Chapter 7
Deductions: Business/Investment Losses and Passive Activity Losses

OBJECTIVES

After completing Chapter 7 , you should be able to:

1. Determine the amount and classification of losses originating from business operations.

2. Ascertain the amount and classification of losses from investment-related activities.

3. Understand tax shelters and the rationale for at-risk rules.

4. Achieve a thorough understanding of the intricacies of the passive activity rules.

5. Identify and determine the amount of allowable business and theft losses.

6. Calculate the amount of a net operating loss and determine the amounts to be carried forward.

7. Understand the allowable home office expenses and determine the limitation on the deduction for such losses.

8. Achieve an understanding of the vacation home rental rules and the limitation on such losses.

OVERVIEW

Deductions are provided in the Code for losses resulting from unprofitable investment-related activities, dispositions of certain assets, and unprofitable business operations. In each of these cases certain limitations or adjustments may apply, thus limiting the amount of deductible loss. Generally, deductible losses from a business, property held for production of income, or investment property are deductible for adjusted gross income.

This chapter deals with losses originating from business operations and certain investment-related activities. Tax shelters, at-risk rules, passive activity rules, business casualty and theft losses, net operating losses, hobby losses, home office expenses, and vacation homes are among the topics addressed. Losses resulting from the sale of capital assets (e.g., stocks and bonds) and business-use assets (Code Sec. 1231) are discussed in Chapter 12 .

Tax Shelters and At-Risk Rules

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TAX SHELTERS

A tax shelter is an activity providing deductions and/or credits to an investor which will reduce tax liability with respect to income from other sources. Prior to the Tax Reform Act of 1986, tax shelters played an unreasonably influ