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Loss & Deduction Limits

Loss & Deduction Limits Chapter 2 Pages 43-93 Chapter Contents P. 43 Loss Limit Framework Hobby & Vacation Loss Limits Basis & At-Risk Rules Passive Activity Limits NOL’s Loss Limits & C Corporations No law changes to these issues Loss Limit Framework P.44 At Risk

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Loss & Deduction Limits

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  1. Loss & Deduction Limits Chapter 2 Pages 43-93

  2. Chapter Contents P. 43 • Loss Limit Framework • Hobby & Vacation Loss Limits • Basis & At-Risk Rules • Passive Activity Limits • NOL’s • Loss Limits & C Corporations No law changes to these issues

  3. Loss Limit Framework P.44 At Risk Investment interest limit PAL Limit Basis Limits Hobby & vacation home, Related party limits Capt. Loss limit Loss Deduction

  4. Safe or Out?

  5. First Base P. 45 • Hobby Loss Rules • Vacation Loss Rules • Related Party Limits Out at First Base!

  6. Safe at First? P. 44 Losses generated from: • Partnerships • S-Corps • LLC Subject to Basis Limits

  7. Second Base P. 45 At Risk limitations

  8. Third Base P. 45 Passive Activity Losses (PAL’s)

  9. Heading for Home! P.45 Capital Loss Limits Last Hurdle

  10. Hobby Loss P.46 • IRC 183 – and related regulations can disallow a loss for a lack of “Profit Motive”

  11. Profit Motive P.46 Profit motive is generally presumed when: • Profit in three of last five years • Two of seven years for horses • One in ten years for beekeeping?

  12. Statute of Limitations P.46 • A taxpayer can elect to extend the Statute of Limitations to postpone the application of the test for the presumption until the fourth year (6 yrs for horses)

  13. Profit Motive Indicators P. 46 Treas. Reg. 1.183-2 Nine Indicators They are Subjective

  14. Nine Factors P.47 • Manner in which the taxpayer carries on the activity • Expertise of the taxpayer • Time & Effort • Expected appreciation of assets

  15. Nine Factors P.47 6. Success of the taxpayer in carrying on other similar or dissimilar activities 7. Occasional Profits 8. Financial status of the taxpayer 9. Personal Pleasure

  16. Loss Limits P.47 • Some Expenses may be deductible • Expenses are separated in layers/tiers • All of the income is reportable

  17. First Tier P. 47 Deductions allowable under another code section • Itemized Deductions

  18. Tier Two P.47 • Deductions other than depreciation (If they would be allowed in a for profit activity) IRC 162 “Trade or Business Expenses”

  19. Tier Three Deductions P.47 • Depreciation to extent of income

  20. Example 2.1 P. 48 Facts Leon owns a yacht Occasionally rents out Total Income $14,000 Total Expenses $16,000 (allocated) What deductions can he claim & where?

  21. Leon has a BIG boat!

  22. Income Analysis P.48 Rental Income $14,000 Tier 1 deductions -0- Tier 2 deductions: (13,500) Remaining Income $500 Tier 3 deductions Depreciation ($2,500) 500 Depreciation Carryover $2,000

  23. Various Court Cases P. 49 • The IRS has been winning most of the cases taken to court • At least act like you are trying to make a profit • Business Plan • Keep Records • Education (in the activity)

  24. Vacation Homes P.49 • IRC 280 covers Disallowance of certain expenses in connection with business use of home, rental of a vacation home

  25. 14 Day Rule P. 50 • For residences rented for 14 days or less (annually) the rental income is not included in taxable income

  26. 14 Day Rule P. 50 No expenses relating to that income is deductible

  27. Non Personal Use Test P. 50 Vacation Home vs. Rental Property A rental meets the non personal use test if owner use is 14 days or less or If personal use is 10% or less of rented days

  28. Personal Use Tests P. 50 • Use by an owner • Use by member of owner’s family • Use under an exchange agreement • Use for less than FMV

  29. What’s the Difference ? P. 51 Vacation Home • Allocate deductions • No deductions in excess of income Rental Activity • No allocation • Excess deduction over income • Passive activity limitations

  30. Ordering Limits P. 51 • Like the hobby loss rules, Vacation Homes & Rental Activity with personal use have an ordering of expenses

  31. Allocation Formula(s) P. 51 • Allocate general expenses not specific to any particular day’s use Per IRC • General Rule: allocate on the basis of the days used … Tax Court & Ninth Circuit Court of Appeals • Interest & Taxes: allocated on the basis of total days in the year…

  32. Example 2.5 P. 52 Facts Allen used his vacation home for 20 days Rented for 180 days Exceeds 14 day & 10% limits (vacation home limits apply)

  33. Example 2.5 & 2.6 P.52-53

  34. Example 2.5 Figure 2.4

  35. Second Base Basis & At-Risk Limitations

  36. S-Corporation Basis P. 54 Basis in stock Plus Certain Debt

  37. Allocations among S/H’s P. 54 General Rule – allocations of income & loss Based on a per-share, per-day weighted average. For all S/H who held any shares on any day Not the same for partnerships (partnership agreement)

  38. Basis @ Acquisition P. 55 Various ways to acquire stock & basis • IRC 351 incorporation –substituted basis (equal to basis in property given to corp.) 2. Purchased stock (basis equal cost) 3 Stock received as a gift (pre 1977 = owners basis + gift tax paid up to FMV)

  39. Basis @ Acquisition P. 55 4. Received as compensation (imputed cost or gross income reported) 5. Received through an estate (FMV at death)

  40. Example 2.6 P.56 • Jeanne inherits 1/3 stock of Jayco • Jayco is a cash basis S-Corporation • FMV @ death was $100,000 • $45,000 of A/R What is Jeanne basis in the stock? (assume pre 8-20-96)

  41. Example 2.6 P.56 $ FMV @ date of death = basis ($100,000) If Jay died after 8-20-96? $100,000 – $15,000 = $85,000 – FMV @ date of death = basis

  42. Yearly Adjustments P.56 • Allocated portion of S-Corp. income (+) • Allocated portion of S-Corp. losses (-) (prorated based on ownership % stock per-day, per-share)

  43. Where to Report P.56 Where to report the items of income or loss or deduction? (From K-1) • Ordinary Income Schedule E • Ordinary Loss Schedule E • Capital Gains or Losses Schedule D • Charitable Contributions Schedule A • Tax Exempt Income Page 1

  44. Example 2.8 P.57 • Zoeco is an S-Corporation • One S/H (all year) • 1/1/03 basis was $110,000 • Ordinary loss $60,000 • Distribution of $70,000 • No accumulated E&P (retained earnings) What is the effect of the earnings & distribution?

  45. Example 2.8 P.57 Basis @ 1/1/03 $110,000 + Ordinary Income -0- • Current Year Distributions (70,000) Adjusted Basis before 2003 loss $40,000 2003 Ordinary Loss $60,000 Limited to 40,000 40,000 Carry Forward to 2004 $20,000

  46. S- Corp. Debt basis P.58 + Basis for a direct loan (guarantee is no good) - Adjustments to debt basis if losses exceed stock basis (reduced by excess loss)

  47. Example 2.9 P.58 Bigtime Inc. – S. Corporation 2003 Ordinary Losses ($100,000) 2004 Ordinary Income 140,000 Sole S/H Stock Basis 60,000 Debt Basis 50,000 How does S/H adjust her basis?

  48. Figure 2.10 P. 59

  49. Figure 2.10 P. 59

  50. Basis for Partners or LLC Members P. 60 Acquisition of Interest • By Contribution of Property (no gain or loss to partner) • Partner’s basis in Partnership interest is basis of property contributed (outsider basis) It is a substitute basis… property for interest

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