The Tax Court took a look at what it takes to create a casualty loss in the case of Mancini v. Commissioner, T.C. Memo. 2019-16. In this case the taxpayer argues that his gambling losses were a casualty loss since a drug he had been prescribed caused him to compulsively gamble. While the court agreed he had proven the causal link between the drug and his gambling, it also found that his loss did not meet the requirements under the IRC to be a treated as a casualty loss.

The drug in question had been prescribed to Mr. Mancini to help control his Parkinson’s disease. While it did so, over time it was discovered that a significant number of patients prescribed the drug developed. As the Court described the situation:

Pramipexole is a dopamine agonist, meaning it activates dopamine receptors in the brain. That helps Parkinson's patients control their movements, but can also affect the brain's executive function in a way that distorts risk/reward assessments. Pramipexole was approved by the FDA in 1997, and by the early 2000s there were reports of users' developing impulse control disorders (ICDs), which make sufferers unable to control their behavior despite negative consequences. The most common ICDs observed among Parkinson's patients taking Pramipexole were compulsive eating (Mancini gained about 40 pounds while on the drug), shopping, or gambling; and hypersexuality. By around 2008 the correlation between Pramipexole and these ICDs was widely accepted. Today physicians prescribing the drug closely monitor patients for signs that they're developing an ICD.

Mr. Mancini did develop ICD related to the use of the drug in the Court view, relying on the testimony of the taxpayer’s expert. In Mr. Mancini’s case the result was compulsive gambling. The gambling habit caused Mr. Mancini to liquidate assets well below market value to obtain funds to gamble after exhausting his more liquid assets. By the time his wife and daughter took action and notified his doctor of his situation he had drained all of bank accounts and virtually all of his retirement funds.

On his tax returns he claimed net losses generated by the drug’s effect at nearly $3.5 million. Normally gambling losses are limited in deduction to the amount of gambling winnings.[1] If these transactions are governed by that rule then the $3.5 million of losses in excess of his winnings would not lead to a tax deduction.

But Mr. Mancini argued that his losses should fall under the personal casualty loss rule of IRC §165(c)(3) which allows a deduction for “losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.”

The IRS argued that this situation did not qualify as a casualty loss under prior case law, and the Tax Court agreed. The Court points out the IRS’s objection that there was no physical damage to Mr. Mancini’s property and the related case law that the agency cited:

A casualty loss is deductible only if the taxpayer’s property suffered physical damage, and here there was none. See, e.g., Furer v. Commissioner, 33 F.3d 58 (9th Cir. 1994), 1994 WL 417425, at *1 (“loss must be the result of physical damage to property”), aff’g without published opinion T.C. Memo. 1993-165; Citizens Bank of Weston v. Commissioner, 28 T.C. 717, 720 (1957) (physical damage of property prerequisite), aff’d, 252 F.2d 425 (4th Cir. 1958); Dubin, 35 T.C.M. (CCH) at 1122 (same).

After describing other cases that demanded physical damage to property in order to obtain the casualty loss deduction[2] the Court concluded:

In each of these cases we had to decide whether a taxpayer was entitled to a casualty-loss deduction, which necessarily meant we had to decide what the prerequisites for that deduction were. And each decision unequivocally held that physical damage to the taxpayer's property was a prerequisite of a casualty loss deduction. We'll follow suit.

The taxpayer objected that the IRS, in Publication 547, Casualties, Disasters, and Thefts, specially allowed a casualty loss in the case of a “loss on deposits [that occurs] when a bank, credit union, or other financial institution becomes insolvent or bankrupt.” Interestingly enough, while Court eventually dismisses this as not relevant since publications aren’t binding on the IRS, it did so after cautioning the IRS that the Court was tempted not to let the IRS off the hook, though it resisted that temptation:

Fortunately for the Commissioner, his own publications aren’t the law. See, e.g., Stengel v. Commissioner, T.C. Memo. 1992-570, 1992 WL 235192, at *2, aff’d without published opinion, 996 F.2d 1227 (9th Cir. 1993). We have said, however, that we’ll treat revenue rulings, which also aren’t binding precedent, as concessions, and it’s tempting to do the same with Publication 547 here. See Rauenhorst v. Commissioner, 119 T.C. 157, 171-73 (2002). But even if we did, that publication says only that taxpayers can claim as a casualty the “type of loss” that occurs when a bank becomes insolvent or goes bankrupt, see IRS Pub. 547, at 4 — it doesn’t authorize casualty-loss deductions for decreases in bank accounts generally. We’re therefore not inclined to let Publication 547 upset decades of caselaw from both our Court and the Ninth Circuit.

[1] IRC §165(d)

[2] Citizens Bank of Weston v. Commissioner, 28 T.C. 717 (1957); Pulvers v. Commissioner, 407 F.2d 838, 839 (9th Cir. 1969), aff'g 48 T.C. 245 (1967); Kamanski v. Commissioner, 477 F.2d 452 (9th Cir. 1973), aff'g T.C. Memo. 1970-352; Dubin, 35 T.C.M. (CCH) at 1120; Pang v. Commissioner, T.C. Memo. 2011-55