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Unformatted text preview: Chapter I8 Losses and Bad Debts Discussion Questions I8-1 The closed transaction doctrine states that a realized loss must be evidenced by a completed transaction or identifiable event. This doctrine exists to prevent taxpayers from recognizing a loss as a result of fluctuating prices prior to the disposition of the property. This is, of course, different from the economic concept for realized loss. p. I8-2. I8-2 The amount of the deductible loss when property is disposed depends on (1) the type of property, (2) the manner in which the property is used, (3) the basis in the property, (4) the amount realized upon disposition, and (5) the way the property is disposed of. pp. I8-2 and I8-3. I8-3 In order to deduct a loss on worthless securities, the taxpayer must first establish when the security actually became worthless. The deduction is only available in the year the security becomes worthless. Once this is determined, Sec. 165(g) provides that the loss incurred is treated as a loss from the sale of a capital asset on the last day of the taxable year. Because of the limitations imposed on the deductibility of capital losses, this may severely restrict the current tax benefit to the taxpayer. Under certain circumstances, if a domestic corporation holds worthless securities in an affiliated corporation, the loss to the domestic corporation is treated as having arisen from a sale of a noncapital asset. This makes the loss an ordinary loss. In order for this exception to apply, two requirements must be met: (1) the domestic corporation must own at least 80% of the voting power of all classes of the affiliated corporation's stock, and (2) more than 90% of the affiliated corporation's gross receipts for all its taxable years must be from nonpassive income. pp. I8-3 and I8-4. I8-4 If the worthless securities consist of securities of an affiliated corporation held by a domestic corporation, the loss is treated as an ordinary loss rather than a capital loss. For this exception to apply the domestic corporation must own at least 80% of the voting power of all classes of the affiliated corporation's stock and more than 90% of the affiliated corporation's gross receipts for all its taxable years must be from nonpassive income. (i.e., sources other than dividends, interest royalties, rents, annuities, and gains from the sale or exchange of stock and securities.) pp. I8-3 and I8-4. I8-5 To have a capital loss, (1) there must be a sale or exchange and (2) the transaction must involve a capital asset. For example, the loss from the destruction of a capital asset is an ordinary loss and not a capital loss because there has not been a sale or exchange. Furthermore, a loss on the sale of inventory is ordinary because inventory is not a capital asset. pp. I8-4 and I8-5....
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- Fall '08
- Taxation in the United States, capital gains.