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Chapter 8
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Chapter 8

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  1. Chapter 8 Losses and Bad Debts

  2. 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

  3. 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

  4. 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

  5. Classifying The Loss On A Taxpayer’s Return • Ordinary vs. Capital loss • Disallowance possibilities

  6. 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)

  7. 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

  8. 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

  9. 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.

  10. Passive Losses • Computation of passive losses and credits • Carryovers • Definition of passive activity

  11. Passive Losses • Taxpayers subject to passive loss rules • Publicly traded partnerships • Rental real estate trade or business • Other rental real estate activities

  12. 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

  13. Taxpayers Subject To Passive Loss Rules • 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

  14. 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

  15. 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

  16. Casualty & Theft Losses • What is a casualty • What is a theft • Deductible amount of casualty loss

  17. 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

  18. 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

  19. 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

  20. Casualty & Theft Losses • Casualty gains and losses attributable to business and investment property • When losses are deductible

  21. Bad Debts • Bona fide debtor-creditor relationship • Taxpayer must have basis in the debt • Debt must be worthless • Non-business bad debts

  22. Bad Debts • Business bad debts • Accounting for the business bad debts • Recovery of bad debts • Deposits in insolvent financial institutions

  23. Net Operating Loss • Involves business income and deductions only and will increase an NOL(Net Operating Loss) • Computing the NOL • Carryback and carryover periods • Recomputation of taxable income in the carryover year

  24. 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

  25. Compliance and Procedural Considerations • Net Operating Loss • Worthless Securities