Describe the three main loss limitations that taxpayers must overcome before deducting losses allocated to them from a specific activity.

Question

What will be an ideal response?

Answer 1

Tax basis-limits the amount of deductible loss to the tax basis the taxpayer has in the activity. Thus, losses from an activity may not reduce the tax basis in that activity below zero. Losses in excess of the taxpayer's basis are carried forward until the taxpayer's basis becomes positive again.

At-risk amount-limits the amount of deductible loss to the amount the taxpayer has at risk in the activity. Generally, the taxpayer's at-risk amount corresponds to his tax basis except that debt allocated to the taxpayer and included in tax basis is not included in the taxpayer's amount at risk if he is not responsible for repaying the debt. However, an exception to this general rule is qualified nonrecourse financing that is included in the taxpayer's amount at risk. Losses limited by the taxpayer's amount at risk are carried forward and deducted when the taxpayer's amount at risk becomes positive again.

Passive loss limits-limits the amount of loss from any passive activity (activities in which the taxpayer does not materially participate) to the taxpayer's passive income for the year. Limited partnerships and rental activities are generally considered to be passive activities. Losses limited by the passive activity loss rules are carried forward until the taxpayer generates passive income or until the taxpayer disposes of the activity producing the passive losses.