Essentials of Federal Taxation 3Rd Edition Spilker Solutions Manual Full Chapter PDF

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Essentials of Federal Taxation 3rd

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Chapter 6
Individual for AGI Deductions
SOLUTIONS MANUAL
Discussion Questions
1. [LO 1] It has been suggested that tax policy favors deductions for AGI compared to itemized
deductions. Describe two ways in which deductions for AGI are treated more favorably than
itemized deductions.
Itemized deductions must exceed the standard deduction before taxpayers receive any tax benefit
from the deductions (this is equivalent to an overall floor limit). In contrast, business deductions
that are deductible for AGI (above the line) reduce taxable income without being subject to an
overall floor limit. Also, itemized deductions are subject to many mechanical limitations including
ceilings, floors, and phase-outs whereas business deductions are generally not subject to these
limits (there are limits on certain specific deductions, but this will be described in greater detail in
chapter9).
2. [LO 1] How is a business activity distinguished from an investment activity? Why is this
distinction important for the purpose of calculating federal income taxes?
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Both business and investment activities are motivated primarily by profit intent, but they can be
distinguished by the level of profit-seeking activity. A business activity is commonly described as a
sustained, continuous, high level of profit-seeking activity, whereas investment activities don’t
require a high level of involvement. The distinction can be important for the location of
deductions, because business deductions are claimed above the line (for AGI on Schedule C) while
investment deductions are generally itemized or from AGI deductions (with the exception of rent
and royalty expenses which are deductible for AGI on Schedule E).
3. [LO 2] Describe how a business element is reflected in the requirements to deduct moving
expenses and how Congress limited this deduction to substantial moves.
A business element is reflected in both the distance test and time test associated with the move. To
satisfy the distance test, the distance from the taxpayer’s old residence to the new place of work
(business element) must be at least 50 miles more than the distance from the old residence to the
old place of work (business element). The time test for a moving expense deduction requires the
taxpayer to be employed full time 39 of the first 52 weeks (or self-employed for 78 of the first 104
weeks) after the move (obviously reflecting a business element).
4. [LO 2] What types of losses may potentially be characterized as passive losses?
Losses from limited partnerships, and from rental activities, including rental real estate, are
generally considered passive losses. In addition, losses from any other activity involving the
conduct of a trade or business in which the taxpayer does not materially participate are also
treated as passive losses. Material participation is defined as “regular, continuous, and
substantial.”
5. [LO 2] What are the implications of treating losses as passive?
Passive losses may not be used to offset portfolio income or active income. Passive losses can only
be used to offset passive income. Passes losses that are limited will be suspended until taxpayers
have passive income or until the activity producing the passive loss is sold.
6. [LO 2] What tests are applied to determine if losses should be characterized as passive?
In general, losses are from trade or business activities are passive unless individuals are material
participants in the activity. Regulations provide seven separate tests for material participation,
and individuals can be classified as material participants by meeting any one of the seven tests.
The seven tests are as follows:
1. The individual participates in the activity more than 500 hours during the year.
2. The individual’s activity constitutes substantially all of the participation in such activity by
the individuals including non-owners.
3. The individual participates more than 100 hours during the year, and the individual’s
participation is not less than any other individual’s participation in the activity.
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4. The activity qualifies as a “significant participation activity” (more than 100 hours spent
during the year) and the aggregate of all “significant participation activities” is greater
than 500 hours for the year.
5. The individual materially participated in the activity for any five of the preceding 10 taxable
years.
6. The individual materially participated for any three preceding years in any personal service
activity (personal services in health, law, accounting, architecture, etc.)
7. Taking into account all the facts and circumstances, the individual participates on a
regular, continuous, and substantial basis during the year.
7. [LO 2] {Planning} All else being equal, would a taxpayer with passive losses rather have wage
income or passive income?
A taxpayer in this situation would prefer passive income because the taxpayer’s passive losses
could be applied currently against the passive income to reduce the amount of tax paid currently.
If the taxpayer had received wage income, the passive losses would have been suspended, and the
tax benefits associated with the passive losses would be deferred.
8. [LO 2] {Planning} Is it possible for a taxpayer to receive rental income that is not subject to
taxation? Explain.
Yes. A taxpayer (owner) who lives in a home for at least 15 days and rents it out for 14 days or
less (residence with minimal rental use) is not required to include the gross receipts in rental
income but is not allowed to deduct any expenses related to the rental.
9. [LO 2] Halle just acquired a vacation home. She plans on spending several months each year
vacationing in the home and on renting the property for the rest of the year. She is projecting tax
losses on the rental portion of the property for the year. She is not too concerned about the losses
because she is confident she will be able to use the losses to offset her income from other sources.
Is her confidence misplaced? Explain.
Because Halle will be living in the home for several months, the home will be considered a
residence with significant rental use. Consequently, she may deduct expenses to obtain tenants
(direct rental expenses such as advertising and realtor commissions) and mortgage interest and
real property taxes allocated to the rental use of the home. To the extent that these expenses
exceed gross rental income she may deduct the loss (the passive loss rules do not apply). However,
the remaining expenses allocated to the rental use of the home may only be deducted to the extent
of the net rental income after deducting the direct rental expenses and rental mortgage interest and
real property taxes allocated to the property. This limitation reduces her ability to deduct a rental
loss from the home.
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10. [LO 2] {Planning} A taxpayer stays in a second home for the entire month of September. He would
like the home to fall into the residence with significant rental use category for tax purposes. What
is the maximum number of days he can rent out the home and have it qualify?
To qualify for the residence with significant rental use category, the taxpayer must have used the
home for personal purposes more than the greater of (1) 14 days or (2) 10% of the total days it is
rented out during the tax year and rented the house for more than 14 days. In this situation, the
taxpayer used the second home for personal purposes for 30 days (the entire month of September).
To qualify, the 30 days of personal use must be greater than 10% of the number of days the
property is rented out. If the taxpayer rents the property out for 300 days, the number of personal
use days will be exactly 10% of the number of rental days, and the property would not qualify as
residence. However, if the taxpayer rents out the property for 299 days, the 30 days of personal
use will be greater than 10% of the number of rental days, so the property would qualify as a
residence with significant rental use. So, the maximum number of days the taxpayer can rent out
the home and have it qualify as a residence with significant rental use is 299 days. Anything more
than that and the property would be considered a nonresidence with rental use.
11. [LO 2] Compare and contrast the IRS method and the Tax Court method for allocating expenses
between personal use and rental use for vacation homes. Include the Tax Court’s justification for
departing from the IRS method in your answer.
The IRS method of allocating deductions between personal and rental use allocates the deductions
based on a fraction with the number of days the property was used for rental property in the
numerator and the number of days the property was used for any reason during the year in the
denominator. Each expense relating to the home is multiplied by this fraction to determine the
amount allocable to rental use. Subject to the gross rental income limitation, tier 1 expenses are
deducted first, followed by tier 2 expenses, and then tier 3 expenses.
The Tax Court and the IRS method of allocating deductions are identical except for the allocation
of the tier 1 expenses of interest and real property taxes. Under the Tax Court approach, interest
and taxes are allocated to rental use based on the fraction of days that the property was rented
over the number of days in the year (not the number of days the property was used for any purpose
during the year). The Tax Court justifies this approach by pointing out that interest expense and
property taxes accrue over the entire year regardless of the level of personal or rental use. The
Tax Court method is generally taxpayer favorable because it tends to allocate less interest and real
property taxes to the rental use which allows more tier 2 and tier 3 expenses to be deducted when
the gross income limitation applies. The taxpayer does not lose deductions for the interest and
property taxes allocated to personal use and not to the rental activity because these expenses are
deductible anyway as itemized deductions.
12. [LO 2] In what circumstances is the IRS method for allocating expenses between personal use and
rental use for second homes more beneficial to a taxpayer than the Tax Court method?
The IRS method is generally more beneficial than the Tax Court method when the property is
considered to be a nonresidence with rental use. When the property is not a residence, the interest
allocated to personal use is not deductible. Thus, under these circumstances, the taxpayer is better
off by allocating as little interest as possible to personal use. The IRS method accomplishes this by
allocating interest (a tier 1 expense) to rental use by dividing the total rental days by the total days
used and allocating the remainder to personal use. The Tax Court method would allocate less
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interest to rental use because the denominator is the number of days in the year, rather than total
days used.
13. [LO 2] Under what circumstances would a taxpayer who generates a loss from renting a home that
is not a residence be able to fully deduct the loss? What potential limitations apply?
By definition, a rental activity is considered to be a passive activity. Because they are passive
losses, losses from rental property are generally not allowed to offset other ordinary or investment
type income.
However, the loss from a rental activity may be deductible under two circumstances. First, a
taxpayer who is an active participant in the rental activity may be allowed to deduct up to $25,000
of the rental loss against other types of income (subject to phase-out beginning at $100,000 AGI).
Second, the taxpayer may offset the passive loss from the rental activity against other sources of
passive income.
14. [LO 2] Describe the circumstances in which a taxpayer acquires a home and rents it out and is not
allowed to deduct a portion of the interest expense on the loan the taxpayer used to acquire the
home.
When a rental home is not a residence, the interest allocable to any personal-use days is
nondeductible.
15. [LO 2] Is it possible for a rental property to generate a positive annual cash flow and at the same
time produce a loss for tax purposes? Explain.
Yes. A taxpayer is able to have a positive cash flow and at the same time produce a loss for tax
purposes. This outcome is possible due to depreciation expense that is deductible for tax purposes
but does not require an annual cash outflow. A rental property could provide a positive cash flow
(gross receipts greater than cash expense for the year) but generate a tax loss when depreciation
expense is deducted.
16. [LO 2] How are the tax issues associated with home offices and vacation homes used as rentals
similar? How are the tax issues or requirements dissimilar?
The tax issues facing renters of second homes are similar in a lot of ways with tax issues facing
taxpayers qualifying for home office deductions. Both taxpayers with home offices and taxpayers
with vacation homes are allowed to deduct business or rental expenses not associated with the use
of the home as for AGI deductions without income limitations. Taxpayers with home offices
allocate expenses of the entire home between personal use of the home and business use of the
home. In a similar way, renters of second homes generally allocate expenses of the second home
between personal use of the home and rental use of the home. Taxpayers with home offices and
vacation homes may deduct mortgage interest and real property taxes allocated to the business or
rental use of the home as for AGI deductions without income limitations. Further, the non
mortgage interest and non real property tax expenses allocated to business use of the home and
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rental use of a residence with significant rental use may be limited by the income generated by the
property (after deducting business and rental expenses unrelated to the home and after deducting
mortgage interest and real property taxes allocated to the business or rental use of the home).
Disallowed expenses are carried over and treated as incurred in the next year.
The treatment of home offices and vacation homes are also dissimilar. By definition, a home office
is located in the taxpayer’s “home” and the home office must be used exclusively for business
purposes. In contrast, the tax consequences of owning a second home depend on the extent to
which the property is used for personal and for rental purposes. Personal use of a rental property
is allowed. This is not the case for home offices.
17. [LO 2] Are employees or self-employed taxpayers more likely to qualify for the home office
deduction? Explain.
Self-employed taxpayers are more likely to qualify for the home office deduction. Both must meet
the requirement of using the home office as either (1) the principal place of business for any of the
taxpayer’s trade or businesses or (2) as a place to meet with patients, clients, or customers in the
normal course of business. However, an employee must meet the additional requirement of using
the home office for the convenience of the employer. Thus, self-employed taxpayers are more likely
to qualify for the home office deduction.
18. [LO 2] Compare and contrast the manner in which employees and employers report home office
deductions on their tax returns.
Both employees and employers will determine the amount of their eligible home office expenses in
the same manner. However, each is subject to different limitations and reports the deduction in
different places on the tax return. An employer reports his home office deduction on Schedule C of
his 1040 and is limited to his Schedule C net income before deducting the home office expense.
Thus, an employer’s home office deduction is a for AGI deduction.
An employee will report his home office expenses as unreimbursed employee business expenses
that are itemized deductions subject to the 2% of AGI floor. Thus, an employee’s home office
deduction is a from AGI deduction.
19. [LO 2] For taxpayers qualifying for home office deductions, what are considered to be indirect
expenses of maintaining the home? How are these expenses allocated to personal and home office
use?
Indirect expenses are expenses incurred in maintaining and using the home. Indirect expenses
include insurance, utilities, interest, real property taxes, general repairs, and depreciation on the
home as if it were used entirely for business purposes. Only indirect expenses allocated to the
home office space, however, are deductible. If the rooms in the home are roughly of equal size, the
taxpayer may allocate the indirect expenses to the business portion of the home based on the
number of rooms. Alternatively, the taxpayer may allocate indirect expenses based on the amount
of the space or square footage of the business-use room relative to the total square footage in the
home.
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20. [LO 2] What limitations exist for self-employed taxpayers in deducting home office expenses, and
how does the taxpayer determine which deductions are deductible and which are not in situations
when the overall amount of the home office deduction is limited?
The total home office deductions other than mortgage interest and real property taxes allocated to
business use of the home allowable for the taxpayer in any given year is limited to a taxpayer’s
Schedule C net income (without any home office expense deductions) minus mortgage interest and
real property taxes allocated to business use of the home. Thus, home office deductions other than
mortgage interest and real property taxes cannot either create or increase a loss on the taxpayer’s
Schedule C. Amounts that are not deducted in the current year are carried over and deducted in
the next year subject to the same Schedule C limitation.
The sequence of deductions for the home office follows the exact same sequence of deductions for
homes with significant personal use and significant rental use. Tier 1-type expenses that would be
deductible as itemized deductions (interest and taxes) are deducted first (and deducted in full
regardless of income). Tier 2-type expenses are deducted second, and Tier 3-type expense
(depreciation) is deducted last.
21. [LO 3] What are the primary tax differences between traditional IRAs and Roth IRAs?
Traditional IRA contributions are deductible and distributions when received are taxable. Roth
IRA contributions are not deductible and distributions when received are not taxable.
22. [LO 3] Describe the circumstances in which it would be more favorable for a taxpayer to
contribute to a traditional IRA rather than a Roth IRA and vice versa.
In general, a traditional IRA will typically provide a better after-tax rate of return when tax rates are
expected to decline in the future. A Roth IRA will generally provide a better after-tax rate of return
when tax rates are expected to increase in the future. If the tax rates are expected to remain the same,
the after-tax rate of return will be the same for both types of IRAs.
23. [LO 3] What are the requirements for a taxpayer to make a deductible contribution to a traditional
IRA? Why do the tax laws impose these restrictions?
To make a deductible contribution to a traditional IRA the taxpayer must (1) not be a participant in
an employer sponsored retirement plan or (2) if they are participating in an employee sponsored
retirement plan, they must have income below a certain threshold. IRAs are meant to help persons
that are unable to participate in an employer sponsored program or that have relatively low levels
of income.
24. [LO 3] What is the limitation on a deductible IRA contribution for 2014?
For those not already participating in an employer sponsored retirement plan, deductible
contributions to an IRA are limited to $5,500 a year or earned income if it is less. Taxpayers who
have reached the age of 50 are able to contribute an additional $1,000. A taxpayer already
participating in an employer sponsored program may also make deductible contributions of the
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same amount if her AGI falls below a certain threshold. The $5,500 (or $6,500) deductible amount
is phased out for taxpayers whose AGI exceeds the threshold amount.
25. [LO 3] Compare the minimum distribution requirements for traditional IRAs to those of Roth
IRAs.
In regards to traditional IRAs, taxpayers are subject to the same minimum distribution
requirements as traditional 401(k) plans. They must begin receiving distribution by the later of
April 1 of the year after the year in which the taxpayer turns 70 ½ or when she retires. The
minimum amount of the distribution is determined by using a table provided by the IRS and is
based upon the taxpayer’s age and account balance.
Taxpayer’s are not ever required to make minimum distributions from Roth IRAs.
26. [LO 3] How are qualified distributions from Roth IRAs taxed? How are nonqualified distributions
taxed?
Qualifying distributions from a Roth IRA are not taxable. Nonqualified distributions are taxed and
penalized to the extent that they are made from the earnings of the IRA. Contributions to a Roth
IRA are from after-tax dollars (non-deductible) and can always be recovered tax free. Nonqualified
distributions are considered to first come from contributions and then earnings.
27. [LO 3] Explain when a taxpayer will be subject to the 10 percent penalty when receiving
distributions from a Roth IRA.
Only nonqualified distributions made from the earnings of a Roth IRA are subject to ordinary taxes
and a 10% penalty. Nonqualified distributions are any distributions if the taxpayer has not had the
Roth IRA account open for at least five years.1 If the Roth account has been open for five years, all
distributions other than distributions (1) made on or after the date the taxpayer reaches 59 ½ years
of age, (2) made to a beneficiary (or to the estate of the taxpayer) on or after the death of the
taxpayer, (3) attributable to the taxpayer being disabled, or (4) used to pay qualified acquisition
costs for first-time homebuyers (limited to $10,000) are considered to be disqualified distributions.
28. [LO 3] Is a taxpayer who contributed to a traditional IRA able to transfer or “roll over” the money
into a Roth IRA? If yes, explain the tax consequences of the transfer.
Taxpayers are able to roll over (transfer) funds from a traditional IRA to a Roth IRA. The entire
amount taken from the traditional IRA is taxed at ordinary rates but is not subject to the 10%
penalty so long as the taxpayer contributes the full amount taken out of the traditional IRA to a
Roth IRA.
29. [LO 3] Assume a taxpayer makes a nondeductible contribution to a traditional IRA. How does the
taxpayer determine the taxability of distributions from the IRA on reaching retirement?
1
The five year period starts on January 1 of the year in which the contribution was made and ends on the last day of
the fifth taxable year.
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When a taxpayer receives a partial distribution from an IRA containing both deductible and
nondeductible contributions, the nontaxable portion of the distribution is determined by
multiplying the ratio of the nondeductible contribution over the entire balance in the account
(nondeductible contributions / entire account balance) by the amount of the distribution.
30. [LO 3] When a taxpayer takes a nonqualified distribution from a Roth IRA,
is the entire amount of the distribution treated as taxable income?
Only the portion of a nonqualified distribution attributable to the earnings from contributions is
taxable (this portion is also penalized at a 10% rate). Distributions are considered to come first
from contributions and then from earnings.
31. [LO 3] Explain why Congress allows self-employed taxpayers to deduct the cost of health
insurance above the line (for AGI) when employees can only itemize this cost as a medical
expense. Would a self-employed taxpayer ever prefer to claim health insurance premiums as an
itemized deductions rather than a deduction for AGI? Explain.
This deduction provides a measure of equity between employees and the self-employed. The cost of
health insurance is essentially a personal expense. However, employees typically aren’t required
to pay insurance premiums because their employers pay the premiums for them as a form of
compensation. The employer is allowed to deduct the premium as a compensation expense, and the
employee is allowed to exclude from taxable income the value of the premiums paid on his behalf.
Thus, from the employee’s perspective, this arrangement has the same effect as if (1) the employer
pays the employee cash compensation in the amount of the premium and (2) the employee pays the
premium and deducts the expense for AGI (completely offsetting the compensation income). In
contrast to employees, self-employed taxpayers pay their own health insurance costs, because they
don’t have an employer to pay these costs for them. Absent a rule to the contrary, self-employed
taxpayers would deduct their medical expenses as itemized deductions subject to strict limitations,
because the cost of the health insurance is a personal expense rather than a business expense. To
treat employees and self-employed taxpayers similarly, Congress allows self-employed taxpayers to
deduct personal health insurance premiums as for AGI rather than itemized deductions. Thus, self-
employed taxpayers are able to (1) receive business income and (2) use the business income to pay
their health insurance premiums and deduct the premiums as a for AGI deduction (completely
offsetting the business income they used to pay the premium). Given the preferential treatment of
for AGI deductions relative to itemized deductions, a self-employed taxpayer should never prefer to
claim health insurance premiums as an itemized deduction rather than a deduction for AGI.
32. [LO 3] Explain why Congress allows self-employed taxpayers to deduct the employer portion of
their self-employment tax.
To put self-employed individuals on somewhat equal footing with other employers that are allowed
to deduct the employer’s share of the social security tax. Hence, self-employed taxpayers are
allowed to deduct the employer portion of the self-employment tax.
33. [LO 3] {Research} Using the Internal Revenue Code, describe two deductions for AGI
that are not discussed in this chapter?
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§62 is the quickest way to identify deductions for AGI, but several can also be identified from the
front of form 1040. Examples include the performing artist deduction, deductions of business
expenses for state and local officials, reforestation expenses, and remitted jury duty pay.
34. [LO 3] Explain why Congress allows taxpayers to deduct interest forfeited as a penalty on the
premature withdrawal from a certificate of deposit.
The full amount of the interest income is included in gross income, and this deduction reduces the
net interest income to the amount actually received by the individual.
35. [LO 3] Describe the mechanical limitation on the deduction for interest on qualified educational
loans.
The maximum deduction for interest expense on qualified education loans is the amount of interest
expense paid up to $2,500. However, the deduction is reduced (phased-out) for taxpayers
depending on the taxpayer’s filing status and modified AGI. Specifically, the deduction for interest
on educational loans is subject to proportional phase-out over a range of $15,000 ($30,000 for
married filing jointly). The range begins for taxpayers at $65,000 of modified AGI ($130,000 for
MFJ) and ends at $80,000 of modified AGI ($160,000 for married filing jointly). Modified AGI for
this purpose is AGI before deducting interest expense on the qualified education loans and before
deducting qualified education expenses. Married individuals who file separately are not allowed to
deduct this expense under any circumstance.
Problems
36. [LO 1] {Tax Forms} Betty operates a beauty salon as a sole proprietorship. Betty also owns and
rents an apartment building. This year Betty had the following income and expenses. Determine
Betty’s AGI and complete page 1 of Form 1040 for Betty. You may assume that Betty will owe
$2,502 in self-employment tax on her salon income.
Interest income $ 11,255

Salon sales and revenue 86,360
Salaries paid to beauticians 45,250
Beauty salon supplies 23,400
Alimony paid to her ex-husband, Rocky 6,000
Rental revenue from apartment building 31,220
Depreciation on apartment building 12,900
Real estate taxes paid on apartment building 11,100
Real estate taxes paid on personal residence 6,241
Contributions to charity 4,237
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The beauty parlor salaries and expenses are deductible on Schedule C as business expenses and
the depreciation and real estate taxes for the apartment building are deductible for AGI as
rental/royalty related deductions. The interest income is included in AGI, and the alimony expense
is deductible for AGI. Note that this solution assumes that the apartment building amounts
represent Betty’s interest and not the total. The residential real estate taxes and the charitable
contributions are itemized deductions.
Interest income $ 11,255
Salon revenue $ 86,360
Less: Salaries - 45,250
Supplies - 23,400
Operating income from salon 17,710
Apartment building revenue $ 31,220
Less: Depreciation - 12,900
Taxes on apartment building - 11,100
Apartment building income 7,220
Less: Employer share of self-employment taxes* -1,251
Alimony deduction -6,000
AGI $ 28,934
*Betty would owe $2,502 in self-employment tax ($17,710 salon income x 92.35% x 15.3% = $2,502).
Of the $2,502, $1,251 ($17,710 x 92.35% x 7.65%) would be deductible as a for AGI deduction.
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37. [LO 2] Larry recently invested $20,000 (tax basis) in purchasing a limited partnership interest in
which he will have no management rights in the company. His at-risk amount is also $20,000. In
addition, Larry’s share of the limited partnership loss for the year is $2,000, his share of income
from a different limited partnership was $1,000, and he had $3,000 of dividend income from the
stock he owns. How much of Larry’s $2,000 loss from the limited partnership can he deduct in the
current year?
Before considering his $2,000 loss, Larry’s tax basis is $20,000 and his at-risk amount is $20,000.
Therefore the basis and at-risk hurdles do not apply. However, Larry still may not deduct $1,000
of the $2,000 loss because he only has $1,000 of passive income for the year. Therefore, Larry has
a $1,000 passive activity loss carryover.
38. [LO 2] Rubio recently invested $20,000 (tax basis) in purchasing a limited partnership interest in
which he will have no management rights in the company. His at-risk amount is $15,000. In
addition, Rubio’s share of the limited partnership loss for the year is $22,000, his share of income
from a different limited partnership was $5,000, and he had $40,000 in wage income and $10,000
in long-term capital gains.
a. How much of Rubio’s $22,000 loss can he deduct considering only the tax basis
limitation?
b. How much of the loss from part a. can Rubio deduct under the at-risk limitations?
c. How much of Rubio’s $22,000 loss from the limited partnership can he deduct in the
current year considering all limitations?
a. Rubio’s initial tax basis in the limited partnership is $20,000. Rubio’s $22,000 loss
reduces his tax basis to zero leaving him with a $2,000 loss carryover because of the tax
basis loss limitation.
b. Rubio’s initial at-risk amount in the limited partnership is $15,000. Rubio’s $22,000 loss
reduces his at-risk amount to zero leaving him with a $5,000 at-risk carryover ($20,000
loss allowed under the tax basis limitation less the $15,000 amount Rubio has at risk).
c. After applying the tax basis and at-risk limitations, Rubio can potentially deduct $15,000
of loss. However, because Rubio is a limited partner this loss is considered a passive
loss. Therefore, Rubio may only deduct this loss in the current year to the extent he has
passive income. Because Rubio has only passive income of $5,000 (from another limited
partnership), he may only deduct $5,000 of the $15,000 loss leaving him with a $10,000
passive activity loss that can be carried forward indefinitely.
39. [LO 2] Anwar owns a rental home and is involved in maintaining it and approving renters. During
the year he has a net loss of $8,000 from renting the home. His other sources of income during the
year were a salary of $111,000 and $34,000 of long-term capital gains. How much of Anwar’s
$8,000 rental loss can he deduct currently if he has no sources of passive income?
Because Anwar meets the definition of an “active participant” and has adjusted gross income of
less than $150,000, before considering his rental loss, he may deduct $2,500 of the loss against his
other income. His $2,500 deduction is computed as follows:
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Description Amount Explanation

(1) Maximum deduction available before $25,000
phase-out
(2) Phase-out of maximum deduction $22,500 [($145,000 AGI –
100,000) x .5]
(3) Maximum deduction in current year $2,500 (1) – (2)
(4) Rental loss in current year $8,000
(5) Rental loss deductible in current year $2,500 Lesser of (3) or (4)
Passive loss carry forward $5,500 (3) – (4)
40. [LO 2] Dillon rented his personal residence at Lake Tahoe for 14 days while he was vacationing in
Ireland. He resided in the home for the remainder of the year. Rental income from the property was
$6,500. Expenses associated with use of the home for the entire year were as follows:
Real property taxes $ 3,100

Mortgage interest 12,000
Repairs 1,500
Insurance 1,500
Utilities 3,900
Depreciation 13,000
a. What effect does the rental have on Dillon’s AGI?

b. What effect does the rental have on Dillon’s itemized deductions?
a. Since Dillon resided in his home for at least 15 days during the year and rented the home for
fewer than 15 days, he excludes the rental income from taxable income and does not deduct
the associated rental expenses. So, the rental has no effect on Dillon’s AGI.
b. He will be allowed to deduct the real property taxes of $3,100 and mortgage interest of $12,000
as itemized deductions
Use the following facts to answer problems 41 and 42.
Natalie owns a condominium near Cocoa Beach in Florida. This year, she incurs the following
expenses in connection with her condo:
Insurance $1,000
Advertising expense 500
Mortgage interest 3,500
Property taxes 900
Repairs & maintenance 650
6-14
Education.
Utilities 950
Depreciation 8,500
During the year, Natalie rented out the condo for 75 days, receiving $10,000 of gross income. She
personally used the condo for 35 days during her vacation. Assume there are 365 days in the year.
41. [LO 2] Assume Natalie uses the IRS method of allocating expenses to rental use of the property.
a. What is the total amount of for AGI (rental) deductions Natalie may deduct in the current year
related to the condo?
b. What is the total amount of itemized deductions Natalie may deduct in the current year related
to the condo?
c. If Natalie’s basis in the condo at the beginning of the year was $150,000, what is her basis in the
condo at the end of the year?
d. Assume that gross rental revenue was $1,000 (rather than $10,000), what amount of for AGI
deductions may Natalie deduct in the current year related to the condo?
Note that the home falls into the residence with significant rental use category.
a. $10,000, calculated as follows:
Gross rental income $10,000
Tier 1 expenses:
Advertising expense = $500
Mortgage interest = (75/110) × $3,500=$2,386
Property taxes= (75/110) × $900=$614
Less: total Tier 1 expenses (3,500)
Balance $6,500
Tier 2 expenses:
Insurance = (75/110) × $1,000=$682
Repairs & Maintenance = (75/110) × $650=$443
Utilities= (75/110) × $950=$648
Less: total Tier 2 expenses (1,773)
Balance $4,727
6-15
Education.
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These are the forces which have established the drift towards
democracy. When all sources of information are accessible to all
men alike, when the world’s thought and the world’s news are
scattered broadcast where the poorest may find them, the non-
democratic forms of government must find life a desperate venture.
Exclusive privilege needs privacy, but cannot have it. Kingship of the
elder patterns needs sanctity, but can find it nowhere obtainable in a
world of news items and satisfied curiosity. The many will no longer
receive submissively the thought of a ruling few, but insist upon
having opinions of their own. The reaches of public opinion have
been infinitely extended; the number of voices that must be heeded
in legislation and in executive policy has been infinitely multiplied.
Modern influences have inclined every man to clear his throat for a
word in the world’s debates. They have popularized everything they
have touched.
In the newspapers, it is true, there is very little concert between
the writers; little but piecemeal opinion is created by their comment
and argument; there is no common voice amidst their counsellings.
But the aggregate voice thunders with tremendous volume; and that
aggregate voice is ‘public opinion.’ Popular education and cheap
printing and travel vastly thicken the ranks of thinkers everywhere
that their influence is felt, and by rousing the multitude to take
knowledge of the affairs of government prepare the time when the
multitude will, so far as possible, take charge of the affairs of
government,—the time when, to repeat Carlyle’s phrase, democracy
will become palpably extant.
But, mighty as such forces are, democratic as they are, no one
can fail to perceive that they are inadequate to produce of
themselves such a government as ours. There is little in them of
constructive efficacy. They could not of themselves build any
government at all. They are critical, analytical, questioning, quizzing
forces; not architectural, not powers that devise and build. The
influences of popular education, of the press, of travel, of commerce,
of the innumerable agencies which nowadays send knowledge and
thought in quick pulsations through every part and member of
society, do not necessarily mould men for effective endeavor. They
may only confuse and paralyze the mind with their myriad stinging
lashes of excitement. They may only strengthen the impression that
“the world’s a stage,” and that no one need do more than sit and look
on through his ready glass, the newspaper. They overwhelm one
with impressions, but do they give stalwartness to his manhood? Do
they make his hand any steadier on the plough, or his purpose any
clearer with reference to the duties of the moment? They stream light
about him, it may be, but do they clear his vision? Is he better able to
see because they give him countless things to look at? Is he better
able to judge because they fill him with a delusive sense of knowing
everything? Activity of mind is not necessarily strength of mind. It
may manifest itself in mere dumb show; it may run into jigs as well
as into strenuous work at noble tasks. A man’s farm does not yield
its fruits the more abundantly in their season because he reads the
world’s news in the papers. A merchant’s shipments do not multiply
because he studies history. Banking is none the less hazardous to
the banker’s capital and taxing to his powers because the best
writing of the best essayists is to be bought cheap.
II.
Very different were the forces behind us. Nothing establishes the
republican state save trained capacity for self-government, practical
aptitude for public affairs, habitual soberness and temperateness of
united action. When we look back to the moderate sagacity and
steadfast, self-contained habit in self-government of the men to
whom we owe the establishment of our institutions in the United
States, we are at once made aware that there is no communion
between their democracy and the radical thought and restless spirit
called by that name in Europe. There is almost nothing in common
between popular outbreaks such as took place in France at her great
Revolution and the establishment of a government like our own. Our
memories of the year 1789 are as far as possible removed from the
memories which Europe retains of that pregnant year. We
manifested one hundred years ago what Europe lost, namely, self-
command, self-possession. Democracy in Europe, outside of
closeted Switzerland, has acted always in rebellion, as a destructive
force: it can scarcely be said to have had, even yet, any period of
organic development. It has built such temporary governments as it
has had opportunity to erect on the old foundations and out of the
discredited materials of centralized rule, elevating the people’s
representatives for a season to the throne, but securing almost as
little as ever of that every-day local self-government which lies so
near to the heart of liberty. Democracy in America, on the other
hand, and in the English colonies has had, almost from the first, a
truly organic growth. There was nothing revolutionary in its
movements; it had not to overthrow other polities; it had only to
organize itself. It had not to create, but only to expand, self-
government. It did not need to spread propaganda: it needed nothing
but to methodize its ways of living.
In brief, we were doing nothing essentially new a century ago.
Our strength and our facility alike inhered in our traditions; those
traditions made our character and shaped our institutions. Liberty is
not something that can be created by a document; neither is it
something which, when created, can be laid away in a document, a
completed work. It is an organic principle,—a principle of life,
renewing and being renewed. Democratic institutions are never
done; they are like living tissue, always a-making. It is a strenuous
thing, this of living the life of a free people; and our success in it
depends upon training, not upon clever invention.
Our democracy, plainly, was not a body of doctrine; it was a
stage of development. Our democratic state was not a piece of
developed theory, but a piece of developed habit. It was not created
by mere aspirations or by new faith; it was built up by slow custom.
Its process was experience, its basis old wont, its meaning national
organic oneness and effective life. It came, like manhood, as the fruit
of youth. An immature people could not have had it, and the maturity
to which it was vouchsafed was the maturity of freedom and self-
control. Such government as ours is a form of conduct, and its only
stable foundation is character. A particular form of government may
no more be adopted than a particular type of character maybe
adopted: both institutions and character must be developed by
conscious effort and through transmitted aptitudes.
Governments such as ours are founded upon discussion, and
government by discussion comes as late in political as scientific
thought in intellectual development. It is a habit of state life created
by long-established circumstance, and is possible for a nation only in
the adult age of its political life. The people who successfully
maintain such a government must have gone through a period of
political training which shall have prepared them by gradual steps of
acquired privilege for assuming the entire control of their affairs.
Long and slowly widening experience in local self-direction must
have prepared them for national self-direction. They must have
acquired adult self-reliance, self-knowledge, and self-control, adult
soberness and deliberateness of judgment, adult sagacity in self-
government, adult vigilance of thought and quickness of insight.
When practised, not by small communities, but by wide nations,
democracy, far from being a crude form of government, is possible
only amongst peoples of the highest and steadiest political habit. It is
the heritage of races purged alike of hasty barbaric passions and of
patient servility to rulers, and schooled in temperate common
counsel. It is an institution of political noonday, not of the half-light of
political dawn. It can never be made to sit easily or safely on first
generations, but strengthens through long heredity. It is poison to the
infant, but tonic to the man. Monarchies may be made, but
democracies must grow.
It is a deeply significant fact, therefore, again and again to be
called to mind, that only in the United States, in a few other
governments begotten of the English race, and in Switzerland, where
old Teutonic habit has had the same persistency as in England, have
examples yet been furnished of successful democracy of the modern
type. England herself is close upon democracy. Her backwardness in
entering upon its full practice is no less instructive as to the
conditions prerequisite to democracy than is the forwardness of her
offspring. She sent out to all her colonies which escaped the luckless
beginning of being made penal settlements, comparatively small,
homogeneous populations of pioneers, with strong instincts of self-
government, and with no social materials out of which to build
government otherwise than democratically. She herself, meanwhile,
retained masses of population never habituated to participation in
government, untaught in political principle either by the teachers of
the hustings or of the school house. She has had to approach
democracy, therefore, by slow and cautious extensions of the
franchise to those prepared for it; while her better colonies, born into
democracy, have had to receive all comers within their pale. She has
been paring down exclusive privileges and levelling classes; the
colonies have from the first been asylums of civil equality. They have
assimilated new while she has prepared old populations.
Erroneous as it is to represent government as only a
commonplace sort of business, little elevated in method above
merchandising, and to be regulated by counting-house principles,
the favor easily won for such views among our own people is very
significant. It means self-reliance in government. It gives voice to the
eminently modern democratic feeling that government is no hidden
cult, to be left to a few specially prepared individuals, but a common,
every-day concern of life, even if the biggest such concern. It is this
self-confidence, in many cases mistaken, no doubt, which is
gradually spreading among other peoples, less justified in it than are
our own.
One cannot help marvelling that facts so obvious as these
should have escaped the perception of some of the sagest thinkers
and most thorough historical scholars of our day. Yet so it is. Sir
Henry Maine, even, the great interpreter to Englishmen of the
historical forces operative in law and social institutions, has utterly
failed, in his plausible work on Popular Government, to distinguish
the democracy, or rather the popular government, of the English
race, which is bred by slow circumstance and founded upon habit,
from the democracy of other peoples, which is bred by discontent
and founded upon revolution. He has missed that most obvious
teaching of events, that successful democracy differs from
unsuccessful in being a product of history,—a product of forces not
suddenly become operative, but slowly working upon whole peoples
for generations together. The level of democracy is the level of
every-day habit, the level of common national experiences, and lies
far below the elevations of ecstasy to which the revolutionist climbs.
III.
While there can be no doubt about the derivation of our
government from habit rather than from doctrine, from English
experience rather than from European thought; while it is evident
that our institutions were originally but products of a long, unbroken,
unperverted constitutional history; and certain that we shall preserve
our institutions in their integrity and efficiency only so long as we
keep true in our practice to the traditions from which our first strength
was derived, there is, nevertheless, little doubt that the forces
peculiar to the new civilization of our day, and not only these, but
also the restless forces of European democratic thought and
anarchic turbulence brought to us in such alarming volume by
immigration, have deeply affected and may deeply modify the forms
and habits of our politics.
All vital governments—and by vital governments I mean those
which have life in their outlying members as well as life in their heads
—all systems in which self-government lives and retains its self-
possession, must be governments by neighbors, by peoples not only
homogeneous, but characterized within by the existence among their
members of a quick sympathy and an easy neighborly knowledge of
each other. Not foreseeing steam and electricity or the diffusion of
news and knowledge which we have witnessed, our fathers were
right in thinking it impossible for the government which they had
founded to spread without strain or break over the whole of the
continent. Were not California now as near neighbor to the Atlantic
States as Massachusetts then was to New York, national self-
government on our present scale would assuredly hardly be
possible, or conceivable even. Modern science, scarcely less than
our pliancy and steadiness in political habit, may be said to have
created the United States of to-day.
Upon some aspects of this growth it is very pleasant to dwell,
and very profitable. It is significant of a strength which it is inspiring
to contemplate. The advantages of bigness accompanied by
abounding life are many and invaluable. It is impossible among us to
hatch in a corner any plot which will affect more than a corner. With
life everywhere throughout the continent, it is impossible to seize
illicit power over the whole people by seizing any central offices. To
hold Washington would be as useless to a usurper as to hold Duluth.
Self-government cannot be usurped.
A French writer has said that the autocratic ascendency of
Andrew Jackson illustrated anew the long-credited tendency of
democracies to give themselves over to one hero. The country is
older now than it was when Andrew Jackson delighted in his power,
and few can believe that it would again approve or applaud childish
arrogance and ignorant arbitrariness like his; but even in his case,
striking and ominous as it was, it must not be overlooked that he was
suffered only to strain the Constitution, not to break it. He held his
office by orderly election; he exercised its functions within the letter
of the law; he could silence not one word of hostile criticism; and, his
second term expired, he passed into private life as harmlessly as did
James Monroe. A nation that can quietly reabsorb a vast victorious
army is no more safely free and healthy than is a nation that could
reabsorb such a President as Andrew Jackson, sending him into
seclusion at the Hermitage to live without power, and die almost
forgotten.
A huge, stalwart body politic like ours, with quick life in every
individual town and county, is apt, too, to have the strength of variety
of judgment. Thoughts which in one quarter kindle enthusiasm may
in another meet coolness or arouse antagonism. Events which are
fuel to the passions of one section may be but as a passing wind to
another section. No single moment of indiscretion, surely, can easily
betray the whole country at once. There will be entire populations
still cool, self-possessed, unaffected. Generous emotions sometimes
sweep whole peoples, but, happily, evil passions, sinister views,
base purposes, do not and cannot. Sedition cannot surge through
the hearts of a wakeful nation as patriotism can. In such organisms
poisons diffuse themselves slowly; only healthful life has unbroken
course. The sweep of agitations set afoot for purposes unfamiliar or
uncongenial to the customary popular thought is broken by a
thousand obstacles. It may be easy to reawaken old enthusiasms,
but it must be infinitely hard to create new ones, and impossible to
surprise a whole people into unpremeditated action.
It is well to give full weight to these great advantages of our big
and strenuous and yet familiar way of conducting affairs; but it is
imperative at the same time to make very plain the influences which
are pointing toward changes in our politics—changes which threaten
loss of organic wholeness and soundness. The union of strength
with bigness depends upon the maintenance of character, and it is
just the character of the nation which is being most deeply affected
and modified by the enormous immigration which, year after year,
pours into the country from Europe. Our own temperate blood,
schooled to self-possession and to the measured conduct of self-
government, is receiving a constant infusion and yearly experiencing
a partial corruption of foreign blood. Our own equable habits have
been crossed with the feverish humors of the restless Old World. We
are unquestionably facing an ever-increasing difficulty of self-
command with ever-deteriorating materials, possibly with
degenerating fibre. We have so far succeeded in retaining
“Some sense of duty, something of a faith,

Some reverence for the laws ourselves have made,
Some patient force to change them when we will,
Some civic manhood firm against the crowd;”
But we must reckon our power to continue to do so with a people

made up of “minds cast in every mould of race,—minds inheriting
every bias of environment, warped by the diverse histories of a score
of different nations, warmed or chilled, closed or expanded, by
almost every climate on the globe.”
What was true of our early circumstances is not true of our
present. We are not now simply carrying out under normal conditions
the principles and habits of English constitutional history. Our tasks
of construction are not done. We have not simply to conduct, but
also to preserve and freshly adjust our government. Europe has sent
her habits to us, and she has sent also her political philosophy, a
philosophy which has never been purged by the cold bath of
practical politics. The communion which we did not have at first with
her heated and mistaken ambitions, with her radical, speculative
habit in politics, with her readiness to experiment in forms of
government, we may possibly have to enter into now that we are
receiving her populations. Not only printing and steam and electricity
have gotten hold of us to expand our English civilization, but also
those general, and yet to us alien, forces of democracy of which
mention has already been made; and these are apt to tell
disastrously upon our Saxon habits in government.
IV.
It is thus that we are brought to our fourth and last point. We
have noted (1) the general forces of democracy which have been
sapping old forms of government in all parts of the world; (2) the
error of supposing ourselves indebted to those forces for the creation
of our government, or in any way connected with them in our origins;
and (3) the effect they have nevertheless had upon us as parts of the
general influences of the age, as well as by reason of our vast
immigration from Europe. What, now, are the new problems which
have been prepared for our solution by reason of our growth and of
the effects of immigration? They may require as much political
capacity for their proper solution as any that confronted the
architects of our government.
These problems are chiefly problems of organization and
leadership. Were the nation homogeneous, were it composed simply
of later generations of the same stock by which our institutions were
planted, few adjustments of the old machinery of our politics would,
perhaps, be necessary to meet the exigencies of growth. But every
added element of variety, particularly every added element of foreign
variety, complicates even the simpler questions of politics. The
dangers attending that variety which is heterogeneity in so vast an
organism as ours are, of course, the dangers of disintegration—
nothing less; and it is unwise to think these dangers remote and
merely contingent because they are not as yet very menacing. We
are conscious of oneness as a nation, of vitality, of strength, of
progress; but are we often conscious of common thought in the
concrete things of national policy? Does not our legislation wear the
features of a vast conglomerate? Are we conscious of any national
leadership? Are we not, rather, dimly aware of being pulled in a
score of directions by a score of crossing influences, a multitude of
contending forces?
This vast and miscellaneous democracy of ours must be led; its
giant faculties must be schooled and directed. Leadership cannot
belong to the multitude; masses of men cannot be self-directed,
neither can groups of communities. We speak of the sovereignty of
the people, but that sovereignty, we know very well, is of a peculiar
sort; quite unlike the sovereignty of a king or of a small, easily
concerting group of confident men. It is judicial merely, not creative.
It passes judgment or gives sanction, but it cannot direct or suggest.
It furnishes standards, not policies. Questions of government are
infinitely complex questions, and no multitude can of themselves
form clear-cut, comprehensive, consistent conclusions touching
them. Yet without such conclusions, without single and prompt
purposes, government cannot be carried on. Neither legislation nor
administration can be done at the ballot box. The people can only
accept the governing act of representatives. But the size of the
modern democracy necessitates the exercise of persuasive power
by dominant minds in the shaping of popular judgments in a very
different way from that in which it was exercised in former times. “It is
said by eminent censors of the press,” said Mr. Bright on one
occasion in the House of Commons, “that this debate will yield about
thirty hours of talk, and will end in no result. I have observed that all
great questions in this country require thirty hours of talk many times
repeated before they are settled. There is much shower and much
sunshine between the sowing of the seed and the reaping of the
harvest, but the harvest is generally reaped after all.” So it must be in
all self-governing nations of to-day. They are not a single audience
within sound of an orator’s voice, but a thousand audiences. Their
actions do not spring from a single thrill of feeling, but from slow
conclusions following upon much talk. The talk must gradually
percolate through the whole mass. It cannot be sent straight through
them so that they are electrified as the pulse is stirred by the call of a
trumpet. A score of platforms in every neighborhood must ring with
the insistent voice of controversy; and for a few hundreds who hear
what is said by the public speakers, many thousands must read of
the matter in the newspapers, discuss it interjectionally at the
breakfast-table, desultorily in the street-cars, laconically on the
streets, dogmatically at dinner; all this with a certain advantage, of
course. Through so many stages of consideration passion cannot
possibly hold out. It gets chilled by over-exposure. It finds the
modern popular state organized for giving and hearing counsel in
such a way that those who give it must be careful that it is such
counsel as will wear well. Those who hear it handle and examine it
enough to test its wearing qualities to the utmost. All this, however,
when looked at from another point of view, but illustrates an infinite
difficulty of achieving energy and organization. There is a certain
peril almost of disintegration attending such phenomena.
Every one now knows familiarly enough how we accomplished
the wide aggregations of self-government characteristic of the
modern time, how we have articulated governments as vast and yet
as whole as continents like our own. The instrumentality has been
representation, of which the ancient world knew nothing, and lacking
which it always lacked national integration. Because of
representation and the railroads to carry representatives to distant
capitals, we have been able to rear colossal structures like the
government of the United States as easily as the ancients gave
political organization to a city; and our great building is as stout as
was their little one.
But not until recently have we been able to see the full effects of
thus sending men to legislate for us at capitals distant the breadth of
a continent. It makes the leaders of our politics, many of them, mere
names to our consciousness instead of real persons whom we have
seen and heard, and whom we know. We have to accept rumors
concerning them, we have to know them through the variously
colored accounts of others; we can seldom test our impressions of
their sincerity by standing with them face to face. Here certainly the
ancient pocket republics had much the advantage of us: in them
citizens and leaders were always neighbors; they stood constantly in
each other’s presence. Every Athenian knew Themistocles’s
manner, and gait, and address, and felt directly the just influence of
Aristides. No Athenian of a later period needed to be told of the
vanities and fopperies of Alcibiades, any more than the elder
generation needed to have described to them the personality of
Pericles.
Our separation from our leaders is the greater peril, because
democratic government more than any other needs organization in
order to escape disintegration; and it can have organization only by
full knowledge of its leaders and full confidence in them. Just
because it is a vast body to be persuaded, it must know its
persuaders; in order to be effective, it must always have choice of
men who are impersonated policies. Just because none but the
finest mental batteries, with pure metals and unadulterated acids,
can send a current through so huge and yet so rare a medium as
democratic opinion, it is the more necessary to look to the excellence
of these instrumentalities. There is no permanent place in
democratic leadership except for him who “hath clean hands and a
pure heart.” If other men come temporarily into power among us, it is
because we cut our leadership up into so many small parts, and do
not subject any one man to the purifying influences of centred
responsibility. Never before was consistent leadership so necessary;
never before was it necessary to concert measures over areas so
vast, to adjust laws to so many interests, to make a compact and
intelligible unit out of so many fractions, to maintain a central and
dominant force where there are so many forces.
It is a noteworthy fact that the admiration for our institutions
which has during the past few years so suddenly grown to large
proportions among publicists abroad is almost all of it directed to the
restraints we have effected upon the action of government. Sir Henry
Maine thought our federal Constitution an admirable reservoir, in
which the mighty waters of democracy are held at rest, kept back
from free destructive course. Lord Rosebery has wondering praise
for the security of our Senate against usurpation of its functions by
the House of Representatives. Mr. Goldwin Smith supposes the
saving act of organization for a democracy to be the drafting and
adoption of a written constitution. Thus it is always the static, never
the dynamic, forces of our government which are praised. The
greater part of our foreign admirers find our success to consist in the
achievement of stable safeguards against hasty or retrogressive
action; we are asked to believe that we have succeeded because we
have taken Sir Archibald Alison’s advice, and have resisted the
infection of revolution by staying quite still.
But, after all, progress is motion, government is action. The
waters of democracy are useless in their reservoirs unless they may
be used to drive the wheels of policy and administration. Though we
be the most law-abiding and law-directed nation in the world, law has
not yet attained to such efficacy among us as to frame, or adjust, or
administer itself. It may restrain, but it cannot lead us; and I believe
that unless we concentrate legislative leadership—leadership, that
is, in progressive policy—unless we give leave to our nationality and
practice to it by such concentration, we shall sooner or later suffer
something like national paralysis in the face of emergencies. We
have no one in Congress who stands for the nation. Each man
stands but for his part of the nation; and so management and
combination, which may be effected in the dark, are given the place
that should be held by centred and responsible leadership, which
would of necessity work in the focus of the national gaze.
What is the valuable element in monarchy which causes men
constantly to turn to it as to an ideal form of government, could it but
be kept pure and wise? It is its cohesion, its readiness and power to
act, its abounding loyalty to certain concrete things, to certain visible
persons, its concerted organization, its perfect model of progressive
order. Democracy abounds with vitality; but how shall it combine with
its other elements of life and strength this power of the governments
that know their own minds and their own aims? We have not yet
reached the age when government may be made impersonal.
The only way in which we can preserve our nationality in its
integrity and its old-time originative force in the face of growth and
imported change is by concentrating it; by putting leaders forward,
vested with abundant authority in the conception and execution of
policy. There is plenty of the old vitality in our national character to
tell, if we will but give it leave. Give it leave, and it will the more
impress and mould those who come to us from abroad. I believe that
we have not made enough of leadership.
“A people is but the attempt of many

To rise to the completer life of one;
And those who live as models for the mass
Are singly of more value than they all.”
We shall not again have a true national life until we compact it by

such legislative leadership as other nations have. But once thus
compacted and embodied, our nationality is safe. An acute English
historical scholar has said that “the Americans of the United States
are a nation because they once obeyed a king;” we shall remain a
nation only by obeying leaders.
“Keep but the model safe,

New men will rise to study it.”
V
GOVERNMENT UNDER THE CONSTITUTION
It is by no means wholly to our advantage that our constitutional

law is contained in definitive written documents. The fact that it is
thus formulated and rendered fixed and definite has seriously misled
us, it is to be feared, as to the true function and efficacy of
constitutional law. That law is not made more valid by being written,
but only more explicit; it is not rendered more sacred, but only more
definite and secure. Written constitutions are simply more or less
successful generalizations of political experience. Their tone of
authority does not at all alter the historical realities and imperative
practical conditions of government. They determine forms, utter
distinct purposes, set the powers of the State in definite hierarchy;
but they do not make the forms they originate workable, or the
purposes they utter feasible. All that must depend upon the men who
become governors and upon the people over whom they are set in
authority. Laws can have no other life than that which is given them
by the men who administer and the men who obey them.
Constitutional law affords no exception to the rule. The Constitution
of the United States, happily, was framed by exceptional men
thoroughly schooled in the realities of government. It consists,
accordingly, not of principles newly invented, to be put into operation
by means of devices originated for the occasion, but of sound pieces
of tested experience. It has served its purpose beneficently, not
because it was written, but because it has proved itself accordant in
every essential part with tried principles of government—principles
tested by the race for whose use it was intended, and therefore
already embedded in their lives and practices. Its strength will be
found, upon analysis, to lie in its definiteness and in its power to
restrain rather than in any unusual excellence of its energetic parts.
For the right operation of these it has had to depend, like other
constitutions, upon the virtue and discretion of the people and their
ministers. “The public powers are carefully defined; the mode in
which they are to be exercised is fixed; and the amplest securities
are taken that none of the more important constitutional
arrangements shall be altered without every guarantee of caution
and every opportunity for deliberation.... It would seem that, by a
wise constitution, democracy may be made nearly as calm as water
D
in a great artificial reservoir.”
D
Sir Henry Maine: Popular Government (Am.
ed.), pp. 110, 111.
We possess, therefore, not a more suitable constitution than

other countries, but a constitution which is perfectly definite and
which is preserved by very formidable difficulties of amendment
against inconsiderate change. The difference between our own case
and that of Great Britain upon which we have most reason to
congratulate ourselves is that here public opinion has definite criteria
for its conservatism; whereas in England it has only shifting and
uncertain precedent. In both countries there is the same respect for
law. But there is not in England the same certainty as to what the law
of the constitution is. We have a fundamental law which is written,
and which in its main points is read by all alike in a single accepted
sense. There is no more quarrel about its main intent than there is in
England about the meaning of Magna Charta. Much of the British
constitution, on the contrary, has not the support of even a common
statute. It may, in respect of many vital parts of it, be interpreted or
understood in half a dozen different ways, and amended by the
prevalent understanding. We are not more free than the English; we
are only more secure.
The definiteness of our Constitution, nevertheless, apart from its
outline of structural arrangements and of the division of functions
among the several departments of the government, is negative
rather than affirmative. Its very enumeration of the powers of
Congress is but a means of indicating very plainly what Congress
can not do. It is significant that one of the most important and most
highly esteemed of the many legal commentaries on our government
should be entitled ‘Constitutional Limitations.’ In expounding the
restrictions imposed by fundamental law upon state and federal
action, Judge Cooley is allowed to have laid bare the most essential
parts of our constitutional system. It was a prime necessity in so
complex a structure that bounds should be set to authority. The
‘may-nots’ and the ‘shall-nots’ of our constitutions, consequently,
give them their distinctive form and character. The strength which
preserves the system is the strength of self-restraint.
And yet here again it must be understood that mere definiteness
of legal provision has no saving efficacy of its own. These distinct
lines run between power and power will not of their own virtue
maintain themselves. It is not in having such a constitution but in
obeying it that our advantage lies. The vitality of such provisions
consists wholly in the fact that they receive our acquiescence. They
rest upon the legal conscience, upon what Mr. Grote would have
called the ‘constitutional morality,’ of our race. They are efficient
because we are above all things law-abiding. The prohibitions of the
law do not assert themselves as taskmasters set over us by some
external power. They are of our own devising. We are self-
restrained.
This legal conscience manifestly constitutes the only guarantee,
for example, of the division of powers between the state and federal
governments, that chief arrangement of our constitutional system.
The integrity of the powers possessed by the States has from the
first depended solely upon the conservatism of the federal courts.
State functions have certainly not decayed; but they have been
preserved, not by virtue of any forces of self-defence of their own,
but because the national government has been vouchsafed the
grace of self-restraint. What curtailment their province might suffer
has been illustrated in several notable cases in which the Supreme
Court of the United States has confirmed to the general government
extensive powers of punishing state judicial and executive officers
for disobedience to state laws. Although the federal courts have
generally held Congress back from aggressions upon the States,
they have nevertheless once and again countenanced serious
encroachments upon state powers; and their occasional laxity of
principle on such points is sufficiently significant of the fact that there
is no balance between the state and federal governments, but only
the safeguard of a customary ‘constitutional morality’ on the part of
the federal courts. The actual encroachments upon state rights
which those courts have permitted, under the pressure of strong
political interests at critical periods, were not, however, needed to
prove the potential supremacy of the federal government. They only
showed how that potential supremacy would on occasion become
actual supremacy. There is no guarantee but that of conscience that
justice will be accorded a suitor when his adversary is both court and
opposing litigant. So strong is the instinct of those who administer
our governments to keep within the sanction of the law, that even
when the last three amendments to the Constitution were being
forced upon the southern states by means which were revolutionary
the outward forms of the Constitution were observed. It was none the
less obvious, however, with what sovereign impunity the national
government might act in stripping those forms of their genuineness.
As there are times of sorrow or of peril which try men’s souls and lay
bare the inner secrets of their characters, so there are times of
revolution which act as fire in burning away all but the basic
elements of constitutions. It is then, too, that dormant powers awake
which are not afterward readily lulled to sleep again.
Such was certainly the effect of the civil war upon the
Constitution of the Union. The implying of powers, once cautious, is
now become bold and confident. In the discussions now going
forward with reference to federal regulation of great corporations,
and with reference to federal aid to education, there are scores of
writers and speakers who tacitly assume the power of the federal
government to act in such matters, for one that urges a constitutional
objection. Constitutional objections, before the war habitual, have, it
would seem, permanently lost their prominence.
The whole energy of origination under our system rests with
Congress. It stands at the front of all government among us; it is the
single affirmative voice in national policy. First or last, it determines
what is to be done. The President, indeed, appoints officers and
negotiates treaties, but he does so subject to the ‘yes’ of the Senate.
Congress organizes the executive departments, organizes the army,
organizes the navy. It audits, approves, and pays expenses. It
conceives and directs all comprehensive policy. All else is negation.
The President says ‘no’ in his vetoes; the Supreme Court says ‘no’ in
its restraining decisions. And it is as much the law of public opinion
as the law of the Constitution that restrains the action of Congress.
It is the habit both of English and American writers to speak of
the constitution of Great Britain as if it were ‘writ in water,’ because
nothing but the will of Parliament stands between it and revolutionary
change. But is there nothing back of the will of Parliament?
Parliament dare not go faster than the public thought. There are vast
barriers of conservative public opinion to be overrun before a ruinous
speed in revolutionary change can be attained. In the last analysis,
our own Constitution has no better safeguard. We have, as I have
already pointed out, the salient advantage of knowing just what the
standards of our Constitution are. They are formulated in a written
code, wherein all men may look and read; whereas many of the
designs of the British system are to be sought only in a cloud-land of
varying individual readings of affairs. From the constitutional
student’s point of view, there are, for instance, as many different
Houses of Lords as there are writers upon the historical functions of
that upper chamber. But the public opinion of Great Britain is no
more a juggler of precedents than is the public opinion of this
country. Perhaps the absence of a written constitution makes it even
less a fancier of logical refinements. The arrangements of the British
constitution have, for all their theoretical instability, a very firm and
definite standing in the political habit of Englishmen: and the greatest
of those arrangements can be done away with only by the
extraordinary force of conscious revolution.
It is wholesome to observe how much of our own institutions
rests upon the same basis, upon no other foundations than those
that are laid in the opinions of the people. It is within the undoubted
constitutional power of Congress, for example, to overwhelm the
opposition of the Supreme Court upon any question by increasing
the number of justices and refusing to confirm any appointments to
the new places which do not promise to change the opinion of the
court. Once, at least, it was believed that a plan of this sort had been
carried deliberately into effect. But we do not think of such a violation
of the spirit of the Constitution as possible, simply because we share
and contribute to that public opinion which makes such outrages
upon constitutional morality impossible by standing ready to curse
them. There is a close analogy between this virtual inviolability of the
Supreme Court and the integrity hitherto vouchsafed to the English
House of Lords. There may be an indefinite creation of peers at any
time that a strong ministry chooses to give the sovereign its
imperative advice in favor of such a course. It was, doubtless, fear of
the final impression that would be made upon public opinion by
action so extraordinary, as much as the timely yielding of the Lords
upon the question at issue, that held the ministry back from such a
measure, on one notable occasion. Hitherto that ancient upper
chamber has had in this regard the same protection that shields our
federal judiciary.
It is not essentially a different case as between Congress and
the Executive. Here, too, at the very centre of the Constitution,
Congress stands almost supreme, restrained by public opinion rather
than by law. What with the covetous admiration of the presidency
recently manifested by some alarmed theorists in England, and the
renewed prestige lately given that office by the prominence of the
question of civil service reform, it is just now particularly difficult to
apply political facts to an analysis of the President’s power. But a
clear conception of his real position is for that very reason all the
more desirable. While he is a dominant figure in politics would seem
to be the best time to scrutinize and understand him.
It is clearly misleading to use the ascendant influence of the
President in effecting the objects of civil service reform as an
illustration of the constitutional size and weight of his office. The
principal part in making administration pure, business-like, and

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5. [LO 2] What are the implications of treating losses as passive?

Interest income $ 11,255

Description Amount Explanation

Real property taxes $ 3,100

a. What effect does the rental have on Dillon’s AGI?

Use the following facts to answer problems 41 and 42.

a. $10,000, calculated as follows:

Gross rental income $10,000

Advertising expense = $500

Mortgage interest = (75/110) × $3,500=$2,386

Property taxes= (75/110) × $900=$614

Less: total Tier 1 expenses (3,500)

Insurance = (75/110) × $1,000=$682

Repairs & Maintenance = (75/110) × $650=$443

Utilities= (75/110) × $950=$648

Less: total Tier 2 expenses (1,773)

“Some sense of duty, something of a faith,

But we must reckon our power to continue to do so with a people

“A people is but the attempt of many

We shall not again have a true national life until we compact it by

“Keep but the model safe,

It is by no means wholly to our advantage that our constitutional

We possess, therefore, not a more suitable constitution than

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