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Survey Of Taxation > Chapter 9: Losses And Bad Debts > Flashcards

Chapter 9: Losses And Bad Debts Flashcards

1
Q

Closed transaction doctrine

A

For a loss it be realized it must have occured in a completed (closed) transaction, evidenced by an identifiable event such as a sale or exchange

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2
Q

Losses on Property used partially for business and partially for personal use

A

Loss attributable to business portion is deductible, but not the personal portion (unless loss was sustained in federally declared disaster zone)

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3
Q

Calculating loss on sale or exchange of property

A

Amount realized (cash+ FMV of any property received+value of any liabilities assumed by the buyer) - adjusted basis

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4
Q

Treatment of selling costs for inventory

A

Generally deductible period expenses but not part of gain or loss from sale

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5
Q

Selling costs for property not usually held for sale in the ordinary course of taxpayer’s business

A

Selling costs reduced amount realized from sale or exchange

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6
Q

Loss on sale of business inventory

A

Ordinary loss

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7
Q

Loss on the sale of a capital asset

A

Capital loss

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8
Q

Expropriated, sized, confiscated, or condemned property

A

If property used in trade or business: treated as sale or exchange and loss is deductible (type of loss depends on type of property)

No deduction for personal-use property

Deduction may be take only in the year property is actually seize

If receive compensation in excess of basis: recognize gain (potentially deferred)

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9
Q

When may a taxpayer abandon property

A

If it becomes worthless or is not worth repairing in order to return property to a serviceable condition

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10
Q

Tax treatment of abandoned property

A

If property still has a basis taxpayer may realize a loss

Loss only deductible if property is business or investment property

Loss is ordinary loss based on property’s adjusted value on date of abandonment

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11
Q

Abandonment of depreciable property

A

Taxpayer must physically abandon the property to take a loss

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12
Q

Tax treatment of worthless securities

A

Taxpayer may take a deduction for securities that become COMPLETELY worthless during the tax year

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

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13
Q

Determining when a security is worthless

A

Taxpayer must show that the security is completely worthless, beyond simple decline in value

Ex: bankruptcy where liabilities exceed FMV of assets so shareholders have no possibility of receiving anything of value

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14
Q

Circumstance where a domestic corporation can treat loss from worthless securities of an affiliate as an ordinary loss

A
  • domestic corporation owns at least 80% of the voting power of all classes of affiliated corporations stock and 80% of the total value of that stock
    AND
  • more than 90% of the affiliated corporation’s gross receipts for all it’s taxable years must be from nonpassive income
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15
Q

Nonpassive income

A

All income other than royalties, rents, dividends, interest, annuities, and gains from the sale or exchange or stocks and securities

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16
Q

Demolition of property

A

Not a deductible loss but rather a cost to be added to the basis on the improved land on which the structure stood

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17
Q

Capital loss

A

Loss on the:
- sale or exchange of a
- capital asset

Must be both of these above

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18
Q

Ordinary loss

A

Losses that are not capital losses

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19
Q

Capital assets

A

Generally all assets except:
- inventory
- notes and accounts receivable
- depreciable property and land used in trade or business

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20
Q

Destruction or abandonment of a capital asset

A

Ordinary loss
(Because casualty is not a sale or exchange)

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21
Q

Non sale or exchange transactions treated as sale or exchange

A
  • securities becoming worthless
  • seizure or condemnation of property
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22
Q

Section 1231 property

A

Real or depreciable property used in trade or business and held for more than one year

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23
Q

Gains and losses on section 1231 property

A

Must be netted together
If net gain = long term capital gain
If net loss= ordinary loss

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24
Q

Section 1244 stock

A

Qualified small business stock

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25
Q

Tax treatment of Loss on section 1244 stock

A

Deductible as ordinary losses up to a maximum of $50,000/tax year ($100,000 if MFJ)
Any remaining loss is capital loss

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26
Q

Qualifications for loss on section 1244 stock to be treated as ordinary

A
  • stock owned by an individual or partnership
  • stock originally issued by the corporation to the individual or to a partnership in which the individual is a partner
  • must be stock in a domestic corporation
  • must must have been received in exchange for cash and property (other than stock or securities) contributed by the individual to the Corp (not for services)
  • corporation cannot have derived over 50% of gross receipts from passive income during the five tax years preceding sale/worthlessness
  • total money and property contributed (to paid in capital and APIC) may not exceed $1M at the time the Corp issued the stock (corporation may have grown after)
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27
Q

Certain disallowed or deferred losses

A
  • transfers of property to a controlled corporation in exchange for that corp’s stock
  • certain like-kind exchanges of property
  • property sold to related parties
  • wash sale transactions
  • losses that exceed the amount for which the taxpayer was at risk
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28
Q

Active income

A

Wages, salaries, active business income

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29
Q

Portfolio income

A

Dividends, interest, annuities, and royalties (and allocable expenses, interest expense) not derived in the ordinary course of trade or business

Also gains or losses on disposal of property that produced portfolio income

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30
Q

Passive income

A

Income from a passive activity (any trade or business that the taxpayer makes money from but does not materially participate in)

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31
Q

General rule for passive income and loss

A

Passive income and loss computed separately for each passive activity in which the taxpayer has invested

Passive losses may be used to offset passive income but not to offset active or portfolio income

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32
Q

Carryover of passive losses

A

Unused passive losses can be carried forward indefinitely, treating them as losses allocated to that specific passive activity

May offset other passive income but not active or investment income

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33
Q

Suspended losses

A

Loss from passive activity carried forward into subsequent years

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34
Q

Determining carryover losses with multiple passive activity losses

A

Pro rata formula to determine amount of loss carried over vs amount applied to current year’s income

Total carryover amount x (loss from activity x/total loss for year) = loss carryover for activity x

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35
Q

Tax treatment of disposal of passive activity in a taxable transaction

A

Any suspended losses from the activity disposed of, remaining after offsetting passive losses against passive incomes may be deducted from other income (after applying the limitation based on excess business losses for noncorporate taxpayers: $262,000 or $524,000 for MFJ)

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36
Q

If passive activity is sold to a related party

A

Suspended loss cannot be deducted until related party sells the activity to a non-related person

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37
Q

Deduction of suspended losses allowable on taxpayer death

A

Deduction allowed to the amount by which the suspended losses excess the increase in the basis (FMV) of the property (suspended losses up to amount of increase are never deductible)

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38
Q

Disposal of a substantial part of a passive activity

A

May be treated as disposition of a separate activity (and suspended losses deducted) if taxpayer can establish with reasonable certainty the income, deductions, credits, and suspended losses allocable to that part of the activity

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39
Q

When is determination of active vs passive activity made?

A

Annually

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40
Q

Former passive activity

A

When an activity that was previously passive is not passive with respect to the taxpayer in the current year

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41
Q

Tax treatment of suspended loss from former passive activity

A

Suspended loss can be deducted against current year’s income from the activity even though it is no longer passive.

Suspended loss in excess of activity’s income remains subject to carryover limitations BUT losses sustained when activity is not passive are deductible against other active business income

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42
Q

Passive activity and tax credits

A

Any tax credits generated in a passive activity may only be used against the portion of the taxpayer’s tax liability attributable to passive income

Unused credits may be carried forward but can only ever offset tax liability from passive income

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43
Q

To determine tax liability attributable to passive income

A

Compare tax liability on income WITHOUT passive income to tax liability on all income

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44
Q

Passive activity

A

Any trade or business in which a taxpayer does not materially participate, as well as any rental activity (with the exception of rental activity considered to be a real property trade or business)

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45
Q

Identification of an “activity”

A

Taxpayers may use any reasonable method of applying the relevant facts and circumstances in grouping operations into activities

Once activities are established the groupings must be consistent in subsequent years unless material changes make grouping inappropriate

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46
Q

Factors used in determining single activities

A
  • similarities and differences in the types of business
  • extent of common control
  • extent of common ownership
  • geographical location
  • interdependencies between the operations
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47
Q

Grouping rental activities

A

Rental operations generally may NOT be grouped with trade or business operations. Unless rental operation is insubstantial in relation to business operation or vice versa

May not combine real estate rental activities with personal property rental activities

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48
Q

Identification of an activity for a pass through entity

A

Must apply same rules but at partnership/s corp level and report operations by activity to partners/shareholders

Partners/shareholders then use same rules

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49
Q

Tests of material participation

A

to be considered materially participating an individual must meet at least one of the following:
- participates in activity for more than 500 hours/year
- their participation constitutes substantially all participation by all individuals (inc non-owners)
- participates for more than 100 hrs/year AND that participation is more than any other’s participation in the year (including non-owners)
- participates in separate “significant participation activities” for over 100 hrs each, for an aggregate of over 500 hrs/year
- materially participated in the activity in any five years of the immediately preceding 10 tax years (need not be consecutive)
- materially participated in the activity for any three years preceding the year in question if a personal service activity
- participates in the activity on a regular, continuous, and substantial basis during the year talking into account all relevant facts and circumstances

Participation of taxpayer’s spouse also taken into account

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50
Q

When must material participation tests be applied

A

Every year

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51
Q

Limited partnerships

A

Generally income and deductions passed to a limited partner are passive, but depends on the material participation tests

52
Q

Working interest in an oil and gas property

A

An interest responsible for the cost of development or operation of an oil and gas property

NOT passive as long as liability in interest is not limited

53
Q

Who do the passive loss rules apply to

A
  • individuals, estates, and trusts (including partner and shareholders receiving income/loss from a S corp or partnership)
  • closely held C corporations
  • personal service corporation
  • certain publicly traded partnerships
54
Q

Closely held C corporation

A

A c corp where more than 50% of the stock is owed by five or fewer individuals at any time during the last half of the corporations taxable year

55
Q

Passive loss rules for closely held C corps

A

Passive losses may not offset portfolio income but MAY offset income from active business operations

56
Q

Personal service corporation

A

A C corp whose owner-employees hold more than 10% of the value of the stock and whose principal activity is performance of personal services that are substantially performed by owner employees

57
Q

Rules to determine if a personal service corporation material participated in an activity

A
  • if one or more of the shareholders who own more than 50% of the value of the outstanding stock materially participate in an activity
58
Q

Passive loss rules for Personal service corporations

A

Rules apply in their entirety. Passive loss cannot be used to offset active business income or portfolio income

59
Q

Rules to determine if a closely held C corp materially participates

A
  • if one or more of the shareholders who own more than 50% of the value of the outstanding stock materially participate in an activity

Plus all the following:
- a substantial portion of the services of at least one full time employee is in the active management of the activity
-a substantial portion of the services of at least three full-time nonowner employees is directly related to the activity
(Both above for the 12 month period ending last day of tax year)
- section 162 business deductions of the activity exceed 15% of the activity’s gross income for the period

60
Q

Publicly traded partnerships

A

PTP
Any partnership if interests in the partnership are either traded on an established securities market or readily tradable on a secondary market

61
Q

Publicly traded partnerships and passive loss rules

A
  • If corporate tax provisions apply generally passive loss rules DO NOT apply
  • if partnership tax provisions apply, passive loss rules apply at the partner level
  • losses from a PTP separate from other types of income, including income from other PTPs. Can only be offset against income from that particular PTP (but not portfolio income)
62
Q

If interest in a PTP disposed of

A

Partner may deduct suspended losses from a PTP if they dispose of their interest. However they may not if the PTP itself sells the passive activity

63
Q

Real property trade or business

A

Involves the development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokering of real property

64
Q

When do the passive loss rules not apply to a real property trade or business

A

Considered an active trade or business if taxpayer:
- performs more than 750 hours of work during the taxable year in material participation in real property trades or businesses
And
- more than 1/2 the personal services performed by the taxpayer in all trades and businesses during the year are in material participation in real property trades or businesses

Employee performing these tasks must own at least 5% of the employer

For MFJ one spouse must separately meet both

65
Q

Rules for closely held C corporation real estate business to be an active business

A

Corporation must derive more than 1/2 it’s gross receipts from real property businesses in which it materially participates

66
Q

Requirements to be allowed to deduct $25,000 of passive losses from real estate rental against other income

A
  • individual taxpayers only
    Must:
  • actively participate in the activity
  • own at least 10% of the value of the activity for the entire year (both years if trying to take a deduction for loss sustained in prior year)
  • $25,000 limit on the sum of both deductions and credits (must convert credits to deduction equivalent)
67
Q

Active participation

A

Lesser standard of involvement than material participation

Must participate in making management decisions and arranging for others to provide services in a significant and bona fide sense

(Limited partner generally cannot actively participate)

68
Q

Limitation on deduction of rental real estate loss

A
  • must first be applied against any other net passive income form the year, before against other income
  • $25,000 reduced by 50% of taxpayer’s AGI on excess of $100,000 (AGI not including any passive activity or real property trade and business loss)
    Any remaining becomes a suspended passive loss
  • limit applied to sum of deductions and credits. must use deductions first
69
Q

Converting credits into deduction equivalents

A

Credit / marginal tax rate

(aka the amount that, taken as a deduction, would reduce the tax liability by an amount equal to the credits)

70
Q

If taxpayer has losses from multiple passive activities eligible for the $25,000 deduction

A

Must allocate deduction ratably (proportionally) between the activities and have suspended losses for the remaining amounts

71
Q

Casualty loss

A

A loss that occurs in an identifiable event that is sudden, unexpected, or unusual

72
Q

Casualty and theft losses of business and investment property

A

Deductible

73
Q

Casualty and theft losses of personal-use property

A

As of 1/1/18 must be a loss incurred in a federally declared disaster to be deductible

74
Q

Sudden event

A

Swift, not gradual or progressive

75
Q

Loss sustained as a result of theft

A

Deductible

Includes: larceny, embezzlement, robbery, blackmail, extortion, kidnapping for ransom

76
Q

Measuring casualty loss for deduction

A
  • amount by which the casualty reduces the property’s FMV (obtained by comparing FMV immediately before casualty and immediately after) use of sentimental value not allowed, no additional deductions for cost of protecting property
  • must be only only for property taxpayers owns
  • may not take deductions for loss of FMV on undamaged property
77
Q

Casualty loss on property only partially destroyed

A

The lesser of the reduction in the property’s FMV of the taxpayer’s adjusted basis

78
Q

Casualty loss on destroyed business or investment property

A

Amount of the taxpayer’s adjusted basis (even if greater than FMV)

79
Q

Casualty loss on destroyed personal use property

A

Amount of loss is lesser of the reduction in the property’s FMV or the property’s adjusted basis

80
Q

How is the reduction in the FMV of property established

A

Ideally by appraisal
Or
By cost of repairs

81
Q

Requirements for using cost of repairs to establish reduction in FMV of property

A
  • repairs will bring the property back into its condition immediately before the casualty
  • cost of repairs is not excessive
  • repairs limited to damage incurred to the property
  • repairs do not increase the value of the property over its value immediately before the casualty
82
Q

Destruction of more than one property by same casualty event

A

Loss on each property calculated separately

83
Q

Change in casualty loss amount of insurance received

A

Loss reduced by any insurance or other recovery received

If payment causes a realized gain, taxpayer may be able to defer or exclude the gain on involuntary conversion

84
Q

Limitations on casualty loss on personal use property

A
  • losses sustained in each separate category must be reduced by $100
  • total for net casualty losses for personal property is reduced by 10% of the taxpayer’s AGI for the year
  • if property is covered by insurance no casualty loss (for what is covered by insurance) can be claimed unless a timely insurance claim is filed
85
Q

Casualty loss as for or from AGI deduction

A

Business or rental investment property : for AGI

Investment (not rental) or personal -use property: from AGI

86
Q

Gain on a casualty

A

If insurance proceeds exceed taxpayers basis in the property

87
Q

Personal casualty losses not resulting from a federal disaster area

A

Deductible to the extent that the taxpayer has personal casualty gains for the year

88
Q

Netting casualty gains and losses of personal-use property

A

Must net gains and losses
1st: reduce gains by losses from non - federally declared disasters
2nd: use any remaining gains to reduce amount of losses from federally declared disaster

Loss also reduced by:
- insurance reimbursements
- $100 limitation

10% of AGI floor not considered until netting is done and results in a loss

89
Q

If casualty gains exceed casualty losses

A

All gains and losses treated as capital gains and losses

Long term or short term depending on how long the asset was held

90
Q

Tax forms for casualty losses

A

Form 4648 (calculations for net casualty gain and loss)

Schedule A form 1040 (itemizing any net loss)

91
Q

Netting Casualty gains and losses on business and investment property

A

Netted together for any property held over one year

If held less than one year= ordinary loss

92
Q

If business and investment property casualty losses exceed gains

A

Business losses and losses on investment properties generating rents or royalties: for AGI deduction

Losses on other investment properties: from AGI deduction

No $100 or 10% AGI limitations

93
Q

Timing of casualty loss deduction

A

Generally in year when taxpayer sustains the loss

Exceptions for:
- theft losses
- insurance/ other reimbursements expected in subsequent years
- certain disaster losses

94
Q

Timing of deduction for theft loss

A

May be deducted in year taxpayer discovers the loss

95
Q

Tax treatment of loss if full recovery anticipated (insurance or otherwise)

A

Taxpayer may not take any deduction in the year of the loss if an expectation of full recovery exists

If taxpayer does not receive the full amount of the recovery they may deduct the unrecovered portion in a subsequent year (when insurance finalized)

96
Q

Tax treatment of casualty loss if taxpayer does not anticipate full recovery

A

May deduct loss of estimated unrecovered amount (assuming had filed timely insurance claim for insured property)

97
Q

If subsequent recovery received for previously deducted casualty loss

A

Reimbursement must be included in income in the year of recovery

Only have to include income to the amount of tax benefit received for previous deduction

98
Q

Taxpayers who suffer losses attributed to a disaster in an area subsequently declared by PotUS as a disaster area

A

Taxpayer may elect to deduct a casualty loss in the year proceeding the year in which it actually occured

If has already filed previous years return when disaster is declared then, if elects, must file an amended return

99
Q

Requirements for deducting bad debt

A
  • a bona fide debtor-creditor relationship exists between the taxpayer and another entity
  • taxpayer has basis in the debt
  • debt becomes worthless during the year
100
Q

Bona fide debt

A

One that arises from a valid and enforceable obligation to pay a fixed or determinable sum of money and results in a debtor-creditor relationship

101
Q

Determining if bona fide debt exists between related parties

A

Intent matters for gift vs loan

Tests include:
- does a note or written instrument exist which evidences an obligation to repay?
- have the parties established a definite schedule of repayment?
- have the parties documented a stated reasonable rate of interest?
- would a person unrelated to the debtor make the loan?

Is it really a capital contribution disguised as a loan or a disguised dividend or salary payment?

102
Q

Third party debt

A

If a taxpayer guarantees or endorses someone else’s obligation and is required to pay if the debtor defaults

103
Q

Deduction of bad third party debt

A

In order to deduct bad debt, guarantor must be able to prove guarantee was not a gift

Then may deduct principal and accrued interest paid on behalf of the debtor as bad debt issued to the debtor at the time of payment

104
Q

Taxpayer’s basis in the debt

A

May be:
- any money loaned
- if property or services provided basis is only established if the taxpayer has previously included the FMV of property or services in their income (Accrual method taxpayer with open account receivable or a signed note. NOT cash method taxpayer who reports no income till payment received)

105
Q

Is legal action required to deduct worthless debt

A

No. In fact if surrounding circumstances show legal action would likely not result in collection of debt the lack of legal action itself may provide proof of worthlessness

106
Q

Partially worthless bad debt

A

business bad debt: some current deduction allowed

Nonbusiness bad debt: must be totally worthless to be deducted

107
Q

Nonbusiness debt

A

Any debt other than
1) a debt created or acquired in connection with trade or business of the taxpayer, or
2) a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business

Debts acquired with business, or incurred in the course of business continue as business debt

108
Q

Requirements for a business debt

A

Proximate relationship between the loan and the taxpayer’s business

Business motive is the dominant motive for making the loan

109
Q

Tax treatment business bad debt

A

Ordinary loss = ordinary business deduction

110
Q

Tax treatment nonbusiness bad debt

A

Short term capital losses in the year the non business debts become wholly worthless (no matter how long the debt has been outstanding)

So any loss in excess of capital gains may only be offset against ordinary income up to $3000, and anything beyond that is carried forward

111
Q

Partial worthlessness

A

Nonbusiness debt: no deduction if still expected to be partially recoverable

Business bad debt: may deduct unrecoverable portion in year becomes expected to be unrecoverable

112
Q

Tax method for accounting for business bad debts

A

Must use specific write off method where debts are written off individually as they become worthless

(May create a temporary difference if using reserve/allowance method for book purposes)

113
Q

Recovery of previously written off bad debt

A

Included in income in year collected to the extent that taxpayer received a benefit for the deduction (tax benefit rule)

114
Q

Loss on deposits in qualified bankrupt or insolvent financial institutions

A

May elect to take as a personal casualty loss in the year in which the individual can reasonably estimate the loss

Loss = difference between basis in deposit and reasonable estimate of what will be recovered

Creates ordinary loss subject to casualty loss limitations

Election applies to all losses sustained by individual in the same institution

115
Q

Qualified financial institutions

A

Banks
Federal or state chartered savings and loans and thrift institutions
Federal or state insured credit unions

116
Q

Net operating loss

A

NOL

When taxable income for the year is negative because business expenses exceed business income

117
Q

Deduction for NOL

A

Taxpayer can carry a net operating loss from one year forward to offset a subsequent years net income (as a deduction)

118
Q

Arriving at taxable income to determine NOL for a year

A
  • add back any NOL deduction taken for a previous year’s loss
  • add back any capital loss deduction
  • add back excess of nonbusiness deductions over non business income (aka any nonbusiness reductions that reduced business income. Wages & salary considered business income & casualty losses on personal use assets are treated as business losses)
119
Q

Steps to add back capital loss deductions to taxable income for NOL calculations

A
  • find net nonbusiness gain/loss vs net business gain/loss
  • nonbusiness net capital gains used to offset any nonbusiness ordinary deductions, THEN used to offset any net BUSINESS capital loss
  • it both groups have net losses both deductions have to be added back
  • nonbusiness net losses may not be used to offset net business capital gains
120
Q

Calculating NOL if you use the standard deduction

A

Standard deduction used as the amount of the nonbusiness deductions

121
Q

Calculating excess of nonbusiness deductions over non business income

A

Total deductions
Less any deductions attributed to business
Less nonbusiness income
= Excess of nonbusiness deductions over non business income

This amount added to taxable income to find NOL

Would not create a NOL lower than taxable income!

122
Q

Carryover periods for NOLs

A

Losses arising before 2018: back 2 years and forward indefinitely
Losses 2018-2020: back 5 years and forward indefinitely
Losses after 2020: not back, only forward indefin

123
Q

Amount of NOL deduction allowable in a following year

A

The lesser of:
- aggregate net operating losses carried over
Or
- 80% of taxable income (before NOL deduction)

124
Q

Excess business losses

A

The excess of aggregate business deductions for the year over the sun of the taxpayer’s aggregate business gross income and gains plus $262,000 if single or $524,000 if MFJ

125
Q

Deduction of excess business loss

A

Not allowable for noncorporate taxpayers after Dec 31 2020

Carried forward and treated as part of the taxpayer’s NOL

Applies at partner/shareholder level

Survey Of Taxation (14 decks)

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