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Chapter 11 Investor Losses
Research Problems
Research Problem 1. Carol is a successful physician who owns 100% of her incorporated medical practice. She and her husband, Dick, are considering the purchase of a commercial office building located near the local community hospital. If they purchase the building, Carol will move her medical practice to the new location and rent space for an arm’s length price. The rent income Carol and Dick receive will be available to absorb passive activity losses generated by other passive activities they own.
The net effect of this arrangement is a reduction in their income tax liability. Will Carol and Dick’s plan work? Why or why not?
Research Problem 2. Five years ago Bridget decided to purchase a limited partnership interest in a fast-food restaurant conveniently located near the campus of Southeast
State University. The general partner of the restaurant venture promised her that the investment would prove to be a winner. During the process of capitalizing the business, $2 million was borrowed from Northside Bank; however, each of the partners was required to pledge personal assets as collateral to satisfy the bank loan in the event that the restaurant defaulted. Bridget pledged shares of publicly traded stock (worth $200,000, basis of $75,000) to satisfy the bank’s requirement.
The restaurant did a good business until just recently, when flagrant health code violations were discovered and widely publicized by the media. As a result, business has declined to a point where the restaurant’s continued existence is doubtful. In addition, the $2 million loan is now due for payment. Because the restaurant cannot pay, the bank has called for the collateral provided by the partners to be used to satisfy the debt. Bridget sells the pledged stock for $200,000 and forwards the proceeds to the bank. Bridget believes that her share of the restaurant’s current and suspended passive activity losses can offset the $125,000 gain from the stock sale. As a result, after netting the passive activity losses against the gain, none of the gain is subject to tax.
How do you react to Bridget’s position?
Research Problem 3. Ida Ross has decided to purchase a new home in a retirement community for $400,000. She has $50,000 in cash for the down payment but needs to borrow the remaining $350,000 to finance the purchase. Her financial adviser, Marc, suggests that rather than seeking a conventional mortgage, she should borrow the funds from State Bank using her portfolio of appreciated securities as collateral. Selling the securities to generate $350,000 in cash would lead to a substantial tax on the capital gain recognized. Therefore, a better strategy would be to borrow against her securities and then claim a deduction for the interest paid on the loan. How do you react to the financial adviser’s strategy?
Research Problem 4. Investment advisers and tax professionals are continuously striving to create sophisticated transactions and investment vehicles (i.e., tax-advantaged investments) that are designed to provide economic benefits to investors by reducing their taxes. These professionals might like to patent such schemes. Identify whether patenting a tax strategy is a legal possibility.
Research Problem 5. Scan the materials offered in several newsgroups frequented by tax advisers and consultants. In what context are “tax shelters” discussed by these professionals? Do these advisers and consultants adequately take into account the rules of §§ 465 and 469?
Roger CPA Review Questions
1. Lee, a married individual, is an employee with three rental properties in which Lee does not actively participate. In 2015, Property 1 had a net loss of $10,000, Property 2 had a net gain of $25,000, and Property 3 had a net loss of $5,000. Lee’s W–2 income in 2015 was $110,000. Considering only the foregoing facts, what is Lee’s 2015 adjusted gross income?
a. $120,000
b. $125,000
c. $110,000
d. $135,000
2. Anscomb is an employee who also solely owns and actively participates in a rental activity which produced a $20,000 loss in the current year. Anscomb’s W–2 income in the current year is $115,000. Considering only the foregoing facts, what should
Anscomb’s adjusted gross income be for the current year?
a. $97,500
b. $115,000
c. $107,500
d. $102,500
3. Lewis is not an active participant in three rental activities, which have turned profits in recent years. The following gain and losses apply to the current year for Lewis:
Gain or (Loss)
Rental Activity 1 ($10,000)
Rental Activity 2 12,000
Rental Activity 3 (8,000)
Total ($ 6,000)
Internet
Activity
Use the tax resources of the Internet to address the following questions. Do not restrict your search to the Web, but include a review of newsgroups and general reference materials, practitioner sites and resources, primary sources of the tax law, chat rooms and discussion groups, and other opportunities.
What amount of the suspended loss should Lewis allocate to Rental Activity 3?
a. $4,500
b. $2,667
c. $0
d. Suspended losses may be allocated according to the taxpayer’s preference
4. Smith bought a rental property in year 1 for $100,000. In year 1, Smith’s adjusted gross income (AGI) was $125,000 and Smith sustained a $30,000 loss on the property.
In year 2, Smith’s AGI was $175,000 and Smith sustained a $20,000 loss on the property. In year 3, Smith sold the property for $155,000. What amount of gain or loss must Smith report on Smith’s year 3 tax return as a result of the sale? Assume
Smith actively participated in the rental activity in all three years, but is not considered a real estate professional for tax purposes.
a. $17,500 gain
b. $0 (no gain or loss)
c. $22,500 gain
d. $20,000 gain
5. Patel bought a rental property in year 1 for $150,000. In year 1, Patel’s adjusted gross income (AGI) was $100,000 and Patel sustained a $15,000 loss on the property.
In year 2, Patel’s AGI was $140,000 and Patel sustained a $10,000 loss on the property. In year 3, Patel sold the property for $175,000. What amount of gain or loss must Patel report on Patel’s year 3 tax return as a result of the sale? Assume
Patel did not actively participate in the rental activity in any of the three years.
a. $25,000
b. $0 (no income or loss)
c. $5,000
d. $20,000
6. The following chart applies to Bettelli, an investor who owns two rental activities,
Property A and Property B, and has no other involvement in passive activities:
Property Income (Loss)
Year 1 A ($12,000)
B 5,000
Year 2 A (6,000)
B 1,000
Bettelli met the requirements for active participation in year 1 but not in year 2.
Bettelli’s AGI in year 1 was $140,000; in year 2, $180,000. In year 3, Bettelli sells
Property A for a $15,000 gain. How much of the gain must Bettelli report on
Bettelli’s year 3 tax return?
a. $0
b. $3,000
c. $8,000
d. $13,000
7. Albert, Berry, and Collins formed ABC Partnership in the current year. Collins, a limited partner, contributed $20,000 in cash to the partnership and also pledged $10,000 of personal property as collateral to meet any partnership debts that may arise. Collins’s share of the current ABC Partnership loss is $50,000. How much of the loss is deductible by Collins under the at-risk rules?
a. $0
b. $10,000
c. $20,000
d. $30,000