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October 19, 2012 CONCEPTS IN FEDERAL TAXATION CHAPTER 7: LOSSES—DEDUCTIONS AND LIMITATIONS.

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Presentation on theme: "October 19, 2012 CONCEPTS IN FEDERAL TAXATION CHAPTER 7: LOSSES—DEDUCTIONS AND LIMITATIONS."— Presentation transcript:

1 October 19, 2012 CONCEPTS IN FEDERAL TAXATION CHAPTER 7: LOSSES—DEDUCTIONS AND LIMITATIONS

2 ADMINISTRATIVE  Attendance  Not required  Factor for final grade  Can help, won’t hurt  Midterm 1  Pass out exams today  Professor has kept some exams  Midterm 2  Unique questions  Research project

3 1. HW Problems Assignment #8 Chapter 7 P#44, 49, 52, 66, Midterm 1 Overview HOMEWORK PROBLEMS

4 Annual (Activity) Losses  Result when an entity’s deductions for the period exceed its income Transaction Losses  Result from the disposition of an asset LOSSES

5 Claudio owns a passive activity that has a basis of $28,000 and a fair market value of $38,000. The activity has suspended losses of $16,000. To reduce their estate, every year Claudio and his wife give their son Anthony and his wife a gift of approximately $40,000. During the year, Anthony sells stock that results in a $10,000 short-term capital loss. A friend of Claudio’s suggests that he give his passive activity to Anthony. The friend says that this will allow Claudio to avoid tax on the $10,000 capital gain and let his son offset his short-term capital loss with the $10,000 ($38,000 - $28,000) gain from the sale of the passive activity. In addition, Claudio can use the suspended loss from the passive activity to offset his other ordinary income. Write a letter to Claudio explaining the tax consequences of making the passive activity a gift to his son. #44

6  Related party sales  Losses on sales of property to a related part is disallowed as a deduction  If property is later sold to an unrelated party at a gain, the gain realized on the sale may be reduced by the amount of lost previously disallowed  Disposition by gift  Carryover basis #44

7  Not accurate!  If Claudio gifts the passive activity to his son, Anthony’s basis in the passive activity is $44,000  Claudio’s $28,000 basis + $16,000 suspended losses  Although Anthony’s basis is increased by the $16,000 suspended loss, neither Claudio nor Anthony receives a deduction for the suspended loss  This treatment prevents Anthony from using the suspended loss deduction against other passive income  if Anthony sells the passive activity in an arm’s length transaction for $38,000 (fair value), he will not recognize a $10,000 gain ($38,000 - $28,000), but rather a $6,000 ($38,000 - $44,000) long-term capital loss #44

8 Stella owns a taxicab company. During the year, two of her cabs are involved in accidents. One is totally destroyed; the other is heavily damaged. Stella is able to replace the destroyed cab with an identical model for $5,500. Her adjusted basis in the destroyed cab is $3,750, and the insurance company pays her $2,800. The adjusted basis of the damaged cab is $3,800. The insurance adjuster estimates that the damaged cab is worth $3,600. Although a comparable cab sells for $7,800, the insurance company gives Stella only $2,900. Write a letter to Stella explaining the amount of her deductible casualty loss. #49

9  The loss on business property totally destroyed is the property’s basis  The loss on partially destroyed business property is measured as the lesser of: 1.the decline in the value of the property 2.the property’s basis  Whether the property is totally destroyed or partially destroyed, the loss is reduced by any insurance reimbursement #49

10 Totally destroyed cab:  Basis: $3,750  The $3,750 basis is reduced by the insurance reimbursement of $2,800 for a deductible loss of $950: Destroyed Cab Adjusted basis$3,750 Insurance reimbursement (2,800) Casualty loss$ 950 #49

11 Partially destroyed cab:  The loss is the lesser of: 1.the decline in the value of the property—$4,200 ($7,800 - $3,600) 2.the property’s basis—$3,800  Stella’s loss is the cab’s basis of $3,800 reduced by the $2,900 insurance reimbursement for a net casualty loss deduction of $900: Damaged Cab Lower of: Adjusted basis$3,800 or Reduction in FMV$4,200 Insurance reimbursement(2,900) Casualty loss$ 900 #49

12  Stella’s total casualty loss on the two accidents is $1,850 ($950 + $900) #49

13 During 2012, Yoko has total capital gains of $8,000 and total capital losses of $16,000. a. What is the effect of the capital gains and losses on Yoko’s 2012 taxable income? Explain.  The capital gains and losses are netted together to determine the net capital gain (loss) position for the year  Yoko has a net capital loss of $8,000: Total capital gains$ 8,000 Total capital losses (16,000) Net capital loss$ (8,000) #52

14 2012 Deduction:$ 3,000 Loss carried forward to 2013:$ (5,000)  The deduction for capital losses is limited to $3,000 per year, with any excess capital loss carried forward for netting in subsequent years  Yoko has a $5,000 capital loss carryforward #52

15 b. Assume that in 2013 Yoko has total capital gains of $10,000 and total capital losses of $7,500. What is the effect of the capital gains and losses on Yoko’s taxable income in 2013? Explain.  The 2013 capital gains and losses are netted with the 2012 $5,000 capital loss carryforward  This results in a net capital loss of $2,500  Because it is under the $3,000 maximum deduction limit, the entire $2,500 net capital loss is deductible in 2013 #52

16 Total capital gains$ 10,000 Total capital losses (7,500) 2012 Loss carryforward (5,000) Net capital loss$ (2,500) 2013 Deduction$ (2,500) #52

17 c. How would your answer change if Yoko’s total capital losses are $14,000 in 2013?  The netting of the 2013 gains and losses with the 2012 $5,000 capital loss carryforward results in a net capital loss of $9,000  Only $3,000 of the loss is deductible in 2013  The $6,000 loss is carried forward to 2014 #52

18 Total capital gains$ 10,000 Total capital losses (14,000) 2012 Loss carryforward (5,000) Net capital loss$ (9,000) 2013 Deduction$ 3,000 Loss carryforward to 2014$ (6,000) #52

19 Jorge and his wife own a beachfront vacation home in Savannah, Georgia. During the year, high winds from a tropical storm shatter a sliding glass door and rain from the storm causes extensive water damage to the kitchen. Fortunately, during a calm in the storm, Jorge is able to board up the door, which limits the water damage to the kitchen. The items damaged in the storm are: Value Value Insurance Cost Before After Proceeds Kitchen Furniture$2,100$1,400 $400 $650 TV$ 250$ 200 $ -0- $125 Refrigerator$1,000$ 950 $100 $800 Linoleum Flooring$1,600$ 900 $ -0- $500 In addition, Jorge pays $625 to replace the sliding glass door. The insurance company will not reimburse him for the cost of the new door because the old sliding glass door did not meet the company’s standards for a hurricane area. What is the amount of Jorge’s casualty loss before considering any annual limitations that may apply? #66

20  The measure of a personal casualty loss is the lesser of 1.the decline in market value of the property 2.the property’s basis  The loss must be reduced by any insurance reimbursements and the $100 statutory floor (personal casualty loss)  Jorge’s casualty loss is $1,400 before considering the annual personal casualty loss limitation (10% of AGI) #66

21 Kitchen furniture (decline in value)$ 1,000 Television (decline in value) 200 Refrigerator (decline in value) 850 Linoleum Flooring (decline in value) 900 Glass door damage (cost to repair) 625 Total loss before insurance reimbursement$ 3,575 Less: Insurance reimbursement ($650 + $125 + $800 + $500) (2,075) Loss net of insurance$ 1,500 Less: statutory floor (100) Net casualty loss before annual limitation$ 1,400  Jorge’s deductible casualty loss will be decreased by 10% of his AGI #66

22 Marsha owns a two-family condominium in southern California that she paid $140,000 for in One unit has 2,400 square feet of space, and the other has 1,600 square feet. Marsha uses the 2,400-square-foot unit as a vacation home and rents the other unit to a retired couple. During the current year, an electrical fire destroys the condominium. Because part of it was used as rental property, Marsha’s insurance company reimburses her only $120,000. The fair market value of the condominium before the fire was $160,000, and her adjusted basis in the rental unit is $20,000. Assume that Marsha’s adjusted gross income before considering the casualty is $55,000. Write a letter to Marsha explaining the effect of the casualty on her taxable income. #69

23  Because the rental property is a mixed-use asset, it must be accounted for as two assets—a business asset and a personal asset  Allocate the business and personal portion of the condominium based on the total square footage of the two units:  40% [1,600  (2, ,600)] of the casualty loss is business  60% [2,400  (2, ,600)] of loss is personal  The gain or loss from the casualty must be computed separately and the appropriate rules for business and personal property applied to each portion #69

24 40% 60% BusinessPersonal Initial basis ($140,000)$ 56,000$ 84,000 Less: depreciation($56,000 - $20,000) (36,000) -0- Adjusted basis$ 20,000$ 84,000 Amount of loss: Adjusted basis $ 20,000$ 84,000 OR Decline in value—Personal ($160,000 x 60% = $96,000)$ 96,000 Less: Insurance proceeds 48,000 72,000 Net casualty gain (loss)$ 28,000 $(12,000) #69

25  Marsha has a $28,000 casualty gain on the business portion of condominium and a $12,000 loss on the personal portion of the condominium  The $28,000 gain is added to her $55,000 AGI, giving her an adjusted gross income of $83,000 ($28,000 + $55,000)  Assuming that Marsha itemizes her deductions, her deductible casualty loss is $3,600: Loss net of insurance$ 12,000 Less: statutory floor (100) Net casualty loss before annual limitation$ 11,900 Annual limitation ($83,000 x 10%) (8,300) Deductible personal casualty loss$ 3,600 #69

26  Midterms have raw grades  Average 117/150  Professor Cerf is reviewing and adjusting for the curve  The class generally did well on the short answer section  Multiple choice section seemed to be more challenging (lower ratio of correct answers)  I assume the time crunch accounted for a lot of the variability in the multiple choice answers  I will post solutions on bSpace  me for questions regarding grading for the midterm MIDTERM 1

27 Recommended time allocation (for students to gauge progress during exam) QuestionWeightPercentMinutes 13020% % %21 MC4027%21 Total150100%80 MC time per question (minutes): 2.1 MIDTERM 1

28 1. During the current year, Trane invests $35,000 in each of two separate corporations. Each investment gives him a 20% ownership interest. Brazil Corporation is a regular corporation that has taxable income of $200,000 and pays dividends totaling $50,000. China Corporation is an S corporation that has taxable income of $100,000 and pays $50,000 of dividends. As a result of these two investments, Trane I. Has $40,000 of taxable income from Brazil Corporation. II. Has $20,000 of taxable income from China Corporation. a. Only statement I is correct. b. Only statement II is correct. c. Both statements are correct. d. Neither statement is correct. MIDTERM 1—MC

29  Distinguish between C corporation and S corporation (conduit)  Brazil Corporation (C)  Only count dividend income  20% of $50,000 = $10,000 taxable income  China Corporation (S)  Income flow through to partners  20% of $100,000 = $20,000 taxable income  Dividends reduce basis MIDTERM 1—MC

30 1. During the current year, Trane invests $35,000 in each of two separate corporations. Each investment gives him a 20% ownership interest. Brazil Corporation is a regular corporation that has taxable income of $200,000 and pays dividends totaling $50,000. China Corporation is an S corporation that has taxable income of $100,000 and pays $50,000 of dividends. As a result of these two investments, Trane I. Has $40,000 of taxable income from Brazil Corporation. II. Has $20,000 of taxable income from China Corporation. a. Only statement I is correct. b. Only statement II is correct. c. Both statements are correct. d. Neither statement is correct. MIDTERM 1—MC

31 2. Roberta invests $16,000 for a 10% interest in Bowie Partnership. In the first year of operations, Bowie reports net income from operations of $80,000 and distributes $6,000 cash to Roberta. How much gross income must Roberta recognize from her investment in Bowie? a. $ 2,000 b. $ 6,000 c. $ 8,000 d. $ 80,000  10% x $80,000 = $8,000 MIDTERM 1—MC

32 3. Nora receives a salary of $55,000 during the current year. She sells some land that she held as an investment at a loss of $15,000 and some stock at a gain of $10,000. Nora's adjusted gross income is: a. $50,000 b. $52,000 c. $55,000 d. $62,000 e. $65,000 MIDTERM 1—MC

33 4. Boris, a single individual, has two sales of stock during the current year. The first sale produces a short-term loss of $27,000 and the second sale results in a long-term gain of $57,000. Boris's taxable income without considering the gain is $125,000. Boris's stock transactions will increase his taxable income by: a. $ -0- b. $30,000 c. $34,000 d. $54,000 MIDTERM 1—MC

34 5. Chip, a single individual has two sales of stock during the current year. The first sale produces a short-term loss of $10,000 and the second sale results in a long-term gain of $40,000. Chip's taxable income without considering the gain is $150,000. Chip's stock transactions will increase his income tax liability by: a. $ 3,200 b. $ 4,500 c. $ 6,000 d. $ 8,000 e. $ 8,400  $30,000 x 15% = $4,500 MIDTERM 1—MC

35 6. Ramona's employer pays 100% of the cost of all employees' group-term life insurance. The life insurance plan is not discriminatory. Ramona’s annual salary is $100,000. What is the maximum amount of coverage that can be provided tax- free? a. $ b. $ 5,000 c. $ 10,000 d. $ 50,000 e. $100,000 MIDTERM 1—MC

36 7. Conzo is injured in an accident while working at his job. He received $1,500 in worker's compensation benefits for 5 weeks of lost work. How much should Conzo report as gross income from the receipt of these benefits? a. $ b. $ 300 c. $ 750 d. $ 900 e. $ 1,500 MIDTERM 1—MC

37 8. The information that follows applies to the current year for Aaron and Janelle, a married couple:  Aaron is employed as a shoe salesman; his compensation is $75,000.  Janelle is employed by the state of Indiana; her compensation is $35,000.  Aaron and Janelle have total allowable itemized deductions of $12,000.  Aaron and Janelle have two dependent children.  Aaron and Janelle have other economic income as follows: - Interest on U.S. Treasury notes $1, Interest on Compost Computer bonds $1, Interest on German government bonds $ Interest on City of Nashville. bonds $1, Aaron's wealthy uncle gives him $1, Janelle sold Aaron's football card collection for $3,000. It cost $ Janelle sells Aaron's fishing boat for $2,000. Aaron had purchased the boat 3 years ago for $2,800. Based on the above information, what is Aaron and Janelle 's adjusted gross income? a. $114,450 b. $114,700 c. $115,450 d. $116,450 e. $116,650 MIDTERM 1—MC

38 Income “Broadly Defined” (includes income from all sources) Minus:Excluded income Equals:Gross income Minus:Deductions for AGI Equals:AGI Minus:Deductions from AGI Minus: Exemptions Equals:Taxable income XTax rate (schedule of rates) Equals:Income tax Minus: Tax credits Tax prepayments Equals: Tax (refund) due with return

39 Aaron’s compensation $75,000 Janelle’s compensation$35,000 Itemized deductions $12,000 Personal exemptions(x2)$7,600 Dependency exemptions (x2)$7,600 Interest on U.S. Treasury notes $1,000 Interest on Compost Computer bonds $1,500 Interest on German government bonds $750 Interest on City of Nashville bonds $1,200 Aaron's wealthy uncle gives him $1,000 Football card ($3,000 - $800)$2,200 Boat ($2,000 - $2,800)($800) MIDTERM 1—MC Included

40 8. The information that follows applies to the current year for Aaron and Janelle, a married couple:  Aaron is employed as a shoe salesman; his compensation is $75,000.  Janelle is employed by the state of Indiana; her compensation is $35,000.  Aaron and Janelle have total allowable itemized deductions of $12,000.  Aaron and Janelle have two dependent children.  Aaron and Janelle have other economic income as follows: - Interest on U.S. Treasury notes $1, Interest on Compost Computer bonds $1, Interest on German government bonds $ Interest on City of Nashville. bonds $1, Aaron's wealthy uncle gives him $1, Janelle sold Aaron's football card collection for $3,000. It cost $ Janelle sells Aaron's fishing boat for $2,000. Aaron had purchased the boat 3 years ago for $2,800. Based on the above information, what is Aaron and Janelle 's adjusted gross income? a. $114,450 b. $114,700 c. $115,450 d. $116,450 e. $116,650 MIDTERM 1—MC

41 9. The information that follows applies to the current year for Revis and Patrica, a married couple. Revis is employed as a shoe salesman; his compensation is $65,000. Patrica is employed as an interior designer; her compensation is $90,000. Revis and Patrica have total allowable itemized deductions of $15,000. Revis and Patrica have two dependent children. Revis and Patrica have other economic income as follows: - Interest on U.S. Treasury bonds $1, Interest on French government bonds $ Interest on City of Miami, Fla. bonds $1, Patrica won $500 from the state lottery - Revis's wealthy uncle dies and leaves him $10, Patrica sold Revis's baseball card collection for $3,000. Revis bought it for $ Patrica sells Revis's fishing boat for $2,000. Revis had purchased the boat for $2,500. Based on the above information, what is Revis and Patrica 's taxable income? a. $129,450 b. $129,950 c. $129,650 d. $144,450 e. $159,450 MIDTERM 1—MC

42 Income “Broadly Defined” (includes income from all sources) Minus:Excluded income Equals:Gross income Minus:Deductions for AGI Equals:AGI Minus:Deductions from AGI Minus: Exemptions Equals:Taxable income XTax rate (schedule of rates) Equals:Income tax Minus: Tax credits Tax prepayments Equals: Tax (refund) due with return

43 Revis’s compensation $65,000 Patrica’s compensation$90,000 Itemized deductions ($15,000) Personal exemptions(x2)($7,600) Dependency exemptions (x2)($7,600) Interest on U.S. Treasury bonds $1,000 Interest on French government bonds $750 Interest on City of Miami, Fla. bonds $1,200 Lottery$500 Revis's wealthy uncle dies$10,000 Baseball card ($3,000 - $800)$2,200 Boat ($2,000 - $2,500)($500) MIDTERM 1—MC Included

44 MIDTERM 1—MC 9. The information that follows applies to the current year for Revis and Patrica, a married couple. Revis is employed as a shoe salesman; his compensation is $65,000. Patrica is employed as an interior designer; her compensation is $90,000. Revis and Patrica have total allowable itemized deductions of $15,000. Revis and Patrica have two dependent children. Revis and Patrica have other economic income as follows: - Interest on U.S. Treasury bonds $1, Interest on French government bonds $ Interest on City of Miami, Fla. bonds $1, Patrica won $500 from the state lottery - Revis's wealthy uncle dies and leaves him $10, Patrica sold Revis's baseball card collection for $3,000. Revis bought it for $ Patrica sells Revis's fishing boat for $2,000. Revis had purchased the boat for $2,500. Based on the above information, what is Revis and Patrica 's taxable income? a. $129,450 b. $129,950 c. $129,650 d. $144,450 e. $159,450 f. $129,250

45 10. Mike and Pam own a cabin near Teluride, Colorado. In the current year the cabin was rented for 8 days to friends. Mike and Pam used the cabin a total of 82 days during the same year. After allocating the expenses between personal and rental use, the following rental loss was determined: Rental income$700 Property taxes(250) Mortgage interest(300) Repairs and maintenance(100) Utilities(150) Rental loss$(100) How should Mike and Pam report the rental income and expenses for last year? a. Report the $100 loss for AGI. b. Include the $700 in gross income, but no deductions are allowed. c. Only expenses up to the amount of $700 rental income may be deducted. d. Report the interest ($300) and taxes ($250) as itemized deductions and the other expenses for AGI. e. No reporting for the rental activity is necessary. MIDTERM 1—MC

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47 10. Mike and Pam own a cabin near Teluride, Colorado. In the current year the cabin was rented for 8 days to friends. Mike and Pam used the cabin a total of 82 days during the same year. After allocating the expenses between personal and rental use, the following rental loss was determined: Rental income$700 Property taxes(250) Mortgage interest(300) Repairs and maintenance(100) Utilities(150) Rental loss$(100) How should Mike and Pam report the rental income and expenses for last year? a. Report the $100 loss for AGI. b. Include the $700 in gross income, but no deductions are allowed. c. Only expenses up to the amount of $700 rental income may be deducted. d. Report the interest ($300) and taxes ($250) as itemized deductions and the other expenses for AGI. e. No reporting for the rental activity is necessary.


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