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REG CPA Practice Questions: Personal-Use Asset and Hobby Losses
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May 3, 2024
In this video, we walk through 3 REG CPA exam practice questions on calculating disallowed losses from hobby losses and from the sale of a personal-use asset. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-understanding-losses-from-hobbies-and-the-sale-of-personal-use-assets/ If you want to learn about Wash Sales, another type of disallowed loss, watch this video: https://youtu.be/AUazLL4yyHo See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:48 Question 1: Introducing Hobby Losses 04:19 Question 2: Hobby Losses Continued 05:54 Question 3: Losses from the Sale of Personal-use Assets 07:09 Pillar Topics
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0:00
Welcome to another Reg Walkthrough video
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I'm Logan and in today's video we're going to be going over hobby and personal use asset
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losses and we will be doing that the Superfast CPA way, which is diving straight into questions
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to learn the material. If this is the first thing you're seeing from us or if you want to learn more about our
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strategies make sure you go to superfastcpa.com and check out our free one hour webinar training
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where we go over the six key ingredients to passing the CPA exam. Again, it's only one hour long, it's free, definitely go check that out, it will save
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you a ton of time. Also, if you like the idea of using questions as your learning material, make sure you check
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out our Superfast CPA app where we not only have audio notes and review notes but also
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five question mini quizzes that you can easily access on your phone throughout the day to
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continually be learning. With that said, let's get straight into the questions
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Now as we get into these questions, I just want to point out this video will be a little
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bit shorter than the other ones because we are only going over hobby losses and personal
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use asset losses and those are pretty simple topics and we're not going to dive super deep
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into them because there's not much to dive into. One very common type of loss that falls into this same category of hobby losses and personal
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use asset losses is something called wash sale losses. Now we're not going to cover those in this video but if you want to learn more about
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wash sale losses, make sure you go check out the video linked in the description where
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I go over wash sale losses specifically. With that said, let's go ahead and go into question one
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Margaret has a passion for painting and regularly sells her artwork at local art fairs
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She has a full-time job as an engineer but she dedicates her weekends to painting
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Last year, Margaret sold several paintings for a total of $6,000. Her painting-related expenses amounted to $8,000 for art supplies, framing, and fair
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booth fees. Margaret's painting activity hasn't ever turned an overall profit. Which of the following is correct regarding Margaret's tax return for last year
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Okay, so this is what would be considered a hobby and we're going to learn more about
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that in the answer. So take a second if you need to, to kind of read through this and make sure you understand
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what it's asking and what it's saying. But when you're ready, come back and we're going to look at the answer to learn more
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about how hobbies are treated. Okay, and here is the answer. So Margaret must report the $6,000 of income but she cannot deduct any expenses since the
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activity is considered a hobby. So let's learn why it's considered a hobby. Since Margaret's painting activity is classified as a hobby because it hasn't shown a profit
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in at least three out of the five years, she must include the income from the activity
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in her taxable income but cannot deduct the expenses associated with her painting hobby
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The IRS differentiates between hobbies and businesses for tax purposes, primarily based
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on the activity's profit motive. Under current tax law, specifically after the Tax Cuts and Jobs Act of 2017, while income
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earned from a hobby must still be reported, taxpayers can no longer deduct expenses associated
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with their hobbies. Losses from hobby activities cannot offset other income, effectively disallowing the
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use of hobby losses to reduce tax liabilities. The determination of whether an activity is a hobby or a business is subjective and considers
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several factors such as the taxpayer's efforts to make the activity profitable, the manner
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in which the activity is carried out, expertise, time, and effort put into the activity, and
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the history of income or losses from the activity. However, a general rule of thumb is that if an activity is profitable in three out
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of the past five years, the IRS presumes it's conducted for profit and therefore considered
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a business, allowing for more favorable tax treatment of expenses and losses
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So essentially, if you're doing something, either you don't care about making money
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you're not doing it to make money so you don't even care, that's a hobby, or more specifically
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in this situation, you know, she is getting money from it, but in the end, she's spending
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more money than she's making and that's how it's been always. She's never made a profit in the end
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That's considered a hobby. Now, if she had turned a profit in three of the past five years, then it would not be
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considered a hobby and she could consider it a business and deduct the expenses
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Now, again, as it said here, there are multiple factors, but overall for the CPA exam, the
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thing that you need to know is that a hobby is something that is not done to turn a profit
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or it has never really turned a profit in the past five years. Like that's the easiest way to think about it
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So let's go ahead and go to the next question just to hammer that home a little bit more. Okay
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Question two, Emma has been making handcrafted jewelry as a pastime and occasionally sells
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her creations at local craft fairs. Over the past five years, she reported a modest profit in the first year, but her jewelry
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activity has incurred losses in the following four years. Despite her losses, Emma has maintained detailed records, conducted the activity in a business
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like manner and has continuously sought to improve her craftsmanship through courses
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and workshops. In the current year, Emma has gross receipts of $12,000 from her jewelry sales, her expenses
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for high quality materials, booth fees, marketing and educational workshops totaled $17,000
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Based on the IRS rules for hobby losses, how should Emma treat her income and expenses
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from the jewelry activity on her tax return? All right. We learned how this works in the previous question
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So pause the video, think through it. And once you've gotten your answer, go ahead and come back and we will look at the answer. Okay
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And the answer is that she must report the income, but she doesn't get to deduct any
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of the expenses again, because it's classified as a hobby. Since Emma's activity has not been profitable for four out of the past five years, it is
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classified as a hobby. So even though she did make a little bit of profit at one point, and she has maintained
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detailed records as if it was a business and done all these things because she hasn't made
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a profit in three of the past five years, she cannot deduct the expenses, but she does
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have to include the income. It's kind of brutal, honestly. So that's how hobby losses work
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That's pretty much all we're going to go over for hobby losses. We're going to go over one more question about losses from personal use assets
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So let's go to the next question. Okay. Question three, Jacob purchased a recreational boat for personal use five years ago for $50,000
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This year he decided to sell the boat due to lack of use
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The boat was sold for $20,000. At the time of the sale, the boat had significantly depreciated in value due to normal wear and
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tear and Jacob had made no significant improvements to the boat since its purchase
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On his tax return, how should Jacob treat the $30,000 difference between the purchase
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price and the selling price? Okay. We don't know how losses from the sale of personal use assets work yet
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So let's go ahead and look at the answer. Okay. Jacob cannot claim a loss since the sale of personal use property is not deductible and
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therefore he should not report the $30,000 difference on his tax return
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And here's the small explanation. The loss from the sale of a personal use asset such as a recreational boat is not deductible
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on an individual's tax return. Personal use property is considered a capital asset and while gains on the sale of such
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assets are taxable, losses are not recognized for tax purposes. So yet again, another situation where you'll get taxed for making money, but if you lose
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money you can't reduce your taxable income. And that's pretty much all I wanted to go over
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To finish the video, let's do one more part of the super fast CPA strategy called pillar topics
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Now, just a reminder, or just letting you know if you haven't heard it before, the idea behind pillar topics is as you're going through the questions or after you've gone through
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the questions to learn the material, you will have noticed three or four topics that are
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obviously important based off of the questions you saw from your review course
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So you take a second and write down those important things so that you can remember
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them for the future. So let's go ahead and look at the pillar topics for this video
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Okay, here are the pillar topics. Hobby losses are not deductible. Plain and simple
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An activity is considered a hobby unless it turns a profit in three of the past five years
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Income from hobbies is taxable while the expenses cannot be used to reduce taxable income
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Losses from the sale of personal property such as a boat or a personal use car, you
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know, anything like that, that's just for you to use, not for a business or anything
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like that. Those are not deductible. However, gains from the sale of those personal properties are taxable
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And that's all I wanted to go over in this video. Again, one more topic that you might want to learn about when it comes to disallowed
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losses because that's what we went over in this video is something called wash sales
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So make sure you go check out the video I have linked in the description where I have a video all about wash sales
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With that said, that's the end of the video. Make sure you go to superfastcpa.com and check out our free one hour webinar training and
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also check out our super fast CPA app where we have five question mini quizzes that you
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can use throughout the day to continually be practicing. If you liked this video, make sure to like it and leave a comment
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I hope this was helpful and I will see you in the next video
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