Passive Income

A customer whose stated objective is current income asks his representative about an affordable housing program. Why is the program a poor match for that objective?

1. A.Interests in such a program may not be sold to individual investors seeking incomeWrong. No eligibility bar of that kind exists; the mismatch here is economic rather than regulatory.
2. B.It distributes monthly, but every dollar distributed is taxed as ordinary incomeWrong. This invents a distribution pattern and answers a tax question the stem did not ask.
3. C.The return is built on credits and passive losses, and cash distributions are limited by designCorrect. The payoff is designed to arrive through the tax return, not through the cash distribution.
4. D.Residual value is guaranteed by the subsidy, which caps the customer's eventual upsideWrong. Residual value in these programs is uncertain rather than guaranteed, and no such cap applies.

Why: The outline describes an affordable housing program's benefits as tax credits and passive losses, and lists limited cash distributions and uncertain residual value among its risks. Rents in subsidized housing are constrained, so there is little surplus cash to distribute; the investor is paid mainly in tax benefits, which are worth something only to someone with the liability and the passive income to absorb them. A customer who needs spendable cash each quarter receives very little of it here. Were the same customer sitting on substantial passive income with no need for current cash, the program could be a reasonable fit.

Jarrah holds a large suspended passive loss and points to an earlier, very profitable year in which he paid substantial tax. He asks his representative whether he can amend that earlier return to use the loss. The correct response is that:

1. A.He may amend it, because passive losses follow the same carryback rules as business lossesWrong. The two regimes are separate, and this one supplies no backward relief at all.
2. B.He may amend it, but only if the income reported in that earlier year was itself passiveWrong. The character of the earlier income is beside the point when no carryback exists.
3. C.He may not carry the loss back; a passive loss moves forward onlyCorrect. The suspended amount waits for future passive income and cannot reopen a closed year.
4. D.He may not carry it back, but he may deduct it currently against his salary insteadWrong. It swaps one unavailable route for another, since wages are nonpassive.

Why: Passive losses run forward only. There is no carryback, so amending a profitable earlier return to absorb a suspended passive loss is not available to him, however much tax that year produced. The suspended loss remains intact and available against passive income in future years. If Jarrah acquires an interest that allocates him passive income next year, the suspended loss becomes usable then.

A customer asks that his traditional IRA subscribe for units of an oil and gas income program, pointing to the depletion deductions the program passes through. What should the representative tell him?

1. A.Partnership interests sit on the list of investments an individual retirement account is barred from holding.Wrong. The barred categories are narrow and a program interest is not among them.
2. B.The interest is not itself off-limits to the account, but the depletion deductions have no value inside a tax-deferred vehicle.Correct. The holding is allowed; what fails is the reason he wants it.
3. C.The deductions flow through to him personally and can be claimed on his own return for the year.Wrong. Amounts allocated to the account belong to the account, not to the owner's personal return.
4. D.The account may hold the units only while the program's units remain listed on an exchange.Wrong. This invents a listing condition that no retirement account rule imposes.

Why: A retirement account may hold a wide range of assets, and the narrow categories it is barred from holding do not include an interest in a program. The obstacle here is not permissibility but purpose. The account already defers tax on what it earns, so a pass-through deduction offsets income that was not going to be taxed currently in any event, and the shelter is simply consumed with nothing to show for it. If the same customer bought the units in a taxable account that had other passive income, the deduction would actually do work.

A limited partner's passive losses for the year exceed her passive income. The unused portion of those losses:

1. A.Is forfeited permanently at the close of the tax year in which it aroseWrong. The excess is suspended rather than destroyed, and it stays available indefinitely.
2. B.Is carried forward against future passive income, but may not be carried backCorrect. The carryforward preserves the deduction while the absence of a carryback closes off earlier years.
3. C.May be carried back to recover tax paid in earlier years, or else carried forwardWrong. No carryback exists here, so the choice it describes is not available to the partner.
4. D.Converts into a tax credit that offsets the partner's liability dollar for dollarWrong. It confuses two distinct items: a suspended deduction does not change character into a credit.

Why: Passive losses in excess of passive income are not deductible currently, but they are not forfeited either. They are carried forward and remain available against passive income in later years. They may not be carried back to an earlier year, which is what separates them from the loss regimes candidates usually encounter first. If she generated more passive income in the current year, more of the loss would be usable now and less would carry forward.