FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client with a high salary from employment and no other passive income sources is interested in a real estate limited partnership primarily for the tax losses it generates. Which statement most accurately describes the suitability concern?
- AThe client should invest since DPP losses offset any type of income under current tax law
- BDPP investments are only suitable for clients in the lowest tax brackets
- CPassive losses from the DPP can only offset passive income, so the client may not benefit from the tax losses
- DDPP losses can always be used to offset W-2 wage income dollar for dollar
Show answer & explanationAnswer & explanation
Correct answer: C. Passive losses from the DPP can only offset passive income, so the client may not benefit from the tax losses
Under passive activity loss rules, losses from a limited partnership (a passive activity) can generally only offset passive income, not active (wage) or portfolio income. A client with only salary income would have no passive income to absorb these losses, making the investment potentially unsuitable for its intended tax benefit.
Why the other options are wrong
- A. Incorrect — passive loss rules specifically restrict use against non-passive income.
- B. Incorrect — suitability depends on liquidity needs and risk tolerance, not solely tax bracket.
- D. Incorrect — wage income is active income and cannot be offset by passive losses.
Passive Activity Loss Rules
Losses generated by passive activities like limited partnerships can only be used to offset passive income, not earned (wage) or portfolio income, per IRS rules.
- Passive losses offset only passive income
- Excess losses are carried forward
- DPPs are illiquid and often used for tax-advantaged income
- Suitability requires client to have passive income sources
Memory trick: Passive losses stay in their own lane — no crossing into wages.