Income Tax-M7: Multiple Choice

12. Last year, Geoff invested $70,000 for a 25% interest in a partnership in which he was not a material participant. The partnership made a profit last year, of which $19,000 was allocated to Geoff. This year, the partnership suffered a loss and Geoff's share was $28,000. What is Geoff's capital at risk in the partnership at the end of the current year? A. $61,000 B. $51,000 C. $38,000 D. $48,000

A. $61,000 At the beginning of this year, Geoff had capital at risk of $89,000 ($70,000 initial investment + $19,000 allocated profit). At the end of the current year, Geoff's capital at risk is $61,000 ($89,000 beginning capital at risk - $28,000 allocated loss).

16. Mack owns a vacation home that he plans to rent for 190 days this year. He also plans to live in the house during the year. What is the maximum number of days he can live in the home without jeopardizing the property's status as a rental property? A. 19 days B. 95 days C. 14 days D. 140 days

A. 19 days Because he will rent the home for 190 days, Mack can use it as a personal residence for up to 19 days (the greater of 14 days or 10% of rental use) without jeopardizing the property's status as a rental property.

7. Which of the following business forms may be tax conduits? I. General partnership II. Limited partnership III. Publicly traded C corporation IV. S corporation A. I, II, and IV B. I and IV C. I, II, and III D. II, III, and IV

A. I, II, and IV General partnerships, limited partnerships, and S corporations may all be tax conduits.

14. Which of the following statements correctly identify the requirements necessary to deduct $25,000 of losses from an active participation real estate program? I. The property cannot be used as a vacation home for more than 14 days or 10% of the number of days during the year that the home was rented at a fair rental price., whichever is greater II. The taxpayers can file as MFS. III. The taxpayer must make the major management decisions related to the property. IV. The taxpayer's interest in the property may not be held as a limited partnership interest. A. I, III, and IV B. II and IV C. II, III, and IV D. I and III

A. I, III, and IV If the taxpayers file with the MFS status, the deduction is limited to $12,500. All other statements are true.

Carryover Losses: Janet has carryover losses of $25,000 from a RELP. Her AGI is $200,000 for the current year. She still owns her interest in the RELP. What can Janet do to use her RELP losses against her other income in the current year? i. Sell her entire interest in the RELP to an unrelated party ii. Buy a MLP that generates income A. I only B. II only C. Both I and II D. Neither I nor II

A. Losses from a nonpublicly traded partnership may offset only income from another nonpublicly traded partnership. Her only option is to attempt to sell her entire interest in the RELP to an unrelated party.

13. Which business entity is never subject to federal income taxation? A. Partnership B. Individual C. S corporation D. C corporation

A. Partnership Partnerships are never subject to federal income tax. They are pass-through entities. C corporations and individuals are separately taxed, and certain S corporation transactions are taxed at the entity level.

3. Which of the following statements correctly identify the requirements necessary to deduct $25,000 of losses from an active participation real estate program? I. The taxpayer must have at least a 10% ownership interest in the property. II. The taxpayer's modified adjusted gross income must not exceed $200,000. III. The taxpayer must make the major management decisions related to the property. IV. The taxpayer's interest in the property may not be held as a limited partnership interest. A. I, III, and IV B. II and IV C. I and III D. II, III, and IV

A. The answer is I, III, and IV. II is false because the phase out range for the active participation real estate deduction is $100,000 to $150,000.

Passive Activity: Louise inherited a home at her parents' deaths earlier this year. She has been renting it to tenants since that time. It is her only rental property and she handles everything from the lease to the repairs. This does not interfere with her full-time employment as an insurance broker. When she reports her income and expenses for the rental, she will treat it as A. a passive activity and follow the passive activity at-risk and loss rules. B. a material participation business. C. a tax shelter. D. a direct participation program.

A. When she reports her income and expenses for the rental, she will treat it as a passive activity and follow the passive activity at-risk and loss rules.

11. During the current tax year, Meghan expects to have the following items of income: Distributive share of general partnership self-employment income $25,000 Distributive share of S corporation income $17,000 Sole proprietorship net income $1,500 How much self-employment tax must Meghan pay for the 2020 tax year (round your answer to the nearest dollar)? A. $4,974 B. $3,744 C. $200 D. $4,055

B. $3,744 The partnership and sole proprietorship income are included. The S corp distribution is treated as a dividend not subject to SE tax. ($26,500 x .9235) x .153 = $3,744

Rental Property: Chris owns a vacation home that he plans to rent for 190 days this year. He also plans to use the home for personal use. What is the maximum number of days he can live in the home without jeopardizing the property's status as primarily for rental use? A. 14 days B. 19 days C. 95 days D. 190 days

B. Because Chris will rent his vacation home for 190 days, he can use the home as a personal residence for up to 19 days (the greater of 14 days or 10% of rental use) without jeopardizing its status as primarily for rental use.

8. Jason and Sarah are accountants and are considering starting a business together. They will both be general partners. Jason and Sarah prefer the partnership form but are concerned about liability issues. Specifically, neither wants to be liable for the acts of the other. Which of the following forms would best suit Jason and Sarah? A. Limited partnership B. Limited liability partnership C. General partnership D. S corporation

B. Limited liability partnership In an LLP, the general partners are not liable for the acts of other partners. In addition, some states will protect the general partners from the claims that arise from obligations of the partnership, but this typically extends only to claims arising out of tort law, not contract law.

9. All of the following statements regarding tax deduction limits on passive activity excess losses are correct except A. excess passive activity losses are the excess of otherwise allowable deductions from the taxpayer's passive activities over the amount of income from the taxpayer's passive activities. B. losses from one nonpublicly traded passive activity may not offset income from another nonpublicly traded passive activity. C. excess passive activity losses are disallowed on the taxpayer's current tax return and instead are deferred. D. excess passive activity losses are fully allowed in the year in which the taxpayer disposes of his entire interest in the passive activity in a taxable transaction.

B. losses from one nonpublicly traded passive activity may not offset income from another nonpublicly traded passive activity. The taxpayer's nonpublicly traded passive losses and nonpublicly traded passive income are aggregated for purposes of the limitation so that losses from one nonpublicly traded passive activity may offset income from another nonpublicly traded passive activity.

6. Which of the following statements regarding the rights of a limited partner is CORRECT? I. A limited partner has no right to take part in the management of the partnership. II. A limited partner is not subject to personal liability for partnership debts. A. Neither I nor II B. I only C. Both I and II D. II only

C. Both I & II Both of these statements are correct.

15. Which of the following may enable a limited partnership to provide specific tax advantages (subject to certain limits)? I. It allows for special allocations. II. It is not subject to the at-risk rules. III. Its distributions may trigger the alternative minimum tax. A. I and II B. II and III C. I only D. I and III

C. I only The partnership business form allows for special allocations. Partners are still subject to at-risk rules and AMT.

Suspended Losses: Joseph, age 54 and single, earns a salary of $190,000 working for a manufacturing company. He is an avid saver and over the years has amassed an investment portfolio of $2 million. He expects the portfolio to appreciate in value at an average rate of 8% per year. Last year, he received dividends and interest from the portfolio of $40,000. After speaking with a financial planner, Joseph decided to invest $50,000 of his portfolio to purchase a 15% interest in a passive activity. Operations of the activity have now resulted in a loss of $400,000, of which Joseph's share is $60,000. How is Joseph's loss for the current year characterized for income tax purposes? A. $60,000 is suspended under the passive activity loss rules. B. $60,000 is suspended under the at-risk rules. C. $10,000 is suspended under the at-risk rules, and $50,000 is suspended under the passive activity loss rules. D. $50,000 is suspended under the at-risk rules, and $10,000 is suspended under the passive activity loss rules.

C. The at-risk rules must be applied before the passive loss rules. Joseph invested $50,000 in the passive activity. Therefore, his at-risk amount is $50,000. Because his share of the loss from the activity is $60,000, Joseph will be allowed to deduct only $50,000, his amount at risk. In addition, $10,000 of the loss ($60,000 total - $50,000 deductible under at-risk rules) has been suspended because of the at-risk rules and must be carried forward. Even though Joseph has a $50,000 loss after applying the at-risk rules, he still is not permitted a deduction for the loss because he has no passive income. Through application of both rules, the entire loss of $60,000 is suspended for the current tax year.

5. John is a single taxpayer. He has an annual salary of $88,000 per year. In addition, he § had consulting income of $4,000, § incurred losses of $5,000 from active participation real estate, and § had short-term capital losses of $4,900. What is John's total (gross) income for the current tax year? A. $87,000 B. $82,100 C. $86,000 D. $84,000

D. $84,000 The consulting income is included, meaning $84,000 is correct. The rental loss is allowable and used to calculate total income (Schedule E). The short term capital loss is capped at $3,000.

10. Lauren owns a vacation home that she also rents to others during the year. The house was rented to unrelated parties for 11 full weeks during the current year. Lauren used the house 16 days for her vacation during the year. After properly dividing the expenses between rental and personal use, it was determined that a loss was incurred as follows: Gross rental income $6,400 Less: Allocated mortgage interest and property taxes ($7,000) Other allocated expenses ($1,000) Net rental loss ($1,600) Which of the following statements regarding the treatment of the rental income and expenses on Lauren's federal income tax return for the current year is CORRECT? A. A $1,600 loss should be reported. B. Because the house was used only 20.8% personally by Lauren, all expenses allocated to personal use may be deducted. C. The $7,000 rental portion of mortgage interest and taxes cannot be deducted. D. Because Lauren used the house for 16 days, the mortgage interest and property taxes are deductible as a rental expense to the extent of the gross rental income of the property.

D. Because Lauren used the house for 16 days, the mortgage interest and property taxes are deductible as a rental expense to the extent of the gross rental income of the property. A vacation home can be classified as a personal residence, a rental property, or a mixed-use property. A personal residence is a property that is rented out for less than 15 days per year. Because the beach house was rented for 11 weeks, it will be classified as either a rental property or a mixed-use property. The determination is based on the number of days the taxpayer used the residence for personal use. To qualify as rental property, the personal use cannot exceed the greater of 14 days per year or 10% of rental days. The property was used for personal use for 16 days, so the vacation home will be considered a mixed-use property. Expenses incurred on a mixed-use property must be allocated between rental use and personal use. The rental expenses on a mixed-use property are only deductible to the extent of rental income received (i.e., the taxpayer cannot claim a loss). The expenses not deducted in the current year may be carried forward.

Limited Partnership Your client, Marian, has substantial unused passive losses from a nonpublicly traded limited partnership. She would like to find an investment that would allow her to utilize her passive losses. Which of these is the most appropriate investment for Marian? A. A master limited partnership generating income B. Certificates of deposit generating portfolio income C. A publicly traded limited partnership generating income D. A nonpublicly traded partnership generating income, in which Marian will not materially participate

D. Only the passive nonpublicly traded partnership generating income (PIG) would allow her to use her otherwise unused passive losses.

At-Risk Rules: In the current year, Bob invested $50,000 for a 20% interest in a partnership in which he was a material participant. The partnership incurred a loss, and Bob's share was $75,000. Which of the following statements regarding Bob's investment is NOT correct? A. Because Bob has only $50,000 of capital at risk, he cannot deduct more than $50,000 against his other income. B. Bob's nondeductible loss of $25,000 may be carried forward and used when the at-risk rules permit the claiming of such amount. C. If Bob has taxable income of $30,000 from the partnership in the following year (and no other transactions that affect his at-risk amount), he can use all of the $25,000 loss carried forward from this year. D. Bob's $75,000 loss is nondeductible in the current year and in the following year under the passive activity loss rules.

D. The correct analysis of the tax treatment of Bob's income is that he is limited to a $50,000 deduction against his other income because of his at-risk amount. The remaining $25,000 is a loss carryforward. If he has taxable income of $25,000 or more in subsequent years, Bob's disallowed loss may be taken. Because Bob is a material participant in the partnership, the passive activity loss rules do not come into play.

2. Which of the following statements best describes a tax benefit associated with an active participation rental real estate investment? A. The first $25,000 of taxable income from the investment is nontaxable. B. The investment will generate portfolio rather than passive income. C. Unlimited losses may be used to offset active or portfolio income of any taxpayer. D. Up to $25,000 in losses may be used to offset active or portfolio income for certain taxpayers.

D. Up to $25,000 in losses may be used to offset active or portfolio income for certain taxpayers Active participation rental real estate investment operating losses are deductible against active or portfolio income up to $25,000 per year, assuming the investor's AGI is $100,000 or less.