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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.

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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. 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

  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 Net Operating Loss (NOL) • 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 ProceduralConsiderations • Casualty losses • Net Operating Losses • Worthless Securities

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