Individuals are allowed a reduction of taxable income on their form 1040 personal income tax return known as a loss, when the taxpayer suffers an economic loss during the taxable year and was not compensated by insurance. Determining the deductible amount of the loss can be difficult. The loss from the sale of property should be equal to the adjusted basis or the basis after making the necessary adjustments such as capital improvements or accumulated depreciation. When determining the amount of the loss there are some exceptions to the deductibility of the loss known as loss limitations. This paper will focus mainly on three possible loss limitations that individuals can run into when calculating their deductible loss: basis limitations,…show more content… This paper will focus on these major loss limitations that individuals must overcome in order to deduct losses on their personal federal incometax return.
Basis Limitations When an individual taxpayer owns interest in a partnership and a loss is passed through to the partner, it is the partner’s responsibility to determine the deductible amount of the loss before reporting the loss on their individual income tax return. The partner’s distributive share of the partnership loss is allowed only to the extent of his or her adjusted basis in the partnership at the end of the tax year in which the loss occurred. If the partner’s loss exceeds the adjusted basis of his partnership interest, the excess must be carried forward. (IRC Section 704) Basis measures the amount that one has invested in the entity. It is generally the cash paid for shares or interest, property contributed, carryover basis if gifted interest, or stepped-up/down basis if inherited. Basis is similar to a checking account. It is equal to its deposits less its withdrawals. Similar to a bank account, basis cannot be negative without realizing a gain. Common increases to basis include: capital contributions, ordinary income, and investment income and gains. Common decreases to basis include: depreciation deductions, charitable contributions, nondeductible expenses, and distributions. In partnerships, basis is increased by the amount of direct loans you have made