[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.165-1]

[Page 891-893]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.165-1  Losses.

    (a) Allowance of deduction. Section 165(a) provides that, in 
computing taxable income under section 63, any loss actually sustained 
during the taxable year and not made good by insurance or some other 
form of compensation shall be allowed as a deduction subject to any 
provision of the internal revenue laws which prohibits or limits the 
amount of the deduction. This deduction for losses sustained shall be 
taken in accordance with section 165 and the regulations thereunder. For 
the disallowance of deductions for worthless securities issued by a 
political party, see Sec. 1.271-1.
    (b) Nature of loss allowable. To be allowable as a deduction under 
section 165(a), a loss must be evidenced by closed and completed 
transactions, fixed by identifiable events, and, except as otherwise 
provided in section 165(h) and Sec. 1.165-11, relating to disaster 
losses, actually sustained during the taxable year. Only a bona fide 
loss is allowable. Substance and not mere form shall govern in 
determining a deductible loss.
    (c) Amount deductible. (1) The amount of loss allowable as a 
deduction under section 165(a) shall not exceed the amount prescribed by 
Sec. 1.1011-1 as the adjusted basis for determining the loss from the 
sale or other disposition of the property involved. In the case of each 
such deduction claimed, therefore, the basis of the property must be 
properly adjusted as prescribed by Sec. 1.1011-1 for such items as 
expenditures, receipts, or losses, properly chargeable to capital 
account, and for such items as depreciation, obsolescence, amortization, 
and depletion, in

[[Page 892]]

order to determine the amount of loss allowable as a deduction. To 
determine the allowable loss in the case of property acquired before 
March 1, 1913, see also paragraph (b) of Sec. 1.1053-1.
    (2) The amount of loss recognized upon the sale or exchange of 
property shall be determined for purposes of section 165(a) in 
accordance with Sec. 1.1002-1.
    (3) A loss from the sale or exchange of a capital asset shall be 
allowed as a deduction under section 165(a) but only to the extent 
allowed in section 1211 (relating to limitation on capital losses) and 
section 1212 (relating to capital loss carrybacks and carryovers), and 
in the regulations under those sections.
    (4) In determining the amount of loss actually sustained for 
purposes of section 165(a), proper adjustment shall be made for any 
salvage value and for any insurance or other compensation received.
    (d) Year of deduction. (1) A loss shall be allowed as a deduction 
under section 165(a) only for the taxable year in which the loss is 
sustained. For this purpose, a loss shall be treated as sustained during 
the taxable year in which the loss occurs as evidenced by closed and 
completed transactions and as fixed by identifiable events occurring in 
such taxable year. For provisions relating to situations where a loss 
attributable to a disaster will be treated as sustained in the taxable 
year immediately preceding the taxable year in which the disaster 
actually occurred, see section 165(h) and Sec. 1.165-11.
    (2)(i) If a casualty or other event occurs which may result in a 
loss and, in the year of such casualty or event, 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, for purposes of section 165, until it can 
be ascertained with reasonable certainty whether or not such 
reimbursement will be received. Whether a reasonable prospect of 
recovery exists with respect to a claim for reimbursement of a loss is a 
question of fact to be determined upon an examination of all facts and 
circumstances. Whether or not such reimbursement will be received may be 
ascertained with reasonable certainty, for example, by a settlement of 
the claim, by an adjudication of the claim, or by an abandonment of the 
claim. When a taxpayer claims that the taxable year in which a loss is 
sustained is fixed by his abandonment of the claim for reimbursement, he 
must be able to produce objective evidence of his having abandoned the 
claim, such as the execution of a release.
    (ii) If in the year of the casualty or other event a portion of the 
loss is not covered by a claim for reimbursement with respect to which 
there is a reasonable prospect of recovery, then such portion of the 
loss is sustained during the taxable year in which the casualty or other 
event occurs. For example, if property having an adjusted basis of 
$10,000 is completely destroyed by fire in 1961, and if the taxpayer's 
only claim for reimbursement consists of an insurance claim for $8,000 
which is settled in 1962, the taxpayer sustains a loss of $2,000 in 
1961. However, if the taxpayer's automobile is completely destroyed in 
1961 as a result of the negligence of another person and there exists a 
reasonable prospect of recovery on a claim for the full value of the 
automobile against such person, the taxpayer does not sustain any loss 
until the taxable year in which the claim is adjudicated or otherwise 
settled. If the automobile had an adjusted basis of $5,000 and the 
taxpayer secures a judgment of $4,000 in 1962, $1,000 is deductible for 
the taxable year 1962. If in 1963 it becomes reasonably certain that 
only $3,500 can ever be collected on such judgment, $500 is deductible 
for the taxable year 1963.
    (iii) If the taxpayer deducted a loss in accordance with the 
provisions of this paragraph and in a subsequent taxable year receives 
reimbursement for such loss, he does not recompute the tax for the 
taxable year in which the deduction was taken but includes the amount of 
such reimbursement in his gross income for the taxable year in which 
received, subject to the provisions of section 111, relating to recovery 
of amounts previously deducted.
    (3) Any loss arising from theft shall be treated as sustained during 
the taxable year in which the taxpayer discovers the loss (see Sec. 
1.165-8, relating to theft losses). However, if in the year of

[[Page 893]]

discovery 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, for 
purposes of section 165, until the taxable year in which it can be 
ascertained with reasonable certainty whether or not such reimbursement 
will be received.
    (4) The rules of this paragraph are applicable with respect to a 
casualty or other event which may result in a loss and which occurs 
after January 16, 1960. If the casualty or other event occurs on or 
before such date, a taxpayer may treat any loss resulting therefrom in 
accordance with the rules then applicable, or, if he so desires, in 
accordance with the provisions of this paragraph; but no provision of 
this paragraph shall be construed to permit a deduction of the same loss 
or any part thereof in more than one taxable year or to extend the 
period of limitations within which a claim for credit or refund may be 
filed under section 6511.
    (e) Limitation on losses of individuals. In the case of an 
individual, the deduction for losses granted by section 165(a) shall, 
subject to the provisions of section 165(c) and paragraph (a) of this 
section, be limited to:
    (1) Losses incurred in a trade or business;
    (2) Losses incurred in any transaction entered into for profit, 
though not connected with a trade or business; and
    (3) Losses of property not connected with a trade or business and 
not incurred in any transaction entered into for profit, if such losses 
arise from fire, storm, shipwreck, or other causalty, or from theft, and 
if the loss involved has not been allowed for estate tax purposes in the 
estate tax return. For additional provisions pertaining to the allowance 
of casualty and theft losses, see Sec. Sec. 1.165-7 and 1.165-8, 
respectively.

For special rules relating to an election by a taxpayer to deduct 
disaster losses in the taxable year immediately preceding the taxable 
year in which the disaster occurred, see section 165(h) and Sec. 1.165-
11.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6735, 29 FR 
6493, May 19, 1964; T.D. 6996, 34 FR 835, Jan. 18, 1969; T.D. 7301, 39 
FR 963, Jan. 4, 1974; T.D. 7522, 42 FR 63411, Dec. 16, 1977]