ACTG 395 - Chapter 6

Charlie and Lucy have a home in Louisville, Kentucky. During the week of the Kentucky Derby, Charlie and Lucy go on vacation and rent their home to a family who wants to attend the derby festivities and the races. Charlie and Lucy receive net rental income of $2,500 for the week. They spend about $500 to stock the bar and provide amenities for their tenants. Utilities, insurance, and interest expense for that week total $300. What is the amount of net rental income Charlie and Lucy will report from this transaction?

$0 Reason: Since the home is NOT rented for 14 days or more, the rental revenue and expenses are not reported.

Darin is a 25% owner in a partnership in which he has a tax basis of $7,000 and an at-risk basis of $5,000. Darin materially participates in the operations of the partnership which incurred a loss of $40,000 in the current year. Based on these facts,

$10,000 of the loss will flow-through to Darin, and he will be able to deduct $5,000.

Darlene is a 50% owner in a partnership in which she has a tax basis and at-risk basis of $10,000. Darlene materially participates in the operations of the partnership which incurred a loss of $35,000 in the current year. Based on these facts,

$17,500 of the loss will flow-through to Darlene, and she will be able to deduct $10,000. Reason: Darlene's percentage of the loss is 50%, so she will have a $17,500 loss flow-through to her. But, since she only has $10,000 at risk, she is limited to deducting only $10,000.

Sharon has a 2,800 square foot home with an additional 1,200 square foot basement. She is an artist and uses the basement exclusively as her painting studio. Sharon can deduct _______________ % of the direct expenses of her basement studio and _____________ % of the indirect costs from maintaining and using her home as a home office deduction.

100 30

A property is considered a "residence" if the taxpayer uses the home for more than the greater of _______ days or ___________% of the number of rental days during the year.

14; 10%

Cyndi has a second home in Mississippi. She rented the home to non-family members for 20 days last year. What is the minimum number of days that she must have used the home for personal purposes in order for it to be considered a residence?

15

The entire $25,000 deduction for rental real estate is phased out when the taxpayer's AGI reaches $

150,000

If a taxpayer is an active participant in a rental activity, she may be allowed to deduct up to $ __________ in rental losses against other types of income

25000

Arnie has a second home in Utah. He rented the home to non-family members for 250 days last year. What is the minimum number of days that Arnie must have used the home for personal purposes in order for it to be considered a residence?

26 Reason: The house must be used for more than the greater of 14 days or 10% of the rental days. So, the minimum is 26 days.

Jay, a single taxpayer, has a 2023 business loss from a partnership. Assuming the loss is deductible under the basis, at-risk amounts, and passive loss rules, what is the maximum amount that Jay can deduct in 2023?

289,000 Reason: The excess business loss limitation is $289,000 for single taxpayers.

When using the simplified method, the deduction for home office expenses is $_____ x business use square footage with a maximum deduction allowed of $____. In addition to this amount, taxpayers are allowed to deduct _____ percent of their mortgage interest and property tax as itemized deductions.

5 1500 100

Travis has a 2,400 square foot home. He is a sales representative for a pharmaceutical company and uses one room of his home exclusively for his business. The area of the office is 240 square feet. During the past year, he painted his office and replaced the door at a cost of $500; paid for utilities for his home, $3,000; paid property taxes, $1,500; paid mortgage interest, $3,600; and replaced a door jam and door for his patio, $600. Travis has $ ______________ in deductible direct expenses and $____________ in deductible indirect expenses

500 810

For 2023, the maximum contribution that a taxpayer under age 50 at year end can make into a Roth IRA is $______________ which is ______________ (equal to/higher than/lower than) the allowable contribution for a traditional IRA. (Please use only ONE word per blank.)

6500; equal to

Which of the following statements is correct regarding IRA contributions for married taxpayers who file a joint tax return?

A non-earning spouse's deductible contribution is limited to total earned income of both spouses reduced by contributions to the other spouse's IRAs.

Which of the following statements regarding material participation is TRUE?

A taxpayer can be materially participating by being involved in more than one activity if the total hours of involvement meet certain levels.

Which of the following statements regarding material participation is FALSE?

A taxpayer must be involved in a business on a full-time basis throughout the year to be considered materially participating.

The operating loss from a passive activity can NOT be used to offset which categories of income?

Active business and portfolio income

Which of the following statements are CORRECT when referring to a home that qualifies as a residence with significant rental use? (Check all that apply.)

All rental income is included in gross income. The taxpayer rents the home for 15 days or more. All direct rental expenses such as advertising are fully deductible.

Which of the following may further restrict the deductible contribution limit of a traditional IRA? Amount of taxpayer's earned income Whether the taxpayer is self-employed Taxpayer's filing status Taxpayer's age Whether the taxpayer is an active participant in an employer-sponsored retirement plan

Amount of taxpayer's earned income Taxpayer's filing status Whether the taxpayer is an active participant in an employer-sponsored retirement plan

Which of the following is meant to limit the ability of investors to deduct "artificial" ordinary losses produced with certain types of debt?

At-risk amount rules

Deductions for business expenses are reported on Schedule ____________ of the individual's Form ____________ , the main document of the individual tax return.

Blank 1: C, c, or Schedule C Blank 2: 1040

Entities such as partnerships, LLCs, and S corporations are known as ___________________ ___________________ entities because their income is reported on the owners' tax returns. Any expenses or losses from these entities are typically deductible ___________________ AGI

Blank 1: flow or pass Blank 2: through Blank 3: for

A taxpayer's income or loss for the year is classified into one of three categories: _______________ income/loss, _______________ income/loss, and _______________ income/loss.

Blank 1: passive or passive activity Blank 2: portfolio Blank 3: active or active business

Corey has a $1,200 home office deduction carryforward from the prior year. He has decided to use the simplified method for calculating the home office deduction in the current year. Which of the following statements is CORRECT regarding the home office deduction?

Corey cannot use the actual expense carryforward as a deduction in the current year if he is using the simplified method. Reason: Corey cannot use the actual expense carryforward in a year where he uses the simplified method, but it will be available in a year where he switches back to the actual method.

Mike sold equipment he is no longer using in his business at a loss of $4,000, and he sold investments at a loss of $8,000. Mike had no other sales of property in the current year. What are the tax implications of these losses to Mike?

Deduct the $4,000 loss on equipment and $3,000 of the loss on investment in the current year. The remaining investment loss is carried forward. Reason: Business losses are fully deductible for AGI, but taxpayers are only allowed to deduct capital losses (investment) against capital gains. Any excess capital loss is allowed to reduce AGI by $3,000 in the current year. The remainder is carried forward.

Which of the following statements are CORRECT when comparing For AGI deductions to From AGI deductions? (Choose all that apply.)

Deduction for AGI reduce AGI thus reducing the limitations on other tax benefits that are decreased or phased out for higher income taxpayers. Certain from AGI deductions may not have an effect on taxable income despite the taxpayer incurring the expense.

Which of the following statements is INCORRECT regarding a residence with significant rental use?

Direct rental expenses are allocated between personal and rental use.

Edward is a partner in ENS, Ltd. The partnership generated a loss during the current year. Edward's share of the loss was $7,000. How should Edward handle the loss for tax purposes assuming there are no basis, at-risk, or passive loss limitations?

Edward can deduct $7,000 for AGI. Reason: The loss is deducted FOR AGI. There is no limitation on the loss because it is not a capital loss.

Which of the following expenses are deductible FOR AGI? (Check all that apply.)

Expenses generated by rental and royalty activities Most expenses generated by business activities

If only one spouse is an active participant in an employer sponsored retirement plan, the non-participating spouse can maximize his or her allowed IRA deduction by choosing the married filing separately status.

FALSE Reason: Under these conditions, choosing the married filing separately status will prohibit a deduction for either spouse if MAGI is $10,000 or more. The phase-out is much less restrictive when filing jointly.

True or False: Taking a home office deduction will always result in a taxpayer having to recognize gain that would otherwise be excluded under the home sale exclusion provisions.

FALSE Reason: Even though contributions are NOT deductible, the maximum level of the allowed contribution may be phased out at higher levels of AGI.

True or false: When renting a vacation home to a relative, the days used will be considered "rental days" as long as the relatives are charged the fair market rental value. The days used will count as "personal use" if the rental fee is below the fair market value.

FALSE Reason: Personal use includes days the taxpayer's relatives stay in the home even if rented a fair market value to the relatives.

True or false: A self-employed individual may deduct the cost of his self-employed health insurance premiums even if his spouse's employer offers family coverage to him.

FALSE Reason: The cost of his self-employed health insurance as a For-AGI deduction is not allowed because he has employer-provided coverage available to him.

True or False: The passive activity loss rules are applied prior to the consideration of tax-basis and at-risk amount loss limits.

FALSE Reason: The passive activity loss rules are applied to any losses that clear the tax-basis and at-risk amount loss limits.

True or False: Taking a home office deduction will always result in a taxpayer having to recognize gain that would otherwise be excluded under the home sale exclusion provisions.

FALSE Reason: This can be true if a taxpayer takes a depreciation deduction using the actual expense method. If the simplified method is used, gain will not have to be recognized.

Expenses associated with generating rental or royalty income are deductible ________ AGI

FOR

True or false: Business expenses are deducted for AGI and reported directly on Form 1040.

False Reason: The revenues and expenses of a business are reported on a separate schedule. The resulting profit or loss is transferred to the Form 1040.

When a nonqualified distribution is received from a Roth IRA, what is the deemed order of the funds distributed?

First from taxpayer contributions; second from account earnings

Which of the following statements is INCORRECT regarding the treatment of revenues and expenses for a residence with significant rental use?

For tax purposes, rental expenses can NOT exceed rental revenues. Reason: If the tier 1 expenses exceed the rental revenue, the property will result in a deductible loss. Otherwise, the expenses are limited to gross rental revenues.

Which of the following situations involving an early distribution of an IRA would result in an exception where the taxpayer would NOT incur the 10% penalty? (Check all that apply.)

Funds are used for qualified higher education expenses. Funds are used for a first-time home purchase. Funds are used for qualifying medical expenses.

Matt and Sarah are selling their home and moving to a new neighborhood. Sarah is going to start college in the fall. She did NOT attend college after high school and is now embarking on her degree. Matt was injured recently in a motorcycle accident and the couple has some very high medical expenses that are coming due. They have considered liquidating their traditional IRAs in order to cover some of these costs. Which types of expenditures can they make from funds in their IRAs without incurring a 10% penalty for early withdrawal?

Higher education and medical expenses

An individually managed retirement plan with tax advantages similar to an employer provided defined contribution plan is known as a(n):

IRA

Which of the following statements regarding the simplified method of home office deduction is incorrect?

If a taxpayer has a prior year carryover and chooses to use this method, the carryover is lost forever.

Which of the following statements is correct?

In order to contribute to an IRA, taxpayers must meet certain eligibility requirements.

Which of the following statements is INCORRECT regarding losses on rental activities?

In order to deduct a loss from a rental activity, the owner must be a material participant in the rental activity.

Choose the statement that is INCORRECT regarding a loss that is generated from the disposal or sale of assets for individuals.

Losses from personal use assets are deductible for AGI.

Horatio and Maria are married and have three children. Horatio is self-employed and pays health insurance premiums for himself and his family. Which of the following situations would disqualify part or all of the premium costs from being deductible for AGI?

Maria has an employer-sponsored health insurance plan available at work, but they do not participate.

Which of the following characteristics are required for a business expense to be deductible? (Check all that apply.)

Necessary Ordinary Directly related to business activity

Which of the following statements is INCORRECT regarding flow-through entities?

Operating income from flow-through entities may or may NOT be taxable in the current year, depending on certain limits imposed on the taxpayer.

Which of the following descriptions BEST defines business activities?

Profit-motivated and requiring a high level of effort from the taxpayer

Which of the following descriptions BEST defines investment activities?

Profit-motivated, but not requiring a high level of effort from the taxpayer

Jacki owns a house that is considered a nonresidence for tax purposes. She lived in the house for 10 days and rented it out for 250 days during the year. Which of the following statements are correct? (Check all that apply.)

Rental expense deductions for the property are NOT limited to gross income. Any loss on the property is considered a passive loss.

Contributions are not deductible and qualified distributions are not taxable from a(n) ________ IRA

Roth

Which of the following statements regarding Roth IRAs is NOT correct?

Roth IRAs are NOT subject to phase-out rules that limit their contribution level.

Two types of tax-advantaged retirement savings opportunities available to self-employment individuals are ______________ IRAs and _____________ 401(k)'s

SEP; individual

Sandy owns a 2-bedroom house with a living room, 2 bathrooms, a kitchen/dinette, and a basement. Which of the following qualify for a home-office deduction? (Check all that apply.)

Sandy has turned the second bedroom into her office for billing and bookkeeping related to her business. She replaced the bedroom furniture with office furniture. Sandy uses her basement as a photo developing lab and framing area for her photography business.

The income and deductions that result from rental property and royalties are reported on:

Schedule E Form 1040

Which of the following statements is correct regarding the deductibility of self-employment tax for self-employed taxpayers?

Self-employed taxpayers can deduct the employer portion of the self-employment tax they pay for AGI.

Match the type of expense to the appropriate tier for the purpose of the home office deduction.

TIer 1: Generally, mortgage interest and real property tax allocated to the business Tier 2: Generally, expenses allocated to the business use of the home except for interest, taxes, and depreciation Tier 3: Depreciation allocated to the business

True or false: A taxpayer's principal place of business can also include the place of business used by the taxpayer for the management activities of the trade or business, if there is no other business location provided for that purpose.

TRUE Reason: A taxpayer's principal place of business also includes the place of business used by the taxpayer for the administrative or management activities of the taxpayer's trade or business if there is no other fixed location where these activities occur.

What are the tax and penalty effects of nonqualified distributions of Roth IRAs?

The account earnings are fully taxable and subject to the 10% penalty, but the account contributions are nontaxable.

Why are individually managed retirement plans, such as traditional or Roth IRAs, not very attractive to small business owners?

The contribution levels are relatively low compared to employer-provided plans.

When a taxpayer has more than one business location, including the home, how can he determine which location is the principal place of business? (Check all that apply.)

The effort spent on administrative or management activities if there is NOT another location for that purpose The total time spent doing work at each location The relative importance of the activities performed at each business

How much of a self-employed taxpayer's self-employment tax may be deducted for AGI?

The employer portion of self-employment tax is deductible.

Which of the following penalties is deductible for AGI?

The penalty for early withdrawal of savings

Which of the following statements is true when considering the deductibility of a suspended passive loss?

The suspended loss may be deducted when a taxpayer generates passive income from that activity or another passive activity.

Which of the statements regarding the deductibility of a suspended passive loss are true? (Check all that apply.)

The suspended loss may be deducted when a taxpayer generates passive income from that activity or another passive activity. The suspended loss may be deducted against active or portfolio income when the taxpayer sells or divests of the passive activity.

Which of the following statements is FALSE regarding the deductibility of home office expenses?

The taxpayer can claim a home office deduction if he uses a portion of the home to meet with clients over the phone or through email.

In order for a taxpayer to be able to deduct the loss on a business activity that he is involved in, which of the following must be true?

The taxpayer must materially participate in the business.

Which of the following statements is INCORRECT regarding the home office deduction when using the actual expense method?

Tier 1 expenses are deductible to the extent of the Schedule C net income before considering the home office deduction.

Match the rental expenses to the appropriate tiers.

Tier 1: Expenses to obtain tenants Tier 2: Operating expenses for the rental property Tier 3: Depreciation on the rental property

Travis has a 2,400 square foot home. He is a sales representative for a pharmaceutical company and uses one room of his home exclusively for his business. The area of the office is 240 square feet. During the past year, he painted his office and replaced the door at a cost of $500; paid for utilities for his home, $3,000; paid property taxes, $1,500; paid mortgage interest, $3,600; and replaced a door jamb and door for his patio, $600. Depreciation expense on the entire home would be $2,000 for the year. If Travis uses the simplified method for deducting home office expenses, which of the following choices are correct? (Check all that apply.)

Travis is allowed to deduct 100% of his mortgage interest and property tax as itemized deductions. Travis has a simplified method deduction of $5 x 240 square feet.

Other than the taxation differences, what is another advantage of Roth IRAs over traditional IRAs?

Unlike traditional IRAs, Roth IRAs do not have any minimum distribution requirements.

In order for a taxpayer to be able to deduct up to $25,000 in rental losses against other types of income, her or she must be a(n) ______ participant in the rental activity.

active

Although losses from rental property are classified as passive losses, there is an exception that allows a taxpayer who is a(n) _______________ participant in a rental activity to deduct up to $_____________

active; 25,000

The intent of the terms ordinary and necessary when referring to deductible business expenses means the expenses must be

appropriate and helpful for generating a profit

Nondeductible contributions to a traditional IRA

are subject to the same earned income limitations as deductible contributions

Activities that are profit-motivated and require a relatively high level of involvement from the taxpayer are referred to as

business or trade

When a taxpayer rents his residence to unrelated parties for 14 or fewer days and lives in the residence for at least 15 days, her or she

does NOT report any rental income and is not allowed to deduct any rental expenses

A taxpayer may deduct interest expense paid on qualified __________________ loans where the proceeds were used for tuition, fees, books, and other necessary expenses. The interest is deductible _______________ (for/from) AGI.

education; for

Losses that are otherwise deductible under the basis, at-risk amounts and passive loss rules may be disallowed due to the _________________ loss limitation

excess business

The phase-out for contributions allowed to Roth IRAs is dependent upon the taxpayer's ______________ and MAGI

filing status

Assuming a taxpayer has sufficient earned income to contribute the maximum allowed to a traditional IRA, the deductible IRA contribution may be phased-out based on _____________ status and modified _____________ income

filing; adjusted gross

LLCs, S Corporations, and partnerships do NOT pay taxes at the organization level; rather these types of activities are ___________________ entities whose operating income and losses are allocated to the owners of the entities.

flow-through

Taxpayers have a choice of deducting the standard deduction or their itemized deductions. Therefore, ______ AGI deductions are considered to be beneficial to more taxpayers because:

for; they are available to all eligible taxpayers, not just those that itemize deductions.

Investment interest expense is deducted _______________ AGI while self-employed business expenses are deducted _______________AGI

from, for

Activities which are profit-motivated, but do NOT require a relatively high level of involvement from the taxpayer are referred to as ____________ activities.

investment

Rental and royalty endeavors are most commonly classified as ___________________ activities

investment

Assuming the taxpayer has owned a Roth IRA account for over 5 years, qualifying distributions include a $10,000 distribution

made when the taxpayer was 60 years old used for a first-time home purchase made because the taxpayer is disabled made to a beneficiary after the death of the taxpayer

Rental activitiesBlank______.

may be classified as investment activities or business activities, but the expenses are always deducted for AGI

A taxpayer's tax-basis and at-risk amounts are

often the same but, if different, at-risk amount will be lower

Even when a taxpayer has sufficient tax basis and sufficient amounts at risk to absorb a loss from a business-related activity, the loss may still be limited by the __________________ loss rule

passive activity

When a taxpayer does NOT materially participate in the business activities of a trade or business (including rental activities) in which he is a partial owner, any loss that flows through to the taxpayer is subject to the __________________ loss rule

passive activity

When a taxpayer owns a home that he does not live in, the home is considered to be a(n) __________ property for tax purposes. If he rents the property at fair market value, any loss is _______________(deductible/nondeductible) for tax purposes.

rental; deductible

Susie owns a condo in Florida. Her personal use days do NOT include the time the condo was

rented to her boyfriend and his family at fair market value

Generally speaking, a taxpayer's investment in an activity adjusted for certain items (income, debt and investments) is equal to his or her _______________

tax basis

Taking a home office deduction can result in higher gains when selling the home if the taxpayer uses

the actual expense method only

When a taxpayer makes nondeductible IRA contributions,

the earnings grow tax-free until a distribution is received. Upon distribution, only the earnings are taxable, not the contributions

Taxpayers who meet certain eligibility requirements can contribute to _____________ IRA and/or ___________ IRAs

traditional; Roth

A 40-year old taxpayer has owned a Roth IRA for more than 5 years. A $10,000 distribution will be considered nonqualified if the distribution was

used to pay for higher education expenses