1.

Losses incurred in trade or business are deductible for AGI

2. Losses incurred in employee’s trade or business are deductible for AGI if the employee is reimbursed.
If the employee is not reimbursed, the loss is characterized as a miscellaneous itemized deduction
3. Losses incurred in transaction for profit are deductible for AGI only if the property was for the production of
rents or royalties. Other investment expenses are itemized deduction.
4. Casualty and theft losses from personal use property in a federally declared disaster area are itemized
deductions.

BAD DEBT
1. If a taxpayer sells goods or provides services on credit and, bad debt deduction is allowed
No deduction is allowed for a bad debt when the taxpayer is on the cash basis
2. specific charge-off method:
In the case of a business debt, partial worthlessness can result in a deduction.
In the case of a nonbusiness debt, a deduction is only allowed if the debt becomes completely worthless.
Bankruptcy may create worthlessness before the settlement date. If this is the case, the deduction may be
taken in the year of worthlessness.
3. Business losses get ordinary treatment whereas non-business gets short-term capital loss
4. Nature depends on whether the lender is engaged in the business of lending money or whether there is a
proximate relationship between the creation of the debt and the lender’s trade or business. If neither is true it
will be treated as nonbusiness. Loans to relatives or friends are the most common type of nonbusiness bad debt.
5. Loans between related parties raise the issue of whether the transaction was a bona fide loan or a gift.
Was a note properly executed? Was there a reasonable rate of interest? Was collateral provided? What collection efforts were made?
What was the intent of the parties?

6. reimbursement should be included in gross income, but only to the extent of a tax benefit in a prior year.

Worthless Securities
1. A loss is allowed for securities that become completely worthless during the year. The losses are treated as
long-term capital loss. There is a $3,000 net capital loss limitation.

Small Business Stock (§ 1244 Stock) Losses

1. Taxpayers can receive an ordinary loss deduction if the loss relates to small business stock (§ 1244 stock)
2. The ordinary loss is limited to $50,000 ($100,000 for married individuals filing jointly) per year. Losses in
excess of these limits receives capital loss treatment.
3. “small business corporation”: the total amount of money and other property received by the corporation for
stock as a contribution to capital does not exceed $1 million.
4. Section 1244 applies only to losses. If there is a gain, then it is a capital gain

Jocelyn and Esteban file a joint return. For the current year, they had the following items:
Salaries $120,000
Loss on sale of § 1244 stock acquired two years ago 105,000
Gain on sale of § 1244 stock acquired six months ago 20,000
Nonbusiness bad debt 19,000
Determine their AGI for the current year.
Net capital loss: 20,000-19,000 (ST)-5000(LT)=4000 (limit to 3,000, 1000 LTCL carryover)
Ordinary loss: 100,000 (file a joint return)
AGI=120,000-100,000-3000= 17000

LOSSES OF INDIVIDUALS
1. Casualty loss must result from an event that is (1) identifiable; (2) damaging to property; and (3) sudden,
unexpected, and unusual in nature.
2. Losses on personal use property are not deductible. The casualty loss rules are an exception. However, a
taxpayer can deduct a personal casualty or theft loss only if the loss occurs in a Federally declared disaster area.
3. The decline in market value is not deductible.
4. Theft losses are deducted in the year of discovery. If an insurance claim exists and there is a reasonable
expectation of recovery, no deduction is permitted.
If in the year of settlement, the recovery is less than the asset’s adjusted basis, a partial deduction may be
available. If the recovery is greater than the asset’s adjusted basis, gain may be recognized.
5. Casualty loss is deducted in the year the loss occurs. However, no casualty loss is permitted if there is a
reasonable expectation of recovery.
If the taxpayer has a partial claim, only part of the loss can be claimed in the year of the casualty, and the
remainder is deducted in the year the claim is settled
6. The taxpayer includes the reimbursement in gross income when the previous deduction resulted in a tax
benefit.
7. Official “Disaster Area” losses can be deducted in the year preceding the year of the loss.

Measuring the Amount of Loss

1. If business or rental property is completely destroyed, the loss is equal to the adjusted basis of the property at
the time of destruction. The loss is a deduction for AGI
2.For partial destruction of business or rental property and partial or complete destruction of personal use
property. The loss is the lesser of the following:
-The adjusted basis of the property.
-The difference between the fair market value of the property before the event and the fair market value
immediately after the event.
The loss is a deduction for AGI
3. If the property is used for both personal and business/rental use, the loss deduction must be computed
separately for the business portion and the personal portion.

Personal Use Loss Reductions: The $100-per-Event and 10%-of-AGI Floors

1. The loss for personal use property must be further reduced by a $100-per-eventfloor and a 10%-of-AGI
aggregate floor.
The $100 floor applies separately to each casualty and applies to the entire loss from each casualty. The
losses are then added together, and the total is reduced by 10 percent of the taxpayer’s AGI. The resulting loss is
the taxpayer’s itemized deduction for casualty and theft losses.
2. When a nonbusiness casualty loss is spread between two taxable years because of an outstanding insurance
claim, the loss in the second year is not reduced by the $100 floor. However, the loss in the second year is still
subject to the 10 percent of second year AGI.

Brian’s new personal use sailboat was completely destroyed by a hurricane in 2019 (a Federally declared
disaster area). The boat had a $15,000 cost and fair market value, but Brian only had $10,000 of insurance
coverage for the boat. He filed an insurance claim and settled with the insurance company in 2020 for $8,000.
Brian is entitled to a $5,000 deduction in 2019 ($10,000-$15,000) and a $2,000 deduction in 2020. Brian’s
$5,000 casualty loss deduction in 2019 is reduced first by $100 and then by 10% of his 2019 AGI. The $2,000
deduction in 2020 is reduced by 10% of his 2020 AGI.

Multiple Losses

Olaf lives in the state of Minnesota. In 2019, a tornado hit the area and damaged his home and automobile.
Applicable information is as follows:

Because of the extensive damage caused by the tornado, the President designated the area a Federal disaster
area. Olaf and his wife, Anna, always file a joint return. Their 2018 tax return shows AGI of $180,000 and
taxable income of $140,000. In 2019, their return shows AGI of $300,000 and taxable income (exclusive of the
casualty loss deduction) of $220,000. Determine the amount of Olaf and Anna’s loss and the year in which they
should take the loss.
Loss before 10% of AGI: (350,000-280,000) +(30,000-20,000)-100=79,900
Because it is Federally disaster area, they can claim loss on last year return or current year return.
Amount of loss for last year: 79900-18,000=61,900
Amount of loss for current year: 79900-30,000=49,900

Personal Casualty Gains and Losses

1. Taxpayer may use a personal casualty loss not attributable to a Federally declared disaster to offset any
personal casualty gains. After this netting process, if any loss remains, it is not deductible, however, a net
personal casualty gain remains, it is offset by any Federally declared disaster area casualty losses.
2. If the gains exceed the losses, the gains and losses are treated as gains and losses from the sale of capital
assets.
3. If personal casualty losses exceed personal casualty gains, all gains and losses are treated as ordinary items.
The gains—and the losses to the extent of gains—are treated as ordinary income and ordinary loss in computing
AGI. Losses in excess of gains are deducted as itemized deductions and are deductible only if related to
Federally declared disaster.
The building is used 40% for business use and 60% for personal use. During 2019, a fire caused major damage
to the building and its contents. Heather purchased the building for $800,000 and has taken depreciation of
$100,000 on the business portion.
At the time of the fire, the building had a fair market value of $900,000. Immediately after the fire, the fair
market value was $200,000. The insurance recovery on the building was $600,000.
The contents of the building were insured for any loss at fair market value.
1) The business assets had an adjusted basis of $220,000 and a fair market value of $175,000. These assets were
totally destroyed.
2)The personal use assets had an adjusted basis of $50,000 and a fair market value of $65,000. These assets
were also totally destroyed.
If Heather’s AGI is $100,000 before considering the effects of the fire, determine her itemized deduction as a
result of the fire. Also determine Heather’s AGI.
Business portion (building):
Adjustable basis: 800,000*0.4-100,000=220,000.
Loss on building: (900,000-200,000) *0.4=280,000, limit to 220,000
Insurance recovery: 600,000*0.4=240,000
Gain on building: 20,000
Personal portion (building):
Adjustable basis: 800,000*0.6-0=480,000
Loss:700,000*0.6=420,000
Insurance recovery=600,000*0.6=360,000
Loss on building: 60,000
Business content
220,000-175,000=45,000 loss
Personal content
65,000-50,000=15,000 gain
AGI=100,000+20,000-45000+15,000-15,000 (personal casualty loss to extent of gain) =75,000
Personal casualty loss on building: 60,000-15,000=45,000 is not deductible

RESEARCH AND EXPERIMENTAL EXPENDITURES

The law permits the following three alternatives for the handling of research and experimental expenditures:
Expensed in the year paid or incurred.
Deferred and amortized.
Capitalized
Expense Method- not be available after December 31, 2021.
A taxpayer can expense all the research and experimental expenditures paid
Deferral and Amortization Method-Taxable Years Beginning before January 1, 2022
Research and experimental expenditures may be amortized over 60 months.
A deduction is allowed beginning with the month in which the taxpayer first realizes benefits from the
experimental expenditure. The election is binding, and a change requires permission from the IRS.

Blue Corporation, a manufacturing company, decided to develop a new line of merchandise. The project began
in 2019. Blue had the following expenses in connection with the project:

The new product will be introduced for sale beginning in July 2021. Determine the amount of the deduction for
research and experimental expenditures for 2019, 2020, and 2021 if:
a. Blue Corporation elects to expense the research and experimental expenditures.
2019 Total expense: 500,000+90.000+8,000+6,000+15,000=619,000
Cost of inspection of material for quality control, promotion expenses, and cost of market survey are not
included as research and experimental expenditure.
2020 total expense: 600,000+70,000+11,000+8,000+14,000=703,000
Cost of inspection of material for quality control, promotion expenses, and advertising are not included as
research and experimental expenditure.
2021: No deduction based on the data provided.
b. Blue Corporation elects to amortize the research and experimental expenditures over 60 months.
The research and experimental expenditures are amortized over a 60-month period beginning with the month in
which the taxpayer first realizes benefits from the experimental expenditure (July 2021). The monthly
amortization is 22,033 (1,322,000/60)
2019: No deduction for research and experimental expenditure
2020: No deduction for research and experimental expenditure.
2021: Deduction for research and experimental expenditure: 22033*6=132,198.

On July 24 of the current year, Sam Smith was involved in an accident with his business use automobile. Sam
had purchased the car for $30,000. The automobile had a fair market value of $20,000 before the accident and
$8,000 immediately after the accident. Sam has taken $20,000 of depreciation on the car. The car is insured for
the fair market value of any loss. Because of Sam’s history, he is afraid that if he submits a claim, his policy will
be canceled. Therefore, he is considering not filing a claim. Sam believes that the tax loss deduction will help
mitigate the loss of the insurance reimbursement. Sam’s current marginal tax rate is 35%.