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Concepts in Federal Taxation Chapter 7: Losses—Deductions and limitations. October 19, 2012. administrative. Attendance Not required Factor for final grade Can help, won’t hurt Midterm 1 Pass out exams today Professor has kept some exams Midterm 2 Unique questions Research project.

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administrative
administrative
  • Attendance
    • Not required
    • Factor for final grade
    • Can help, won’t hurt
  • Midterm 1
    • Pass out exams today
    • Professor has kept some exams
  • Midterm 2
    • Unique questions
  • Research project
homework problems
Homework Problems

1. HW Problems

Assignment #8

Chapter 7

P#44, 49, 52, 66, 69

2. Midterm 1 Overview

losses
losses

Annual (Activity) Losses

  • Result when an entity’s deductions for the period exceed its income

Transaction Losses

  • Result from the disposition of an asset
slide5
#44

Claudio owns a passive activity that has a basis of $28,000 and a fair market value of $38,000. The activity has suspended losses of $16,000. To reduce their estate, every year Claudio and his wife give their son Anthony and his wife a gift of approximately $40,000. During the year, Anthony sells stock that results in a $10,000 short-term capital loss. A friend of Claudio’s suggests that he give his passive activity to Anthony. The friend says that this will allow Claudio to avoid tax on the $10,000 capital gain and let his son offset his short-term capital loss with the $10,000 ($38,000 - $28,000) gain from the sale of the passive activity. In addition, Claudio can use the suspended loss from the passive activity to offset his other ordinary income. Write a letter to Claudio explaining the tax consequences of making the passive activity a gift to his son.

slide6
#44
  • Related party sales
    • Losses on sales of property to a related part is disallowed as a deduction
    • If property is later sold to an unrelated party at a gain, the gain realized on the sale may be reduced by the amount of lost previously disallowed
  • Disposition by gift
    • Carryover basis
slide7
#44
  • Not accurate!
  • If Claudio gifts the passive activity to his son, Anthony’s basis in the passive activity is $44,000
    • Claudio’s $28,000 basis + $16,000 suspended losses
  • Although Anthony’s basis is increased by the $16,000 suspended loss, neither Claudio nor Anthony receives a deduction for the suspended loss
    • This treatment prevents Anthony from using the suspended loss deduction against other passive income
  • if Anthony sells the passive activity in an arm’s length transaction for $38,000 (fair value), he will not recognize a $10,000 gain ($38,000 - $28,000), but rather a $6,000 ($38,000 - $44,000) long-term capital loss
slide8
#49

Stella owns a taxicab company. During the year, two of her cabs are involved in accidents. One is totally destroyed; the other is heavily damaged. Stella is able to replace the destroyed cab with an identical model for $5,500. Her adjusted basis in the destroyed cab is $3,750, and the insurance company pays her $2,800. The adjusted basis of the damaged cab is $3,800. The insurance adjuster estimates that the damaged cab is worth $3,600. Although a comparable cab sells for $7,800, the insurance company gives Stella only $2,900. Write a letter to Stella explaining the amount of her deductible casualty loss.

slide9
#49
  • The loss on business property totally destroyed is the property’s basis
  • The loss on partially destroyed business property is measured as the lesser of:
    • the decline in the value of the property
    • the property’s basis
  • Whether the property is totally destroyed or partially destroyed, the loss is reduced by any insurance reimbursement
slide10
#49

Totally destroyed cab:

  • Basis: $3,750
  • The $3,750 basis is reduced by the insurance reimbursement of $2,800 for a deductible loss of $950:

Destroyed Cab

Adjusted basis $3,750

Insurance reimbursement (2,800) Casualty loss$ 950

slide11
#49

Partially destroyed cab:

  • The loss is the lesser of:
    • the decline in the value of the property—$4,200 ($7,800 - $3,600)
    • the property’s basis—$3,800
  • Stella’s loss is the cab’s basis of $3,800 reduced by the $2,900 insurance reimbursement for a net casualty loss deduction of $900:

Damaged Cab

Lower of:

Adjusted basis $3,800

or

Reduction in FMV $4,200

Insurance reimbursement (2,900)

Casualty loss $ 900

slide12
#49
  • Stella’s total casualty loss on the two accidents is $1,850 ($950 + $900)
slide13
#52

During 2012, Yoko has total capital gains of $8,000 and total capital losses of $16,000.

a. What is the effect of the capital gains and losses on Yoko’s 2012 taxable income? Explain.

  • The capital gains and losses are netted together to determine the net capital gain (loss) position for the year
  • Yoko has a net capital loss of $8,000:

Total capital gains $ 8,000

Total capital losses (16,000)

Net capital loss $ (8,000)

slide14
#52

2012 Deduction:$ 3,000

Loss carried forward to 2013:$ (5,000)

  • The deduction for capital losses is limited to $3,000 per year, with any excess capital loss carried forward for netting in subsequent years
  • Yoko has a $5,000 capital loss carryforward
slide15
#52

b. Assume that in 2013 Yoko has total capital gains of $10,000 and total capital losses of $7,500. What is the effect of the capital gains and losses on Yoko’s taxable income in 2013? Explain.

  • The 2013 capital gains and losses are netted with the 2012 $5,000 capital loss carryforward
  • This results in a net capital loss of $2,500
  • Because it is under the $3,000 maximum deduction limit, the entire $2,500 net capital loss is deductible in 2013
slide16
#52

Total capital gains $ 10,000

Total capital losses (7,500)

2012 Loss carryforward(5,000)

Net capital loss $ (2,500)

2013 Deduction $ (2,500)

slide17
#52

c. How would your answer change if Yoko’s total capital losses are $14,000 in 2013?

  • The netting of the 2013 gains and losses with the 2012 $5,000 capital loss carryforward results in a net capital loss of $9,000
  • Only $3,000 of the loss is deductible in 2013
  • The $6,000 loss is carried forward to 2014
slide18
#52

Total capital gains $ 10,000

Total capital losses (14,000)

2012 Loss carryforward(5,000)

Net capital loss $ (9,000)

2013 Deduction $ 3,000

Loss carryforward to 2014 $ (6,000)

slide19
#66

Jorge and his wife own a beachfront vacation home in Savannah, Georgia. During the year, high winds from a tropical storm shatter a sliding glass door and rain from the storm causes extensive water damage to the kitchen. Fortunately, during a calm in the storm, Jorge is able to board up the door, which limits the water damage to the kitchen. The items damaged in the storm are:

Value Value Insurance

Cost Before After Proceeds

Kitchen Furniture $2,100 $1,400 $400 $650

TV $ 250 $ 200 $ -0- $125

Refrigerator $1,000 $ 950 $100 $800

Linoleum Flooring $1,600 $ 900 $ -0- $500

In addition, Jorge pays $625 to replace the sliding glass door. The insurance company will not reimburse him for the cost of the new door because the old sliding glass door did not meet the company’s standards for a hurricane area. What is the amount of Jorge’s casualty loss before considering any annual limitations that may apply?

slide20
#66
  • The measure of a personal casualty loss is the lesser of
    • the decline in market value of the property
    • the property’s basis
  • The loss must be reduced by any insurance reimbursements and the $100 statutory floor (personal casualty loss)
  • Jorge’s casualty loss is $1,400 before considering the annual personal casualty loss limitation (10% of AGI)
slide21
#66

Kitchen furniture (decline in value) $ 1,000

Television (decline in value) 200

Refrigerator (decline in value) 850

Linoleum Flooring (decline in value) 900

Glass door damage (cost to repair) 625

Total loss before insurance reimbursement $ 3,575

Less: Insurance reimbursement ($650 + $125 + $800 + $500) (2,075)

Loss net of insurance $ 1,500

Less: statutory floor (100)

Net casualty loss before annual limitation $ 1,400

  • Jorge’s deductible casualty loss will be decreased by 10% of his AGI
slide22
#69

Marsha owns a two-family condominium in southern California that she paid $140,000 for in 1997. One unit has 2,400 square feet of space, and the other has 1,600 square feet. Marsha uses the 2,400-square-foot unit as a vacation home and rents the other unit to a retired couple. During the current year, an electrical fire destroys the condominium. Because part of it was used as rental property, Marsha’s insurance company reimburses her only $120,000. The fair market value of the condominium before the fire was $160,000, and her adjusted basis in the rental unit is $20,000. Assume that Marsha’s adjusted gross income before considering the casualty is $55,000. Write a letter to Marsha explaining the effect of the casualty on her taxable income.

slide23
#69
  • Because the rental property is a mixed-use asset, it must be accounted for as two assets—a business asset and a personal asset
  • Allocate the business and personal portion of the condominium based on the total square footage of the two units:
    • 40% [1,600  (2,400 + 1,600)] of the casualty loss is business
    • 60% [2,400  (2,400 + 1,600)] of loss is personal
  • The gain or loss from the casualty must be computed separately and the appropriate rules for business and personal property applied to each portion
slide24
#69

40% 60% BusinessPersonal

Initial basis ($140,000) $ 56,000 $ 84,000

Less: depreciation ($56,000 - $20,000)(36,000) -0-     

Adjusted basis $ 20,000$ 84,000

Amount of loss:

Adjusted basis $ 20,000 $ 84,000

OR

Decline in value—Personal ($160,000 x 60% = $96,000) $ 96,000

Less: Insurance proceeds 48,000 72,000

Net casualty gain (loss) $ 28,000 $(12,000)

slide25
#69
  • Marsha has a $28,000 casualty gain on the business portion of condominium and a $12,000 loss on the personal portion of the condominium
  • The $28,000 gain is added to her $55,000 AGI, giving her an adjusted gross income of $83,000 ($28,000 + $55,000)
  • Assuming that Marsha itemizes her deductions, her deductible casualty loss is $3,600:

Loss net of insurance $ 12,000

Less: statutory floor (100)

Net casualty loss before annual limitation $ 11,900

Annual limitation ($83,000 x 10%) (8,300)

Deductible personal casualty loss $ 3,600

midterm 1
Midterm 1
  • Midterms have raw grades
    • Average 117/150
  • Professor Cerf is reviewing and adjusting for the curve
  • The class generally did well on the short answer section
  • Multiple choice section seemed to be more challenging (lower ratio of correct answers)
  • I assume the time crunch accounted for a lot of the variability in the multiple choice answers
  • I will post solutions on bSpace
  • Email me for questions regarding grading for the midterm
midterm 11
Midterm 1

Recommended time allocation (for students to gauge progress during exam)

Question Weight Percent Minutes

1 30 20% 16

2 40 27% 21

3 40 27% 21

MC 40 27% 21

Total 150 100% 80

MC time per question (minutes): 2.1

midterm 1 mc
Midterm 1—MC

1. During the current year, Trane invests $35,000 in each of two separate corporations. Each investment gives him a 20% ownership interest. Brazil Corporation is a regular corporation that has taxable income of $200,000 and pays dividends totaling $50,000. China Corporation is an S corporation that has taxable income of $100,000 and pays $50,000 of dividends. As a result of these two investments, Trane

I. Has $40,000 of taxable income from Brazil Corporation.

II. Has $20,000 of taxable income from China Corporation.

a. Only statement I is correct.

b. Only statement II is correct.

c. Both statements are correct.

d. Neither statement is correct.

midterm 1 mc1
Midterm 1—MC
  • Distinguish between C corporation and S corporation (conduit)
  • Brazil Corporation (C)
    • Only count dividend income
    • 20% of $50,000 = $10,000 taxable income
  • China Corporation (S)
    • Income flow through to partners
    • 20% of $100,000 = $20,000 taxable income
    • Dividends reduce basis
midterm 1 mc2
Midterm 1—MC

1. During the current year, Trane invests $35,000 in each of two separate corporations. Each investment gives him a 20% ownership interest. Brazil Corporation is a regular corporation that has taxable income of $200,000 and pays dividends totaling $50,000. China Corporation is an S corporation that has taxable income of $100,000 and pays $50,000 of dividends. As a result of these two investments, Trane

I. Has $40,000 of taxable income from Brazil Corporation.

II. Has $20,000 of taxable income from China Corporation.

a. Only statement I is correct.

b. Only statement II is correct.

c. Both statements are correct.

d. Neither statement is correct.

midterm 1 mc3
Midterm 1—MC

2. Roberta invests $16,000 for a 10% interest in Bowie Partnership. In the first year of operations, Bowie reports net income from operations of $80,000 and distributes $6,000 cash to Roberta. How much gross income must Roberta recognize from her investment in Bowie?

a. $ 2,000

b. $ 6,000

c. $ 8,000

d. $ 80,000

  • 10% x $80,000 = $8,000
midterm 1 mc4
Midterm 1—MC

3.Nora receives a salary of $55,000 during the current year. She sells some land that she held as an investment at a loss of $15,000 and some stock at a gain of $10,000. Nora's adjusted gross income is:

a. $50,000

b. $52,000

c. $55,000

d. $62,000

e. $65,000

midterm 1 mc5
Midterm 1—MC

4. Boris, a single individual, has two sales of stock during the current year. The first sale produces a short-term loss of $27,000 and the second sale results in a long-term gain of $57,000. Boris's taxable income without considering the gain is $125,000. Boris's stock transactions will increase his taxable income by:

a. $ -0-

b. $30,000

c. $34,000

d. $54,000

midterm 1 mc6
Midterm 1—MC

5. Chip, a single individual has two sales of stock during the current year. The first sale produces a short-term loss of $10,000 and the second sale results in a long-term gain of $40,000. Chip's taxable income without considering the gain is $150,000. Chip's stock transactions will increase his income tax liability by:

a. $ 3,200

b. $ 4,500

c. $ 6,000

d. $ 8,000

e. $ 8,400

  • $30,000 x 15% = $4,500
midterm 1 mc7
Midterm 1—MC

6. Ramona's employer pays 100% of the cost of all employees' group-term life insurance. The life insurance plan is not discriminatory. Ramona’s annual salary is $100,000. What is the maximum amount of coverage that can be provided tax-free?

a. $ - 0 -

b. $ 5,000

c. $ 10,000

d. $ 50,000

e. $100,000

midterm 1 mc8
Midterm 1—MC

7. Conzois injured in an accident while working at his job. He received $1,500 in worker's compensation benefits for 5 weeks of lost work. How much should Conzo report as gross income from the receipt of these benefits?

a. $ - 0 -

b. $ 300

c. $ 750

d. $ 900

e. $ 1,500

midterm 1 mc9
Midterm 1—MC

8. The information that follows applies to the current year for Aaron and Janelle, a married couple:

  • Aaron is employed as a shoe salesman; his compensation is $75,000.
  • Janelle is employed by the state of Indiana; her compensation is $35,000.
  • Aaron and Janelle have total allowable itemized deductions of $12,000.
  • Aaron and Janelle have two dependent children.
  • Aaron and Janelle have other economic income as follows:

- Interest on U.S. Treasury notes $1,000.

- Interest on Compost Computer bonds $1,500.

- Interest on German government bonds $750.

- Interest on City of Nashville. bonds $1,200.

- Aaron's wealthy uncle gives him $1,000.

- Janelle sold Aaron's football card collection for $3,000. It cost $800.

- Janelle sells Aaron's fishing boat for $2,000. Aaron had purchased the boat 3 years ago for $2,800.

Based on the above information, what is Aaron and Janelle 's adjusted gross income?

a. $114,450

b. $114,700

c. $115,450

d. $116,450

e. $116,650

midterm 1 mc10
Midterm 1—MC

Income “Broadly Defined” (includes income from all sources)

Minus: Excluded income

Equals: Gross income

Minus: Deductions for AGI

Equals: AGI

Minus: Deductions from AGI

Minus: Exemptions

Equals: Taxable income

X Tax rate (schedule of rates)

Equals: Income tax

Minus: Tax credits

Tax prepayments

Equals: Tax (refund) due with return

midterm 1 mc11
Midterm 1—MC

Aaron’s compensation $75,000

Janelle’s compensation $35,000

Itemized deductions $12,000

Personal exemptions (x2) $7,600

Dependency exemptions (x2) $7,600

Interest on U.S. Treasury notes $1,000

Interest on Compost Computer bonds $1,500

Interest on German government bonds $750

Interest on City of Nashville bonds $1,200

Aaron's wealthy uncle gives him $1,000

Football card ($3,000- $800) $2,200

Boat ($2,000- $2,800) ($800)

midterm 1 mc12
Midterm 1—MC

8. The information that follows applies to the current year for Aaron and Janelle, a married couple:

  • Aaron is employed as a shoe salesman; his compensation is $75,000.
  • Janelle is employed by the state of Indiana; her compensation is $35,000.
  • Aaron and Janelle have total allowable itemized deductions of $12,000.
  • Aaron and Janelle have two dependent children.
  • Aaron and Janelle have other economic income as follows:

- Interest on U.S. Treasury notes $1,000.

- Interest on Compost Computer bonds $1,500.

- Interest on German government bonds $750.

- Interest on City of Nashville. bonds $1,200.

- Aaron's wealthy uncle gives him $1,000.

- Janelle sold Aaron's football card collection for $3,000. It cost $800.

- Janelle sells Aaron's fishing boat for $2,000. Aaron had purchased the boat 3 years ago for $2,800.

Based on the above information, what is Aaron and Janelle 's adjusted gross income?

a. $114,450

b. $114,700

c. $115,450

d. $116,450

e. $116,650

midterm 1 mc13
Midterm 1—MC

9. The information that follows applies to the current year for Revis and Patrica, a married couple.

•Revisis employed as a shoe salesman; his compensation is $65,000.

•Patricais employed as an interior designer; her compensation is $90,000.

•Revisand Patrica have total allowable itemized deductions of $15,000.

•Revisand Patrica have two dependent children.

•Revisand Patrica have other economic income as follows:

- Interest on U.S. Treasury bonds $1,000.

- Interest on French government bonds $750.

- Interest on City of Miami, Fla. bonds $1,200.

- Patrica won $500 from the state lottery

- Revis's wealthy uncle dies and leaves him $10,000.

- Patrica sold Revis's baseball card collection for $3,000. Revis bought it for $800.

- Patrica sells Revis's fishing boat for $2,000. Revis had purchased the boat for $2,500.

Based on the above information, what is Revis and Patrica 's taxable income?

a. $129,450

b. $129,950

c. $129,650

d. $144,450

e. $159,450

midterm 1 mc14
Midterm 1—MC

Income “Broadly Defined” (includes income from all sources)

Minus: Excluded income

Equals: Gross income

Minus: Deductions for AGI

Equals: AGI

Minus: Deductions from AGI

Minus: Exemptions

Equals: Taxable income

X Tax rate (schedule of rates)

Equals: Income tax

Minus: Tax credits

Tax prepayments

Equals: Tax (refund) due with return

midterm 1 mc15
Midterm 1—MC

Revis’s compensation $65,000

Patrica’s compensation $90,000

Itemized deductions ($15,000)

Personal exemptions (x2) ($7,600)

Dependency exemptions (x2) ($7,600)

Interest on U.S. Treasury bonds $1,000

Interest on French government bonds $750

Interest on City of Miami, Fla. bonds $1,200

Lottery $500

Revis's wealthy uncle dies $10,000

Baseball card ($3,000 - $800) $2,200

Boat ($2,000 - $2,500) ($500)

midterm 1 mc16
Midterm 1—MC

9. The information that follows applies to the current year for Revis and Patrica, a married couple.

•Revisis employed as a shoe salesman; his compensation is $65,000.

•Patricais employed as an interior designer; her compensation is $90,000.

•Revisand Patrica have total allowable itemized deductions of $15,000.

•Revisand Patrica have two dependent children.

•Revisand Patrica have other economic income as follows:

- Interest on U.S. Treasury bonds $1,000.

- Interest on French government bonds $750.

- Interest on City of Miami, Fla. bonds $1,200.

- Patrica won $500 from the state lottery

- Revis's wealthy uncle dies and leaves him $10,000.

- Patrica sold Revis's baseball card collection for $3,000. Revis bought it for $800.

- Patrica sells Revis's fishing boat for $2,000. Revis had purchased the boat for $2,500.

Based on the above information, what is Revis and Patrica 's taxable income?

a. $129,450

b. $129,950

c. $129,650

d. $144,450

e. $159,450

f. $129,250

midterm 1 mc17
Midterm 1—MC

10. Mike and Pam own a cabin near Teluride, Colorado. In the current year the cabin was rented for 8 days to friends. Mike and Pam used the cabin a total of 82 days during the same year. After allocating the expenses between personal and rental use, the following rental loss was determined:

Rental income $700 

Property taxes (250)

Mortgage interest (300)

Repairs and maintenance (100)

Utilities (150)

Rental loss $(100)

How should Mike and Pam report the rental income and expenses for last year?

a. Report the $100 loss for AGI.

b. Include the $700 in gross income, but no deductions are allowed.

c. Only expenses up to the amount of $700 rental income may be deducted.

d. Report the interest ($300) and taxes ($250) as itemized deductions and the other expenses for AGI.

e. No reporting for the rental activity is necessary.

midterm 1 mc19
Midterm 1—MC

10. Mike and Pam own a cabin near Teluride, Colorado. In the current year the cabin was rented for 8 days to friends. Mike and Pam used the cabin a total of 82 days during the same year. After allocating the expenses between personal and rental use, the following rental loss was determined:

Rental income $700 

Property taxes (250)

Mortgage interest (300)

Repairs and maintenance (100)

Utilities (150)

Rental loss $(100)

How should Mike and Pam report the rental income and expenses for last year?

a. Report the $100 loss for AGI.

b. Include the $700 in gross income, but no deductions are allowed.

c. Only expenses up to the amount of $700 rental income may be deducted.

d. Report the interest ($300) and taxes ($250) as itemized deductions and the other expenses for AGI.

e. No reporting for the rental activity is necessary.