An abusive tax shelter is an investment arrangement that claims tax deductions considered by the IRS to be illegal. These shelters may engage in any of the following arrangements:
- Inflated appraisals
- Losses on nonrecourse loans
- Mischaracterization of the substance of a transaction
- Mismatched income and deductions
- Unrealistic allocations
- Unusual financing techniques
These arrangements commonly route invested funds through partnerships or trusts. An abusive tax shelter has no economic purpose; it exists solely to reduce the income taxes of investors.
When this type of arrangement is declared illegal, investors are liable for back taxes, penalties, and interest charges.