Comprehensive volume chapte chapter 11

COMPREHENSIVE VOLUME CHAPTER 11--INVESTOR
LOSSES

Student: ___________________________________________________________________________

1. Stuart is the sole owner and a material participant in a business in which he has $50,000 at risk. If the
business incurs a loss of $80,000 from operations, Stuart can deduct the full amount.
True False

2. Stan owns a 20% interest in a partnership (not real estate) in which his at-risk amount was $38,000 at the
beginning of the year. During the year, the partnership borrows $80,000 on a nonrecourse note and incurs a loss
of $50,000 from operations. Stan’s at-risk amount at the end of the year is $44,000.
True False

3. In the current year, Rich has a $40,000 loss from a business he owns. His at-risk amount at the end of the
year, prior to considering the current year loss, is $24,000. He will be allowed to deduct the $40,000 loss this
year if he is a material participant in the business.
True False

4. Judy owns a 20% interest in a partnership (not real estate) in which her at-risk amount was $35,000 at the
beginning of the year. The partnership borrowed $50,000 on a recourse note and made a $40,000 profit during
the year. Her at-risk amount at the end of the year is $43,000.
True False

5. Tonya owns an interest in an activity (not real estate) that converted recourse financing to nonrecourse
financing. Recapture of previously allowed losses is required if Tonya’s at-risk amount is reduced below zero as
a result of the debt restructuring.
True False

6. Kelly, who earns a yearly salary of $120,000, sold an activity with a suspended passive loss of $44,000. The
activity was sold at a loss and Kelly has no other passive activities. The suspended loss is not deductible.
True False

7. All of a taxpayer’s tax credits relating to a passive activity can be utilized when the activity is sold at a loss.
True False

8. During the year, Lion Company incurs a $25,000 loss on a passive activity, has active income of $17,000, and
portfolio income of $12,000. If Lion is a personal service corporation, it may deduct $17,000 of the $25,000
passive loss.
True False

9. Coyote Corporation has active income of $45,000 and a passive loss of $23,000 in the current year. Coyote
cannot deduct the $23,000 loss if it is a personal service corporation.
True False

10. Peach Company, a closely held C corporation, incurs a $58,000 loss on a passive activity during the year.
The company has active income of $34,000 and portfolio income of $24,000. If Peach is a not a personal
service corporation, it may deduct the entire $58,000 passive loss.
True False

11. Wolf Corporation has active income of $55,000 and a passive loss of $33,000 in the current year. Wolf
cannot deduct the $33,000 loss if it is a closely held C corporation that is not a personal service corporation.
True False

12. Nathan owns Activity A, which produces income, and Activity B, which produces passive losses. From a
tax planning perspective, Nathan will be better off if Activity A is passive.
True False

13. Anita owns Activity A which produces active income and Activity B which produces losses. From a tax
planning perspective, Anita will be better off if Activity B is a passive activity.
True False

14. David participates 580 hours in an activity during the year; others participate for 1,400 hours. David is a
material participant in the activity.
True False

15. Joe participates 95 hours in an activity, while an employee participates 5 hours. Joe has materially
participated in the activity.
True False

16. Mary Jane participates for 100 hours during the year in an activity she owns. She has no employees and is
the only participant in the activity. The activity is a significant participation activity.
True False

17. A taxpayer is considered to be a material participant in a significant participation activity if he or she spends
at least 400 hours in the activity.
True False

18. Rachel participates 150 hours in Activity A and 400 hours in Activity B, both of which are nonrental
businesses. Both activities are passive.
True False

19. Lucy participates for 405 hours in Activity A and 101 hours in Activity B, both of which are nonrental
True False

20. From January through November, Vern participated for 420 hours as a salesman in a partnership in which he
owns a 50% interest. The partnership has four full-time employees. During December, Vern spends 110 hours
cleaning the store and painting the walls in order to meet the material participation standards. Vern qualifies as a
material participant.
True False

21. Joyce owns an activity (not real estate) in which she participates for 100 hours a year; her husband
participates for 450 hours. Joyce qualifies as a material participant.
True False

22. When determining whether an individual is a material participant, participation by an owner’s spouse
generally counts.
True False

23. Kathy is a full-time educator, but she owns an apartment building and devotes 550 hours to managing the
activity. All losses from the rental activity will be considered nonpassive and deductible against active income
because she is a real estate professional.
True False

24. Bruce owns a small apartment building that produces a $25,000 loss during the year. His AGI before
considering the rental loss is $85,000. Bruce must be an active participant with respect to the rental activity in
order to deduct the $25,000 loss under the real estate rental exception.
True False

25. In the current year, Kenny has a $35,000 loss from a real estate rental activity. Kenny provides 1,000 hours
of service to that activity, which is more than half of his working hours for the year. Kenny can deduct the
$35,000 loss.
True False

26. Services performed by an employee are treated as being related to a real estate trade or business if the
employee performing the services has more than a 5% ownership interest in the employer.
True False

27. In the current year, Abby has AGI of $95,000 and a $40,000 loss from a real estate rental activity in which
she is a 15% owner. If she is an active participant, she can deduct $25,000 of the loss.
True False

28. Individuals can deduct from active or portfolio income losses of up to $25,000 from real estate rental
activities in which they actively participate.
True False

29. Individuals with modified AGI of $100,000 can deduct against active or portfolio income losses of up to
$25,000 from real estate rental activities in which they actively participate.
True False

30. Roger owns and actively participates in the operations of an apartment building which produces a $40,000
loss during the year. He has AGI of $150,000 from an active business. He may deduct $25,000 of the loss.
True False

31. Bonnie owns and actively participates in the operations of an apartment building that produces a $40,000
loss during the year. In addition, she has AGI of $100,000 from an active business. Her at-risk amount in the
apartment building is $200,000. She may deduct $25,000 of the loss in the current year, while the remaining
$15,000 is a suspended passive loss.
True False

32. Susan dies owning a passive activity with a basis of $75,000, a fair market value of $140,000, and
suspended losses of $80,000. A $15,000 passive loss can be deducted on Susan’s final income tax return.
True False

33. Chris receives a gift of a passive activity from his father whose basis was $60,000. Suspended losses related
to the activity are $18,000. Chris will be allowed to offset the $18,000 suspended losses against future passive
income.
True False

34. Eric makes an installment sale of a passive activity having suspended losses of $40,000. He collects 25% of
the sales price in the current year, and will collect 25% in each of the next three years. Eric can deduct $10,000
of the passive loss this year.
True False

35. Gail exchanges passive Activity A, which has suspended losses of $15,000, for passive Activity B in a
nontaxable exchange. The new owner of passive Activity A can offset the $15,000 suspended losses against
passive income in the future.
True False

36. Jared earned investment income of $22,000 and incurred investment interest expense of $14,000 during
2011. He incurred other investment expenses of $7,000 during the year. Jared may deduct $14,000 of
investment interest in 2011.
True False

37. Investment income can include gross income from interest, dividends, annuities, and royalties not derived in
the ordinary course of a trade or business; income from a passive activity; and income from a real estate activity
in which the taxpayer actively participates.
True False

38. Seth had interest income of $31,000, investment expenses of $28,000, and a long-term capital gain of
$8,000 on an investment. In calculating his net investment income, Seth may deduct a maximum of $11,000
investment interest.
True False

39. Earl, who earned investment income of $13,500, incurred investment interest expense of $7,700, and other
investment expenses of $9,000. Earl may carry over $3,200 of investment interest and deduct it in the future.
True False

40. In 2011, Judy invested $200,000 for a 25% interest in a limited liability company (LLC) involved in an
activity in which she is a material participant. The LLC reported losses of $680,000 in 2011 and $360,000 in
2012 with Judy’s share being $170,000 in 2011 and $90,000 in 2012. How much of the losses can Judy deduct?

A. $0 in 2011; $0 in 2012.
B. $170,000 in 2011; $0 in 2012.
C. $170,000 in 2011; $30,000 in 2012.
D. $170,000 in 2011; $90,000 in 2012.
E. None of the above.

41. Which of the following decreases a taxpayer’s at-risk amount?
A. Cash and the adjusted basis of property contributed to the activity.
B. Amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as
security property not used in the activity.
C. Taxpayer’s share of amounts borrowed for use in the activity that is qualified nonrecourse financing.
D. Taxpayer’s share of the activity’s income.

42. In 2011, Pearl invests $80,000 for a 10% partnership interest in an activity in which she is a material
participant. The partnership reports losses of $500,000 in 2011 and $450,000 in 2012. Pearl’s share of the
partnership’s losses is $50,000 in 2011 and $45,000 in 2012. How much of the losses can Pearl deduct?
A. $50,000 in 2011 and $30,000 in 2012.
B. $50,000 in 2011 and $45,000 in 2012.
C. $0 in 2011 and $0 in 2012.
D. $50,000 in 2011 and $0 in 2012.

43. In 2011, Kipp invested $65,000 for a 30% interest in a partnership conducting a passive activity. The
partnership reported losses of $200,000 in 2011 and $100,000 in 2012, Kipp’s share being $60,000 in 2011 and
$30,000 in 2012. How much of the losses from the partnership can Kipp deduct assuming he owns no other
investments and does not participate in the partnership’s operations?
A. $0 in 2011; $30,000 in 2012.
B. $60,000 in 2011; $30,000 in 2012.
C. $60,000 in 2011; $5,000 in 2012.
D. $60,000 in 2011; $0 in 2012.

44. Nora acquired passive activity A several years ago that until 2010 was profitable. However, the activity
produced losses of $100,000 in 2010 and $50,000 in 2011. Nora had passive income from activity B of $40,000
in 2010 and $0 in 2011. How much loss is suspended from activity A in each year?
A. $60,000 in 2010 and $50,000 in 2011.
B. $100,000 in 2010 and $50,000 in 2011.
C. $0 in 2010 and $0 in 2011.
D. None of the above.

45. Carl, a physician, earns $200,000 from his medical practice in the current year. He receives $45,000 in
dividends and interest during the year as well as $5,000 of income from a passive activity. In addition, he incurs
a loss of $50,000 from an investment in a passive activity. What is Carl’s AGI for the current year after
considering the passive investment?
A. $195,000.
B. $200,000.
C. $240,000.
D. $245,000.

46. Samantha sells a passive activity (adjusted basis of $50,000) for $90,000. Suspended losses attributable to
this property total $30,000. The realized gain and the taxable gain are:
A. $40,000 realized gain; $70,000 taxable gain.
B. $10,000 realized gain; $10,000 taxable gain.
C. $40,000 realized gain; $0 taxable gain.
D. $40,000 realized gain; $10,000 taxable gain.

47. Alex has three passive activities with at-risk amounts in excess of $100,000 for each. During the year, the
activities produced the following income (losses).

Activity A ($75,000)
Activity B (25,000)
Activity C 25,000
Net passive loss ($75,000)

Alex’s suspended losses are as follows:
A. $75,000 is allocated to C; $0 to A and B.
B. $37,500 is allocated to A; $37,500 to B.
C. $56,250 is allocated to A; $18,750 to B.
D. $25,000 is allocated to A, B, and C.

48. In the current year, Crow Corporation, a closely held C corporation that is not a personal service
corporation, has $100,000 of passive losses, $80,000 of active business income, and $20,000 of portfolio
income. How much of the passive loss may Crow deduct in the current year?
A. $0.
B. $20,000.
C. $80,000.
D. $100,000.
E. None of the above

49. In the current year, Spring Corporation, a closely held personal service corporation, has $120,000 of passive
losses, $70,000 of active business income, and $50,000 of portfolio income. How much of the passive loss may
Spring deduct in the current year?
A. $120,000.
B. $70,000.
C. $50,000.
D. $0.

50. Charles owns a business with two separate departments. Department A produces $100,000 of income and
Department B incurs a $60,000 loss. Charles participates for 550 hours in Department A and 100 hours in
Department B. He has full-time employees in both departments.
A. If Charles elects to treat both departments as a single activity, he cannot offset the $60,000 loss against the
$100,000 income.
B. Charles may not treat Department A and Department B as separate activities because they are parts of one
business.
C. If Charles elects to treat the two departments as separate activities, he can offset the $60,000 loss against the
$100,000 income.
D. If Charles elects to treat both departments as a single activity, he can offset the $60,000 loss against the
$100,000 income.

51. Tara owns a shoe store and a bookstore. Both businesses are operated in a mall. She also owns a restaurant
across the street and a jewelry store several blocks away.
A. All four businesses can be treated as a single activity if Tara elects to do so.
B. Only the shoe store and bookstore can be treated as a single activity, the restaurant must be treated as a
separate activity, and the jewelry store must be treated as a separate activity.
C. The shoe store, bookstore, and restaurant can be treated as a single activity, and the jewelry store must be
treated as a separate activity.
D. All four businesses must be treated as separate activities.

52. Which of the following factors should be considered in determining whether an activity is treated as an
appropriate economic unit?
A. The similarities and differences in types of business.
B. The extent of common control.
C. The extent of common ownership.
D. The geographic location.
E. All of the above.

53. Which of the following is not a factor that should be considered in determining whether an activity is treated
as an appropriate economic unit?
A. The interdependencies between the activities.
B. The extent of common control.
C. The extent of common ownership.
D. The geographical location.
E. All of the above are relevant factors.

54. Art owns significant interests in a hardware store and a bookstore at a mall in Washington, D.C. He also
owns a hardware store and a bookstore at a mall in San Francisco. Which of the following is not a way in which
the interests may be grouped?
A. One activity.
B. A hardware activity and a bookstore activity.
C. A Washington, D.C. activity and a San Francisco activity.
D. Four separate activities.
E. Any of the above may be the basis for grouping.

55. Rick, a computer consultant, owns a separate business (not real estate) in which he participates. He has one
employee who works part-time in the business.
A. If Rick participates for 500 hours and the employee participates for 620 hours during the year, Rick qualifies
as a material participant.
B. If Rick participates for 550 hours and the employee participates for 2,000 hours during the year, Rick
qualifies as a material participant.
C. If Rick participates for 120 hours and the employee participates for 120 hours during the year, Rick does not
qualify as a material participant.
D. If Rick participates for 95 hours and the employee participates for 5 hours during the year, Rick probably
does not qualify as a material participant.

56. Ned, a college professor, owns a separate business (not real estate) in which he participates in the current
year. He has one employee who works part-time in the business.
A. If Ned participates for 120 hours and the employee participates for 120 hours during the year, Ned does not
qualify as a material participant.
B. If Ned participates for 95 hours and the employee participates for 5 hours during the year, Ned probably does
not qualify as material participant.
C. If Ned participates for 500 hours and the employee participates for 520 hours during the year, Ned qualifies
as material participant.
D. If Ned participates for 600 hours and the employee participates for 2,000 hours during the year, Ned qualifies
as a material participant.

57. Paula owns four separate activities. She elects not to group them together as a single activity under the
“appropriate economic unit” standard. Paula participates for 130 hours in Activity A, 115 hours in Activity B,
260 hours in Activity C, and 100 hours in Activity D. She has one employee, who works 125 hours in Activity
D. Which of the following statements is correct?
A. Activities A, B, C, and D are all significant participation activities.
B. Paula is a material participant with respect to Activities A, B, C, and D.
C. Paula is not a material participant with respect to Activities A, B, C, and D.
D. Losses from all of the activities can be used to offset Paula’s active income.

58. Tom owns five activities, and he elects not to group them together as a single activity under the “appropriate
economic unit” standard. During the year, he participates for 120 hours in Activity A, 150 hours in Activity B,
140 hours in Activity C, 110 hours in Activity D, and 100 hours in Activity E.
A. Activities A, B, C, D, and E are all significant participation activities.
B. Tom is a material participant only in Activities A, B, and C.
C. Tom is a material participant in Activities A, B, C, D, and E.
D. Tom is not a material participant in any of the activities.

59. Dena owns interests in five businesses and has full-time employees in each business. She participates for
100 hours in Activity A, 120 hours in Activity B, 130 hours in Activity C, 140 hours in Activity D, and 125
hours in Activity E.
A. All five of Dena’s activities are significant participation activities.
B. Dena is a material participant with respect to all five activities.
C. Dena is not a material participant in any of the activities.
D. Dena is a material participant with respect to Activities B, C, D, and E.

60. Maria, who owns a 50% interest in a restaurant, has been a material participant in the restaurant activity for
the last 20 years. She retired from the restaurant at the end of last year and will not participate in the restaurant
activity in the future. However, she continues to be a material participant in a retail store in which she is a 50%
partner. The restaurant operations produce a loss for the current year, and Maria’s share of the loss is $80,000.
Her share of the income from the retail store is $150,000. She does not own interests in any other activities.
A. Maria cannot deduct the $80,000 loss from the restaurant because she is not a material participant.
B. Maria can offset the $80,000 loss against the $150,000 of income from the retail store.
C. Maria will not be able to deduct any losses from the restaurant until she has been retired for at least three
years.
D. Assuming Maria continues to hold the interest in the restaurant, she will always treat the losses as active.

61. Sarah, who owns a 50% interest in a grocery store, was a material participant in the activity for the last 25
years. She retired from the grocery store at the end of last year and will not participate in the activity in the
future. However, she continues to be a material participant in an office supply store in which she is a 50%
partner. The operations of the grocery store resulted in a loss for the current year and Sarah’s share of the loss is
$40,000. Sarah’s share of the income from the office supply store is $75,000. She does not own interests in any
other activities.
A. Sarah cannot deduct the $40,000 loss from the grocery store because she is not a material participant.
B. Sarah will not be able to deduct any losses from the grocery store until future years.
C. Sarah can offset the $40,000 loss from the grocery store against the $75,000 of income from the office
supply store.
D. Sarah will not be able to deduct any losses from the grocery store until she has been retired for at least four
years.

62. Jed spends 32 hours a week, 50 weeks a year, operating a DVD rental store that he owns. He also owns a
music store in another city that is operated by a full-time employee. He elects not to group them together as a
single activity under the “appropriate economic unit” standard. Jed spends 40 hours per year working at the
music store.
A. Neither store is a passive activity.
B. Both stores are passive activities.
C. Only the DVD rental store is a passive activity.
D. Only the music store is a passive activity.

63. Jenny spends 32 hours a week, 50 weeks a year, operating a DVD rental store that she owns. She also owns
a music store in another city that is operated by a full-time employee. Jenny spends 140 hours per year working
at the music store. She elects not to group them together as a single activity under the “appropriate economic
unit” standard.
A. Neither store is a passive activity.
B. Both stores are passive activities.
C. Only the DVD rental store is a passive activity.
D. Only the music store is a passive activity.

64. Skeeter invests in vacant land for the purpose of realizing a profit on its appreciation. He leases the land
during the period he holds it. The unadjusted basis of the property is $75,000 and its fair market value is
$105,000. The lease payments are $1,200 per year.
A. The leasing activity will be treated as a rental activity and will be treated as a passive activity regardless of
how many hours Skeeter participates.
B. The leasing activity will be treated as a rental activity and will not be treated as a passive activity if Skeeter
qualifies as a real estate professional.
C. The leasing activity will not be treated as a rental activity.
D. The leasing activity will be treated as a rental activity and will not be treated as a passive activity if Skeeter
devotes more than 500 hours to the activity.

65. Kenton has investments in two passive activities. Activity A, acquired three years ago, produces income in
the current year of $60,000. Activity B, acquired last year, produces a loss of $110,000 in the current year. At
the beginning of this year, Kenton’s at-risk amounts in Activities A and B are $10,000 and $120,000,
respectively. What is the amount of Kenton’s suspended passive loss with respect to these activities at the end of
the current year?
A. $100,000.
B. $50,000.
C. $40,000.
D. $0.

66. Rachel acquired a passive activity several years ago. Until 2008, the activity was profitable, and Rachel’s
at-risk amount at the beginning of 2008 was $300,000. The activity produced losses for Rachel of $80,000 in
2008, $50,000 in 2009, and $70,000 in 2010. In 2011, the activity produced income of $90,000. How much is
Rachel’s suspended passive loss at the beginning of 2012?
A. $150,000.
B. $110,000.
C. $60,000.
D. $0.

67. Emily earns a salary of $150,000, and invests $60,000 for a 20% interest in a passive activity. Operations of
the activity result in a loss of $400,000, of which Emily’s share is $80,000. How is her loss characterized?
A. $60,000 is suspended under the passive loss rules and $20,000 is suspended under the at-risk rules.
B. $60,000 is suspended under the at-risk rules and $20,000 is suspended under the passive loss rules.
C. $80,000 is suspended under the passive loss rules.
D. $80,000 is suspended under the at-risk rules.

68. Several years ago, Joy acquired a passive activity. Until 2009, the activity was profitable. Joy’s at-risk
amount at the beginning of 2009 was $250,000. The activity produced losses of $100,000 in 2009, $80,000 in
2010, and $90,000 in 2011. During the same period, no passive income was recognized. How much is
suspended under the at-risk rules and the passive loss rules at the beginning of 2012?
At-risk Passive loss
A. $0 $270,000.
B. $20,000 $250,000.
C. $30,000 $240,000.
D. $260,000 $10,000.

69. Jerry’s at-risk amount in a passive activity is $100,000 at the beginning of the current year. His current loss
from the activity is $45,000. Jerry had no passive activity income during the year. At the end of the current
year:
A. Jerry has an at-risk amount in the activity of $55,000 and a suspended passive loss of $45,000.
B. Jerry has an at-risk amount in the activity of $100,000 and a suspended passive loss of $45,000.
C. Jerry has an at-risk amount in the activity of $55,000 and no suspended passive loss.
D. Jerry has an at-risk amount in the activity of $100,000 and no suspended passive loss.

70. Wes’s at-risk amount in a passive activity is $25,000 at the beginning of the current year. His current loss
from the activity is $35,000 and he has no passive activity income. At the end of the current year, which of the
following statements is incorrect?
A. Wes has a loss of $25,000 suspended under the passive loss rules.
B. Wes has an at-risk amount in the activity of $0.
C. Wes has a loss of $10,000 suspended under the at-risk rules.
D. Wes has a loss of $35,000 suspended under the passive loss rules.
E. None of the above is incorrect.

71. Jon owns an apartment building in which he is a material participant and a computer consulting business. Of
the 2,000 hours he spends on these activities during the year, 55% of the time is spent operating the apartment
building and 45% of the time is spent in the computer consulting business.
A. The computer consulting business is a passive activity but the apartment building is not.
B. The apartment building is a passive activity but the computer consulting business is not.
C. Both the apartment building and the computer consulting business are passive activities.
D. Neither the apartment building nor the computer consulting business is a passive activity.

72. Consider the following three statements:

(1) Tad invests in vacant land for the purpose of realizing a profit on its appreciation. He leases the land during the period he holds it. The
unadjusted basis of the property is $25,000 and its fair market value is $35,000. The lease payments are $400 per year.
(2) A farmer owns land with an unadjusted basis of $25,000 and a fair market value of $35,000. He used it for farming purposes in the two
prior years. In the current year, he leases the land to another farmer for $400.
(3) At City Hospital, each inpatient is provided a private room while medical care is provided.

In which of the three cases above could the rental activity automatically be considered a passive activity?
A. Case 1 only.
B. Case 2 only.
C. Case 3 only.
D. Cases 1, 2, and 3.

73. Andrea, a single taxpayer, has $90,000 in salary, $15,000 in income from a limited partnership, and a
$40,000 passive loss from a real estate rental activity in which she actively participates. Her modified adjusted
gross income is $90,000. Of the $40,000 loss, Andrea may deduct:
A. $0.
B. $15,000.
C. $25,000.
D. $40,000.
E. Some other amount.

74. Roxanne, who is single, has $125,000 of salary, $10,000 of income from a limited partnership, and a
$26,000 passive loss from a real estate rental activity in which she actively participates. Her modified adjusted
gross income is $125,000. Of the $26,000 loss, how much is deductible?
A. $0.
B. $10,000.
C. $25,000.
D. $26,000.

75. Lucy dies owning a passive activity with an adjusted basis of $90,000. Its fair market value at that date is
$145,000. Suspended losses relating to the property were $75,000. Which of the following statements is true?
A. The heir’s adjusted basis is $145,000, and Lucy’s final deduction is $20,000.
B. The heir’s adjusted basis is $145,000, and Lucy’s final deduction is $75,000.
C. The heir’s adjusted basis is $90,000, and Lucy’s final deduction is $75,000.
D. The heir’s adjusted basis is $220,000, and Lucy has no final deduction.

76. Caroyl made a gift to Tim of a passive activity (adjusted basis of $50,000, suspended losses of $20,000, and
a fair market value of $80,000). No gift tax resulted from the transfer.
A. Tim’s adjusted basis is $80,000, and Tim can deduct the $20,000 of suspended losses in the future.
B. Tim’s adjusted basis is $80,000.
C. Tim’s adjusted basis is $50,000, and the suspended losses are lost.
D. Tim’s adjusted basis is $50,000, and Tim can deduct the $20,000 of suspended losses in the future.

77. Identify from the list below the type of disposition of a passive activity where the taxpayer keeps the
suspended losses of the disposed activity and utilizes them on a subsequent taxable disposition.
A. Disposition of a passive activity by gift.
B. Nontaxable exchange of a passive activity.
C. Disposition of a passive activity at death.
D. Installment sale of a passive activity.

78. Tony is married and files a joint tax return for 2011. He has investment interest expense of $95,000 for a
loan made to him in 2011 to purchase a parcel of unimproved land. His income from investments [dividends
(not qualified) and interest] totaled $18,000. Tony paid $3,600 of real estate taxes on the unimproved land.
Tony also has a $4,500 net long-term capital gain from the sale of stock held as an investment. Calculate Tony’s
maximum investment interest deduction for 2011.
A. $95,000.
B. $22,500.
C. $18,900.
D. $18,000.

79. Ramon incurred $83,100 of interest expense related to his investments in 2011. His investment income
included $34,500 of interest and a $37,500 net capital gain on the sale of securities. What is the maximum
amount of Ramon’s investment interest expense deduction in 2011?
A. $19,500.
B. $34,500.
C. $72,000.
D. $83,100.

80. Match the treatment for the following types of transactions.

1. Treatment of a disposition of The suspended losses are added to ___
a passive activity at death. the basis of the property. _
Suspended losses are allowed to
the taxpayer to the extent they exceed
2. Treatment of a disposition of the amount, if any, of the step-up in ___
a passive activity by gift. basis allowed. _
3. Treatment of suspended
credits when passive activity is The losses are allowed in the years ___
sold at a loss. in which gain is recognized. _
4. Treatment of a sale of a
passive activity where all of the
realized gain or loss is The taxpayer keeps the suspended ___
recognized currently. losses. _
5. Treatment of an installment Any suspended losses may be used ___
sale of a passive activity. in the current year. _
6. Treatment of a nontaxable ___
exchange of a passive activity. No correct choice is given. _

81. Sarah purchased for $100,000 a 10% interest in a business venture that is not subject to the passive activity
rules. During the first year, her share of the entity’s loss was $120,000. At the beginning of the second year, the
entity obtained $800,000 of recourse financing. During the second year, Sarah withdrew cash of $20,000, and
her share of the entity’s loss was $25,000. Calculate the amount of loss that Sarah may claim in each of the two
years and determine her at-risk amount at the end of each year.

82. In 2011, Emily invests $100,000 in a limited partnership that is not a passive activity. During 2011, her
share of the partnership loss is $70,000. In 2012, her share of the partnership loss is $50,000. How much can
Emily deduct in 2011 and 2012?

83. Sam, who earns a salary of $400,000, invested $160,000 for a 40% working interest in an oil and gas limited
partnership (not a passive activity) last year. Through the use of $1,600,000 of nonrecourse financing, the
partnership acquired assets worth $2 million. Depreciation, interest, and other deductions related to the activity
resulted in a loss in the partnership’s initial year of $300,000, of which Sam’s share was $120,000. Sam’s share
of loss from the partnership is $60,000 in the current year. How much of the loss from the partnership can Sam
deduct in each year?

84. Joyce, an attorney, earns $100,000 from her law practice in the current year. In addition, she receives
$35,000 in dividends and interest during the year. Further, she incurs a loss of $35,000 from an investment in a
passive activity. What is Joyce’s AGI for the year after considering the passive investment?

85. Caroline sells a rental house for $320,000 that has an adjusted basis of $280,000. During the years of her
ownership, $75,000 of losses have been incurred that were suspended under the passive activity loss rules.
Determine the tax treatment to Caroline on the disposition of the property.

86. Seth has four passive activities. The following income and losses are generated in the current year.

Activity Gain (Loss)
A ($60,000)
B (25,000)
C (15,000)
D 10,000
Total ($90,000)

How much of the $90,000 net passive loss can Seth deduct this year? Calculate the suspended losses (by activity).

87. Pat sells a passive activity for $100,000 that has an adjusted basis of $55,000. During the years of her
ownership, $60,000 of losses have been incurred that were suspended under the passive activity loss rules. In
addition, the passive activity generated tax credits of $10,000 that were not utilized and suspended. Determine
the tax treatment to Pat on the disposition of the property.

88. Green, Inc., a closely held personal service corporation, has the following transactions in the current year:
$100,000 of passive losses, $80,000 of active business income, and $20,000 of portfolio income. How much of
the passive loss may Green use to offset other types of income this year?

89. Tangerine Corporation, a closely held (non-personal service) C corporation, earns active income of
$400,000 in the current year. The corporation also receives $35,000 in dividends during the year. In addition,
Tangerine incurs a loss of $60,000 from an investment in a passive activity. What is Tangerine’s income for the
year after considering the passive investment?

90. Lloyd, a life insurance salesman, earns a $400,000 salary in the current year. As he works only 30 hours per
week in this job, he has time to participate in several other businesses. He owns an ice cream parlor and a car
repair shop in Tampa. He also owns an ice cream parlor and a car repair shop in Portland and a car repair shop
in St. Louis. A preliminary analysis on December 1 of the current year shows projected income and losses for
the various businesses as follows:

Income (Loss)
Tampa ice cream parlor (95 hours participation) $56,000
Tampa car repair shop (140 hours participation) (89,000)
Portland ice cream parlor (90 hours participation) 34,000
Portland car repair shop (170 hours participation) (41,000)
St. Louis car repair shop (180 hours participation) (15,000)

Lloyd has full-time employees at each of the five businesses listed above. Review all possible groupings for Lloyd’s activities. Which grouping
method and other strategies should Lloyd consider that will provide the greatest tax advantage?

91. Samantha invested $75,000 in a passive activity several years ago, and on January 1, 2010, her amount at
risk was $15,000. Her shares of the income and losses in the activity for the next three years are as follows:

Year Income (Loss)
2010 ($20,000)
2011 (15,000)
2012 25,000

How much can Samantha deduct in 2010 and 2011? What is her taxable income from the activity in 2012? (Consider both the at-risk rules as well as
the passive loss rules.)

92. Ken has a $40,000 loss from an investment in a partnership in which he does not materially participate. He
paid $30,000 for his interest. How much of the loss is disallowed by the at-risk rules? How much is disallowed
by the passive loss rules?

93. During the year, James performs the following personal services in three separate activities: 800 hours as a
CPA in his tax practice, 400 hours in a real estate development business (in which he is not a material
participant), and 600 hours in an apartment leasing operation. He expects that losses will be realized from the
two real estate ventures while his tax practice will show a profit. James files a joint return with his wife whose
salary is $200,000. What is the character of the income and losses generated by these activities?

94. In the current year, Lucile, who has AGI of $70,000 before considering rental activities, is active in three
separate real estate rental activities and is in the 28% tax bracket. She had $15,000 of losses from Activity A,
$25,000 of losses from Activity B, and income of $20,000 from Activity C. She also had $3,100 of tax credits
from Activity A. Calculate her deductions and credits currently allowed and the suspended losses and credits.

95. Faye dies owning an interest in a passive activity property (adjusted basis of $150,000, suspended losses of
$52,000, and a fair market value of $180,000). What, if any, can be deducted on her final income tax return?

96. Barb borrowed $100,000 to acquire a parcel of land to be held for investment purposes. During 2011, she
paid interest of $11,000 on the loan. She had AGI of $75,000 for the year. Other items related to Barb’s
investments include the following:

Investment income $10,000
Long-term capital gain on sale of stock 7,500
Investment counsel fees 2,000

Barb is unmarried and elects to itemize her deductions. She has no miscellaneous itemized deductions other than the investment counsel fees.

a. Determine Barb’s investment interest deduction for 2011, assuming she does not make any special election regarding the
computation of investment income.
b. Discuss the treatment of Barb’s investment interest that is disallowed in 2011.
c. What election could Barb make to increase the amount of her investment interest deduction for 2011?

97. Explain how a taxpayer’s at-risk amount in a business venture is adjusted periodically.

98. Identify how the passive loss rules broadly classify various types of income and losses. Provide examples of
each category.

99. Discuss the treatment given to suspended passive activity losses and credits. What happens to an activity’s
unused losses and credits when the activity is sold?

100. List the taxpayers that are subject to the passive loss rules and summarize the general impact of these rules
on these taxpayers.

101. What special passive loss treatment is available to real estate activities?

102. When a taxpayer disposes of a passive activity by death, what happens to any unused passive losses?

103. Describe the general rules that limit the deduction of investment interest expense.

104. Identify the types of income that are classified as investment income. Discuss the flexibility that a
taxpayer has with respect to certain types of income that may potentially be considered investment income.

COMPREHENSIVE VOLUME CHAPTER 11--INVESTOR
LOSSES Key

1. Stuart is the sole owner and a material participant in a business in which he has $50,000 at risk. If the
business incurs a loss of $80,000 from operations, Stuart can deduct the full amount.
FALSE

2. Stan owns a 20% interest in a partnership (not real estate) in which his at-risk amount was $38,000 at the
beginning of the year. During the year, the partnership borrows $80,000 on a nonrecourse note and incurs a loss
of $50,000 from operations. Stan’s at-risk amount at the end of the year is $44,000.
FALSE

3. In the current year, Rich has a $40,000 loss from a business he owns. His at-risk amount at the end of the
year, prior to considering the current year loss, is $24,000. He will be allowed to deduct the $40,000 loss this
year if he is a material participant in the business.
FALSE

4. Judy owns a 20% interest in a partnership (not real estate) in which her at-risk amount was $35,000 at the
beginning of the year. The partnership borrowed $50,000 on a recourse note and made a $40,000 profit during
the year. Her at-risk amount at the end of the year is $43,000.
FALSE

5. Tonya owns an interest in an activity (not real estate) that converted recourse financing to nonrecourse
financing. Recapture of previously allowed losses is required if Tonya’s at-risk amount is reduced below zero as
a result of the debt restructuring.
TRUE

6. Kelly, who earns a yearly salary of $120,000, sold an activity with a suspended passive loss of $44,000. The
activity was sold at a loss and Kelly has no other passive activities. The suspended loss is not deductible.
FALSE

7. All of a taxpayer’s tax credits relating to a passive activity can be utilized when the activity is sold at a loss.
FALSE

8. During the year, Lion Company incurs a $25,000 loss on a passive activity, has active income of $17,000, and
portfolio income of $12,000. If Lion is a personal service corporation, it may deduct $17,000 of the $25,000
passive loss.
FALSE

9. Coyote Corporation has active income of $45,000 and a passive loss of $23,000 in the current year. Coyote
cannot deduct the $23,000 loss if it is a personal service corporation.
TRUE

10. Peach Company, a closely held C corporation, incurs a $58,000 loss on a passive activity during the year.
The company has active income of $34,000 and portfolio income of $24,000. If Peach is a not a personal
service corporation, it may deduct the entire $58,000 passive loss.
FALSE

11. Wolf Corporation has active income of $55,000 and a passive loss of $33,000 in the current year. Wolf
cannot deduct the $33,000 loss if it is a closely held C corporation that is not a personal service corporation.
FALSE

12. Nathan owns Activity A, which produces income, and Activity B, which produces passive losses. From a
tax planning perspective, Nathan will be better off if Activity A is passive.
TRUE

13. Anita owns Activity A which produces active income and Activity B which produces losses. From a tax
planning perspective, Anita will be better off if Activity B is a passive activity.
FALSE

14. David participates 580 hours in an activity during the year; others participate for 1,400 hours. David is a
material participant in the activity.
TRUE

15. Joe participates 95 hours in an activity, while an employee participates 5 hours. Joe has materially
participated in the activity.
TRUE

16. Mary Jane participates for 100 hours during the year in an activity she owns. She has no employees and is
the only participant in the activity. The activity is a significant participation activity.
FALSE

17. A taxpayer is considered to be a material participant in a significant participation activity if he or she spends
at least 400 hours in the activity.
FALSE

18. Rachel participates 150 hours in Activity A and 400 hours in Activity B, both of which are nonrental
FALSE

19. Lucy participates for 405 hours in Activity A and 101 hours in Activity B, both of which are nonrental
FALSE

20. From January through November, Vern participated for 420 hours as a salesman in a partnership in which he
owns a 50% interest. The partnership has four full-time employees. During December, Vern spends 110 hours
cleaning the store and painting the walls in order to meet the material participation standards. Vern qualifies as a
material participant.
FALSE

21. Joyce owns an activity (not real estate) in which she participates for 100 hours a year; her husband
participates for 450 hours. Joyce qualifies as a material participant.
TRUE

22. When determining whether an individual is a material participant, participation by an owner’s spouse
generally counts.
TRUE

23. Kathy is a full-time educator, but she owns an apartment building and devotes 550 hours to managing the
activity. All losses from the rental activity will be considered nonpassive and deductible against active income
because she is a real estate professional.
FALSE

24. Bruce owns a small apartment building that produces a $25,000 loss during the year. His AGI before
considering the rental loss is $85,000. Bruce must be an active participant with respect to the rental activity in
order to deduct the $25,000 loss under the real estate rental exception.
TRUE

25. In the current year, Kenny has a $35,000 loss from a real estate rental activity. Kenny provides 1,000 hours
of service to that activity, which is more than half of his working hours for the year. Kenny can deduct the
$35,000 loss.
TRUE

26. Services performed by an employee are treated as being related to a real estate trade or business if the
employee performing the services has more than a 5% ownership interest in the employer.
TRUE

27. In the current year, Abby has AGI of $95,000 and a $40,000 loss from a real estate rental activity in which
she is a 15% owner. If she is an active participant, she can deduct $25,000 of the loss.
TRUE

28. Individuals can deduct from active or portfolio income losses of up to $25,000 from real estate rental
activities in which they actively participate.
TRUE

29. Individuals with modified AGI of $100,000 can deduct against active or portfolio income losses of up to
$25,000 from real estate rental activities in which they actively participate.
TRUE

30. Roger owns and actively participates in the operations of an apartment building which produces a $40,000
loss during the year. He has AGI of $150,000 from an active business. He may deduct $25,000 of the loss.
FALSE

31. Bonnie owns and actively participates in the operations of an apartment building that produces a $40,000
loss during the year. In addition, she has AGI of $100,000 from an active business. Her at-risk amount in the
apartment building is $200,000. She may deduct $25,000 of the loss in the current year, while the remaining
$15,000 is a suspended passive loss.
TRUE

32. Susan dies owning a passive activity with a basis of $75,000, a fair market value of $140,000, and
suspended losses of $80,000. A $15,000 passive loss can be deducted on Susan’s final income tax return.
TRUE

33. Chris receives a gift of a passive activity from his father whose basis was $60,000. Suspended losses related
to the activity are $18,000. Chris will be allowed to offset the $18,000 suspended losses against future passive
income.
FALSE

34. Eric makes an installment sale of a passive activity having suspended losses of $40,000. He collects 25% of
the sales price in the current year, and will collect 25% in each of the next three years. Eric can deduct $10,000
of the passive loss this year.
TRUE

35. Gail exchanges passive Activity A, which has suspended losses of $15,000, for passive Activity B in a
nontaxable exchange. The new owner of passive Activity A can offset the $15,000 suspended losses against
passive income in the future.
FALSE

36. Jared earned investment income of $22,000 and incurred investment interest expense of $14,000 during
2011. He incurred other investment expenses of $7,000 during the year. Jared may deduct $14,000 of
investment interest in 2011.
TRUE

37. Investment income can include gross income from interest, dividends, annuities, and royalties not derived in
the ordinary course of a trade or business; income from a passive activity; and income from a real estate activity
in which the taxpayer actively participates.
FALSE

38. Seth had interest income of $31,000, investment expenses of $28,000, and a long-term capital gain of
$8,000 on an investment. In calculating his net investment income, Seth may deduct a maximum of $11,000
investment interest.
TRUE

39. Earl, who earned investment income of $13,500, incurred investment interest expense of $7,700, and other
investment expenses of $9,000. Earl may carry over $3,200 of investment interest and deduct it in the future.
TRUE

40. In 2011, Judy invested $200,000 for a 25% interest in a limited liability company (LLC) involved in an
activity in which she is a material participant. The LLC reported losses of $680,000 in 2011 and $360,000 in
2012 with Judy’s share being $170,000 in 2011 and $90,000 in 2012. How much of the losses can Judy deduct?

A. $0 in 2011; $0 in 2012.
B. $170,000 in 2011; $0 in 2012.
C. $170,000 in 2011; $30,000 in 2012.
D. $170,000 in 2011; $90,000 in 2012.

41. Which of the following decreases a taxpayer’s at-risk amount?
A. Cash and the adjusted basis of property contributed to the activity.
B. Amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as
security property not used in the activity.
C. Taxpayer’s share of amounts borrowed for use in the activity that is qualified nonrecourse financing.
D. Taxpayer’s share of the activity’s income.

42. In 2011, Pearl invests $80,000 for a 10% partnership interest in an activity in which she is a material
participant. The partnership reports losses of $500,000 in 2011 and $450,000 in 2012. Pearl’s share of the
partnership’s losses is $50,000 in 2011 and $45,000 in 2012. How much of the losses can Pearl deduct?
A. $50,000 in 2011 and $30,000 in 2012.
B. $50,000 in 2011 and $45,000 in 2012.
C. $0 in 2011 and $0 in 2012.
D. $50,000 in 2011 and $0 in 2012.

79. Ramon incurred $83,100 of interest expense related to his investments in 2011. His investment income
included $34,500 of interest and a $37,500 net capital gain on the sale of securities. What is the maximum
amount of Ramon’s investment interest expense deduction in 2011?
A. $19,500.
B. $34,500.
C. $72,000.
D. $83,100.

80. Match the treatment for the following types of transactions.

1. Treatment of a disposition of a The suspended losses are added to
passive activity at death. the basis of the property. 2
Suspended losses are allowed to the
taxpayer to the extent they exceed the
2. Treatment of a disposition of a amount, if any, of the step-up in basis
passive activity by gift. allowed. 1
3. Treatment of suspended credits
when passive activity is sold at a The losses are allowed in the years in
loss. which gain is recognized. 5
4. Treatment of a sale of a passive
activity where all of the realized
gain or loss is recognized The taxpayer keeps the suspended
currently. losses. 6
5. Treatment of an installment Any suspended losses may be used in
sale of a passive activity. the current year. 4
6. Treatment of a nontaxable
exchange of a passive activity. No correct choice is given. 3

81. Sarah purchased for $100,000 a 10% interest in a business venture that is not subject to the passive activity
rules. During the first year, her share of the entity’s loss was $120,000. At the beginning of the second year, the
entity obtained $800,000 of recourse financing. During the second year, Sarah withdrew cash of $20,000, and
her share of the entity’s loss was $25,000. Calculate the amount of loss that Sarah may claim in each of the two
years and determine her at-risk amount at the end of each year.

Initial at-risk amount $100,000
Subtract: Deductible first year loss of $120,000, limited to at-risk amount of
$100,000 (100,000)
At-risk amount at the end of first year $ –0–
Suspended loss at the end of first year $ 20,000

At-risk amount at the beginning of the second year $ –0–
Add: Share of recourse debt 80,000
Subtract: Withdrawal (20,000)
Deductible $25,000 second year loss + $20,000 loss suspended from prior
year (45,000)
At-risk amount at the end of second year $ 15,000

Suspended loss at the end of second year $ –0–

82. In 2011, Emily invests $100,000 in a limited partnership that is not a passive activity. During 2011, her
share of the partnership loss is $70,000. In 2012, her share of the partnership loss is $50,000. How much can
Emily deduct in 2011 and 2012?

Although the passive loss rules do not apply, the at-risk rules limit Emily’s deductions. She can deduct $70,000
in 2011 and her at-risk amount will be reduced to $30,000 ($100,000 – $70,000 deducted). She will be limited
to a $30,000 deduction in 2012 unless she increases her amount at risk. For example, if Emily invests an
additional $20,000 in 2011, her at-risk amount would be $50,000 ($30,000 balance + $20,000 additional
investment), and she would be able to deduct the entire $50,000 loss in 2012.

83. Sam, who earns a salary of $400,000, invested $160,000 for a 40% working interest in an oil and gas limited
partnership (not a passive activity) last year. Through the use of $1,600,000 of nonrecourse financing, the
partnership acquired assets worth $2 million. Depreciation, interest, and other deductions related to the activity
resulted in a loss in the partnership’s initial year of $300,000, of which Sam’s share was $120,000. Sam’s share
of loss from the partnership is $60,000 in the current year. How much of the loss from the partnership can Sam
deduct in each year?

Sam has $160,000 at risk at the end of the partnership’s initial year and can deduct the $120,000 loss in that
year. Sam’s at-risk amount is decreased to $40,000 as a result of the $120,000 loss. Because his at-risk amount
is $40,000 at the end of the current year, he can deduct only $40,000 of the $60,000 loss in the current year.

84. Joyce, an attorney, earns $100,000 from her law practice in the current year. In addition, she receives
$35,000 in dividends and interest during the year. Further, she incurs a loss of $35,000 from an investment in a
passive activity. What is Joyce’s AGI for the year after considering the passive investment?

Joyce cannot deduct the passive loss against active or portfolio income. Therefore, her AGI after considering the
passive investment is $135,000 ($100,000 active income + $35,000 portfolio income).

85. Caroline sells a rental house for $320,000 that has an adjusted basis of $280,000. During the years of her
ownership, $75,000 of losses have been incurred that were suspended under the passive activity loss rules.
Determine the tax treatment to Caroline on the disposition of the property.

Because Caroline disposes of her entire interest in the passive activity, she is able to recognize fully the losses
that had been suspended during the years of her ownership. With the current utilization of the $75,000
suspended loss, a net deductible loss of $35,000 results, which is treated as a loss that is not from a passive
activity.

Net sales price $320,000
Less: Adjusted basis (280,000)
Total gain $ 40,000
Less: Suspended losses (75,000)
Deductible loss ($ 35,000)

86. Seth has four passive activities. The following income and losses are generated in the current year.

Activity Gain (Loss)
A ($60,000)
B (25,000)
C (15,000)
D 10,000
Total ($90,000)

How much of the $90,000 net passive loss can Seth deduct this year? Calculate the suspended losses (by activity).

None. The suspended losses of $90,000 are allocated as follows:

Activity Suspended Loss
A $60,000/$100,000 ´ $90,000 $54,000
B $25,000/$100,000 ´ $90,000 22,500
C $15,000/$100,000 ´ $90,000 13,500
Total suspended loss $90,000

87. Pat sells a passive activity for $100,000 that has an adjusted basis of $55,000. During the years of her
ownership, $60,000 of losses have been incurred that were suspended under the passive activity loss rules. In
addition, the passive activity generated tax credits of $10,000 that were not utilized and suspended. Determine
the tax treatment to Pat on the disposition of the property.

Because Pat disposes of her entire interest in the passive activity, she is able to recognize fully the losses that
had been suspended during the years of her ownership. With the current utilization of the $60,000 suspended
loss, a net deductible loss of $15,000 results, which is treated as a loss that is not from a passive activity.
However, the suspended credits are lost and may not be used. The tax credits are allowed on dispositions only
when there is sufficient tax on the disposition (i.e., due to a gain) to absorb them.

Net sales price $100,000
Less: Adjusted basis (55,000)
Total gain $ 45,000
Less: Suspended losses (60,000)
Deductible loss ($ 15,000)

88. Green, Inc., a closely held personal service corporation, has the following transactions in the current year:
$100,000 of passive losses, $80,000 of active business income, and $20,000 of portfolio income. How much of
the passive loss may Green use to offset other types of income this year?

The passive loss limitations apply to personal service corporations. Therefore, the $100,000 of passive losses
may not be used to offset any other income and is suspended for use in the future when Green generates passive
income or disposes of the passive activity.

89. Tangerine Corporation, a closely held (non-personal service) C corporation, earns active income of
$400,000 in the current year. The corporation also receives $35,000 in dividends during the year. In addition,
Tangerine incurs a loss of $60,000 from an investment in a passive activity. What is Tangerine’s income for the
year after considering the passive investment?

A closely held (non-personal service) C corporation can offset passive losses against active, but not portfolio
income. Therefore, Tangerine’s income is $375,000 [($400,000 active income – $60,000 passive loss) + $35,000
portfolio income].

90. Lloyd, a life insurance salesman, earns a $400,000 salary in the current year. As he works only 30 hours per
week in this job, he has time to participate in several other businesses. He owns an ice cream parlor and a car
repair shop in Tampa. He also owns an ice cream parlor and a car repair shop in Portland and a car repair shop
in St. Louis. A preliminary analysis on December 1 of the current year shows projected income and losses for
the various businesses as follows:

Income (Loss)
Tampa ice cream parlor (95 hours participation) $56,000
Tampa car repair shop (140 hours participation) (89,000)
Portland ice cream parlor (90 hours participation) 34,000
Portland car repair shop (170 hours participation) (41,000)
St. Louis car repair shop (180 hours participation) (15,000)

Lloyd has full-time employees at each of the five businesses listed above. Review all possible groupings for Lloyd’s activities. Which grouping
method and other strategies should Lloyd consider that will provide the greatest tax advantage?

The basic issue relates to how the car repair shops and ice cream parlors should be grouped under the passive
activity rules so as to maximize the tax benefit to Lloyd. The $400,000 salary is active income. If the
participation levels stay the same in the ice cream parlor and car repair shop businesses, all profits and losses
will be passive, assuming each location is a separate activity. As a result, a net passive loss of $55,000 ($89,000
loss + $41,000 loss + $15,000 loss – $56,000 profit – $34,000 profit) would be suspended and not be available
to offset his salary. To mitigate this result, three options should be considered.

Option 1 is based on the significant participation activity rule. If all of the businesses are treated as separate
activities, Lloyd would not be considered a material participant, even under the significant participation activity
rule. Under the significant participation activity rule, the car repair shops would be considered significant
activities, but the ice cream parlors would not. But even with the car repair shops, the total participation is not
expected to exceed the more-than-500 hour threshold (140 + 170 + 180 = 490). If Lloyd could participate 11
more hours in any of the car repair shop businesses, they would be treated as active and the net loss from the car
repair shops of $145,000 ($89,000 + $41,000 + $15,000) could be offset against his salary. Further, if Lloyd
does not participate any more in the other ice cream parlor businesses, their combined $90,000 of income will
be reported as passive income. This characterization as passive could be helpful if Lloyd were to acquire
additional businesses in the future that produce passive losses.
Under option 2, both the ice cream parlor and car repair shop businesses could be combined as a “single
activity” based on common ownership. Because Lloyd has participated more than 500 hours in the five
businesses, the net loss of $55,000 would be considered active and could be used to offset his salary.

Option 3 would combine the car repair shops as one activity based on product while the ice cream parlors would
be treated as a separate activity based on product. As with option 1, if Lloyd could participate 11 more hours in
any of the car repair shop businesses, they would be treated as active, and the net loss of $145,000 ($89,000 +
$41,000 + $15,000) could be offset against his salary. Also, he could treat the ice cream parlors as a single
business and the net income would be passive, which could be helpful in the future if other passive ventures
would be acquired.

91. Samantha invested $75,000 in a passive activity several years ago, and on January 1, 2010, her amount at
risk was $15,000. Her shares of the income and losses in the activity for the next three years are as follows:

Year Income (Loss)
2010 ($20,000)
2011 (15,000)
2012 25,000

How much can Samantha deduct in 2010 and 2011? What is her taxable income from the activity in 2012? (Consider both the at-risk rules as well as
the passive loss rules.)

If losses were limited only by the at-risk rules, Samantha would be able to deduct the following amounts in
2010 and 2011.

Year Loss Allowed* Disallowed
2010 $20,000 $15,000 $ 5,000
2011 15,000 –0– 15,000

$35,000 $15,000 $20,000

*Allowed under the at-risk rules, then reclassified as passive losses and subject to the passive loss limitations.

However, the losses are limited by the passive loss rules as follows:

Year Passive Deductible* Suspended
2010 $15,000 $ –0– $15,000
2011 –0– –0– –0–
$15,000 $ –0– $15,000

In 2012, the $25,000 income increases Samantha’s at-risk amount to $25,000 so she is now allowed to deduct the $20,000 of disallowed losses. The
$25,000 is passive income, which can be offset by $25,000 of suspended losses, leaving a suspended loss of $10,000. At the end of 2012, Samantha
has no unused losses under the at-risk rules, $10,000 of suspended passive losses, and a $5,000 at-risk amount ($15,000 at-risk amount on 1/1/10 –
$15,000 loss in 2010 – $0 loss in 2011 + $25,000 income in 2012 – $20,000 reclassified passive loss in 2012).

92. Ken has a $40,000 loss from an investment in a partnership in which he does not materially participate. He
paid $30,000 for his interest. How much of the loss is disallowed by the at-risk rules? How much is disallowed
by the passive loss rules?

The at-risk limits disallow $10,000 of the deduction ($40,000 loss – $30,000 at risk). Ken is not a material
participant, so the remaining $30,000 is disallowed by the passive loss rules.

93. During the year, James performs the following personal services in three separate activities: 800 hours as a
CPA in his tax practice, 400 hours in a real estate development business (in which he is not a material
participant), and 600 hours in an apartment leasing operation. He expects that losses will be realized from the
two real estate ventures while his tax practice will show a profit. James files a joint return with his wife whose
salary is $200,000. What is the character of the income and losses generated by these activities?

James is a material participant in the tax practice but not in the real estate development business. This causes the
real estate development activity to be classified as passive. Further, the apartment leasing operation is a passive
activity. It is a rental activity and does not qualify for the real estate rental exception given the taxpayers’ level
of income. Therefore, the income from the tax practice may not be offset by either the losses from the real estate
development business or the apartment leasing operation.

James does not qualify for the exception for real estate professionals because he has not spent more than half of
his personal services in real estate trades or businesses in which he materially participates.

94. In the current year, Lucile, who has AGI of $70,000 before considering rental activities, is active in three
separate real estate rental activities and is in the 28% tax bracket. She had $15,000 of losses from Activity A,
$25,000 of losses from Activity B, and income of $20,000 from Activity C. She also had $3,100 of tax credits
from Activity A. Calculate her deductions and credits currently allowed and the suspended losses and credits.

Lucile can utilize $20,000 of losses and $1,400 of credits under the real estate rental activities exception as
follows:

Income (Loss): Activity A ($15,000)

Activity B (25,000)
Activity C 20,000
Net loss ($20,000)
Utilized loss 20,000
Suspended loss $ –0–

Utilized credit $ 1,400

Suspended credit $ 1,700

After deducting the $20,000 loss, Lucile has an available deduction equivalent of $5,000 [$25,000 (maximum loss allowed) – $20,000 (utilized
loss)]. Then the maximum amount of credits Lucile may claim is $1,400 [$5,000 deduction equivalent ´ .28 (marginal tax bracket)] that is allocated to
Activity A.

95. Faye dies owning an interest in a passive activity property (adjusted basis of $150,000, suspended losses of
$52,000, and a fair market value of $180,000). What, if any, can be deducted on her final income tax return?

On Faye’s final income tax return, a deduction of $22,000 is allowed, determined as follows:

FMV of property at death $180,000
Adjusted basis of property (150,000)
Increase (step-up) in basis $ 30,000

Suspended loss ($ 52,000)
Increase in basis 30,000
Suspended loss allowable on Faye’s final income tax return ($ 22,000)

96. Barb borrowed $100,000 to acquire a parcel of land to be held for investment purposes. During 2011, she
paid interest of $11,000 on the loan. She had AGI of $75,000 for the year. Other items related to Barb’s
investments include the following:

Investment income $10,000
Long-term capital gain on sale of stock 7,500
Investment counsel fees 2,000

Barb is unmarried and elects to itemize her deductions. She has no miscellaneous itemized deductions other than the investment counsel fees.

a. Determine Barb’s investment interest deduction for 2011, assuming she does not make any special election regarding the
computation of investment income.
b. Discuss the treatment of Barb’s investment interest that is disallowed in 2011.
c. What election could Barb make to increase the amount of her investment interest deduction for 2011?

a. Barb’s investment interest deduction is limited to net investment income, which is computed as follows:

Income from investments $10,000
Less: Investment expenses* (500)
Net investment income $ 9,500

*Because Barb has no other miscellaneous itemized deductions, the deductible investment expenses are the smaller of (1)
$2,000, the amount of investment expenses included in the total of miscellaneous itemized deductions subject to the 2%-of-AGI
floor, or (2) $500, the amount of miscellaneous expenses deductible after the 2%-of-AGI floor is applied [$2,000 – $1,500 (2%
of $75,000 AGI)].

Barb’s investment interest expense deduction in 2011 would be limited to $9,500, the amount of net investment income. The
balance of $1,500 would be disallowed in 2011.

Total investment interest expense $11,000
Less: Net investment income (9,500)
Investment interest disallowed in 2011 $ 1,500

b. The $1,500 of investment interest disallowed may be carried over and becomes investment interest expense in the subsequent
year subject to the net investment income limitation in 2012.
c. Barb could increase her investment interest deduction by electing to treat the LTCG as investment income. This would increase
her investment income for purposes of calculating her investment interest deduction. So she would be able to deduct the full
$11,000 of investment interest expense. If she makes the election, the amount so elected would not be available for beneficial
alternative tax rate treatment for net capital gain.

97. Explain how a taxpayer’s at-risk amount in a business venture is adjusted periodically.

Once a taxpayer’s initial at-risk amount in an investment is established, it must be revised periodically to reflect
the impact of various events. The at-risk amount generally is increased each year by the taxpayer’s share of
income and decreased by the taxpayer’s share of losses from the activity. In the case of a partnership, the at-risk
amounts are increased when the partnership increases its debt and decreased when the partnership reduces its
debt. Cash and the adjusted basis of property contributed to the activity increase the at-risk amount, while
withdrawals decrease the at-risk amount.

98. Identify how the passive loss rules broadly classify various types of income and losses. Provide examples of
each category.

The passive loss rules require income and losses to be classified into one of three categories: active, passive, or
portfolio. Active income includes salary and wages, profit from a trade or business in which the taxpayer is a
material participant, and gain on the sale of assets used in an active trade or business. Portfolio income includes
interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. The final
category, passive income or loss, is generated by a passive activity. The following activities are treated as
passive: (1) any trade or business or income-producing activity in which the taxpayer does not materially
participate, and (2) subject to exceptions, all rental activities, whether the taxpayer materially participates or
not.

99. Discuss the treatment given to suspended passive activity losses and credits. What happens to an activity’s
unused losses and credits when the activity is sold?

In general, passive losses are deductible to the extent of passive income from all of the taxpayer’s current-year
passive activities. Passive credits can be utilized only against regular tax attributable to passive income. If
passive losses or credits are not used in the current year, they are carried over indefinitely for potential use in
the succeeding years to offset passive income (or regular tax attributable to passive income) in those years.

An activity’s unused (or suspended) passive losses that exist when a taxpayer sells the passive activity may be
used to reduce the gain from the sale, or increase the recognized loss. Thus, the suspended passive losses are
fully utilized in the year of disposition. In contrast, passive credits are allowed on dispositions only when there
is sufficient tax on passive income to absorb them.

100. List the taxpayers that are subject to the passive loss rules and summarize the general impact of these rules
on these taxpayers.

The passive loss rules apply to individuals, estates, trusts, personal service corporations, and closely held C
corporations. Passive income or loss from investments held by S corporations or partnerships flows through to
the owners and the passive loss rules apply at the owner level.

For individuals, estates, trusts, and personal service corporations, losses or expenses generated by passive
activities can be deducted only to the extent of income from all of the taxpayer’s passive activities. The
application of the passive loss rules to closely held (non-personal service) C corporations is slightly different:
these taxpayers may use passive losses to offset active income, but not portfolio income. Any unused passive
losses are suspended and carried forward to future years to offset passive income generated in those years.
Otherwise, suspended losses may be used when a taxpayer disposes of his or her entire interest in an activity.

101. What special passive loss treatment is available to real estate activities?

The special passive loss rules available to real estate activities allow the deduction of all or part of real estate
rental losses against active or portfolio income, even though the activity otherwise is defined as a passive
activity. The special rules are available in two situations:

· Losses from real estate rental activities are not treated as passive losses for certain qualifying real estate professionals.

· Qualifying individuals may deduct up to $25,000 of losses from real estate rental activities against active and portfolio income.
The potential annual $25,000 deduction is reduced by 50 percent of the taxpayer’s AGI in excess of $100,000.

102. When a taxpayer disposes of a passive activity by death, what happens to any unused passive losses?

A transfer of a taxpayer’s interest in an activity by reason of the taxpayer’s death results in suspended losses
being allowed to the decedent to the extent they exceed the amount, if any, of the step-up in basis allowed.
Suspended losses are lost to the extent of the amount of the basis increase. The losses allowed generally are
reported on the deceased taxpayer’s final income tax return.

103. Describe the general rules that limit the deduction of investment interest expense.

The deduction of investment interest expense is limited to net investment income for the year. Any investment
interest expense not deducted in the current year is carried over for potential use in succeeding years.

Investment interest expense is interest incurred on borrowed funds used to acquire or continue to hold
investment assets. Net investment income is investment income (e.g., interest, annuities, royalties) reduced by
investment expenses (i.e., deductible expenses directly connected to the production of investment income).

104. Identify the types of income that are classified as investment income. Discuss the flexibility that a
taxpayer has with respect to certain types of income that may potentially be considered investment income.

Investment income is gross income from interest, dividends (in certain cases), annuities, and royalties not
derived in the ordinary course of a trade or business. Passive activity income and income from a real estate
activity in which the taxpayer actively participates are not included as investment income.

The taxpayer may elect to treat net capital gain and qualified dividends as investment income. Net capital gain
includes gain attributable to the dispositions of property producing investment income or held for investment
purposes. Qualified dividends are dividends that are taxed at the same marginal rate that is applicable to a net
capital gain. If the taxpayer elects to treat net capital gain and qualified dividend income as investment income,
they may not be taxed using the preferential capital gains rates.

Comprehensive volume chapte chapter 11

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Comprehensive volume chapte chapter 11