Chapter 7
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Bad Debts (business versus nonbusiness)
Worthless Securities (holding period)
1244 Stock
Casualty Losses (business versus personal)
Research & Development (R&D) - expense or
capitalize??
• Net Operating Losses
Business and Nonbusiness Bad Debt
• Business Bad Debt is deductible as an
ordinary loss in the year incurred.
• NonBusiness Bad Debt is always treated as
a SHORT TERM CAPITAL LOSS. No loss
recognized until the debt is completely
worthless
Worthless Securities
• Capital loss is allowed for securities (stocks,
bonds) that become completely worthless during
the year. Loss is considered to have become
worthless on the last day of the taxable year.
• 1244 Stock – Small business stock that when
issued meets certain qualifications. Loss is
considered to be ordinary (not capital). Only
individual shareholders qualify, and the loss is
limited to $50,000 per taxpayer ($100K joint).
1244 applies only to losses, not gains.
Casualty Loss
• Casualty – sudden, unusual and unexpected. (fire,
tornado, hurricane, storm, theft)
• Casualty rules apply to business as well as
nonbusiness (personally owned) property. But the
rules are different between the two.
• Generally, deducted in the year the loss occurs (for
theft, year of discovery). If reasonable prospect of
recovery (insurance) is expected, no loss
permitted. If you expect a partial recovery, a
partial deduction can be taken.
• Disaster Area Losses – deduct in prior year or
current year.
Casualty Loss – Computing Loss
• Business Loss / Completely Destroyed –
loss is equal to adjusted basis at time of loss
(reduced by insurance recovery).
• Business Loss / Partial Destruction – loss is
equal to lesser of:
• Adjusted basis
• Difference between FMV before and after the event
(the decrease in value due to the casualty)
Casualty Loss – Personal
• Personal Loss – loss is equal to lesser of:
• Adjusted basis
• Difference between FMV before and after the event
(the decrease in value due to the casualty)
• Amount of the loss must be reduced:
• $100 per event (per tornado, per fire etc.)
• 10% of AGI
(aggregate of all casualites)
Casualty Loss – Personal (con’t)
• Are casualty losses deductions FOR AGI or
deductions FROM AGI?? Answer: it depends.
• Can we have gains from casualty losses?
How are they treated?
• In determining the 10% of AGI reduction,
net all casualties together including gains or
losses.
Research and Development Expense
• Definition – costs associated with the
development of an experimental model, plant
process, a formula, invention, etc.
• Does Not Include: expenditures relating to testing
or inspecting products for quality control.
Advertising or promotion, or consumer surveys do
not qualify. Efficiency studies or management
studies do not qualify.
R & D (con’t)
• Expense Method – election can be made to
expense all R&D expenditures in the
current year and all subsequent years.
Cannot change methods once you start.
Why would you want to change?
• Capitalize and Amortize – R&D expenses
are accrued and amortized over 60 180
months beginning in the month in which
taxpayer realizes benefits from the
expenditure.
Net Operating Losses
• Net Operating Loss (NOL’s) occur when
deductions exceed revenue leaving the
taxpayer with a net loss for the taxable year.
• NOL’s may are first carried back to the
preceeding two tax years and then forward
for as many as twenty years.
• An irrevocable election may be made not to carry
the loss back but only to carry it forward.
Salary
100,000
Rental Loss
-10,000
Dividends
1,000
1244 Gain
30,000
1244 Loss
40,000
Personal Casualty Gain
6,000
Personal Casualty Loss
-8,000
Business loan of $40,000 made in 2001. Borrower indicates in
2004 that the company is liquidating and expects to pay 50 cents
on the dollar once assets are sold. Expect to receive payment in
2005.
Nonbusiness loan of $10,000 is made in 2002. Borrower files for
bankruptcy in the summer of 2004. Lender receives 20 cents on
the dollar at November 18th, 2004 in final settlement.
Bought 100 shares of ABC stock on September 1, 2003. Paid
$10,000 for the shares. The stock went worthless on June 26,
2004.
What is the AGI?