Chapter 6: Deductions and Losses

Comprehensive vocabulary flashcards covering individual tax deductions, trade or business expense criteria, capitalizations, statutory restrictions, substantiation, and special disallowance rules from Chapter 6.

Legislative Grace Principle

The legal doctrine established in INDOPCO, Inc. v. Comm'r providing that deductions are a matter of legislative grace and taxpayers bear the burden of substantiating claimed deductions with sufficient records.

Deductions For AGI

Deductions that directly reduce gross income to determine Adjusted Gross Income (AGI), including trade or business expenses, losses on business or investment property, $50\%$ of self-employment taxes, and traditional IRA contributions.

Itemized Deductions (Deductions From AGI)

Expenses deducted from AGI that offer a tax benefit only if their aggregate amount exceeds the standard deduction; examples include medical expenses, qualified residence interest, state and local taxes, and charitable contributions.

IRC Sec. 162

The Internal Revenue Code section that authorizes deductions for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business with a profit motive.

IRC Sec. 212

The Internal Revenue Code section that allows deductions for ordinary and necessary expenses incurred for the production of income, the management or conservation of income-producing property, or in connection with the determination, collection, or refund of any tax.

IRC Sec. 262

The statutory provision that establishes the general rule prohibiting individual taxpayers from deducting personal, living, or family expenses unless specifically permitted by Congress.

Ordinary Expense

An expense that bears a reasonable and proximate relationship to the income-producing activity or property, and is customary or usual to that particular type of business or activity.

Necessary Expense

An expenditure that is appropriate and helpful to the trade or business, determined by whether a reasonable business person would have incurred the same cost, without requiring the expense to be indispensable.

Reasonable Expense

A requirement that an expenditure must be reasonable in amount and not excessive or unusual when compared to similar expenses incurred by comparable businesses.

IRC Sec. 179

An elective tax provision permitting taxpayers to currently expense up to a statutory maximum of capital expenditures ($\$1,220,000$ for 2024) for new tangible property used in a trade or business.

IRC Sec. 265

The statutory provision disallowing deductions for expenses allocated or directly related to the production of tax-exempt income, such as interest paid on a loan used to purchase tax-exempt municipal bonds.

De Minimis Lobbying Exception

An exception under IRC Sec. 162(e)(4)(B) allowing the deduction of in-house lobbying expenditures provided the total does not exceed $\$2,000$ for the year, excluding payments made to professional lobbyists.

IRC Sec. 195

A provision allowing taxpayers entering a new trade or business to elect to deduct up to $\$5,000$ of start-up or investigation expenses and amortize the remaining balance over a period of not less than $180$ months.

Cohan Rule

A legal precedent allowing taxpayers to use reasonable estimates to establish deduction amounts when it is clear that an expense was incurred but substantiating records are incomplete.

All-Events Test

The accrual method accounting standard required for deducting an expense, met when all events have occurred to fix the liability, the amount can be determined with reasonable accuracy, and economic performance has occurred.

Points

Prepaid interest paid to acquire a principal residence, which is deductible in the year of payment if designated as points on the settlement statement, calculated as a percentage of the loan, customary in the area, and secured by the residence.

IRC Sec. 267 Related-Party Rules

Statutory rules that disallow losses realized on property sales between related taxpayers and defer deductions for unpaid accrued expenses until the payee recognizes the corresponding income.

Hobby Profit Presumption

A statutory presumption that an activity is engaged in for profit if it shows a profit in at least $3$ out of $5$ consecutive tax years (or $2$ out of $7$ consecutive tax years for the raising and racing of horses).

Vacation Home Personal-Use Classification

A classification for a residence rented for less than $15$ days in a tax year, wherein all rental income is excluded from gross income and only otherwise deductible personal expenses (such as property taxes and interest) are allowed.

Vacation Home Mixed-Use Classification

A classification where a property is rented for more than $14$ days and personal use exceeds the greater of $14$ days or $10\%$ of rental days; allowable rental expenses are prorated and limited to rental income, precluding a deductible loss.

Vacation Home Rental Classification

A classification where personal use does not exceed the greater of $14$ days or $10\%$ of rental days; all allocated rental expenses are deductible and may generate a deductible loss.

Tier 1 Vacation Home Expenses

The first tier of deductible vacation home expenses, consisting of costs deductible even if not incurred in a trade or business context, such as mortgage interest and real estate taxes.

Tier 2 Vacation Home Expenses

The second tier of deductible vacation home expenses, consisting of operating costs that would be deductible in a business context but do not affect property basis, such as utilities, insurance, and maintenance.

Tier 3 Vacation Home Expenses

The third and final tier of deductible vacation home expenses, consisting of business-type costs that reduce the tax basis of the property, specifically depreciation.

Schedule C

The IRS tax schedule used by sole proprietors and single-member LLCs to report gross business receipts and deduct trade or business expenses taken for AGI.

Schedule E

The IRS tax schedule used by individuals to report rental and royalty income along with associated ordinary and necessary expenses taken for AGI.