[jeff]

Welcome to the Q4 2017 CPA Exam Study Group for REG. 🙂

Introduce yourselves and let your fellow NINJAs know when you plan to take your REG exam.

The Five Steps (NINJA Framework): https://www.another71.com/pass-the-cpa-exam/

[Sandy]

Hi AR,

In Q2, Lane has passive income from S corp – $1500 , which you can use to offset other passive loss.

In Q1, the only source of passive activity is rental activity, so that the formula for active participation kicked in and the allowable loss is 10,000.

But I am somewhat confused with material participation and active participation.
Anyone can explain ?

[pcunniff]

@sophie – im glad you asked this question because I was confused with this for a while. Once you are an active participant (work over 500 hours or are generally working 40 hours + a week as a real estate agent) your passive (not martially participating) activity becomes active and you can offset that full amount of the loss against income. I was very confused at first, but the key here is to note that passive activity losses can be offset against income when the participant is an active participant per the test stated above. I hope this helps.

Take the exam in a week from tomorrow and will be checking frequently with questions. I prefer to be drilled on pship/s corp/ reg corp problems as they are by far the most tested on this exam.

[joonpark1212]

I had a question on a GLEIM SIMGS regarding Ccorporation contribution. Could anyone provide their insights?

Question: Calculate gain or loss that will be recognized by the shareholders as a whole”

Situation: Maria and Kim started Grand Slam, Inc., in 2017. Kim transferred a building with a basis of $250,000 and a FMV of $330,000 for 75% of the stock. Maria agreed to perform advertising services in exchange for her stock.

Answer: $80,000; Stock exchanged for services is not counted toward the 80% control threshold. The FMV of the stock received in exchange for services is gross income to the shareholder ($330,000 ÷ 3). Any other shareholders involved in the transaction must recognize any gain on the transfer of property. A control group shareholder’s basis in the stock of the corporation is the adjusted basis in the contributed property minus boot received (including liabilities assumed by the corporation) plus any gain recognized. Kim would have a recognized gain of $80,000 ($330,000 FMV – $250,000 adjusted basis),

I thought the answer had to be $190,000; Kim's recognized gain $80,000 + Maria's income from service $110,000 [($330,000 ÷ 75%) – $330,000]

[Anonymous]

@sophie ,

@pcunniff ,

According to my Gleim outline, there is actually a difference between materially participating and actively participating.

Materially participating requires meeting one of the following tests:
1. Participate more than 500 hours
2. Participation constitutes substantially all participation in the activity.
3. Participates more 100 hours and exceeds participation of any other individual
4. Materially participated in the activity for any 5 years preceding 10 years before the year in question

Active participation is less stringent and requires:
1. participation in management decisions or arranging to provide services (such as repairs)
2. Ownership of at least 10% of interest in the property (including spouse)

Anyway, I am wondering if you meet the materially participating test, does that mean you automatically meet the active participation test? Active participation is required to take the rental real estate activity deduction (mom & pop) mentioned in the above problem.

Definitely a confusing area!

[Anonymous]

@joonpark1212

Contributing only services for stock does not count towards the 80% control threshold for Sec. 351 exchanges, and thus doesn't meet the non-recognition of gain criteria. Therefore, the taxpayer reports ordinary income for the FMV value of the stock received and thus does not recognize a gain.

(The general rule is that you don't recognize a gain in an exchange for services, you just take a FMV value in property received and report it as ordinary income)

[Sandy]

After reviewing the previous discussions, and after a little bit search. I have some conclusions, but just want to ask if this is right.

1. Material participation include both “real estate person” and active participation.

2. In the question, it just mentioned material participation. But it didn't say the person is a real estate person. So you just assumed he is active participating rather than working as real estate person.

Does it make sense?

[joonpark1212]

@benj2017 Thank you again.

In general: shareholder does not recognize gain in services, only reports ordinary income
In 351: shareholder recognizes gain, instead of ordinary income

Would my summary make sense?

[pcunniff]

@benj2017 thats actually a good point. To be honest, I think you're right about “if they are materially participating – they are considered active.” I am looking at a 2017 tax book from McGraw-Hill to further clarify

Active business income: Income from activities in which the taxpayer materially participates in a meaningful way, including salary and self employment income.

There was a problem that helped it click for me (which may be out of the scope of the exam since they will probably tell you if its “active” or not).

To clarify, if you are a limited partner in a partnership and have ordinary losses (considered passive losses) you CANT deduct these loses until you either 1) dispose of your p-ship interest or 2) generate passive income to offset these losses. This cannot fall under ordinary or portfolio income. I get confused with portfolio income because of the (unearned income from div, royalties, interest, and annuities (but thats besides the point)). The rule is you can't deduct passive against these two (ordinary and portfolio income).

However, if you are this limited partner and decide to meet one of the MATERIAL PARTICIPATION TESTS, thereby converting future partnership losses from passive to active – you can deduct these losses as ORDINARY LOSSES because they wouldn't technically be “passive anymore.” I know general partners wouldn't be, but limited partners are. Further, if you are a managing member, again, the losses generated from the partnership in which are “ordinary” fall in the active bucket vs passive and would be deductible to that partner according to the tax basis and at risk basis.

I know its very very confusing. But if you read that a few times, it'll click.

[Anonymous]

@joonpark1212 ,

In Sec. 351 (and in property transactions in general), you always recognize services contributed as ordinary income for the FMV of stock received. If you contribute property and services then the transaction qualifies for non-recognition of gain on the property, but only if the property's FMV is at least 10% of the value of the services.

Think about it logically. If you contribute services for stock, then the FMV of the stock is your compensation which you report as ordinary income. There is no basis to increase or to recognize a gain on. However if you contribute property worth $500 and services worth $5,000 for stock worth $5500, and the property's basis to you is $250, then you have a realized gain of $250. Under Sec. 351 you don't recognize that gain if after the transfer you (and/or other persons party to the transfer) control 80% of voting and value of the corporation.

[Anonymous]

@pcunniff

Thanks for the explanation, I definitely need to read more on that. I think you're right in that on the exam we'll be told if the taxpayer is actively or materially participating.

I'm just curious if the taxpayer is “materially” participating in the rental real estate activity whether that entitles them to the up to $25,000 deduction? Or does it have to be “active” participation for them to qualify?

Ugggh….

[pcunniff]

Anyone have any tips or good material useful for wash sale losses? Id like to work a problem with a lot of facts is possible.

[pcunniff]

@benj2017 if they are materially participating or active and own at least 10% of the rental activity – the mom and pop exception (25k) against ordinary income applies

[joonpark1212]

@benj2017 your explanation on sec351 services was very helpful, thanks for the logic question as well.
I might have been confused mainly because one review material has mixed up the words btw gain and income.

My take on the rental loss is that $25,000 loss can offset ordinary income if you are above an active participant which is less than material participant.

[pcunniff]

@joonpark1212 … thats it and it would make sense because you own 10% of the rental activity. Becker's text phrases it as:
Taxpayers may deduct up to $25,000 of net passive losses attributable to rental real estate annually if the individual is actively participating/managing (although not participating to the extent needed to avoid passive activity classification as described below) and own 10% of the rental activity.

(not passive activity)
As described by your test above

[mashloum]

My exam on 5th of Dec and I feel totly lost with the REG material
Is this normal?!
Any advice?

[Author]

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