Letters to the Editor: On Tax Cheating

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Tax ‘Cheating’ by Ordinary Taxpayers” (Allen J. Rubenfield and Ganesh M. Pandit, March 2007) gave good examples and I agree with the conclusions, except for one. Situation 1, “Small Insurance Damage Claims,” leaves the impression that failure to have car damage repaired within two years might cause the full $497.17 insurance proceeds to be taxable under section 1033. The complete answer is more complicated.
Treasury Regulations section 1.165-7(b)(1) defines a loss as the lesser of adjusted basis or the difference in fair market value, reduced by insurance recovery and salvage value. Alternately, section 1.165-7(a)(2)(ii) defines the loss as the cost of repairs, if repairs are actually made. If the insurance reimbursement exceeds one of these benchmarks, such excess may be taxable under section 1033.

Jay Starkman

The article says that a recipient of cash for auto damage must report it as taxable income if they don’t get the car fixed.
I must have been asleep. My understanding is that, as long as the cash received is less than or equal to the decrease in value of the auto, then the cash received is tax free, but must be subtracted from the cost basis of the car.

Fred Pike

One of the coauthors responds:

I don’t disagree with the letter writers or question the legitimacy of what they say. What I was getting at could obviously have been explained a little better, or perhaps the example could have been written better.

If the vehicle is a personal-use vehicle and you decide to keep the money as opposed to having the vehicle repaired, how do you determine the reduction in fair market value? Do you go on the Kelley Bluebook website (www.kbb.com) and say your car was in great shape as opposed to fair or poor shape? If you continue to use the vehicle as your personal vehicle even with the damage, has there really been any loss suffered? Do you obtain an appraisal, to determine what the actual loss is? What about older vehicles? What if it is not the insurance company that gives you the money, but the other driver because he does not want his insurance rates to increase? What about the money you pocketed? Is it really a replacement for your loss, or are you enjoying it?

This is personal property, and you cannot take a loss on personal property; therefore, personal property has a $0 loss basis. The gain basis would seem to be whatever you sell your car for, whether the actual Bluebook value or FMV is greater, less, or nothing at all. Because there is no basis to reduce a loss against, anything you receive would be taxable income, as I interpret both sections 61 and 1033.

I think the example is as correct as you want to picture it. The problem with the tax law is exactly what you are seeing. It is open to interpretation by whoever takes the time to go through it. None of us understands it. Mine is one interpretation of the law based simply on the pocketing of a few dollars.

Allen J. Rubenfield, JD, CPA
Clark Atlanta University, Atlanta, Ga.

Editor’s note: In the print edition of this article in the March issue, two references to IRS Form 4684 on page 44 were inadvertently transposed to read 4864. There is no IRS Form 4864. The editors apologize for the error.




















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