Question

Wes’s at-risk amount in a passive activity is $25,000 at the beginning of the current year. His current loss from the activity is $35,000 and he has no passive activity income. At the end of the current year, which of the following statements is incorrect?

	a.	Wes has a loss of $25,000 suspended under the passive loss rules.
	b.	Wes has an at-risk amount in the activity of $0.
	c.	Wes has a loss of $10,000 suspended under the at-risk rules.
	d.	Wes has a loss of $35,000 suspended under the passive loss rules.
	e.	None of the above is incorrect.

ANSWER:	d
RATIONALE:	The at-risk amount of $25,000 is reduced to zero by $25,000 of the passive loss. As a result, the $10,000 unused loss is suspended under the at-risk rules. The $25,000 of passive loss is suspended under the passive loss rules because Wes has no passive income.

Explain how to get this answer

Answer 1

The best way to justify Option D is to clarify the options A, B, C, D and E.

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Option A is correct because Wes has no passive income. The amount of passive losses limited by at-risk limitation rules (which would be $25,000) can only be set-off only against the passive income. As Wes has not earned any passive income during the year, the entire amount of $25,000 (as limited by at-risk limitation rules) will get suspended under the passive loss rules. Before applying passive activity rules, it is necessary to apply at-risk limitation rules.

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For Option B, the at-risk amount in the activity of $0 arrived as below:

At Risk-Amount at the Beginning of the Year	25,000
Less Current Loss Allowable	25,000
At Risk-Amount at the End of the Year	$0

The maximum amount of passive activity loss that can adjusted is limited by the amount at-risk at the beginning of the period (which is $25,000 in this case). Therefore, Wes can claim a maximum deduction of $25,000 and will have $0 at-risk amount at the end of the year.

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For Option C, the amount of suspended loss under the at-risk rules is calculated as follows:

Current Passive Activity Loss	35,000
At Risk-Amount at the Beginning of the Year	25,000
Loss Suspended under At-Risk Rules	$10,000

At-risk amount can be adjusted against income from passive activity only to the extent of the value that is at-risk (which is $25,000 in this case). Any leftover amount (which would be $10,000) can be carried forward to future years indefinitely and adjusted if sufficient basis is available in future.

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Option D is incorrect, as Option A is correct. The maximum amount of loss that can be suspended under passive activity rules would be limited to $25,000 and not $35,000.

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Option E is not to be considered as Option D is an incorrect statement and therefore, the answer to the question.