Slide 1LOSSES AND BAD DEBTS (1 of 2)LOSSES AND BAD DEBTS (2 of 2)Transactions that May Result in Losses (1 of 2)Transactions that May Result in Losses (2 of 2)Classifying the Losses on the Taxpayer’s Tax ReturnOrdinary vs. Capital Loss§1244 StockDisallowance PossibilitiesPassive LossesComputation of Passive Losses and CreditsCarryoversDefinition of a Passive Activity (1 of 2)Definition of a Passive Activity (2 of 2)Taxpayers Subject to Passive Loss RulesPublicly Traded PartnershipsRental Real Estate Trade or BusinessOther Rental Real Estate ActivitiesCasualty and Theft Losses (1 of 2)Casualty and Theft Losses (2 of 2)Casualty DefinedTheft DefinedDeductible Amount of Casualty LossLimitations on Personal-Use PropertyNetting Casualty Gains and Losses on Personal Use PropertyCasualty Gains & Losses Attributable to Business and Investment PropertyWhen Losses Are DeductibleBad Debts (1 of 2)Bad Debts (2 of 2)Bona Fide Debtor-Creditor Relationship (1 of 2)Bona Fide Debtor-Creditor Relationship (2 of 2)Taxpayer’s Basis in the DebtDebt Must Be WorthlessNonbusiness Bad DebtsBusiness Bad DebtsNet Operating LossesComputing the Net Operating Loss for IndividualsCarryback And Carryover PeriodsRecomputation Of Taxable Income In The Carryover YearTax Planning Considerations (1 of 2)Tax Planning Considerations (2 of 2)Compliance and Procedural ConsiderationsSlide 438-1©2007 Prentice Hall, Inc.©2007 Prentice Hall, Inc.8-2LOSSES AND BAD DEBTSLOSSES AND BAD DEBTS(1 of 2)(1 of 2)Transactions that may result in lossesClassifying the losses on the taxpayer’s tax returnPassive lossesCasualty and theft lossesBad debts©2007 Prentice Hall, Inc.8-3LOSSES AND BAD DEBTSLOSSES AND BAD DEBTS(2 of 2)(2 of 2)Net operating lossesTax planning considerationsCompliance and procedural considerations©2007 Prentice Hall, Inc.8-4Transactions that May Transactions that May Result in LossesResult in Losses (1 of 2) (1 of 2)Sale of exchange of propertySelling costsDeducted in year incurred for inventoryReduction of amount realized for non-inventoryExpropriated, seized, or confiscated propertyNot a casualty or theftTreated as sale or exchange©2007 Prentice Hall, Inc.8-5Transactions that May Transactions that May Result in LossesResult in Losses (2 of 2) (2 of 2)Abandoned propertyOrdinary loss if business or investment propertyNondeductible if personal propertyWorthless securitiesSecurities must be completely worthlessCapital loss on last day of tax yearDemolition of propertyAdd cost of demolition to basis of land©2007 Prentice Hall, Inc.8-6Classifying the Losses on Classifying the Losses on the Taxpayer’s Tax Returnthe Taxpayer’s Tax ReturnOrdinary vs. capital loss§1244 stockDisallowance possibilities©2007 Prentice Hall, Inc.8-7Ordinary vs. Capital LossDependent on type of property involved and type of transaction involved§1231 propertyIncludes real property or depreciable property used in a trade or business and held for more than one year©2007 Prentice Hall, Inc.8-8§1244 StockLosses on §1244 stock treated as ordinary rather than capital loss$50K limitation or $100K if filing MFJQualification as §1244 stock≤ 50% of gross receipts from passive sources during prior 5 tax years, ANDContributions to capital and paid-in surplus ≤ $1M at time of issue©2007 Prentice Hall, Inc.8-9Disallowance PossibilitiesTransfers of property to controlled corporation in exchange for stockProperty sold to certain related partiesWash salesLosses limited because losses exceed amount for which taxpayer is at risk©2007 Prentice Hall, Inc.8-10Passive LossesPassive LossesComputation of passive losses & creditsCarryoversDefinition of a passive activityTaxpayers subject to passive loss rulesPublicly traded partnershipsRental real estate trade or businessOther rental real estate activities©2007 Prentice Hall, Inc.8-11Computation of Passive Losses and CreditsIncome classified into three categoriesActive incomeE.g., wages, salaries, active business incomePortfolio income (investment income)E.g., interest, dividends, royaltiesPassive incomeNet income/loss calculated separately for each activityPassive losses can only offset passive income©2007 Prentice Hall, Inc.8-12CarryoversSuspended lossesDisallowed passive losses that are carried forward indefinitely Taxable disposition of interest in passive activitySuspended losses from activity used to reduce gain on disposition after losses used to offset current passive income©2007 Prentice Hall, Inc.8-13Definition of a Passive Activity(1 of 2)Any rental activityAny trade, business, or investment activity in which taxpayer does not materially participateInterest in limited partnerships is passive activity because limited partners not legally barred from participating in management of ptrshp©2007 Prentice Hall, Inc.8-14Definition of a Passive Activity(2 of 2)Material participation testsOnly need to meet one testParticipate > 500 hrs in activityParticipation constitutes substantially all participation in activity by all individualsParticipate > 100 hrs in activity and participation more than all other individualsSum of participation in all passive-type activities > 500 hrsMaterial participation in 5 of last 10 years©2007 Prentice Hall, Inc.8-15Taxpayers Subject to Passive Loss RulesApplies to individuals, estates, trusts, closely-held C Corporations, PSCs, and certain publicly traded partnershipsApplies to owners of partnerships and S Corporations©2007 Prentice Hall, Inc.8-16Publicly Traded PartnershipsAny partnership if partnership interests traded on primary or secondary marketsIf corporate tax provisions apply to PTP, passive rules do not applyIf partnership tax provisions apply to PTP, passive loss rules apply at partner level©2007 Prentice Hall, Inc.8-17Rental Real Estate Trade or BusinessPassive activity rules do not apply to real estate professionals who materially participate in real estate trade or business activities if > 50% of personal services performed in real property trades or businesses ANDTaxpayer performs > 750 hrs in real property trades or businesses©2007 Prentice Hall, Inc.8-18Other Rental Real Estate ActivitiesTaxpayers actively participating in rental real estate activities with AGIs not in excess of $100KMay deduct $25K of such