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TAX1 Woodward Fall2012 FSU

If the taxpayer uses the property in a trade or business or holds the property for investment the tax law generally provides a

deduction for the losses

Other losses on personal-use property (e.g, a sale of personal residence at a loss)

are not deductible

For taxpayers to deduct a loss on property,

the loss must be both realized and recognized for tax purposes

The amount of loss realized on the sale of property is computed by

subtracting adjusted basis from amount realized.

Taxpayers can only deduct losses they incur in the sale or exchange of

property used in a trade or business or held for investment

A loss on business or investment property which is abandoned is deductible as an ordinary loss to the extent of the property's

adjusted basis on the date of abandonment.

A mere decline in value is not sufficient to create a deductible loss if the stock has

any recognizable value

Once the taxpayer determines the year of worthlessness , the taxpayer treats the loss as a

loss from the sale of a capital asset on the last day of the tax year

Taxpayers may not deduct any demolition costs or

any loss sustained on account of the demolition

Taxpayers must add demolition costs to the basis of

the land on which the demolished structure previously stood

Whether a deductible loss is ordinary or capital depends on

the type of property involved and the transaction in which the taxpayer sustains the loss

If both elements (i.e. a sale or exchange and a capital asset) are not present,

the deduction is an ordinary loss

Because a casualty is not a sale or exchange, the destruction of a capital asset in a casualty creates

an ordinary rather than capital loss

Taxpayers often invested in activities called tax shelters,

that would spin off tax deductions and credits, many were passive investments

In enacting the passive loss rules, Congress did not want to prevent taxpayers from

currently deducting or using losses and credits generated in active business endeavors of the taxpayer

When applying the limitations of the passive activity rules, a taxpayer's AGI is classified into active income, portfolio income and passive income. For this purpose, portfolio income includes

dividends, interest, annuities, and royalties.

Portfolio income becomes part of net investment income, which is used in computing

the deduction limit for investment interest expense

A taxpayer may use losses generated in one passive activity to offset income from other passive activities, but may not use them to offset

either active or portfolio income

A taxpayer carries over disallowed passive activity losses indefinitely and treats them as

losses allocable to that specific passive activity in the following tax years

A taxpayer may use suspended losses to

offset passive activity income of the subsequent year, but not to offset other types of income

When a taxpayer disposes of a passive activity in a taxable transaction, the taxpayer can compute

the economic gain or loss by the activity and can deduct the suspended losses of the activity against other income

If the taxpayer sells the passive activity to a related party, he or she may not deduct the suspended loss until

the related party sells the activity to a nonrelated person

An activity that was previously passive may not be passive with respect to

the taxpayer for the current year

Passive activity includes

any trade or business in which the taxpayer does not materially participate as well as any rental activity

Passive activity is based on two critical elements:

An identification of exactly what constitutes as an activity and a determination of whether the taxpayer has materially participated in that activity

Taxpayers may deduct currently up to $25,000 of

passive losses from rental real estate activities

Once taxpayers establish the activities they must be consistent in grouping these activities in subsequent years unless

material changes in the facts and circumstances clearly make the groupings inappropriate

The taxpayer may not combine rental activities involving real estate with

rental activities involving personal property

Partnerships and S corporations must identify their business and rental activities by applying these rules at the partnership or S corporation level and then

must report the results of their operations by activity to the partners or shareholders

If the taxpayer does not Materially Participate in the activity, it is deemed to be a

passive activity with respect to that taxpayer

Many rental real estate activities are not considered rental real estate businesses and are, therefore,

subject to the passive loss rules

If an individual taxpayer meets certain requirements, the taxpayer still may deduct against income up to $25,000 of

annual losses from theses passive rental real estate activities

Individuals must do both of the following

- Actively participate in the activity
- Own at least 10% of the value of the activity for the entire tax year

Active participation is different from material participation, and is a

lesser standard of involvement

Up to $25,000 of passive losses attributable to rental real estate can be deducted each year against

income from nonpassive sources such as salary, interest, and dividends

Taxpayers may take a limited deduction if the loss on personal-use property arises from

a fire, shipwreck, other casualty, or theft.

Casualty loss

is one that occurs in an identifiable event that Is sudden, unexpected, unsusual.

A taxpayer may also deduct loss sustained as the result of a theft, which includes

theft of business, investment, or personal-use property

Measure the loss by comparing the property's

FMV immediately before and immediately after the casualty

Property partially destroyed, amount of the loss is the lesser of

the reduction in the property's FMV or the taxpayer's adjusted basis in the property

Business or Investment property totally destroyed in a casualty, the amount of the loss is

the taxpayer's adjusted basis in the property, even if it is greater than the property's FMV

Personal-use property totally destroyed in a casualty, the amount of the loss is

limited to the lesser of the reduction in the property's FMV or the property's adjusted basis

The amount an individual may deduct for a casualty loss on personal-use property is subject to two limitations

1- Losses sustained in each separate casualty must be reduced by $100, and
2- The total amount of all net casualty losses for personal-use is reduced by 10% of the taxpayers AGI for the year

Many taxpayers who sustain casualty and theft losses on personal-use property DO NOT receive

a tax deduction

If the casualty gains exceed the losses for the year, all the gains and losses are treated as

capital gains and losses

A taxpayer may elect to deduct a casualty loss in the year preceding the year in which

the loss actually occurs

This election is available to taxpayers who suffer losses attributable to a disaster that occurs in an area subsequently declared by the

President of the United States as a disaster area

A bona fide debtor-creditor relationship mist exist between

the taxpayer and some other person or entity

Taxpayers may only use the specific write-off method of accounting in

deducting the bad debt

For bad debt to be deductible,

the creditor must have basis in the debt

A cash method taxpayer reports income only in the year in which

payment in the form of cash or property is received

Because a note constitutes the receipt of property, a cash method taxpayer

reports income in the year the note is received

If the cash method taxpayer does not receive a note and the receivable is an open account item,

the taxpayer reports no income until the receivable is collected

The taxpayer has no basis in the receivable and does not receive bad debt if

the receivable is not collected

Except for certain specialized industries, however, taxpayers can use only the

specific write-off method for tax purposes

Net operating loss generally involves only

business income and expenses

The starting point in calculating an individuals NOL is

generally taxable income

Net Operating Loss for Individuals

- ADD back any NOL DEDUCTION
- ADD BACK ANY CAPITAL LOSS DEDUCTION
- ADD BACK THE DEDUCTION FOR PERSONAL EXEMPTION
- ADD BACK EXCESS OF BUSINESS DEDUCTIONS OVER NONBUSINESS INCOME

NOL is initially carried back for two years and is deductible

as an offset to the taxable income of the carryback years

If any loss remains, taxpayers may then

carry it forward for a period of 20 years

For both carryback and carryforward periods, the loss must be deducted from

the years in chronological order

Any NOL that is not used during the carryover period

expires and is of no further tax benefit

A taxpayer may elect to not caryback the NOL, but to carry the loss

forward; which does not extend beyond 20 years

Loss carryovers from two or more years, the loss of the earliest year is always completely used first before

deducting any of the losses incurred in a subsequent year

Because the NOL is attributable to a taxpayer's trade or business, it is

deductible for AGI

All of these deductions except the deduction for charitable contributions must be

recomputed using the reduced AGI amount

If an NOL is incurred, when would a taxpayer elect to forgo the carryback period and only carry the loss deduction forward?

If an NOL is incurred, when would a taxpayer elect to forgo the carryback period and only carry the loss deduction forward?

How is a claim for refund of taxes filed by an individual who carries an NOL deduction back to a prior year?

A claim for refund of taxes is filed by either filing an amended return on Form 1040X or filing for a quick refund on Form 1045.

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