Chapter 7

1. Chapter 7 • Bad Debts (business versus nonbusiness) • Worthless Securities (holding period) • 1244 Stock • Casualty Losses (business versus personal) • Research & Development (R&D) - expense or capitalize?? • Net Operating Losses

2. Business and Nonbusiness Bad Debt • Business Bad Debt is deductible as an ordinary loss in the year incurred. • NonBusiness Bad Debt is always treated as a SHORT TERM CAPITAL LOSS. No loss recognized until the debt is completely worthless

3. Worthless Securities • Capital loss is allowed for securities (stocks, bonds) that become completely worthless during the year. Loss is considered to have become worthless on the last day of the taxable year. • 1244 Stock – Small business stock that when issued meets certain qualifications. Loss is considered to be ordinary (not capital). Only individual shareholders qualify, and the loss is limited to $50,000 per taxpayer ($100K joint). 1244 applies only to losses, not gains.

4. Casualty Loss • Casualty – sudden, unusual and unexpected. (fire, tornado, hurricane, storm, theft) • Casualty rules apply to business as well as nonbusiness (personally owned) property. But the rules are different between the two. • Generally, deducted in the year the loss occurs (for theft, year of discovery). If reasonable prospect of recovery (insurance) is expected, no loss permitted. If you expect a partial recovery, a partial deduction can be taken. • Disaster Area Losses – deduct in prior year or current year.

5. Casualty Loss – Computing Loss • Business Loss / Completely Destroyed – loss is equal to adjusted basis at time of loss (reduced by insurance recovery). • Business Loss / Partial Destruction – loss is equal to lesser of: • Adjusted basis • Difference between FMV before and after the event (the decrease in value due to the casualty)

6. Casualty Loss – Personal • Personal Loss – loss is equal to lesser of: • Adjusted basis • Difference between FMV before and after the event (the decrease in value due to the casualty) • Amount of the loss must be reduced: • $100 per event (per tornado, per fire etc.) • 10% of AGI (aggregate of all casualites)

7. Casualty Loss – Personal (con’t) • Are casualty losses deductions FOR AGI or deductions FROM AGI?? Answer: it depends. • Can we have gains from casualty losses? How are they treated? • In determining the 10% of AGI reduction, net all casualties together including gains or losses.

8. Research and Development Expense • Definition – costs associated with the development of an experimental model, plant process, a formula, invention, etc. • Does Not Include: expenditures relating to testing or inspecting products for quality control. Advertising or promotion, or consumer surveys do not qualify. Efficiency studies or management studies do not qualify.

9. R & D (con’t) • Expense Method – election can be made to expense all R&D expenditures in the current year and all subsequent years. Cannot change methods once you start. Why would you want to change? • Capitalize and Amortize – R&D expenses are accrued and amortized over 60 180 months beginning in the month in which taxpayer realizes benefits from the expenditure.

10. Net Operating Losses • Net Operating Loss (NOL’s) occur when deductions exceed revenue leaving the taxpayer with a net loss for the taxable year. • NOL’s may are first carried back to the preceeding two tax years and then forward for as many as twenty years. • An irrevocable election may be made not to carry the loss back but only to carry it forward.