Question 1

During the year, R earned a salary of $100,000 and received interest and dividend income.In addition, his interest in a limited partnership, in which he is a passive investor, produced a loss of $5,000.Which of the following statements is true?

Accepted Answer

As a passive investor in a limited partnership, R's loss of $5,000 is considered a passive activity loss. He cannot deduct it against his salary and other non-passive income. However, R can carry over the loss to future years to offset future passive income or to deduct it in full when he disposes of his interest in the limited partnership. Therefore, option C is true.

Question 2

The at-risk rules effect which of the following?

Accepted Answer

The at-risk rules limit the amount of loss a taxpayer can claim to the amount they have at risk in the activity, affecting whether losses can be deducted in the current year.

Question 3

Among the three businesses that F owns, the only one that does not make a profit is a restaurant.F has spent about 400 hours this year trying to turn the business around.He has spent about 350 hours in each of the other two activities (a total of 700 hours).F may offset the loss attributable to the restaurant against the profits from his other businesses.

Accepted Answer

According to the information given, F can offset the loss from the restaurant against the profits from his other businesses. Therefore, the statement is true.

Question 4

Interest expense incurred by a passive activity in which a taxpayer has an interest can be deducted against any interest income that the taxpayer has.

Accepted Answer

Interest expense from a passive activity can only be deducted against income from the same passive activity, not against any interest income.

Question 5

In a tax shelter investment, phantom income and turnaround are most likely to be attributable to which of the following?

Accepted Answer

Phantom income and turnaround are most likely to be attributable to deferral because deferral allows investors to postpone paying taxes on income until a later date. This can create a situation where investors have income that is not taxed, but they still have the cash flow from the investment. This can lead to phantom income, which is income that is not taxed but is still reported on the investor's tax return. Turnaround is a situation where an investment that was initially losing money starts to make money. This can be caused by a number of factors, but one common factor is deferral. Deferral can allow investors to hold onto an investment for longer than they would otherwise be able to, which can give the investment time to turn around.

Question 6

E owns a condominium on the Emerald Coast of Florida.The condominium is contained in a 12 story high rise overlooking the beach.This year the management company that manages the unit for E rented it to an elderly couple from Michigan for the months of January through April.The management company provided telephone, cable, trash removal, and laundry service.Assuming the average rental period was about 30 days, E's activity is treated as a rental activity for purposes of the passive loss rules.

Accepted Answer

The rental of the condominium by E is considered a rental activity for purposes of the passive loss rules, even if the management company provided services such as telephone, cable, trash removal, and laundry.

Question 7

V owns a small beach-front cottage (her second home), which she rented out during the past year.She is actively involved in this rental activity, which is her only venture of this type.She rented the cottage for 200 days during the year for $10,000.She also used it personally for 18 days.During the year, expenses allocable to the rental activity were, interest $5,000, taxes $4,000, maintenance and insurance $1,000, and depreciation expenses allocable to the cottage of $4,000.For the year, her adjusted gross income was $80,000.With respect to the expenses attributable to the rental, V may

Accepted Answer

V may deduct all expenses directly related to the rental activity, which includes interest, taxes, maintenance and insurance, and depreciation expenses allocable to the cottage. The total expenses amount to $14,000 ($5,000 + $4,000 + $1,000 + $4,000). Since V actively participates in the rental activity, she may deduct up to $25,000 in rental real estate losses against her other income, subject to certain limitations. However, since her rental income of $10,000 exceeds her rental expenses of $14,000, she may only deduct the actual expenses of $14,000.

Question 8

J owns a vacation home (his second home) in Michigan.During the year, he rented it out for two weeks and used it for personal purposes three weeks.His expenses directly related to renting out the property were, utilities, $280, and maid service, $75.The portion of taxes allocable to the rental activity was $50.Income from the rental was $300.J will

Accepted Answer

Since J rented out the vacation home for less than 15 days during the year, the rental income is not reportable, and no expenses related to the rental can be deducted.

Question 9

H owns an apartment complex of 30 units.One of his tenants manages the property in exchange for use of an apartment rent-free.H makes all of the major decisions regarding the units and is in regular contact with his manager.This year, the complex generated a loss of $35,000.Assuming H's A.G.I.is $120,000, H may deduct

Accepted Answer

Since H owns an apartment complex and is actively involved in managing it, he can deduct up to $25,000 of losses from his nonpassive rental real estate activities against his AGI. However, since the loss of $35,000 exceeds the maximum allowable deduction, he can only deduct $15,000 in the current tax year and carry over the remaining $20,000 to future years.

Question 10

J owns a 50 percent interest in an S corporation.This year the S corporation produced a loss of $100,000.In determining the amount of loss that J may deduct, which of the following statements is true?

Accepted Answer

The at-risk limitations are applied before the passive loss limitations for calculating the amount of loss deductible by an individual in an S corporation. Therefore, J's deductible loss would first be limited by the at-risk rules before considering any passive loss limitations.

Question 11

One of the reasons the at-risk rules did not achieve their objective and the passive loss rules were required concerned

Accepted Answer

The at-risk rules only limited the amount a taxpayer could deduct to their investment in an activity, but did not consider the debt used to finance that investment. Taxpayers could use nonrecourse debt to increase their investment and therefore increase their deductions, without truly risking their own resources. This loophole was closed with the passive loss rules, which limited deductions based on the amount of the taxpayer's economic investment in the activity, including both equity and debt.

Question 12

J owns a condominium in Myrtle Beach.He rented it out for seven months during the year (210 days).During the year, J used the condo for personal purposes for less than 15 days.J does not have to report any of the income but he is not entitled to deduct any of the related expenses.

Accepted Answer

J must report the rental income on their tax return, but they can deduct certain rental expenses such as mortgage interest, property taxes, and repairs/maintenance. However, because the unit was used for personal purposes for less than 15 days, J may still be able to claim the personal use portion of mortgage interest and property taxes as itemized deductions on Schedule A.

Question 13

M is a 25 percent limited partner in an oil and gas partnership.He acquired his interest in the partnership by contributing $5,000 cash and land with an adjusted basis to him of $6,000 and a fair market value of $10,000.The partnership has outstanding recourse debt of $30,000 and outstanding nonrecourse debt of $80,000 on December 31, 20X1 and 20X2.For 20X1 the partnership produced a loss of $100,000.Ignoring the passive loss rules, how much of this loss may he deduct?

Accepted Answer

The correct answer is A.The partner's share of the partnership loss is $25,000 (25% x $100,000). However, the partner's basis in the partnership is only $11,000 ($5,000 cash + $6,000 adjusted basis of land). Therefore, the partner's deductible loss is limited to $11,000.

Question 14

G owns a small rustic farm (her second home) in New England, which she rented out to tourists during the past year.She is actively involved in this rental activity, which is her only venture of this type.She rented the farm for 200 days during the year for $10,000.She also used it personally for 35 days.During the year, expenses allocable to the rental activity were, interest $5,000, taxes $4,000, maintenance and insurance $1,000, and depreciation expense allocable to the cottage of $4,000.For the year, her adjusted gross income was $160,000.With respect to the expenses attributable to the rental, G may

Accepted Answer

CG can deduct expenses up to the amount of rental income received, which is $10,000. This includes the interest, taxes, maintenance, and insurance expenses totaling $10,000. Additionally, since G is actively involved in the rental activity and it is her only such venture, she can also deduct depreciation expense, making the total deductible expenses $14,000. However, the deduction of depreciation is subject to the passive activity loss rules, which may allow her to deduct it against her rental income. Since her adjusted gross income is $160,000, she may not be able to deduct the full amount of depreciation if it creates a loss, but she can still deduct up to the amount of her rental income.

Question 15

Tax shelters are typically built on three elements, including

Accepted Answer

Tax shelters are built on deferral, conversion, and leverage. Deferral involves delaying or spreading out taxable events to a later time when tax rates may be lower or the taxpayer's overall income may be lower. Conversion involves converting income from a taxable source to a non-taxable source, such as converting traditional IRA funds to a Roth IRA. Leverage involves using borrowed money to invest and taking advantage of the tax deduction for the interest paid on the loan. All three elements are typically used to create tax shelters.

Question 16

L owns a condominium at Cape Cod.This year he rented it out for 210 days.During the year, L used the condo for personal purposes for two weeks during June.Interest expense on the unit's mortgage for the year allocable to the personal use was $9,000.The $9,000 of interest expense is deductible assuming the condominium qualifies as L's primary or secondary residence.

Accepted Answer

The interest expense is not deductible as personal interest because the condo was rented out for more than 14 days, making it a rental property for tax purposes, and the personal use does not qualify it as a primary or secondary residence under these circumstances.

Question 17

K owns a condominium in Vail.This year he rented it out for 210 days.During the year, K used the condo for personal purposes for the entire month of December.The activity is not treated as a rental activity for purposes of the passive loss rules.

Accepted Answer

K used the condo for personal purposes for the entire month of December. The activity is not treated as a rental activity for purposes of the passive loss rules. So, K can deduct the rental income and expenses from the rental activity.

Quiz 12: Deductions for Certain Investment Expenses and Losses