Question

Taxpayer owns a parcel of undeveloped real estate that has a basis to taxpayer of $200,000. Taxpayer purchased the real estate in 2003 for investment. Taxpayer sold the property to his nephew on January 10, 2017 for $80,000. Is the loss deductible by the taxpayer, and what Code sections are applicable to the transaction? Assume taxpayer has no other capital gains or losses for the year.

        

a.        No amount of the loss is not deductible because the sale is to a related party; Code Section 1001(a) and Code Section 267(a) and (d).

b.         The loss is deductible; Code Section 469(c)(7).

c.         $3,000 of the loss is deductible in the current year; Code Sections 1001(a) and 1211(b).

d.         None of the above answers is correct.

Answer 1

Tax shelters were popular investments for tax avoidance because they could generate deductions and other benefits that could be used to offset other income. Some tax shelters even advertised a 10-to-1 tax write-off, meaning that $10 of losses could be claimed for each $1 invested; so a taxpayer in the 35% bracket could save $3.50 for each $1 invested, netting $2.50 at the expense of the government. The primary purpose of tax shelters was simply to generate losses so that the "investors" could lower their taxable income. Indeed, they were not even an investment, since they had no economic value — they were simply a means of taking advantage of tax loopholes.

Most of these tax shelters or partnerships took advantage of nonrecourse financing. Nonrecourse debt is an obligation for which the borrower is not personally liable. For instance, a partnership to buy real estate often uses mortgages collateralized by the property. None of the partners have any personal liability for the mortgages — neither does the partnership. If there is a default, the lender's only option is to foreclose on the property. Many of these tax shelters generated losses in the early years through accelerated depreciation and interest expense deductions. Consequently, 2 major provisions were added to the tax law to limit the effectiveness of tax shelters: at-risk limitations and passive activity rules.
Although the at-risk limitation rules reduced the deductions, they still allowed taxpayers to defer income to a future year. So to prevent this, Congress passed passive activity rules that allowed passive losses to be deducted only from passive profits. Passive activity rules cover real estate investments, limited partnerships, closely held corporations, or any other type of investment in a business in which the investor is not active or for which losses of the business are passed through to the investor.