I just want to verify that I have a correct understanding of the IRS position that casualty loss deductions are only the basis of the property lost, not its fair market value.
For example, lets say an old couple has a house for which they paid $20,000 in 1975. The house burns down in 2018 and at that time it has a fair market value of $650,000. The couple can only deduct the $20,000 they paid for the house originally. Is that right? Seems kind of crazy.
If you wonder why that is: If you think the couple should be able to deduct a $650,000 loss from taxes, then they should have paid taxes on $630,000 profit first.
Your observation is correct, they consider the loss in Fair Market Value as long as that loss doesn't exceed the cost basis.
That is why a person needs insurance. While there is a mortgage on a house, the lender insists on the policy to protect their investment.
Once the mortgage is paid off, the homeowner has to decide how to protect their property. It isn't just an investment property it is also their home. They need a policy that covers them so they can rebuild or replace.
If they have an insurance policy then their actual loss will be smaller, and they might not need to claim a casualty loss.
