Settlement award - home buyer sues seller

Have a new one. Client bought home in 2012 for $466,000. They began having stucco issues in 2017 so they brought in many experts (builders, engineers, etc) to review the issue(s). My client sued the seller for failure to disclose these issues and ultimately won the law suit in 2019. Cost to repair the stucco was approximately $265k and legal fees were approx. $80k split between 2017 (5k), 2018 (15k) and 2019 (60k). He was awarded $195k + $10k punitive damages + $15k in Pre judgement interest.

I know the treatment of the punitive damages and pre judgement interest but wondering about the $195k. Can it be treated as reduction in basis (and then the repairs increase his basis)? I've read that recovery of damages due to loss in value is not taxable but a reduction in basis. I'm not aware of any FMV assessment that the client had done, but it could be reasonable to determine that the cost to repair is the reduction in value. The 'origin of claim' seems to be a compensatory, contractual suit. Thoughts?

I'm not aware of any FMV assessment that the client had done, but it could be reasonable to determine that the cost to repair is the reduction in value.

I agree that this is a reasonable assessment.

Loss-in-value of property
•
Property settlements for loss in value of property that are less than the adjusted basis of your property are not taxable and generally do not need to be reported on your tax return. However, you must reduce your basis in the property by the amount of the settlement.
•
If the property settlement exceeds your adjusted basis in the property, the excess is income. For more information, see the Instructions for Schedule D, (Form 1040) Capital Gains and Losses and the Instructions for Form 4797, Sales of Business Property.

https://www.irs.gov/pub/irs-pdf/p4345.pdf

I'm not aware of any FMV assessment that the client had done, but it could be reasonable to determine that the cost to repair is the reduction in value.

I agree that this is a reasonable assessment.

Loss-in-value of property
•
Property settlements for loss in value of property that are less than the adjusted basis of your property are not taxable and generally do not need to be reported on your tax return. However, you must reduce your basis in the property by the amount of the settlement.
•
If the property settlement exceeds your adjusted basis in the property, the excess is income. For more information, see the Instructions for Schedule D, (Form 1040) Capital Gains and Losses and the Instructions for Form 4797, Sales of Business Property.

https://www.irs.gov/pub/irs-pdf/p4345.pdf

I've gone through that pub, but wanted to see if someone had gone through this and treated it as non-taxable. 195k is a lot of money to rely on that one line item.

I know the treatment of the punitive damages and pre judgement interest but wondering about the $195k. Can it be treated as reduction in basis (and then the repairs increase his basis)?

See PLR 200513011:
https://www.irs.gov/pub/irs-wd/0513011.pdf

I know the treatment of the punitive damages and pre judgement interest but wondering about the $195k. Can it be treated as reduction in basis (and then the repairs increase his basis)?

See PLR 200513011:
https://www.irs.gov/pub/irs-wd/0513011.pdf

Thanks Dave, that PLR is helpful.

I just found this thread from last year while trying to help a friend with a similar question.

My friend is the first purchaser of his home from the builder. He has defective stucco that is going to cost him $100k to replace. He is suing the builder and believes he will receive $20k.

I believe the tax consequences are as follows:
* The $100k spent on fixing the defective stucco does not give him any type of tax deduction. (I looked at the casualty losses to see if he would be entitled to anything under that).
* The $100k spent will be added to the basis of his home.
* The $20k lawsuit settlement would not be taxed as income, but would reduce the basis of his home.

Thank you in advance for any comments you may share.

My friend is the first purchaser of his home from the builder. He has defective stucco that is going to cost him $100k to replace. He is suing the builder and believes he will receive $20k.. It may not matter, but how much time elapsed between when he bought the house and the stucco problem became apparent?

Thanks Nilodop.
Purchased the home in 2006, and discovered the problem in 2014. Then started the litigation.

So I agree, it's highly unlikely to be a casualty. I'd say your ananlysis, 1-2-3, is right. Others agree? Coddington?

Thank you Nilodop, I really appreciate it.