MURRAH, Chief Judge.
In the taxable year 1954, the taxpayer-appellants suffered certain losses due to severe drought and abnormal weather conditions. Several trees and valuable plantings on their residential grounds were killed and there was other physical damage. The losses were not compensated for by insurance, or otherwise, and they now seek to deduct them as ordinary losses under Title 26 U.S.C. § 165.
At the trial, two issues were presented to a jury: (1) whether this loss was a casualty as defined in the Internal Revenue Code, and, if so, (2) the extent of the decrease in market value of the taxpayers' property as a result thereof. It was found that the loss was a casualty, and the property had decreased in value by $10,000. The casualty loss and amount thereof having been thus established, there remained the question whether it was an ordinary loss under Section 165 or a capital loss under Section 1231. Section (a) of this latter statute provides in substance that where there is an "involuntary conversion" of capital assets into "other property or money," the losses must be offset by gains incurred during the same period. Subsection (a) (2) defines involuntary conversions as "losses upon the destruction * * * of * * * capital assets held for more than 6 months * * *." The trial court was of the opinion
Section 165, and its predecessor 23(e), have traditionally been the means for deducting uncompensated casualty losses from income where, as here, the property is non-income producing.
In order to fully comprehend the true import and taxable incidence of Section 1231, it is necessary to consider some of the legislative history and original purposes of the Section. It first became a part of the 1939 Internal Revenue Code in 1942, as Section 117(j). The avowed purpose was to allow taxpayers, whose property had been seized in furtherance of the war effort a capital gain rather than an increase in ordinary income. This is so because not infrequently the taxpayer received much more for his seized property than his depreciated cost, and it seemed unjust to tax him at wartime's exceptionally high income tax
If a taxpayer has seen fit to insure his property, he is, in due course, compensated by his insurer and the loss reduced proportionately. If, however, the casualty is uncompensated, it seems to follow that he should be allowed an ordinary deduction. This is made clear when it is seen that Section 1231 is contextually similar to the sections dealing with capital gains and losses.
The government urges that this result will read the definition of "involuntary conversion," found in Subsection (a) (2) out of the statute, but we do not think so. If the statute is construed to apply to compensated involuntary conversions, the definition is still useful in arriving at a meaning for the term. But we are convinced that the Subsection serves only a definitive function and has no intended substantive effect.
We are then left with the question of the force and effect of the Treasury Regulation, § 1.1231-1(e), when it says that involuntary conversions are to be treated under Section 1231, "whether or not there is a conversion into other property or money." This can lead to only one of two conclusions, either the Regulation is clearly inconsistent with the terms of the statute and invalid,
We therefore conclude that Section 1231 is inapplicable here, and the judgment is reversed and remanded for recomputation of the taxpayers' liability in accordance with Section 165.
"(a) General rule. — There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.
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"(c) Limitation on losses of individuals. — In the case of an individual, the deduction under subsection (a) shall be limited to —
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"(3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft * * *."
"(a) General rule. — If, during the taxable year * * * the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of * * * capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. For purposes of this subsection —
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"(2) losses upon the destruction, in whole or in part, theft or seizure, or requisition or condemnation of property used in the trade or business or capital assets held for more than 6 months shall be considered losses from a compulsory or involuntary conversion."
"* * * (e) Involuntary conversion. For purposes of Section 1231 * * * Losses upon the complete or partial destruction, theft, seizure, requisition or condemnation of property are treated as losses upon an involuntary conversion whether or not there is a conversion of the property into other property or money."