 Hello and welcome to the session in which you would look at this CPA exam simulation. The first thing you do when you are faced with a CPA exam simulation is just to browse to see what is the simulation is all about and if we click here it looks like we have to do some computation. Now some simulations there might be a drop-down menu in some simulation you might have to do journal entries, in some simulation you might have to review some document and correct sorting items and in some simulation you might have to do some research. Well this is computational so we have to do some computation and input the answers this is the type. After you figure out the type and this should take you like two seconds is the topic. What is the topic about? First take a look at the items here just browse through the simulation it looks like amount at risk, amount at risk, suspended passive loss. Well at this point you know what is the simulation is about. It's about the amount at risk and passive losses notice here suspended passive losses, passive losses. Once you know this okay say okay great it's about at risk amount and passive losses. You should be breathing slower stay calm you learn this with FARHAT you learn this with your account with your CPA review course. I am ready to tackle this simulation. What you do is look to see how many exhibits you have you only have one exhibit year two activity. At this point we're gonna read this and before we open the exhibit and learn a little bit more about what we are being asked then we would look at the exhibit and you will start to answer the questions. The key is not to panic. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead start your free trial today. On January 1st year two two individual taxpayers Berkey B and Link L B and L each invested in a business activity. Berk actively participated in the rental commercial property so it's active and it's rental. This is relevant, important. It should be processing in your mind. Link was a passive investor in a cattle breeding business operated as a limited partnership. Both activities sustained losses in year two the exhibits above relate to the to each activity for Berkey and Link. So let's take a look at the exhibit. The referencing the exhibit. Now real quick look at the exhibit. Berkey in the commercial real estate active 50% owner in the activity. Berkey invested I'm just gonna say be invested $10,000 in cash. Modified adjusted gross income 110. Investor share of activity losses 35 there's 35,000 of losses from this rental activity. Investor share of non-recourse debt as of December 31st year two. So notice here what they're giving you they're giving you their share. They're not telling you the debt in the partnership and you have to figure things out. They're telling you Berkey's investor share be investor share and it's a non-recourse. Well it's 50,000 also Berkey's share of recourse debt is 45. Now you want to know the difference between recourse and non-recourse debt. Well what is recourse debt? Recourse debt means what? Recourse debt means B so the recourse debt is responsible personally responsible for the debt. So there's more risk for B because if anything goes wrong B the lender can come after B personally. Non-recourse debt usually is a collateralized debt. What does that mean? It means this debt there's an asset that's put against that debt and this debt is basically is the responsibility for all the partners. This is the difference. This is for B and passive income from other sources. B does not have any passive income from other sources. Let's look at L his share in the interest and of the partnership 10% link invested 60,000 modified adjusted gross income 175. Investor share of activity loss we have a loss we are dealing with here investor share of non-recourse debt 40,000 investor share of recourse debt is zero and we have passive income from other sources so L you got a passive income from other sources this is what we have okay great now you're gonna take a note of this maybe copy this down real quick on a piece of paper it doesn't matter what you want to do now we are ready to answer the question. First thing we are going to compute is the amount at risk in measuring loss limitation for B and for L what is the amount of risk the amount of risk is how much you invested and you are at risk if something happens well you could invest cash you could invest property you can invest you could have some recourse that because you are responsible for that so we have to look at B and B invested $10,000 in cash no property and B is responsible for a $45,000 recourse debt well that's what we have at risk amount for B is 55,000 L link invested cash of 60,000 there's no property involved there's no recourse that there's no rec there's no recourse that what does that mean it means L is responsible for how much L is responsible for $60,000 this is the at risk amount well at this point you'll go back here you would say okay great I believe it was 55,000 for 55 55,000 for B and 60,000 for L this is the amount of risk that's the that's the question the loss that can be deducted in year two now why do we have to compute why do we have to compute the loss to be deducted because that's good because they both have losses they both have losses B has 35 losses from the partnership from the real estate and L has $50,000 okay commercial real estate now how much of losses can can be deducted well we have at risk amount of 35,000 but how much can we deduct remember B is an active B is an active B is an active participant remember they thought it's a real estate property and it's he's active well if he's active basically nothing however and here we have to kind of be careful know the rule about rental real estate he's active it's rental real estate there's an exception for small businesses mom and pop and you can deduct up to 25,000 if you're a small business it's it's called the mom and pop exception what does that mean it means of the 35,000 of the 35,000 for the rental remember it's a rental there's a possibility of B deducting 25,000 can be deducted 25,000 there's a plenty of basis well yes and no yes means possibility but there's a limitation well why let's look at B's income because remember this is for small for small small business people or mom and pop that's called mom and pop the modified adjusted income for B is 110 and this is one of the things that you have to know about you know you don't you don't you don't need to know a lot about limit limitations but this is you have to know the mom and pop rule the mom and pop rules yes yes you can get deduct 25,000 of your income of your income and losses however congress is a generous to a point if you if you're making in quote too much money according to congress and too much money starting at 100,000 going up to 150 there's a range of $50,000 once you start to go above that range in AGI you will start to lose part of that 25 now B happens to be B happens to be standing B happens to be standing right here at 110 so B is $10,000 inside the range of 50,000 so that's 10,000 divided by 50 is 20 percent what does that mean it means of the 25,000 that you can potentially deduct first of all B has $35,000 in losses plenty of losses and B has plenty of basis however because of the mom and pop exception at least they're getting 25 then you have the limitation so you have to take out 20 percent of this you're gonna lose 5,000 what's left is only 20,000 you can deduct I mean if this was some other business you can deduct any of it why because B is an active participant in this real estate if you're active you cannot you know take active losses and deduct it against passive basis therefore you can do that you cannot take basically because this is an active income active loss actually active loss you can do that because you're active you're active in the partnership then what's going to happen you can only deduct 20,000 therefore as far as B we can deduct 20,000 okay we can deduct 20,000 if if again if their AGI was less than 100,000 they could have took they could have took the 25,000 what about L L's basis is 60 and L losses are losses are where's the losses cash investment modified AGI set 50,000 so there's plenty of losses and plenty of basis can we deduct this no we can't because because of what again this is passive loss passive loss passive loss okay this is not real state real estate business if it was you know like B B was able to deduct some of it L cannot however if we notice L has $5,000 in passive income you can take passive losses and L is a passive investor he's a limited investor silent investor and we can deduct of the 50,000 we can deduct only five because the five it's gonna take out the passive income so you can deduct passive losses against passive income and as a result the answer for this is only 5,000 so you can take the losses and deduct 5,000 against passive income from other sources that's fine passive losses can be deducted deducted against passive income amount at risk at December 31st year two so what's the amount of risk at December 31st year two well we have to do what well we have to start with our initial investment so let's go back to the let's go back here so we started with the the balance was we start with how much we started with 55,000 let's go down here we started with 55,000 then we had a loss of 35,000 hold on a second yes you had a loss of 35,000 but why are you deducting 35,000 you were only able to deduct 20,000 remember we only actually were able to deduct 20,000 although you can only deduct 20,000 the 35,000 of losses would reduce your at risk amount so you're at the end of the year the at risk amount is 20,000 the same concept applies to L L's basis of 60,000 and L losses how much L's losses were 50,000 well L only deducted 5 it does not matter when we adjust the basis we adjusted for all the losses therefore what's left is 10,000 okay let's go back here you'll put 20,000 for Berkey the at risk amount at the end of the year and 10,000 for L last question is suspended passive losses what is suspended suspended means you cannot use now it's they're suspended well let's see let's go back to that one note you had 35,000 of losses B had 35,000 of losses in total B was able to use how much of it 20,000 what is the suspended 15 L had 60,000 of losses uh yeah 60,000 and L 50 or 60 let's see L 50,000 the basis starting at 60 so L had 50 was able to use 5,000 the suspended are 45,000 45,000 so I'm gonna come here and I'm going to input the answer 15,000 and 45,000 what's gonna happen with my suspended part passive losses they're suspended I can use those losses to offset passive income in future years so I'm gonna carry them so I can offset passive income in future years so this is how you will approach this simulation let's recap what type of simulation number computation topic at risk and passive activity losses now right from the get go if you if you if you are not prepared if you did not learn about the at risk amount how to compute the at risk amount the passive activity loss rule you can't answer this multiple this simulation whether it's a simulation or a multiple choice if you don't know the topic you don't know the topic okay because I can take this four questions and then turn it each one of them into a multiple choice and that's why I always say a simulation is no more than a multiple choice the key to solving simulation is knowledge and where can you obtain the knowledge what confidence I can tell you with far hat lectures you can get this knowledge this is how I can help you prepare for the exam invest in yourself CPA exam is worth it I'm always here to help you and stay safe