Acct 308 Chap7 lesson

Acct 308 Chap7 lesson - CCH Federal Taxation Comprehensive...

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CCH Federal Taxation Comprehensive Topics Chapter 7 Deductions: Business/Investment Losses and Passive Activity Losses ©2005, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 http://tax.cchgroup.com
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CCH Federal Taxation Comprehensive Topics 2 of 45 Abusive Tax Shelters Before 1987, a 50% or higher return on equity by high-income taxpayers was not unusual given that tax rates were high (e.g., the top tax rate from 1965 to 1981 was 70%) and depreciation allowances were generous (e.g., 1981–1983 depreciation on office buildings could be computed using a 15-year life and the 175% declining-balance method; today, it is 39 years with the straight-line method). Typical tax shelters once provided high returns without necessarily making a before-tax profit. Chapter 7, Exhibit 1a
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CCH Federal Taxation Comprehensive Topics 3 of 45 Abusive Tax Shelters Example Before–1987 Tax Shelter 10 investors form "Pay-No-Tax," a limited partnership (LP), and each contributes $10,000. The LP obtains a $900,000 nonrecourse loan from Easy Money building. Note: “nonrecourse” means the S & L would have no claims against the investors personally in the event of default. The The building never exceeds 50% occupancy. Chapter 7, Exhibit 1b
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CCH Federal Taxation Comprehensive Topics 4 of 45 Abusive Tax Shelters At 50% occupancy, the annual cash flows appear as follows: Description LP Each of the 10 Partners (a) Rental income $ 70,000 $ 7,000 (b) Operating expenses (40,000) (4,000) (c) Interest payments (90,000) (9,000) (d) = (a) – (b) – ( c) Negative cash flow (60,000) (6,000) (e) Depreciation (100,000) (10,000) (f) = (d) – (e) Tax loss (160,000) (16,000) (g) = (f) x 70% Tax benefit from loss (70% tax bracket from 1965 – 1981) 112,000 11,200 (h) = (d) + (g) Net cash [($60,000) + $112,000] $52,000 $ 5,200 (i) = (h) ÷ equity Annual return on equity 52% 52% Chapter 7, Exhibit 1c
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CCH Federal Taxation Comprehensive Topics 5 of 45 Passive Activity Loss Rules The PAL rules generally provide that all income and loss must be placed in one of three categories: Active (losses are fully deductible to the extent of basis) Passive (losses are deductible only against passive income, with some exceptions) Portfolio (dividends, interest, royalties, etc.; interest expense is limited to net investment income) Chapter 7, Exhibit 3a
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6 of 45 Effect of PAL Rules . The PAL rules eliminated most tax shelters effective January 1, 1987. Values that had been artificially inflated due to tax benefits plummeted, and the real estate industry and S & Ls collapsed during the next six years. Taxpayers paid hundreds of billions of dollars to replace federally insured deposits loaned out by the S & L’s and other institutions. Passive Activity Loss Rules
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Acct 308 Chap7 lesson - CCH Federal Taxation Comprehensive...

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