Tax Investments in Casinos

At the end of December last year, Jerry requested for his 2006 tax return to be completed. Through the questionnaire that he was required to complete, the following information was gathered. During the year, Jerry worked as a professional boxer, earning a salary of $300,000. He also made a $100,000 investment in the start-up of a new casino. When Jerry is not competing in boxing matches, he likes to spend his time gambling. Every Friday night from 6:00pm to 6:00am the next morning, he gambles at a local casino. He has lost $300,000 over the year. These losses came from a loan of $450,000 that the casino loaned him. Luckily for Jerry, his state has ruled that loans from a casino in excess of $150,000 are unenforceable. This information was reviewed and researched to determine Jerry’s tax liability for 2006.

Passive Investment in Casino

Jerry works as a professional boxer, earning a yearly salary of $300,000. His investment of $100,000 into a new casino is not part of his normal work as a boxer, thus making it a passive activity. A passive activity is something one does not materially participate, or something that is not participated in on a regular, continuous, and substantial basis as described by the Internal Revenue Code Section 469 . Therefore, any losses incurred in a passive activity, such as the investment in the new casino, can only offset the income associated with that passive activity; these losses can not be used to offset ordinary income. These losses would be reported on Form 8582, Passive Activity Loss Limitations.

Although Jerry does spend every Friday night from 6:00pm to 6:00am at the casino gambling, this is not an active involvement in the operations of the business. He’s time spent at the casino is merely for his own benefit and pleasure.

If Jerry wanted to have his investment in the casino treated as an active activity, he must be able to prove, through substantiation, that he materially participated in the operations of the casino. He must show that either he spent more than 500 hours working for the casino, or more than 100 hours and the aggregate of all passive activities exceed 500 hours. If he is able to prove that the casino is not a passive activity for him, he will be able to deduct any losses incurred with the casino against the income from the casino and his income from boxing. These losses would be reported in Schedule C, Profit or Loss from Business.

Unenforceable loan

A taxpayer’s loan should not be reported as income because there is an obligation to repay the debt. It is not considered income because it does not increase the individual’s wealth – while the individuals assets increase, the liabilities also increase. Section 61 states considers a discharge of indebtedness as gross income. This consideration is because the taxpayer no longer has the obligation to repay the debtor. In Jerry’s situation, the state law does not consider casino loans above $150,000 to be enforceable. Therefore, we would advise him to include the amount above $150,000 as income received in that year. He should use the remaining amount to repay the enforceable amount of the casino loan.

There are exceptions made by the Internal Revenue Code that allow the discharge of indebtedness to be excluded from gross income. Code Section 108 specifies that the cancellation of debt due to bankruptcy, insolvency, certain farm debts, or non-recourse loans permits the taxpayer to exclude