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Unformatted text preview: 93 Chapter 7 Deductions: Business/Investment Losses and Passive Activity Losses SUMMARY OF CHAPTER Deductions are allowed for losses from unprofitable investment-related activities, dispositions of certain assets, and unprofitable business operations. Generally, deductible losses from a business, property held for production of income, or investment property are deductible for adjusted gross income. Losses derived from personal-use property, if deductible, are usually deductible from adjusted gross income as an itemized deduction. This chapter deals with losses originating from business operations and certain investment-related activities. Tax Shelters and At-Risk Rules ¶7001 Tax Shelters A tax shelter is an activity providing deductions and/or credits to an investor which will reduce tax liability with respect to income from other sources. Investments in tax shelters have been restricted by the at-risk rules and the passive activity rules. Essentially all limited partnership investments, rental properties, and businesses in which an owner does not materially participate have been affected. ¶7125 At-Risk Rules The at-risk rules disallow losses that are in excess of an investor’s amount at risk. In a general sense, at risk is the amount of investment that an investor could possibly lose. An investor is not at risk for nonrecourse borrowings, stop-loss arrangements, no-loss guarantees, or borrowings in which the lender has an interest (as in seller financing). Passive Activity Loss Rules ¶7201 Application of Rules The at-risk rules must first be satisfied, then the passive activity loss rules apply. A passive loss can then be used in the following ways: offset passive income, offset other income (under certain conditions), and/or become suspended. Passive income and losses are “before AGIÄ items. ¶7205 Classification of Income Because of the passive activity rules, income is required to be classified as active, passive, or portfolio income. Ordinarily, active income is attributable to the direct efforts of the taxpayer, such as salary, commissions, wages, etc. Passive income is income derived from a passive activity. Portfolio income is interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. ¶7211 Disallowance of Passive Losses and Credits For tax years beginning in 1991, no passive activity losses or credits may be deducted against active and portfolio income. Interests in passive activities acquired by the taxpayer on or before October 22, 1986 (the date on which the Tax Reform Act of 1986 was enacted), were eligible for a special deduction and credit phaseout of losses for a five-year period. ¶7215 Suspended Losses Generally, any loss or credit from a passive activity which is disallowed by the passive loss rules is treated as a deduction or credit allocable to such activity in the next taxable year. Suspended losses can become deductible Chapter 7 94 CCH Federal Taxation — Comprehensive Topics...
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This note was uploaded on 11/17/2010 for the course FI 515 FI 515 taught by Professor Senn during the Spring '10 term at Keller Graduate School of Management.
- Spring '10