At 7 am on the morning of May 30, 1941, George Barringer was putting gas into his car in a garage northwest of Indianapolis. It wasn’t just any car; the number 35 was painted on it. And it wasn’t just any garage; it was part of a complex of garages called “Gasoline Alley” at the Indianapolis Motor Speedway. Barringer’s car had qualified at 122.299 mph.
At the same moment, in the next garage last-minute preparations were also taking place. The Thorne Engineering crew was working on its entry, number 5, to be driven by Joel Thorne. Part of the final preparations included a bit of spot welding.
Gasoline fumes from Barringer’s garage drifted over into Thorne’s area and ignited. The resulting fire destroyed a number of wooden garages in Gasoline Alley. Fire officials, racing crews and others were pulling cars, equipment, fuel drums and anything else they could from the flames.
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| Viewing the remains of George Barrington's racer, May 1941. From left: Deacon Litz, George Barrington, Wilbur Shaw. Photo courtesy of IMS Photo Operations |
What would be the tax effects if such an event occurred today? Before we answer that, we should get acquainted with some tax lingo – specifically the term “casualty.”
A “casualty” is defined as the damage or destruction of property due an identifiable event. This event must be sudden, unexpected or unusual.[1] Unless an event that results in damage or destruction of property meets this definition of a “casualty,” no deduction is normally allowed.
“Sudden” means swift and not gradual or progressive. The classic example of gradual damage is termite damage to a structure. From a racer’s standpoint, normal engine wear would probably be classified as gradual and not a casualty.
An “unexpected” event is ordinarily unanticipated or unintended.
An “unusual” event is one that’s not considered to be a day-to-day occurrence. It’s not typical of the activity in which you’re engaged.
Assuming your loss fits the definition of a “casualty,” the next step is to consider whether the property was owned by a corporation or individually. The ownership factor makes a great deal of difference in the tax treatment of casualty losses.
A casualty loss sustained by corporation is treated as a “sale of property.” If a corporation owns a racecar (or any other business asset) that’s damaged or destroyed, and the event qualifies as a “casualty loss,” then the adjusted basis of the item (cost less accumulated tax depreciation) is compared with the sales price of the asset after the loss. If the sales price is larger than the net book value, you normally have a taxable gain; if less, then a taxable loss results. If there’s no insurance recovery or the asset is scrapped, then the sale price is zero and a taxable loss can result.
The tax treatment is entirely different for property owned by an individual.
There’s a special rule for individually owned racecars damaged or destroyed in competition: there is no deductible loss because there’s no “casualty.” In a 1982 private letter ruling[2], the IRS stated, “in automobile races, crashes and collisions involving the participants’ automobiles are common. Such events are neither extraordinary nor nonrecurring…Without regard to whether the loss resulted from an event that was sudden and unexpected, the loss did not result from an event that was unusual.” Bottom line: you can’t get a casualty loss deduction for an individually owned racecar involved in a crash during a race.
If the asset is not an individually owned racecar damaged or destroyed in competition, individually owned property can be divided into two categories:
- Business property, which includes property held for the production of income, and
- Personal use property.
If business property is completely destroyed as a result of a casualty loss, the individual owning the property will follow the same rules as a corporation mentioned above.
However, if the business property owed by an individual is only partially destroyed due to a casualty loss, the loss is the lesser of the following items:
- The adjusted basis of the property, or
- The difference between the fair market value before and immediately after the casualty loss. In many cases, the cost of repairs is a good measure of this difference.
Any insurance recovery reduces the casualty loss, regardless of whether the property being owned by an individual or corporation. In some taxes (incredible as it may seem) a taxable gain could result from a casualty loss when insurance recovery is figured into the computations.
The distinction between business use property and personal use property for individuals also depends on the hobby loss rules, which were mentioned in earlier blogs. If there’s no profit motive in your racing activity, the individually owned racing equipment that suffered a casualty loss will probably be considered personal use property.
To compute the casualty loss on personal use assets, you would use the same rules as for computing the partially casualty loss on business use assets, There’s a limitation on casualty losses for personal use assets.The loss is only deductible if:
- You itemize your deductions,
- The loss is greater than 10% of your Adjusted Gross Income, and
- You must subtract $100 from each loss prior to deduction.
Going back to the 1941 race, if today’s tax rules had been in effect and assuming George Barringer owned his car personally and his racing were considered an “activity for profit,” the destroyed race car would have qualified as a casualty loss of a business asset, since it wasn’t involved in a race at the time of the fire. However, if there were no fire and his car would have been raced that Memorial Day of 1941, any damage sustained during the race would be ineligible for a casualty loss deduction.
Interesting footnotes: Only 31 cars started in the 1941 Indy 500. George Barringer was awarded 32nd place in the final race results and received $530 for his efforts. His car was the only one of the 33 entries that was damaged or destroyed in the fire. Sam Hanks, who would eventually win the 1957 race, was awarded the 33rd spot in the 1941 race. Hanks didn’t even start the 500; his car was damaged in a practice session the day before. Joel Thorne’s car started the 1941 Indy 500 in the 23rd position and crashed on the fifth lap in the first turn. He placed 31st and was awarded $535.
Wilbur Shaw led for 107 laps but had an accident on lap 151 due to a blown tire. Days earlier, he was examining the tires he would use during the race. The tires he felt least comfortable with were marked “Use Last” in chalk. However, the water used by the fire department to extinguish the garage fire washed off his chalk instructions written on the tires. As a result, the less desirable tires were randomly placed with the others in his pit box prior to the start of the race.
Stuff happens…
Drop me an email at phil.schurrer.racingprof@gmail.com if you or your group would be interested in a detailed presentation about this topic or other tax and financial aspects of motor sports. I'd also be interested in any comments you have about the blog or suggestions for future topics
Until next time …
Phil Schurrer, CPA
“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.
Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.
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