Chapter 14

Question 1

Three types of income: Active Income

Answer 1

1. wages, salary, commissions, bonuses, and other payments for services rendered by the taxpayer. 2. profit from a trade or business in which the taxpayer is a material participant. 3. Gain on the sale or other disposition of assets used in an active trade or business. 4. Income from intangible property if the taxpayer personal affords significantly contributed to the creation of the property.

Question 2

Three Types of Income: Passive Income

Answer 2

Any trade or business or income-producing activity in which the taxpayer does not materially participate. 2. Subject to certain exemptions, all rental activities, whether the taxpayer materially participates or not.

Question 3

Three Types of Income: Portfolio Income

Answer 3

1. Interest, dividends, annuities and royalties not derived in the ordinary course of trade or business. 2. Gain or loss from the disposition of property that produces portfolio income or is held for investment purposes.

Question 4

Passive Activities

Answer 4

Passive income or loss is derived from the conduct of a passive activity. Section 169 defines a passive activity as any activity: in which the taxpayer does not materially participate, that is limited partnership interest, or that is a rental activity, even if the taxpayer materially participates in the activity.

Question 5

Material participation

Answer 5

1 Greater than 500 hours devoted to an activity. or 2. Greater than 100 devoted to activity and the most of any participant or 3. greater than 100 hours devoted to several activities that add up to more than 500 hours.

Question 6

Grouping of Passive Activities

Answer 6

To make the tax rules surrounding the use of passive activities a bit more user-friendly, it is possible to group several passive activities into a n “appropriate economic unit. Once grouped into an appropriate economic unit, the limitations imposed on passive activities will apply on a group basis, as opposed to per unit basis.

Question 7

Basis Limitation

Answer 7

The first limitation that is imposed on the deductibility of passive losses is the basis limitation. The basis limitation states that the maximum allowable loss that a taxpayer can deduct is equal to his or her basis in the investment.

Question 8

At Risk Rules

Answer 8

Once the basis rule has been applied to the loss from the activity, a second test must be met in order to claim a deduction for income tax purposes. The at risk rule states that a taxpayer may not deduct, in the current tax year, more than the amount that he/she is at risk fro the investment.

Question 9

Passive Activity Loss Rules

Answer 9

After application of the basis limitation rules and the at-risk rules, one additional test must be met before a taxpayer may deduct a passive loss for federal income tax purposes. The passive activity loss rule states that losses falling into the passive bucket from a passive activity can generally only be offset against gains that are in the passive bucket.

Question 10

Suspended Losses When Taxpayer Dies

Answer 10

If the asset is stepped up, reduce the suspended losses by the amount stepped up. If the asset is stepped down, deduct the full suspended loss.

Question 11

Rental Property Exceptions

Answer 11

1. Customer use is less than or equal to 7 days. 2. Customer use less than or equal to 30 days and personal services provided. 3. Extraordinary personal services are provided. 4. Renal activity incidental to non-rental activity. 5. Rental activity available during business hours for nonexclusive use of customers. 6. Rental property use din activity conducted by partnership, where taxpayer is owner and active participant.

Question 12

Real Estate Professionals Exception

Answer 12

Losses from rental real estate activities incurred by real estate professionals are treated as active losses if the individual meets the following requirements for material participation: a. more than half of the personal services that the taxpayer performs in trade or business are performed in real property trades or business in which the taxpayer materially participates or b. the taxpayer performs more than 750 hours of services in these real property trades or businesses as a material participant.

Question 13

Individual Investor Exception

Answer 13

Up to 25,000 of losses on real estate rental activities of an individual may be deducted against active or portfolio income under the active participant test. A) To qualify, the taxpayer must own 10 percent mor more of all interest in the activity and must actively participate in the activity. B> The active participation standard can be met if the taxpayer participates in making management decisions in a significant and bona fide sense.