South Western Federal Taxation 2014 Taxation of Business Entities 17Th Edition Smith Solutions Manual Full Chapter PDF

South-Western Federal Taxation 2014
Taxation of Business Entities 17th Edition

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CHAPTER 6
LOSSES AND LOSS LIMITATIONS
SOLUTIONS TO PROBLEM MATERIALS
Status: Q/P
Question/ Learning Present In Prior
Problem Objective Topic Edition Edition
1 LO 1 Bad debts: business Unchanged 1

2 LO 1 Bad debts: nonbusiness Unchanged 2
3 LO 2 Worthless securities versus theft loss Unchanged 3
4 LO 1 Bad debt and cash basis taxpayer Unchanged 4
5 LO 1, 2 Bad debt and § 1244 stock Unchanged 5
6 LO 2 § 1244 stock Unchanged 6
7 LO 2 Transfer of § 1244 stock to another individual Unchanged 7
8 LO 3 Casualty loss: disaster area loss New
9 LO 3 Casualty loss: occurrence Unchanged 9
10 LO 3 Casualty loss: insurance recovery Unchanged 10
11 LO 4 Net operating loss: calculation Modified 11
12 LO 6 At-risk rules New
13 LO 6 At-risk rules Unchanged 13
14 LO 6,7,8 Application of at-risk and passive loss rules Unchanged 14
15 LO 6 Passive activity loss rules: general New
application
6-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
6-2 2014 Entities Volume/Solutions Manual
16 LO 5, 6 Passive activity loss rules: general Unchanged 16

application
17 LO 6 Sale of passive activity and suspended Modified 17
losses
18 LO 6 Sale of passive activity and suspended Unchanged 18
losses
19 LO 6 Passive losses of personal service Unchanged 19
corporation
20 LO 6 Passive losses of corporations New
21 LO 7 Material participation determination Unchanged 21
22 LO 7 Issue ID Unchanged 22
23 LO 6, 8 Interaction of at-risk and passive loss rules Unchanged 23
24 LO 7 Character of property: held as investment Unchanged 24
property or rental property
25 LO 8 Interaction of at-risk and passive loss rules Unchanged 25
Status: Q/P
Question/ Learning Present In Prior
Problem Objective Topic Edition Edition
28 LO 5, 6, 8 Interaction of at-risk and passive loss rules Unchanged 28

29 LO 5, 6, 8 Passive loss deduction amounts Unchanged 29
30 LO 9 Rental loss: active participation New
31 LO 5, 6, 7 Ethics problem Unchanged 31
32 LO 6, 9 Joint or separate return: real estate rental Modified 32
exception
33 LO 9 Real estate rental exception Unchanged 33
34 LO 9 Passive activity loss allowed, suspended Unchanged 34
losses and credits
35 LO 9 Rental real estate loss deduction Unchanged 35
36 LO 5,6,10 Ethical consideration Unchanged 36
37 LO 5,6,10 Gift of a passive activity New
Bridge
Discipline
Problem
1 Bad debt expense Unchanged 1

2 At-risk rules Unchanged 2
3 Passive activity loss rules: Unchanged 3
general application
Losses and Loss Limitations 6-3
Research
Problem
1 Casualty loss deduction Unchanged 1

2 Definition of portfolio income and its New
relationship with passive losses
3 Classification of property as rental: Unchanged 3
extraordinary personal services
exception
4 Internet activity Unchanged 4
5 Internet activity Unchanged 5
1. Smith, Raabe, and Maloney, CPAs

5191 Natorp Boulevard
Mason, OH 45040
January 29, 2013
Loon Finance Company
100 Tyler Lane
Erie, PA 16563
Dear Sir:
This letter is to inform you of the possibility of taking a bad debt deduction.
Your loan to Sara is a business bad debt; therefore, you are allowed to take a
bad debt deduction for partial worthlessness. You will be able to take a bad debt
deduction in the current year of $26,000 ($30,000 – $4,000) based on partial
worthlessness.
Should you need more information or need to clarify anything, please contact
me.
Sincerely,
John J. Jones, CPA
Partner
TAX FILE MEMORANDUM
January 29, 2013
From: John J. Jones
Subject: Bad Debt Deduction
Loon Finance Company’s $30,000 loan to Sara is a business bad debt.

Therefore, a bad debt deduction is allowed for partial worthlessness of $26,000
(i.e., Sara has filed for bankruptcy and Loon has been notified that the most the
company can expect to receive is $4,000). Loon will be able to claim an additional
bad debt deduction in the year when a final settlement has been reached with
respect to the loan assuming the amount collected is less than $4,000.
pp. 6-2 and 6-3
2. Monty must include up to $10,000 in gross income, but only to the extent of a tax
benefit in a prior year. Because the debt is a nonbusiness bad debt, the $11,000
would have been reported as a short-term capital loss. Last year, Monty had
capital gains of $4,000 and taxable income of $20,000. Therefore, $7,000 of the
$11,000 loss produced a tax benefit. Hence, only $7,000 would be included in
Monty’s gross income this year. pp. 6-2 to 6-4
3. Jack should be concerned with the following issues:
• Should this be treated as a worthless security?
• Should this be treated as a theft loss?
• Does the theft loss create an NOL?
• Can the NOL be carried back 3 years?
pp. 6-5 and 6-6
4. Worthless debts arising from unpaid wages are not deductible as a bad debt
unless the taxpayer has included the amount in income for the year for which the
bad debt is deducted or for a prior tax year. Jake used the cash method of
reporting income. Therefore, fees for services by Jake that allegedly were owed
by the City have never been included in income, and unpaid amounts, even if
earned, do not constitute bad debts within the meaning of §166 for which a
deduction for worthlessness may be claimed. p. 6-2
5. Salary $120,000
§ 1244 ordinary loss (limit of $100,000) (100,000)
Short-term capital gain on § 1244 stock $20,000
Short-term capital loss (nonbusiness bad debt) (19,000)
Net short-term capital gain 1,000
Net long-term capital loss (remaining § 1244 loss) (5,000)
Net capital loss (limit) (3,000)
Adjusted gross income ($ 17,000)
pp. 6-4 to 6-6
6. Sell all of the stock in the current year:
Current year’s AGI

Salary $ 80,000
Ordinary loss (§ 1244 limit) (50,000)
Long-term capital gain $ 8,000
Long-term capital loss ($80,000 – $50,000) (30,000)
Long-term capital loss (limit) (3,000)
AGI $ 27,000
Next year’s AGI

Salary $
90,000
Long-term capital gain $ 10,000
Long-term capital loss carryover (19,000)
($22,000 – $3,000)
Long-term capital loss (limit) (3,000)
AGI $ 87,000
Total AGI
Current year $ 27,000
Next year 87,000
Total $114,000
Sell half of the stock this year and half next year:
Current year’s AGI
Salary $ 80,000
Ordinary loss (§ 1244 stock) (40,000)
Long-term capital gain 8,000
AGI $ 48,000
Next year’s AGI

Salary $ 90,000
Ordinary loss (§ 1244 stock) (40,000)
Long-term capital gain 10,000
AGI $ 60,000
Total AGI
Current year $ 48,000
Next year 60,000
Total $108,000
Mary’s combined AGI for the two years is lower if she sells half of her § 1244
stock this year and half next year. p. 6-6

Mason, OH 45040
July 30, 2013
Mr. Mike Sanders
2600 Riverview Drive
Cape Girardeau, MO 63701
Dear Mr. Sanders:
This letter is in response to your question with respect to stock you held in a
corporation that qualified as a small business corporation under § 1244. Our
conclusion is based upon the facts you provided us. Any change in facts may
cause our conclusion to be inaccurate.
Your brother, Paul, gave you the stock a few months after he acquired the stock.
Paul paid $30,000 for the stock three years ago. You sold the stock this tax year
for $10,000.
You may deduct the difference between the selling price of the stock, $10,000,
and the cost of the stock to your brother Paul, $30,000. When property is given
to another, there is a carryover of the basis the donor had in the property. Thus,
your tax basis in the stock will be the $30,000 tax basis your brother, Paul, had
in the stock. You will have a long-term capital loss of $20,000 on the sale of the
stock. Because you were not the original holder of the stock, you may not take
an ordinary loss deduction on the sale.
Should you need more information or need to clarify our conclusion, do not
hesitate to contact me.
Sincerely yours,
David C. Via, CPA
Partner
TAX FILE MEMORANDUM
July 18, 2013
FROM: David C. Via
SUBJECT: Mike Sanders

Today I talked to Mike Sanders with respect to his sale of stock which was issued
to his brother, Paul, pursuant to § 1244. Paul paid $30,000 for the stock three
years ago and gave the stock to his brother, Mike, a few months after he acquired
it. Mike sold the stock in the current tax year for $10,000.
At issue: May a donee of stock in a corporation that qualified as a small business
corporation under § 1244 take an ordinary loss deduction pursuant to § 1244?
Conclusion: No. Only the original holder of § 1244 stock qualifies for ordinary
loss treatment.
p. 6-6
8. The amount of the loss before the 10% of AGI limitation is computed as follows:
Home ($350,000 – $280,000) $70,000

Auto ($30,000 – $20,000) 10,000
Total loss $80,000
Less: $100 (100)
Loss before 10% of AGI $79,900
Because the President declared the area a disaster area, Olaf and Anna could
claim the loss on last year’s return or on the current year’s return.
Amount of loss on last year’s return:

Loss $79,900
Less: 10% of AGI (10%  $180,000) (18,000)
Total loss $61,900
Amount of loss on current year’s return:

Loss $79,900
Less: 10% of AGI (10%  $300,000) (30,000)
Total loss $49,900
If Olaf and Anna apply the loss to the prior year, the benefit of the loss will be at
a rate of 25% because taxable income will be $78,100 ($140,000 – $61,900). If
the loss is applied to the current year, the benefit will be at a rate of 28% because
taxable income will be $165,100 ($215,000 – $49,900). The tax savings will be
$15,475 (25%  $61,900) if the loss is taken on the prior year’s return and
$13,972 (28%  $49,900) if the loss is taken on the current year’s return.
Therefore, Olaf and Anna should include the loss on the prior year’s return,
because the tax savings is $1,503 ($15,475 – $13,972) greater.
pp. 6-7 to 6-10
9. The tax issues for John are as follows:
• Is the loss a theft loss or an investment loss?
• Is the loss subject to either the personal loss limits ($100 floor and
10%-of-AGI floor) or the limits on itemized deductions (2%-of-AGI floor)?
• How is the amount of the loss determined?
pp. 6-7 to 6-11

Mason, OH 45040
January 26, 2013
Snipe Industries
450 Colonel’s Way
Warrensburg, MO 64093
Gentlemen:
This letter is to inform you of the tax consequences of filing a claim versus not
filing a claim with your insurance company for reimbursement for damages to the
car driven by Sam Smith.
Because the claim is being made by a company and not an individual, you may
deduct the casualty loss in full even if no claim for insurance is filed. Thus, your
plan will work. The full $18,000 loss is deductible. Note that the result would have
been different if the casualty loss were claimed by an individual. In such a
circumstance, because the car was insured, the amount of the tax deduction
would be determined as if a claim had been filed with the insurance company
and the reimbursement was received. Consequently, the deduction would have
been zero.
The benefit of filing the claim, absent any tax consequences, is an expected cash
inflow of $15,000 from the insurance company, while the tax savings from the
casualty loss deduction if no claim is made is $2,700 (assuming a 15% tax rate).
Thus, the expected cost of policy cancellation should be at least $12,300
($15,000 – $2,700) to justify not filing a claim.
Should you need more information or need to clarify anything, please contact
me.
Sincerely,
John J. Jones, CPA
Partner
pp. 6-7 to 6-10
11. a. Business receipts $144,000

Less: Business expenses (180,000)
Net business loss ($ 36,000)
Alimony received 22,000
Interest income 3,000
Adjusted gross income ($ 11,000)
Less: Itemized deductions (24,000)
Personal and dependency exemptions (3 × $3,900) (11,700)
Taxable income ($ 46,700)
b. Taxable income ($46,700)
Add: Personal and dependency exemptions 11,700
Excess of nonbusiness deductions ($24,000)
over nonbusiness income ($3,000 + $22,000) –0–
NOL ($35,000)
In calculating the NOL, the alimony received of $22,000 is not treated as
business income.
pp. 6-12 to 6-14
12. The at-risk rules limit Fred’s deductions. He can deduct $35,000 in 2012, thereby
reducing his at-risk amount to $15,000 ($50,000 original investment – $35,000
deducted). He will be limited to a $15,000 deduction in 2013 unless he increases
his amount at risk. Fred’s share of the partnership losses is not subject to the
passive loss restrictions because his interest is not a passive activity. Examples
19 and 20

Mason, OH 45040
February 5, 2013
Mr. Bill Parker
54 Oak Drive
St. Paul, MN 55164
Dear Mr. Parker:
This letter is in response to your inquiry regarding the tax treatment of losses that
you could expect this year and next year from an investment in Best Choice
Partnership. As I understand the facts, you would invest $60,000 in the
partnership with the expectation that your share of the partnership losses in the
current and succeeding years would be $40,000 and $25,000, respectively.
Even though your investment would not be subject to the passive activity
limitations, the amount of the deduction that you may claim in any one year is
subject to the at-risk rules. Essentially, these rules provide that your deductions
are limited to the amount that you have invested in the venture or the amount
that you could lose if the investment were to be unsuccessful. Consequently, in
your case, the initial amount that you would have at risk would be $60,000.
Therefore, you would be able to deduct $40,000 in the current year, which would
cause your at-risk basis to be lowered to $20,000 ($60,000 – $40,000). Because
your at-risk basis at the end of next year would be only $20,000, your share of
the partnership loss that would be deductible would be limited to $20,000. The
amount not deducted under this scenario would be deductible later when your
at-risk basis increases, for example, by additional investments you may make in
the partnership or because of income generated by the partnership.
If you have additional questions or need further clarification, please call me.
Sincerely,
John J. Jones, CPA
pp. 6-16 and 6-17
14. Application of the at-risk rules:
• What is their at-risk basis and does it include their share of the entity-level
borrowing?
• What amount of the partnership’s loss will David and Debbie be able to
deduct in the current year and what amount (if any) will be suspended
because of the at-risk rules?
Application of the passive activity rules:
• Whether the investment is a passive activity or whether David and Debbie

are treated as material participants in the venture.
• If the passive activity rules apply, what amount may be deducted in the
current year and what amount is suspended under the passive loss rules for
future use?
What is the interaction between the at-risk rules and the passive activity rules in
determining the current treatment of losses flowing from the investment?
pp. 6-15 to 6-20
15. In 2012, Kay cannot deduct any of the passive loss. The $35,000 loss is
suspended and carried forward to 2013 where $15,000 is deducted. After
deducting $15,000, the remaining $20,000 of the 2012 passive loss remains
suspended. Examples 20 and 21
16. The $50,000 loss is suspended under the passive loss rules because Ray is not
a material participant. AGI is $140,000. p. 6-19 and Example 23
17. Last year, Sarah could deduct nothing against nonpassive income and was
required to allocate the $20,000 net loss among the three loss activities.
Income (loss):
Activity A $ 30,000
Activity B (30,000)
Activity C (15,000)
Activity D (5,000)
Net passive loss ($ 20,000)
Net passive loss allocated to:
Activity B (30/50 × $20,000) ($12,000)

Activity C (15/50 × $20,000) (6,000)
Activity D (5/50 × $20,000) (2,000)
Total suspended losses ($20,000)
In the current year, Sarah has a net gain of $10,000 from the sale of Activity D.
She can offset the $2,000 suspended loss from the activity and the current year’s
loss of $1,500 from the activity against the $10,000 gain. In addition, the
remaining net gain of $6,500 ($10,000 – $2,000 – $1,500) from the sale may be
used to absorb passive losses from the other activities.
pp. 6-19, 6-20, and Examples 26 and 27
18. a. Net sales price $100,000

Less: Adjusted basis (35,000)
Total gain $ 65,000
Less: Suspended losses (40,000)
Taxable gain (passive) $ 25,000
Example 24
b. Net sales price $100,000

Total gain $ 25,000
Deductible loss ($ 15,000)
Example 25
c. Net sales price $100,000

Total gain $ 25,000
Deductible loss ($ 15,000)
The suspended passive losses are fully deductible. The suspended credits are
lost forever because the sale of the activity did not generate any tax.
Examples 25 and 29
19. The passive loss limitations apply to personal service corporations. Therefore, the
$100,000 of passive losses may not be used in the current year to offset any of
Ash’s other income. Instead, the amount is suspended for use in the future when
Ash generates passive income or disposes of the passive activity. pp. 6-22 and
6-23
20. a. A personal service corporation is not allowed to offset passive losses

against active or portfolio income. Therefore, White’s taxable income is
$436,000 ($400,000 income from operations + $36,000 portfolio income).
b. A closely held, non-personal service corporation is allowed to offset
passive losses against active income, but not against portfolio income.
Therefore, White’s taxable income is $396,000 ($400,000 income from
operations – $40,000 passive loss + $36,000 portfolio income).
pp. 6-22 and 6-23
21. John is entitled to treat the loss as active if his participation constitutes
substantially all of the participation in the activity of individuals (including
nonowner employees) for the year. If John is the only individual who participates
in the activity, he would be entitled to an active loss deduction. p. 6-25
22. • The amount of Rene’s at-risk basis in the hardware business and whether
the losses flowing from the entity are limited by the at-risk rules.
• Whether the profits and losses from the public accounting firm are
classified as passive or active.
• Whether Rene is a material participant in the hardware business.
• Whether Rene is subject to the passive loss rules.

pp. 6-15 to 6-26
Mason, OH 45040
January 23, 2014
Ms. Kristin Graf

123 Baskerville Mill Road
Jamison, PA 18929
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. Here you have an
at-risk basis of $0, suspended losses under the at-risk rules of $7,000, and
suspended passive losses of $1,000. If this investment is made, your share of
the projected profits for this year would increase from $1,000 to $8,000. The
other choice is to invest $10,000 as a limited partner in the Ragged Mountain
Winery. This would produce passive income of $9,000 this year. The following
analysis is based on these facts.
Invest $10,000 in Rocky Road Excursions:
Expected profit from investment $8,000

Beginning at-risk basis $ –0–
Increase to at-risk basis due to profit 8,000
Increase to at-risk basis due to investment 10,000
$18,000
Use of loss suspended by at-risk rules (7,000)

Ending at-risk basis $11,000
Beginning suspended passive loss ($ 1,000)

Reclassified suspended passive loss (7,000)
Use of suspended passive losses—revised (8,000)
Current taxable income $ –0–
Current tax liability $ –0–
Invest $10,000 in Ragged Mountain Winery:
Expected profit from investment—Ragged Mountain Winery $9,000

Expected profit from investment—Rocky Road Excursions 1,000
Use of suspended passive losses from Rocky Road Excursions
($1,000 reclassified suspended loss under the at-risk rules +
$1,000 suspended passive loss) (2,000)
Current taxable income $8,000
Current tax liability ($8,000  28%) $2,240
As you can see, the tax effects of the two options vary significantly due to the
interplay of the at-risk and the 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
Examples 45 to 48
24. Fred owns a passive activity that currently produces an annual $2,800 loss that
is not deductible because of the absence of passive income. Upon renting the
land, Fred hopes to have the rent income classified as passive income. As a
result, the $2,800 loss could be deducted up to the amount of the rent income.
Therefore, a key consideration is setting the rent at a level so as to ensure that
it will be treated as passive income. For the rent income to be treated as income
from a passive activity, the rent charge must be at least 2% of the property’s
unadjusted basis. Consequently, the rent income should be at least $2,000
($100,000 × 2%). If Fred sets the rent at any amount less than $2,000, the entire
receipt will be treated as income that is not from a passive activity. In such a
case, the $2,800 passive loss could not be deducted and would be suspended.
Digging Deeper 7
25. a. Maxine’s accountant was referring to the impact of the at-risk and passive
activity loss rules on the deductibility of the loss from the Teal investment.
The at-risk rules are designed to prevent taxpayers from deducting losses
in excess of the actual economic investment in the activity. The passive
loss rules prevent taxpayers from deducting passive losses in excess of
passive income. In Maxine’s current situation, she apparently has no other
investments that produce passive income (i.e., she previously sold such
an interest).
b. Maxine’s current at-risk amount is $1,000, and she has no other
investment activity that produces passive income. Therefore, Maxine’s
current year deduction is limited by both the at-risk and passive loss rules.
The $13,000 loss reduces the at-risk basis to $0, and the $12,000 balance
of the loss is suspended. The $1,000 loss not limited by the at-risk rules
also is suspended under the passive loss rules because Maxine does not
have any passive income. Therefore, none of the $13,000 loss can be
deducted.
c. The financial adviser’s suggestion is faulty. By making an additional

$12,000 investment in Teal, the at-risk basis is increased to $13,000
($1,000 + $12,000). This avoids any suspension of the loss under the at-
risk rules. However, because Maxine has no passive income, the entire
$13,000 loss is suspended under the passive loss rules.
d. Maxine has two basic choices. One choice involves two steps, the first
being to make the additional $12,000 investment in Teal as suggested by
her financial adviser. In addition, she should purchase an interest in a new
investment that is expected to produce passive income of at least $13,000
annually. Under this alternative, the additional investment in Teal insures
that the at-risk rules will not limit the deduction, while the investment in a
new passive activity will generate passive income against which the
$13,000 loss may be offset. Maxine’s second option is to consider selling
her interest in Teal. The sale of the interest will not be restricted by the at-
risk rules, and the final economic gain or loss from her investment will be
recognized for tax purposes. If the entire interest is sold, the passive loss
rules will not restrict the deductibility of the final year’s loss.
pp. 6-15 to 6-20, and 6-29

26. Lee’s share of BlueSky’s loss in 2013 is $80,000 ($400,000 × 20%), and the
entire loss is suspended under the passive loss rules. His share of the passive
income in 2014 is $40,000 ($200,000 × 20%). His at-risk amount is $80,000
($120,000 – $80,000 passive loss in 2013 + $40,000 share of income in 2013).
In 2014, he may deduct $40,000 of his $80,000 suspended loss against the
passive income. This leaves a $40,000 suspended loss at the end of 2014. pp.
6-29 and 6-30
27. Grace is allowed a $40,000 deduction. Because her at-risk basis is only $40,000,
of the $50,000 loss $10,000 is suspended. The available $40,000 loss is not
subject to the passive activity loss rules because she was a material participant.
As the loss is treated as an active loss, Grace’s income for tax purposes is
$100,000 ($140,000 – $40,000). pp. 6-29 and 6-30
28. a. If Jonathan is not a material participant, $45,000 of his $60,000 loss

($300,000 loss × 20% interest) is reclassified as a passive loss and
disallowed under the passive loss limits. The remaining $15,000 is
disallowed by the at-risk limits. Therefore, Jonathan’s AGI is $218,000
($200,000 salary + $18,000 portfolio income).
b. If Jonathan is a material participant, $45,000 of his $60,000 loss is

deductible as an active loss. The remaining $15,000 is disallowed by the
at-risk limits. Therefore, Jonathan’s AGI is $173,000 ($200,000 salary +
$18,000 portfolio income – $45,000 active loss).
p. 6-29
29. If losses were limited only by the at-risk rules, Gerald would be able to deduct
the following amounts in 2012 and 2013.
Year Loss Allowed* Disallowed
2012 $40,000 $30,000 $10,000
2013 30,000 –0– 30,000
*Allowed under the at-risk rules, reclassified as a passive loss subject to the
passive loss limitations.
However, the losses also are limited by the passive loss rules as follows:
Year Passive Deductible Suspended

2012 $30,000 $–0– $30,000
2013 –0– –0– –0–
In 2014, the $50,000 income increases Gerald’s at-risk amount to $50,000,
enabling him to deduct the $40,000 of disallowed losses. The $50,000 is passive
income that can be offset by $50,000 of suspended losses, leaving a suspended
loss of $20,000. At the end of 2014, Gerald has no unused losses under the at-
risk rules, $20,000 of suspended passive losses, and a $10,000 adjusted basis
in the activity [$30,000 (adjusted basis on 1/1/2012) – $40,000 (loss in 2012) –
$30,000 (loss in 2013) + $50,000 (income in 2014)]. Examples 45 to 48

Mason, OH 45040
March 5, 2013
Mr. Benny Jackson

125 Hill Street
Charleston, WV 25311
Dear Benny:
This letter is in response to your inquiry regarding the $60,000 loss incurred this
year in conjunction with your investment in the apartment building. (I have
assumed the property is not low-income housing as it is located in an exclusive
part of the city.) At issue is whether any of this loss is deductible from your
current AGI of $130,000.
The apartment rental activity is considered a passive activity and, in general, is

subject to the passive activity rules. However, under an exception for an active
participant, you will be able to deduct $10,000. Specifically, the law allows losses
of up to $25,000 from certain real estate rental activities to be deducted each
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This was a proud day in the life of modern

art. This exhibition would prove that the
machine could not conquer man.
[Transcriber's Note: This etext was produced from

Fantastic Universe December 1956.
Extensive research did not uncover any evidence that
the U.S. copyright on this publication was renewed.]
The Cimabue Gallery was the last stronghold of
nostalgia—expensive nostalgia. Apart for the
robot attendants—unfortunately necessary, the
times being what they were—there was
practically nothing machine-made about the
Gallery, dedicated as it was to being more than
a mere commercial venture. Evelyn E. Smith
returns to these pages with a gently ironic story
of men and dreams—the day after tomorrow....
"This," said Mr. Ditmars, "is a proud day in the life of the Cimabue
Gallery."
"It is a proud day in the life of modern art," added Mr. Replogle,
feeling that Mr. Ditmars was giving too parochial a picture of the
situation, "for it proves with more force than ever that the machine
will not conquer man."
Both partners gazed with varying degrees of complacency at the
large, brightly-colored oil paintings that covered the refined pastel
walls of the Cimabue. There was almost nothing machine-made
about the gallery—the thick, soft rugs had been hand-woven at
fabulous expense by workmen in the less industrialized areas of the
Middle East, the furnishings hand-carved by tribesmen deep in the
heart of the Australian bush. The only exception was the robot
attendants, which were, unfortunately, necessary, for no one paid
attention to human beings any more unless they were top
management or very high in the hierarchy of handcrafters.
Cimabue could afford all this luxury, and more too, for, now that big
business had become an art, art had become a big business. People
saved the excess from their government subsidies—or, if they were
lucky enough to have professional status, their salaries—to buy a
painting, a holograph manuscript ... anything to distinguish their
homes from the uniform grey mass of material comforts which the
government bestowed on everyone alike. As a result, the partners
were as wealthy as anyone outside the ruling class could hope to be.
However, Mr. Replogle, at least, was not happy. He suffered from
nightmares.
"But where is Orville?" demanded the man from the Times-Herald-
Mirror. "We haven't come to interview you two—you always say the
same thing about every new artist you discover. In fact, we already
have your words set up in type."
Mr. Ditmars gave him a benign smile. "Orville's case is different.
Never before in history has an absolutely unknown artist received
such an immediate ovation from the public. Why, almost every
picture on exhibit is already sold—the buyers have kindly allowed us
to retain them on our walls for the duration of the show as a service
to the public."
"Cimabue is more than a mere commercial venture," Mr. Replogle
added, wishing he could slip off for a paraspirin; his head hurt most
mechanically. "It is a cultural institution."
"Yeah, Orville did get pretty good write-ups," the World-Post and
Journal man conceded, "though any half-way decent artist sells like
hotcakes these days. People naturally go for anything that's hand-
made." And he fingered his hand-painted tie self-consciously. "But it
can't last."
This disturbed Mr. Replogle more than it should have. But he had
been bothered for many years by his recurring dream—a dream so
frightful that he did not dare to confide it to anyone because of its
terrifying plausibility. And anything said or done by day that seemed
to approach that midnight horror roused him to immediate
defensiveness. "Oh, yes it can last!" he protested. "It will! It must! For
art is the people's last bulwark against the machine—the one area
which cannot be mechanized, which reassures the human race that
it still is pre-eminent."
"Kindly do not touch the pictures," the roboguard droned.
"I was only feeling Orville's impasto," the lady from the Woman's
Own News defended herself. "Very thick."
I couldn't have told her to stop, Mr. Replogle reflected bitterly.
Coming from me it would have been rude, but from a robot it's all
right. Everyone knows a robot's only aim is to serve man. Our
altruism depends on our individual consciences; theirs is built-in and,
hence, more reliable.
"But where is Orville?" the man from the Times-Herald-Mirror
persisted. "He was supposed to be here at three-thirty, and it's
almost four now."
"Softly, softly," said Mr. Ditmars. "The robobar doesn't open itself until
four anyway, so you know you're in no hurry.... And, remember, a
great artist mustn't be rushed—he is not a machine, you know."
"Hervey McGeachin is bringing him," Mr. Replogle explained. "One
could hardly hurry McGeachin," he added ... unnecessarily, for
everyone knew that one didn't hurry the richest man in the United
States—one awaited his pleasure. Beside being fabulously wealthy,
McGeachin had the reputation of being something of a recluse, but
this did not make him more newsworthy, for all members of top
management tended to be a bit eccentric. The rank was hereditary—
it took more than one generation for a family to begin to understand
its machines—and there was a lot of inbreeding, with the usual
results.
"Orville is a protege of Mr. McGeachin's, isn't he?" asked the lady
from Woman's Own.
"Yes," Mr. Ditmars said. "All that was in the press release. He's one
of Mr. McGeachin's employees. Mr. McGeachin discovered him
personally, and he got in touch with us." Mr. Ditmars almost swelled
with visible pride; Mr. Replogle wished he would exercise a bit more
self-restraint. Such an open display of emotion was vulgar—almost
mechanical, one might say. Especially since they themselves were
management, in a way, although one didn't, of course, apply such a
word to those who dealt in the arts and crafts. The general public
feared and respected the management which governed them, but
they loved entrepreneurs.
"A factory hand!" Woman's Own gushed. "What a story that will
make!"
The male reporters laughed as one male. "Where have you been all
these years, cookie?" asked the World-Post and Journal. "I doubt if
there's a factory left in the United States that isn't mechanized to the
very hilt by now—with robot labor for the more specialized
operations."
"I know," she sighed. "Deep down inside of me I really know. I was
just hoping. I suppose I am—" and she batted her eyelashes "—like
all females, an incurable romantic. What do you suppose Orville is,
then?"
"Might be a clerk," Time-week suggested. "A lot of the big places still
use live clerical help for tone, and, of course, you always need a few
human beings around in case the machines break down."
"I somehow got the impression that he was an executive," Mr.
Ditmars said frostily.
"Let's hope not. It would ruin the human element in the story. You
can't expect our readers to identify with management."
"A minor executive, that is," Mr. Replogle hastened to inform them,
before Ditmars could open his big mouth again. "More like a shipping
clerk."
"Is Orville his first or his last name?" Woman's Own wanted to know.
"Just Orville," Mr. Ditmars said. "Like Rembrandt."
"Of course Rembrandt did have a last name," Mr. Replogle pointed
out. "He just isn't known by it."
"And Orville's more like Grandma Moses, anyhow, I would say,"
commented the Times-Herald-Mirror.
"He is a primitive, true," Mr. Replogle said judiciously. "If you insist
upon pinning a label on him, you might call him a post pre-
Raphaelite, with just a soupcon of Rousseau."
"I didn't know Rousseau painted," the World-Post and Journal man
said, busily clicking on his typopad.
"Not that one," Mr. Replogle told him kindly. "The other two."
"How old is Orville?" Woman's Own held her typopad at the ready.
"How many children does he have? Is he married? Fond of animals?
What does he eat for breakfast?"
"For heaven's sake," Mr. Ditmars exploded, "it isn't the man himself
that matters—it's the man as interpreted through his art! And you
can see that art for yourself." He waved his arms toward the pale
gallery walls. "Drink it in and absorb the essence of the artist."
"But we'd like a little more factual data, as a point of departure. After
all, our readers—"
"All right, all right," Mr. Ditmars said before Mr. Replogle could stop
him, "I'll give you all the facts we have—to wit, none. All we know
about Orville we put into the release. McGeachin's been keeping him
under wraps. We don't know a thing about him. He's eccentric—
McGeachin, I mean."
"Could be Orville also," the World-Post and Journal suggested.
Mr. Ditmars sighed. "Could be Orville also," he conceded.
"It's more of a story if Orville is eccentric. You more or less expect it
from management."
"Well," Mr. Replogle said, unable to contain himself further—his head
was really blasting off—"artists can be pretty peculiar people too."
It was Mr. Ditmars' turn to glare at him.
"Make way for Hervey McGeachin III and Orville," the robot at the
door declaimed. "Make way...."
Every head swivelled to catch sight of the well-known but seldom-
seen financier, as he came jerkily through the crowd. All the
journalists were dressed in the maroon or beige or navy synthetics of
almost similar cut that mass production had enforced upon the entire
population, save for the very wealthy. Gay knitted mittens, colorful
plumed hats, rainbow-hued scarves—all of which were
ostentatiously hand-made—showed that the pressmen were
professionals and not mere government pensioners who could do
nothing that a machine could not do as well or better. However,
although there were no sumptuary laws as such, few of the
journalists could afford more than one or two of these costly, status-
making accessories.
McGeachin was completely costumed in rugged individualist style.
His scarlet silk hose, emerald satin knee breeches, swallow-tailed
plum velvet coat, and starched white ruff made Mr. Replogle, who
had been rather proud of his own pale blue brocade waistcoat and
seal-skin mukluks almost sick with envy. He's so hand-made he's
practically mechanical, he said bitterly to himself.
McGeachin was followed by a Class Three, All-Purpose Manual
Labor Robot, well-burnished but of rather an early pattern. Surely,
Mr. Replogle thought, if the financier had to use a mechanical man,
and personal attendants were far more hand-made, he could at least
have got a more recent model.
"Welcome to Cimabue, Mr. McGeachin," Mr. Ditmars and Mr.
Replogle said almost simultaneously.
"But where is Orville?" the senior partner added.
McGeachin pointed with his long green cigar. "This is Orville," he
said in a crisp metallic voice.
Mr. Replogle could feel himself growing pale all the way down to his
mukluks. This was precisely the way his nightmare had always
begun. Only now it was reality ... or was it? Perhaps he was back in
the dream again. He could close his eyes and, when he opened
them, he would be lying in his own standard air-conditioned toti-
comfort sleeplounge under his own satin-covered, goose-down filled
luxury quilt.
"A robot!" he could hear Mr. Ditmars wail, as the typopads began to
click thinly, his voice somehow sounding far away. "How could you—
why didn't you let us know he was a robot beforehand?"
Mr. Replogle opened his eyes and nothing had changed; it was all
real—it was the end.
"Because you would have discriminated against him," Hervey
McGeachin was saying, his grey face shiny with excessive emotion.
"Everybody discriminates against my poor robots. Trustworthy, hard-
working, clean, loyal to a fault—yet everybody discriminates against
them merely because they're machines. I knew that, if I had told you
he was a robot, you would never have hung his pictures in Cimabue,
in spite of the fact that it was I who recommended him."
Top management or no, Mr. Replogle felt he must speak; there were
principles at stake. The dismal future of humanity rested somehow in
his own shaking hands. "Sir," he said, in a hoarse voice, "you have
not dealt fairly with us. You said that this Orville was a protege of
yours."
"And so he is." McGeachin put a thick, unmuscular arm around the
robot's hard shoulders. "He is my protege and friend and I don't care
if people do call me a robot-lover."
There was a gasp from the reporters, even those representing the
liberal press.
McGeachin pointed his cigar at them. "Listen," he said.
"Autobiographical note." Typopads began to click. "Up until the age
of seventeen I hardly knew there was anybody on the planet but
robots. My father didn't have time to mess around with kids, since he
believed in running all of his multifarious industries personally. I,
myself, though I tour the factories only once a year, have succeeded,
by means of a computer and a ouija board, in increasing what little
remained of his vast fortune after taxes to an amount that is ten
times as great as his was at its peak."
"How do you spell ouija?" the man from the World-Post and Journal
interrupted.
"So," McGeachin continued, after affably spelling the word and
making a few adverse remarks on the sad state of current education,
"during my childhood, I was left entirely in the care of robots, and I
was a happy, carefree lad until I was sent to Harvard. There I
discovered the dark truth which has over-shadowed my life ever
since and rendered me a virtual recluse—that there are also large
numbers of people in the world. Give me a robot, any time.
Trustworthy, hard-working, clean, loyal to a fault, and, in Orville's
case, artistic also. Tell 'em how you started in to paint, Orville."
"Well, it was like this, gents," Orville said in a voice like a rusty hinge.
"I work for the Perfect Paint Section of the Superior Chemicals
Division of the Universal Materials Corporation, which is a subsidiary
of the McGeachin interests, and, as I'm getting along in gears, I was
put onto artists' oil colors, which are individually ground, like all the
artists nowadays want 'em to be—"
"In all McGeachin products, from paints to parliaments," the financier
interjected, "the customer comes first, insofar as his desires are
compatible with the mass-production methods necessarily imposed
upon us by automation."
"—And there was a little left over of some colors what wouldn't fit into
the tubes, and the forebot says to me, he says, 'Throw 'em into the
disposal, Orville—'"
"—All the McGeachin robots have names. It gives that personal
touch I like to have around my plants." There was something
extraordinarily odd about McGeachin, Mr. Replogle felt, though he
couldn't quite put his finger on just what it was ... something more
than mere eccentricity, something curiously sinister.
"—And I says to the forebot, 'Begging your pardon, sir, but if there
was no other use for 'em, I would like to try my hand at painting a
picture like on the pretty calendars Perfect Paint sends out every
Christmas.' And he says to me, laughing-like, 'Well, if that's what you
want to do with your restoration period, Orville, more power to you' ...
which is—" the robot snickered "—a kind of little joke we have
amongst ourselves at the factory."
One of the Cimabue robots gave a laugh which Mr. Replogle cut
short with a glance.
"But I didn't know they could do that," the Times-Herald-Mirror said
plaintively. "Laugh, I mean."
"Ah," McGeachin told him, "that's because you never bothered to
understand the real robot. You don't look beyond the metal to the
wires that vibrate underneath."
"So I painted a picture on a piece of cardboard," Orville continued
patiently, "—the side of a carton it was—and the picture was much
admired in the plant, though I says it as shouldn't, and Mr.
Pembroke, the superintendent, went so far as to ask if he might have
it to hang in his office, which, of course, I was glad to have him do.
And there it come to the attention of Mr. McGeachin when he was
making his annual tour of the plant.... Mr. McGeachin is—" Orville
approximated a modest cough "—by way of being a connoissoor."
"When I saw that picture, I knew I was standing in the presence of
solid genius," McGeachin took over. "Mind you, when I heard it had
been painted by a robot, I was surprised myself, I admit it freely. But
I was not prejudiced. I had spent all my life with machines and I
knew of what fine handcraft they were capable. 'Why shouldn't a
robot paint a picture?' I asked myself. 'No reason whatsoever,' I
answered. And I was right, as is amply evidenced by this splendid
and tastefully arranged display." He beamed at Mr. Ditmars, who
groaned.
"But it's impossible," the lady from Woman's Own protested, looking
as if only the dignity of her profession kept her from bursting into
tears. "How could a robot paint a picture. How could it want to paint
a picture?"
"I dunno," Orville, as the only one who could conceivably be
expected to answer this question, said. "It just come to me like that.
You could say I was inspired, I guess."
"But inspiration is a human prerogative! If a robot can be inspired,
what is left for people now?"
"'Tisn't for me to say, miss," Orville said modestly, "only I don't see
why we both couldn't be inspired. Peaceful coexistence, like. If
robots are designed to serve man, they could do a better job of it if
both—man and machine—work side by side harmoniously."
"Work!" exclaimed the male reporters unharmoniously.
Mr. Replogle closed his eyes. He had never expected to hear such a
mechanical word in the chaste purlieux of his gallery—his and Mr.
Ditmars' gallery, that was, but it didn't matter, soon it wouldn't be
anybody's gallery. Reality was following the inexorable course of the
dream and they were doomed.
"No offense intended," Orville said hastily. "I meant work like maybe
painting or knitting. I didn't mean machine work."
"And why not machine work?" McGeachin demanded. "Why
shouldn't man work with his hands instead of just crafting?"
A little man, Replogle thought, would be lynched for saying a more
than mechanical thing like that—mechanical, why it was down-right
subversive!—but McGeachin was secure because of the position
that he maintained only as a result of the sweat and toil of others.
Only, of course, robots don't sweat. The light film that had begun to
cover Orville was doubtless only excess oil. Disgusting,
nevertheless.
"Listen," McGeachin said, pointing his long, green cigar at the
reporters. "Important announcement. I have decided to replace all
my feedback equipment, except where the most delicate operations
are involved, by people."
The typopads clicked furiously.
"You ask me why?" although no one had; they were much too
stunned. "Because robots, though trustworthy, hard-working, clean,
and loyal to a fault, have one drawback—they're expensive. A
worker dies or gets sick, it's no extra money out of my pocket—I got
to pay taxes for his welfare anyway. A robot breaks down, his loss is
all mine. A human worker I got to take care of maybe six, seven
hours a day, a robot twenty-four hours—and it isn't as if they worked
all that time; they got to have rest periods too, or they wear out too
fast. A human worker isn't my responsibility—a robot I got to look out
for all the time."
"But I thought you liked machines better than people," Mr. Replogle
said.
"So, is management expected to like labor? Is labor supposed to like
management? Traditional enemies. I just figured out why I've been
so unhappy most of my life—I like my employees. It's unnatural. It's
—"
"Wrong, Mr. McGeachin?" quavered Woman's Own. "What do you
mean?"
"I'm going to put people in my factories and have robots at my dinner
table.... They don't eat—" McGeachin chuckled fruitily "—so you can
see what an economy move that would be."
Nobody laughed. If McGeachin hadn't been top management—really
top management—Mr. Replogle knew, he would have been torn to
pieces. But top management was boss; it was government; it was
divine right. Nobody did anything.
"If the machine can replace man," Orville suggested, "why can't man
replace the machine? Plenty of room for both.... Did I say something
wrong?" he added, seeing the expressions on the human faces that
surrounded him.
"You're just ahead of your time, boy." McGeachin clapped him on the
shoulder. "But you're right. Why can't man co-exist with the
machine? Why can't robots paint pictures and write books and
compose operas, while people work in the factories? Don't know just
yet how it'll work out in the factories, but it'll be a great day for art!"
"We're going to have to give the money back," Mr. Replogle said
dully.
"What money?" McGeachin asked, obviously annoyed by this
anticlimactic remark.
"The money paid for Orville's pictures. We cheated the buyers—
unwittingly, it is true, but we cheated them nonetheless. We sold the
pictures as hand-mades. They're machined."
"But I have hands," Orville protested.
Mr. Ditmars shook his head. "You're a machine. Replogle is right.
Cimabue is ruined."
"I'll make good your losses," McGeachin said in his crisp, metallic
voice, and just then Mr. Replogle knew what had been bothering him
all along about the financier. Despite his completely hand-made
costume McGeachin looked exactly like a robot. The triumph of
environment over heredity—or was it as simple as that, Mr. Replogle
wondered. Everyone knew who Hervey McGeachin's father was, but
who had his mother been?
"No one can make good our losses," Mr. Ditmars told him. "Modern
art has suffered a crushing blow from which it will never recover. The
handwriting is on the wall."
"You mean the typewriting," Mr. Replogle said.
*** END OF THE PROJECT GUTENBERG EBOOK MR.
REPLOGLE'S DREAM ***
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South-Western Federal Taxation 2014

Taxation of Business Entities 17th Edition

Solution Manual: https://testbankpack.com/p/solution-manual-for-

Test Bank: https://testbankpack.com/p/test-bank-for-south-western-

1 LO 1 Bad debts: business Unchanged 1

16 LO 5, 6 Passive activity loss rules: general Unchanged 16

28 LO 5, 6, 8 Interaction of at-risk and passive loss rules Unchanged 28

1 Bad debt expense Unchanged 1

1 Casualty loss deduction Unchanged 1

1. Smith, Raabe, and Maloney, CPAs

TAX FILE MEMORANDUM

January 29, 2013

From: John J. Jones

Subject: Bad Debt Deduction

Loon Finance Company’s $30,000 loan to Sara is a business bad debt.

3. Jack should be concerned with the following issues:

• Should this be treated as a worthless security?

• Should this be treated as a theft loss?

• Does the theft loss create an NOL?

• Can the NOL be carried back 3 years?

pp. 6-5 and 6-6

pp. 6-4 to 6-6

6. Sell all of the stock in the current year:

Current year’s AGI

Next year’s AGI

Next year’s AGI

7. Smith, Raabe, and Maloney, CPAs

July 18, 2013

FROM: David C. Via

SUBJECT: Mike Sanders

Home ($350,000 – $280,000) $70,000

Amount of loss on last year’s return:

Amount of loss on current year’s return:

• Is the loss a theft loss or an investment loss?

• How is the amount of the loss determined?

pp. 6-7 to 6-11

10. Smith, Raabe, and Maloney, CPAs

11. a. Business receipts $144,000

13. Smith, Raabe, and Maloney, CPAs

Dear Mr. Parker:

John J. Jones, CPA

pp. 6-16 and 6-17

14. Application of the at-risk rules:

Application of the passive activity rules:

• Whether the investment is a passive activity or whether David and Debbie

pp. 6-15 to 6-20

Net passive loss allocated to:

Activity B (30/50 × $20,000) ($12,000)

pp. 6-19, 6-20, and Examples 26 and 27

18. a. Net sales price $100,000

b. Net sales price $100,000

c. Net sales price $100,000

20. a. A personal service corporation is not allowed to offset passive losses

• Whether Rene is a material participant in the hardware business.

• Whether Rene is subject to the passive loss rules.

January 23, 2014

Ms. Kristin Graf

Invest $10,000 in Rocky Road Excursions:

Expected profit from investment $8,000

Use of loss suspended by at-risk rules (7,000)

Beginning suspended passive loss ($ 1,000)

Current tax liability $ –0–