Casualty and NOL losses

1
Losses
Steven M. Foulks, CPA, CFP
2
Agenda

• Net operating losses (NOLs)
• Casualty losses
• 1244 losses

3
NOL computation

• Think of the NOL computation as a unique
  computation using many of the elements used in
  the computation of taxable income, but
• in a unique way

4
NOL computation

• There are four elements used in calculating
  NOLs
• net business income, or loss (BI(L))
• net non business income or loss (NBI(L))
• net business capital gains or losses (BCG(L))
• net non business capital gains or losses
  (NBCG(L))

5
NOL theory

• Theory Only business losses and personal
  casualty losses can create an NOL.
• The other three elements can only serve to reduce
  NOLs, not to create, or increase them.

6
NOL theory

• An NOL can only occur in a year if taxable income
  for the year is negative.

7
NOLs

• Three steps in the NOL Process
• Calculate the NOL in the year of occurrence
• Change the taxable income computation due to an
  NOL carryover or carryback being used in a given
  year
• If the carryover, or carryback created negative
  taxable income in the step above, the amount of
  the NOL to be carried to future years.

8
NOL carryovers

• Carryover period
• Must first carryback to 2 prior years, then
• Carryforward 20 future years
• May make an irrevocable election to just
  carryforward
• When there are NOLs from two or more years, use
  on a FIFO basis for using up carryovers

9
Calculating NOLs

• Two methods are used for calculating the NOL
• Indirect method - Adjusting TI as the author
  explained in depth (follows IRS form procedure)
• Direct method - As a separate computation which I
  personally prefer
• What follows is a discussion of direct method and
  the related formula

10
Calculating NOLs

• NOL T/B CL - (NBCG -NBCL)1 (NBI -
  NBE)21 BCG - BCL)1
• Terms are normally -, but assume for this
  equation
• 1 ignore expression in parenthesis if negative
• 2 if the expression in in parenthesis is positive
  then the term in should be
• (NBCG - NBCL)1 BCG - BCL1 NBI - NBE1

11
Calculating NOLs

• DEFINITION OF TERMS
• T/B - trade or business income less related
  business expenses, also includes salaries and
  rental /royalty activities less related expenses
• CL - Deductible personal casualty losses
• NBCG/NBCL - non business capital gains and
  losses (note LT and ST distinctions are
  irrelevant)

12
Calculating NOLs

• BCG/BCL - Business capital gain/loss
• NBI - non business income (passive income other
  than rent, royalty, or capital asset
  transactions)
• NBE - itemized deductions ( less personal
  casualty losses and employee business expenses),
  or the standard deduction whichever is larger

13
Calculating NOLs

• I think the author has left out a few important
  facts in his write-up of the indirect method
• NBE can offset net NBCG
• net BCL can offset net NBCG and NBI

14
Adjusting TI computations for NOLs

• NOLs are just deductions for AGI
• All itemized deductions reduced by AGI must be
  recomputed (but not charitable deductions)
• All credits must be recomputed because of the new
  tax liability caused by deducting the NOL

15
NOL creates negative TI in previous step

• If using the NOL caused the TI to become
  negative, you need to determine if any NOL
  remains to be carried forward. Here are the
  steps
• First calculate modified taxable income
• taxable income for year in which you used NOL
  calculated the regular way, except you exclude
• Net capital loss (NCL) deductions
• exemptions
• NOL carryforward to current year

16
NOL creates negative TI in previous step

• Second deduct modified taxable income from the
  NOL of interest (the one which is being back, or
  forward to the current tax year)
• The resulting number - NOL carry forward to
  future years

17
Casualty losses
18
Three important steps

• Determine the type of casualty loss
• Determine the maximum deduction/income
• Determine the effect on taxable income

19
Type and Maximum Deduction/Income

• Three categories
• Partial business casualty loss
• lesser of change in FMV immediately before and
  after casualty, or the adjusted basis of property
• less insurance proceeds

20
Type and Maximum Deduction/Income

• Categories
• Complete business casualty loss
• adjusted basis of property
• less insurance proceeds

21
Type and Maximum Deduction/Income

• Categories
• All personal casualties losses
• same as partial business casualty
• less 100 floor for casualty loss events
• less insurance proceeds
• Regarding the 3 categories, if the results are
  negative you have a casualty gain, otherwise the
  result is a casualty loss

22
Effect on Taxable Income

• If you have a net business casualty loss
• the loss is deductible for adjusted income (or, a
  negative gross income item on the tax return)
• If you have a net business casualty gain
• if held for more than 1 year, gains are 1231
  gains
• if held for less than 1 year, gains are ordinary
  gains

23
Effect on Taxable Income

• If you have a net personal casualty gain
• all gains and losses are capital gains and losses
• If you have a net personal casualty loss
• net casualty loss - 10 of AGI is an itemized
  deduction

24
Other important issues

• When is the casualty loss deductible?
• What is a casualty?

25
Section 1244 Stock

• Sale or worthlessness of Section 1244 stock
  results in ordinary loss rather than capital loss
  for individuals
• Ordinary loss treatment (per year) is limited to
  50,000 (100,000 for married, filing jointly
  taxpayers)
• Loss in excess of per year limit is treated as
  capital loss

26
Section 1244 Stock

• Section 1244 is stock
• owned by original purchaser and
• limited to 1 million of capitalization (on a
  tax basis)
• Section 1244 does not apply to gains

27
Section 1244 Stock

• Example of Section 1244 loss
• In 1994, Sam purchases from XYZ Corp. stock
  costing 150,000. (Total XYZ stock outstanding
  is 800,000.) In 1997, Sam sells the stock for
  65,000.
• Sam, a single taxpayer, has the following tax
  consequences
• 50,000 ordinary loss
• 35,000 long-term capital loss