15 Loss Limitations

Question 1

Provide two types of deductible losses by individual taxpayers.

Answer 1

Deductible losses by individual taxpayers are generally limited to the following:
*Trade or business
*Transactions entered into for profit
*Passive activities (only to the to the extent of passive income)
*Casualty and theft losses (if in a federally declared
disaster area)

Question 2

True or False: A realized loss is the same as a recognized loss.

Answer 2

False: Not all realized gains are necessarily recognized (ie, taxable and reportable to the IRS), and losses may be subject to deductible limitations.

Question 3

How is amount realized determined on the sale of an asset?

Answer 3

Cash received
+ FMV of property and/or services received
+ Debt relief (buyer assumes debt)
− Selling expenses
= Amount realized

Question 4

How is adjusted basis determined when an asset is sold?

Answer 4

Original cost
+ Capital improvements
− Accumulated depreciation
=Adjusted basis

Question 5

If an individual taxpayer has a net capital loss of $4,400, what amount can the individual deduct on their tax return?

Answer 5

If a net capital loss (i.e. netting of all capital asset dispositions) is incurred for the year, individuals are allowed to deduct up to $3,000 ($1,500 if married filing separately) of the loss against ordinary income. Remaining losses are carried forward indefinitely. ($1,400 carried forward = $4,400 - $3,000 deductible)

Question 6

Describe short-term holding period and long-term holding period.

Answer 6

Short-term holding period includes assets held for 365 days or less. Long-term holding period includes assets held for more than 365 days.

Question 7

True or False: The sale of an inherited asset is always classified as long-term.

Answer 7

True

Question 8

What is the holding period for a nonbusiness bad debt?

Answer 8

The write-off of nonbusiness bad debts is always classified as short-term capital losses, regardless of the actual holding period.

Question 9

Jessica has the following in the current year:
Short-term capital gain $1,200
Long-term capital loss $3,800
Section 1231 gain $2,900
What is Jessica’s reportable gain/loss?

Answer 9

Jessica has a net short-term capital gain of $300. The Section 1231 gain is treated as a long-term capital gain and is netted against the long-term capital loss resulting in a net long-term capital loss of $900. The net long-term capital loss of $900 is netted against the short-term capital gain resulting in a net short term capital gain of $300 ($1,200 - $900).

Question 10

If a taxpayer has a capital loss and a unrecaptured Section 1250 gain, a capital gain from the sale of a collectible, and long-term capital gains, what is the correct ordering procedure to offset the capital loss?

Answer 10

Losses offset the gains in order from the highest to the lowest tax rate as follows:
* First, apply losses against LTCGs on collectibles (eg, stamps, coins) which are taxed at 28%
* Second, apply remaining losses against unrecaptured Section 1250 gains that are taxed at 25%
* Third, any remaining LTCGs are generally taxed at 0%, 15%, or 20% depending on the taxpayer’s income level

Question 11

Define at-risk.

Answer 11

The amount the taxpayer could lose in the activity if the activity became worthless.

Question 12

A loss from a partnership is deductible if the taxpayer clears what three hurdles?

Answer 12

The loss from a partnership is deductible if it clears the basis, at-risk, and possibly the passive income hurdles. Suspended losses are carried forward until sufficient basis or P/S interest sold.

Question 13

What is included in determining the at-risk amount?

Answer 13

A taxpayer’s at-risk amount is generally the same as their basis in the activity, including their share of recourse debt (i.e., personally liable), amounts personally pledged as security for property not used in the activity, and qualified nonrecourse debt financing.

Question 14

True or False: A limited partner can include recourse debt in determining their at-risk amount.

Answer 14

False: A limited partner’s basis is increased for nonrecourse debt and qualified nonrecourse debt.

Question 15

Describe the calculation of a partner’s outside basis.

Answer 15

Partner’s initial contribution (or amount paid, if purchased)
Increased by:
* Additional contributions
* Share of increase in partnership liabilities
* Share of partnership income /other income
Decreased by:
* Cash and property distributions
* Share of reduction in partnership liabilities
* Share of partnership losses/other deductions
Partner’s ending basis (not below zero)
= Partner’s outside basis

Question 16

Describe the calculation of shareholder’s outside basis in an S corporation.

Answer 16

Shareholder’s beginning basis in corporation
+ Additional contributions
+ Percentage share of corporation’s ordinary income and separately stated income, gains
– Distributions from corporation (ie, cash and property)
– Percentage share of corporation’s operating loss and separately stated deductions, losses
= Ending shareholder outside basis

Question 17

True or False: Liabilities incurred by an S corporation are included in a shareholder’s outside basis.

Answer 17

False: Unlike partners, shareholders are not liable for the S corporation’s debt; therefore, no adjustment is required to their basis for corporation debt. However, direct loans from a shareholder of the corporation represent a separate “debt basis”.

Question 18

Describe the excess business loss limitation rule.

Answer 18

Individual taxpayers are subject to the excess business loss (EBL) limitation which is designed to limit the amount of loss deducted annually on an individuals’ tax return. Losses exceeding a statutory threshold amount are disallowed losses in the current year and carried forward as a net operating loss (NOL).

Question 19

True or False: A hobby loss is deductible.

Answer 19

False. If an activity is treated as a hobby, the activity may not create a deductible loss. Gross profit (ie, gross income less cost of goods sold) generated by the activity is taxable and reported as other income on Schedule 1 of the taxpayer’s tax return.

Question 20

Describe three factors that could be used to determine if an activity is a hobby or not.

Answer 20

Regulations have established nine factors that are considered when determining if an activity is a hobby or a for-profit business. There is no minimum number of factors that must be met; instead the evaluation of an activity is subjective in nature.
1. Is the activity conducted in a business manner?
2. Does the taxpayer (or their advisors) have required expertise?
3. How much time and effort is spent on the activity?
4. Does the taxpayer expect that the assets will appreciate in value?
5. Any previous success by taxpayers in similar activities?
6. What is the history of income or losses from the activity?
7. What is the relationship of profits earned to losses incurred?
8. What is the financial status of the taxpayer? Are there other substantial sources of income?
9. Are there elements of personal pleasure or recreation in the activity?

Question 21

Define a wash sale.

Answer 21

A wash sale occurs when securities are sold at a loss and the taxpayer acquires the same or substantially identical securities within 30 days before or after the sale.

Question 22

True or False: A wash sale is not deductible.

Answer 22

True. Losses from wash sales are not deductible because the taxpayer’s economic position does not change. The nondeductible loss is added to the basis of the acquired stock. If the number of shares acquired is less than the number originally purchased, the disallowed loss must be prorated (i.e. based on the shares acquired).

Question 23

Greg sold his boat at a loss of $4,200. Is this loss deductible?

Answer 23

No. Losses on the sale of assets held for personal-use or household use at prices less than original cost are not reported, as they are presumed to represent consumption.