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I’m stuck on a concept I ran into illustrated in the following MCQ. The part I’m confused about is in bold.
Question:
Don Wolf became a general partner in Gata Associates on January 1, 2013 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, 2013, 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 2013 is
Answer: $5,000
Explanation from CPAexcel’s answer:
Passive activity losses are the amount that total losses from passive activities exceed total gains from passive activities. The characterization of a partner’s share of the partnership’s income as passive or nonpassive depends on the partner’s participation in the partnership’s income earning activities.
Since Wolf did not materially participate in the partnership business, his share of the partnership’s operating loss, $5,000, is considered a loss from a passive activity. Passive income does not include portfolio income.
As a result, Wolf’s share of the $20,000 in interest income would not be passive. Therefore, since Wolf had no gains from passive activities to offset the loss from his share of the partnership’s operating loss, Wolf would have a passive loss of $5,000, equal to his share of the partnership’s operating loss.
It makes sense to me that the partnership operating income is considered passive income for Wolf. But why would this fact change the character of the interest income? The explanation above says that the “interest income would not be be passive.”…..Ok so what does it become then, portfolio income???
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