United States District Court, E.D. Michigan, Southern Division
REPORT AND RECOMMENDATION MOTION FOR SUMMARY JUDGMENT (Dkt. 15)
MICHAEL HLUCHANIUK, Magistrate Judge.
I. PROCEDURAL HISTORY
Plaintiff filed a complaint for a tax refund under 26 U.S.C. § 7422 on June 28, 2013. (Dkt. 1). This matter was referred to the undersigned for all pretrial proceedings on November 20, 2013. (Dkt. 9). The United States filed an answer to the complaint on December 16, 2013. (Dkt. 11). A Case Management Order was entered on March 21, 2014, including a discovery deadline of September 18, 2014. (Dkt. 14). On July 18, 2014, the United States filed a motion for summary judgment. (Dkt. 15). On that same date, the United States filed a motion to stay discovery pending a decision on its motion for summary judgment, which was granted. (Dkt. 16, 17). On August 11, 2014, plaintiff filed a response to the motion for summary judgment. (Dkt. 21). The United States filed a reply on August 19, 2014. (Dkt. 24). Plaintiff, with leave of the Court, filed a sur-reply on September 3, 2014. (Dkt. 26). This matter is now ready for report and recommendation.
For the reasons set forth below, the undersigned RECOMMENDS that defendant's motion for summary judgment be GRANTED.
II. FACTUAL BACKGROUND
A. Plaintiff's Complaint
On May 26, 2006, plaintiff purchased a home located in West Bloomfield, Michigan for $265, 000. (Dkt. 1). At the time of the sale, the sellers had specific knowledge of the extensive problems with water penetration from the roof and foundation, structural problems, mold, and other defects. Plaintiff contends that the sellers misrepresented the condition of the house to plaintiff and actively concealed evidence of the problems before plaintiff's and the home inspector's visits to the property. Plaintiff says he was not aware of the problems at the time of purchase. As a result of the fraud perpetrated by the sellers, plaintiff significantly overpaid for the house and ultimately lost the house.
The complaint alleges that the Michigan state court held that the sellers misrepresented the state of the property. Plaintiff hired an expert appraiser who indicated that the value of the property in 2006 with the undisclosed damages was only $140, 000. Thus, the loss to plaintiff was $125, 000 along with additional loss items under the statute. According to the complaint, this loss was not reimbursed to plaintiff through insurance or otherwise. Plaintiff timely submitted 1040X amended returns for the tax years 2006 and 2007, including a claim for a casualty loss for the financial damages incurred by the purchase of the property due to fraud and misrepresentation. The amount of the casualty loss is $20, 869 (2006 = $14, 956; 2007 = $5, 913).
Plaintiff contends that the IRS lost plaintiff's amendments and mismanaged the entire claim process. The IRS Examiner, after unsuccessfully exhausting other improper means of rejecting the claim, finally rejected the claim on her incorrect and unfounded assertion that there was no basis for a casualty loss in the law. The appeals division upheld the rejection of the refund claim. In November 2012, plaintiff finally received a letter denying his claim. Plaintiff contacted Leonard Bartold, an Appeals Manager at the IRS, to request clarification of the IRS' reasoning. No further explanation was received. Plaintiff now seeks a refund for the casualty loss and/or theft claim.
B. Defendant's Motion for Summary Judgment
While defendant does not concede that plaintiff suffered a casualty or theft loss as contemplated by 26 U.S.C. § 165, defendant also contends that this issue need not be addressed at this time. Rather, defendant argues that plaintiff did not suffer a deductible loss in 2006 because he had a reasonable prospect of recovery from the sellers that lasted until 2009, when the amount of the alleged loss could finally be computed and ascertained for purposes of the Internal Revenue Code.
Section 165 of the I.R.C. permits, in pertinent part, deductions for losses "sustained during the taxable year and not compensated for by insurance or otherwise" that arise from some "casualty" or "theft." 26 U.S.C. § 165(a), (c)(3). The Treasury Regulations promulgated under 26 U.S.C. § 165 echo the statute in limiting deductions to when the loss "can be ascertained with reasonable certainty whether or not such reimbursement will be received." 26 C.F.R. § 1.165-1(d)(2)(i). No loss deduction is permitted in any year for which there exists "a reasonable prospect of recovery." Id. In the case of any loss, if "there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained ... until it can be ascertained with reasonable certainty whether or not such reimbursement will be received." Id. The kinds of factors that suggest that all or part of a loss will not be reimbursed "with reasonable certainty" include events such as the adjudication, settlement, or abandonment of the claim. Id. According to defendant, this rule applies with equal force to theft losses. See 26 C.F.R. § 1.165-1(d)(3) (adopting virtually identical language to that found in 26 C.F.R. § 1.165-1(d)(2) with respect to theft losses) and 26 C.F.R. § 1.165-8(a)(2); Ramsay Scarlett & Co., Inc. v. Comm'r, 521 F.2d 786, 787 (4th Cir. 1975), aff'g 61 T.C. 795 (1974); Rainbow Inn, Inc. v. Comm'r, 433 F.2d 640, 642-43 (3d Cir. 1970). Thus, defendant maintains that when a taxpayer possesses a claim for reimbursement in the year the theft is discovered, a loss is not sustained for purposes of 26 U.S.C. § 165(a) as long as and to the extent that there remains a reasonable prospect of recovery with respect to such claim. 26 C.F.R. § 1.165-1(d)(3); see Scofield's Estate v. Comm'r, 266 F.2d 154, 159-60 (6th Cir. 1959) ("at least prima facie weight to the good faith determination of a taxpayer that recovery of a given loss is worth pursuing by litigation.").
A reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment from third parties or otherwise, and there is a substantial possibility that such claims will be decided in his favor. Nat'l Home Products, Inc. v. Comm'r, 71 T.C. 501, 525-26 (1979), quoting Ramsay Scarlett, 521 F.2d at 811. The standard is one of foresight, focusing on what was a "reasonable expectation" as of the close of the taxable year for which the deduction is claimed. Id. ; see Dawn v. Comm'r, 675 F.2d 1077, 1078 (9th Cir. 1982); Ramsay Scarlett & Co., 61 T.C. at 811 (inferring reasonable prospect of recovery existed in 1965 even though suit not filed until 1967); Scofield's Estate, 266 F.2d at 159; see also Parmelee Transp. Co., 351 F.2d 619, 628 (Ct. Fed.Cl. 1965) (observing that taxpayer carries the burden of proving "no reasonable prospect" of recovery of the loss); Geisler v. C.I.R., 955 F.2d 47 (9th Cir. 1992) (unpublished opinion) (citing Dawn for the proposition that "[t]axpayer's presumptive state of mind, as evidenced by the filing of a lawsuit, goes far toward showing the reasonableness of their prospect of recovery."). Moreover, the filing of a lawsuit to recover the loss gives rise to an inference that plaintiff had such a claim and indeed pursued it. See Lapin v. Comm'r, 956 F.2d 1167 (9th Cir. 1992) (unpublished opinion) (citing Dawn, 675 F.2d at 1078); Gale v. Comm'r, 41 T.C. 269, 276 (1963); Zinn v. United States, 885 F.Supp.2d 866, 873 (N.D. Ohio 2012); see also McCullough v. C.I.R., T.C. Memo. 1990-653 (1990) (rejecting taxpayer's claim for theft loss deduction in 1985 or 1986 since taxpayer filed lawsuit in 1988 to recover the losses). Only when the claims are exhausted does the prospect of recovery (or an absence of recovery) become known to a degree that will permit a deduction at that time. 26 C.F.R. § 1.165-1(d)(2)(i); see also Brill v. United States, 2011 WL 249740 (N.D. Cal. Jan. 26, 2011).
Defendant points out that plaintiff bears the burden of proving with reasonable certainty as of the end of 2006 that his loss would never be recovered. See Jeppsen v. Comm'r, 128 F.3d 1410, 1418 (10th Cir. 1997), cert. denied, 524 U.S. 916 (1998). If plaintiff's prospect of recovery was "simply unknowable" at the end of 2006, then he would not be entitled to take the casualty or theft-loss deduction in that year. Jeppsen, 128 F.3d at 1418; see also Vincentini, 429 Fed.Appx. 560, 564 (6th Cir. 2011) (explaining that "[s]peculation and conjecture will not support a taxpayer deduction under this provision"). Here, defendant contends that plaintiff is not eligible to claim a casualty or theft loss deduction on his amended 2006 federal income tax return because he had a reasonable prospect of recovery in that year. Rather, far from being merely a "prospect, " plaintiff actually pursued his claims against the sellers in Michigan state court through a civil action filed in 2008 - a case that was ultimately resolved in his favor in the ...