section 165(c)(1) or (c)(2) of the Code as a loss incurred in a trade or business or a transaction entered into for profit. See Mazzei v. Commissioner, 61 T.C. 497 (1974), in which the Tax Court held that a taxpayer who entered into a conspiracy to counterfeit United States currency could not take a loss deduction under section 165(c)(2) or (c)(3) when the genuine currency the
taxpayer provided for use in the counterfeiting process was stolen by co-conspirators. The loss had a direct relationship to the taxpayer's participation in the counterfeiting scheme. Thus, the court concluded that the loss should be denied on the grounds of public policy.
Nor is a deduction available under sections 162 or 212 of the Code, as it is self-evident that taxpayer sustained a loss and not a deductible ordinary and necessary expense. Accord, Holt v. Commissioner, 69 T.C. 75 (1977), in which the Tax Court held that a taxpayer engaged in an illegal marijuana trafficking business could not take a loss deduction under section 165(c)(1) for a forfeited truck and horse trailer used in that business, nor the confiscated marijuana, on public policy grounds. The taxpayer was also denied a business expense deduction for his adjusted basis in this property on the basis of the court's conclusion that it was self-evident that the confiscation and forfeiture resulted in losses, and not expenses for purposes of section 162(a).
HOLDING
Neither a loss nor an expense deduction is available to a taxpayer who burns down a building and receives no insurance proceeds because the arson is discovered.
Rev. Rul. 81-24, 1981-1 C.B. 79, 1981-4 I.R.B. 10.