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 income tax 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
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Mrs. Tschetschot works as a database project manager, and was also a professional tournament poker player in 2000. She then claimed a net loss from her tournament poker activity as business losses on her Schedule C. The commissioner determined that this deduction related to the tournament poker should be subject to the limitation provided in Code §165(d) as an itemized deduction, to the extent of the Mrs. Tschetschot’s winnings. Based on that, the commissioner assessed a deficiency of income tax as well as an accuracy-related penalty under Code §6662(a).
25-7 If a loss cannot be accrued in the period when ti is probable that an asset had been impaired or a liability had been incurred because the amount of loss cannot be reasonable estimated, the loss shall be charged to the income of the period in which the loss can be reasonably estimated and shall not be charged retroactively to an earlier period. All estimated losses for loss contingencies shall be charged to income rather than charging some to income and others to retained earnings as prior period adjustments.”
IRC §702(a) emphasizes that partners must report their distributive shares of partnership income. §704(a) says that the partnership agreement determines the partner’s distributive shares of income, gain, loss, deductions, and credits, pursuant to the limitations set forth in §704(b). Such limitations were calculated and phrased in terms of the “tax avoidance test” prior to 1976. This test stated that allocations of income, gain, loss, deductions, or credits would be disregarded if the principal purpose for said allocations was tax avoidance per §704(b)(2). In 1976, a new “substantial economic effect” test was adopted in 1976 to determine the limitations relating to a partner’s distributive share. §702(a)(9) requires an allocation of bottom line income or loss to have economic substance that reflects the actual division of such items when viewed from an economic rather than a tax viewpoint.
Section 360-10-35-17 of the Code states that an impairment loss shall be recognized if the carrying value of a fixed asset is not recoverable and exceeds its fair value. The carrying value of the fixed asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and disposal of the asset. An impairment loss shall be measured by the amount by which the carrying value exceeds the fair value.
In 2013 Marianne sold land, building and equipment with a combined basis of $150,000 to an unrelated third party and in return received an installment note of $80,000 per year for five years. Of the $250,000 gain on sale, $150,000 was classified as Section 1245 gain and the remaining $100,000 was Section 1231 gain. In 2013, Marianne had a capital loss carryover of $60,000, $50,000 of which she used to offset her Section 1231 gain; she recognized no Section 1245 gain. The following year she recognized $40,000 of 1245 gain and $10,000 of Section 1231 gain which she promptly offset with the last $10,000 of the capital loss carryover. In 2015, she recognized $50,000 Section 1245 gain and no Section 1231 gain.
According to ASC 450-20-30-1, “ If some amount within a range of loss appears at the time to be a better estimate than any other amount within the range, that amount shall be accrued. When no amount within the range is a better estimate than any other amount, however, the minimum amount in the range shall be accrued. Even though the minimum amount in the range is not necessarily the amount of loss that will be ultimately determined, it is not likely that the ultimate loss will be less than the minimum amount.”
Once a gain or loss is recognized, a taxpayer must determine how the recognized gain or loss affects the taxpayer’s tax liability. The character depends on a combination of two factors: purpose or use of the asset and holding period. The purpose or use of the asset is important because the law does not treat all assets equally. The general use categories are: (1) trade or business, (2) for the production of income (rental activities), (3) investment, and (4) personal. Based on these criteria, we can categorize an asset into one of three groups: (1) ordinary, (2) capital, or (3) section 1231. Characterizing the gain or loss is important because all gains and losses are not equal. Ordinary gains and losses are taxed at ordinary income rates, regardless of the holding
As a general rule for policy, tax deductions make most sense for items that represent reductions in ability to pay tax, such as casualty losses. Credits are more appropriate for subsidies provided through the tax system.
(3) What amount of loss is allocable to the limited partner, Dr. Ashin, in this taxable year?
Thus, a capital expenditure which is related only to the sick person and is not related to permanent improvement or betterment of property, if it otherwise qualifies as an expenditure for medical care, shall be deductible; for example, an expenditure for eye glasses, a seeing eye dog, artificial teeth and limbs, a wheel chair, crutches, an inclinator or an air conditioner which is detachable from the property and purchased only for the use of a sick person, etc. Moreover, a capital expenditure for permanent improvement of property may qualify as a medical expense to the extent that the expenditure exceeds the increase in the value of the related property, if the particular expenditure is related directly to medical care. Such a situation could arise, for example, where a taxpayer is advised by a physician to install an elevator in his residence so that the taxpayer's wife who is afflicted with heart disease will not be required to climb stairs. If the cost of installing the elevator is $1,000 and the increase in the value of the residence is determined to be only $700, the difference of $300, which is the amount in excess of the value enhancement, is deductible as a medical expense. If, however, by reason of this expenditure, it is determined that the value of the residence has
Suspended losses that are incurred as a result of the disposition of a passive interest are subject to an annual capital loss limit. Suspended losses can, however, be used to offset income realized in a later year that is generated from material participation in the activity that initially produced the loss. For example, if a taxpayer incurs a $5,000 suspended loss in one year from a passive activity and then materially participates in the activity the following year and earns $10,000, then the suspended loss may be applied against $5,000 of the
Net book value at end of year 1 is $8,793. Less what you received on the sale $7,500. Gives you a disposal loss of $1,293 using the straight-line method of depreciation. You then add the disposal loss from the previous years depreciation $1,880, which results in a total income statement impact of $3,173.
The cost basis is the original value of an asset or security at the time it was purchased plus the additional costs associated with it such as settlement and closing costs, fees, commissions, taxes and other adjustments paid to acquire the asset either paid in cash, in trade or through a loan. The cost basis helps determine the capital loss or gain on the sale, exchange, or other disposition of property as well as uses it to figure out deductions for depreciation, amortization, depletion, and casualty losses. If one uses the property for both business or for production of income and for personal purposes, one must allocate the basis based on the use. Only the basis allocated to the business or the production of income part of the property can be depreciated. Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property, increase your basis. If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis.