Module 7 Passive Activity and At-Risk Rules Flashcards
James has suspended losses from a nonpublicly traded partnership of $17,000. In 2023, he has income from a nonpublicly traded partnership of $15,000. What amount of suspended losses, if any, may James deduct in 2023?
A)
$0
B)
$15,000
C)
$2,000
D)
$17,000
b
He may deduct (under the at-risk limitations) his share of the partnership loss to the extent of his investment in the partnership. With a $17,000 loss and only $15,000 in income, James can only deduct $15,000 of the loss.
LO 7.2.2
Which of the following statements regarding passive activity losses is CORRECT?
When determining the amount of suspended loss that may be used against income, the at-risk rules are applied before the passive activity loss rules.
If a loss is not allowed because of the at-risk limitations, the loss is a suspended loss eligible for deduction as a disposition of a passive activity.
A)
Both I and II
B)
I only
C)
II only
D)
Neither I nor II
b
Statement I is correct. Statement II is incorrect. If a loss is not allowed because of the at-risk limitations, the loss is a suspended loss and is not eligible for deduction as a disposition of a passive activity.
LO 7.1.1
Jasper invested $20,000 for a 30% interest in a nonpublicly traded limited partnership. Jasper is not a material participant. The partnership has a loss this year and Jasper’s share is $15,000. This is the only nonpublicly traded limited partnership Jasper owns an interest in, but Jasper did have portfolio income of $9,000 in the same year in addition to his salary of $150,000. How much of the loss can Jasper deduct this year?
A)
$0
B)
$9,000
C)
$15,000
D)
$6,000
a
Because Jasper has no passive income to offset the passive loss, the loss is suspended under the passive activity loss rules.
LO 7.2.2
pon the disposition of a passive activity interest by gift, the suspended losses are
A)
deductible to the extent the losses exceed any increase in the fair market value of the activity.
B)
deductible in full.
C)
completely lost.
D)
added to the basis of the interest.
d
Upon the disposition of a passive activity by gift, the suspended losses are added to the basis of the activity.
LO 7.1.2
Mack owns a vacation home that he plans to rent for 190 days this year. He also plans to live in the house during the year. What is the maximum number of days he can live in the home without jeopardizing the property’s status as a rental property?
A)
95 days
B)
14 days
C)
19 days
D)
140 days
c
Because he will rent the home for 190 days, Mack can use it as a personal residence for up to 19 days (the greater of 14 days or 10% of rental use) without jeopardizing the property’s status as a rental property.
LO 7.2.4
During the current tax year, Jim has $10,000 of passive income from a publicly traded limited partnership. He also has a nonpublicly traded limited partnership that will generate a $10,000 passive loss. How much of this passive loss, if any, is deductible by Jim during the current tax year?
A)
$6,500
B)
$10,000
C)
$1,000
D)
$0
d
Income from a publicly traded limited partnership may not be offset by any other passive losses. Remember that income and losses from nonpublicly traded partnerships may be used to offset each other.
LO 7.2.2
Jim has the following items from four investments:
Passive income from a publicly traded limited partnership $16,000
Passive loss from a publicly traded limited partnership $(8,500)
Passive income from a non-publicly traded limited partnership $13,000
Passive loss from a non-publicly traded limited partnership $(20,000)
What is the total amount of passive losses that may be deducted during the current year?
A)
$20,000
B)
$13,000
C)
$28,500
D)
$29,000
b
The passive loss of $20,000 from the non-publicly traded partnership (non-PTP) is deductible, but it can only offset income from another qualified source, which in this case is the other non-publicly traded partnership. Thus, only $13,000 of the $20,000 is currently deductible. The rest of the losses are suspended. Losses from a publicly traded partnership (PTP) are likewise suspended until the same PTP has income in the future.
LO 7.2.2
Jean leases a house from Nan. The rent is normally $850 per month. Nan accepts reduced monthly rent of $500 per month for the current year in addition to Jean providing repairs to the property. The repairs are worth $2,500 and cost $3,200. How much must Nan include in income due to the house rental?
A)
$8,500
B)
$6,000
C)
$9,200
D)
$10,200
a
The actual rent received of $6,000 plus the fair market value of the services provided, $2,500, are included in income.
LO 7.2.3
Which of the following statements correctly identify the requirements necessary to deduct $25,000 of losses from an active participation real estate program?
The taxpayer must have at least a 10% ownership interest in the property.
The taxpayer’s modified adjusted gross income must not exceed $200,000.
The taxpayer must make the major management decisions related to the property.
The taxpayer’s interest in the property may not be held as a limited partnership interest.
A)
I and III
B)
I, III, and IV
C)
II, III, and IV
D)
II and IV
b
The answer is I, III, and IV. II is false because the phaseout range for the active participation real estate deduction is $100,000 to $150,000.
LO 7.2.1
Your client, Sally, is considering investing in real estate as a way to diversify her investments. She has heard of active participation rental real estate, but is unsure of the requirements that must be met. What can you accurately tell her with respect to active participation rental real estate?
The interest may not be held through a limited partnership.
A deduction-equivalent tax credit of up to $25,000 is available.
The taxpayer must hold a 10% or greater ownership interest.
The taxpayer must make the major management decisions.
A)
III and IV
B)
I and II
C)
I and IV
D)
I, III, and IV
d
The deduction for active participation rental real estate requires that the taxpayer participate in management in a bona fide sense; making the major management decisions. To qualify, the interest may not be held through a limited partnership, and the taxpayer must have at least a 10% or greater ownership interest in the property. The loss is deductible when computing the gross income. Active participation rental real estate generates an above-the-line deduction of up to $25,000 annually, not a credit.
LO 7.2.1
Jane has the following income and losses for the current year:
$1,500 loss from a 30% interest in Laminate Partnership in which she does not materially participate
$500 loss from a .2% limited partnership interest in Venture, a limited partnership
$2,400 loss from a 12% interest in an S corporation in which she manages one of the departments
$32,000 salary as manager with an S corporation
$600 of dividend income from Higher Mutual Fund
What is Jane’s adjusted gross income?
A)
$32,000
B)
$32,600
C)
$30,200
D)
$28,200
c
Jane’s AGI is $30,200. She has $32,600 of income from salary and dividends, and the S corporation loss of $2,400 is deductible because the information provided leads us to the conclusion that she is materially participating in the S corporation: $32,600 - $2,400 = $30,200. The Laminate Partnership and the Venture LP are both passive activities; therefore, the losses would be deductible only against passive income.
LO 7.1.2
Jack operates a cosmetic manufacturing business as an S corporation. In the current year, the business placed in service $33,000 of new property eligible for limited expensing under Section 179. If taxable income before cost recovery is $12,750, the maximum amount that the business can elect this year under Section 179 is
A)
$33,000.
B)
$8,000.
C)
$12,750.
D)
$25,000.
c
The expensing election is limited to taxable income before the expensing election is calculated; therefore, $12,750 is the maximum Jack’s business can elect under Section 179. The remaining amount of $12,250 is carried forward until the income of the business is sufficient to use up the remaining Section 179 expense election.
LO 7.1.2
If the Taylors rented their condo for 300 days last year, how many days could the Taylors have used it personally and still maintained the classification of the condo as primarily a rental use property?
A)
30 days
B)
0 days
C)
14 days
D)
3 days
a
The Taylors could have used the property personally for a total of 30 days (300 rental days × 10%). If rental property is rented at least 15 days a year and is not used for personal use more than the greater of 14 days per year or 10% of the rental days, it is classified as primarily rental use. This treatment permits the Taylors to deduct expenses associated with the rental (not personal) use on Schedule E of IRS Form 1040.
LO 7.2.4
Paula purchased an interest in a master limited partnership (MLP) that produced a loss of $7,000 this year. She also purchased a real estate limited partnership (RELP) that generated $10,000 of passive income this year. How much, if any, of the passive loss from the MLP could be used to offset Paula’s income from the RELP in the current year?
A)
$0
B)
$3,500
C)
$3,000
D)
$7,000
a
The answer is $0. Paula’s losses from the MLP cannot be used to offset income from the RELP. MLP losses may only be used to offset income from the same MLP.
LO 7.2.2
Which one of the following statements is CORRECT regarding the effect of the taxpayer’s death on suspended passive losses?
A)
They are nondeductible up to the amount of the step-up in basis of the activity.
B)
The death of the taxpayer has no effect on the suspended passive losses.
C)
They are completely nondeductible upon the death of the taxpayer.
D)
They are fully deductible upon the death of the taxpayer.
a
They are nondeductible up to the amount of the step-up in basis of the activity.
LO 7.1.2
Which of the following forms of business may be classified as direct participation programs?
General partnership
Limited partnership
S corporation
Closely held C corporation
A)
I, II, and III
B)
I and II
C)
III and IV
D)
IV only
a
The tax advantages provided by direct participation programs are founded upon the principle that most types of business organizations function as tax conduits; therefore, a closely held C corporation cannot qualify as there is no flow through of gains and losses.
LO 7.1.1
Which one of the following best describes the role of a special allocation in a limited partnership?
A)
It requires all items to be distributed pro rata based on a partner’s capital account balance.
B)
It allows an allocation of items of income and expense that is not pro rata.
C)
It establishes the standards for allocating the proceeds of non-routine or “special” items of income.
D)
It allocates management responsibility to the general partners.
b
A special allocation allows an allocation of items in a manner that differs from the “normal” pro rata allocation of deduction, income, credit, etc.
LO 7.1.1
All of the following statements regarding tax deduction limits on passive activity excess losses are correct except
A)
excess passive activity losses are disallowed on the taxpayer’s current tax return and instead are deferred.
B)
excess passive activity losses are fully allowed in the year in which the taxpayer disposes of his entire interest in the passive activity in a taxable transaction.
C)
losses from one nonpublicly traded passive activity may not offset income from another nonpublicly traded passive activity.
D)
excess passive activity losses are the excess of otherwise allowable deductions from the taxpayer’s passive activities over the amount of income from the taxpayer’s passive activities.
c
The taxpayer’s nonpublicly traded passive losses and nonpublicly traded passive income are aggregated for purposes of the limitation so that losses from one nonpublicly traded passive activity may offset income from another nonpublicly traded passive activity.
LO 7.1.2
Erma, age 40, anticipates an adjusted gross income of $177,000 for the current tax year. All her income is attributable to active and portfolio income. She would like to acquire an investment that would reduce her tax liability without exposing her to personal liability. Which one of the following investments is the most appropriate for Erma?
A)
A master limited partnership that will produce passive losses
B)
A historic rehabilitation real estate limited partnership that will produce rehabilitation tax credits
C)
An oil and gas working interest that will produce losses
D)
An “active participation” investment in rental real estate that will produce losses
b
Erma’s AGI is too high to claim the active participation real estate exception. Losses from a master limited partnership can only be deducted against income generated by the same partnership in another tax year. The oil and gas working interest will generate unlimited liability. Thus by process of elimination, the correct answer is historic rehabilitation credit.
LO 7.2.2
You are a CFP® professional and are meeting with your client Brenda to monitor her ongoing financial status. Brenda owns a vacation home in New Mexico. She is now renting the property to others for the entire year except for 10 days during the summer when she and her family used it for their vacation. The gross rental income that Brenda received is $65,000. The expenses for the home for both the rental period and her personal use total $5,000. Brenda would like you to explain how this will change her income tax situation, in particular, how much of the rental expenses are deductible. After reviewing the documents she sent to you prior to the meeting, you have an answer for Brenda. How much of a deduction for rental expenses can Brenda take on her tax return?
A)
$5,000
B)
$4,721
C)
$4,863
D)
$3,411
c
Brenda can deduct the cost of renting the home if she occupies it for the greater of no more than 14 days per year or for 10% of the number of days the property is rented. Because Brenda occupies the house for only 10 days during the year, this test is satisfied. Even though this rental use exception is allowed, the deductible expenses related to the rental of the house are limited. Specifically, she can only deduct a portion of the actual rental expenses, which equals the number of days during the year that the house is rented to others divided by the total number of days that the house is used by either tenants or Brenda. Given 365 days per year, Brenda’s tenants occupy the house all but 10 days, for a total of 355 days. She is allowed to deduct 97.26% (355 days ÷ 365 days) of the $5,000 rental expenses, which equals $4,863.
LO 7.2.4
Natalia, a commissioned salesperson and single taxpayer divorced in 2018, has provided the following information for the current tax year:
Sales commissions $60,000
Keogh contribution $6,000
Alimony paid to Natalia’s former spouse $12,000
Limited partnership passive loss $30,000
Self-employment tax liability $8,478
What is Natalia’s adjusted gross income for the 2023 tax year?
A)
$42,000
B)
$37,761
C)
$33,522
D)
$3,522
b
Total income = $60,000.
Adjustments = $6,000 + $12,000 + ($8,478 ÷ 2) = $22,239.
$60,000 – $22,239 = $37,761.
The passive loss is suspended because Natalia has no passive income to offset.
LO 7.2.2
Which of the following activities is treated as a rental activity under the passive activity rules?
Property rental where average customer use is 6 days
Property rental where average customer use is more than 30 days and no significant services are provided
Property rental where extraordinary services are provided on behalf of the owners
Property rental where the property is customarily made available during defined business hours for the nonexclusive use of customers
A)
II only
B)
II and III
C)
II, III, and IV
D)
I only
a
Only Statement II is treated as a rental activity according to IRS regulations. If a rental is 30 days or less and significant personal services are provided, the activity is a service rather than a rental activity.
LO 7.2.3
Carl, June, and Diane are partners. There is one employee, Mark, who is part-time, working 250 hours per year, primarily in the busy season. Carl works 1,900 hours annually while June works 600 hours and Diane devotes 550 hours in the busy season. Who qualifies as a material participant in the partnership?
A)
Carl and June
B)
Carl, Mark, June, and Diane
C)
Carl only
D)
Carl, June, and Diane
d
Carl, June, and Diane each participate more than 500 hours in the partnership and are considered material participants.
LO 7.2.1
What, if any, is the primary difference in tax treatment between a general partnership and a limited partnership?
A)
Limited partnerships are taxed as corporations, while general partnerships are taxed as partnerships.
B)
The limited partners are treated only as capital investors, whereas the active partners receive both ordinary and capital distributions.
C)
None of these.
D)
The limited partners only receive capital distributions, while the general partners receive only ordinary income distributions.
c
As long as the limited partnership is classified as a partnership (and not a C corporation) for tax purposes, the taxation is no different than it would be if the organization were a general partnership. That is, the partnership issues a K-1 to all of the partners for their distributive share of items of income and loss. Limited partners generally must treat net income or loss from the partnership as passive.
LO 7.1.1