Chapter 7 Reading Notes

Question 1

Deductible losses on personal use property are deducted as

Answer 1

an itemized

deduction

Question 2

If the gambling is a trade or business, his

gambling losses are deductions

Answer 2

for AGI

Question 3

If the gambling activity is not a trade or

business, the losses are

Answer 3

itemized deductions

Question 4

A business bad debt is classified as

Answer 4

a deduction for AGI

Question 5

a nonbusiness bad debt is classified as

Answer 5

a short-term capital loss

Question 6

If a taxpayer sells goods or provides services on credit and the account receivable
subsequently becomes worthless, a bad debt deduction is permitted only if income
arising from the creation of the account receivable was

Answer 6

previously included in

income.

Question 7

No deduction is allowed, for example, for a bad debt arising from the sale
of a product or service when the taxpayer is on the

Answer 7

cash basis because no income is

reported until the cash has been collected.

Question 8

Taxpayers (other than certain financial institutions) may use only the _____ ____ __ ____ in accounting for bad debts.

Answer 8

specific charge-off method

Question 9

Certain financial institutions are

allowed to use the ______ _______ for computing deductions for bad debts.

Answer 9

reserve method

Question 10

A taxpayer using the specific charge-off method may claim a deduction when a
specific business debt becomes what two things

Answer 10

either partially or wholly worthless

Question 11

What about for a non-business debt

Answer 11

It must be wholly worthless

Question 12

If a business debt previously deducted as partially worthless becomes totally
worthless in a future year, only what can be deducted?

Answer 12

the remainder not previously deducted can be

deducted in the future year.

Question 13

If the taxpayer purchased the debt and it went bad, the deduction is equal to

Answer 13

the amount the taxpayer paid for the debt instrument

Question 14

The loss is deductible only in the year of partial or total worthlessness for non-business
debts

Answer 14

False. The loss is deductible only in the year of partial or total worthlessness for business debt. It’s only recognized in the year of total worthlessness for non-business debts

Question 15

In 2010, Ross loaned $1,000 to Kay, who agreed to repay the loan in two years. In
2012, Kay disappeared after the note became delinquent. If a reasonable investigation
by Ross indicates that he cannot find Kay or that a suit against Kay would not result in
collection, Ross can do what?

Answer 15

deduct the 1,000 in 2012

Question 16

In Example 3, assume that Kay filed for personal bankruptcy in 2011 and that the debt
is a business debt. At that time, Ross learned that unsecured creditors (including Ross)
were ultimately expected to receive 20 cents on the dollar. In 2012, settlement is
made, and Ross receives only $150. How much should he deduct for 2011 and 2012

Answer 16

He should deduct 800 in 2011 and 50 in 2012

Question 17

A nonbusiness bad debt is a debt unrelated to the taxpayer’s trade or business either
when it was _______ or when it became ______

Answer 17

created; worthless

Question 18

the most common type of nonbusiness bad debt.

Answer 18

loans to relatives or friends

Question 19

is deductible as an ordinary loss in the year incurred

Answer 19

business bad debt

Question 20

is always treated as a short-term capital loss

Answer 20

nonbusiness bad debt

Question 21

The maximum
amount of a net short-term capital loss that an individual can deduct against
ordinary income in any one year is

Answer 21

3000

Question 22

What is better business debt or nonbusiness? Explain

Answer 22

business debt because is better because nonbusiness is limited to 3000

Question 23

In 2011, Leif sold his business but retained a claim (note or account receivable) against E X A M P L E 6
Bob. The claim became worthless in 2012. Leif’s loss is treated as a?

Answer 23

business bad debt because the debt was created in the conduct of is former trade or business

Question 24

Can corporations have nonbusiness bad debt?

Answer 24

The nonbusiness bad debt provisions are not applicable to corporations. It is
assumed that any loans made by a corporation are related to its trade or business.
Therefore, any bad debts of a corporation are business bad debts.

Question 25

Lana loans $2,000 to her widowed mother for an operation. Lana’s mother owns no E X A M P L E 7
property and is not employed, and her only income consists of Social Security benefits.
No note is issued for the loan, no provision for interest is made, and no repayment
date is mentioned. In the current year, Lana’s mother dies, leaving no estate. Assuming
that the loan is not repaid, can Lana take a deduction?

Answer 25

Lana cannot take a deduction for a nonbusiness bad debt

because the facts indicate that no debtor-creditor relationship existed

Question 26

Explain worthless securities?

Answer 26

securities that become completely worthless during the year. Such securities are shares of stock, bonds, notes, or other
evidence of indebtedness issued by a corporation or government

Question 27

Explain small business stock (§ 1244 stock)

Answer 27

However, it is possible to receive an ordinary loss
deduction if the loss is sustained on small business stock (§ 1244 stock). This loss
could arise from a sale of the stock or from the stock becoming worthless

Question 28

Who can receive ordinary loss deduction under the small business stock 1244 stock?

Answer 28

Only

individuals7 who acquired the stock from the corporation are eligible

Question 29

The ordinary loss treatment is limited to how much?

Answer 29

50,000 (100,000 for married indivuduals filing jointly)

Question 30

Losses on § 1244 stock in

excess of the statutory limits receive capital loss treatment?

Answer 30

True

Question 31

Ordinary is business bad debt? Capital loss is nonbusiness?

Answer 31

True

Question 32

The corporation must meet certain requirements for the loss on such stock to
be treated as an ordinary—rather than a capital—loss. The major requirement is

Answer 32

that the total amount of money and other property received by the corporation for
stock as a contribution to capital (or paid-in surplus) does not exceed $1 million.
The $1 million test is made at the time the stock is issued

Question 33

ection 1244 stock cannot

be common or preferred stock.

Answer 33

False. It can be both

Question 34

Bad Debt Deduction table 7.2 on page 7-7

Answer 34

.

Question 35

An individual may deduct the following losses under § 165(c):

Answer 35

• Losses incurred in a trade or business.
• Losses incurred in a transaction entered into for profit.
• Losses caused by fire, storm, shipwreck, or other casualty or by theft.

Question 36

An individual taxpayer may deduct losses to property used in the taxpayer’s
trade or business or losses to property used in a transaction entered into for profit.
Examples include

Answer 36

a loss on property used in a proprietorship, a loss on property
held for rent, or a loss on stolen bearer bonds.

Question 37

Note that an individual’s losses on
property used in a trade or business or on transactions entered into for profit are
not limited to losses caused by fire, storm, shipwreck, or other casualty or by theft?

Answer 37

True

Question 38

An individual taxpayer suffering losses from damage to nonbusiness property
can deduct only those losses attributable to

Answer 38

fire, storm, shipwreck, or other casualty
or theft. Although the meaning of the terms fire, storm, shipwreck, and theft is relatively
free from dispute, the term other casualty needs further clarification. It means
casualties analogous to fire, storm, or shipwreck. The term also includes accidental
loss of property provided the loss qualifies under the same rules as any other casualty.

Question 39

The term also includes accidental
loss of property provided the loss qualifies under the same rules as any other casualty.
These rules are that the loss must result from an event that is what 3 things.

Answer 39

1. identifiable
2. damaging to property
3. sudden, unexpected and unusual

Question 40

an event that is swift and precipitous and not gradual or progressive.

Answer 40

sudden event

Question 41

an event that is ordinarily unanticipated and occurs

without the intent of the individual who suffers the loss.

Answer 41

unexpected event

Question 42

is an
event that is extraordinary and nonrecurring and does not commonly occur during
the activity in which the taxpayer was engaged when the destruction occurred

Answer 42

unusual event. Examples include hurricanes, tornadoes, floods, storms, shipwrecks, fires, auto accidents,
mine cave-ins, sonic booms, and vandalism.

Question 43

Damage must be to the taxpayer’s property to qualify as a

Answer 43

casualty loss

Question 44

A taxpayer can take a deduction for a casualty loss from an automobile accident
only if

Answer 44

the damage was not caused by the taxpayer’s willful act or willful negligence.

Question 45

Ted parks his car on a hill and fails to set the brake properly and to curb the wheels.
As a result of Ted’s negligence, the car rolls down the hill and is damaged. Do the repairs qualify for casualty loss treatment.

Answer 45

The repairs
to Ted’s car should qualify for casualty loss treatment because Ted’s act of negligence
appears to be simple rather than willful

Question 46

Not all acts of God are treated as casualty losses for income tax purposes. Because a
casualty must be what three things?

Answer 46

Sudden
unexpected,
unusual

Question 47

Examples of nonsudden events that generally do not qualify as casualties include

Answer 47

disease and insect damage

Question 48

Other examples of events that are not casualties are losses resulting from

Answer 48

a
decline in value rather than an actual loss of the property. No loss was allowed
where the taxpayer’s home declined in value as a result of a landslide that
destroyed neighboring homes but did no actual damage to the taxpayer’s home

Question 49

Similarly, a taxpayer was allowed a loss for the actual flood damage to his property
but not for the decline in market value due to the property being flood-prone?

Answer 49

true

Question 50

are computed like other casualty losses (discussed in the following
section), but the timing for recognition of the loss differs

Answer 50

theft losses

Question 51

When is a theft loss deducted

Answer 51

in
the year of discovery, not the year of the theft (unless, of course, the discovery
occurs in the same year as the theft

Question 52

Keith’s new sailboat, which he uses for personal purposes, was stolen from the storage E X A M P L E 1 1
marina in December 2011. He discovered the loss on June 3, 2012, and filed a claim
with his insurance company that was settled on January 30, 2013. Assuming that there
is a reasonable expectation of full recovery, no deduction is allowed in 2012. A partial
deduction may be available in 2013 if

Answer 52

the actual insurance proceeds are less than the
lower of the fair market value or the adjusted basis of the asset. (Loss measurement
rules are discussed later in this chapter.)

Question 53

are casualties sustained in an area designated as a disaster area
by the President of the United States

Answer 53

disaster area losses

Question 54

different measurement rule applies for partial destruction of business property
and income-producing property and for partial or complete destruction of personal
use property. In these situations, the loss is the lesser of the following:

Answer 54

• The adjusted basis of the property.
• The difference between the fair market value of the property before the event
and the fair market value immediately after the event.

Question 55

Rocky, who had AGI of $30,000, was involved in a motorcycle accident in 2012. His
motorcycle, which was used only for personal use and had a fair market value of
$12,000 and an adjusted basis of $9,000, was completely destroyed. He received $5,000
from his insurance company. What is rocky’s casualty loss deduction?

Answer 55

Rocky’s casualty loss deduction is $900 [$9,000 basis −
$5,000 insurance recovery − $100 floor − $3,000 (.10 × $30,000 AGI)]. The $900 casualty
loss is an itemized deduction (from AGI). n

Question 56

When a nonbusiness casualty loss is spread between two taxable years because of
the reasonable prospect of recovery doctrine, the loss in the second year is reduced
by the $100 floor

Answer 56

False. It is not reduced in the second year. owever, the loss in
the second year is still subject to the 10 percent floor based upon the taxpayer’s second-
year AGI

Question 57

What types of losses are subject to the 100 dollar floor and 10% of AGI.

Answer 57

Only personal use assets

Question 58

Casualty and theft losses incurred by an employee

in connection with a trade or business are deductible for AGI if

Answer 58

the loss is reimbursed by the employer.

Question 59

If the loss is not reimbursed, the loss is deductible

Answer 59

from AGI as a miscellaneous itemized deduction subject to the 2 percent of AGI floor

Question 60

all such costs incident to the development of an experimental or
pilot model, a plant process, a product, a formula, an invention, or
similar property, and the improvement of already existing property
of the type mentioned. The term does not include expenditures such
as those for the ordinary testing or inspection of materials or products
for quality control or those for efficiency surveys, management
studies, consumer surveys, advertising, or promotions.

Answer 60

research and experimental expenditures

Question 61

The law permits the following three alternatives for the handling of research and
experimental expenditures:

Answer 61

• Expensed in the year paid or incurred.
• Deferred and amortized.
• Capitalized.

Question 62

If the costs are capitalized, a deduction is not available until

Answer 62

the research project

is abandoned or is deemed worthless

Question 63

domestic

production activities deduction (DPAD) is?

Answer 63

9% times the lesser of Qualified production activities income (QPAI) or Taxable (or modified adjusted gross) income
or alternative minimum taxable income

Question 64

Qualified production activities income (QPAI) is the excess of

Answer 64

domestic production
gross receipts (DPGR) over the sum of:
• The cost of goods sold allocated to such receipts.
• Other deductions, expenses, or losses directly allocated to such receipts.
• The ratable portion of deductions, expenses, and losses not directly allocable
to such receipts or another class of income

Question 65

Five specific categories of DPGR qualify for the DPAD:

Answer 65

• The lease, license, sale, exchange, or other disposition of qualified production
property (QPP) that was manufactured, produced, grown, or extracted
(MPGE) in the United States.
• Qualified films largely created in the United States.
• The production of electricity, natural gas, or potable water.
• Construction (but not self-construction) performed in the United States.
• Engineering and architectural services for domestic construction.

Question 66

Do Example 28

Answer 66

.

Question 67

An NOL generally must be applied initially to the

Answer 67

wo taxable years preceding the
year of the loss (unless an election is made not to carry the loss back at all). It is carried
first to the second prior year and then to the immediately preceding tax year
(or until used up).

Question 68

If the loss is not fully used in the carryback period, it must be

Answer 68

carried forward to the first year after the loss year and then forward to the second,
third, etc., year after the loss year.

Question 69

The carryover period is 20 years. A loss sustained

in 2012 is used in this order:

Answer 69

2010, 2011, 2013 through 2032

Question 70

A three-year carryback period is available for any portion of an individual’s NOL
resulting from a

Answer 70

casualty or theft loss

Question 71

small business is a business whose average annual gross receipts
for a three-year period are

Answer 71

$5 million or less

Question 72

A 5-year carryback period and a 20-year carryover period are allowed for a

Answer 72

farming loss

Question 73

When the taxpayer has NOLs in two or more years, the rule is always to use what loss first?

Answer 73

the earliest
year’s loss first until it is completely absorbed. The later years’ losses can then be
used until they also are absorbed or lost

Question 74

A taxpayer can irrevocably elect not to carry back an NOL to any of the prior years. In that
case, the loss is available as a carryover for 20 years?

Answer 74

True. This could be beneficial if the tax bracket is higher in carryforward years