Diamond lost, how to report.

Technical topics regarding tax preparation.
#1
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Client lost the diamond in her mother's engagement ring. Her mother gave her the ring years ago. Mother is now deceased.

Taxpayer said insurance company will either replace the diamond, or give her the cash value of the diamond. She had the diamond appraised a few years ago at $30000.

She wants to know if she would have to pay tax if she gets cash, or can avoid tax if she gets the diamond replaced.

The way I read the law regarding casualty losses, if she gets cash, she will need to determine the basis of the diamond (basis of the diamond at time of gift), and the difference between that and the $30000 (if she gets that much) will be a LTCG to her.

If the diamond is replaced, she will not owe tax until she sells it.

Am I seeing this correctly? Any comments appreciated.
 

#2
Nilodop  
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The way I read the law regarding casualty losses. Is a "loss" a casualty? There's a case where the woman's husband closed a car door too soon and it hit the ring and the diamond was never found. Tax Court allowed a casualty-loss deduction for the value of a diamond that popped out of an engagement ring and disappeared in a gravel driveway after a car door was accidentally slammed on the ring-wearer’s hand. White , 48 T.C. at 434; see also Rev. Rul. 72-592, 1972-2 C.B. 101. Some other ways to lose it might not be. Like, say, if the setting loosened over the years, and the stone just got lost.

Lucky they had that kind of insurance.
 

#3
Nilodop  
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Which is not to say all is lost. Worst possible interpretation, and wrong in my opinion, is that the loss is a non-deductible sec 262 loss, and the insurance reimbursement (or in-kind replacement) is income, taxable.

Next worst might be to apply the casualty-loss concepts, in which case the scenarios you summarize would apply. Trouble is, if it's not a casualty, there's no authority for that.

But wait - in order to have income, you need an accession to wealth, and you'd argue that did not happen, because you have the same value before and after the loss, thanks to the insurance you bought. And IRS would argue that above "worst" scenario applies, because the reimbursement/replacement by the insurance co. was the accession to wealth (income, taxable) because the loss from the lost diamond was not deductible. Going in circles.

But then you'd say that because of your foresight in buying the insurance, you'e shifted the risk of (economic) loss to that company, and so you had neither a loss nor income in a tax sense. That's my story and I'm stickin' to it.
 

#4
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Insurance Co. to pay taxpayer $20000 for diamond she lost. She had it appraised a few years back at $30000. Taxpayer wants to use the money to buy a new diamond, to replace the lost diamond. I will research, but if anyone can steer me to an easy answer for tax outcome, it would be appreciated.
 

#5
Nilodop  
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Not all tax issues have an easy answer. You say she lost it, so why are you applying casualty-loss rules? And what was her tax basis in the diamond? And what's your reaction to what's said in post #3?
 

#6
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Frankly, I am kind of lost on this thing. Basis? Taxpayer got the engagement ring with the diamond in it years ago from her mom. A gift. Basis would be the adjusted basis in the mom's hand when she gave her daughter her engagement ring. This was after the husband died, so perhaps there could be a step-up in basis at that time? Who knows what the basis is.

Taxpayer had the diamond appraised a few years ago at $30000. So if the insurance company pays her $20000 cash for the insurance claim, it seems, Nilodrop, that you are saying she has no taxable gain, and no taxable loss. I like it. I am still looking for anything that supports this in writing.

To help me understand your position, let's say for example's sake taxpayer can establish a $10000 adjusted basis in the diamond. If the insurance company paid her $9000 for the loss, then she might have a $1000 taxable loss. And if they paid her $31000 for it, then she might have a $1000 gain ($30000 appraised value). And anything in between (the $20000) would have no tax effect. Is this what you are suggesting with " . . . neither a loss nor income in a tax sense. That's my story and I'm stickin' to it."
 

#7
Andrew  
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Do you have the appraisal for 30K? Do you have the invoice for the original purchase price? It's sounds like not which is understandable. At best, the insurance appraisal will fly as the basis for the diamond.
 

#8
Nilodop  
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Taxpayer had the diamond appraised a few years ago at $30000. So if the insurance company pays her $20000 cash for the insurance claim, it seems, Nilodrop, that you are saying she has no taxable gain, and no taxable loss. I like it. I am still looking for anything that supports this in writing.

To help me understand your position, let's say for example's sake taxpayer can establish a $10000 adjusted basis in the diamond. If the insurance company paid her $9000 for the loss, then she might have a $1000 taxable loss. And if they paid her $31000 for it, then she might have a $1000 gain ($30000 appraised value). And anything in between (the $20000) would have no tax effect. Is this what you are suggesting with " . . . neither a loss nor income in a tax sense. That's my story and I'm stickin' to it."


Well, not exactly. I'm saying that unless you give us more facts, this is not a casualty, but rather a personal item/event/transaction, a personal asset that got lost. If there were no insurance, the loss, measured by value decline (30k down to zero) but limited to basis, would be not deductible. If insurance pays 9k, the formula is the same and so is the result.

But that formula works like this if the insurance pays more than basis. The economic gain is still, in your example of 31k insurance proceeds, just 1k, but the tax gain is still measured against tax basis, so there'd be a gain of 21k (31k proceeds minus 10k basis).

My theory, for which I have no case, reg., ruling, etc., but my notion of the applicable tax principle, is something like a tax-benefit approach. There was indeed an economic loss, in your example, 30k, the market value. But had it not been insured, it would have been, as stated above, a non-deductible personal loss; therefore, goes the theory, the recovery to the extent of 30k, is an offset to a non-deductible loss, and not an item of income. What little looking I did produced no authority for the theory. Then I threw in that bit that shifting the risk of loss, at your personal, non-deductible cost of insurance premiums, somehow plays into the analysis, kind of like with life insurance, where your beneficiary collects $x but it's not taxable. The obvious flaw in that theory is that sec 101 covers the death benefit, and no section covers my theory. Yet I said I'd stick with it, and I do.

It occurs to me that the various cases, rulings, whatever on destruction of personal property by slow damage that is held to not be a casualty loss might address my theory. How aboutn you take a look. Let us know.

And I almost forgot the argument that there has been no accession to wealth if the insurance co.pays 39k or less. It can be challenged based on whether the loss and reimbursement are viewed together, or as separate transactions/events.

Since it's not a theft or casualty, we also need to address the year of the event, i.e., is it when you dicovered it was lost (like the theft rule) or would IRS want you to prove (don't aak me how) that it was lost on a specific date.
 

#9
mariaku  
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I'd also like to check when the ring ownership passed from M to D. You said "Client lost the diamond in her MOTHER's engagement ring. Her mother GAVE her the ring years ago. Mother is NOW DECEASED."

Did the M make a gift during her lifetime, or did she let the D borrow it and then the D inherited in upon the M's passing? Basis differences may be significant.
 

#10
Nilodop  
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And I almost forgot the argument that there has been no accession to wealth if the insurance co.pays 30k or less. It can be challenged based on whether the loss and reimbursement are viewed together, or as separate transactions/events.


Can some of you deep thinkers comment on this? In a way, that's where the casualty loss rules take us. But they are specific rules in the law and regs. Can we apply them (as indeed OP did) where it's just a personal loss, not a casualty? Suppose you own a fairly beat up car, with a dented and rusty fender. The entire car only cost you $3,000, and the fender's portion of that is, say, $200. Then the fender falls off from rust because you leaned on it too hard and (pretend) the insurance co. reimburses you for the $500 it costs to replace it. It's not a (tax-defined) casualty. Is the $300 a taxable gain, or was there no accession to wealth?
 

#11
tshonk  
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I thought now casualty losses are only allowed in federally declared disaster.
 

#12
Nilodop  
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That's true but then we'd not have the fun of figuring out all the other related stuff.

Also, if there are casualty gains, then non-disaster casualty losses are allowed to offset them.

But we remain with the issue of whether this loss was a casualty loss.
 


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