Erline Begins Investing in Various Activities During the Current Year

question 128

Essay

Erline begins investing in various activities during the current year.Unfortunately,her tax advisor fails to warn her about the passive loss rules.The results of the three passive activities she purchased for the current year are:
$\begin{array}{lr}& \text { Income (Loss) } \\\text { Passive Activity 1 } & \$(36,000) \\\text { Passive Activity 2 } & 22,000 \\\text { Passive Activity 3 } &(4,000)\\\end{array}$
a.If Erline's adjusted gross income is $170,000 before considering the effect of the passive activities, what will Erline's adjusted gross income be for the current year? Fully explain the effect of the passive activity investments on her adjusted gross income.
b.Because Passive Activity 1 has been such a loser, Erline is considering selling it. However, she is concerned about the effect of the sale on her taxable income because her tax advisor told her that her basis in the activity is only $14,000 and she could sell it for $32,000. Explain the effect on her taxable income if she sells Activity 1 for $32,000.

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Definitions:

Issued Shares

The number of shares that have been allocated to be sold and are held by shareholders, including both public investors and company officers or insiders.

Treasury Shares

Stocks that were issued and later reacquired by the issuing company, reducing the amount of outstanding stock on the open market.

Contributed Surplus

An account on the shareholders' equity section of the balance sheet that represents the excess amount investors paid over the par value of the shares.

Retained Earnings

Accumulated net incomes of a company not paid out as dividends but retained for reinvestment in the business or to pay off debts.