chapter 7 solutions

chapter 7 solutions - Chapter7AnswerstoQuestions...

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Chapter 7  Answers to Questions Tax Shelters: Definition 1. A tax shelter is any activity that provides tax write-offs which reduce an investor’s tax liability with regard to income from other sources. Two limitations that apply to deductibility of losses from tax shelters are the at-risk rules (Code Sec. 465) and passive activity rules (Code Sec. 469). Tax Shelters: Usage 2. Tax shelters were popular because of their tax-saving features (i.e., the pass-through of losses and credits) which lowered many upper income investors’ tax liability. Tax shelter activity has been virtually eliminated by the passive activity rules, which were a major component of the Tax Reform Act of 1986. At-Risk Rules: At Risk Defined 3. “At risk” is the amount of investment that an investor would stand to lose if the whole activity in which the investment was made became worthless. At-Risk Rules: Nonrecourse Loans 4. A nonrecourse loan is borrowing without personal liability for repayment. Should the borrower default, the lender merely takes the property purchased (or other collateral) as satisfaction of the debt. The buyer will not be at risk in the case of seller financing because the lender (seller) has an interest in the borrowings. This is true even if the seller is a financial institution. (There is an exception to the at-risk rules for  third party lenders of nonrecourse debt on real property.) Passive Losses: General Rule for Deductions 5. The general rule for the deductibility of passive losses is that passive losses can only offset passive income, except for the disposition of an entire interest in a passive activity, from fully taxable transactions and certain pre-enactment activities. Passive Losses: Application of Rules 6. The at-risk rules must be satisfied first, then the passive rules are applied. Both restrict losses from becoming deductions. Passive Losses: Classification of Income 7. Active income is income derived from the direct efforts of the individual, such as wages, salaries,  commissions, tips, etc. Passive income is income from passive activities, such as income from the operation of a  limited partnership in which an investor is a limited partner. Portfolio income is income from stocks, bonds,  annuities, and royalties not derived in the ordinary course of a business. Dividends, interest, and the sale of  stocks, bonds, etc., are portfolio income items.
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This note was uploaded on 01/14/2012 for the course ACCT 101 taught by Professor Smith during the Spring '11 term at UT Arlington.

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chapter 7 solutions - Chapter7AnswerstoQuestions...

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