Losses and Tax Benefit Rule

Question 1

What losses are deductible under 165?

Answer 1

1) Losses incurred in trade/business/transaction entered into for profit
2) Personal casualty losses if in a federally declared disaster area (subject to other limits)

Question 2

What is the insurance claim reimbursement limitation on 165?

Answer 2

If insurance reimburses the loss, then you can’t claim the loss deduction.

If the loss is personal and insurance would have paid but you don’t file a claim, you can’t claim the deduction
If the loss is in trade/business/transaction for profit, you can be insured and not file a claim and still claim the deduction

Question 3

What is a personal casualty loss?

Answer 3

A loss from fire, storm, shipwreck, or other casualty or from theft

Question 4

When are losses deductible?

Answer 4

Losses are only deductible in the year in which they occurred

Question 5

What is the alteration to the realization doctrine for 165 losses only?

Answer 5

A loss doesn’t require a realization event in the 1001(a) sense but it still requires an identifiable event per 1.165-1b
(e.g. change in legal rights, fire, theft, abandonment, shipwreck, car wreck, etc). Simple declines in market value don’t trigger a loss.

Question 6

What are the two cases for parsing declines in market value from identifiable events where you can deduct the loss?

Answer 6

Zakon: if loss in legal rights can deduct a loss under 165 because closed transaction. Same goes for fires, thefts, etc.
Rev Rul 81-145 (airplanes): If the market value has declined, without a change in legal rights, cannot deduct a loss under 165 unless you also close the transaction with identifiable events first (sale satisfies 1001 and 165 or abandonment/fire satisfies 165)

Question 7

If there is no change in legal rights and market value drops to 0, how do you get your 165 loss?

Answer 7

You need to manufacture an identifiable event or realization event. If you abandon the property, then that is a disposition of property under 1001(a), so you can then deduct it

Question 8

What’s the point of 165?

Answer 8

Creates a deduction for certain losses calculated under 1001.. NOT ALL LOSSES ARE DEDUCTIBLE (If you buy a car for personal use and then resell it later, you can’t claim a loss)

Question 9

How much of a loss can you deduct under 165?

Answer 9

Your basis and no more (Zakon)

Question 10

Can you claim a partial loss if there is a fixed identifiable event?

Answer 10

Yes. If there is an identifiable fixed event a loss can be partial. Can claim the lesser of loss in FMV and adjusted basis (e.g. fire, theft, other damage)

Question 11

Why does the loss deduction not always make sense?

Answer 11

e.g. You buy a warehouse for $500K. It appreciates to $1M. Part burns and now worth $750K. you only reduced a large gain to a smaller one, but you can still deduct the $250K loss (and reduce basis).

Question 12

What is the main case for the tax benefit rule?

Answer 12

Alice Phelan Sullivan Corp

Question 13

Explain the tax benefit rule?

Answer 13

If you deduct some thing based on an assumption about the future that does not obtain and is like to a receipt for the current year, you have to pay tax on it. (you took a deduction that we now know you didn’t deserve) Current rates apply (so you could be a winner or loser depending on the movement of tax rates). You add the amount of the deduction to current income (not FMV or value of deduction)

Question 14

What are some examples of when the tax benefit rule applies?

Answer 14

A charitable deduction taken in prior year and the property reverts back to you
Pay insurance premiums and deduct them but then you get a big claim paid back to you

Question 15

Does the tax benefit rule apply if there was no deduction taken in prior year?

Answer 15

Not really because there is no deduction that you need to “undo” (you paid tax in the past)

Question 16

What is the exclusionary aspect of the Tax benefit rule

Answer 16

If you claimed a deduction in a prior year but did not have sufficient income to use it, you can claim the unused portion of the deduction from prior year in current year. e.g. If you had 80K of income and $100K of deductions $20K of the deduction was wasted, so if you receive an extra $50K that is related to that past transaction, you only have to include (50-20=)$30K in income

Question 17

What is the inclusionary aspect of the tax benefit rule?

Answer 17

The alice philan sullivan idea that you must INCLUDE the value of deductions in past year that were taken. (in contrast with the exclusionary aspect which says that if you claimed deductions in the past that were not actually used, you can EXCLUDE the amount received this year to the extent of that wasted deduction

Question 18

What is the main case for recovery of loss? (core facts and holding)

Answer 18

Clark v Commissioner (tax attorney screwed up and caused him to overpay his taxes, Clark later recovered the value of the mistake from the attorney. Clark did not have to recognize income on the prior loss because he neither could nor did deduct the loss in the first place)

Question 19

What is the Recovery of Loss Rule

Answer 19

If in the past you had a loss where you neither could nor did take a deduction, and you later recoup that loss, you do not have to include the recoupment in income
- This makes sense because taxable income was too high in a prior year

Question 20

What is the key limitation on the benefits you can get from the recovery of loss rule?

Answer 20

Not everything can be linked
- Paying too much tax might be linked to a malpractice recovery from your tax preparer BUT if you won $100 on the lottery because a thief stole $100 from you and made you feel desperate and want to play the lottery, that’s not sufficiently linked

Question 21

What is the effect if you get a recovery for something that you took a deduction for in the past?

Answer 21

The recoupment is taxable income (this is the tax benefit rule)