Erline Begins Investing in Various Activities During the Current Year

question 6

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 $\$ 32,000$ .

---

Definitions:

Least-squares Regression

A statistical method used to determine the line of best fit by minimizing the squared differences between observed values and those predicted by a linear function.

Mixed Cost

Expenses that have both fixed and variable components, varying with the level of activity but not in direct proportion.

High-low Method

A technique used in cost accounting to estimate variable and fixed costs based on the highest and lowest levels of activity.

Fixed Manufacturing Cost

Costs that do not change with the level of production, such as rent, salaries, and insurance.