 Hello and welcome to this session. This is Professor Farhad and this session will look at a CPA simulation that's covered on the CPA REC section. It also helps you if you are taking an income tax course or if you are an enrolled agent exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, tax and a finance lecture. This is a topic. These are the courses of the topics that I covered, including thousands of CPA questions. If you like my lectures, please like them, share them, put them in playlists. If they're benefiting you, it means they might benefit other people and please connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources such as PowerPoint slides, true, false, multiple choice, additional exercises. If you're studying for your CPA exam, 2000 plus CPA questions. If you are serious about passing the exam, check out my website. So let's take a look at this CPA simulation and it seems pretty straightforward, not lot of exhibits, only one exhibits. Now on the CPA exam, be aware if there are too many exhibits, it means usually it's not asking for much. They're trying to throw a lot of stuff at you. It's only a few exhibits that you have to be aware. But anyhow, the simulation is no more than a multiple choice in a different format. That's all what a simulation is. So let's take a look at this simulation on January 1st, two individual taxpayers, Burkey and Link, each invested in a business activity. Burkey actively participated in the rental commercial property. That's an important piece of information. Their active participant in its rental commercial real property, Link was a passive investor. That's important in a cattle breeding business operated as a limited partnership. So L was a passive, B was active. Both activity sustained losses in year two, the exhibit above relate to each activity for Burkey and Link. And they're asking us for the amount at risk, the loss that can be deducted, the amount at risk at the end of the year, and the suspended passive losses. So now let's take a look at the exhibit and see what we can find out. Ownership and the activity, Burkey 50%, Burkey invested $10,000, modified adjusted gross income $110, investor share of activity loss $35, investor share of non-recourse debt at December 31st, $50,000, investor share of recourse debt. So you want to make sure you understand the difference between non-recourse and recourse. Why? Because non-recourse debt, you are not responsible for that debt. In other words, they cannot come after you personally. They cannot come after you personally. Well, the recourse debt, okay, the recourse debt is. So here you are responsible, Burkey is personally guaranteeing the $45,000. What's that going to do? They're asking us about the at risk amount that's going to be part of the at risk amount. Link on the other side, on the other hand, owns 10%, invested cash $60,000, modified adjusted gross income $175, their investor share of losses $50,000, investor share of non-recourse $40,000. And guess what? Link does not like to have recourse debt. They have no recourse debt. But Link has passive income from other sources of $5,000. So the first question is they're asking you, it's what's the at risk amount in measuring loss limitation? Because the at risk amount is the maximum amount you're going to take in loss limitation. So what is the at risk amount? Well, the at risk amount is what you invested, basically, what you invested in the business, okay. What did be invested in the business? Well, they invested cash, be invested. Let's start with the first one. So if you invested cash, that's an at risk amount. If you contributed property, the basis generally speaking is there, plus if you have any recourse debt. So that's generally general rule or what's involved. So the Berkey invested cash, yes, Berkey invested $10,000, no property, and Berkey is responsible for $45,000 in recourse debt. Therefore, the at risk amount in measuring loss limitation is $55,000. That's the at risk amount for Berkey. Now for Link, Link invested $60,000 cash, no property and no recourse debt. So that's easy. So make sure if you got a question like this, make sure you answer Link, which is only $60,000. That's an easy, easy points to pick up on the exam. So Berkey is $55,000, the at risk amount, which is going to determine the loss limitation for year two. And Berkey is $60,000. That's the maximum, the loss limitation. The second question is the loss that can be deducted in year two. First for Berkey. Well, let's look. Investor's share of the activity loss is $35,000. That's the amount of the loss. You might be saying, hold on a second. If I have $35,000 of activity loss, I can take it because I have $55,000 of at risk amount. Not at all. You have to be careful. This is, you're actively participating in a rental real estate, in a commercial real estate. What does that mean? It means the maximum you can deduct, the maximum you can take a deduction is $25,000. This is important here. That's why they told you in the example that it's Berke actively participated in the rental of a commercial property. In rental of the commercial property, if you're actively participant, you can take up to $25,000. It's kind of an exception. Now, so is the answer $25,000 and the answer is no. Well, Congress is generous, but to a point, I can assure you, if Congress allows individual to deduct $25,000 from rental real estate, many people will own homes because that's a generous deduction. Guess what? Congress says, if you once you reach $100,000 of adjusted gross income, we're going to take away from this $25,000 and it's going to go away once you reach $150,000. So the phase out range is $50,000. The phase out range is $50,000. And guess what? If the phase out range of $50,000, if this is $50,000, Berke is $10,000 into the range. This is $10,000. $10,000 out of $50,000. So basically, he's $10,000 into the range, $10,000 out of $50,000, $20%. Well, what does that mean? It means of the $25,000 deduction that Congress allows, Berke is going to lose 20% because his AGI is $10,000 above the limit. That's $5,000. They're going to lose that deduction. Well, if they lose $25,000, what's left is $20,000. So that's the loss that can be deducted. Now, you could also offset losses if you have a passive income, but there's no passive income for Berke. Link. Link, he is a passive investor. So all of this is passive loss. That's the bad news. The good news is there's some passive income. Guess what? If you have some passive income, you can deduct the passive income against the passive loss. Therefore, Link can deduct $5,000. That's it. There's no $25,000 for him because that's cattle breeding. It's not rental real estate or commercial rental real estate. Now, they're asking us for the amount of risk as of the end of the year. Well, if we want to know the amount of the risk at the end of the year, we have to know the beginning of the year. The beginning of the year was $55,000, the amount at risk. Then, we deducted $20,000, but the investor share of loss activity is $35,000. Although we only deducted $20,000, yes, we did deduct $20,000, but our share of the loss is $35,000. We experience $35,000 of losses. Therefore, the amount of risk at the end of the year is $20,000. And this is a little bit tricky because students says, well, hold on a second, and only deducted $20,000. Yes, you deducted $20,000, but you experience $35,000 of losses. As you experience the losses, they're going to reduce your at risk amount. Let's look at link. Link, the beginning at risk amount is $60,000. It's right here. Then again, they were only able to deduct $5,000, but the actual losses were how much? The actual losses for them were $50,000. The actual losses were $50,000. It doesn't matter what you talk. So what's left is $10,000. What left is $10,000. That's $4,000. $10,000. Now, suspended passive losses at December 31st. Suspended means you could not use them. Suspended losses. It means they're suspended. You can't use them. Well, guess what? In losses, Berkey had $35,000 in losses. He was able to deduct $20,000. What's left is $15,000. So the suspended losses are the losses that you could not take. And why you could not take them? Because you are limited. You are limited. I mean, the Congress was generous enough to give you that $20,000. If Berkey was in some other business other than this active participant in a rental commercial property, they won't be able to take any losses. So what's left suspended is $15,000. For Link, the losses were $50,000. They used up $5,000. They were able to deduct $5,000. What's left is $45,000. And this is basically how you would approach this CPA simulation on the exam. You'll be lucky if you get a passive activity loss because usually they don't ask for a lot. But if you are, I mean, this is, you know, if you, if you face something like this on the exam, you better be ready. But I don't think they would ask you anything more in-depth than this. So the trick here is to know that you have a recourse stat. It's part of your at-risk amount. It's very important to understand what's the at-risk amount, the purpose of it. Again, as I always end up by asking you or encouraging you to visit my website for additional resources, you're going to study for your CPA exam one time. You're going to study for your CPA exam one time. It's worth it. Invest in your career. And CPA is worth it for your future. Good luck and study hard.