Exam (elaborations)
Chapter 11. Investor Losses
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Chapter 11. Investor Losses
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CHAPTER 11: INVESTOR LOSSES1. Jack owns a 10% interest in a partnership (not real estate) in which his at-risk amount is $42,000 at the
beginning of the year. During the year, the partnership borrows $80,000 on a nonrecourse note and
incurs a loss of $60,000 from operations. Jack’s atrisk amount at the end of the year is $44,000.
a. True
b. False
ANSWER: False
RATIONALE: The amount a taxpayer has at risk is increased by the taxpayer’s share of additional
recourse debt and decreased by the share of losses from the activity. The at-risk amount is
not affected by nonrecourse debt. Jack’s yearend atrisk amount is $36,000 [$42,000 –
(10% × $60,000 loss)].
1. Sherri owns an interest in a business that is not a passive activity and in which she has $20,000 at risk. If
the business incurs a loss from operations during the year and her share of the loss is $32,000, this loss
will be fully deductible.
a. True
b. False
ANSWER: False
RATIONALE: The at-risk provisions limit the deductibility of losses from business and income-producing
activities for individuals and closely held corporations. The loss reduces Sherri’s atrisk
amount to $0 and results in a suspended loss of $12,000 under the at-risk rules.
2. In the current year, Don has a $55,000 loss from a business he owns. His at-risk amount at the end of the
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, year, prior to considering the current year loss, is $36,000. He will be allowed to deduct the $55,000 loss
this year if he is a material participant in the business.
a. True
b. False
ANSWER: False
RATIONALE: Don’s loss deduction will be limited to $36,000 by the atrisk rules.
3. 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.
a. True
b. False
ANSWER: False
RATIONALE: Judy is considered at-risk for amounts borrowed on a recourse note because she is
personally liable for repayment of the debt. Therefore, her at-risk amount is increased by
her share of the recourse debt incurred by the partnership. Judy’s atrisk amount at the
end of the year is $53,000 [$35,000 + (20% × $50,000 recourse note) + (20% × $40,000
profit)].
4. 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 atrisk amount is reduced below
zero as a result of the debt restructuring.
a. True
b. False
ANSWER: True
5. 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.
a. True
b. False
ANSWER: False
RATIONALE: A suspended passive loss may be deducted when the activity is sold, even if the sale of
the activity results in a loss. The suspended loss can offset Kelly’s active income from
her job.
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, 6. All of a taxpayer’s tax credits relating to a passive activity can be utilized when the activity is sold at a
loss.
a. True
b. False
ANSWER: False
RATIONALE: Tax credits associated with a passive investment are lost if the investment is disposed of
at a loss.
1. Jackson Company incurs a $50,000 loss on a passive activity during the year. The company has active
income of $34,000 and portfolio income of $24,000. If Jackson is a personal service corporation, it may
deduct $34,000 of the passive loss.
a. True
b. False
ANSWER: False
RATIONALE: The passive loss rules apply to individuals, estates, trusts, closely held C corporations, and
personal service corporations. Therefore, Jackson, a personal service corporation, is not
allowed to offset passive losses against active or portfolio income.
7. Oriole Corporation has active income of $45,000 and a passive loss of $23,000 in the current year. Under
an exception, Oriole can deduct the $23,000 loss if it is a personal service corporation.
a. True
b. False
ANSWER: False
RATIONALE: Personal service corporations may not offset passive losses against active income.
1. Gray Company, a closely held C corporation, incurs a $50,000 loss on a passive activity during the year.
The company has active income of $34,000 and portfolio income of $24,000. If Gray is not a personal
service corporation, it may deduct $34,000 of the passive loss.
a. True
b. False
ANSWER: True
RATIONALE: The passive loss rules apply to individuals, estates, trusts, personal service corporations,
and closely held C corporations. Only closely held C corporations that are not personal
service corporations are allowed to offset passive losses against active income.
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, 2. 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.
a. True
b. False
ANSWER: False
RATIONALE: Closely held C corporations that are not personal service corporations may offset passive
losses against active income but not against portfolio income.
3. Linda owns investments that produce portfolio income and Activity A that produces losses. From a tax
perspective, Linda will be better off if Activity A is not passive.
a. True
b. False
ANSWER: True
RATIONALE: Linda benefits from Activity A’s losses only if the activity is not a passive activity. If it is a
passive activity, Linda needs to generate passive income to absorb the passive losses.
4. 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.
a. True
b. False
ANSWER: True
RATIONALE: Taxpayers who have passive losses generally benefit by having profitable activities
classified as passive so that the passive losses can offset the passive income.
5. A taxpayer is considered to be a material participant if he or she spends more than 500 hours in the
activity.
a. True
b. False
ANSWER: True
6. Dick participates in an activity for 90 hours during the year. He has no employees and there are no other
participants. Dick is a material participant.
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