It might appear that studying loss limitations before looking at allocations is backwards, but understanding how loss limitations work puts the allocation issues into perspective. It is easier to understand allocations once the consequences of an allocation are appreciated.

This topic begins with a categorical examination of each entity and an identification of the loss limitations that apply. For C corporations, it’s a matter of reminding students about section 1211, and pointing out the limited applicability of the at-risk and passive loss limitations. For S corporations and partnerships, it’s a matter again of refreshing students’ recollections of section 1211, describing the basis limitations, and noting that the at-risk and passive loss limitations are significant elements in computing the taxable income of many partners and S corporation shareholders.

A problem that deals with the section 704(d) basis limitation for partnerships illustrates the issues that arise both for partnerships and S corporations. The concept of multiple disallowed loss carry-forwards intrudes and illustrates the challenges of keeping track of more than a few facts at one time.

Then, because at-risk and passive loss limitations are not limited to business entity transactions, but aren’t given much, if any, attention in the basic tax course, I take the students through a short lecture in which I try to explain the basic principles of those limitations without getting mired in details. I do, however, take them far enough into the policy behind the limitations and the unexpected consequences of how section 469 operates so that they can understand what PIGs are. I’ll leave that discussion to another day.

Next: Allocations in the Corporate Context