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AICPA Certification REG : CPA Regulation

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Question 6: Don Wolf became a general partner in Gata Associates on January 1, 1989, with a 5% interest in
Gata's
profits, losses, and capital. Gata is a distributor of auto parts. Wolf does not materially participate in
the
partnership business. For the year ended December 31, 1989, Gata had an operating loss of
$100,000.
In addition, Gata earned interest of $20,000 on a temporary investment. Gata has kept the principal
temporarily invested while awaiting delivery of equipment that is presently on order. The principal
will be
used to pay for this equipment. Wolf's passive loss for 1989 is:
A. $0
B. $4,000
C. $5,000
D. $6,000
Correct Answer: C
Explanation
Choice "c" is correct. Wolf's passive loss for 1989 is $5,000 ( $100,000 operating loss * 5% interest in
partnership).
Choice "a" is incorrect. Wolf did not materially participate in the partnership, so the loss was passive.
Choice "b" is incorrect. Wolf's passive loss of $5,000 could not be reduced by his distributive share of
the
partnership's "interest income" totaling $1,000. Interest income is considered "portfolio income,"
and
neither the partnership nor a partner can offset it against passive losses.
Choice "d" is incorrect. No items of income or deduction from portfolio income or activities in which
the
taxpayer materially participates may be combined or offset with passive losses unless the activity
generating the loss is completely disposed of in a taxable transaction.