12
Deductions for Certain Investment Expenses and Losses
Test Bank
True or False
________ 1. The form of organization usually used for traditional tax shelters is a C
corporation.
________ 2. The acceleration of expenses to early periods and the postponement of
income to later periods are key ingredients of most tax shelters. The term
used to describe this aspect of a tax shelter is conversion.
________ 3. In tax shelter jargon, conversion concerns the differing tax treatments
given to losses arising from the tax shelter activity and the gains upon
the sale of the activity.
________ 4. The at-risk rules generally limit the amount of deductible losses from an
activity to the amount of resources that the investor has committed to the
activity.
________ 5. The at-risk and passive loss rules operate so as to affect the character of
gain or loss on the sale of an investment activity.
________ 6. A taxpayer’s at-risk amount increases only for contributions of cash and
property and income earned by the activity that is not withdrawn from
the business.
________ 7. The at-risk amount is reduced by distributions and losses.
________ 8. J and K decided they wanted to get in the rental real estate business. This
year J and K formed a partnership. The partnership bought a 200 unit
complex called Lazy Acres from the Trumpet Group for $1,000,000. The
partnership gave Trumpet $200,000 cash and a note for $800,000 which
was secured by the apartment complex. For purposes of the at-risk rules,
the note to Trumpet is considered qualified nonrecourse financing.
________ 9. J and K decided they wanted to get in the rental real estate business. This
year J and K formed a partnership. The partnership bought a 200 unit
complex called Lazy Acres from the Trumpet Group for $1,000,000. The
partnership gave Trumpet $200,000 cash and a note for $800,000 which
was secured by the apartment complex. The partnership borrowed the
cash from the First National Bank of Boston and secured the loan with a
parcel of land that it owned. For purposes of the at-risk rules, the amount
of debt secured by the land is included in the at-risk amount.
________ 10. G is a general partner in a partnership that leases heavy-duty equipment
(e.g., bulldozers, backhoes, compactors, excavators). G’s at-risk amount
increases as the partnership’s recourse debt increases.
________ 11. L is a limited partner in a partnership that leases heavy-duty equipment
(e.g., bulldozers, backhoes, compactors, excavators). L’s at-risk amount
increases as the partnership’s recourse debt increases.
________ 12. X is a general partner in a general partnership that leases heavy-duty
equipment (e.g., bulldozers, backhoes, compactors, excavators). All of
the equipment purchases are financed using nonrecourse debt that is
secured by the equipment. X’s at-risk amount includes his share of
recourse and nonrecourse debt.
________ 13. Oxbow LLC develops apartment complexes all around the metropolitan
area of Dallas. The company creates separate partnerships in which it
serves as a general partner. Each partnership purchases land, hires an
architect and contractor that build the apartments, and then operates
complex. The development activity is financed out of nonrecourse loans
made by First National Bank of Ohio that has a 20 percent interest in the
deal. The loans are at reasonable rates and comparable to those made to
other borrowers. In addition, the loans are secured by the real estate.
This year L purchased an investment interest in one of the partnerships,
West Albany LLC. L’s share of the nonrecourse debt is included in his
at-risk amount.
________ 14. The at-risk rules generally do not operate to restrict losses from real
estate investments as long as they are financed through loans made by
commercial banks at market rates of interest.
________ 15. This year L’s share of losses from an investment in a partnership is
$10,000. Any loss that is not deductible due to the at-risk limitations is
carried forward and is deducted in future years to the extent she has
amounts at-risk.
________ 16. Losses that are not deductible due to the at-risk limitations are carried
back two years and then forward 20 years.
________ 17. In determining the amount of that a taxpayer can deduct from an activity,
the at-risk rules are applied before the passive loss rules.
________ 18. In determining the amount of loss that a taxpayer can deduct from an
activity, both the at-risk and passive loss limitations must be applied.
________ 19. The Trinity Group, an S Corporation, is owned by Tom Trinity. Tom
serves as CEO of the organization. The company owns and operates a
number of hotels and motels in Louisiana and Mississippi. Individuals
typically stay at the hotels one or two days. Losses flowing from the
corporation to Tom will be limited by both the at-risk rules and the
passive activity rules.
________ 20. The effect of the passive activity rules is to deny favorable capital gain
treatment on the sale of certain investments.
________ 21. An activity that constitutes a rental for purposes of the passive loss rules
is always passive regardless of the taxpayer’s participation except when
the exception for real estate developers applies.
________ 22. Suspended losses from a passive activity can be deducted against
portfolio and other income if the taxpayer sells his entire interest in the
activity,
________ 23. Passive losses normally can be used to offset other passive income such
as interest and dividends.
________ 24. A passive loss includes a loss from the sale of an investment such as
stock of a publicly held company like IBM where the taxpayer is merely
an investor and does not work for the company.
________ 25. Deductible net operating losses occur only after the losses have survived
the at-risk and passive loss rules.
________ 26. A group of doctors own Glenbrook Manor LLC, which owns and
operates a nursing home. The home has 130 units where its tenants live
and receive skilled nursing care. Each tenant signs an annual lease. The
LLC would automatically be considered a passive activity since it is a
rental business.
________ 27. Brian and his father-in-law formed Southern Sands Golf Club LLC. It is
a daily fee course (not a private club). They advertise it as “your country
club for a day.” The activity would be considered a rental activity and
automatically passive since they are renting the course for use of their
patrons.
________ 28. During the year, J sold his interest in Sterling XXI, a limited partnership,
for a gain of $30,000. At the time of the sale, J had suspended losses
from Sterling of $50,000. For the year, J also had a loss from another
passive activity of $35,000. As a result, J’s taxable income will decrease
by $50,000, and he will have a suspended loss of $5,000.
________ 29. This year T sold his interest in Century Properties, a limited partnership,
for a gain of $40,000. At the time of the sale, T had suspended losses
attributable to Century of $25,000. For the year, T also had a $32,000
loss from Mervin Gardens, another limited partnership interest. T will
carry over the entire $32,000 loss from Mervin Gardens to the following
year.
________ 30. P is the sole shareholder as well as an employee of PQ Accounting
Services Incorporated. The corporation concentrates on tax return
preparation and preparation of monthly financial statements. P currently
owns an interest in a limited partnership in which he expects to generate
losses for the next several years. Assuming P transfers the interest in the
partnership to the corporation, any losses of the partnership may be used
to reduce the corporation’s taxable income.
________ 31. L is the sole shareholder and an employee of LDI Incorporated. The
corporation manufactures custom-made kitchen cabinets. L currently
owns an interest in a limited partnership in which he expects to generate
losses for the next several years. Assuming L transfers the interest in the
partnership to the corporation, any losses of the partnership may be used
to reduce the corporation’s operating income.
________ 32. During the year, Mr. Y joined together in a partnership with Ms. Z to
form Pizza and Videos to Go. Mr. Y provided only the financial backing,
while Ms. Z managed the operation. During the first year of operations,
the partnership generated a loss. Mr. Y and Ms. Z may use their
respective shares of the loss (in their entirety) to reduce their investment
income.
________ 33. S owns a duplex, which she rents out on a long-term basis. Although she
is actively involved in managing the property, no significant services are
provided. During the year, S earned a salary of $70,000 and had interest
income of $10,000. Assuming the rental activity generates a $20,000
loss, all of the loss may be used by S to reduce her salary and interest
income.
________ 34. During the year, Q, employed full time as an attorney, spent 550 hours
managing an apartment complex he owns. The operation of the
apartment complex is considered a passive activity
________ 35. A regular C corporation that is owned by five unrelated parties is not
subject to the passive loss rules.
________ 36. Publicly traded corporations normally would not be subject to the
passive loss rules.
________ 37. B owns 10 hardware stores, each located in a different city. Since each
store is located in a separate city he must treat each store as a separate
activity.
________ 38. Rental activities and other trade or business activities cannot be
aggregated since up to $25,000 of losses from certain rental activities
may be deducted annually.
________ 39. C is a C.P.A. and operates his own practice out of a seven story building
that he owns. He rents out five floors and uses two for his own business.
This year he had a loss of $30,000 from the rental side of his operations.
His accounting practice netted a profit of $600,000. C may offset the
$30,000 loss against the $600,000 profit from his business.
________ 40. D operates a small rental car agency by the airport. Most of his
customers rent cars for one or two days. D’s operation is not considered a
rental activity for purposes of the passive loss rules.
________ 41. 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.
________ 42. 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.
________ 43. 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.
________ 44. 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.
________ 45. 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.
________ 46. 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.
Multiple Choice
________ 47. The at-risk rules effect which of the following?
a. Whether income from an investment is tax-exempt or taxable
b. Whether gain on the sale of an investment activity is taxed as
favorable long-term capital gain or ordinary income
c. Whether the losses from an activity’s operations can be deducted in
the current year
d. More than one of the above
________ 48. One of the reasons the at-risk rules did not achieve their objective and
the passive loss rules were required concerned
a. The treatment of nonrecourse debt
b. The treatment of recourse debt
c. The ability of taxpayer’s to utilize leverage
d. The limited scope of the rules (i.e., they applied only to a few
activities)
________ 49. Tax shelters are typically built on three elements, including
a. Deferral
b. Conversion
c. Leverage
d. All of the above
________ 50. In a tax shelter investment, phantom income and turnaround are most
likely to be attributable to which of the following?
a. Deferral
b. Conversion
c. Leverage
d. None of the above
________ 51. 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?
a. $11,000
b. $18,500
c. $25,000
d. $38,500
e. None of the above
________ 52. 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?
a. The passive loss limitations are applied before the at-risk limitations
b. The at-risk limitations are applied before the passive loss limitations
c. Neither the passive loss limitations nor the at-risk limitations apply
in determining the amount of loss that is deductible.
d. None of the above is correct.
________ 53. 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?
a. R can deduct the loss to the extent of his interest and dividend
income.
b. R can never deduct this loss.
c. R cannot deduct the loss but can carry it over and deduct it in
subsequent years under the appropriate circumstances.
d. More than one but less than all of the above statements are true.
e. None of the above statements is true.
________ 54. 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
a. None of the loss
b. $25,000 and carryover $ 10,000 of the loss
c. $ 15,000 and carryover $20,000 of the loss
d. $ 15,000 and carryover $ 10,000 of the loss
e. None of the above
________ 55. T purchased a limited partnership interest in 2005. T is a passive
investor. During the current year, the partnership’s loss is $20,000.
Which of the following statements is true?
a. If T is an individual, she may deduct her share of the loss to the
extent of any dividend income that she receives because losses on
passive investments are deductible to the extent of income on
investments.
b. If T is an individual, she may deduct the loss, as long as the
partnership was engaged in real estate rental activities and her share
of the loss is less than $25,000.
c. If T is a corporation, it may deduct its share of the loss if all of T’s
stock is held by Ms. Tee. (The corporation, which manufactures gift
wrap paper, had earnings from operations during the year greater
than $20,000.)
d. All of the above are true.
e. None of the above is true.
________ 56. Which of the following is true regarding losses arising from passive
activities?
a. The passive loss rules were aimed at investors in limited
partnerships; consequently, the rules do not apply if the loss arises
from an S corporation.
b. Passive losses that were not deductible in prior years can be deducted
in the year in which the taxpayer sells his entire interest.
c. Losses are deductible if the taxpayer can establish that he satisfies
either the material participation test or, alternatively, the active
participation test.
d. All of the above statements are true.
e. None of the above statements is true.
________ 57. 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
a. Report income of $300 and deduct $405
b. Report no income and deduct no expenses related to the vacation
home
c. Report no income and deduct $50
d. Report income of $300 and deduct $300
e. Report none of the above
________ 58. 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
a. Deduct expenses of $ 10,000
b. Deduct expenses of $10,000 and the balance of any remaining
expenses to the extent of any passive income that she may have
c. Deduct $14,000 of expenses
d. Deduct none of the expenses
e. Deduct none of the above
________ 59. 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
a. Deduct expenses of $10,000
b. Deduct expenses of $10,000 and the balance of any remaining
expenses to the extent of any passive income that she may have
c. Deduct $ 14,000 of expenses
d. Deduct none of the expenses
e. Deduct none of the above
________ 60. D, age 60, is a practicing accountant. However, over the years, he has
become heavily involved in numerous deals with his clients, primarily
apartment rentals. Recently, he has been spending substantially more
times relating to the rentals than he does his accounting practice.
Unfortunately, these efforts have not paid off and he has substantial
losses from his rental properties for the year. D has no passive income
and his adjusted gross income for the year if $300,000. D did not sell any
of the properties during the year. Which of the following statements
concerning the passive loss rules is true?
a. D’s losses from his rental activities will be considered passive
regardless of the amount of his participation.
b. Under the relief provisions provided for investors in residential real
estate, D will be able to deduct a minimum of $25,000 of losses from
his rental real estate activities assuming he actively participates.
c. Even if D does not sell any of his rental real estate interests, he still
may be able to deduct all of the losses from his rental real estate
activities.
d. None of the above is true.
12
Deductions for Certain Investment Expenses and Losses
Solutions to Test Bank
True or False
Multiple Choice
