1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 FEBRUARY 24, 2015 10 11 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 12 APPEAL OF 13 LARRY G. DIGHERA 14 NO. 515547 15 AGAINST PROPOSED ASSESSMENT OF 16 ADDITIONAL INCOME TAX 17 18 19 20 21 22 23 Reported by: Kathleen Skidgel 24 CSR No. 9039 25 Juli Price Jackson 26 CSR No. 5214 27 28 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chairman 3 4 Sen. George Runner (Ret.) Vice Chairman 5 6 Fiona Ma, CPA Member 7 8 Diane L. Harkey Member 9 10 Yvette Stowers Appearing for Betty T. 11 Yee, State Controller (per Government Code 12 Section 7.9) 13 Joann Richmond 14 Chief Board Proceedings 15 Division 16 For Board of 17 Equalization Staff: Anthony Epolite Tax Counsel IV 18 19 For Franchise Tax Board: Raul Escatel Tax Counsel 20 David Gemmingen 21 Tax Counsel 22 For the Petitioner: Joseph A. Vinatieri 23 Attorney 24 Larry G. Dighera Taxpayer 25 John Bostwick 26 Representative 27 Michael Arnold Witness 28 ---oOo--- 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 FEBRUARY 24, 2015 4 ---oOo--- 5 MR. HORTON: Ms. Richmond, what is our next 6 matter? 7 MS. RICHMOND: Our next matter is item B3 8 Larry G. Dighera. 9 Please come forward. 10 MR. HORTON: Mr. Epolite, would you please 11 introduce the issues in this case. 12 MR. EPOLITE: Good morning, Chairman 13 Horton, Members. 14 The issue in this appeal is whether 15 appellant has shown that he's entitled to the 16 casualty loss deduction under Internal Revenue Code 17 Section 165. 18 MR. HORTON: Thank you. 19 Welcome to the Board of Equalization. We 20 would ask that you introduce yourself for the 21 record. Please be advised you have ten minutes to 22 make your presentation, and you will also be allowed 23 five minutes on rebuttal after the Department has 24 made their presentation. 25 Please commence at your convenience. We'd 26 ask that you introduce yourself for the record, 27 please. 28 MR. BOSTWICK: John Bostwick, CPA. 3 1 MR. HORTON: Welcome. 2 MR. ARNOLD: Michael Arnold, appraiser. 3 MR. VINATIERI: And good morning, Members 4 of the Board. I'm Joe Vinatieri on behalf of the 5 applicant or, excuse me, appellant taxpayer. 6 I know this is your second Board hearing, 7 the first one here in southern California, and I 8 want to welcome you. I look forward to working with 9 you over these next four years. 10 So this morning we have a -- it's a unique 11 case. I believe it's -- in fact, I believe it's a 12 case of first impression. It relates to the loss of 13 some prime Santa Barbara County ocean bluff land 14 into the Pacific Ocean due to bluff failure and 15 substantial diminution in value of the property 16 owned by my client. 17 I think in this case a picture's worth a 18 thousand words. So, if you would -- I'm assuming 19 you have the handouts in front of you. If you'd 20 look at the handouts we've provided you. And I'd 21 like to go through those with you. 22 Did you get yours? 23 MR. ESCATEL: No, did you provide them? 24 MR. HORTON: It's -- my apology, 25 Mr. Vinatieri, but you want to direct all your 26 questions to us, please. 27 MR. VINATIERI: I'm sorry. I'm just 28 checking to make sure the FTB has a copy. 4 1 MR. HORTON: Check with us, sir. 2 MR. VINATIERI: I'm sorry, Mr. Chairman. I 3 wanted to make sure the FTB has their copy also. 4 MR. HORTON: FTB, do you have -- 5 MR. ESCATEL: We don't have a copy. 6 MR. HORTON: Okay. Here, I'll give them 7 mine. 8 MS. HARKEY: I can give them mine. I've 9 looked at this. 10 MR. VINATIERI: There -- there should have 11 been plenty of handouts, so -- 12 MR. HORTON: All right. And I will share 13 with Ms. Harkey. 14 MR. VINATIERI: Thank you, Mr. Chairman. 15 MR. HORTON: You're welcome, sir. 16 MR. VINATIERI: So the first picture that 17 we have here, this is taken shortly after the event, 18 January 11, 2005. This is the bluff of -- my 19 client's home is back behind. And at that time 20 there were 85 feet taken; 85 feet long, 10 feet 21 back, total of 850 feet. 22 If you go to Exhibit B, there was a 23 follow-up catastrophe the following year. And this 24 shows the second catastrophe. And I just want to 25 point out to you, at the top of the bluff there 26 you'll see the gazebo on the left-hand side. 27 If you go to Exhibit C, here's the gazebo. 28 And we put in here, in the red lines, the 2004 5 1 original blufftop and then the April 2010 current 2 blufftop when this picture was taken. You can see 3 the -- how the fence is basically teetering over the 4 side. 5 And if you turn to -- and I know I'm moving 6 kind of quickly here, but we only have a couple 7 minutes and I have our appraiser here. 8 Exhibit D, Exhibit D is an aerial view 9 showing the -- where the current bluff was. That's 10 the green line. The red line is the -- that 11 original bluff that we just saw. You'll see the 12 house centered in the middle there. There's Austin 13 Road on the top. And then you can see where the 14 bluff is, where the gazebo is about ready to go over 15 the side. 16 So why is this case unique? That's what I 17 said earlier. Because the Santa Barbara County 18 specific setback requirements mandated against this 19 particular property severely limited the utility of 20 the property to any owner or purchaser of the 21 property after a bluff failure. 22 Now, why is this important? Look at 23 Exhibit E. Exhibit E is our actual -- actual 24 depiction of what those setback requirements are. 25 And I'm going to have Mr. -- Mr. Arnold go into it 26 and he'll explain to you what you see in the red. 27 So just kind of keep this to the side. 28 The problem is if an owner of the property 6 1 wanted to modify or rebuild, he or she would not be 2 able to do so because of these legal setback 3 requirements that you see here in front of you in 4 "E." 5 So let me just now move, if I can, to the 6 law, Exhibit F. And this is the Treasury Reg. 7 We've all seen it. And I've highlighted in yellow 8 the portion that's important here, down at the 9 bottom. 10 So, first of all, we have to determine 11 under "method of valuation," you'll note we must 12 determine the fair market value -- second -- of the 13 property -- third -- immediately before and -- 14 four -- immediately after the casualty. So those -- 15 that's in yellow. And then the last part, "by a 16 competent appraisal." 17 Those are the five requisites. We meet 18 those five requisites. I'm going to show you right 19 now. 20 First, fair market value is defined by this 21 Board in Property Tax Rule 2 as a price paid between 22 a willing buyer and a willing seller, neither of 23 which is taking advantage of the exigencies of the 24 other. So that's "fair market value." 25 Property. Property is defined in this 26 Board's Assessors' Handbook 502 which is the 27 appraisal unit that people normally buy and sell in 28 the marketplace. And in 502, specifically, for 7 1 single family homes like this one, it's the 2 combination of the land and the improvements which 3 is the typical unit of sale. 4 So the property here is more than just the 5 850 square feet that fell in the ocean. It's the 6 whole unit; the land and the property together. 7 Third, immediately after the casualty -- in 8 other words, we have to provide the fair market 9 value of the property just before the December 28, 10 2004 date. That's our magic date here. 11 And then fourth, immediately after the 12 casualty, the catastrophe, what's the numeric value 13 as a result of that catastrophe? 14 Fifth, how does the taxpayer show that fair 15 market value? By a competent appraisal. 16 So we've met these requirements. But with 17 respect to that last requirement, let me invite you 18 to meet now Michael Neal Arnold. He's a 19 well-regarded Santa Barbara County independent 20 appraiser. He is certified with the State of 21 California. And he's a member of the Appraisal 22 Institute. That's the -- the institute for those 23 who are -- are most knowledgeable in the appraisal 24 field. 25 And he's going to go through his appraisal, 26 letter appraisal of May 5th, 2009, which is marked 27 as Exhibit G in your packet. And then also Exhibit 28 H which is he's boiled it down, his appraisal down 8 1 into Exhibit H with some bullet points. 2 So, with that, meet Mr. Arnold. 3 MR. ARNOLD: Thank you. Good morning. 4 Barely morning. 5 So as Joe just said, I, rather than -- than 6 going through the entire letter, what I've done is 7 highlighted areas. Obviously I'm happy to answer 8 any questions you may have about these items or 9 things that are in the letter document. 10 What -- what I have on the outline, which 11 is your document H, are some bullet points about 12 value before, value after. A second page is just a 13 summary of the calculations that I made. Again, 14 these are the same calculations that are in that 15 letter report. 16 So in looking at the market value before 17 the damages that were sustained on the 28th of 18 December, I considered a number of things. I think 19 reference had been made, prior, to the Greg Wood 20 appraisal that was done in August of 2004, a few 21 months before the event. In that appraisal he 22 opined that the market value of the property was 23 3,148,000. And he, at that point, allowed remaining 24 work to be done equivalent to $360,000. 25 I looked at the report, confirmed the 26 comparable sales he used, considered the adjustments 27 that he made and felt that he had completed a 28 reasonable analysis of market value as of August. 9 1 Based on market activity, I allowed appreciation of 2 approximately one percent a month for the time 3 between August and December, the two dates. 4 The second thing that I've done, which was 5 not included in the report, it's sort of a test. 6 It's not -- it's not a full cost approach, but kind 7 of a test of value which is the third page, H-3 on 8 the lower right-hand side. The cost approach is one 9 of the standard approaches to value in real estate 10 appraisal. It's based on the economic principles or 11 factors of production which include land, labor and 12 materials, and enterprise or entrepreneurship. 13 So I used the site acquisition of a million 14 150, a replacement cost on the structure of $500 per 15 square foot, which is reflective of a high-end 16 quality home as of the date of value. The site 17 improvements are $250,000, which was an estimate 18 provided as of the date of value for remaining site 19 work to be done. 20 So the total replacement cost equated to 21 $2,910,500. To that I made an allowance for 22 entrepreneurial profit or reward to the entrepreneur 23 for doing the project of 15 percent, which results 24 in an indication of $3,347,000. 25 Generally, the cost approach is considered 26 to be the most conservative of the valuation 27 techniques. 28 The third thing that I did -- and this was 10 1 referenced in the letter -- was consider market 2 activity that occurred around the date of sale. H-4 3 on the handout is a summary of properties that sold 4 in 2004 and 2005. The -- the factor that determined 5 whether or not they were included in this survey is 6 whether or not they had a beach or ocean influence. 7 The columns indicate the location of the 8 property, description. About half of them were 9 condominiums. Site area, improvement area. The 10 situation, whether they were actually on the beach 11 or a blufftop. Sale date and sale price. 12 I would point out to you three sales in 13 particular. Number two is adjacent to the west of 14 the subject property. It sold in May of 2005, so 15 five to six months after the date of sale. It was 16 advertised by the realtor as being a -- they didn't 17 call it a tear-down. They say, "Live in the 18 existing house while you design your dream home." 19 The property, when it sold, the home was 20 raised and they replaced it with a new 21 4,000-square-foot home that was completed in 2009. 22 MR. VINATIERI: I'm sorry, Mr. Arnold. If 23 we look at Exhibit D, there's a home to the lower 24 left-hand side in that aerial overview. Is that the 25 home that you just referred to? 26 MR. ARNOLD: That's the one that was 27 removed, yes. 28 The other two data, 5 and 7, are of 11 1 particular interest, I'd say, because they're 2 situated in locations between the City of Santa 3 Barbara and the subject property which don't enjoy 4 the influence of being one of the prestige 5 neighborhoods. Generally Montecito and Hope Ranch 6 are in that category in the Santa Barbara area. So 7 I considered that market data. 8 And finally, based on my professional 9 experience in the -- in the valuation of properties 10 in Santa Barbara for 40 years or more, I formed the 11 opinion that the market value of the subject 12 property, if it were complete as of the 28th of 13 December, was $3,650,000. From that I subtracted 14 the estimate of $250,000 to complete the unfinished 15 work on the site. So an "as is" value of 3,400,000. 16 So the next consideration was market value 17 after. As reference was made, there's the actual 18 loss of site area to consider, but there's also the 19 impacts of that loss on the total property to be 20 considered. 21 In a sense that the lost site area is the 22 simple part, we had a site that technically was 23 comfortably over an acre, but there was 24 approximately 20,000 square feet of usable area on 25 top of the bluff. And the 850 square feet that were 26 lost is approximately 4.25 percent of that site 27 area. So I used an estimated value for the site of 28 a million three, applied 4.25 percent to that, 12 1 and -- and got the indication of $55,250. 2 The other issues -- excuse me for going 3 fast, but I'm really worried about the time here. 4 The other issues are both utility issues. The first 5 utility issue -- and I refer you back to that "E," 6 the site plan that was referenced earlier. 7 So this is a site plan that shows the 8 location of the bluff before the event and the 9 location, the dark in the center, "proposed 10 residence" was the proposed residence. 11 You'll notice that there are dash lines 12 across the top of the residence, the bottom of the 13 residence and each side of the residence. The dash 14 line across the top is the setback from the center 15 line of Austin Road; it's 50 feet required setback 16 from the center line. You can see the house was 17 built right on that setback. 18 The right and left sides, or west and east, 19 are the side yard setbacks set by the CC&R's of the 20 local home owners association. I've highlighted 21 them in red. Again, the structure was built right 22 to those boundaries. 23 The other dash line, by the way, are the 24 county-required setbacks of 10 feet; but they're 25 superceded by the CC&R's. 26 Finally, the lower or southerly dash line 27 is the setback established by the county, the 28 required setback to allow for a 50-year period 13 1 between the date of construction and the time when 2 the bluff erosion hit the structure. They estimated 3 for this area a bluff erosion of 18 inches a year. 4 So 50 years equates to 75 feet. Generally in the 5 Santa Barbara area, it's between one and two feet 6 for most areas. 7 So the building envelope is essentially 8 determined by those red lines. 9 Now, as you can see, I drew on there -- and 10 that's an approximate -- but at the bottom, a 11 10-foot pushback from the bluff. And then I did a 12 similar 10-foot pushback into the residence so that 13 on -- it renders the existing residence being not 14 conforming to setbacks after the event on the 28th 15 of December. 16 As reference was made, there was a 17 subsequent event that essentially eliminated the 18 building envelope, but that's not really the -- the 19 point of this discussion today. 20 So according to an official of the county 21 planning department, Brian Banks, if the structure 22 were to burn down after this event, it could not be 23 rebuilt the way it is. It would have to be within 24 the new setbacks. 25 Now you can see it's already a long narrow 26 structure, and it would be even more so. The -- the 27 total distance from the top to the bottom setbacks 28 originally were just over 30 feet. Now they're just 14 1 over 20 feet. So you're talking about an extremely 2 narrow long residence is all that could be built on 3 the site if the improvements were lost. 4 MS. RICHMOND: Time's expired. 5 MR. VINATIERI: Mr. Chairman, I'd request 6 that we allow Mr. Arnold to finish up his testimony. 7 I think, in looking at it here, he's probably got 8 about two minutes. 9 Would that be correct? 10 MR. ARNOLD: Yes. 11 MR. HORTON: Please continue. 12 MR. VINATIERI: Thank you. 13 MR. ARNOLD: The other issue involving 14 utility is a -- is really part of the -- a 15 definition for market value. All definitions of 16 market value, either stated or by implication, 17 include the concept that current value, the value 18 today, is the present worth or the present value of 19 the benefits that the buyer or owner anticipates 20 receiving over that ownership period. 21 In income-producing properties, those 22 benefits are often calculated based on rental income 23 or net income to the property. 24 In residential properties, it's not often 25 considered as income, but rather the right to use 26 and enjoy the property. 27 And it's difficult usually in a residential 28 property to know what the life of that ownership 15 1 would be if you bought the property with the 2 intention of living in it until it didn't exist 3 anymore. 4 This is a somewhat of a unique situation 5 because -- because -- because of the county 6 requirements, anybody buying this house on the date 7 of value would have known that they could expect a 8 50-year life. And as I discussed in the report -- I 9 think it's pages 3 through 5 -- after the event, 10 that'd have been reduced to an approximately 35-year 11 life. So as of the date of value, after the event, 12 the anticipated future benefits have been reduced by 13 approximately 30 percent. 14 The last thing that I would do is just 15 refer you to the second page, which just summarizes 16 the calculations. And the numbers in parentheses 17 are the page numbers in the letter report that you 18 have that have the same numbers. 19 But very briefly, market value before, we 20 discussed, 3 million 4. Subtract the aerial -- 21 the -- the amount for the area actually lost results 22 in a subtotal of 3,344,000. I use 7-and-a-half 23 percent as a reflection of -- of diminished value as 24 a result of the shrunken building envelope and 25 issues associated with that around marketing and 26 financing the property. 27 The loss benefits, I used the 30 percent 28 that I just made reference to, so that we have 16 1 3 million 344, less the amount for the shrunken 2 building envelope, less the benefits associated with 3 the shortened life span of the property, resulting 4 in a value after of 2,090,000. Excuse my rounding. 5 Then the final calculation, the value 6 before, 3.4 million. Subtracting the market value 7 after of 2,090,000, results in approximately 8 $1,300,000. 9 Thank you. 10 MR. HORTON: Thank you very much. 11 We'll now go to the Department. The 12 Department has 12 minutes to make their 13 presentation. We would ask that you commence with 14 your introduction for the record. 15 Then we will go -- return to the appellant 16 and allow them five minutes on rebuttal. 17 MR. ESCATEL: Good morning, Board Members. 18 My name is Raul Escatel representing respondent 19 Franchise Tax Board, along with my co-counsel David 20 Gemmingen. 21 At the outset, there's no dispute here that 22 Mr. Dighera's property suffered a casualty loss in 23 the storms of 2004. That is not in dispute. 24 The issue here is whether Mr. Dighera's 25 entitled to a casualty loss in $1.3 million for the 26 entire property, including the -- the -- the alleged 27 drop in fair market value; or whether, under Section 28 165(c), he's only entitled to actual physical damage 17 1 done to his property, which here we know is 4.25 2 percent of the property or $55,250. 3 A couple of concepts will help explain this 4 distinction. 5 As a general proposition, we look at the 6 concept of realization. Realization is, at the 7 time, for tax purposes, we determine what the actual 8 value of gains or losses are. A realization event 9 is -- could be some kind of disposition of property 10 whether it be a sale; it could be a condemnation; it 11 could be an abandonment. But it is at that time 12 where gains and losses are realized for tax 13 purposes. 14 An exception to this is found in the 15 casualty loss rules in 165(c)(3) which basically 16 allows a taxpayer to claim a loss based on certain 17 enumerated events. 165(c) basically says -- 18 provides a casualty loss for instances arising out 19 of a sudden, unexpected or unusual cause, including 20 those that arise from fire, storms, shipwreck or 21 theft. 22 Here, we know that the casualty was based 23 on the erosion to the bluff based on the 2004 24 storms. 25 It's important to understand this concept 26 of realization because what -- FTB is not disputing 27 the -- the appraisal. In fact, we use Mr. Arnold's 28 appraisal in terms of computing how much loss 18 1 Mr. Dighera was entitled to. 2 I -- Mr. Vinatieri's absolutely correct 3 that the method for valuing a casualty loss is found 4 in the regulations that he put before you. And it's 5 important that I read this because it says -- 6 MR. GEMMINGEN: Say where it is. 7 MR. ESCATEL: It's in the -- 8 MR. GEMMINGEN: Exhibit F. 9 MR. ESCATEL: Exhibit F from Mr. Vinatieri. 10 "The appraisal must recognize the 11 effects of any general market decline 12 affecting undamaged as well as damaged 13 property which may occur simultaneously 14 with the casualty, in order that any 15 deduction under this section shall be" -- 16 and this is important -- "limited to the 17 actual loss resulting from damage to the 18 property." 19 MR. GEMMINGEN: Pardon me, Board Members. 20 That is found at the upper right corner, just below 21 the yellow highlighted line of the regulation that 22 appellants passed out. 23 MR. ESCATEL: I apologize. 24 And this is important because in 25 Mr. Arnold's appraisal -- Mr. Arnold's appraisal did 26 exactly that. 27 On page 5 of his appraisal dated May 5th, 28 2009 it says: 19 1 "Considering the above discussions, the 2 following calculations were made." 3 And he says, I quote, impact of site loss, 4 $55,250. Impact to the remaining property is one 5 point two five four million -- 1,254,281. 6 It's important that we have this 7 information because that actually breaks out, as the 8 regulation requires, the actual damage to the 9 undamaged property as well. And that is the -- that 10 is a deduction -- the actual physical loss, the 11 impact of the site loss in Mr. Arnold's report in 12 the amount of $55,250 is what FTB granted as a 13 casualty loss to Mr. Dighera. 14 The reason why we have to wait -- so in 15 this case, we're not saying that Mr. Dighera might 16 not be entitled to additional losses from this 17 property. However, what we are saying, and what the 18 law is clear about, is that now is not the time. In 19 2004 was not the time to actually realize those 20 losses because there was no realization event. 21 Yeah, there was no disposition of the property. 22 A good example would be holding stock. 23 Stock, the government is not in the business of 24 taxing fluctuations in value of investment -- 25 investments. We don't look at whether Apple had a 26 bad quarter in terms of determining whether at the 27 end of that year the person who held the stock is 28 entitled to a loss or if the stock appreciated 20 1 significantly, that they -- we should be taxing 2 them. 3 And the reason why we don't do this is 4 because in the -- in the -- in the example of -- 5 let's say a taxpayer has property that appreciates 6 significantly, at the end of that year the taxpayer 7 might not have the money to actually pay that 8 appreciation in the property. 9 It's a -- it's a concept of fairness that 10 we wait until the realization event in order to 11 actually determine whether or not there was a loss 12 or a gain on the disposition of that property, the 13 realization event. That closes that transaction, 14 and it's at that point that we can determine whether 15 or not the taxpayer here, Mr. Dighera, is entitled 16 to a gain or a loss. It is at that time and not 17 before, that that determination is made. 18 And this case is a great example of this. 19 This property fluctuated, as I provided your Board 20 recently, I discovered that Mr. Dighera turned to a 21 reverse mortgage. The valuation of that property 22 was -- is $4.1 million. Would it be fair to tax 23 Mr. Dighera on $4.1 million based on the 24 appreciation to that property? No, we wait until a 25 realization event in order to determine any gains or 26 losses. And it's at that point that we make that 27 determination. 28 So that concludes my presentation unless -- 21 1 and I'll take any questions from the Board. 2 MR. HORTON: On rebuttal, please. 3 MR. VINATIERI: Yes, a couple things. 4 First of all, Mr. Chairman, we strenuously object to 5 the characterization of a reverse mortgage procured 6 in October or November of 2014 and its relevance to 7 December 2004. 8 And I've lodged with the Board this morning 9 an objection that I sent in last night. And I'd 10 like to have it marked as Exhibit I. I don't know 11 whether the Board has it in front of -- 12 MR. HORTON: So be it. 13 MR. VINATIERI: Should have it in front of 14 you. So we'll make that "I" if we could. 15 And I'd just point out to you your own 16 Rules of Procedure 5523.6 talks about presentation 17 of evidence or exhibits. And it's very clear that 18 evidence has to be relevant, has to be relevant. So 19 we got 10 years difference, number one. 20 Number two, the letter that came in from 21 Mr. Escatel basically says, in so many words, well, 22 in order to get a reverse mortgage, you must have 23 had an appraisal. And, therefore, the appraisal, 24 which we don't see, but the appraisal must say X 25 number of dollars because otherwise they wouldn't 26 have given you a loan, a reverse mortgage of this 27 kind, amount, and therefore that somehow relates to 28 the value 10 years before. 22 1 And -- and Section 5523.6(a) talks about 2 admissible evidence, makes it very clear the Board 3 may refuse to allow the presentation of evidence 4 that it considers irrelevant, untrustworthy or 5 unduly repetitious. 6 So we would like to have marked as "I," my 7 letter which was submitted to the Board. And I'd 8 like to have the -- as I indicated in that letter, 9 I'd like to have any reference to a reverse mortgage 10 in 2014, I'd like to have that stricken from -- from 11 Mr. Escatel's letter. 12 Secondly -- 13 MR. HORTON: We will not strike it, but 14 we'll -- the Board Members will take it under 15 consideration relative to the testimony that you 16 provided. 17 MR. VINATIERI: Thank you. 18 MR. HORTON: It's on the record. 19 MR. VINATIERI: Secondly, I want to provide 20 a -- a further exhibit or rebuttal exhibit. I think 21 it's very important. And this was not given out in 22 advance, but I'd like to do it now in light of some 23 of the discussion that was just given. And this is 24 a -- I'd like to have this marked as applicant's or 25 appellant's "J," please. 26 And what this is is this is from the Santa 27 Barbara County Assessment Appeals Board. This 28 relates to 2009. So it's a couple years after the 23 1 fact. So I'm not doing it for purposes of the value 2 here. But I'm doing it for purposes of showing the 3 Board that the Santa Barbara County Assessor's 4 Office themselves looked at this property for 5 purposes of decline in value. 6 And I will just point out to you on page -- 7 it says: "Stipulation Before the Board of 8 Equalization, the County of Santa Barbara, State of 9 California." It has Mr. Dighera's name. It has 10 Mr. Bostwick, who's in front of you, his name. And 11 this is relative to parcel number 065310023. 12 Remember here, there's two parcels, 023 and 025. 13 That's the economic unit, the land and the home. 14 You will note, if you go down into the 15 statement of facts, I've highlighted: 16 "The subject property is found to have 17 a shortened expected economic life due to 18 continuing erosion." 19 That mirrors what my appraiser just said. 20 "The Assessor's office conducted a 21 review of the comparable market data for 22 sales of similar ocean bluff properties to 23 determine the fair market value of the 24 subject property, assuming no adverse site 25 conditions." 26 Well, this has a huge site condition. It 27 has 850 feet that's now gone. This property was 28 then discounted based on the expected remaining 24 1 life, economic life of the property due to erosion. 2 So what -- why is this important? Because 3 this -- this essentially backstops what Mr. Arnold 4 did by the assessor of the county himself, ending up 5 with a refund because it was over-assessed. 6 So I wanted to make sure that the Board had 7 this and was aware of the fact that there's other 8 people other than just -- than just Mr. Arnold who 9 looked at this as an issue. 10 Now, what I'd like to do with respect to 11 Mr. Escatel and his argument about realization, let 12 me just point out to you again, let's go to Exhibit 13 F, the yellow highlighted. 14 He went ahead and talked about the -- the 15 section right under the highlighted portion where it 16 talks about: 17 "This appraisal must recognize the 18 effects of any general market decline..." 19 Any general market decline. 20 So there's no general market decline here. 21 General market decline is the whole area, such as in 22 the Finkbohner case and the Kamanski case; where in 23 Finkbohner you had the -- the -- the creek 24 overflowed, as we know. And in that case the 25 circuit court allowed economic damages. 26 In the Kamanski case there was an earth 27 slide that really just cracked, the taxpayers in 28 that case, a little bit of their -- their foun- -- 25 1 not their foundation, but their -- their driveway. 2 And in that case the Ninth Circuit said, well, 3 that's not enough. And they talked about what we 4 call the -- what -- the mere fluctuation in value, 5 temporary impairment. They talked about buyer 6 resistance. 7 Well, that's true with respect to all 8 properties in the area, because that's what happened 9 to all the properties. 10 What happened here was specific to 11 Mr. Dighera's property. And in that sense, 12 Finkbohner goes -- would agree with our position. 13 Kamanski disagrees with our position. But it 14 doesn't really matter because in both those cases 15 the properties were only minimally impacted. 16 In this case, this property was majorly 17 impacted for the very reason that we see here in our 18 exhibit on the setback requirements. 19 So to say that somehow in F, in the IRS 20 reg., that there's effects of any general market 21 decline, there's no general market decline. It's 22 this property. It's specific decline to this 23 property. 24 And then it says: 25 "...affecting undamaged as well as 26 damaged property..." 27 Well, I'll just point out to you that -- 28 that the argument, I believe, is that, well, the 26 1 rest of the property wasn't damaged. And I will -- 2 I'll just let you know that with respect to the -- 3 I'm trying to pull it out here. With respect to 4 the -- the -- the actual case of -- of Kamanski, the 5 statement was made -- it says here -- and this is a 6 case that is the Ninth Circuit. It says: 7 "Minor physical damage by way of cracks 8 in walls and pavements." 9 And so the tax court found the loss 10 sustained was nondeductible personal loss. And, of 11 course, originally there was a personal loss issue 12 here. There's not anymore. That's gone. And I 13 appreciate the FTB dealing with that. 14 And it says, too, was not due to physical 15 damage caused by the slide but by, too, buyer 16 resistance. 17 Well, here there is actual physical damage 18 to the property. Buyer resistance for a generalized 19 situation, we're not talking about a generalized. 20 We're talking about here. 21 And it says here that casualty losses -- 22 this is third requirement of Kamanski, the FTB's own 23 cited case -- the casualty loss is limited to damage 24 directly caused by the casualty. Directly caused by 25 the casualty. 26 And I think there's a narrow view on the 27 part of the FTB that only it's the 850 square feet 28 that went into the ocean. Well, I'm going to say to 27 1 you, based upon the exhibit that we just showed you 2 on the setback requirements, 850 feet, yeah, that's 3 direct. But what else is direct? They can't 4 rebuild this property. In fact, if they were to try 5 to rebuild it, they'd have to rebuild it in the 6 middle of the setback requirement where that 7 residence is right now, as Mr. Arnold just told you. 8 So -- so the Kamanski case itself said the 9 casualty loss is limited to damage directly caused 10 by the -- the casualty. I mean, I don't know what 11 more direct can be relative to this situation than 12 Santa Barbara County saying, "You can't rebuild." 13 In fact, I'll make this representation to 14 the Board, after the second casualty a year later, 15 they can't rebuild if this thing -- at all if this 16 thing -- if this house burns down. Right now you 17 might be able to rebuild it. I think Mr. Arnold 18 said it's 30 feet. Now it's 20 feet, with this 19 casualty. Now the subsequent, you can't rebuild it 20 at all. 21 So, I mean, I think it's really important 22 to understand, going back to the reg., what the reg. 23 says. And -- and it's real clear. The reg. says 24 that you have to have fair market value immediately 25 before, immediately after. You have to have it done 26 by a competent appraisal or appraiser. Mr. 27 Arnold is one of the best in Santa Barbara County. 28 And I'll -- I'll -- I'll wind up my 28 1 argument, and I'm going to be very quick about this. 2 And that is, the fact that we have a burden of 3 proof, we have a burden of producing evidence. They 4 are determined to be correct in what they've done. 5 We have this in -- in income tax cases. We have it 6 in property tax cases. And, unfortunately, the 7 rules for tax appeals don't go far enough into this. 8 And some of us were involved in writing these a 9 couple years ago, and maybe they need to be looked 10 at again. 11 MR. RUNNER: Mm-hmm. 12 MR. VINATIERI: But if you go to the 13 property tax rules, it's real clear in the -- in the 14 Board's own Assessment Appeals Manual that you give 15 to the Assessment Appeals Board up and down the 16 State of California, that I use when I'm in front of 17 Santa Barbara County Assess- -- Assessment Appeals 18 Board or LA County or Orange County or San Francisco 19 County or Sacramento County, it doesn't matter, we 20 all have the same rules and the same manual. And it 21 says very clearly that we have the burden of 22 producing evidence to overcome the official 23 presumption that the FTB, in this case, has done it 24 properly, has done it correctly. 25 But once we produce that evidence and we 26 meet that production, then it's incumbent upon the 27 assessor, or the FTB in this case, to produce their 28 own evidence of what that market value should be. 29 1 And one of the things that's bothered me 2 from the get-go on this is they've always agreed 3 with our $55,250 that Mr. Arnold came up with. But 4 when it came to the rest, of course not. 5 And I look at -- I look at all the tax 6 court cases, and most all of them on casualty loss 7 IRS normally has an appraiser, taxpayer normally has 8 an appraiser, and then it goes in front of the tax 9 court or goes in front of whomever, and then they 10 make a decision as to, well, who's right and what's 11 the value, etcetera. Kind of like what we do in 12 property tax when we do these cases in property tax. 13 We have nothing of the sort here. So I -- 14 I'm just going to make the argument to you, Members 15 of the Board, that -- that with respect to our rules 16 for tax appeals, under Rule 5540, 5541, burden of 17 proof, where it basically indicates that we have the 18 burden of proof as to all issues of fact, that we've 19 met that burden. They've done nothing to controvert 20 our testimony, our competent evidence. And that, as 21 a matter of law, this Board should hold in favor of 22 our position, in favor of Mr. Dighera and our 23 appraisal in this situation. 24 Thank you. 25 MR. HORTON: Thank you. 26 Discussion, Members? 27 Member Runner. 28 MR. RUNNER: Let me just -- I want to -- I 30 1 want to try to understand at least the 2 appropriateness of what FTB is saying in terms of 3 the casualty loss that they believe is valid versus 4 the amount that they believe is not valid. 5 So if I'm understanding correctly, in terms 6 of the appropriateness of what it is that the 7 taxpayer would do, it would be appropriate to use 8 that square footage loss as a casualty loss in that 9 particular tax year? 10 MR. ESCATEL: Yes. 11 MR. RUNNER: Okay. So the square footage 12 loss is an appropriate casualty loss. 13 MR. ESCATEL: That's the actual physical 14 damage to the property, correct. 15 MR. RUNNER: Okay. The physical damage to 16 the property. 17 And then you argued a bit that the -- the 18 other economic loss that could result as a part of 19 that physical property loss is not calculated. 20 That's calculated and set when the house is sold or 21 something; is that what you're telling -- is that 22 what your testimony is? 23 MR. ESCATEL: That's a -- a great question. 24 So basically what I said earlier was there 25 is a loss. We're not -- we don't dispute that. 26 MR. RUNNER: Right. 27 MR. ESCATEL: But the thing is that -- and 28 as we -- as I said earlier, there -- the values will 31 1 fluctuate. 2 Mr. Vinatieri said that the reverse 3 mortgage has no bearing on something that happened 4 10 years ago, but it actually has direct bearing 5 because it shows that property can fluctuate in 6 value. 7 So to determine the -- the proper time to 8 determine the amount of loss -- 9 MR. RUNNER: But is that the point of what 10 we're discussing? 11 MR. ESCATEL: -- or gain -- 12 MR. RUNNER: Is the key to this issue 13 fluctuating -- 14 MR. ESCATEL: No. 15 MR. RUNNER: -- market value? 16 MR. ESCATEL: The key to this discussion is 17 that the proper time to recognize a loss or a gain 18 is at the time of a realization event. 19 MR. RUNNER: But that's on the -- 20 MR. ESCATEL: For example, a sale. 21 MR. RUNNER: But that's -- again, that's 22 judging -- that's going back to market value now 23 instead of loss, casualty loss, right? Because 24 you -- I mean you basically have dismissed the fact 25 that casualty loss should not include the ability to 26 use that property the way it was originally 27 configured or allowed to be used. 28 MR. ESCATEL: I see what you're saying. 32 1 MR. RUNNER: So what you're saying is 2 basically -- but potentially the buyer -- I mean, it 3 seems to me, if you use market though, the problem 4 that you have with that -- that theory is that their 5 market value may be a whole lot more if indeed that 6 property -- if that -- if that -- if that loss was 7 not experienced. 8 I mean their -- their market value that 9 they have today -- you know, you throw out the 10 number $4 million -- might be an already discounted 11 amount because of the casualty loss. 12 MR. ESCATEL: That -- that's possible. 13 MR. RUNNER: Well, then -- well, then -- 14 then it's -- then it seems to me that the -- that 15 the taxpayer has indeed had a loss that you're not 16 recognizing. You're just hoping that the market 17 makes up for it. 18 MR. ESCATEL: No. Under the -- under the 19 law -- under the case law, the loss directly 20 attributable to a casualty loss as defined under 21 165(c)(3) is the actual physical damage, and also 22 the case law. Any other losses in excess of 23 that are not covered. 24 MR. RUNNER: Of course we're having a bit 25 of a different argument from -- from -- from the 26 taxpayer and taxpayer representative, correct? 27 MR. ESCATEL: That's -- yes. 28 MR. RUNNER: Okay. 33 1 MR. ESCATEL: We differ -- we differ on 2 this. 3 MR. RUNNER: Okay, okay. 4 MR. ESCATEL: Because this is a legal 5 issue. 6 MR. RUNNER: That's right. I got two 7 lawyers who disagree in regards to that issue, 8 right? 9 MR. ESCATEL: Go figure. 10 MR. RUNNER: Okay. 11 MR. ESCATEL: So what we're -- what FTB 12 contends is that the proper amount under the law for 13 determining a casualty loss is what Mr. Arnold's 14 appraisal clearly stated is the actual physical 15 damage which was 4.25 percent of the property. 16 MR. RUNNER: Yeah, right. The factual 17 square footage of the property. 18 MR. ESCATEL: Any losses -- right. Any 19 losses on top of that, those losses will have to 20 wait in order for some event to happen to determine 21 whether or not -- 22 MR. RUNNER: Okay, I hear you. But my 23 problem with that argument is they -- the event that 24 takes place is the sale, will also already factor in 25 the casualty loss, the value -- what -- as a 26 result -- the value of the property based on the 27 casualty loss. 28 MR. ESCATEL: I understand. 34 1 MR. RUNNER: And so under your theory, 2 they -- under -- it seems to me under your theory 3 the taxpayer may -- might not ever -- may not ever 4 realize the casualty loss in regards to the use of 5 the property. 6 Let me go back to the taxpayer, taxpayer 7 representative real quick. Again, walk through why 8 it is you would believe the FTB's language 9 interpreting loss is too narrow and what would be 10 the -- the legal basis for expanding it to the issue 11 of the use of the property. 12 MR. VINATIERI: Well, I -- I actually think 13 you hit it on the head, Mr. Runner. The question 14 is -- and that's why I keep going back to Exhibit 15 F -- what does the regulation say? It doesn't say 16 anything about realization. It doesn't say anything 17 about a subsequent sale. It doesn't say anything 18 about that at all. 19 The very thing that you've just 20 articulated, which comes straight out of here, was 21 actually discussed in the Finkbohner case. And that 22 was one of the reasons why, in the Finkbohner case, 23 the Court said there's a very good chance that if 24 you don't do it now, down the road you're never 25 going to actually realize what that loss is. 26 MR. RUNNER: Right. 27 MR. VINATIERI: And I mean -- and that was 28 a difference -- that's the difference between the 35 1 Finkbohner case, which was in 1986, versus the 2 Kamanski case, which was in 1973. 3 So -- so that was the point, and that is 4 the point here. And that's why I keep coming back 5 to this business of realization. There's no 6 temporary impairment, there's no buyer resistance, 7 all a temporary nature. This is permanent. 8 MR. RUNNER: Mm-hmm. 9 MR. VINATIERI: And that's the point. And 10 I think that's exactly what the regulation says. I 11 don't see anything in here, in this reg. -- and we 12 all agree that this is what we got to follow -- says 13 nothing about, well, in order to really know what 14 that loss is, you got to have the catastrophe and 15 then you got to sell the property so that you really 16 know what your loss is. It doesn't say that. In 17 fact -- 18 MR. RUNNER: Well, I guess -- let me go 19 back to this issue in regards to that. Because what 20 would be happening, as my understanding, is the 21 taxpayer would never be able to realize their 22 loss. 23 MR. VINATIERI: If Mr. Dighera, in this 24 case, is not able to sell this property and dies in 25 this property or is of an age that he passes away 26 and he's still -- this is still his home, you're 27 absolutely correct. And you know what, that could 28 happen here because of the nature of what we've got 36 1 of the nature of the permanent impairment. 2 So you're -- you're -- you're spot-on, 3 Mr. Runner. 4 MR. RUNNER: Thank you. 5 MR. HORTON: Member Harkey. 6 MS. HARKEY: Thank you. Having been a 7 blufftop resident, I understand about the general 8 effects of a slide. And I also understand about the 9 direct effects of a slide from a practical 10 standpoint rather than a legal standpoint. 11 And this -- I Googled earth when I got this 12 case and I looked at it and I actually -- I mean, 13 you can see, quite clearly, what was taken away and 14 you can see -- I was trying to figure out if it was 15 one lot or two and I actually found out it was two 16 lots. 17 And so my big question was with regard to 18 what could possibly be built there? Did you have an 19 envelope? 20 I think that you've set that out in Exhibit 21 E, but I've also heard that -- while it may not 22 pertain to this case, that subsequent to Exhibit E, 23 that probably nothing could be built there at the 24 moment. So we're kind of stuck with what we've got 25 as far as a residence. 26 I also heard that in 2014 -- and I know 27 this is not supposed to be part of the record, or 28 maybe we're supposed to ignore it or use it -- but 37 1 that the appraisal was $4 million? Well, that would 2 indicate to me, being a layman and not an attorney, 3 that if we had a 2004 appraised value, I believe we 4 had at 3.4, and between 2004 and 2014 we're only at 5 4 million, we've had a huge loss here. 6 So not legalistic and not going by the 7 code -- although I do appreciate this -- I'm just 8 looking at this from a -- a permanent loss. And it 9 would seem to me we do have a permanent loss. 10 And so can you refute that? This is to the 11 Department. 12 MR. ESCATEL: Ms. Harkey, the law is very 13 clear as to -- for casualty loss purposes. And 14 that's one thing we should be very clear about, 15 casualty losses under the code as opposed to losses. 16 Like I said earlier, we don't dispute that 17 there -- there could have been additional impairment 18 and losses to the property. What we're saying is 19 under 165(c)(3) for a casualty loss deduction, we 20 properly -- the law is very clear that Mr. Dighera 21 is only entitled to a loss to the extent of actual 22 physical damage to the property as laid out in 23 Mr. Arnold's appraisal. And that is what we gave 24 him. 25 And I understand that it seems like a 26 little because of -- but the -- the problem is 27 that -- and that's why we wait for an event like a 28 realization event, a selling of the property, to 38 1 determine how much. 2 And, in fact, Mr. Dighera's own declaration 3 he said he bought this property to flip it. I mean 4 that realization event was -- and he tried to sell 5 the property over the years. There was many 6 listings where he tried to sell the property for -- 7 actually for 4 -- over $4 million. 8 And that is so -- I think we need to like 9 separate those two things. A loss for casualty loss 10 purposes is the actual physical damage, which we 11 granted. How that damage affects the remainder of 12 the property, under the law, is not allowed. Those 13 losses must have to wait until some kind of event 14 happens to release some. Or there could be gains. 15 But for purposes of 160 -- and this is just for 16 purposes of 165(c)(3), it's the actual physical 17 damage. 18 MR. GEMMINGEN: I think, if I may also 19 add -- this is David Gemmingen -- to your example. 20 Losses are based upon basis. And the 21 casualty loss rules limit the amount of loss to the 22 amount of the basis which is the cost of the land. 23 And so you have to look at what the taxpayer's cost 24 of land is. And if the taxpayer, say, inherited 25 this land at a zero basis, the fact that there may 26 have been fluctuations in value, the taxpayer would 27 still not be -- not be allowed to take a loss at all 28 because loss is limited to basis. 39 1 And the reason why basis is the -- is the 2 required amount is it looks to that realization 3 event to determine whether if there's -- after a 4 sale, at one point you're measuring gain or loss by 5 the amount that the property was sold for versus the 6 basis. 7 And so looking here at -- at an initial 8 appraisal given -- with the amounts of like $500 a 9 square foot in the appraisal as opposed to the 10 actual cost the taxpayer has expended, you're 11 looking at a measure that is not the correct 12 starting point for the loss. 13 MS. HARKEY: Well, I -- I -- I'm confused 14 as to when this loss would be able to take place 15 because we've kind of gone over that with 16 Mr. Runner's comments. And if it was fix-and-flip, 17 it may have qualified under the 1031, which it 18 didn't. And, quite honestly, the state would have 19 been better off had it qualified under 1031. Now 20 we've got casualty loss, which I believe this 21 casualty loss is permanent in nature. 22 And so, I'll leave it there. Thank you. 23 MR. HORTON: Member Ma. 24 MS. MA: Okay. So I think we all agree 25 that there was a casualty loss, right? 26 So, I'm a CPA. If I'm going to determine 27 the casualty loss, I'm going to go to the 28 regulation. And under Section 1.165-7, under 40 1 casualty losses, under 2, subsection 2, method of 2 valuation, you have to read the whole paragraph, 3 right? 4 MR. ESCATEL: Yes. 5 MS. MA: So you have to take the valuation 6 before and after the casualty losses, and then also 7 take into effect any general market decline, 8 affecting the undamaged as well as the damaged 9 property, which occurred simultaneously, 10 simultaneously with the casualty, right? 11 So I don't understand how you can only take 12 the second half, the impact of the site loss, how 13 that -- how that is defined by general market 14 decline when there's only one event that happened to 15 the building. Number one. 16 So you have to read the whole thing -- 17 MR. ESCATEL: Yes. 18 MS. MA: -- right? 19 And I think the assessor did do a good job 20 in determining what the value is before and after 21 and then taking into consideration the general 22 market conditions, if there was any. 23 Secondly, I also sat on the Assessment 24 Appeals Board for about nine years. And normally 25 the taxpayer presents their method of valuation and 26 then the government prepares theirs. 27 And I would assume -- this is only my first 28 case here in front of you guys -- that you would 41 1 have your valuation using the regulation, taking the 2 value you think is the valuation immediately before, 3 immediately after, and taking into consideration the 4 general marketing versus just taking a number off of 5 their appraisal. 6 MR. ESCATEL: Good point. 7 So to start off with, the reason why we 8 don't have an apprais- -- because we agree with 9 their appraisal. 10 And, but -- but once again -- and it's a 11 very -- it's a very fine distinction, but it's very 12 important. What interprets the regulation in terms 13 of only allowing the physical damage is the case 14 law, Kamanski being the -- the leading case in the 15 Ninth Circuit and its progeny, that a lot -- 16 That line of cases, as briefed on my 17 various briefs to your Board, is that in those cases 18 the courts only allowed a casualty loss for only 19 that amount of actual physical damage and did not 20 consider how that -- that -- that actual damage 21 affected the remainder of the property. 22 So, you're correct. In reading this thing 23 in its entirety, it's -- we look at one -- two 24 things. It's like the appraisal is -- you need 25 to -- you need to look at the entire loss. Not just 26 the actual physical loss, but the actual -- but 27 the -- how that loss affects the remainder of the 28 property in order to carve out how much, for 42 1 casualty loss purposes, is deductible. 2 And then we look at the cases. And the 3 cases all are pretty much uniform except for the 4 Finkbohner case that only actual -- only that little 5 chunk of that actual physical damage portion is 6 deductible under 165(c)(3). 7 And, I think, once again I reiterate what I 8 said earlier is that there could be additional 9 losses. But for purposes of a casualty loss 10 deduction under 165(c)(3), it is only the actual 11 physical damage that is going to be allowed, not the 12 diminution in value, not the -- as we say, buyer 13 resistance, not how that damage affects willing 14 buyers' perception of the property because -- and 15 the reason being is that sometimes those effects are 16 fleeting and the property will rebound. 17 When we look at bluff property -- and Mr. 18 Dighera, in his declaration, stated he knew that 19 this property was eroding at 18 inches a year. This 20 was not a -- a -- a mystery. And the fact that the 21 storm exacerbated that does not in itself allow a 22 deduction for the entire amount of the value that 23 they claim now. So -- 24 MS. MA: So I tend to disagree, right? 25 Casualty loss, casualty loss is defined by sudden 26 and unexpected. A storm is specifically in the 27 regulation that -- 28 MR. ESCATEL: Correct, yes. 43 1 MS. MA: -- it qualifies as casualty loss. 2 So whether the bluff erodes at 18 inches, whether, 3 you know, Mr. Dighera wanted to flip the property, 4 whether, you know, he has a -- what is this -- a 5 reverse mortgage really has nothing to do with 6 whether a casualty loss occurred on that date and 7 whether it's defined by regulation and how to 8 calculate it. So everything that you're talking 9 about doesn't -- doesn't apply, in my opinion. 10 MR. ESCATEL: Okay. Um -- 11 MR. HORTON: That's just a statement. 12 Member Ma? 13 MS. MA: I'm done. 14 MR. HORTON: Oh. 15 Member -- Member Stowers. 16 MS. STOWERS: Okay. To appellant, the 17 taxpayer's currently living in the property? 18 MR. VINATIERI: Yes. 19 MS. STOWERS: Did he have to move off the 20 property or his tenant move off the property 21 following the casualty, or was the property 22 continued to be useful? 23 MR. VINATIERI: Continued to be used in the 24 manner in which it was intended. 25 MS. STOWERS: Okay. On the appraisal where 26 we have the loss of utility $250,000 and some 27 change, I was under the impression that that 28 represent a future buyer's inability to get 44 1 financing and insurance for the property; is that 2 correct? 3 MR. VINATIERI: I'd like to ask Mr. Arnold 4 to respond to that. 5 MR. ARNOLD: The, um -- the lost utility 6 is -- is an attempt to reflect a market impact of 7 the shrunken building envelope, so that if something 8 were to happen to the house you wouldn't be able to 9 rebuild it the way it was, along with difficulties 10 in if you wanted to sell the property and having to 11 disclose that fact to potential buyers. Having to 12 disclose that fact to potential lenders could be a 13 problem. All of those things in my mind. 14 I -- in the letter I think I said it was a 15 5- to 10-percent impact on value, and I picked the 16 middle of the range -- 17 MS. STOWERS: Mm-hmm. 18 MR. ARNOLD: -- at 7-and-a-half percent, 19 which does equate to that approximate $250,000. 20 MS. STOWERS: So what does the loss in 21 benefits represent? 22 MR. ARNOLD: Loss in benefits is the 23 shortened -- uh, uh, uh -- life of the property. 24 Again, the notion was defined by the County 25 of Santa Barbara that you had a 50-year life the day 26 or the -- before the storm occurred. And after the 27 storm, that was reduced to a 35-year life. So 28 anybody buying that property would have to build 45 1 into their decision about what they're willing to 2 pay for it the knowledge that they only had 35 years 3 rather than 50 years to enjoy the use of the 4 property. 5 MS. STOWERS: Okay, I understand. 6 So, from what you're describing to me, the 7 loss in utility and the loss in benefit does not 8 represent physical damages. And under my 9 understanding of the casualty rules, there has to be 10 a physical damage. And it's also my understanding 11 under the general rules there has to be a closed and 12 completed transaction. 13 So, in my opinion, the loss in utilities 14 and the loss in benefits are not closed and 15 completed until the taxpayer decides to sell the 16 property. Appellant? 17 MR. VINATIERI: Yeah. And I -- and I 18 understand your -- your statement. But I'd, once 19 again, just go back to Exhibit F and what the reg. 20 says, and there's nothing about a closed -- a closed 21 transaction and that. So I mean we've -- we've had 22 that discussion. 23 MS. STOWERS: Right. I -- I'm looking at 24 165 in general. I mean we are under 165. And you 25 have to have a closed and completed transaction. 26 And then from there you go from 165(a) to 27 165(c) talking about the casualty. And under the 28 casualty, the only difference being that you can 46 1 take your loss in the year it occurred or you can 2 take the loss the prior year. But you still have to 3 have a closed and completed transaction. 4 MR. VINATIERI: Understood. 5 MS. STOWERS: And case law says physical 6 damages. 7 No other comment. 8 MR. HORTON: Interesting. 9 Question of the Department. Department 10 seems to be clear that there are two distinct 11 definitions of loss here: Economic loss versus what 12 you view as casualty loss. Why isn't both the same? 13 MR. ESCATEL: To the extent they overlap, 14 they probably could be. But, in fact, I think the 15 calculation -- and Mr. Arnold could speak to this, 16 as to how he determined the loss to the actual site 17 might have some of those factors. 18 But when we look at the casualty loss 19 component of the loss in and of itself, we just look 20 at the actual physical damage and not to the 21 remainder. I mean, it's possible they can overlap, 22 I'm sure, but -- 23 MR. HORTON: But given your definition, how 24 do you reconcile Finkbohner and Kamanski's 25 interpretation of casualty loss in attributing the 26 loss to -- some loss to economic value in 27 determining the actual value of the loss to the 28 property itself? 47 1 In other words, the 55 -- and -- and -- and 2 I ask this question because in the appraiser, the 3 appraiser is looking at economic loss. And so 4 they're not really looking at it from a casualty 5 loss perspective. 6 And, quite frankly, I think if you were 7 charged with the responsibility of attributing a 8 loss to the property that actually was eroded, you 9 might find a much larger number than 55,000 in his 10 appraisal because he would go back and say -- I 11 would guess here as a real -- former real estate 12 agent, I would guess that he would go back and say, 13 well, if that's your definition, using your 14 definition, the property that fell off actually has 15 a greater loss by virtue of the setbacks and so 16 forth, that that property was of a greater value 17 than what he attributed in his -- in his -- in his 18 appraisal. 19 So he might just have a flip. So the mere 20 acceptance of his numbers, without accepting his 21 methodology, may -- you may find yourself at fault. 22 So again, therein is the reason that I have 23 this line of questioning, to try to determine, you 24 know, how do you reconcile, you know, the two court 25 cases with the definition; and at the same time the 26 definition used by the appraiser, and -- and then 27 establishing your value, which your value that 28 you've accepted is based on a totally different 48 1 premise that was used in the appraisal. 2 MR. ESCATEL: So to answer your question, 3 so first, the Finkbohner versus Kamanski dichotomy. 4 One, Finkbohner is a minority view. I think only 5 three cases have followed its reasoning. And even 6 the IRS has disavowed it in the same year that the 7 decision came out. 8 But a big difference between -- even under 9 Finkbohner, I think as I argued in my opening brief, 10 Mr. Dighera still wouldn't be allowed a casualty 11 loss because the -- the reason why the judge in that 12 case found that there should be a loss allowed above 13 and beyond any physical damage was because there was 14 a permanent change in the neighborhood. 15 There, there was a cul-de-sac was flooded 16 and I think seven homes were wiped out and they were 17 not allowed to be built back. There was a permanent 18 change in the neighborhood. 19 Whereas, in our case -- 20 MR. HORTON: My apologies for interrupting. 21 MR. ESCATEL: Oh. 22 MR. HORTON: I just wanted to interject. 23 So the erosion of this cliff is not -- would not be 24 considered a permanent -- and by virtue that 25 theoretically he could have constructed additional 26 property on there had that not taken place, i.e. the 27 gazebo? 28 MR. ESCATEL: Right. But the difference 49 1 being is that in our case erosion is an ongoing 2 affect, an ongoing condition of bluff property. 3 Whereas, in Finkbohner, it was a sudden event that 4 caused the -- the flooding that resulted in the 5 homes not being built. There it was unexpected. In 6 our case it's expected. In fact, when Mr. Dighera 7 bought the property, he knew that the property was 8 eroding at 18 inches a year. It's -- 9 MR. HORTON: I think in Finkbohner they 10 concluded that it was a curable -- because they went 11 in and actually cured the activity, was the reason 12 for their conclusion. Was that not also taken into 13 consideration? 14 MR. ESCATEL: No, no. It was -- I think -- 15 I believe it was uncurable. 16 MR. HORTON: It was uncurable. Okay. 17 MR. ESCATEL: Yeah, in Finkbohner. 18 And uncurable in the context of Finkbohner 19 involved the fact that you could no longer build 20 houses there; it was open space. The government no 21 longer allowed anyone to build a house there that 22 wasn't already living there. Where -- 23 MR. HORTON: So -- so Finkbohner took into 24 consideration a position of the government as 25 opposed to the actual activity? 26 MR. ESCATEL: Well -- 27 MR. HORTON: And -- and -- and I posed that 28 because the invert of your argument is is that we 50 1 can't take in consider- -- we shouldn't take in 2 consideration the setbacks and the economic in 3 fact -- impact. 4 MR. ESCATEL: Well, no. I mean the reason 5 why I -- I mentioned Finkbohner is only to show that 6 there, there was a permanent change in the 7 neighborhood as a very general matter. Whereas 8 here, people are still developing on bluff property 9 even though at some point the setback is going to 10 get to a point where, you know, it might be 11 inhabitable. 12 And just to -- just to elucidate that 13 point, however, we do not -- like the IRS, we do not 14 believe that Finkbohner is the correct case to apply 15 to this. It's more Kamanski which is the Ninth 16 Circuit case. 17 MR. HORTON: Okay. Kamanski, how do you 18 reconcile -- well, Kamanski is probably on point 19 with your argument. 20 To the -- to the appellant relative to 21 Kamanski being on point with their argument, any 22 thoughts in that regard? 23 MR. VINATIERI: Actually, as I indicated in 24 my argument that in both Kamanski and Finkbohner, 25 neither of those properties had any major actual 26 physical damage. Neither. Which is different than 27 our situation here. 28 And this is what I've been trying to talk 51 1 to FTB about for years now in this case is that, 2 whether it be Finkbohner which goes one way and 3 allows it, whether it's Kamanski which goes the 4 other way and says, no, it's only actual physical 5 damage, even though Finkbohner says -- it talks 6 about "the casualty loss is limited to damage 7 directly caused by the casualty," but what does 8 "directly caused by the casualty?" 9 I'd argue here that because of this Exhibit 10 E, that we have direct damage. But -- but be that 11 as it may, either way, this is the only case that 12 I've seen in all these casualty loss cases where you 13 actually have the actual land washing away, which 14 then as a result because of Santa Barbara legal 15 setback requirements precludes, basically, Mr. 16 Dighera from rebuilding. 17 And so -- so I mean whether you want to go 18 the Finkbohner route or whether you want to go the 19 Kamanski, factually both of those are a little bit 20 different than this. This is a unique case. 21 And I just have to disagree with -- with 22 counsel about the fact that, yes, there's a geology 23 report that says that this bluff is going 18 inches 24 a year. And by the way, that's up and down the 25 Santa Barbara coast. But that geology report also 26 said very specifically that there were no incidents 27 in the last 40 years that they had surveyed of any 28 catastrophic bluff failure. 52 1 Mr. Dighera, when he decided to do the 2 exchange on this property, looked at the report and 3 said, well, gee, there's not a problem with anything 4 catastrophic, so therefore, this isn't such a bad 5 idea from an economic standpoint. And Santa Barbara 6 County said from a safety standpoint we're relying 7 on -- on the geology report that says there's been 8 no catastrophic. 9 So yes, there's 18 inches a year and 18 10 inches a year turns out to be 50 years and that's 11 hence the setbacks. 12 So to say that somehow -- somehow it was 13 pre -- or it was assumed that this type of thing 14 could happen is absolutely incorrect. Eighteen 15 inches a year? Yes. 16 He was going to buy it. He had it. He had 17 50-year life. I'm going to live it in for 50 years 18 or I'm going to sell it. 19 Then the next day it's 35 years. Now, if 20 there's not a decline in the market value to a 21 willing buyer and a willing seller -- 22 And -- and I got to keep coming back. I'm 23 sorry, but I got to keep coming back to the reg. It 24 says "fair market value." It doesn't talk about 25 some value based upon casualty loss or whatever. 26 This is the IRS's own reg. Fair market value before 27 and after, exactly what Mr. Arnold did. Nothing 28 about this physical stuff. Physical's only one 53 1 aspect. 2 MR. HORTON: Thank you. 3 To the Department, what are your thoughts 4 about the Internal Revenue Code 1.165-7? 5 MR. ESCATEL: As I stated earlier, I -- I 6 think we have a disagreement how we read it. 7 We do look at the fair market value before 8 and we look at the fair market value after. And 9 what we look at is we look at the fair market value 10 of the property as directly affected by the -- 11 MR. HORTON: Casualty loss. 12 MR. ESCATEL: -- casualty loss. So -- 13 MR. HORTON: Gotcha. 14 Question of both parties. The reason I 15 didn't strike the, uh -- the, uh, reverse mortgage 16 thing because no one really said to what point they 17 were introducing the evidence. But I would 18 speculate that the point is, is that if there's an 19 appreciation in economic value, you have the reverse 20 effect. 21 And so what happens to the taxpayer if 22 there's a appreciation in value, subsequent periods 23 where the value estimated by the appraiser is 24 actually more by virtue of change in the economic 25 climate? 26 ---oOo--- 27 28 54 1 ---oOo--- 2 MR. VINATIERI: I think, Mr. Horton, 3 obviously, that's the reason I objected to it 4 because it's all speculative. It's all speculative. 5 We -- I mean, I don't have the appraisal. 6 And I -- and I have to be careful what I say here, 7 but when we make loans these days, after the debacle 8 of the 2006-7-8, there's to be safeguards relative 9 to what you can loan on. 10 And I don't have an appraisal that says to 11 me, here's how I came up to this $4 million figure. 12 And I don't think I'm going to say 13 anything else. 14 MR. HORTON: Okay, yeah. 15 Sorry, I asked a leading question. 16 We'll go to the Department -- to Appeals, 17 just for their perspective on the law. 18 Does -- will -- does the law allow us to 19 take into consideration the economic value 20 attributed to the remaining land and the -- the 21 restrictions as it relates to the setbacks 22 established by the local municipality? 23 And I'm okay with you generalizing. 24 MR. EPOLITE: We're dealing with the 25 federal statute. So, in doing so, we look to 26 federal regulations and federal case law. 27 So, here in California we're in the Ninth 28 Circuit. The vast majority of cases in the Ninth 55 1 Circuit stand for the proposition that casualty 2 losses under 165 are limited to the physical damage 3 incurred to the property. 4 The Finkbohner decision is an Eleventh 5 Circuit case, not a Ninth Circuit case. Our cases 6 that have cited Finkbohner and a few -- and that 7 have followed Finkbohner are the only case that we 8 have been able to find in which a taxpayer has been 9 successful under the permanent diminution theory of 10 Finkbohner is Finkbohner. 11 We haven't find -- found another single 12 case in which a taxpayer has been successful under 13 the permanent diminution theory. 14 Moreover, in reviewing Regulation 165-7, it 15 says that there are two ways in which a casualty 16 loss can be valued -- the difference between the 17 fair market value before and the fair market value 18 after, or, in the alternative, the cost of repairs 19 to the property damage. 20 In our opinion that infers cost repairs to 21 the property damage is talking about physical 22 damage. 23 In addition, the subparagraph I that we've 24 been focused on today ends with the thought that 25 under this section shall be limited to the actual 26 loss resulting from damage to the property -- to the 27 actual loss resulting from damage to the property. 28 In our opinion that is again talking about 56 1 the physical loss. 2 There obviously is a difference and 3 conflict in the federal circuit courts with 4 Finkbohner on the one hand and the case law in the 5 Ninth Circuit. The Ninth Circuit, we would advise, 6 that you should find to be more persuasive. You can 7 look at Finkbohner, but we would tell you that you 8 should find it less persuasive. 9 MR. HORTON: Okay. 10 MR. VINATIERI: Might I respond to that -- 11 MR. HORTON: Let me -- 12 MR. VINATIERI: Mr. Chairman? 13 MR. HORTON: -- let me -- let me reverse my 14 discussion then. 15 And this question of the appraiser, the 16 value assigned to the actual physical loss at the 17 time, did you take into consideration -- if that -- 18 if that property that eroded were to exist, did you 19 take into consideration the impact as it relates to 20 the setbacks and ability to build on that property 21 was no longer in existence if he wanted to? 22 Or did you just take into consideration the 23 actual property that fell off and the value of that 24 property? 25 MR. ARNOLD: If I -- if I understand your 26 question, and I think I do, on the -- the first 27 calculation that I did was oriented just to the -- 28 the value of that physical 850 square feet as a part 57 1 of the larger parcel, but not having any 2 ramifications beyond just being a part of the larger 3 parcel. 4 MR. HORTON: So, question of the 5 Department, it seems to me that in the appraisal 6 some consideration should have been given to that 7 land, which is to this activity. 8 I understand your argument. I understand 9 what the Department has said relative to the Ninth 10 Circuit decision, case laws and so forth. 11 But given all of the testimony here, it 12 seems that the appraiser was right, given his 13 methodology and his understanding; wrong, given the 14 testimonies here today, because that property itself 15 that fell off, the actual casualty loss, did not 16 give consideration to the overall impact on the 17 property, which it should have. 18 I mean, if -- if -- you know, if half of 19 your house falls apart, I mean, you know, I mean, 20 the land fell off, so, you should have given 21 consideration to the values associated with the rest 22 of the property. 23 So, I mean, I don't know how much, I am not 24 the appraiser, but -- so, the question is, one, do 25 you find -- in establishing this value and accepting 26 that, did you take those variables into 27 consideration? 28 MR. ESCATEL: Well, Mr. Horton, the problem 58 1 with -- with doing that is that -- and this is the 2 reason why realization is the best time to determine 3 the losses because -- 4 MR. HORTON: No, I'm saying realization at 5 the time -- I'm -- I'm -- I'm assuming your legal 6 argument. 7 MR. ESCATEL: Okay. 8 MR. HORTON: I'm just not necessarily 9 assuming your valuation that you took. 10 MR. ESCATEL: Okay. 11 MR. HORTON: It's the testimony of the 12 appraiser that he would have appraised that value 13 much higher had he understood the -- the variables 14 that are presented here. 15 And, I, quite frankly, think that it should 16 have been much higher. 17 But did you take it into consideration? 18 And would you have directed your appraiser, had you 19 hired an appraiser, would you have given that 20 appraiser and said, 21 "I need to know the actual value of 22 this chunk of land, not just, you know, 23 from a cost basis, but I need to know the 24 actual value of that land, given the 25 current environment of the setbacks and 26 valuations and so forth." 27 MR. ESCATEL: Well, I mean based on my 28 reading of the case law, I think that the amount 59 1 that was attributed to that is correct. 2 And it isn't -- 3 MR. HORTON: I'm not speaking of amounts. 4 MR. ESCATEL: -- but -- 5 MR. HORTON: I'm speaking of methodology. 6 MR. ESCATEL: -- the methodology is -- and 7 I'm not an appraiser, but all I can say is that I 8 think -- I -- I wouldn't know how to answer that 9 question because I'm not an appraiser. 10 MR. HORTON: Well, let me help you. 11 What if we were discussing capital gain and 12 we were looking a capital gain situation, would you 13 take those variables into consideration? 14 MR. ESCATEL: Yes and -- 15 MR. HORTON: Then why wouldn't you take 16 them as a loss? 17 MR. ESCATEL: -- well, here's -- here -- 18 okay, so, here's -- when I read -- when I went 19 through the appraisal, I found it reasonable for 20 certain reasons. 21 Some of the -- some of the factors that 22 Mr. Arnold considered were factors that legally 23 should not be attributed. 24 For example, the -- we know that the 25 restrictions on the property is not -- under the 26 casualty loss case law is not a reason to allow -- 27 restrictions are not factored in. 28 MR. HORTON: My apologies, but now you're 60 1 arguing against yourself? 2 MR. ESCATEL: No, no, no. 3 I took Mr. Arnold's appraisal as reasonable 4 and that's why I felt that the $55,000 was 5 reasonable in light of the facts in this case. 6 I agree with -- I agree with the amount. 7 MR. GEMMINGEN: And if I might, Chairman 8 Horton, you asked about capital gains. 9 And again the capital gains would only be 10 measured at the time of an actual sale of the asset. 11 So, you would have a true valuation placed by the 12 market on what a third party would buy it for. 13 MR. HORTON: That valuation would reflect 14 all of the variables in the market -- 15 MR. GEMMINGEN: But there would -- 16 MR. HORTON: -- the same thing -- 17 MR. GEMMINGEN: -- be a true disposition of 18 the property. So, we would know what the party says 19 as opposed to an appraised amount. 20 MR. HORTON: -- I agree, I agree. You get 21 no disagreement from me. 22 But then we would be back looking at market 23 value. And then it didn't appear that he looked at 24 market value on the actual casualty loss that was 25 there. 26 Anyway, further discussion, Members? 27 Hearing none, is there a motion? 28 MS. STOWERS: Move to take it under 61 1 submission. 2 MR. HORTON: Member Stowers moves to take 3 the matter under submission. 4 Second by Member Harkey. 5 Without objections, such will be the order. 6 Thank you so very much for appearing before 7 you, this is really -- I really enjoyed the 8 conversation as well as the debate and discussion of 9 the law. Appreciate that. 10 ---oOo--- 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 62 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, KATHLEEN SKIDGEL, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on February 24, 2015 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 1 through 54 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: March 23, 2015 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 63 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on February 24, 2015 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 55 through 62 14 constitute a complete and accurate transcription of 15 the shorthand writing. 16 17 Dated: March 9, 2015 18 19 20 ____________________________ 21 JULI PRICE JACKSON 22 Hearing Reporter 23 24 25 26 27 28 64