Question

Kristin Graf is trying to decide how to invest a $10,000 inheritance. One option is to make an additional investment in Rocky Road Excursions in which she has an at-risk basis of $0, suspended losses under the at-risk rules of $7,000, and suspended passive activity losses of $1,000. If Kristin makes this investment, her share of the expected profits this year will be $8,000. If her investment stays the same, her share of profits from Rocky Road Excursions will be $1,000. Another option is to invest $10,000 as a limited partner in the Ragged Mountain Winery; this investment will produce passive activity income of $9,000. Complete the letter to Kristin to review the tax consequences of each alternative. Kristin is in the 28% tax bracket. If an amount is zero, enter "0".

Dear Kristin: This letter is in response to your request for assistance in analyzing the tax consequences from two investment alternatives. One alternative is to make an additional investment of $10,000 in Rocky Road Excursions. The other choice is to invest $10,000 as a limited partner in the Ragged Mountain Winery. The following analysis is based on these facts.
Invest $10,000 in Rocky Road Excursions:
Expected profit from investment $
Beginning at-risk basis $
Increase to at-risk basis due to profit $
Increase to at-risk basis due to investment $
Use of loss suspended by at-risk rules $
Ending at-risk basis $
Beginning suspended passive activity loss $
Reclassified suspended passive activity loss $
Use of suspended passive activity losses—revised $
Current taxable income $
Current tax liability $
Invest $10,000 in Ragged Mountain Winery:
Expected profit from investment—Ragged Mountain Winery $
Expected profit from investment—Rocky Road Excursions $
Use of suspended passive activity losses from Rocky Road Excursions $
Current taxable income $
Current tax liability $
As you can see, the tax effects of the two options vary significantly due to the interplay of the at-risk and passive activity loss rules. This analysis should help you make a more informed investment decision. If you need any further explanation, please contact me. Sincerely, Libba Eanes, CPA Partner

Answer 1

Answer is explained in the explanation section below.

Step-by-step explanation:

Solution:

Invest $10,000 in Rocky Road Excursions:

Expected Profit from Investment = $8000

Beginning at risk basis = $0

Increase to at-risk basis due to Profit = $8000

Increase to at-risk basis due to investment = $10000

Total = $8000 + $10000 + $0 = $18000

Use of Loss Suspended by at-risk rules = $7000

Ending at risk basis = $11000

Beginning Suspended passive Loss = $1000

Reclassified Suspended passive loss = $ 7000

Use of Suspended passive losses - revised = $8000

Current Taxable Income = $0

Current Tax Liability = $0

Invest $10,000 in Ragged Mountain Winery:

Expected Profit from investment - Ragged Mountain Winery = $9000

Expected Profit from investment - Rocky Road Excursions = $1000

Use of Suspended passive losses from Rocky Road Excursions

($1000 + reclassified suspended under at-risk rules + $1000 suspended passive loss) = $2000

Current Taxable Income = $8000

Current Tax Liability = ($8000 x 28%) = $2.240