Chapter_7 - CHAPTER 7 LOSSES DEDUCTIONS AND LIMITATIONS I...

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CHAPTER 7 LOSSES - DEDUCTIONS AND LIMITATIONS I. Nature of a Loss A. Annual (Activity) Loss 1. Results from deductions in excess of income B. Transaction Losses 1. Results from a disposition at less than basis a. Amount Realized < Basis (Adjusted Basis) C. On returns, losses are categorized as deductions D. Concepts 1. Overall - Ability to Pay 2. Legislative Grace 3. Realization 4. Capital Recovery E. Categorization of Losses (Figure 7-1) 1. Trade or Business 2. Production of Income 3. Personal Use
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II. Annual (Activity) Losses (Figure 7-2) A. Net Operating Losses (NOL) 1. Effect of ANNUAL ACCOUNTING PERIOD 2. NOL provisions are restricted to Business Losses a. Personal Casualty Losses are considered business losses for NOL purposes. 3. Conduit Entities a. Losses flow to owners 4. Treatment of NOL's a. Carryback 2 years/then forward 20 years to offset income. b. May elect not to carryback 5.
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Limitation - Corporate Acquisitions a. Use of NOL deduction is restricted when there has been an Chapter 7 - 3 ownership change in excess of 50% during the last three years. III. Tax Shelter Losses A. At-Risk Rules Chapter 7 - 4 1. Designed to limit the amount of loss a taxpayer can deduct from an activity to the taxpayer's economic investment in the activity. Note adjustment for debt which the taxpayer is personally liable for. 2. Calculation of Amount At-Risk (Exhibit 7-1) -- Basically, the maximum amount of personal funds (assets) that could be lost if the activity failed. Amount at risk is also adjusted for the taxpayer’s share of the income (loss) from the activity and reduced by withdrawls from the activity. When the activity has income that is taxed to the taxpayer, the income becomes subject to loss, and thus, increases the taxpayer’s amount at risk. 3. Weakness in rules - allowance of nonrecourse debt on real property as an increase of the amount at-risk. Nonrecourse debt is a liability that is secured only by the underlying property. The borrower is not personally liable for the debt. After 1987, nonrecourse financing is considered at risk if the taxpayer is either engaged in the trade or business of holding real property or is holding the real property for the production of income.
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