The Fundamentals of Federal Taxation: Problems and Materials, Fourth Edition by John A. Miller & Jeffrey A. Maine

The Fundamentals of Federal Taxation: Problems and Materials, Fourth Edition by John A. Miller & Jeffrey A. Maine

Author:John A. Miller & Jeffrey A. Maine
Language: eng
Format: mobi
ISBN: 9781531002060
Publisher: Carolina Academic Press
Published: 2017-04-30T21:00:00+00:00


Tier 2: Deductions that would be allowable if the activity in question had been conducted for profit but that do not result in adjustments to basis of property (e.g., business expenses under section 162). Treas. Reg. §1.183-1(b)(2).

Tier 3: Deductions that would be allowable if the activity had been conducted for profit but, unlike Tier 2 deductions, result in basis adjustments (e.g., depreciation). Treas. Reg. §1.183-1(b)(3).

Deductions attributable to a hobby activity are marshaled into one of these three tiers for the following reasons. Tier 1 deductions are allowed in full subject, of course, to any limitations to which they would otherwise be subject (e.g., $100 floor for casualty losses). Tier 2 deductions are allowed only to the extent that gross income from the activity exceeds the total Tier 1 deductions. Tier 3 deductions are allowed only to the extent that gross income from the activity exceeds the sum of Tier 1 and Tier 2 deductions. These principles can be illustrated with the following simple example.

Example. Taxpayer owns 20 acres on the side of a mountain. Each weekend in the winter, he allows his friends to snow tube on his property. This year, Taxpayer receives $10,000 from his friends to help out with expenses. Taxpayer incurs the following expenses: $5,000 for real estate taxes; $4,000 for wages paid to a neighbor to groom the snow; and $3,000 of depreciation attributable to a snow blowing machine. Assuming the activity is not engaged in for profit, Taxpayer is entitled to deductions to the extent of income from the activity, $10,000. Thus, the $5,000 in property taxes (Tier 1) are deductible in full. Since gross income exceeds the Tier 1 deductions by $5,000, the $4,000 in wages (Tier 2) are deductible in full. Finally, gross income exceeds both Tier 1 and Tier 2 deductions by only $1,000, therefore, only $1,000 of depreciation (Tier 3) is deductible this year.

Section 183 applies to individuals, S corporations, estates, and trusts. Treas. Reg. §1.183-1(a). Some courts have applied section 183 to partnerships as well. See Brannen v. Commissioner, 78 T.C. 471 91982), aff'd, 722 F.2d 695 (11th Cir. 1984).

Section 183 Checklist

Step 1: Define the “activity” of the taxpayer. Note that two or more undertakings may be treated as one activity for purposes of section 183. See Treas. Reg. §1.183-1(d).

Step 2: Is the activity engaged in for profit? Consider the IRC §183(d) presumption. Consider the nine factors in Treas. Reg. §1.183-2(b).

Step 3: If the activity is not engaged in for profit, deductions are allowed to the extent of hobby income. Apply IRC §183(b); Treas. Reg. §1.183-1(b).

Step 4: If the activity is engaged in for profit, determine whether the activity is a “trade or business” activity or an “investment” activity. Apply Groetzinger v. Commissioner, discussed in Chapter 7.

Step 5: If the activity is a trade or business, see IRC §§162 (expenses), 165(c)(1) (losses), 167(a)(1) (depreciation).

Step 6: If the activity is an investment, see IRC §§212 (expenses), 165(c)(2) (losses), 167(a)(2) (depreciation).



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