TAX 4001 FINAL EXAM STUDY GUIDE
Tax Shelter - Answer -Wealthy taxpayers in high income tax bracket invest in
opportunities where they can collect a loss and bring down their taxable income
- focused around non recourse financing - obligation where borrower isn't personally
liable
- Previous investment strategy before laws put in place
- Used to avoid/defer taxes = offset income from other source
How does tax shelter benefit the investor? - Answer -- Tax savings that pay for itself
(pay partial amount for larger taxable income savings)
- Accelerated depreciation and interest expense deductions generated in early years
- At least, tax shelter deferred recognition of any net income until activity is sold
- Ultimately, the sale will make a capital gain
New laws make investors focus on.... - Answer -The economics of investment instead
of tax avoidance possibilities that an investment can generate
At risk limitation reason - Answer -Designed to prevent deduction from loss in excess of
economic investment
- Limit the tax payer deduction to the amount they are "at risk"
- Created to limit loss in excess of investment
At risk limitation rules - Answer -Can deduct losses from activity only to extent the
taxpayer is at risk
- Any losses disallowed due to at risk limitation are carried forward and at risk amount
must increase in order to deduct later
- Previously allowed losses must be recaptured to extent they fall below zero
What triggers at risk to fall below zero - Answer -Distributions received or status
change of non recourse debt to recourse
Level for S corporation and partnerships - Answer -Owner level
Initial at risk limitation amount usually equals... - Answer -- Cash and adjusted basis of
property contributed
- Amount borrowed for the investment in which personally liable
Not included in at risk limitation - Answer -- Non recourse debt
- Debt in which the lender has interest
Qualified non recourse debt included in at risk limitation when... - Answer -Activity
includes real estate
, Increase at risk limitation - Answer -- Cash contribution to activity and adjusted basis of
property
- Amounts borrowed for the use in the activity for which personally liable
- Taxpayers share of amounts borrowed for use in the activity that are qualified non
recourse financing
- Taxpayer share of activity income
Decrease at risk limitation - Answer -- Withdrawal from activity
- Taxpayer share of the activity loss
- Taxpayers share of any reductions of debt for which recourse against the taxpayer
exists
- Reductions of qualified non recourse debt
PAL - Answer -Passive activity loss
- Disallow deduction of passive activity losses against active or portfolio income even
when taxpayer is at risk to the extent of the loss
- This rule can cause at risk amounts to become disallowed under PAL
Three categories on income - Answer -Active, Portfolio, Passive
Active income - Answer -- Wages/salary
- Profit from trade and business
- Gain from sale or disposition of asset used in active trade of business
- Income from intangible property created by the taxpayer
Portfolio income - Answer -- Interest
- Dividends
- Annuities
- Gains/losses from disposition of asset held for investment
Passive income - Answer -- Any trade or business in which taxpayer does not
materially participate
- Subject to certain exceptions (rental)
Passive income questions - Answer -- What constitutes the activity?
- Is there material participation?
- Is it a rental property?
Rules of passive activity loss - Answer -Limit the extent to which losses in the passive
category can be used to offset the income in other categories
- Passive losses can only offset passive income (can't reduce active and portfolio)
- Disallowed losses are suspended and carried forward to offset future passive activity
- Any remaining is used only when interest is disposed of entirely- in which case loss
may offset active and portfolio as well (fully taxable disposition)
If you have an active loss... - Answer -You can offset all income types
Tax Shelter - Answer -Wealthy taxpayers in high income tax bracket invest in
opportunities where they can collect a loss and bring down their taxable income
- focused around non recourse financing - obligation where borrower isn't personally
liable
- Previous investment strategy before laws put in place
- Used to avoid/defer taxes = offset income from other source
How does tax shelter benefit the investor? - Answer -- Tax savings that pay for itself
(pay partial amount for larger taxable income savings)
- Accelerated depreciation and interest expense deductions generated in early years
- At least, tax shelter deferred recognition of any net income until activity is sold
- Ultimately, the sale will make a capital gain
New laws make investors focus on.... - Answer -The economics of investment instead
of tax avoidance possibilities that an investment can generate
At risk limitation reason - Answer -Designed to prevent deduction from loss in excess of
economic investment
- Limit the tax payer deduction to the amount they are "at risk"
- Created to limit loss in excess of investment
At risk limitation rules - Answer -Can deduct losses from activity only to extent the
taxpayer is at risk
- Any losses disallowed due to at risk limitation are carried forward and at risk amount
must increase in order to deduct later
- Previously allowed losses must be recaptured to extent they fall below zero
What triggers at risk to fall below zero - Answer -Distributions received or status
change of non recourse debt to recourse
Level for S corporation and partnerships - Answer -Owner level
Initial at risk limitation amount usually equals... - Answer -- Cash and adjusted basis of
property contributed
- Amount borrowed for the investment in which personally liable
Not included in at risk limitation - Answer -- Non recourse debt
- Debt in which the lender has interest
Qualified non recourse debt included in at risk limitation when... - Answer -Activity
includes real estate
, Increase at risk limitation - Answer -- Cash contribution to activity and adjusted basis of
property
- Amounts borrowed for the use in the activity for which personally liable
- Taxpayers share of amounts borrowed for use in the activity that are qualified non
recourse financing
- Taxpayer share of activity income
Decrease at risk limitation - Answer -- Withdrawal from activity
- Taxpayer share of the activity loss
- Taxpayers share of any reductions of debt for which recourse against the taxpayer
exists
- Reductions of qualified non recourse debt
PAL - Answer -Passive activity loss
- Disallow deduction of passive activity losses against active or portfolio income even
when taxpayer is at risk to the extent of the loss
- This rule can cause at risk amounts to become disallowed under PAL
Three categories on income - Answer -Active, Portfolio, Passive
Active income - Answer -- Wages/salary
- Profit from trade and business
- Gain from sale or disposition of asset used in active trade of business
- Income from intangible property created by the taxpayer
Portfolio income - Answer -- Interest
- Dividends
- Annuities
- Gains/losses from disposition of asset held for investment
Passive income - Answer -- Any trade or business in which taxpayer does not
materially participate
- Subject to certain exceptions (rental)
Passive income questions - Answer -- What constitutes the activity?
- Is there material participation?
- Is it a rental property?
Rules of passive activity loss - Answer -Limit the extent to which losses in the passive
category can be used to offset the income in other categories
- Passive losses can only offset passive income (can't reduce active and portfolio)
- Disallowed losses are suspended and carried forward to offset future passive activity
- Any remaining is used only when interest is disposed of entirely- in which case loss
may offset active and portfolio as well (fully taxable disposition)
If you have an active loss... - Answer -You can offset all income types
