Chapter 7

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business Property Partially Destroyed treatment This year, a hurricane damages a warehouse used by Sugar Exporters, Inc. (SEI), in its exporting operation. SEI had paid $200,000 for the warehouse and had taken $80,000 in depreciation before the hurricane. Appraisals indicate that the warehouse was worth $300,000 before the hurricane. In its damaged state, the warehouse can be sold for only $100,000. SEI's warehouse is covered by insurance. SEI receives $100,000 from the insurance company for the hurricane damage. What is SEI's casualty loss?

Decline in Value from Hurricane $300,000 FMV (before) - $100,000 (After Damage) = $200,000 Value SEI's unrecovered investment in the warehouse $200,000 Purchase - $80,000 Deprecation = $120,000 Unrecovered Investment Unrecovered Investment < Decline in Value The maximum amount that SEI can recover through a loss deduction is the $120,000 basis

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses-Business Property Fully Destroyed Treatment

Deduct the adjusted basis - insurance recovery The measure of a taxpayer's investment in a property is its basis. Therefore, the measure of a business casualty loss is the property's basis.

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses-Business Property Partially Destroyed treatment

Deduct the lesser of the property's adjusted basis, or the decline in the property's value Calculation FMV(before) + FMV(After Casualty) = Decline in Value of Casualty The purpose of this measurement rule is to ensure that the amount of the loss deducted does not exceed the amount of unrecovered investment in the property.

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss

Disallow the deduction of passive activity losses from other forms of income passive activity losses cannot generally be used to shelter other sources of income. Even the basic operation of the passive loss rules can be extremely complex, and the complexity of the rules increases as a taxpayer engages in more and more passive activities. -Any trade or business in which the taxpayer does not materially participate

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Transaction Losses: Investment-Related Losses Wash Sale losses:

Disallowed because the sale violates the substance-over-form doctrine -it is an artificial loss created for tax purposes without any change in the taxpayer's underlying economic position.

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Transaction Losses: Investment-Related Losses Losses on Related Party Sales:

Disallowed because they generally fail the arm's length transaction concept -The primary provision regarding losses is that a loss on the sale of property to a related party is disallowed as a deduction.

LO 4: Explain the at-risk rules and how they limit annual loss deductions. "At Risk" Clarity?

equal to cash or other assets that have been contributed to the activity. any debts of the activity for which the taxpayer would be responsible if the activity could not pay them are also considered. Thus, is the maximum amount of personal funds (assets) that could be lost if the activity failed.

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses-Business Property Fully Destroyed Treatment A driver for Portable Phone Providers (PPP) is involved in an accident that totally destroys one of the company's vans. The van had been purchased for $26,000, and depreciation taken to date on the van is $8,000. PPP's van is covered by insurance and that PPP receives $15,000 from the insurance company for the accident. The unrecovered portion was $18,000. What is PPP's casualty loss?

$18,000 Basis - $15,000 from insurance Recovery = $3000 as PPP's Loss

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses-Business Property Fully Destroyed Treatment The unrecovered portion was $18,000(AB) PPP receives $20,000(Insurance) for the destruction of its van. What is PPP's casualty gain (loss)?

$20,000 - $18,000 = $2000 as Casualty Gain Under the capital recovery concept, PPP has a gain from the receipt of insurance proceeds in excess of adjusted basis.

LO 1 Explain the difference between an annual loss and a transaction loss. Emma owns a restaurant. During the current year, she has gross income of $74,000 and allowable deductions related to the business of $90,000. What is Emma's income from the restaurant?

($74,000 − $90,000) = $16,000 Emma has suffered a business loss of $16,000; annual loss created by an excess of allowable deductions over income.

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss: Classifications 1)Portfolio income

-unearned income from dividends, interest, royalties, annuities, and other assets held as investments. Includes income from the sale of the asset creating the income. The main characteristic of portfolio income is that such investments almost always produce positive income while the investment is held. §Considered non-passive

LO 5: Discuss passive losses and how they limit annual loss deductions. Two basic tests for material participation

1) Individual (including the individual's spouse) participates in the activity for more than 500 hours per year 2) Taxpayer spends more than 100 hours a year in the activity, and the time spent in the activity is more hours than any other owner or non-owner spends on the activity (known as the 100-hour test)

LO 12 Understand the tax treatment of personal casualty losses. Personal Casualty Losses Treatment -Loss is reduced by

1) Insurance proceeds received, 2)$100 per event (Administrative Convenience), and 3) 10% of AGI per year

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. A taxpayer qualifies as a real estate professional if:

1) More than 50% of the taxpayer's total personal services (work) are in real property trades or businesses in which the taxpayer materially participates. 2) The taxpayer performs more than 750 hours a year of service in real property trades or businesses in which the taxpayer materially participates. 3) The taxpayer materially participates in the rental activity.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Active Participant in Real Estate Exception

1) must own at least a 10-percent interest in the activity 2) and have significant and bona fide involvement in it. Significant and bona fide involvement requires that the individual be involved in some significant aspect of the rental (e.g., arranging financing, collecting rents, arranging for repairs and maintenance, keeping the activities records). easily meet the significant involvement standard.

LO 3 Discuss the general operation of a tax shelter. Tax Shelter

Activities designed to minimize the effect of tax on wealth accumulation generally applied to investments that produce significant tax losses as a result of the allowable deductions associated with the investment. Dominant business purpose is lacking Primary motivation is tax reduction The basic intent of the generous tax laws is to provide incentive to taxpayers to engage in activities that they ordinarily would reject because of either low returns or high risk. Are often vehicles for tax law abuse

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition upon Death Harriet dies on January 2, Year 4. PA1 has a fair market value of $30,000 and an adjusted basis of $36,000 as of that date. The suspended loss at that date is $13,500. How much of the suspended loss can be deducted on Harriet's Year 4 income tax return?

Because PA1 has an unrealized loss of $6,000 as of the date of death, there is no excess of suspended loss over unrealized gain. Therefore, no suspended loss deduction is allowed on Harriet's Year 4 income tax return.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition upon Death Harriet dies on January 2, 2022. PA1 has a fair market value of $42,000 and an adjusted basis of $36,000 as of that date. The suspended loss at that date is $13,500. How much of the suspended loss can be deducted on Harriet's 2022 income tax return?

Because she died, the $6,000 in gain is never subject to income tax. Therefore, the suspended loss deduction is limited to the $7,500 by which she would have been able to reduce her income had the property been sold. That is, $7,500 is the amount of suspended loss in excess of the unrealized gain on PA1.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Decuction treatment-Example 26 Rory is a mechanic who owns an apartment building that has a net rental loss of $22,000 during the current year. His adjusted gross income is $120,000. If Rory owns no other passive activities, how much of the rental loss can he deduct?

Because the property is rental real estate, it always is considered a passive activity. Rory owns 100% of the property, and it is assumed that he is involved in the rental in some significant way. The special deduction for rental real estate is $25,000. However, he must reduce the allowable deduction by $10,000= [($120,000 − $100,000) × $0.50] to $15,000. Rory can deduct $15,000 of the rental loss against his $120,000 of adjusted gross income. The remaining $7,000 is suspended and treated like any other passive loss.

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss: Limited Partnerships

Being a limited partner in an LP is generally considered a passive activity General partners are involved in management activities and day to day operations, and are considered active Limited partners have little to no responsibilities in the partnership and are considered passive Limited partners are investors who purchase their interest to provide capital for the partnership. They generally have no responsibilities for operating the partnership.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Passive Activity Loss: Exceptions for Rental Real Estate

By definition, all rental activities are passive 2) real estate professionals who materially participate in rental real estate business are allowed to offset any losses against other active or portfolio income -permitted to treat the loss from the rental property as a loss from a trade or business (i.e., an active activity). 3)And, taxpayers who actively participate in rental real estate business may offset a portion of losses -as great as $25,000 per year against portfolio and active sources of income

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Investment-related losses-Net Capital Losses of Individuals

Individual taxpayers may deduct only $3,000 of net capital loss annually Any loss in excess of $3,000 is carried forward and netted against capital gains in subsequent years. Thus, the capital loss limitation is a deferral-of-loss-recognition provision, not a total loss disallowance provision.

LO 2: Understand the tax treatment of annual net operating losses. The Daffron Corporation, a calendar year taxpayer, was incorporated in Year 1 and had operating income of $25,000. The company incurred a net operating loss of $35,000 in Year 2 and had operating income in Year 3 of $40,000. Assume that the tax rate for all 3 years is 21%. What is the treatment of the Year 2 loss?

For tax years after December 31, Year 1, a taxpayer that incurs a NOL is not permitted to carry that loss back to offset prior years' income but rather can only carry the NOL forward. In addition, the maximum amount of income that can be offset from that carryforward loss is limited to 80% of taxable income Therefore, over the 3-year period, Daffron's total tax liability is $6,930, and it has a NOL carryforward of $3,000.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition by Sale Harriet has a Year 2 suspended loss carryover attributable to PA1 of $13,000. Continuing with that example, assume that the three passive activities have the following results for Year 3: PA1: $(2000) PA 1 Suspended Loss Carryforward from year 2: (13000) Total Loss Attributable to PA1: (15,000) PA2: 2000 PA3: (5000) Year 3 Suspended Loss: ($18,000) Return to example 28. Assume that Harriet sells PA1 on January 2, Year 4, for $42,000. Her basis in PA1 is $36,000. What is the effect of the sale of PA1 on Harriet's taxable income in Year 4?

Harriet's gain of $6,000 = ($42,000 − $36,000) on the sale of PA1 is included in her gross income for Year 4. The $13,500 suspended loss is deductible against active and portfolio income sources. Thus, the net effect of the sale is a reduction in her taxable income of $7,500 = ($6,000 − $13,500)

LO 4: Explain the at-risk rules and how they limit annual loss deductions. Example 8: During the first year that Jolene operates the business she purchased in example 7, she suffers a loss of $70,000. She also withdraws $40,000 from the business for her personal use. What is Jolene's at-risk amount in the business at the end of the first year of operation?

Jolene has a sufficient amount at risk to enable her to deduct the loss from the business. Therefore, she must reduce her amount at risk by the $70,000 loss. In addition, the $40,000 withdrawn from the business is no longer at risk. Thus, her amount at risk has declined to $90,000 ($200,000 − $70,000 − $40,000) at the end of the first year of operation.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Example 16 Both Alf and Bart are lawyers. The two decide to purchase an apartment building in Year 1 at a cost of $600,000. Each provides half of the $60,000 down payment. Both are busy practicing law, so they hire Chester to manage the building. Chester has full control over all management decisions (getting tenants, collecting rent, taking care of repairs, etc.). In Year 2, Bart decides to quit practicing law and take Chester's place as the manager of the building. Bart devotes all his personal services, 2,000 hours, to managing the apartments (getting tenants, collecting rent, taking care of repairs, etc.). Alf continues to work as a lawyer. Is the apartment building a passive activity for either of them?

In Year 1, the rental activity is passive for both Alf and Bart. real estate professional exception? -Bart can treat the rental property as an active activity in Year 2. -More than 50% of his personal services are devoted to working in a real property trade or business in which he materially participates The rental property remains passive for Alf because he fails to meet any of the tests. In fact, Alf does not even materially participate in the rental activity.

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss: Classifications 2) Active income:

Income from a trade or business in which the taxpayer materially participates. This category includes wages and salaries as well as income from a trade or business in which the taxpayer materially participates. earned income

LO 4: Explain the at-risk rules and how they limit annual loss deductions. Example 7: Jolene purchases a business for $200,000 by investing $20,000 of her own funds and borrowing $180,000 from State Bank. She is personally liable for repayment of the loan to State Bank. What is Jolene's at-risk amount in the business?

Jolene is at risk for $200,000. If the business is not successful, she stands to lose the $20,000 in cash she invested and would be liable for payment of the $180,000 loan. Thus, she can lose a maximum of $200,000 from her investment in the business.

LO 4: Explain the at-risk rules and how they limit annual loss deductions. Example 9: Assume that Jolene purchases $40,000 worth of equipment by borrowing from Local Bank. Local Bank makes the loan with the equipment as the security for the debt. Jolene is not personally liable for the debt. How are Jolene's basis and at-risk amount affected by the purchase of the equipment?

Jolene obtains a basis of $40,000 in the equipment. However, because she is not personally liable for the debt incurred to finance the purchase, she is not at risk with respect to the debt. That is, if her business fails, she will not be personally liable for repayment of the debt. Therefore, her at-risk amount does not increase.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition upon Death

Leaves the passive activity in the decedent's estate that all assets are valued at the fair market value at the date of death. §Passive activity with unrealized gain --§Beneficiary takes passive activity with stepped-up basis --§Any unrealized gain on activity decreases amount of suspended loss to release --Any unrealized gain on activity decreases amount of suspended loss to release Passive activity with unrealized loss --§No suspended loss is released

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Transaction Losses: Investment-Related Losses. Losses on Related Party Sales: Treatment

Loss is carried forward with the property 1) Gain from later sale may be offset by deferred loss -the gain realized on the sale may be reduced by the amount of loss previously disallowed 2) Loss cannot be created or increased by using the deferred loss -The gain on a subsequent sale to an unrelated party may be reduced only to zero (no gain or loss recognized).

LO 12 Understand the tax treatment of personal casualty losses. Personal Casualty Losses Treatment

Loss is the lesser of 1) Property's adjusted basis, 2)Decline in the value of the property (repair cost)

LO 11 Discuss the tax treatment of transaction losses incurred in a personal activity. Personal use losses

Losses from the disposition of personal use assets are generally not deductible (autos, jewelry, furniture, and clothing have no tax effect.) Exception exists for personal casualty losses incurred from a federally declared disaster --Would only be deductible as personal itemized deductions. Thus, a taxpayer needed to itemize to deduct a personal casualty or theft loss.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition By Gift

Neither donor nor donee recognizes any gain or loss on the transaction Donee takes a carryover basis in activity-is necessary to ensure that any unrealized gains on the gift property do not go untaxed. Any suspended losses are used to increase the donee's basis in the activity -Effect of this treatment is to recognize that the donor does not realize (or recognize) a gain on the disposition of a gift property

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Investment-related losses

Net capital losses result from netting short-term and long-term capital gains and losses occurs when a taxpayer's total capital losses exceed the taxpayer's total capital gains for a tax year. The treatment of a net capital loss for an individual is different than the treatment for a corporation

LO 2: Understand the tax treatment of annual net operating losses. Annual Losses: Net Operating Losses Treatment

No tax in year NOL occurs A carryback allowed the loss to reduce income in prior years. Because a tax has already been paid on the prior years' income, a carryback resulted in a prompt refund of taxes paid. A carryforward allowed the loss used to offset income in future periods. Carry-forward unused NOL 20 years -In a C-corporation, the maximum amount of income that can be offset from a carryforward loss is limited to 80% of taxable income in that year

LO 2: Understand the tax treatment of annual net operating losses. Annual Losses: Net Operating Losses Example 3: Pete is the sole proprietor of Pete's Pizza Parlor. During the current year, the pizza parlor has income of $80,000 and deductions of $100,000, resulting in a net operating loss of $20,000. What is the treatment of the loss?

Not a true conduit entity, the loss from the pizza parlor flows through to the owner, Pete, and is reported on his return. Pete is allowed to deduct the $20,000 loss from the pizza parlor against his other sources of income.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Decuction treatment

Permits up to $25,000 of rental real estate loss to be deducted annually -Deduction amount is reduced by $0.50 for each dollar of AGI over $100,000 -For AGI over $150,000, no allowed loss deduction remains

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities.

Rental activities that do not provide significant services are always considered passive activities - these activities are all rentals of real property that include no significant provision of personal services. The tax law allows a taxpayer who actively participates in rental real estate to deduct losses as great as $25,000 per year against portfolio and active sources of income

LO 1 Explain the difference between an annual loss and a transaction loss. Transaction Losses

Result from the disposition of an asset An asset that is disposed of at less than its basis creates a loss that represents the taxpayer's unrecovered capital investment.

Transaction Losses

Result from the disposition of business, investment or personal-use assets Allowance of deductions for losses follows the same line of reasoning as for the allowance of deductions OPTIONS 1) Trade or Business Losses 2)Investment Related Losses 3) Personal Losses

LO 1 Explain the difference between an annual loss and a transaction loss. Annual (Activity) Losses

Result when an entity's deductions for the period exceed its income

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business Property Partially Destroyed treatment The maximum amount that SEI can recover through a loss deduction is the $120,000 basis SEI's warehouse is covered by insurance. SEI receives $100,000 from the insurance company for the hurricane damage. What is SEI's casualty loss

SEI's deductible loss is $20,000 ($120,000 − $100,000). Loss must be reduced by the $100,000 of insurance proceeds

LO 4: Explain the at-risk rules and how they limit annual loss deductions. To determine amounts actually at-risk,

Start with the amount of cash or other assets contributed Add debts for which taxpayer is responsible Adjust for share of income (loss) from the activity Reduce by amount of withdrawals

LO 2: Understand the tax treatment of annual net operating losses. Annual Losses: Net Operating Losses What happens when a taxable entity has an NOL?

Taxable entity NOLs (C-corps) pays tax on the income it generates, it would pay no tax for the year in which an NOL occurs. Taxable entities are not allowed to pass the loss through to their owners for deduction. With no relief from this situation, taxable entities are at a distinct disadvantage.

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss: Limitations

Taxpayers subject to the limitations: -All non-corporate taxable entities -a conduit entity is usually a material participant in the operation of the business. However, the loss from the conduit flows through to the owners of the entity. -Thus, conduit entities must report the results of their operations to owners so that the owners may apply the applicable rules for the deduction of losses. Taxpayers not subject to the limitations: -Publicly held corporations can offset passive losses against both active and portfolio income, -while a closely held corporation can offset passive losses only against active income.

LO 6 Explain the limitations on the deductibility of passive losses incurred in non-real estate activities. Example 24: Harriet has a taxable income of $100,000 in Year 1 from portfolio and active income sources. In addition, she owns two passive activities. Passive activity 1 (PA1) has a net loss of $20,000, and passive activity 2 (PA2) has a net income of $2,000 in Year 1. What is the effect of the two passive activities on Harriet's Year 1 income?

The $2,000 of income from PA2 is included in gross income With Rules, only $2,000 of the loss from PA1 is deductible in Year 1 The net $18,000 = ($20,000 − $2,000) passive loss in Year 1 is not deductible against Harriet's $100,000 of taxable income from portfolio and active income sources When are passive losses Deductible? -deductible only up to the amount of passive income.

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Example 16 Both Alf and Bart are lawyers. The two decide to purchase an apartment building in Year 1 at a cost of $600,000. Each provides half of the $60,000 down payment. Both are busy practicing law, so they hire Chester to manage the building. Chester has full control over all management decisions (getting tenants, collecting rent, taking care of repairs, etc.). Alf and Bart agree to split the profits evenly after paying Chester's salary of $50,000. Is the building a passive activity for Alf and Bart?

The apartment building is a rental activity for passive loss purposes. It is a rental of tangible property with no significant services provided. Thus, it is a passive activity. This is true for both Alf and Bart.

LO 2: Understand the tax treatment of annual net operating losses. Annual Losses: Net Operating Losses

The only deductions allowed for annual losses are for those incurred in a trade or business It results from an excess of allowable deductions over income for the accounting period Incurred in trade or business operations -Caused by business expenses -May not be caused by investment or personal expenses

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Real Estate Professional Exception

The taxpayer materially participates as an active activity and to use any losses to offset active and portfolio income -permitted to treat the loss from the rental property as a loss from a trade or business

LO 8 Discuss the general tax treatment of transaction losses incurred in a trade or business. Trade or business losses

Transaction losses incurred in the course of business are deductible For an individual, a trade or business loss is deductible as a deduction for adjusted gross income

LO 7: Explain the limitations on the deductibility of passive losses incurred in real estate activities. Disposition by Sale

When an entire interest in a passive activity is sold in a taxable transaction, any suspended loss on the activity is deductible in the year of sale against portfolio and active income. Frees the suspended loss to offset income of any other activity 1)First, offsets other passive income 2)Second, offsets gain from disposal 3)Third, any remaining PAL offsets ordinary income

LO 1 Explain the difference between an annual loss and a transaction loss. General Scheme for Treatment of Losses

annual loss incurred in a passive activity is not generally allowed as a deduction.

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Investment-related losses-Net Capital Losses of Corporations

corporations are not allowed to deduct net capital losses against noncapital gain income. Corporations can use capital losses only to offset capital gains. §Carry-back for 3 years, then forward for 5 if not used within 3 years

LO 5: Discuss passive losses and how they limit annual loss deductions. Passive Activity Loss: Classifications 3) Passive Income

earned or unearned income from a trade or business in which a taxpayer does not materially participate may produce either income or loss, but most passive activities are loss activities.

LO 4: Explain the at-risk rules and how they limit annual loss deductions. The intention of the at-risk rules is to

limit loss deductions by individuals and closely held corporations on business and investment-related activities to the amount of the taxpayer's actual economic investment. This is done by limiting the current year's loss deduction to the amount that the taxpayer has at risk in the activity

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Transaction Losses: Investment-Related Losses Losses on Small Business Stock

may be deducted up to $50,000 per person ($100,000 per married couple) per year Requirements 1) A corporation with capitalization of less than $1 million 2) Stock must have been bought directly from corporation 3)Excess over $50,000 ($100,000) is netted with other capital gains and losses -carried forward as a capital loss are subject to the capital loss limitation in later years, not the small business stock limitation

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Investment-related losses-Net Capital Losses of Individuals Year 1 Capital Gain: $12,000 Year 2 Capital Loss: (20,000) Year 2 Capital Gain: 17,000 Year 2 Capital Loss: (16,000) What is Mona's deductible capital loss in Year 1 and Year 2?

net capital loss of $8,000 in Year 1 the capital loss limitations means she can deduct only $3,000 of this loss in Year 1. The remaining $5,000 of loss is carried forward to Year 2 and included in the Year 2 netting: Per the capital loss limitations, $3,000 of the net capital loss is deductible in Year 2. The remaining $1,000 of net capital loss must be carried forward and included in Mona's capital gain-and-loss netting in Year 3.

LO 10: Discuss the tax treatment of transaction losses incurred in production-of-income activities, including wash sales, small business stock, and related party sales. Transaction Losses: Investment-Related Losses Wash Sale losses: Treatment

occurs when a security is sold at a loss, and during +/- 30 days of the sale the seller buys substantially identical securities Disallowed loss amount is added to the basis of the replacement security

LO 6 Explain the limitations on the deductibility of passive losses incurred in non-real estate activities. General Rule for Passive Activities

purpose is to deny current loss deductions for tax-shelter activities. Passive activity losses must be netted against passive activity income Net passive losses are not currently deductible -A suspended loss is not permanently disallowed. Suspended losses are carried forward and may be deducted against passive income in subsequent years. Net passive gains are reported with other income

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses

result from damage caused by a sudden, unexpected and/or unusual event

LO 6 Explain the limitations on the deductibility of passive losses incurred in non-real estate activities. Example 25 Harriet has a taxable income of $100,000 in Year 1 from portfolio and active income sources. In addition, she owns two passive activities. Passive activity 1 (PA1) has a net loss of $20,000, and passive activity 2 (PA2) has a net income of $2,000 in Year 1. Now, purchases passive activity 3 (PA3) in Year 2. The results of the three passive activities in Year 2 are as follows: PA1: ($10,000) PA2: 3000 PA3: 12,000 What is the effect of the passive activities on Harriet's Year 2 taxable income?

suspension and carryforward of the 2019 net passive loss means $5000 Deduction of the 2019 Suspended Loss Against 2020 Passive income PA2 + PA3 = $15000 included in Gross Income --> OFFSET $15,000 LOSS FROM PA1, LEAVING UNCHANGED 2020 TAXABLE INCOME The $13,000 net passive loss is carried forward to 2021.

LO 9: Understand the tax treatment of business casualty and theft losses of transaction losses Business casualty and theft losses-Business Property Fully Destroyed Treatment A driver for Portable Phone Providers (PPP) is involved in an accident that totally destroys one of the company's vans. The van had been purchased for $26,000, and depreciation taken to date on the van is $8,000. What is the measure of the loss on the van?

the measure of the loss is the unrecovered investment in the van, its basis. Although the van cost $26,000, the company has recovered $8,000 of the cost through depreciation deductions. The unrecovered portion, $18,000= ($26,000 − $8,000), is the amount of the investment lost.