PORTFOLIO

Loss Deductions (Portfolio 527)

Tax Management Portfolio, Loss Deductions, No. 527-4th, explains what is necessary to establish a deductible loss; the Portfolio is relevant to all losses of whatever nature. Before a loss may be deducted, the taxpayer must establish that the loss is evidenced by a closed and completed transaction, fixed by identifiable events, and actually sustained during the taxable year. Further, the taxpayer must establish that he or she is the person who sustained the loss and is entitled to claim it, and that the loss was either incurred in a trade or business, or a transaction entered into for profit, or qualified as a casualty loss.

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DESCRIPTION

Tax Management Portfolio, Loss Deductions, No. 527-4th, explains what is necessary to establish a deductible loss; the Portfolio is relevant to all losses of whatever nature. Before a loss may be deducted, the taxpayer must establish that the loss is evidenced by a closed and completed transaction, fixed by identifiable events, and actually sustained during the taxable year. Further, the taxpayer must establish that he or she is the person who sustained the loss and is entitled to claim it, and that the loss was either incurred in a trade or business, or a transaction entered into for profit, or qualified as a casualty loss.

The Portfolio discusses the related party loss disallowance and deferral provisions, the “sham” transaction doctrine as applied to losses, and also public policy as a factor in denying a deduction. The Portfolio also discusses in detail a number of specific categories of loss, including abandonment losses, war and confiscation losses, casualty losses, financial institution deposit losses, theft losses and wagering losses.


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AUTHORS

Loss Deductions was authored by the following experts:
JOHN C. MCCOY
John C. McCoy, B.B.A., University of Notre Dame (1969); J.D., high honors, George Washington University (1976); Arent Fox LLP (1976–2013), partner (1984–2003), counsel (2004–2013); member, District of Columbia, Virginia, Maryland and American Bar Associations.

TABLE OF CONTENTS

Detailed Analysis

I. Summary of Legislative History

II. The Nature of an Allowable Loss

A. In General

B. The Role of Realization

1. Realization Is Necessary: In General

2. The Deregulation Cases

3. What Type of “Identifiable Event” Is Necessary?

4. What Constitutes Realization: Cottage Savings

5. Regulations Promulgated in Wake of Cottage Savings

6. Distinguishing a Loss from Other Events

a. Distinguishing a Loss from a Bad Debt

b. Distinguishing a Loss from an Expense

C. Basis

1. In General

2. Loss of Income Items

D. Reimbursement (or Amount Realized) and Timing

1. In General

2. Timing

a. Closed Transaction

b. Reasonable Prospect of Recovery

c. No Reasonable Prospect of Recovery

3. Actual Recovery

E. Special Statutory Provisions

1. Statutory Disallowances

a. Section 165(j)

b. Section 183

c. Sections 267 and 707(b)

d. Section 271

e. Section 1091

f. Section 1092: Tax Straddles

g. Section 1211: Limitation on Capital Losses

h. Other Statutory Disallowances

2. Statutory Conversion of Capital Loss into Ordinary Loss

F. Related Party Loss Disallowance and Deferral: 267 and 707(b)

1. In General

2. Scope

a. Related Persons

b. Basic Requirement: Sale or Exchange of Property

c. Indirect Sales

d. Involuntary Sales

e. “Nonsale” Transactions

f. Corporate Liquidation Exception

(1) General Rule

(2) Exceptions to the Exception

3. Effect of 267(a)(1) Disallowance

a. In General

b. “No Netting” Rule

c. Corporate Earnings and Profits

d. Reduction of Transferee's Gain - 267(d)

4. Losses Between Controlled Group Members - Section 267(f)

G. Disallowance Under Case Law Doctrines

1. Sham Transactions

2. Frustration of Public Policy

a. In General

b. Criminal Restitution

3. Intentional or Grossly Negligent Destruction

III. Losses from Business or Transactions Entered Into for Profit

A. Business or Profit Requirement

1. Corporations

2. Individuals

a. Trade or Business

b. Transactions Entered Into for Profit

B. Abandonment or Worthlessness of Property Other than Securities

1. Use of the Asset

2. Required Actions and Intent

3. Acts That Constitute Abandonment

4. Acts That Do Not Constitute Abandonment

5. Section 197 Assets

6. The Amount of the Loss

7. Will the Taxpayer Be Treated as Having Sold or Exchanged the Property

a. Actual or Deemed Consideration

b. Treated as a Sale or Exchange by Statute

8. Worthless in an Earlier Tax Year

C. Retirements and Extraordinary Obsolescence

1. Cost Recovery Property

2. Depreciable Property That Is Not ACRS or MACRS Property

D. Demolition

1. In General

Content

2. Leasehold Improvements

E. Worthless Securities

1. Worthless Securities in General

a. Introduction

b. Security Defined

c. What the Taxpayer Must Prove

(1) Basis of Security

(2) Prior Worth

(3) Current Worthlessness

(a) Balance Sheet Insolvency

(b) Identifiable Event

(i) Examples

(ii) Can Tax Worth Preclude Worthlessness?

(iii) The Extreme Case: Irrevocable Insolvency

(iv) Events Subsequent to Claimed Worthlessness

d. Section 165(g) and S Corporations

e. Consequences of Worthlessness of Stock Under 382

2. Securities of an Affiliate

a. Members of a Consolidated Return Group

b. General - Definitions

c. Stock Ownership

d. Type of Income

3. Abandonment of Stock

F. War and Expropriation Losses

1. Introduction

2. Tax Treatment of Foreign Expropriation Losses

a. In General

b. Confiscation Defined

c. When Loss Is Deductible

d. Seizure vs. Bad Debt

e. Recoveries of Foreign Expropriation Losses

f. Special Rules of Prior Law

3. Domestic Confiscation Losses

G. Employee Losses on Repayment of Benefit Payments

1. In General

2. Offset Against Military Disability Pay

3. Repayment of Severance to Restore Employee Benefits

4. Repayment of Sick Leave

5. Overpayment Repaid to Qualified Plan

H. Special Treatment of Fannie Mae and Freddie Mac Preferred Stock

I. Losses From Ponzi Schemes in Taxable Years Beginning After 2007

IV. Who Is Entitled to Deduct the Loss?

Introductory Material

A. Recognizing an Entity's Existence

1. Corporation

2. Trusts

3. Partnerships

B. Agency

C. Bona Fide Ownership

V. Casualty and Theft Losses

A. Statutory Outline

1. In General

2. Elements of a Casualty Loss

3. Alternative Minimum Tax

B. Ownership

1. In General

2. Partial Estates

a. Life Estates

b. Leasehold Interests

c. Joint Ownership

C. Definition of Casualty

1. Introduction

a. In General

b. Losses Indirectly Resulting from Casualty Conditions

c. Deterioration, Disease, and Old Age

2. Specific Occurrences

a. Accident

(1) Automobile

(2) Household

(3) Other

b. Animals and Insects

(1) In General

(2) Termites

c. Blasting, Explosions, and Bombs

d. Death

e. Disaster

f. Dismissal from Employment

g. Drought

h. Earthquake

i. Fire

j. Flood and High Water

k. Freeze

l. Lightning

m. Lost or Misplaced Property

n. Repossession

o. Salt Waste Intrusion

p. Shipwreck

q. Smog

r. Snow and Ice

s. Soil Subsidence, Cave-ins, and Slides

t. Sonic Boom

u. Storage and In Transit

v. Storms

w. Vandalism

x. War and Confiscation Losses

y. Insolvent Financial Institutions

3. Burden of Proof

D. Amount of the Casualty Loss Deduction

1. Introduction

2. Measure of the Loss

a. Trade or Business (Income-Producing) Property

b. Personal-Use Property

c. Multiple Use Property

d. Converted Property

3. Limitations on Deductions

a. $100 Nondeductible Amount

b. Ten Percent of Adjusted Gross Income Limitation

c. Passive Activity Limitation

d. Potential Insurance Claims on Personal Property Casualties

4. Determining the Amount of the Loss

a. Appraisals

b. Cost to Restore to Original Condition

c. Trade-in or Sale Value

d. Clean-up Expenses

e. Personal Expenses

f. Cost of Recovery

5. Recoveries and Compensation

a. In General

b. Use and Occupancy Insurance

c. Rehabilitation and Disaster Relief Payments

d. Section 123: Insurance Proceeds for Living Expenses

6. Burden of Proof

a. In General

b. Appraisals

E. Timing of the Casualty Loss Deduction

1. In General

a. Prospects of Recovery

b. Disaster Loss Election

c. Disaster Loss Deduction for Condemned Residences

2. Burden of Proof

F. Tax Character and Other Consequences of the Casualty Loss Deduction

1. In General

a. Section 1231 - Business or Investment Property Held for More than One Year

b. Business or Investment Property Held for One Year or Less

c. Personal Use Property

d. Relationship to 1033

e. Inventory

f. Estate Tax - Income Tax Election

2. Basis Adjustments

3. Net Operating Loss Deduction

G. Theft Losses

1. In General

2. Proving a Loss Was Caused by Theft

a. Definition of Theft

(1) General Rule

(2) Relationships that May Negate Theft

(a) Family

(b) Joint Ownership

(c) Entities and Their Owners

(3) Public Policy Considerations

b. Theft vs. Bad Debt or Worthless Investment

(1) Inability to Obtain Reimbursement from an Insolvent Thief

(2) Bad Debt or Worthless Investment Due to Theft

(3) Misrepresentations

c. Exceptions Based on the Type of Property Stolen

d. Failure to Pursue Remedies or Report Loss to the Police

3. Amount of the Theft Loss Deduction

a. Introduction

b. Zero Basis Property

c. Proving the Basis and Fair Market Value

(1) In General

(2) Recoveries and Compensation

4. Timing of the Theft Loss Deduction

a. In General

b. Prospect of Recovery

VI. Losses for Certain Deposits in Financial Institutions

A. General

B. Definitions

C. Election

1. Time and Manner of Election

2. Consent to Revoke Previous Casualty Loss Election

D. Amount and Recovery of Loss

VII. Wagering Losses

A. Introduction

B. Definition of Wagering Gains and Losses

1. In General

2. Compensation Income Versus Wagering Gain

3. Winning Wager Received as a Gift

4. Partnership

C. Itemized Deduction or Reduction of Gross Income

1. Consequences

2. Trade or Business Test

D. Burden of Proof

1. In General

2. Records

a. In General

b. Unavailability of Records

c. Adequacy of Records

d. Credibility of Records and Supporting Evidence

3. Cohan Rule

4. Other Formulas

E. Losses for Gambling Casinos


WORKING PAPERS

Working Papers

Table of Worksheets

Relevant Worksheets Appearing in Other Portfolios:

Worksheet 1 Deductible Casualty/Theft Loss Example and Form 4684

Worksheet 2 IRS Publication 544, Sales and Other Dispositions of Assets (Excerpt)

Worksheet 3 IRS Publication 547, Casualties, Disasters, and Thefts (Business and Nonbusiness)

Worksheet 4 IRS Publication 584, Nonbusiness Disasters, Casualty, and Theft Loss Workbook

Worksheet 5 [Reserved]

Worksheet 6 Revenue Procedure 95-27, Safe Harbor Provisions for Certain Structural Modifications to Buildings [ 280B]

Worksheet 7 Reference Guide for Claiming Losses [ 165]

Worksheet 8 Sample Early Disaster Loss Deduction Election Under 165(i)

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Legislative History:

Treasury Rulings:

Cases:

UNOFFICIAL

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