At-Risk Rules in Taxation

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Questions and Answers

Who qualifies as a lender in the context of property acquisition financing?

Promoters financing the investment

Investors receiving a financing fee

Sellers of the property

Banks and credit unions (correct)

What characterizes interest as defined in tax terms?

Compensation for the use or forbearance of money (correct)

A fee charged for property management

Revenue generated from selling property

The profit earned from investments

When is interest income generally reported by cash basis taxpayers?

In the year received (correct)

At the end of the loan term

When the interest is earned

When the loan is paid off

How is prepaid interest generally treated for tax purposes?

Allocated and deductible over the loan term Signup and view all the answers

What is the limit on the deduction for investment interest expense for non-corporate taxpayers?

The lesser of investment interest paid or net investment income Signup and view all the answers

Which of the following statements about points in lending is true?

Points are treated as prepaid interest and can reduce the interest rate Signup and view all the answers

Which of these statements about investment income is false?

It is separate from net investment income calculations Signup and view all the answers

Which of the following types of interest expense is generally limited by tax provisions?

Investment interest expense Signup and view all the answers

Which of the following increases a taxpayer's at-risk amount?

Cash and adjusted basis of property contributed Signup and view all the answers

What is NOT included in the taxpayer's amount at risk?

Loans guaranteed by the taxpayer Signup and view all the answers

Which of the following decreases a taxpayer's at-risk amount?

Withdrawals from the activity Signup and view all the answers

Under which condition can a taxpayer increase their at-risk amount after having a loan guaranteed?

When rights against the primary obligor are lost Signup and view all the answers

Which of the following is true about qualified nonrecourse financing?

It is considered at-risk when used for real property activities. Signup and view all the answers

What must the IRS consider when evaluating if arrangements are designed to bypass at-risk limitations?

The existence of a valid business purpose Signup and view all the answers

What happens if a taxpayer has a reduction of debt for which recourse against them exists?

Their at-risk amount decreases. Signup and view all the answers

Which of the following is a characteristic of borrowing that increases the at-risk amount?

Taxpayer’s share of the activity’s income Signup and view all the answers

Which statement best describes the at-risk limitation?

Taxpayers can only deduct losses to the extent they are at-risk. Signup and view all the answers

How are losses in partnerships or S Corporations treated under the at-risk rules?

They can be aggregated if 65% or more of the losses go to active participants. Signup and view all the answers

What happens to previously allowed losses when the at-risk amount is decreased below zero?

They must be recaptured. Signup and view all the answers

Under the aggregation rules, what is treated as a single activity?

All leasing activities by a partnership. Signup and view all the answers

What must occur when losses from an activity generate income?

At-risk limitations do not apply unless there are carryover losses. Signup and view all the answers

What is the implication of the active trade or business exception for C corporations?

It does not apply to personal holding companies. Signup and view all the answers

Which rule governs the computation of at-risk limitations?

They are computed for each activity separately. Signup and view all the answers

Which of the following accurately describes the management participation requirement for aggregation?

Active participation must be demonstrated by individuals claiming losses. Signup and view all the answers

What is the primary tax benefit for the seller in a sale-leaseback transaction?

Deducting the full amount of rent payments Signup and view all the answers

Under which circumstance would a transaction likely be treated as a financing arrangement rather than a sale-leaseback?

If the seller retained a repurchase option Signup and view all the answers

In a sale-leaseback transaction, who claims depreciation?

The buyer, as the new property owner Signup and view all the answers

What must be established for a transaction to qualify as a sale-leaseback according to legal standards?

The transaction must involve multiple parties and external financing Signup and view all the answers

What could lead to greater deductions for the seller in a sale-leaseback transaction?

Full depreciation of the property already claimed Signup and view all the answers

What is the primary ordering rule when multiple loan proceeds are in the same account?

Withdrawals come first from debt proceeds in the account. Signup and view all the answers

What does the 15-day rule allow taxpayers to do regarding expenditures?

Treat an expenditure as coming from deposited debt proceeds. Signup and view all the answers

What is the limit on business interest paid or accrued after 2017?

It is limited to the sum of business interest income and 30% of adjusted taxable income. Signup and view all the answers

Which expenditures are repaid first according to the ordering repayment rule?

Amounts allocated to personal expenditures. Signup and view all the answers

For which years was the limit on deductions for business interest increased to 50% of adjusted taxable income?

2019 and 2020. Signup and view all the answers

What can businesses do with limited business interest according to Section 163(j)?

Carry it forward indefinitely to future years. Signup and view all the answers

What system must be used for certain property in farming or real property trades when an election is made?

The alternative depreciation system (ADS). Signup and view all the answers

Which type of interest can be fully deductible according to the regulations?

Floor plan financing interest. Signup and view all the answers

Study Notes

At-Risk Rules

Deductible losses are limited to the amount the taxpayer is at-risk
Losses carried forward until the at-risk amount increases
Previously allowed losses recaptured if the at-risk amount is reduced below zero
At-risk rules apply separately to each activity
Deductible losses are limited when losses exceed the amount at risk
At-risk limitations do not apply if the activity generates income (unless carryover losses exist)
Previously allowed losses must be recaptured if the at-risk amount is reduced

Increasing At-Risk Amount

Cash and adjusted basis of property contributed to the activity
Borrowed funds used in the activity where the taxpayer is personally liable or uses property outside the activity for security
Borrowed funds used in the activity in qualified nonrecourse financing (real estate)
Taxpayer's share of the activity's income

Decreasing At-Risk Amount

Withdrawals from the activity
Taxpayer's share of the activity's deductible loss
Taxpayer's share of any debt reductions where the taxpayer is liable or qualified nonrecourse debt reductions

Other At-Risk Rules

Loans from persons who have an interest in the activity (other than as a creditor), or from a related individual do not increase the at-risk amount
Loans guaranteed by a taxpayer are generally not included in the at-risk amount as the taxpayer is not personally liable
The IRS can disregard arrangements designed to avoid the at-risk limitations
Recourse debt converted to nonrecourse debt is generally not considered at-risk

Qualified Nonrecourse Financing

Qualified nonrecourse financing is considered at-risk for real estate if the borrowing is for holding real property, the borrowing is from a qualified entity, and the borrowing is not convertible debt

Interest

Interest is compensation for the use or forbearance of money

Interest Income and Expense

Interest received by a lender is taxable income
Interest expense is generally deductible and must be paid on indebtedness
Prepaid interest is taxable upon receipt
Prepaid interest expense is generally allocated over the term of the loan
Points are typically prepaid interest deductible over the loan term, unless for services provided by the lender

Investment Interest

Investment interest is interest on loans used to purchase investment property (stock, bonds, land)
The investment interest deduction is limited for non-corporate taxpayers
Net investment income is investment income less investment expenses

Tracing Debt Proceeds

There is an ordering rule when debt proceeds from multiple loans are deposited in the same account
The 15-day rule may be used to treat an expenditure as coming from deposited debt proceeds
There is an ordering repayment rule when debt is repaid and debt proceeds are allocated to more than one expenditure

Business Interest

Business interest paid or accrued is limited to the sum of business interest income, 30% of adjusted taxable income, and floor plan financing interest
The business interest limitation may be carried forward indefinitely
The limitation does not apply to farming or real property trades if an election is made

Sale-Leaseback

The transaction must be treated as a sale and leaseback rather than a financing transaction to obtain tax benefits
If treated as a financing transaction, the seller may not deduct lease payments and the payments will be treated as payments on a loan
Determining whether a transaction is a sale-leaseback or a financing arrangement can be difficult

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Description

This quiz covers the fundamental concepts of at-risk rules in taxation, including limitations on deductible losses and how the at-risk amount can increase or decrease. Test your knowledge on how these rules apply to various activities and the implications for taxpayers. Ideal for students of tax law and accounting.