FAR 33 - Deductions 4 - Limitations on Business Deductions Flashcards
Jason Budd, CPA, reports on the cash basis. In April 2013, Budd billed a client $3,500 for the following professional services:
Personal estate planning $2,000
Personal tax return preparation 1,000
Compilation of business financial statements 500
No part of the $3,500 was ever paid. In April 2014, the client declared bankruptcy, and the $3,500 obligation became totally uncollectible. What loss can Budd deduct on his tax return for this bad debt? A. $0 B. $ 500 C. $ 1,500 D. $3,500
A. Since Budd reports on the cash basis he did not recognize income when the client was billed. Therefore, he has no basis in the receivable to deduct when it becomes uncollectible.
For the year ended December 31, 2014, Sanchez had a net operating loss of $100,000. Taxable income for the earlier years, computed without reference to the net operating loss, was as follows:
Taxable income 2010 $90,000 2011 $80,000 2012 $50,000 2013 $40,000
If Sanchez makes no special election to waive the net operating loss carryback, what amount of net operating loss will be available to Sanchez for 2015? A. $ 0 B. $ 10,000 C. $ 60,000 D. $ 100,000
B. The $100,000 NOL would first be carried back to 2012 and offset $50,000 of income. It would then be carried to 2013 and offset $40,000 of income. This would leave $10,000 of NOL ($100,000 - $50,000 - $40,000) to carryforward to 2015.
An individual’s losses on transactions entered into for personal purposes are deductible only if
A. The losses qualify as casualty or theft losses.
B. The losses can be characterized as hobby losses.
C. The losses do not exceed $3,000 ($6,000 on a joint return).
D. No part of the transactions was entered into for profit.
A. An individual’s losses on transactions entered into for personal purposes are only deductible if the losses qualify as casualty or theft losses. If the losses originated due to a trade or business, individuals also may deduct losses originating from transactions entered into for profit.
T/F: A bad business loan can be written off as a loss in the year in which the loan becomes nonperforming.
True
T/F: A security can be deducted as a loss in the year in which the security loses a substantial portion of its value.
False.
In general, the security must be totally worthless (no residual value).
T/F: A bona fide loan to a neighbor can be deducted as a non-business bad debt if the neighbor refuses to pay and no collection is feasible.
True
Lane, a single taxpayer, received $160,000 in salary, $15,000 in income from an S Corporation in which Lane does not materially participate, and a $35,000 passive loss from a real estate rental activity in which Lane materially participated. Lane's modified adjusted gross income was $165,000. What amount of the real estate rental activity loss was deductible? A. $0 B. $15,000 C. $25,000 D. $35,000
B. Lane has $160,000 in active income, $15,000 of passive income, and $35,000 of passive losses. Note that the exception that allows deduction for up to $25,000 of rental real estate losses does not apply since Lane’s modified AGI exceeds $150,000. The passive losses can only be deducted to the extent of passive income, so $15,000 is correct.
Smith has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities. What amount of the rental losses may Smith deduct in determining taxable income? A. $0 B. $15,000 C. $20,000 D. $40,000
B. Since Smith actively participates in the rental real estate activity he can deduct up to $25,000 of rental losses. However, this deduction is reduced once modified AGI exceeds $100,000. Smith has $20,000 of excess AGI ($120,000 − $100,000) so he loses $10,000 ($20,000 × 50%) of the deduction. Of the $40,000 of losses, he can deduct $15,000 ($25,000 − $10,000). The remaining $25,000 of losses is suspended.
Brenda, employed full time, makes beaded jewelry as a hobby. In year 2, Brenda’s hobby generated $2,000 of sales, and she incurred $3,000 of travel expenses. What is the proper reporting of the income and expenses related to the activity?
A. Sales of $2,000 are reported in gross income, and $2,000 of expenses are reported as an itemized deduction subject to the 2% limitation.
B. Sales of $2,000 are reported in gross income, and $3,000 of expenses are reported as an itemized deduction subject to the 2% limitation.
C. Sales and expenses are netted, and the net loss of $1,000 is reported as an itemized deduction NOT subject to the 2% limitation.
D. Sales and expenses are netted and deducted for AGI.
A. Income from a hobby is reported as other income on the front page of Form 1040. Deductions such as travel expenses are 2% miscellaneous itemized deductions, and expenses can be deducted only to the extent of revenues.
Don Wolf became a general partner in Gata Associates on January 1, 2014 with a 5% interest in Gata’s profits, losses, and capital. Gata is a distributor of auto parts. Wolf does not materially participate in the partnership business. For the year ended December 31, 2014, Gata had an operating loss of $100,000. In addition, Gata earned interest of $20,000 on a temporary investment. Gata has kept the principal temporarily invested while awaiting delivery of equipment that is presently on order. The principal will be used to pay for this equipment.
Wolf's passive loss for 2014 is A. $0 B. $4,000 C. $5,000 D. $6,000
C. Passive activity losses are the amount that total losses from passive activities exceed total gains from passive activities. The characterization of a partner’s share of the partnership’s income as passive or nonpassive depends on the partner’s participation in the partnership’s income earning activities. Since Wolf did not materially participate in the partnership business, his share of the partnership’s operating loss, $5,000, is considered a loss from a passive activity. Passive income does not include portfolio income.
As a result, Wolf’s share of the $20,000 in interest income would not be passive. Therefore, since Wolf had no gains from passive activities to offset the loss from his share of the partnership’s operating loss, Wolf would have a passive loss of $5,000, equal to his share of the partnership’s operating loss.
Cobb, an unmarried individual, had an adjusted gross income of $200,000 in 2014 before any IRA deduction, taxable social security benefits, or passive activity losses.
Cobb incurred a loss of $30,000 in 2014 from rental real estate in which he actively participated.
What amount of loss attributable to this rental real estate can be used in 2014 as an offset against income from nonpassive sources? A. $0 B. $12,500 C. $25,000 D. $30,000
A. Passive activity losses normally only may be used to offset passive activity income. Rental activities are considered passive activities, regardless of the level of participation by the taxpayer.
However, a natural person is allowed an allowance for offsetting up to $25,000 of nonpassive income with passive losses resulting from rental activities, provided certain conditions are met. The person must own at least 10 percent of the rental activity and must have actively participated.
Hence, Cobb’s $30,000 loss from his rental real estate activities would be considered a passive loss, initially indicating that Cobb would be limited to the $25,000 allowance. However, the $25,000 allowance is reduced by 50 percent of the amount that the taxpayer’s adjusted gross income exceeds $100,000. Thus, Cobb’s credit must be reduced by $50,000, which exceeds Cobb’s $30,000 passive loss.
Therefore, Cobb may not use any of his loss attributable to the rental real estate to offset against income from nonpassive sources.
T/F: Passive losses cannot offset active income for individuals but can offset investment income.
False.
The expenses and revenues from passive activities are combined (netted) and the expenses in excess of revenue (the passive loss) are suspended.
T/F: Rental receipts are excluded for the rental of a residence when the residence is used by the taxpayer for more than two weeks.
False.
- If rented for less than 15 days a year, it is treated as a personal residence. Rent income is excluded and mortgage interest and property taxes are deductible on Schedule A.
- If rented for 15 days or more, and if it is not used for personal purposes for more than the greater of 1) 14 days or 2) 10% of the total days rented, it is treated as rental property. All rent is taxable, net of all regular rental expenses, pro-rated for the percentage of rental days only. A rental loss is allowable.
- If rented for 15 days or more, and if it is used for personal purposes for more than the greater of 1) 14 days or 2) 10% of the total days rented, it is treated as personal/rental property. All regular expenses are pro-rated as above for rental days, but a rental loss is not allowed. Expenses must be deducted in the same order as for a hobby.
T/F: Hobby expenses can be deducted only to the extent that the hobby generates revenue.
True
Hobby : An activity that is not primarily profit oriented because it is primarily undertaken for personal enjoyment.
Hobby expenses may be deducted if the hobby generates revenue.
T/F: Taxpayers always bear the burden of proving that an activity is conducted for the purpose of making a profit.
False.
The burden of proving a lack of profit motive can be shifted to the IRS.
1. When the activity generates a profit in three out of five consecutive years, the IRS must prove the taxpayer has no profit motive in conducting the activity.
2. If there are losses in at least three of the previous five years, the taxpayer has the burden to prove that the activity is a business.
