Chapter 8
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Transcript of Chapter 8
Chapter 8
Losses and Bad Debts
Learning Objectives
• Identify transactions that may result in losses
• Determine the proper classification for losses
• Calculate the suspended loss from passive activities
• Identify what constitutes a passive activity loss
Learning Objectives
• Determine when a taxpayer has materially participated in a passive activity
• Identify and calculate the deduction for a casualty or theft loss
• Compute the deduction for a bad debt• Compute a net operating loss deduction
Transactions That May Result In Losses
• Sale or exchange of property
• Expropriation, seizure, or confiscation of property
• Abandonment of property• Worthless securities• Demolition of property
Classifying The Loss On A Taxpayer’s Return
• Ordinary vs. Capital loss
• Disallowance possibilities
Ordinary Vs. Capital Loss
• Dependent on type of property involved and type of transaction involved
• Losses on qualifying Sec. 1244 stock are treated as ordinary rather than capital loss($50,000 limitation or $100,000 if filing MFJ)
Qualification as Sec. 1244 Stock
• Must be issued and owned by an individual or partnership
• Corporation must be domestic
• Stock must be issued for cash or property, not services
Qualification as Sec. 1244 Stock
• Corporation must not have derived > 50% of gross receipts from passive income sources during the immediately preceding 5 tax years, and
• At the time stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1 million
Disallowance Possibilities
• Transfers of property to a controlled corporation in exchange for stock
• Property sold to certain related parties
• Wash sales• Losses limited because the losses
exceed the amount for which the taxpayer is at risk.
Passive Losses
• Computation of passive losses and credits
• Carryovers
• Definition of passive activity
Passive Losses
• Taxpayers subject to passive loss rules
• Publicly traded partnerships
• Rental real estate trade or business
• Other rental real estate activities
Definition of a Passive Activity• Includes any rental activity and any trade,
business, or investment activity in which the taxpayer does not materially participate
• Investments in limited partnerships generate passive losses due to the legal restrictions on limited partners’ involvement in the management of the partnership
• Applies to individuals, estates, trusts, closely-held C Corporations, Personal Service Corporations, and certain publicly traded partnerships
• While not applied to partnerships and S Corporations directly, applies to owners
Taxpayers Subject To Passive Loss Rules
Passive Losses
• Types of income– Active: wages, salaries, business– Portfolio: dividends, interest, annuities,
royalties– Passive: rental, trade, business or
investment
• General rule: passive losses can only be used to offset passive income
Passive Losses: Exceptions
• Real estate professionals who materially participate in real estate trade or business activities
• Taxpayers actively participating in rental real estate activities with AGIs not in excess of $100,000 may deduct $25,000 of such rental real estate losses against portfolio and active income
Casualty & Theft Losses
• What is a casualty
• What is a theft
• Deductible amount of casualty loss
Casualty
• A casualty loss results from an identifiable event that was sudden, unexpected, or unusual
• Qualifying casualties include fire, flood, hurricane, tornado,
hail, and cyclone
Theft
• Generally, criminal intent and violation of a state law are required to meet the definition of theft
• Includes larceny, embezzlement, robbery, blackmail, extortion, and ransom
Casualty & Theft Losses• Limitations on personal use property
– Subject to two limitations: the losses sustained in each separate casualty are reduced by $100, and the total amount of all net casualty losses is reduced by 10 % of the taxpayer’s AGI
– Netting casualty gains and losses on personal use property
Casualty & Theft Losses
• Casualty gains and losses attributable to business and investment property
• When losses are deductible
Bad Debts• Bona fide debtor-
creditor relationship
• Taxpayer must have basis in the debt
• Debt must be worthless
• Non-business bad debts
Bad Debts
• Business bad debts
• Accounting for the business bad debts
• Recovery of bad debts
• Deposits in insolvent financial institutions
Net Operating Loss
• Involves business income and deductions only and will increase an Net Operating Loss (NOL)
• Computing the NOL• Carryback and
carryover periods• Recomputation of
taxable income in the carryover year
Tax Planning Considerations
• Taxpayers should document their determination that a particular debt is worthless
• Documentation of fair market value is important to support a casualty loss
• Taxpayer should consider forgoing NOL carryback to only carry forward if a higher marginal rate is expected in the future or a carryback would jeopardize tax credits
Compliance and Procedural
Considerations• Casualty losses
• Net Operating Losses
• Worthless Securities