The Tax Court held that because the collapse of a retaining wall was due to progressive deterioration that had begun at least 20 years before the wall's collapse, the owner of a co-op was not entitled to a casualty loss deduction for amounts paid to fix the wall. The court rejected the taxpayer's argument that the collapse of the wall was due to excessive spring rain which overstressed a recently installed drainage system and caused rapidly accelerating movement in the wall in the four weeks immediately preceding the collapse. Alphonso, T.C. Memo. 2016-130.
Christina Alphonso is a tenant-stockholder of Castle Village Owners Corp., a New York cooperative housing corporation (i.e., co-op). Castle Village owns a tract of land in Manhattan on which five high-rise residential buildings sit. Before May 12, 2005, the grounds near those five Castle Village apartment buildings were supported by a retaining wall of stone masonry construction that had been built between 1921 and 1925. Before May 12, 2005, the retaining wall in question ran parallel to Riverside Drive for approximately 800 feet and had an average height of 65 feet.
In 1985, Castle Village retained an engineer to perform an inspection of the retaining wall. In a letter to Castle Village, the engineer indicated that a portion of the retaining wall showed signs of movement and instability and that several cracks were observed and that relief drains appeared not to function properly. For the next 20 years, various engineering and architectural firms were hired to address issues with the retaining wall. There were two documented times when work was performed either directly on the wall or close to the wall - the installation of rock anchors/bolts in 1986 and drainage modifications beyond the top of the wall in 2004.
On May 12, 2005, a 150-foot portion of the retaining wall collapsed onto Riverside Drive. The various consultants whom Castle Village had retained over the previous 20 years had reported their findings about the retaining wall in numerous letters, reports, proposals, and/or memoranda sent to Castle Village. Most of the major problems in and around the retaining wall that those consultants had observed and described in those respective documents were observed in and around the 150-foot section of the retaining wall that collapsed.
On her 2005 Form 1040, Alphonso reported a casualty loss of $26,390 and, after making reductions required by Code Sec. 165(h)(1) and (2) (relating to the dollar limitation per casualty and the limitation on the deductible amount), she claimed a casualty loss deduction of $23,188. The IRS disallowed the deduction.
Under Code Sec. 165(a), (c) and (h), an individual can deduct losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty. A loss is treated as sustained during the tax year in which the loss occurs, as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such tax year. As defined in Code Sec. 165(c)(3), the term "other casualty" refers to an event that shares characteristics with a fire, storm, or shipwreck. A casualty is an event which is due to a sudden, unexpected, or unusual cause.
In Fay v. Helvering, 120 F.2d 253 (2d Cir. 1941), the Second Circuit held that the progressive deterioration of property through a steadily operating cause is not a casualty. The Tax Court, in Carlson v. Comm'r, T.C. Memo. 1981-702, held that a collapse, even one that occurs suddenly, is not a casualty when the collapse is caused by progressive deterioration. Similarly, in Hoppe v. Comm'r, 42 T.C. 820 (1964), the Tax Court held that a loss that is accelerated by a contributing factor such as rain or wind is not a casualty if the loss is caused by progressive deterioration.
However, in Helstoski v. Comm'r, T.C. Memo. 1990-382, the Tax Court held that the taxpayers sustained a casualty loss when a storm caused a dam to fail, which resulted in damage to the taxpayers' property and a decrease in the fair market value of the property. The court rejected the IRS's contention that the cause of the damage was gradual erosion of the earth that occurred over a period of years.
In Alphonso v. Comm'r, 136 T.C. 247 (2011) (Alphonso I), the Tax Court initially denied Alphonso's casualty loss deduction on the grounds that Alphonso held no property interest in the cooperative's grounds sufficient to entitle her to the deduction. She appealed to the Second Circuit, arguing that her right to use the grounds and to exclude persons who are not tenants or the guests of tenants, coupled with her obligations as a tenant-stockholder under the cooperative lease, constituted a property interest in the land sufficient to entitle her to the casualty loss deduction. In Alphonso v. Comm'r, 2013 PTC 17 (2d Cir. 2013), the Second Circuit agreed with Alphonso and vacated the Tax Court's holding and remanded the case back to the Tax Court. According to the Second Circuit, under New York law, Alphonso's right to use the grounds, shared with other residents of Castle Village and their respective guests but not with anyone else, was a property interest in the grounds.
Before the Tax Court, Alphonso argued that the cause of the collapse of the retaining wall was excessive rainfall during the months of January through May 2005, which overstressed the recently installed drainage system (i.e., the 2004 drainage modifications) and caused rapidly accelerating movement in the wall in the four weeks immediately preceding the collapse. Proceeding from that core contention, Alphonso argued that the Tax Court's decision in Helstoski supported her position that the collapse of the retaining wall was a casualty within the meaning of Code Sec. 165(c)(3).
The Tax Court disagreed with Alphonso and held that the collapse of the retaining wall was not a casualty within the meaning of Code Sec. 165(c)(3) and thus Alphonso was not entitled to a casualty loss deduction. According to the court, the cause of the collapse of the retaining wall was due to a progressive deterioration in and around that wall that had begun at least 20 years before the wall's collapse on May 12, 2005. The court found that although the spring 2005 rainfall and the 2004 drainage modifications may have been contributing factors to the particular time at which the retaining wall collapsed, they did not cause that collapse.
With respect to Alphonso's reliance on the decision in Helstoski, the court said that reliance was misplaced. The court found the facts in Helstoski with respect to the cause of the failure of the dam and the loss to the taxpayers' property to be materially distinguishable from the facts dealing with the cause of the collapse of the retaining wall and the loss to Alphonso's property value.
For a discussion of casualty losses, see Parker Tax ¶84,505.