IRC Sec. 165(i) - An Opportunity to Accelerate COVID-19 Losses to 2019

During recent weeks, much attention has been focused on the tax provisions contained in the CARES Act, as well as the creation and implementation of federal loan programs, such as the Paycheck Protection Program.  However, a provision of pre-CARES Act tax law may provide taxpayers with significant tax and cash flow benefits in this challenging period – namely, IRC Sec. 165(i), entitled “Disaster Losses.”

On March 13, 2020, President Trump declared there to be an “emergency” under Sec. 501(b) of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (“Stafford Act”).  Subsequently, he approved major disaster declaration requests under Sec. 401(a) of the Stafford Act for all 50 states, the District of Columbia and various U.S. territories.  Each of these major disaster declarations stated that a major disaster existed with respect to COVID-19 in that jurisdiction, beginning on January 20, 2020 and continuing.  As described below, these actions effectively triggered the availability of IRC Sec. 165(i) to our current COVID-19 situation.

Under IRC Sec. 165(i) and its related income tax regulations, any loss occurring in a disaster area and attributable to a federally declared disaster warranting assistance by the federal government may, at the election of the taxpayer, be taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred.  The loss must be otherwise allowable as a deduction under IRC Sec. 165 (“Losses”), which generally requires that there be basis in tangible or intangible property and the loss be (i) evidenced by closed and completed transactions; (ii) fixed by identifiable events; and (iii) actually sustained during the year of the event.  IRC Sec. 165 is applicable, in part, to all losses incurred in a trade or business and losses incurred in any transaction entered into for profit though not connected with a trade or business. The amount of the loss cannot exceed the uncompensated amount (reflecting insurance or other reimbursement) determined on the basis of the facts existing at the date the taxpayer claims the loss.  An election under this subsection applies to the entire loss sustained from that disaster during the disaster year. 

Examples

Examples of losses attributable to COVID-19 after March 13, 2020* that might potentially be claimed in 2020 but accelerated to 2019 under IRC Sec. 165(i) include the following:

• Closure of stores and facility locations
• Complete abandonment of leasehold improvements
• Permanent retirement of fixed assets
• Disposal of inventory, supplies and other property that has become unsaleable
• Losses from the sale or exchange of property
• Losses on mark-to-market securities
• Worthless securities (but not bad debts)
• Certain termination payments to cancel contracts, licenses or leases
• Abandonment of pending business transactions for which costs have been capitalized
• Prepayment of events, conferences, etc. where refunds or credits are not provided.

Losses that should not qualify for IRC Sec. 165(i) treatment include, for example, lost revenues and a decline in fair market value of property due to economic conditions related to COVID-19.

Making/Revoking the Election

The election is made either on an original federal income tax return for the preceding year or an amended federal income tax return for the preceding year, attaching Form 4684, “Casualties and Thefts,” to such return. The due date for making the IRC Sec. 165(i) election is six months after the due date for filing the taxpayer’s federal income tax return for the disaster year, determined without regard to any extension of time to file.  (Note: In the case of a partnership operating under the new centralized partnership audit rules, the partnership may need to file an administrative adjustment request instead of an amended return if an amended return were otherwise required.)

Subject to the “Consistent Returns” requirements noted below, an IRC Sec. 165(i) election may be revoked on or before the date that is 90 days after the due date for making the election.

If a corporation determines that because of this election it has overpaid income taxes for 2019, it may request a “quickie refund” on Form 4466, “Corporation Application for Quick Refund of Estimated Tax.” Calendar year taxpayers must file the request no later than July 15, 2020 (as a result of extended filing deadlines), and before filing the 2019 tax return.  And, if any loss is created for 2019 as a result of the election, the loss can be carried back for five years pursuant to the provisions of the CARES Act. 

Consistent Returns

A taxpayer may not make an IRC Sec. 165(i) election for a disaster loss if the taxpayer claims a deduction (as a loss, as cost of goods sold, or otherwise) for the same loss for the disaster year (i.e., 2020).  If the taxpayer has claimed a current deduction for a disaster loss for the disaster year and the taxpayer wants to make an IRC Sec. 165(i) with respect to that loss, the taxpayer must file an amended federal income tax return to remove the previously deducted loss on or before the date that the taxpayer makes the IRC Sec. 165(i) election for the loss.  Conversely, if the taxpayer has claimed a deduction for a disaster loss for the preceding year based on an IRC Sec. 165(i) election and wants to revoke the election, the taxpayer must file an amended federal income tax return to remove the loss for the preceding year on or before the date the taxpayer files the federal income tax return or amended federal income tax return for the disaster year that includes the loss.

Summary

Taxpayers that had a profitable 2019 taxable year and have realized losses post-March 13, 2020* directly attributable to the COVID-19 disaster should evaluate the making of an IRC Sec. 165(i) election, accelerating these 2020 losses to 2019.

*The reference date for claiming losses may be as early as January 20, 2020.