Chapter 11 Investor Losses

Click here go to purchase the Solutions Manual

---

Problems
34. LO.2 In 2015, Fred invested $50,000 in a general partnership. Fred’s interest is not considered to be a passive activity. If his share of the partnership losses is $35,000 in 2015 and $25,000 in 2016, how much can he deduct in each year?
35. LO.2 In the current year, Bill Parker (54 Oak Drive, St. Paul, MN 55164) is considering making an investment of $60,000 in Best Choice Partnership. The prospectus provided by Bill’s broker indicates that the partnership investment is not a passive activity and that Bill’s share of the entity’s loss in the current year will likely be $40,000, while his share of the partnership loss next year will probably be $25,000. Write a letter to Bill in which you indicate how the losses would be treated for tax purposes in the current year and the following year.
36. LO.2, 11 Heather wants to invest $40,000 in a relatively safe venture and has discovered two alternatives that would produce the following reportable ordinary income and loss over the next three years:
Year
Alternative 1
Income (Loss)
Alternative 2
Income (Loss)
1 ($20,000) ($48,000)
2 (28,000) 32,000
3 72,000 40,000
She is interested in the after-tax effects of these alternatives over a three-year horizon.
Assume that Heather’s investment portfolio produces sufficient passive activity income to offset any potential passive activity loss that may arise from these alternatives, that her cost of capital is 6% (see Appendix G for the present value factors), that she is in the 25% tax bracket, that each investment alternative possesses equal growth potential, and that each alternative exposes her to comparable financial risk. In addition, assume that in the loss years for each alternative, there is no cash flow from or to the investment (i.e., the loss is due to depreciation), while in those years when the income is positive, cash flows to Heather equal the amount of the income. Based on these facts, compute the present value of these two investment alternatives and determine which option
Heather should choose.
37. LO.1, 3 Dorothy acquired a 100% interest in two passive activities: Activity A in January
2011 and Activity B in 2012. Through 2014, Activity A was profitable, but it produced losses of $200,000 in 2015 and $100,000 in 2016. Dorothy has passive activity income from Activity B of $20,000 in 2015 and $40,000 in 2016. After offsetting passive activity income, how much of the net losses may she deduct?
38. LO.1, 3 A number of years ago, Kay acquired an interest in a partnership in which she is not a material participant. Kay’s basis in her partnership interest at the beginning of 2015 is $40,000. Kay’s share of the partnership loss is $35,000 in 2015, while her share of the partnership income is $15,000 in 2016. How much may Kay deduct in 2015 and 2016, assuming that she owns no other passive activities?
39. LO.3 Mike, an attorney, earns $200,000 from his law practice and receives $45,000 in dividends and interest during the year. In addition, he incurs a loss of $50,000 from an investment in a passive activity acquired three years ago. What is
Mike’s net income for the current year after considering the passive investment?
40. LO.3, 11 Emily has $100,000 that she wants to invest and is considering the following two options:
• Option A: Investment in Redbird Mutual Fund, which is expected to produce interest income of $8,000 per year.
• Option B: Investment in Cardinal Limited Partnership (buys, sells, and operates wine vineyards). Emily’s share of the partnership’s ordinary income and loss over the next three years would be as follows:
Year Income (Loss)
1 ($ 8,000)
2 (2,000)
3 34,000
Emily is interested in the after-tax effects of these alternatives over a three-year horizon.
Assume that Emily’s investment portfolio produces ample passive activity income to offset any passive activity losses that may be generated. Her cost of capital is 8% (see Appendix G for the present value factors), and she is in the 28% tax bracket. The two investment alternatives possess equal growth potential and comparable financial risk. Based on these facts, compute the present value of these two investment alternatives and determine which option Emily should choose.
41. LO.3 Ray acquired an activity several years ago, and in the current year, it generates a loss of $50,000. Ray has AGI of $140,000 before considering the loss from the activity. If the activity is a bakery and Ray is not a material participant, what is his AGI?
42. LO.3, 11 Jorge owns two passive investments, Activity A and Activity B. He plans to dispose of Activity A in the current year or next year. Juanita has offered to buy Activity A this year for an amount that would produce a taxable passive activity gain to Jorge of $115,000. However, if the sale, for whatever reason, is not made to Juanita, Jorge believes that he could find a buyer who would pay about $7,000 less than Juanita. Passive activity losses and gains generated (and expected to be generated) by Activity B follow:
Two years ago ($35,000)
Last year (35,000)
This year (8,000)
Next year (30,000)
Future years Minimal profits
All of Activity B’s losses are suspended. Should Jorge close the sale of Activity A with Juanita this year, or should he wait until next year and sell to another buyer?
Jorge is in the 28% tax bracket.
43. LO.3 Sarah has investments in four passive activity partnerships purchased several years ago. Last year the income and losses were as follows:
Activity Income (Loss)
A $ 30,000
B (30,000)
C (15,000)
D (5,000)
In the current year, she sold her interest in Activity D for a $10,000 gain. Activity D, which had been profitable until last year, had a current loss of $1,500. How will the sale of Activity D affect Sarah’s taxable income in the current year?
44. LO.3 Leon sells his interest in a passive activity for $100,000. Determine the tax effect of the sale based on each of the following independent facts:
a. Adjusted basis in this investment is $35,000. Losses from prior years that were not deductible due to the passive activity loss restrictions total $40,000.
b. Adjusted basis in this investment is $75,000. Losses from prior years that were not deductible due to the passive activity loss restrictions total $40,000.
c. Adjusted basis in this investment is $75,000. Losses from prior years that were not deductible due to the passive activity loss restrictions total $40,000. In addition, suspended credits total $10,000.
45. LO.3 Ash, Inc., a closely held personal service corporation, has $100,000 of passive activity losses. In addition, Ash has $80,000 of active business income and $20,000 of portfolio income. How much of the passive activity loss may Ash use to offset the other types of income?
46. LO.3 In the current year, White, Inc., earns $400,000 from operations and receives $36,000 of interest income from various portfolio investments. White also pays $150,000 to acquire a 20% interest in a passive activity that produces a $200,000 loss.
a. Assuming that White is a personal service corporation, how will these transactions affect its taxable income?
b. Same as part (a), except that White is closely held but not a personal service corporation.
47. LO.2, 3, 7, 11 Kristin Graf (123 Baskerville Mill Road, Jamison, PA 18929) is trying to decide how to invest a $10,000 inheritance. One option is to make an additional investment in Rocky Road Excursions in which she has an at-risk basis of $0, suspended losses under the at-risk rules of $7,000, and suspended passive activity losses of $1,000. If Kristin makes this investment, her share of the expected profits this year will be $8,000. If her investment stays the same, her share of profits from Rocky Road Excursions will be $1,000. Another option is to invest $10,000 as a limited partner in the Ragged Mountain Winery; this investment will produce passive activity income of $9,000. Write a letter to Kristin to review the tax consequences of each alternative. Kristin is in the 28% tax bracket.
48. LO.2, 3, 7, 11 The end of the year is approaching, and Maxine has begun to focus on ways of minimizing her income tax liability. Several years ago she purchased an investment in Teal Limited Partnership, which is subject to the at-risk and the passive activity loss rules. (Last year Maxine sold a different investment that was subject to these rules and that produced passive activity income.) She believes that her investment in Teal has good long-term economic prospects. However, it has been generating tax losses for several years in a row. In fact, when she was discussing last year’s income tax return with her tax accountant, he said that unless “things change” with respect to her investments, she would not be able to deduct losses this year.
a. What was the accountant referring to in his comment?
b. You learn that Maxine’s current at-risk basis in her investment is $1,000 and that her share of the current loss is expected to be $13,000. Based on these facts, how will her loss be treated?
c. After reviewing her situation, Maxine’s financial adviser suggests that she invest at least an additional $12,000 in Teal to ensure a full loss deduction in the current year. How do you react to his suggestion?
d. What would you suggest Maxine consider as she attempts to maximize her current-year deductible loss?
49. LO.2, 3, 7 A number of years ago, Lee acquired a 20% interest in the BlueSky Partnership for $60,000. The partnership was profitable through 2015, and
Lee’s amount at risk in the partnership interest was $120,000 at the beginning of
2016. BlueSky incurred a loss of $400,000 in 2016 and reported income of $200,000 in 2017. Assuming that Lee is not a material participant, how much of his loss from
BlueSky Partnership is deductible in 2016 and 2017? Consider the at-risk and passive activity loss rules, and assume that Lee owns no other passive investments.
50. LO.2, 3, 5, 7 Grace acquired an activity four years ago. The loss from the activity is $50,000 in the current year (at-risk basis of $40,000 as of the beginning of the year). Without considering the loss from the activity, she has gross income of $140,000. If the activity is a convenience store and Grace is a material participant, what is the effect of the activity on her taxable income?