Chapter 7 Class Notes Overview of Deductions and Losses (Chapter 7)

Chapter 7 Class Notes Overview of Deductions and Losses (Chapter 7)

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Chapter 7: Deduction for Expenses: General Requirements The Internal Revenue Code provides that nothing is deductible unless the law specifically authorizes a deduction: Several provisions are designed to grant the deduction for specific items. For example, § 163 permits individuals to deduct certain types of interest expense including “Qualified residence interest”. Qualified residence interest is interest paid on the mortgages on a taxpayer’s principal and secondary residence. We will discuss the specific rules governing “qualified residence interest” in greater depth when we go over Chapter 11 on itemized deductions. While the code also permits certain other types of interest to be deducted (also to be discussed in Chapter 11) it expressly denies the deduction of prepaid interest. Prepaid interest instead must be capitalized and deducted ratably over the period of the loan. An exception applies to “points” paid for a debt incurred by the taxpayer to purchase his or her principal residence which can be deducted as an itemized deduction. Thus, as a general rule taxpayers may deduct, as an itemized deduction, the interest on a principal and second residence and points paid on the acquisition of a principal residence. There are a number of other specific rules governing the deductibility of interest. This will be more discussed in other chapters. Another example of a provisions designed to grant the deduction for specific items is §164 which permits an itemized deduction for taxes. Under this rules taxes such as state and local income taxes paid by an individual and real estate taxes paid on a personal residence are permitted to be deducted as an itemized deduction. Although a taxpayer’s deductions require statutory authorization, this does not mean that a particular deduction must be specifically mentioned in the IRC. Some deductions are allowed because they satisfy the conditions of some broadly defined category of deductions. For example, no specific deduction is allowed for the adverting expenses of a restaurant owner, but the expense may be deductible if it meets the criteria for deduction of business expenses (see IRC § 162 shown below). § 162 Trade or business expenses. (a) In general. There shall be allowed as a deduction all the ordinary and necessary expenses paid 1
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or incurred during the taxable year in carrying on any trade or business, including (1) a reasonable allowance for salaries or other compensation for personal services actually rendered; (2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and (3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. Although IRC Section § 162(a) specifically enumerates three items that are deductible, the
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Chapter 7 Class Notes Overview of Deductions and Losses (Chapter 7)

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