Ch. 8 Notes

I. Transactions that may result in losses. Realization is a prerequisite for loss.
Ex. If a taxpayer holds tock that had a $25,000 fair market value at the beginning of the tax year and a $15,000 fair market value at the end of the tax year, no loss is recognized for tax purposes, even though the value of the stock has decreased by $10,000.
A. Sale or Exchange of Property
1.) In a sale or exchange, the amount of the loss is the excess of the property’s adjusted over the amount realized.
Ex. If the taxpayers realizes $10,000 from the sale of an asset with an adjusted basis of $18,000, the realized loss is $8,000 (10,000 – 18,000)

2.) Losses incurred on the sale of personal use property are not deductible.
3.) Losses on trade on business property and investment property are deductible
B. Expropriated , Seized or Confiscated Property
1.) Property expropriated, seized or confiscated by a foreign government gives rise to a deductible loss only if the property is used in a trade or business and is held for investment.
2.) Any allowable deduction must be taken in the year of actual seizure.
3.) Any gain realized on seizure would be treated under the involuntary conversion rules.
C. Abandoned Property
1.) Abandoned property used in a trade or business or held for investment gives rise to a deductible loss.
2.) The amount of the asset at the date of abandonment.
3.) The character of the loss is ordinary, since there is no sale or exchange.
D. Worthless Securities Treated as a capital loss on the last day of the tax year.
Ex. If a calendar year taxpayer owns securities which become worthless on march 15, the tax treatment is to recognize a capital loss on Dec. 31st.
E. Demolition of Property demolition costs are to be added to the basis of the underlying property.
II. Classifying the Loss on the Taxpayer’s tax return.
A. Ordinary versus capital loss
1.) Dependent on the types of property involved and the type of transaction involved.
2.) Losses on qualifying Sec. 1244 stock are treated as ordinary ($50,000 or $100,000 limitation) rather than capital offset capital gains plus $3,000 of ordinary income.
- To qualify as Sec. 1244 stock:
 The stock must be owned and issued by and individual or partnership.
 The corporation must be a domestic corporation.
 The stock must be issued for cash or property and not for services.
 The corporation may not have derived over 50% of its gross receipts from passive income sources during the immediately preceding 5 tax years. And at the time the stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1,000,000
B. Disallowance Possibilities
1.) Certain realized losses are disallowed in special situations, including related party transactions and wash sales.
2.) Other potential disallowance situation include transfer of property in exchange for tock. Sec. 351, like-kind exchanges and partnerships (both under the (at risk) limitation and the passive loss rules.)
III. Passive Losses
A.)
1.) Passive losses may only offset passive income, not portfolio or active income
2.) Portfolio income included non-business dividends, interest, royalties, annuities, and certain gains and losses on property
3.) Credits generated from passive activities are also limited. These credits may only offset tax liabilitiy generated by passive income.

B.) Carryovers

1. Un-utilized passive losses may be used against future income or on the disposition of the passive activity interest.
2. The carryover is unlimited in amount and duration.

C.) Definition of Passive Activity
1. Includes any rental activity and any trade, business, or investment activity in which the taxpayer does not materially participate.
2. Investments in limited partnerships generate passive losses due to the legal restrictions on limited partner’s involvement in he mgt of the partnership.

C. Taxpayers subject to passive loss rules

1.) Apply to individuals, estates, trust, closely-held C corp personal service corp. and certain publicly-traded partnerships.
2.) While the passive loss rules do not apply to partnerships and S-Corp. They do apply to the owners (partners & shareholders)

IV. Casualty and Theft Losses
• Casualty defined
o A casualty loss results from an identifiable event that was sudden, unexpected or unusual.
o Qualifying casualties included fire, flood, hurricane , tornados, hail, and cyclone.
• Theft Defined
o Generally, criminal intent and violation or a state law are required to meet the definition of theft.
o Theft for tax purposes includes robbery, blackmail, extortion and ransom.
• Deductible Amount of Casualty Loss
o For personal use property the deductible amount is the lesser of the reduction in FMV or adjusted basis.
o In the total destruction of business property the deductible amount is the property’s adjusted basis.
V. Bad Debts
• Bonda-Fide debtor Creditor Relationships
o Valid and enforceable obligations to pay a fixed or determinable sum of money
• Taxpayer’s Basis in the Debt.
o Creditor must have a basis in the debt for the bad debt to be deductible
• Debt Must be Worthless
VI. Tax Planning Consideration
• Bad Debts – Taxpayers should document their determination that a particular debt is worthless.
• Casualties
o Documentation of FVC is important to support a casualty loss deduction.