FPC 303 Ch 8
Michael owns a beach home, which is his second home, in a national resort area. Since this
home is only a vacation home, and he can generate substantial cash flow by renting the
property, Michael lists the property with a real estate agent who successfully rents the property
for 12 weeks a year. Michael and his family use the home for the entire month of September, for
two weeks in January, and for two weeks in May each year. If Michael's gross rental income
from the property is $60,000, and he has $75,000 of expenses (mortgage interest, real estate
taxes, brokerage fees, and miscellaneous expenses) associated with the rental activity, which of
the following statements is correct?
A)Michael will be able to take a deduction for expenses limited to $60,000.
B)Michael will report a $15,000 loss on the property for tax purposes this year.
C)The $15,000 loss on the property is suspended under the passive activity rules.
D - ANS-A)Michael will be able to take a deduction for expenses limited to $60,000.
Rationale
This is a mixed-use property, since the property was rented out for more than 14 days (12
weeks), and Michael used the property for more than 14 days (8 weeks) (10 percent of the
rental days, in this example, would only be 8.4 days). Therefore, Michael must include the rental
income, but is permitted to deduct expenses to the extent of the income generated from the
activity as a production of income expense, which directly offsets gross income (is an
above-the-line deduction). Therefore, there will be no increase in Michael's AGI or taxable
income for the year. The $15,000 of additional expenses that would otherwise have generated a
loss are not deductible, so there is no loss that can be suspended under the passive activity
rules. Since the expenses are deducted as above-the line deductions, the income will not
reduce itemized deductions since it will not increase AGI.
All of the following expenses incurred when an individual travels from his office to a client's
place of business to discuss business matters will qualify as a business deduction, EXCEPT:
A)A $6 toll to cross the commerce bridge.
B)Mileage expense for the round trip to visit the client.
C)A $30 parking ticket for parking in a no-parking zone since no other parking spaces were
available.
D)Cost of printing material for the client meeting. - ANS-C)A $30 parking ticket for parking in a
no-parking zone since no other parking spaces were available.
Rationale
Penalties and fines are never deductible business expenses, even if they are incurred in the
conduct of a trade or business. The other expenses are deductible.
John, a single individual, is an avid coin collector. To raise some money to support his hobby,
John began to occasionally buy and sell coins about 10 years ago, incurring business-related
, expenses in those transactions. John does not consider himself to be in the business of dealing
in coins, and over the time he has been selling coins, he has never made a profit. This year,
John grossed $4,000 in sales, and had $4,500 in expenses associated with the activity. John's
AGI for the year (including any inclusion due to the coin trading activity) is $50,000, and aside
from the coin trading loss, his only other permissible itemized deductions are mortgage interest
of $8,000 and real estate taxes of $2,500. Which of the following statements concerning this
situation is correct?
A)John will take the $500 loss from the coin business into his gross income.
B)Since he has never made money from the activity, he is not required - ANS-D)The increase in
John's taxable income as a result of the coin trading activity is equal to the income of $4,000.
Rationale
John is engaging in a hobby activity. He has never made a profit, and does not appear to have a
profit motive. Consequently, he must include all $4,000 in his gross income. He cannot deduct
his hobby expenses after 2017.
Christopher runs an extortion racket in his home neighborhood. He paid Bobby $100,000 to run
the street operations, and incurred $30,000 for secretarial support and $20,000 in
miscellaneous expenses, such as rent for his office and supplies. Christopher had gross income
from the extortion ring of $400,000. How much of the income is subject to income tax this year?
A)$250,000.
B)$270,000.
C)$300,000.
D)$400,000. - ANS-A)$250,000.
Rationale
Even though Christopher is running an illegal business, the income from the activity is subject to
income tax. Christopher is entitled to deduct all reasonable and necessary expenses associated
with the production of the income, including salaries and costs incurred in business operations.
Which of the following statements concerning Net Operating Losses (NOL) is correct?
A)NOLs must be used in the current tax year to offset other income; they cannot be applied to
other tax years.
B)NOLs can be carried back up to six years to offset income from those prior tax years.
C)NOLs can be carried forward indefinitely.
D)Prior to carrying forward NOLs, a taxpayer is required to apply the NOLs against prior-year
income for at least two years. - ANS-C)NOLs can be carried forward indefinitely.
Rationale
NOLs can be carried forward indefinitely and cannot generally be carried back for years after
2017.
Happy Harry not only uses drugs, he also sells them to a circle of friends and associates. This
year, Harry grossed $650,000 from drug sales. He paid $125,000 to his street pushers to
Michael owns a beach home, which is his second home, in a national resort area. Since this
home is only a vacation home, and he can generate substantial cash flow by renting the
property, Michael lists the property with a real estate agent who successfully rents the property
for 12 weeks a year. Michael and his family use the home for the entire month of September, for
two weeks in January, and for two weeks in May each year. If Michael's gross rental income
from the property is $60,000, and he has $75,000 of expenses (mortgage interest, real estate
taxes, brokerage fees, and miscellaneous expenses) associated with the rental activity, which of
the following statements is correct?
A)Michael will be able to take a deduction for expenses limited to $60,000.
B)Michael will report a $15,000 loss on the property for tax purposes this year.
C)The $15,000 loss on the property is suspended under the passive activity rules.
D - ANS-A)Michael will be able to take a deduction for expenses limited to $60,000.
Rationale
This is a mixed-use property, since the property was rented out for more than 14 days (12
weeks), and Michael used the property for more than 14 days (8 weeks) (10 percent of the
rental days, in this example, would only be 8.4 days). Therefore, Michael must include the rental
income, but is permitted to deduct expenses to the extent of the income generated from the
activity as a production of income expense, which directly offsets gross income (is an
above-the-line deduction). Therefore, there will be no increase in Michael's AGI or taxable
income for the year. The $15,000 of additional expenses that would otherwise have generated a
loss are not deductible, so there is no loss that can be suspended under the passive activity
rules. Since the expenses are deducted as above-the line deductions, the income will not
reduce itemized deductions since it will not increase AGI.
All of the following expenses incurred when an individual travels from his office to a client's
place of business to discuss business matters will qualify as a business deduction, EXCEPT:
A)A $6 toll to cross the commerce bridge.
B)Mileage expense for the round trip to visit the client.
C)A $30 parking ticket for parking in a no-parking zone since no other parking spaces were
available.
D)Cost of printing material for the client meeting. - ANS-C)A $30 parking ticket for parking in a
no-parking zone since no other parking spaces were available.
Rationale
Penalties and fines are never deductible business expenses, even if they are incurred in the
conduct of a trade or business. The other expenses are deductible.
John, a single individual, is an avid coin collector. To raise some money to support his hobby,
John began to occasionally buy and sell coins about 10 years ago, incurring business-related
, expenses in those transactions. John does not consider himself to be in the business of dealing
in coins, and over the time he has been selling coins, he has never made a profit. This year,
John grossed $4,000 in sales, and had $4,500 in expenses associated with the activity. John's
AGI for the year (including any inclusion due to the coin trading activity) is $50,000, and aside
from the coin trading loss, his only other permissible itemized deductions are mortgage interest
of $8,000 and real estate taxes of $2,500. Which of the following statements concerning this
situation is correct?
A)John will take the $500 loss from the coin business into his gross income.
B)Since he has never made money from the activity, he is not required - ANS-D)The increase in
John's taxable income as a result of the coin trading activity is equal to the income of $4,000.
Rationale
John is engaging in a hobby activity. He has never made a profit, and does not appear to have a
profit motive. Consequently, he must include all $4,000 in his gross income. He cannot deduct
his hobby expenses after 2017.
Christopher runs an extortion racket in his home neighborhood. He paid Bobby $100,000 to run
the street operations, and incurred $30,000 for secretarial support and $20,000 in
miscellaneous expenses, such as rent for his office and supplies. Christopher had gross income
from the extortion ring of $400,000. How much of the income is subject to income tax this year?
A)$250,000.
B)$270,000.
C)$300,000.
D)$400,000. - ANS-A)$250,000.
Rationale
Even though Christopher is running an illegal business, the income from the activity is subject to
income tax. Christopher is entitled to deduct all reasonable and necessary expenses associated
with the production of the income, including salaries and costs incurred in business operations.
Which of the following statements concerning Net Operating Losses (NOL) is correct?
A)NOLs must be used in the current tax year to offset other income; they cannot be applied to
other tax years.
B)NOLs can be carried back up to six years to offset income from those prior tax years.
C)NOLs can be carried forward indefinitely.
D)Prior to carrying forward NOLs, a taxpayer is required to apply the NOLs against prior-year
income for at least two years. - ANS-C)NOLs can be carried forward indefinitely.
Rationale
NOLs can be carried forward indefinitely and cannot generally be carried back for years after
2017.
Happy Harry not only uses drugs, he also sells them to a circle of friends and associates. This
year, Harry grossed $650,000 from drug sales. He paid $125,000 to his street pushers to
