The IRS has issued additional guidance related to a problem Connecticut homeowners had with deteriorating concrete foundations due to pyrrhotite in the concrete mixture in Announcement 2020-5.[1]

The Announcement describes the problem as follows:

Pyrrhotite is a mineral that oxidizes in the presence of water and oxygen, leading to the formation of expansive mineral products. Pyrrhotite is naturally found in certain stone aggregates used to produce concrete and can cause concrete to deteriorate prematurely in certain cases.

In August 2015, agencies of the State of Connecticut began investigating numerous complaints by homeowners concerning the premature deterioration of the concrete foundations of their homes. These agencies concluded that the premature deterioration of the concrete foundations was due to the presence of pyrrhotite in the concrete mixture used to pour the foundations (deteriorating concrete foundations).

The issue involves the tax status of payments made by an insurance company formed by the state of Connecticut to homeowners who had foundation damage related to pyrrhotite. The IRS describes the program as follows:

In 2017, the State of Connecticut mandated the establishment and funding of an entity, the Connecticut Foundation Solutions Indemnity Company, Inc. (CFSIC), to assist homeowners with the expeditious repair of the most severe cases of deteriorating concrete foundations. In addition to establishing the CFSIC, the State of Connecticut authorized the CFSIC to raise funds and augment the monies bonded by the state to remedy the issue of deteriorating concrete foundations.

In January 2019, the CFSIC began accepting applications from homeowners seeking financial assistance to repair their deteriorating concrete foundations. All claims require a contract between the homeowner and a contractor for repair or replacement of the foundation. The contract must set forth the total cost of repair. The CFSIC pays the lesser of: (1) the expenses pertaining to the repair of the crumbling foundation to a structurally safe level, or (2) $175,000, per residential building. There are two types of claims that homeowners can make. The first type of claim requests that the CFSIC pay the contractor directly, on behalf of the homeowner, for eligible expenses before and during the performance of the repair work. The second type of claim requests that the CFSIC reimburse the homeowner directly for eligible expenses previously paid to the contractor. Payments under both types of claims commenced in 2019.

In Revenue Procedures 2017-60 and 2018-14 the IRS released guidance that allowed taxpayers who incurred expenses to repair these foundations to claim a casualty loss under IRC §165.

This newly released guidance looks at what happens to taxpayers who receive payments from the CFSIC. If a taxpayer had previously claimed a deduction for payments that later were reimbursed by the CFSIC, IRC §111 governs the tax treatment as described below:

If a Connecticut homeowner who paid amounts to repair damage to a personal residence with a deteriorating concrete foundation has claimed a deduction under the safe harbor or otherwise on an original or amended Federal income tax return for an earlier taxable year, then payments received by the homeowner from the CFSIC in a subsequent taxable year must be included in the homeowner’s gross income in the Federal income tax return for the subsequent taxable year to the extent the deduction claimed for the earlier taxable year resulted in a Federal income tax benefit. See section 111 of the Code. For example, if a homeowner claimed a deduction of $125,000 for such amounts in an earlier taxable year and the entire deduction resulted in a reduction in Federal income tax from the tax that would apply without the deduction, a $125,000 recovery must be included as gross income in the homeowner’s Federal income tax return for the subsequent taxable year.

However, what was not so clear is what should happen if a taxpayer who had not previously claimed a loss deduction or did not receive a benefit from claiming the deduction receives a payment (either directly or to a contractor on the taxpayer’s behalf) from the CFSIC.

If a Connecticut homeowner has not claimed a Federal income tax deduction for amounts paid to repair damage to a principal residence under the safe harbor or otherwise, or to the extent such a deduction did not result in a Federal income tax benefit, payments from the CFSIC to contractors (on behalf of the homeowner) or reimbursements paid to the homeowner will not be treated as includible in gross income of the homeowner in the year the payment or reimbursement is paid. Reimbursed repair costs cannot be deducted or included in the basis of a home.

The announcement relieves concerns that it was possible this CFSIC payment might have been viewed as an accession to wealth under IRC §61, and therefore includible in gross income. The IRS has made clear that the agency does not see this as part of gross income.

[1] Announcement 2020-5, April 22, 2020, https://www.irs.gov/pub/irs-drop/a-20-05.pdf, retrieved April 22, 2020