Rental Property and Loss Limitations

Question 1

Bonnie received $30,000 in wages, and her husband Clyde had a net loss of $2,500 on his Schedule C (the loss was not a hobby loss under the tax code). Clyde materially participated in his Schedule C activity. They had dividend income of $1,500. Clyde also had a $20,000 loss from a rental real estate activity in which he actively participated. How much of the rental loss can they deduct on their current-year joint income tax return?

A. $2,500

B. $20,000

C. $0

D. $10,000

Answer 1

$20,000

Since Clyde is deemed to actively participate in the rental real estate activity, he avoids the passive activity limitation rules. Thus, they may deduct the entire amount of the loss (up to $25,000) from the rental real estate activity (Publication 527).

Question 2

Paul Bristol, a cash-basis taxpayer, owns an apartment building. The following information was available for the current year:
*An analysis of the bank deposit slips showed recurring monthly rents received totaling $50,000 for the current year.
*On March 1, the tenant in apartment 2B paid Bristol $2,000 to cancel the lease expiring on December 31 of the current year.
*The lease of the tenant in apartment 3A expired on December 31 of the current year and the tenant left improvements valued at $1,000. The improvements were not in lieu of any required rent.
In computing net rental income for the current year, Bristol should report gross rents of

A. $50,000

B. $51,000

C. $52,000

D. $53,000

Answer 2

$52,000

Gross rents include the $50,000 of recurring rents plus the $2,000 lease cancellation payment. The cancellation payment is in lieu of rent so it must be included in income like rent. The $1,000 of leasehold improvements are excluded from income since they were not in lieu of rent (Sec. 109 and Publication 17).

Question 3

Dr. J has adjusted gross income for the current year of $130,000 before the deduction for a $6,000 contribution to his IRA, and before any potential deduction for $40,000 of losses from rental real estate activities in which he actively participates. How much of the rental losses may he deduct if the rental real estate activities were acquired in the current year?

A. $13,000

B. $25,000

C. $0

D. $10,000

Answer 3

$10,000

The $25,000 allowance of losses from active participation in rental real estate activities against nonpassive income is reduced by 50% of the amount by which adjusted gross income (determined without regard to Social Security benefits, IRA contributions, and passive losses) exceeds $100,000 [Sec. 469(i)(3)]. Dr. J’s adjusted gross income exceeds $100,000 by $30,000 ($130,000 income – $100,000 threshold). Therefore, the $25,000 allowance is reduced by $15,000 ($30,000 × 50%). This leaves $10,000 of losses ($25,000 allowance – $15,000 reduction) that can be deducted (Publication 925).

Question 4

Clarence, a real estate professional, owned 10 rental properties. Clarence’s real estate activities are his sole occupation, which he works at all year. Throughout 2020, Clarence was involved in the operation of all properties on a regular, continuous, and substantial basis. At the end of the year, his real estate operations resulted in a $75,000 net loss. Clarence’s spouse, Carlette, had received $90,000 in wages in 2020. Their only other income during the year was $5,000 interest. Which of the following statements is true?

A. Clarence and Carlette may offset their $95,000 income with $25,000 of their real estate loss on their 2020 joint tax return if Clarence actively participated in the real estate activity.

B. Clarence and Carlette may not offset their $95,000 income with any real estate loss on their 2020 joint tax return.

C. Clarence and Carlette may fully offset their $95,000 income with their $75,000 real estate loss on their 2020 joint tax return.

D. None of the answers are correct.

Answer 4

Clarence and Carlette may fully offset their $95,000 income with their $75,000 real estate loss on their 2020 joint tax return.

Certain real estate professionals may be able to treat rental real estate activities as nonpassive [Code Sec. 469(c)(7)]. To qualify, (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year must involve real property trades or businesses in which the taxpayer materially participates, and (2) the taxpayer must perform more than 750 hours of service during the tax year in real property trades or businesses in which the taxpayer materially participates. These two requirements must be satisfied by one spouse if a joint return is filed (Publication 925). Assuming that the requirements for the exception are satisfied, the passive activity loss rules are not applied, and Clarence and Carlette may offset their income with the entire $75,000 loss.

Question 5

Terry, an accrual-basis taxpayer, owns a six-unit apartment building for which he receives rent of $420 per month per unit. In the current year, five of the units were rented for the entire 12-month period. The sixth unit was occupied from January 1 through March 31. Upon vacating the unit, the tenant was not refunded his security deposit of $280 due to damages to the unit. The unit was subsequently rented for 1 year beginning August 1 of the current year. On August 1, the new tenant paid the first and last month’s rent and a refundable security deposit of $280. What is Terry’s total rental income for the current year?

A. $29,260

B. $26,460

C. $28,840

D. $29,540

Answer 5

$29,260

Accrual-basis taxpayers report income when it is earned. All amounts received or accrued as rents are includible in income. Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease. Advance rent received upon execution of a lease is includible in gross income in the year received, whether the taxpayer is on the cash or the accrual basis. For the current year, Terry must include $25,200 for the five units rented continuously during the year. Although not specifically stated, it is presumed that Terry received rental income of $1,260 from unit six while it was occupied for the first 3 months of the current year. The $280 security deposit of the first tenant in unit six is includible as rental income because Terry became entitled to the funds to repair damages to the unit after the tenant vacated it. Terry also received rental income of $2,520, which included $420 of prepaid rent, from the second tenant of unit six. The refundable security deposit of $280 paid by the second tenant of unit six is not part of Terry’s rental income for the current year because Terry was not authorized to retain any portion of the deposit during the year (Publication 17).

Question 6

Jerry, a general contractor by trade, is a tenant of Montgomery Apartments. In exchange for 4 months of rent ($500/month), Jerry provided the following items and services for Paul, the owner of the apartments:
Paint and miscellaneous supplies for the apartments
$300
Labor for painting and miscellaneous repairs
$700
Labor and supplies for paving the apartment parking area
$1,000
How should Paul treat this transaction on his Schedule E?

A. Rental income of $2,000, rental expenses of $1,000, and depreciation computed on the capital expenditures of $1,000.

B. No rental income or rental expenses are to be reflected on the Schedule E because the net effect is zero.

C. Rental income of $2,000 and rental expenses of $2,000.

D. Rental income of $2,000 and depreciation computed on the capital expenditures of $2,000.

Answer 6

Rental income of $2,000, rental expenses of $1,000, and depreciation computed on the capital expenditures of $1,000.

As a general rule, if a lessee pays any of the expenses of his or her lessor, such payments are additional rental income to the lessor [Reg. 1.61-8(c)]. Since the expenses are in effect treated as if paid by the lessee to the lessor, and then paid by the lessor to a third party, the lessor may deduct them. The $1,000 cost of painting and miscellaneous repairs is for routine maintenance costs and can be deducted as rental expenses. The $1,000 cost of paving the parking area should be capitalized and properly depreciated (Publication 17).

Question 7

During the current year, Amanda, who is single, received $110,000 in salary and realized a $30,000 loss from her rental real estate activities in which she actively participates. She contributed $2,000 to an IRA. What is the amount that Amanda may claim as loss from her current-year real estate activities?

A. $25,000

B. $30,000

C. $21,000

D. $20,000

Answer 7

$20,000

The $25,000 allowance of losses from active participation in rental real estate activities against nonpassive income is reduced by 50% of the amount by which adjusted gross income (determined without regard to Social Security benefits, IRA contributions, and passive losses) exceeds $100,000. Amanda’s adjusted gross income exceeds $100,000 by $10,000 ($110,000 salary – $100,000 threshold) [Sec. 469(i)(3)]. Therefore, the $25,000 allowance is reduced by $5,000 ($10,000 × 50%). This leaves $20,000 of losses ($25,000 allowance – $5,000 reduction) that can be deducted (Publication 925).

Question 8

Erica received $40,000 in wages, and her husband Paul had a net loss of $2,000 on his Schedule C. Paul materially participated in his Schedule C activity. They had interest income of $500. Paul also had a $28,000 loss from a rental real estate activity in which he actively participates. How much of the rental loss can they deduct on their current-year joint income tax return?

A. $25,000

B. $500

C. $25,500

D. $28,000

Answer 8

$25,000

Since Paul is deemed to actively participate in the rental real estate activity and Paul and Erica’s adjusted gross income is less than $100,000, they are allowed to deduct $25,000 against other income (Publication 925).

Question 9

Mr. and Mrs. Bradshaw own a vacation home at the lake. They are trying to determine their days of personal use for the current year. Which of the following would be considered personal-use days?

A. The Bradshaw’s son, Seth, rented the lake house for 30 days in December. He does not have an interest in the property, and he used it as his main home. Seth paid fair rental price.

B. Mr. and Mrs. Bradshaw rented the house for 4 days in September to Mrs. Bradshaw’s nephew, Jacob. Jacob paid fair rental price.

C. Mr. and Mrs. Bradshaw rented a mountain cabin from Lucia for 4 days in October. Lucia rented their lake house for 4 days also. They each paid a fair rental price.

D. Mr. and Mrs. Bradshaw, their daughter, and grandchildren spent 7 days in May at the vacation home. Mr. Bradshaw spent substantially all of his time painting the interior. Mrs. Bradshaw and the others spent all of their time on recreation.

Answer 9

Mr. and Mrs. Bradshaw rented a mountain cabin from Lucia for 4 days in October. Lucia rented their lake house for 4 days also. They each paid a fair rental price.

A vacation home is deemed to have been used by Mr. and Mrs. Bradshaw if, for any part of the day, the home is used by any individual under a reciprocal arrangement, whether or not a rental price is charged (Publication 527).

Question 10

Mr. Lee rents his vacation home. Given the following information, determine the correct treatment of the rental income and expenses on his current-year return:
Days rented in the current year to
unrelated parties at a fair rental price
56 
Days used for personal purposes in the
current year
18 
Total income and expenses during the current year:
Gross rental income
$5,000 
Allocated interest and taxes
$(4,000)
Other allocated expenses
$(1,500)
Net rental loss
$(500)

A. A $500 loss should be shown on Schedule E, Form 1040.

B. The interest and taxes should be shown on Schedule E, Form 1040.

C. Rental expenses (other than interest and taxes) are limited to the gross rental income in excess of deductions for interest and taxes allocated to rental use.

D. Mr. Lee should include none of the income or expenses from the vacation home on his current-year income tax return.

Answer 10

Rental expenses (other than interest and taxes) are limited to the gross rental income in excess of deductions for interest and taxes allocated to rental use.

The tax code restricts the deductions with respect to a dwelling unit used by the taxpayer as a residence. A taxpayer is deemed to use a dwelling unit as a residence if (s)he uses it for personal purposes for a number of days that exceeds the greater of 14 days or 10% of the number of days during the year for which the unit is rented at a fair rental. Since Mr. Lee rented the home for only 56 days, he was allowed to use it for personal purposes for only 14 days. Thus, Mr. Lee’s deductible loss is limited. When a dwelling unit is used by the taxpayer as a residence, the tax code disallows a deduction for expenses exceeding the gross income derived from rents reduced by deductions allowable (e.g., taxes and interest), whether or not the unit was used for rental purposes. Under the tax code, the order of deductions is (1) the allocable portion of expenses deductible regardless of rental activity, (2) deductions not affecting basis, and (3) those that do affect basis (Publication 527).

Question 11

With regard to rental property and personal use of vacation homes and other dwelling units, all of the following statements are true EXCEPT

A. If you rented or tried to rent property for 12 or more consecutive months, you do not count as days of personal use the days on which you used the property as your main home (either before or after offering it for rent) when determining if you used your property as a home.

B. If family members use the property for recreational purposes on the same day you spend working substantially full-time repairing and maintaining your property, the day is counted as a day of personal use.

C. If you use a dwelling unit as a home and rent it for fewer than 15 days during the year, you do not have to include any of the rent in your income, and you cannot deduct any of the rental expenses.

D. If you rent out a room in your home that is always available for short-term occupancy by paying customers, you do not use the room yourself, and you only allow paying customers to use the room, then the room is not considered to be a dwelling unit.

Answer 11

If family members use the property for recreational purposes on the same day you spend working substantially full-time repairing and maintaining your property, the day is counted as a day of personal use.

The use of a dwelling for repairs and annual maintenance will not constitute personal use by the taxpayer, even if other family members use the property during the same time for recreational purposes. However, the taxpayer must engage in repairs and maintenance on a substantially full-time basis for the day (Publication 527).

Question 12

Ms. Oak rented a small house to Mr. Acorn for $500 a month for all of the current year. The house was in serious need of rehabilitation. Mr. Acorn, an electrician, approached Ms. Oak with a proposal that he would rewire the house in lieu of payment of his January through April rent (4 months). Ms. Oak accepted Mr. Acorn’s offer, and Mr. Acorn completed his work in July. In August, Ms. Oak notified Mr. Acorn that she would be out of town for 3 months starting at the beginning of September, and she asked him to “look after things.” While she was away, he paid $200 to have the furnace repaired. When she returned at the end of November, he paid her $1,300 (3 months’ rent for September, October, and November less the $200 he had paid for the furnace). Mr. Acorn timely paid his rent on the first of each month for May, June, July, August, and December. What amount should Ms. Oak include in her current-year gross rental income?

A. $6,200

B. $4,200

C. $4,000

D. $6,000

Answer 12

$6,000

In general, improvements made by a lessee on the lessor’s property are excluded from income under Sec. 109 unless they are in lieu of rent. In this case, Mr. Acorn rewired the house in lieu of 4 months’ rent. The $2,000 ($500 × 4) of improvements must be included in income. If a lessee pays any of the expenses of his or her lessor, such payments are additional rental income to the lessor [Reg. 1.61-8(c)]. Since the expenses are in effect treated as if paid by the lessee to the lessor and then paid by the lessor to a third party, the lessor may deduct them (Publication 17). Therefore, Ms. Oak must include all 12 months of rent in income, for a total of $6,000.

Question 13

Troy, a cash-basis taxpayer, owns an office building. His records reflect the following for 2020:
*On March 1, 2020, office B was leased for 12 months. A $900 security deposit was received, which will be used as the last month’s rent.
*On September 30, 2020, the tenant in office A paid Troy $3,600 to cancel the lease expiring on March 31, 2021.
*The lease of the tenant in office C expired on December 31, 2020, and the tenant left improvements valued at $1,400. The improvements were not in lieu of any required rent.
Considering just these three amounts, what amount must Troy include in rental income on his income tax return for 2020?

A. $5,900

B. $4,500

C. $1,800

D. $5,000

Answer 13

$4,500

Rental income includes the $900 security deposit and the $3,600 lease cancellation payment. The security deposit must be included because it was intended as rent, and the cancellation payment was in lieu of rent, so it also must be included. The $1,400 of leasehold improvements are excluded from income since they were not in lieu of rent (Publication 17 and IRC Sec. 109).

Question 14

Lois, a cash-basis taxpayer, had tenants who paid $500 on July 5, of the current year to have a small water pipe fixed that had burst while she was out of town. At the same time, the tenants spent $30 to replace some broken light switches. In August of the current year, the tenants paid the monthly rent of $600 less these expenses. For August of the current year, Lois should show

A. $70 as rental income and the $530 should not be reflected on her tax return.

B. $600 as rental income, then deduct the $530 if and when she reimburses the tenants.

C. None of the answers are correct.

D. $600 as rental income and the $530 as an expense.

Answer 14

$600 as rental income and the $530 as an expense.

As a general rule, if a lessee pays any of the expenses of his or her lessor, such payments are additional rental income to the lessor [Reg. 1.61-(c)]. Since the expenses are in effect treated as if paid by the lessee to the lessor, and then paid by the lessor to a third party, the lessor may deduct them (Publication 17).

Question 15

Alex started his own welding business this year. He paid $8,000 for a truck, contributed $15,000 cash and paid $20,000 for tools for the business. His bank loaned $50,000 to buy a building for the business. The building secures the loan. What is Alex’s at-risk amount for this activity?

A. $43,000

B. $103,000

C. $93,000

D. $53,000

Answer 15

$43,000

Section 465 generally limits losses from an activity for each year to the amount the taxpayer has at-risk in the activity at year end. A taxpayer is generally considered at-risk for money and the adjusted basis of property contributed to the activity and amounts borrowed for use in the activity. However, if amounts borrowed for use in the activity are secured by property used in the activity, those amounts are not considered at-risk. The at-risk amounts result only from amounts the taxpayer is personally liable for (Publication 925). Alex is personally liable for $43,000 ($8,000 truck + $15,000 cash + $20,000 tools).

Question 16

John and Mary had a pipe burst in the basement of your rental home. They were unable to reach you on vacation. They had the plumber come out and repair the pipe and damage. They paid the plumber $575. They deducted $575 from their rent of $5,000. How much rent should be considered income that month?

A. $4,425

B. $5,575

C. $5,000

D. $5,745

Answer 16

$5,000

As a general rule, if a lessee pays any of the expenses of his or her lessor, such payments are additional rental income to the lessor [Reg. 1.61-8(c)]. Since the expenses are treated as if paid by the lessee to the lessor and then paid by the lessor to a third party, the lessor may deduct them (Publication 17).

Question 17

John and Mary moved into your rental property and paid a $10,000 security deposit. You agreed to use this security deposit as their last month’s rent. Additionally, they paid a painting contractor $2,500 to paint the interior. How much of these payments should be reported as rental income for this year?

A. $10,000

B. $5,000

C. $0

D. $12,500

Answer 17

$10,000

Section 109 states that the value of leasehold improvements that are not made in lieu of rent is excluded from the lessor’s gross income. Security deposits generally are not included in income but, since it was agreed upon to use the security deposit as the last month’s rent, it is considered rental income. Prepaid rent is income when received even if the lessor uses the accrual method of accounting (Publication 17).

Question 18

With regard to the passive loss rules involving rental real estate activities, which one of the following statements is true?

A. The term “passive activity” loss limitations does not apply to a rental real estate activity when the individual performs more than 50% of his or her personal services during the year in real property trades or businesses in which (s)he materially participates and at least 750 hours of service are performed in those real property trades or businesses in which (s)he materially participates.

B. The passive activity rules do not apply to taxpayers whose adjusted gross income is $300,000 or less.

C. Passive rental activity losses may be deducted only against passive income, but passive rental activity credits may be used against taxes attributable to nonpassive activities.

D. Gross investment income from interest and dividends not derived in the ordinary course of a trade or business is treated as passive activity income that can be offset by passive rental activity losses when the “active participation” requirement is not met.

Answer 18

The term “passive activity” loss limitations does not apply to a rental real estate activity when the individual performs more than 50% of his or her personal services during the year in real property trades or businesses in which (s)he materially participates and at least 750 hours of service are performed in those real property trades or businesses in which (s)he materially participates.

Passive activities generally include any activity involving the conduct of a trade or business or the production of income in which the taxpayer does not materially participate (Sec. 469). However, an individual may avoid passive activity limitation treatment on a rental real estate activity if two requirements are met: (1) more than 50% of the individual’s personal services performed during the year are performed in the real property trades or businesses in which the individual materially participates, and (2) the individual performs more than 750 hours of service in the real property trades or businesses in which the individual materially participates. If 50% or less of the personal services performed are in real property trades or businesses, the individual will be subject to the passive activity limitation rules (Publication 925).

Question 19

Tom Brown, who is single, owns a rental apartment building property. This is the only rental property that Tom owns. He actively participates in this rental activity as he collects the rents and performs ordinary and necessary repairs. In 2020, Tom had a loss of $30,000 on this rental activity and had no reportable passive income. His adjusted gross income, without regard to this rental loss, is $60,000. How much of the rental loss may Tom deduct on his 2020 return?

A. $30,000

B. $6,000

C. $25,000

D. $0

Answer 19

$25,000

All rental activity is passive. A person who actively participates in rental real estate activity is entitled to deduct up to $25,000 of losses from the passive activity from other-than-passive income, provided that the individual’s income does not exceed $100,000. Single individuals and married individuals filing jointly can qualify for the $25,000 amount. Married individuals who live together for the entire year and file separately cannot qualify. Thus, Tom may deduct $25,000 of the loss (Publication 925).

Question 20

For purposes of the rules that apply to vacation homes and other dwelling units, consider the following information; then compute Kim’s allowable depreciation for the current year.
Days rented in the current year
120
Personal-use days
25
Gross rents received in the current year
$2,000
Expenses for the current year allocated to rental use:
Interest and taxes
$1,000
Repairs
$500
Depreciation
$8,000

A. $0

B. $500

C. $6,400

D. $8,000

Answer 20

$500

The tax code restricts the deductions with respect to a dwelling unit used by the taxpayer as a residence. A taxpayer is deemed to use a dwelling unit as a residence if (s)he uses it for personal purposes for a number of days that exceeds the greater of 14 days or 10% of the number of days during the year for which the unit is rented at a fair rental. Since Kim rented the house for 120 days, she was allowed to use it for personal purposes for only 14 days without treating it as a residence. Therefore, Kim’s house is treated as her residence. When a dwelling unit is used by the taxpayer as a residence, the tax code disallows a deduction for expenses exceeding gross income derived from rents, reduced by deductions allowable (e.g., taxes and interest), whether or not the unit was used for rental purposes. Under the tax code, the order of deductions is (1) the allocable portion of expenses deductible regardless of rental activity, (2) deductions not affecting basis, and (3) those that do affect basis.
Gross rent
$2,000 
Interest and taxes
$(1,000)
Repairs
$(500)
Depreciation
$(500)
Income
$0

Question 21

Roger signed a 10-year lease to rent office space from Doug. In the first year, Roger paid Doug $5,000 for the first year’s rent and $5,000 as rent for the last year of the lease. How much must Doug include in income in the first year of the lease?

A. $5,500

B. $10,000

C. $5,000

D. $0

Answer 21

$10,000

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b) (Publication 17). Since Doug has an unrestricted claim to the $5,000 of rent paid in advance, it would be included in his rental income.

Question 22

During the year, Dan had the following expenses for his rental house:
1. Replaced a screen in the storm door
2. Replaced the heating system
3. Sowed grass seed in some bare spots on the lawn
4. Built a detached two-car garage
5. Installed a new dishwasher
6. Bought a welcome mat for the front stoop
Which of these items must be depreciated rather than deducted as an expense on his Schedule E?

A. 1, 3, 4, and 5.

B. 2, 4, 5, and 6.

C. 3, 4, and 6.

D. 2, 4, and 5.

Answer 22

2, 4, and 5.

The heating system, two-car garage, and new dishwasher must be depreciated instead of expensed because they add value to the rental home and must be capitalized. The replacement of a screen, sowing of grass seed, and the acquisition of a welcome mat for the front step are routine expenses (Publication 527).

Question 23

In the current year, Heidi, a self-employed individual, had net profits from her Schedule C business of $125,000. Besides her Schedule C deductions, Heidi took an $8,831 deduction for her Social Security taxes, and her deduction for self-employed health insurance was $650. Heidi also realized a $30,000 loss from her rental real estate activity in which she actively participated. What is Heidi’s deductible rental real estate loss for the current year?

A. $12,825

B. $25,000

C. $12,500

D. $12,175

Answer 23

$12,825

The $25,000 allowance of losses from active participation in rental real estate activities against nonpassive income is reduced by 50% of the amount by which adjusted gross income (determined without regard to Social Security benefits, IRA contributions, and passive losses) exceeds $100,000 [Sec. 469(i)(3)]. The health insurance, however, must be subtracted from her net profits, for a total of $124,350 ($125,000 net profits – $650 health insurance). Heidi’s adjusted gross income exceeds $100,000 by $24,350. Therefore, the $25,000 allowance is reduced by $12,175 ($24,350 × 50%). This leaves $12,825 of losses ($25,000 allowance – $12,175 reduction) that can be deducted (Publication 925).

Question 24

Passive activity rules apply to

A. S corporations.

B. Grantor trusts.

C. Closely held corporations.

D. Partnerships.

Answer 24

Closely held corporations.

Although passive activity rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities. The passive activity rules apply to individuals, estates, trusts, personal service corporations, and closely held corporations (Publication 925).

Question 25

Paul owns a second home at the lake. During the year, he spent 3 weeks (21 days) at the lake home, rented it to his daughter for three 3-day weekends for a total of $220, and rented it to friends for 10 weeks (70 days) at fair rental value of $300 per week. His expenses for the year include
Depreciation
$2,000
Insurance
$100
Mortgage interest
$1,000
Real estate taxes
$2,000
Utilities
$1,000
What amount may he deduct for expenses on his Schedule E, Rental Income?

A. $3,220

B. $3,000

C. $4,620

D. $2,100

Answer 25

$3,220

When a taxpayer rents real property that (s)he also uses for personal property, then all or part of mortgage interest, real estate taxes, casualty losses, or other rental expenses not related to the taxpayer’s use of the unit as a home may be deducted by the taxpayer if (s)he does not occupy the property for more than the greater of 14 days or 10% of the total days it was rented to others at a fair rental price. However, if the taxpayer does not meet this requirement, (s)he may only deduct the expenses that are in proportion to the period the residence was rented. If there is still income in excess of the deductions previously listed, other expenses, including depreciation, may be deducted up to the amount of the remaining income. (Publication 527.)
70 days Rental use
21 + 9 = 30 days Personal use (use by family qualifies as personal use if they do not pay fair market value)
100 days Total use
Proportion of rental use: 70/100 = .70 × 100 = 70%
Proportion of expenses to be allocated to rental expenses:
Mortgage interest $1,000 × 70% = $700
Real estate taxes
$2,000 × 70% = $1,400
Insurance
$100 × 70% = $70
($700 + $1400 + $70) = $2,170
Other expenses:
Depreciation
$2,000 × 70% = $1,400
Utilities
$1,000 × 70% = $700
($1400 + $700) = $2,100
These expenses may be deducted up to the total amount of income. All rent received by the taxpayer for all persons who rented (either by discount or FMV) is income; therefore, $3,220 [($300/week × 10 weeks) + $220] is the total income from rent. Thus, $2,170 plus $1,050 of other expenses may be deducted.

Question 26

Which of the following is NOT an example of a passive activity?

A. A limited partner’s interest in a limited partnership.

B. The rental of office equipment with no provision of unusual services.

C. The farming of land when the taxpayer owning the land has hired others to manage operations.

D. A working interest in oil and gas property, when the taxpayer-owner has unlimited liability, and does not materially participate in the activity.

Answer 26

A working interest in oil and gas property, when the taxpayer-owner has unlimited liability, and does not materially participate in the activity.

Passive activities generally include any activity involving the conduct of a trade or business or the production of income and in which the taxpayer does not materially participate (Sec. 469). However, Sec. 469(c)(3) of the tax code excludes from the passive activity definition any working interest in oil or gas property in which the form of ownership does not limit liability. This is true whether or not the taxpayer-owner materially participates in the activity (Publication 925).

Question 27

A taxpayer who materially participates in rental real estate activities in the current year may offset some losses and credits from the activity against nonpassive income (salary, self-employment earnings, etc.) provided that the taxpayer performs more than 50% of his or her personal services for the year in real property trades or businesses in which (s)he materially participates and the number of service hours performed in those real property trades or businesses in which (s)he materially participates is more than

A. 500

B. 750

C. 1,000

D. 450

Answer 27

750

After December 31, 1993, the losses from rental real estate activities may offset nonpassive income if the taxpayer meets two requirements: (1) More than 50% of personal services performed during the year are performed in the real property trades or businesses in which (s)he materially participates, and (2) the taxpayer performs more than 750 hours of service in the real property trades or businesses in which (s)he materially participates [Publication 925 and Sec. 469(c)(7)(B)].

Question 28

Under the rules governing the existence of a passive activity, which of the following would NOT constitute material participation in a trade or business activity for the current tax year?

A. You participated in the activity for more than 500 hours.

B. You participated in the activity for less than 50 hours during the current year, but you materially participated in the activity for 5 of the 10 preceding years.

C. You participated in the activity for less than 100 hours, but you participated on a regular, continuous, and substantial basis.

D. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual for the year.

Answer 28

You participated in the activity for less than 100 hours, but you participated on a regular, continuous, and substantial basis.

Generally, to be considered as materially participating in an activity during a tax year, an individual must satisfy any one of the following tests: (1) (S)he participates more than 500 hours; (2) his or her participation constitutes substantially all of the participation in the activity; (3) (s)he participates for more than 100 hours, and this participation is not less than the participation of any other individual; (4) the activity is a “significant participation activity,” and his or her participation in all such activities exceeds 500 hours; (5) (s)he materially participated in the activity for any 5 years of the 10 years that preceded the year in question; (6) the activity is a “personal service activity,” and (s)he materially participated in the activity for any 3 years preceding the tax year in question; or (7) (s)he satisfies a facts and circumstances test that requires him or her to show that (s)he participated on a regular, continuous, and substantial basis [Temporary Reg. Sec. 1.469-5T(a)]. The regulations state, however, that, if an individual participates in an activity for less than 100 hours, (s)he will be precluded from applying the facts and circumstances test. Thus, it does not matter that the participation was on a regular, continuous, and substantial basis since it amounted to less than 100 hours (Publication 925).

Question 29

Andre, an accrual-basis taxpayer, owns a six-unit apartment building for which he receives rent of $600 per month per unit. In the current year, five of the units were rented for the entire 12-month period. The sixth unit was occupied from January 1 through March 31. Upon vacating the unit, the tenant was not refunded his security deposit of $400 due to damages to the unit. The unit was subsequently rented for one year beginning August 1 of the current year. On August 1, the new tenant paid the first and last month’s rent and a refundable security deposit of $400. What is Andre’s total rental income for the current year?

A. $42,200

B. $41,800

C. $41,200

D. $40,800

Answer 29

$41,800

Accrual-basis taxpayers report income when it is earned. All amounts received or accrued as rents are includible in income. Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease. Advance rent received upon execution of a lease is includible in gross income in the year received, whether the taxpayer is on the cash or the accrual basis. For the current year, Andre must include $36,000 for the five units rented continuously during the year. Although not specifically stated, it is presumed that Andre received rental income of $1,800 from unit six while it was occupied for the first 3 months of the current year. The $400 security deposit of the first tenant in unit six is includible as rental income because Andre became entitled to the funds to repair damages to the unit after the tenant vacated it. Andre also received rental income of $3,600, which included $600 of prepaid rent, from the second tenant of unit six. The refundable security deposit of $400 paid by the second tenant of unit six is not part of Andre’s rental income for the current year because Andre was not authorized to retain any portion of the deposit during the year (Publication 17).

Question 30

The at-risk rules

A. Limit a taxpayer’s deductible losses from investment activities.

B. Limit the type of deductions in income-producing activities.

C. Apply at the entity level for partnerships and S corporations.

D. Apply to business and income-producing activities on a combined basis.

Answer 30

Limit a taxpayer’s deductible losses from investment activities.

The at-risk rules are contained in Sec. 465 and limit a taxpayer’s deductible losses from each business and income-producing activity to the amount for which the taxpayer is at risk with respect to that activity. Although originally designed to limit deductible losses from tax shelters, the at-risk rules apply across the board to most activities (Publication 925).

Question 31

All of the outstanding stock of Bryant Corporation is owned equally by three individuals. Bryant is not a personal service corporation. During the current year, Bryant had active rental real estate income of $250,000, a passive loss on the rental of an office building (acquired in 1989) of $300,000, and portfolio income of $150,000. The corporation earns more than 60% of its gross receipts from the rental real estate in which it materially participates. How much of Bryant’s income may be offset by the rental loss?

A. No income may be offset.

B. $0 rental income and $150,000 portfolio income.

C. $250,000 rental income and $50,000 portfolio income.

D. $250,000 rental income and $0 portfolio income.

Answer 31

$250,000 rental income and $50,000 portfolio income.

Bryant Corporation is a closely held corporation because more than 50% of the value of its stock is held by five or fewer individuals during the last half of the year. After December 31, 1993, a closely held C corporation is not subject to the passive activity loss rules for real estate trades or businesses if during the tax year the corporation derives more than 50% of its gross receipts from the real property trades or businesses in which it materially participates [Sec.469(c)(7) and Publication 925]. Therefore, Bryant may offset its $300,000 passive loss against active and portfolio income.

Question 32

Mr. Wolf, a cash-basis taxpayer, owns an apartment building. His records reflect the following information for the current year:
*Cost of floor repairs paid by Tenant G that were Mr. Wolf’s responsibility for maintaining the building in good repair
$950
*Security deposits to be returned to tenants upon expiration of their leases next year
$1,350
*Advance rents received in December for the first 6 months of next year
$3,000
Tenant G’s rent was reduced by the expenses he paid. What is the amount of gross rental income Mr. Wolf should include on his current-year Schedule E?

A. $5,300

B. $2,300

C. $4,350

D. $3,950

Answer 32

$3,950

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b). Since Mr. Wolf has an unrestricted claim to the $3,000 of rent paid in advance, it would be included in his rental income. The security deposits of $1,350 would not be included in rental income since they were not intended as advance rental payments. (Mr. Wolf does not have an unrestricted claim since they must be returned unless there are damages or rent is not paid.) The expenses of $950 paid by a tenant in lieu of paying the full rental price are also gross income unless intended as a gift [Reg. 1.61-8(c)]. Therefore, Mr. Wolf’s gross rental income is $3,950 (Publication 17).

Question 33

Bill took out a $100,000 non-recourse loan and bought an apartment building. The building is not security for the loan. Bill spent $25,000 of his own money on repairs before he rented the apartment building to the public. Bill is single, works full-time, and earns $80,000 per year. Bill’s loss from the rental real estate activity, in which he actively participates, is $30,000. He has no passive income. For what amount is Bill at-risk, and how much of Bill’s passive loss from his rental activity is deductible?

A. At-Risk $25,000. Passive Loss $25,000

B. At-Risk $125,000. Passive Loss $30,000

C. At-Risk $125,000. Passive Loss $25,000

D. At-Risk $100,000. Passive Loss $25,000

Answer 33

At-Risk $25,000 Passive Loss $25,000

IRS Publication 925 states that a taxpayer is not considered at risk for his or her share of any nonrecourse loan used to finance an activity or to acquire property used in the activity unless the loan is secured by property not used in the activity. Bill took out a nonrecourse loan, and the building is not security for the loan. Since Bill is deemed to actively participate in the rental real estate activity and Bill’s adjusted gross income is less than $100,000, he is allowed to deduct $25,000 against other income.
Authors’ note: Based on the information given, the answer is probably $25,000 at-risk and $25,000 passive loss. You are at-risk for qualified nonrecourse financing secured by real property used in the holding of real property. Since this problem stated that the building was not security for the loan (who would lend in that manner?) and no other real property was mentioned as security, we have to consider this loan to be non-risk.

Question 34

Maria received $40,000 in wages, and her husband Scott had a net gain of $8,500 on a passive partnership interest. Scott also had a $35,000 loss from a rental real estate activity in which he actively participated. How much of the rental loss can they deduct on their current-year joint income tax return?

A. $35,000

B. $0

C. $25,000

D. $33,500

Answer 34

$33,500

All rental activity is passive. However, a person who actively participates in rental real estate is allowed to deduct up to $25,000 of losses from the passive activity from other than passive income (Publication 925). Since Scott is deemed to actively participate in the rental real estate activity, he may offset the $8,500 of passive income with the passive loss and deduct an additional $25,000 of his wife’s active income, for a total of $33,500 ($8,500 + $25,000).

Question 35

Tammy owns a house at the beach, which she rented out from May 1 through October 31 of the current year. During April of the current year, she spent 10 days there on vacation. In November, she spent 5 days at Dionne’s mountain home and paid Dionne fair rental value. Dionne also paid Tammy a fair rental price for using her beach house for 9 days in December of the current year. Also, during November, Tammy’s grandson stayed at the beach house for 3 days without any charge. How many days would the beach house be considered to have been used for personal purposes when applying the rules to vacation homes and dwellings?

A. 13

B. 22

C. 0

D. 10

Answer 35

22

The tax code restricts the deductions with respect to a dwelling unit used by the taxpayer as a residence. A taxpayer is deemed to use a dwelling unit as a residence if (s)he uses it for personal purposes for a number of days that exceeds the greater of 14 days or 10% of the number of days during the year for which the unit is rented at a fair rental. The home is deemed to be used by the taxpayer for personal purposes if, for any part of the day, the home is used by any individual under a reciprocal arrangement, whether or not rent is charged. Similarly, the home is considered to be used for personal purposes when a relative stays at the home unless it is considered a main dwelling and a fair rental is charged (Publication 527). Therefore, Tammy’s beach house was used for personal purposes for 22 days (10 days for Tammy + 9 days for Dionne + 3 days for Tammy’s grandson).

Question 36

John owns an apartment building and actively participates in the rental activity. He advertises, rents the apartments to the tenants, collects rents, and makes repairs when needed. John’s sister, Gloria, also owns an apartment building and spends more than half of her time developing, constructing, renting, managing, and operating her apartment building as well as providing regular cleaning, linen service, and maid service for the convenience of the tenants. Which of the siblings has self-employment income from his or her respective apartment building?

A. Neither John nor Gloria.

B. Both John and Gloria.

C. Gloria only.

D. John only.

Answer 36

Gloria only.

Rent from real estate is not considered self-employment income unless either the taxpayer is a real estate dealer or the taxpayer provides services for his or her tenants. John does not provide services to his tenants in this case (repairs are for maintaining his own investment).

Question 37

You own a vacation home on Amelia Island, Florida, which you rented for 10 days during the current year. Rental expenses were $2,000 and rental income was $5,000. How much of the rental income should be reported on the tax return?

A. $7,000

B. $0

C. $3,000

D. $5,000

Answer 37

$0

Rent is included in gross income under Sec. 61. Section 280A(g) provides that if a dwelling unit is used as a residence and rented out for less than 15 days per year, then (1) none of the rental income is included in gross income and (2) no deduction for the rental use will be allowed (Publication 17).

Question 38

Andre, an accrual-basis taxpayer, rents a house for $1,000 per month. The house was rented from January through October, Year 1, when the tenant moved out and left substantial damages. Andre did not refund the $600 security deposit. Andre hired Jerry, a carpenter, to repair the house for $2,400, which included all labor and materials. Jerry completed the work on November 30, Year 1. Instead of paying Jerry for the work, Andre rented the house to Jerry beginning December 1, Year 1. They agreed the work would be in exchange for December of Year 1 and January of Year 2 rent. Jerry will begin paying rent of $1,000 per month on February 1, Year 2. Jerry was not required to pay a security deposit. What amount should Andre include in gross rent on his income tax return for Year 1?

A. $10,000

B. $10,600

C. $12,400

D. $13,000

Answer 38

$13,000

Amounts received or accrued as rents in payment for the use of property must be included in gross income. Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease. Therefore, Andre must recognize $10,000 ($1,000 × 10 months) and $600 as rental income from the previous tenant. Improvements made by a lessee on the lessor’s property are generally excluded from income under Sec. 109, unless they are made in lieu of rent. Improvements in lieu of rent are included in the lessor’s income when the improvements are completed and at the fair market value of the improvements. In this case, the improvements made by Jerry are made in lieu of 2 months’ rent; thus, Andre must recognize the $2,400 fair market value (Publication 17).

Question 39

John offers his beach cottage for rent from June through August 31 (92 days). His family uses the cottage during the last 2 weeks in May (15 days). He was unable to find a renter for the first week in August (7 days). The person who rented the cottage for July allowed him to use it over a weekend (2 days) without any reduction in, or refund of, rent. The cottage was not used at all before May 16 or after August 31. Total income received was $11,000. Total expenses were $4,000. What percentage of the expenses for the cottage can John deduct as rental expenses?

A. 83%

B. 85%

C. 25%

D. 100%

Answer 39

85%

When a taxpayer has a vacation home, the expenses must be allocated between personal use and rental use (Publication 527). There was a total of 100 days of usage during the year (15 days in May, 92 days from June through August 31, less 7 days unrented in August). Total days of rental were 85 days (92 days from June through August 31, less the 7 days unrented in August). The proportion of rental use is 85% (85 days of rental divided by the 100 days of total usage). The taxpayer had personal usage for the 15 days in May. The 2-day period of personal use in the cottage while it was rented at fair market value does not count as personal use.

Question 40

Jerry, a general contractor by trade, is a tenant of Montgomery Apartments. In exchange for 4 months’ rent ($900/month), Jerry provided the following items and services for Paul, the owner of the apartments:
*Paint and miscellaneous supplies for the apartments
$700
*Labor for painting and miscellaneous repairs
$1,000
*Labor and supplies for paving the apartment parking area
$1,900
How should Paul treat this transaction on his current-year Schedule E?

A. No rental income or rental expenses to be reflected on the Schedule E because the net effect is zero.

B. Rental income of $3,600, rental expenses of $1,700, and depreciation computed on the capital expenditures of $1,900.

C. Rental income of $3,600 and depreciation computed on the capital expenditures of $3,600.

D. Rental income of $3,600 and rental expenses of $3,600.

Answer 40

Rental income of $3,600, rental expenses of $1,700, and depreciation computed on the capital expenditures of $1,900.

As a general rule, if a lessee pays any of the expenses of his or her lessor, such payments are additional rental income to the lessor. Since the expenses are in effect treated as if paid by the lessee to the lessor and then paid by the lessor to a third party, the lessor may deduct them. The $1,700 cost of painting and miscellaneous repairs is for routine maintenance costs and can be deducted as rental expenses. The $1,900 cost of paving the parking area should be capitalized and properly depreciated (Publication 527).

Question 41

Which of the following is a true statement concerning losses from passive activities?

A. Losses from each passive activity are not deductible, regardless of income earned in other passive activities.

B. The rules apply to losses but not credits.

C. Losses from one passive activity may offset income from another passive activity.

D. The losses may offset passive income, such as interest and dividends, but not business income or earned income.

Answer 41

Losses from one passive activity may offset income from another passive activity.

In general, losses from passive activities may not offset nonpassive income such as salary, interest, dividends, or active business income (Sec. 469). However, deductions from one passive activity may offset income from the same passive activity, and losses from one passive activity may generally offset income from another passive activity (Publication 925).

Question 42

Kathy rented out her summer home for 80 days and used it personally for 20 days. She paid $1,000 for repairs and $2,000 for utilities. Rental income was $8,000. What was Kathy’s net rental income?

A. $5,600

B. $0

C. $8,000

D. $5,000

Answer 42

$5,600

If the taxpayer uses rental property for personal purposes more than the greater of (1) more than 14 days or (2) more than 10% of the number of days the property is rented, the property is considered a vacation home. Expenses of vacation homes are limited to gross income. Expenses must be allocated between the personal use and the rental use based on the number of days of use of each (Publication 527). Kathy rented out the home for 80% (80 days used by Kathy ÷ 100 total days) of its total use. Kathy’s rental income is $5,600 [$8,000 – ($2,000 + $1,000) × 80%].

Question 43

Which of the following is NOT considered a day of personal use of a dwelling unit for determining if it is used as a home?

A. A day on which a related person uses the dwelling unit as her main dwelling and pays fair rental value.

B. A day on which the dwelling unit is rented to a relative at a fair rental price.

C. A day on which an unrelated co-owner uses the dwelling unit for personal purposes.

D. A day on which an unrelated person uses the dwelling unit as her main dwelling and pays less than fair rental value.

Answer 43

A day on which a related person uses the dwelling unit as her main dwelling and pays fair rental value.

If the taxpayer rents the home at a fair rental value to any person (including a relative) for use as that person’s main dwelling, such use by that person is not considered personal use by the taxpayer (Publication 527).

Question 44

Gewald enters into an agreement to lease a house to Dorschuk. Although the fair rental value of the house is $5,000 per year, Dorschuk is required to pay only $3,000 per year in return for building a patio, a sundeck, and a hot tub which will be left on the premises at the end of the lease. The lease is to last for 2 years. Dorschuk finishes all the improvements in the first year of the lease. How much and when must Gewald recognize rental income from this transaction?

A. $3,000 in the first year and $7,000 in the second year.

B. $7,000 in the first year and $3,000 in the second year.

C. $3,000 in the first year and $3,000 in the second year.

D. $5,000 in the first year and $5,000 in the second year.

Answer 44

$7,000 in the first year and $3,000 in the second year.

Section 61(a)(5) includes rents in gross income whether received in cash, in property, or as services. Improvements made by a lessee on the lessor’s property are generally excluded from income under Sec. 109 unless they are made in lieu of rent (Publication 17). In this case, the improvements made by Dorschuk are made in lieu of $2,000 of rent in the first year of the lease and $2,000 of rent in the second year of the lease. Improvements in lieu of rent are included in the lessor’s income when the improvements are completed or placed on the property (the same as if cash rent had been received at that time). Since Dorschuk paid $3,000 in cash in the first year and completed the improvements in the first year, Gewald must recognize $7,000 of rental income in the first year. Gewald must also recognize $3,000 of rental income in the second year when it is received.

Question 45

Barry is a lawyer. He owns 10 apartment buildings that are managed by his brother’s real estate business. At the end of the year, the apartment buildings resulted in a $40,000 loss. Barry earned $80,000 in wages. His wife, Claire, earned $20,000 from her part-time job. Their other income included $5,000 in dividends from their mutual funds. They had no other income. How much of the rental loss can Barry use assuming Barry actively participates in the apartment buildings?

A. $25,000

B. $22,500

C. $0

D. $40,000

Answer 45

$22,500

Any rental activity is a passive activity, whether or not the taxpayer participates in the activity. An individual who actively participates in a rental real estate activity may use up to $25,000 of net losses from the rental real estate activity to offset other income. The $25,000 is reduced by 50% of the amount by which AGI (determined without regard to Social Security, IRA contributions, and passive losses) exceeds $100,000. Barry has AGI of $105,000 ($80,000 wages + $20,000 Claire’s income + $5,000 dividends). Accordingly, his allowable $25,000 deduction will be reduced by $2,500 [($105,000 – $100,000) × 50%] and is therefore $22,500 ($25,000 deduction – $2,500 reduction). If Barry does not actively participate, he is not allowed a deduction (Publication 925).

Question 46

Which of the following is NOT rental income in the year received?

A. Security deposit, equal to 1 month’s rent, to be refunded at the end of the lease if the building passes inspection.

B. Payment to cancel the remaining lease.

C. January 2021 rent received December 2020.

D. Repairs paid by the tenant in lieu of rent.

Answer 46

Security deposit, equal to 1 month’s rent, to be refunded at the end of the lease if the building passes inspection.

Rental income is any payment received for the use of occupation of property. When a payment is made to cancel a lease, the amount paid is rental income. If property or services are offered in lieu of rent, the FMV of the property or services is regarded as rent. Advance rent is treated as rental income for the period in which it is received. Security deposits held to ensure tenants live up to the terms of the lease are not treated as rental income (Publication 17).

Question 47

Heathcliff and Gertrude file a joint income tax return for the current year. During the current year, Heathcliff received wages of $120,000 and taxable Social Security benefits of $5,000. Gertrude actively participated in a rental real estate activity in which she had a $30,000 loss. They had no other income during the current year. How much of the rental loss may they deduct on their current-year income tax return?

A. $0

B. $12,500

C. $15,000

D. $25,000

Answer 47

$15,000

The $25,000 allowance of losses from active participation in rental real estate activities against nonpassive income is reduced by 50% of the amount by which adjusted gross income (determined without regard to Social Security benefits, IRA contributions, and passive losses) exceeds $100,000 [Sec. 469(i)(3)]. Heathcliff and Gertrude’s adjusted gross income exceeds $100,000 by $20,000 ($120,000 wages – $100,000 threshold). Therefore, the $25,000 allowance is reduced by $10,000 ($20,000 × 50%). This leaves $15,000 of losses ($25,000 allowance – $10,000 reduction) that can be deducted (Publication 925).

Question 48

Sid and Rudy co-own a lakeside cabin that they rent to vacationers whenever possible. The cabin was not used as a main home by anyone until October 1 of the current year. During the current year, the following occurred:
1. Rudy used the cabin for a 3-week (21-day) vacation.
2. Sid’s brother, Chester, rented the cabin for 2 months (61 days) at less than fair rental price.
3. Prior to October 1, Sid and Rudy spent a total of 26 days at the cabin working substantially full time repairing and maintaining the cabin.
4. Starting October 1 and continuing for the balance of the year (92 days), Sid and Rudy rented the cabin to Sid’s son, Martin, who used the cabin as his main home and paid a fair rental price.
What is the number of personal-use days that Sid will use in dividing his current-year expenses between rental-use and personal-use days?

A. 61 days.

B. 174 days.

C. 200 days.

D. 82 days.

Answer 48

82 days.

A vacation home is deemed to have been used by the taxpayer for personal purposes if, for any part of the day, the home is used by
The taxpayer, any other person who owns an interest in the home, or the relatives of either
Any individual who uses the home under a reciprocal agreement whether or not rent is charged
Any individual who uses the home unless a fair rental is charged
An exception exists when a relative rents the home at a fair rental value for use as a principal residence. Sid’s personal days include the 21 days Rudy spent at the cabin and the 61 days Chester rented the cabin at less than the fair rental (Publication 527).

Question 49

Jevon, a cash-basis taxpayer, owns two rental properties. Based on the following information, compute the amount that he must include in his 2020 gross rental income.
*Property #1, security deposit on one-year lease received 2/1/20. All of deposit returned at lease end
$1,000
*Property #1, payment received 2/1/20 for last month of lease (2/21)
$1,400
*Property #1, rental income received in 2020, 2/20 - 12/20
$15,400
*Property #2, rental income received in 2020, 1/20 - 12/20
$18,000
*Property #2, security deposit received 1/1/20 to be used for last month’s rent
$1,500
*Property #2, rent for 1/21 received 12/28/20
$1,600

A. $35,000

B. $33,400

C. $37,900

D. $36,400

Answer 49

$37,900

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b). Thus, all rent payments received should be included in the current year’s gross rental income. If a security deposit is intended as an advance rent payment, it must be included in income in the year received. Security deposits not intended as rent are income only if the lessor becomes entitled to them upon the lessee’s violation of the lease (Publication 17). Jevon must include the $36,400 ($1,400 + $15,400 + $18,000 + $1,600) plus the $1,500 security deposit intended as an advance rent payment. The $1,000 security deposit is not included because Jevon does not have an unrestricted claim to the money.

Question 50

Miss Jones owns several rental properties, which she acquired in January of last year, and actively participates in all activities connected with the rentals. She received a salary of $42,300 from her advertising job in the current year. Her net rental loss for the current year was $60,000. What is the amount of rental loss that Miss Jones can deduct in the current year?

A. $42,300

B. $0

C. $25,000

D. $60,000

Answer 50

$25,000

In the case of rental real estate activities in which an individual actively participates, up to $25,000 of losses from such activities are allowed each year against nonpassive income [Sec. 469(i)]. Since Miss Jones had an adjusted gross income of less than $100,000, no phaseout calculation is necessary, and the full $25,000 of losses may be deducted against her $42,300 of nonpassive (earned) income (Publication 925).

Question 51

Johnny, a cash-basis taxpayer, owns two rental properties. Based on the following information, compute the amount that he must include in his 2020 gross rental income.
*Property #1, security deposit on 1-year lease received 2/1/20. Entire deposit was returned at lease end.
$500
*Property #1, payment received 2/1/20 for last month of lease (2/21)
$700
*Property #1, rental income received in 2020, 2/20 - 12/20
$7,700
*Property #2, rental income received in 2020, 1/20 - 12/20
$9,000
*Property #2, security deposit received 1/1/20 to be used for last month’s rent
$750
*Property #2, rent for 1/21 received 12/28/20
$800

A. $16,700

B. $18,950

C. $18,200

D. $17,500

Answer 51

$18,950

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b). Thus, all rent payments received should be included in the current year’s gross rental income. If a security deposit is intended as an advance rent payment, it must be included in income in the year received. Security deposits not intended as rent are income only if the lessor becomes entitled to them upon the lessee’s violation of the lease (Publication 17). Johnny must include the $18,200 ($700 + $7,700 + $9,000 + $800) plus the $750 security deposit intended as an advance rent payment. The $500 security deposit is not included because Johnny does not have an unrestricted claim to the money.

Question 52

Johnson, an accrual-method landlord, receives the following receipts during the year associated with his rental of apartments:
Lessees’ refundable deposits
$2,000
Value for modifying a lease
$50
Rent
$10,000
Lessee improvements made in lieu of rent
$1,500
Prepaid rent
$500
Bonus for granting a lease
$200
What amount should Johnson report as taxable income from his rental investment?

A. $14,250

B. $12,250

C. $12,050

D. $12,000

Answer 52

$12,250

Rent is income from an investment. Gross income includes the value received by a landlord for modifying a lease, rent payments, lessee improvements made to the property in lieu of rent, prepaid rent regardless of the method of accounting used, and a bonus received by a landlord for granting a lease. Thus, the amount to be reported by Johnson as taxable income is $12,250 ($50 + $10,000 + $1,500 + $500 + $200). A lessee’s refundable deposit intended to secure performance under the lease is not income to the lessor (Publication 17).

Question 53

Which of the following would be considered passive activity income?

A. Personal service income.

B. State, local, and foreign income tax refunds.

C. Alaska Permanent Funds dividends.

D. None of the answers are correct.

Answer 53

None of the answers are correct.

There are two kinds of passive activities: (1) trade or business activities in which the taxpayer does not materially participate and (2) rental activities, unless the taxpayer is a real estate professional (Publication 925).

Question 54

The Becks own and operate an assisted-living facility. They provide maid service and meals in a common dining room. Where should they report the income and expenses from this activity?

A. Short-term capital gain on Schedule D.

B. Other Income on Form 1040 and expenses as itemized deductions on Schedule A.

C. Income and expenses on Schedule E, Supplemental Income and Loss.

D. Income and expenses on Schedule C, Profit or Loss From Business.

Answer 54

Income and expenses on Schedule C, Profit or Loss From Business.

Income and expenses from a non-passive activity, other than farming activities, are reported on Schedule C, Profit or Loss From Business (Publication 17).

Question 55

Larry purchased 100 shares of ABC stock on May 31, Year 1, for $100 per share. On October 28, Year 1, he sold the 100 shares for $90 per share. On November 22, Year 1, his wife, Vickie, purchased 100 shares of ABC stock for $80 per share. Vickie held the stock until September 30, Year 2. On that date, she sold the stock for $110 per share. They filed married filing separately on all returns.

A. Larry has a short-term loss of $1,000 on his Year 1 tax return.

B. Vickie will have a short-term gain of $3,000 on her Year 2 tax return, and Larry takes the short-term loss of $1,000 on his Year 1 tax return.

C. Vickie has short-term gain of $3,000 on her Year 2 tax return.

D. Vickie will have a long-term gain of $2,000 on her Year 2 tax return and Larry will not have any capital loss on his Year 1 tax return.

Answer 55

Vickie will have a long-term gain of $2,000 on her Year 2 tax return and Larry will not have any capital loss on his Year 1 tax return.

Publication 550 states, “You cannot deduct losses from sales or trades of stock or securities in a wash sale. A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
1. Buy substantially identical stock or securities,
2. Acquire substantially identical stock or securities in a fully taxable trade, or
3. Acquire a contract or option to buy substantially identical stock or securities.
If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.” Larry’s unrecognized loss can be used to reduce Vickie’s gain [$11,000 selling price – ($8,000 purchase price + $1,000 Larry’s unrecognized loss) = $2,000 recognized gain]. The holding periods are added together, creating a long-term capital gain.

Question 56

In the current year, the Aloha Gardens apartment complex had rental losses of $40,000. Which of the following is true?

A. Steve and his wife Barbara each have a 5% interest in the property and manage the apartments. They had nonpassive income of $30,000 for the year. They may offset their share of the rental loss against their nonpassive income.

B. T Trust has a 40% interest in the property. The trustee is active in managing the apartments. The trust may offset its portion of the rental loss against other income earned during the year.

C. Kathy has an interest as a limited partner in the property. Her nonpassive income for the year is $50,000. She may offset her portion of the rental loss against her nonpassive income up to $25,000.

D. John’s estate has a 20% interest in the property. John was actively involved in managing the complex from 2010 until his death in 2016. His estate may offset its portion of the rental loss against any nonpassive income.

Answer 56

Steve and his wife Barbara each have a 5% interest in the property and manage the apartments. They had nonpassive income of $30,000 for the year. They may offset their share of the rental loss against their nonpassive income.

In the case of rental real estate activities in which an individual actively participates, up to $25,000 of losses from such activities are allowed each year against nonpassive income [Sec. 469(i)]. Active participation requires only participation such as making management decisions on lease terms, tenant approvals, repair versus replacement decisions, etc., even if an agent handles day-to-day matters. An individual is not treated as actively participating in a rental real estate activity if the individual’s and spouse’s interests are less than 10% of all interests in the activity [Sec. 469(i)(6)(A)]. Since Steve and his wife together own 10% of the property and manage the apartments, they qualify for allowing up to $25,000 of rental real estate losses against nonpassive income (Publication 925). Their share of the losses is $4,000 ($40,000 × 10%).

Question 57

Peter owned a cottage on the lake that he bought in Year 1. In Year 2, he rented the cottage for 10 days to a stranger and used the cottage for 20 days for his own personal use. The cottage was not used the rest of the year. Peter had rental income of $1,000, and he paid $600 for repairs. How should he report these activities on his Year 2 return?

A. $333 income, $200 expense.

B. $667 income, $400 expense.

C. $0 income, $0 expense.

D. $1,000 income, $600 expense.

Answer 57

$0 income, $0 expense.

When a residence is rented for less than 15 days, the rental income does not need to be reported as income. However, any corresponding rental expenses cannot be deducted (Publication 527).

Question 58

William owns a four-unit apartment building for which he receives $500 per month per unit. Three of the units were rented for the entire 12 months. The fourth unit was occupied from January 1 to April 30, Year 1. Upon vacating the unit, the tenant was not refunded his security deposit of $500 due to damage to the unit. The unit was subsequently rented for 1 year beginning August 1, Year 1. On August 1, Year 1, the new tenant paid the first and last months’ rent and a refundable security deposit of $500. What is William’s rental income for Year 1?

A. $23,500

B. $24,000

C. $22,500

D. $23,000

Answer 58

$23,500

Accrual-basis taxpayers report income when it is earned. All amounts received or accrued as rents are includible in income. Security deposits are income if and when the lessor becomes entitled to the funds by reason of the lessee’s violation of the terms of the lease. Advance rent received upon execution of a lease is includible in gross income in the year received, whether the taxpayer is on the cash or the accrual basis. For the current year, William must include $18,000 for the three units rented continuously during the year. Although not specifically stated, it is presumed that William received rental income of $2,000 from unit four while it was occupied for the first 4 months of the current year. The $500 security deposit of the first tenant in unit four is includible as rental income because William became entitled to the funds to repair damages to the unit after the tenant vacated it. William also received rental income of $3,000, which included $500 of prepaid rent, from the second tenant of unit four. The refundable security deposit of $500 paid by the second tenant of unit four is not part of William’s rental income for the current year because William was not authorized to retain any portion of the deposit during the year (Publication 17).

Question 59

Jose started renting a house to Bill for $600 per month beginning February 1, Year 1. Bill paid $1,200 on January 15, Year 1, which included 1 month’s rent and 1 month’s security deposit. The rent is due by the 5th of the month. The lease specifies that the security deposit will also be used as the final month’s rent. Bill pays the rent on the 2nd of each month. In July, Bill also paid $150 for repairs to the air-conditioning system, and in September he paid $80 for a roof repair. He deducted the amounts from the rent paid to Jose for those months. Bill was unable to pay December’s rent until January of the next year. How much should Jose report as rental income for Year 1?

A. $6,600

B. $6,900

C. $6,000

D. $7,200

Answer 59

$6,600

Income, although not actually in a taxpayer’s possession, is constructively received in the taxable year during which it is credited to his or her account, set apart for him or her, or otherwise made available without restriction (Reg. 1.451-2). However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions (Publication 538). The security deposit representing the final month’s rent is included; however, the rent received in January for December rent is not included.

Question 60

All of the following statements relating to net operating losses and the at-risk limits are true EXCEPT

A. If the amounts that you borrow for use in the activity are secured by property not used in the activity, the amount considered at-risk is limited to the net fair market value (the fair market value on the date the property is pledged less any prior or superior claims to which it is subject) of your interest in the property.

B. If you have a loss in excess of your at-risk investment, the loss disallowed will not be allowed in subsequent years unless you increase your at-risk investment.

C. In applying at-risk limits to individuals, each item of leased Sec. 1245 equipment, farm, or oil and gas property is treated as a separate activity.

D. You are considered at-risk for the amount of money you borrow to contribute to an activity, other than activities involving the holding of real property, if the lender’s recourse is only to your interest in the activity.

Answer 60

You are considered at-risk for the amount of money you borrow to contribute to an activity, other than activities involving the holding of real property, if the lender’s recourse is only to your interest in the activity.

Section 465 generally limits losses from an activity for each year to the amount the taxpayer has at-risk in the activity at year end. A taxpayer is generally considered at-risk for money and the adjusted basis of property contributed to the activity and amounts borrowed for use in the activity. But amounts borrowed for use in the activity are not included as at-risk if the lender has no recourse against the borrower personally, except for certain qualified financing with respect to real property (Publication 925).

Question 61

In the current year, Todd owned a waterfront vacation home that he used from January 1 to February 28. The rest of the year he rented the vacation home for $1,000 per month, at fair rental price. Mortgage interest for the year was $15,000 and repairs were $1,500. Depreciation was $150 for the rental period. What is the amount that is carried over to the next tax year as unused rental expenses?

A. $1,407

B. $150

C. $1,650

D. $3,982

Answer 61

$1,407

The revenue is $10,000 from rental. The interest allocated to the rental is $12,575 ($15,000 × 306/365). This interest is fully deductible in computing a rental loss for the year. The remaining interest would also be deductible (assuming the vacation home qualified as a second residence). The repairs of $1,257 ($1,500 × 306/365) plus the $150 depreciation are nondeductible because there is no income to cover it and it is carried forward to the following year. Total carryforward is $1,407 (Publication 527).

Question 62

In the current year, Jerry signed a 5-year lease to rent space to the MacBee restaurant. That year, MacBee paid Jerry $24,000 for the first year’s rent and $24,000 for the last year’s rent. Jerry reports his income using the accrual method of accounting. How much of the $48,000 is included in Jerry’s current-year income?

A. $48,000

B. $120,000

C. $24,000

D. $0

Answer 62

$48,000

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b) (Publication 17). Since Jerry has an unrestricted claim to the $24,000 of rent paid in advance, it would be included in his rental income.

Question 63

Mr. Cypress owned a small three-unit apartment building in Detroit, Michigan. The rent on each apartment was $1,000 per month. During 2020, he received the following payments:
*Apt. A - Timely rent payments for 12 months
*Apt. B - The apartment was vacant in January and February. On 3/1/20, a new tenant entered into a 1-year lease from 3/1/20 through 2/28/21. The tenant paid first and last month’s rent and a security deposit of $1,500. The security deposit is to be returned at the end of the lease if the tenant lives up to the terms of the lease. The tenant timely paid the rent for the next 9 months (April through December) on the first of each month.
*Apt. C - In December, after timely paying the rent for 12 months of the year, the tenant came to Mr. Cypress and told him that he had been transferred to a new job location in Tennessee. He asked to be released from his 2-year lease obligation, which was scheduled to expire on June 30, 2021. Mr. Cypress agreed to accept 3 months’ rent to cancel the lease. The tenant paid Mr. Cypress $3,000 to cancel the lease in December.
Assuming Mr. Cypress is a cash-basis taxpayer, what amount should Mr. Cypress include in his 2020 gross income from the apartment building?

A. $35,500

B. $35,000

C. $39,500

D. $38,000

Answer 63

$38,000

Both cash- and accrual-basis taxpayers must include amounts in gross income upon actual or constructive receipt if the taxpayer has an unrestricted claim to such amounts under Reg. 1.61-8(b). Thus, all the rent payments should be included in the current year’s gross rental income. Security deposits are income only if the lessor becomes entitled to the funds because of the lessee’s violation of the terms of the lease. Therefore, Mr. Cypress does not have an unrestricted claim to the security deposit. The cancellation payment is in lieu of rent, so it must be included in income like rent. Mr. Cypress should recognize $12,000 from Apt. A ($1,000 rent × 12 months) plus $11,000 from Apt. B ($10,000 for rent + $1,000 last month’s rent) plus $15,000 from Apt. C ($12,000 rent + $3,000 cancellation payment), for a total of $38,000 (Publication 17).