Which investment activity has the greatest potential for reducing Sally's tax liability?

Investing in a newly created limited partnership for low-income housing that produces tax credits is highly effective in reducing tax liability due to the characteristics of tax credits themselves. Tax credits are particularly powerful because they directly reduce the amount of tax owed on a dollar-for-dollar basis, unlike deductions that merely reduce taxable income.

Low-income housing tax credits are specifically designed to incentivize investment in the development of affordable housing. When an investor participates in such programs, they generally receive tax credits that can be utilized to offset their federal income tax liability significantly. This approach not only encourages socially beneficial behavior by supporting affordable housing but also provides a substantial financial advantage for the investor, potentially resulting in a significant overall reduction in their tax obligation.

While the other options might also seemingly offer some tax benefits, they typically involve passive losses or deductions that may not provide the same level of direct tax relief as the credits associated with low-income housing investments. Passive loss rules can limit the deductibility of losses to the extent of passive income, and in some cases, any losses may not be usable currently, depending on the taxpayer's overall income and participation level. Thus, the investment in low-income housing through tax credits stands out as the most advantageous for reducing Sally's tax liability effectively.