Question

Klaus, a certified public accountant, earns $189,000 from his practice. He also receives $4,300 in dividends and interest from various portfolio investments. During the year, he pays $40,000 to acquire a 25% interest in a partnership that produces a $175,000 loss for the year. He has $3,000 of passive income from other sources. Compute Klaus's AGI, assuming that:

a. He does not participate in the operations of the partnership.

In this case, Klaus's AGI is $.____________________________

b. He is a material participant in the operations of the partnership.

In this case, Klaus's AGI is $.______________________________

Answer 1

Solution

a.)

When Klau's doesn’t participate in the operation of the partnership, he is not allowed to deduct any amount related to the losses made by the partnership firm. In this case, his $40,000 is considered an investment and he can only deduct the losses when he realizes it. So, the AGI for Klau's under this scenario would be:

AGI = Gross Income + Dividend Income
AGI = $189,000 + $4,300
AGI = $193,300

b.)

When Klau's participates in the operation of the partnership, he becomes an active business partner and is allowed to claim deduction for lesser of 25% of loss made by the company or actual amount invested by him (i.e. $40,000)
25% of the losses = $175,000*25% =$43,750
Since proportionate loss for Klau's is higher than his actual investment, he is allowed to make the deduction for $40,000.
AGI = $189,000 + $4,300 - $40,000
AGI = $153,300