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heavy rains and flooding. Both parties agree that the damage to
the road from the storms would qualify as a casualty loss under
section 165. The parties also agree that the property at issue
was used in a trade or business or held for the production of
income, and therefore any loss realized would be subject to the
limitations contained in section 1.165-7(b), Income Tax Regs.
Section 165(a) allows a deduction for “any loss sustained
during the taxable year and not compensated for by insurance or
otherwise.” In the case of a casualty loss, if property used in
a trade or business or held for the production of income is
damaged, the amount of the loss taken into account for the
purposes of section 165(a) is the lesser of: (1) The amount
equal to the fair market value of the property immediately before
the casualty reduced by the fair market value immediately after
the casualty; or (2) the amount of the adjusted basis of the
property. Sec. 1.165-7(b)(1), Income Tax Regs. The reason for
this limitation is clear. Where the taxpayer suffers a loss from
a destruction of market value greater than the cost of the
property to him, that excess in value destroyed represents
unrealized appreciation, and he may not claim a deduction for
such loss because he never recognized or paid a tax on the gain.
Keefer v. Commissioner, 63 T.C. 596, 600 (1975).
There is an additional limitation on the recognition of loss
with respect to property used in a trade or business or in any
transaction entered into for profit. The loss must be determined
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