Ch 4 Federal Taxation of Property Transactions

Question 1

IRC Section 267 has a special rule for sales to a related party that are unpaid at the end of the year. In which of the following cases does the rule apply?

A.
When a cash-basis seller sells to a cash-basis buyer

B.
When an accrual-basis seller sells to an accrual-basis buyer

C.
When a cash-basis seller sells to an accrual-basis buyer

D.
When an accrual-basis seller sells to a cash-basis buyer

Answer 1

C. When a cash-basis seller sells to an accrual-basis buyer

The rule applies when the seller is on the cash basis and the buyer is on the accrual basis. The buyer may not deduct the expense until the seller has reported the income.

Question 2

Which of the following credits may be offset against the gross estate tax to determine the net estate tax of a U.S. citizen?

A. Unified credit
B. Credit for gift taxes paid on gift made after 1976

A. Both A and B

B. Neither A norB

C. Only B

D. Only A

Answer 2

D. Only A

Estate and gift taxation has been combined into a unified system. The unified credit 统一抵税额 is a specific credit allowed against the estate tax and will encompass prior gifts as well.

As a result, option B (credit for gift taxes paid on gift made after 1976) is already included in option A, the unified credit.

Question 3

You are a partner in HiJack Partnership. The adjusted basis of your partnership interest at the end of the current year is zero. Your share of potential ordinary income from partnership depreciable property is $5,000. The partnership has no other unrealized receivables or substantially appreciated inventory items. You sell your interest in the partnership for $11,000 in cash. Which of the following statements is accurate?

1. You report the entire amount as a capital gain since your adjusted basis in the partnership is zero.
2. You report $5,000 as ordinary income from the sale of the partnership’s depreciable property.
3. You report the remaining $6,000 gain as capital gain.

A.
Two (2) and 3 are correct, but 1 is incorrect.

B.
All of the statements are incorrect.

C.
All of the statements are correct.

D.
One (1) is correct, but 2 and 3 are incorrect.

Answer 3

A.
Two (2) and 3 are correct, but 1 is incorrect.

The $5,000 is reported under the ordinary income rules for depreciation recapture. The additional payment of $6,000 is a capital gain and reportable in the current year.

Question 4

You are a partner in HiJack Partnership. The adjusted basis of your partnership interest at the end of the current year is zero. Your share of potential ordinary income from partnership depreciable property is $5,000. The partnership has no other unrealized receivables or substantially appreciated inventory items. You sell your interest in the partnership for $11,000 in cash. Which of the following statements is accurate?

1. You report the entire amount as a capital gain since your adjusted basis in the partnership is zero.
2. You report $5,000 as ordinary income from the sale of the partnership’s depreciable property.
3. You report the remaining $6,000 gain as capital gain.

A.
Two (2) and 3 are correct, but 1 is incorrect.

B.
All of the statements are incorrect.

C.
All of the statements are correct.

D.
One (1) is correct, but 2 and 3 are incorrect.

Answer 4

A. Two (2) and 3 are correct, but 1 is incorrect.

The $5,000 is reported under the ordinary income rules for depreciation recapture. The additional payment of $6,000 is a capital gain and reportable in the current year.

Question 5

Danielson invested $2 million in DEC, a qualified small business corporation. Six years later, Danielson sold all of the DEC stock for $16 million and purchased an office building with the proceeds. Danielson had not previously excluded any gain on the sale of small business stock. What is Danielson’s taxable gain after the exclusion?

A.
$0

B.
$6 million

C.
$7 million

D.
$9 million

Answer 5

C. $7 million

IRC Section 1202 permits a taxpayer, other than a corporation, to exclude in general 50% of the gain realized on the sale of a qualified small business corporation if the taxpayer holds the stock for more than five years prior to sale. The amount of gain which may be excluded in this manner is limited, on a “per issuer” basis, to the greater of $10 million or 10 times the taxpayer’s basis in the stock.

In this example, 50% of the gain is $7 million ($16,000,000 − $2,000,000 × 0.50). Compare that number to:
10 times the taxpayer’s basis, which would be $20 million ($2,000,000 × 10)= $10 million
The gain excluded is limited to the greater of either (1) or (2) above—in this case, $20 million. However, since the gain exclusion is calculated at $7 million, the limitation is not met and $7 million is excluded.

Question 6

Which of the following minerals do not have a percentage depletion rate of 15% for mining in the United States?

A.
Gold

B.
Silver

C.
Copper

D.
Clay

Answer 6

D.
Clay

Clay mining deposits can be written off using a percentage depletion rate of either 5% or 7.5%, depending on the end use of the clay.

Gold, silver, copper, and iron ore mining use the 15% depletion rate for the cost recovery of the capital investment in the mining properties.

Question 7

For an individual business owner, which of the following would typically be classified as a capital asset for federal income tax purposes?

A.
Accounts receivable

B.
Marketable securities

C.
Machinery and equipment used in a business

D.
Inventory

Answer 7

B.
Marketable securities

Capital assets are investment property and personal-use property. Capital assets do not include the following:

Property held for resale (inventory)
Real or depreciable property used in a trade or business
Accounts or notes receivable acquired in normal business operations

Question 8

Which of the following items qualifies for treatment under IRC Section 1231 (“Property Used in the Trade or Business and Involuntary Conversions”)?

A.
Copyright used in the business, held for 10 years

B.
Building used in the business, held for 6 months

C.
Machinery used in the business, held for 11 months

D.
Computer used in the business, held for 4 years

Answer 8

D. Computer used in the business, held for 4 years

IRC Section 1231 transactions include sales or exchanges of real property or depreciable personal property. This property must be used in a trade or business and held longer than one year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. These assets qualify for treatment under IRC Section 1231. Generally, a net Section 1231 loss is ordinary loss and a net Section 1231 gain (except for depreciation recapture) is long-term capital gain.

A sample of items that are not capital assets include but are not limited to the following:
Property held mainly for sale to customers or property that will physically become part of merchandise for sale to customers
Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered
A copyright; a literary, musical, or artistic composition if personal efforts created the property or if the property was acquired in a way that entitled the taxpayer to the basis of the previous owner whose personal efforts created it (for example, if the property was received as a gift)
In this case, a copyright is not a capital asset and the building and machinery are capital assets used in a business but were held for less than one year. Hence, the best answer choice is the computer used in a business for four years.

Question 9

Platt owns land that is operated as a parking lot. A shed was erected on the lot for the related transac­tions with customers. With regard to capital assets and Section 1231 assets, how should these assets be classified?

A.
Land: Capital; Shed: Capital

B.
Land: Section 1231; Shed: Capital

C.
Land: Capital; Shed: Section 1231

D.
Land: Section 1231; Shed: Section 1231

Answer 9

D. Land: Section 1231; Shed: Section 1231

IRC Section 1221 defines a capital asset by exclusion. If an item is listed there, then it is not a capital asset. All property used in a taxpayer’s trade or business is excluded from being a capital asset.

IRC Section 1231 defines “property used in the trade or business” to mean property used in the trade or business, of a character which is subject to the allowance for depreciation and real property used in the trade or business. Both the land and the shed are used in the business and cannot be capital assets, but must qualify

Question 10

Summer, a single individual, had a net operating loss of $20,000 three years ago. A Section 1244 stock loss made up 3/4ths of that loss. Summer had no taxable income from that year until the current year. In the current year, Summer has gross income of $80,000 and sustains another loss of $50,000 on Section 1244 stock. Assuming that Summer can carry the entire $20,000 net operating loss to the current year, what is the amount and character of the Section 1244 loss that Summer can deduct for the current year?

A.
$35,000 ordinary loss

B.
$35,000 capital loss

C.
$50,000 ordinary loss

D.
$50,000 capital loss

Answer 10

C.
$50,000 ordinary loss

The total loss for the current year equals $70,000, which is the $20,000 loss carryover plus the current-year loss of $50,000. However, Section 1244 has a limit of $50,000 per year. Therefore, of the total loss of $70,000, $50,000 will be allowed Section 1244 status and will be treated as an ordinary loss.

Question 11

A sole proprietor of a farm implement store sold a truck for $15,000 that had been used to make service calls. The truck cost $30,000 three years ago, and $21,360 depreciation was taken. What is the appropriate classification of the $6,360 gain for tax purposes?

A.
Ordinary gain

B.	 	
Section 1231 (property used in the trade or business and involuntary conversions) gain

C.
Long-term capital gain

D.
Short-term capital gain

Answer 11

A.
Ordinary gain

IRC Section 1231 property is defined as an asset used in a trade or business subject to depreciation and capital gain treatment would be available. But IRC Section 1231 is modified by IRC Section 1245, which states that personal (versus real) property’s depreciation taken must be recaptured as ordinary income first. If a gain still remains after the depreciation recapture, then capital gain treatment is applied. In this example, total depreciation taken of $21,360 is greater than the total gain of $6,360. Therefore, all of the $6,360 gain is ordinary.

Question 12

A taxpayer lived in an apartment building and had a 2-year lease that began 16 months ago. The taxpayer’s landlord wanted to sell the building and offered the taxpayer $10,000 to vacate the apartment immediately. The taxpayer’s lease on the apartment was a capital asset but had no tax basis. If the taxpayer accepted the landlord’s offer, the gain or loss would be which of the following?

A.
An ordinary gain

B.
A short-term capital loss

C.
A long-term capital gain

D.
A short-term capital gain

Answer 12

C.
A long-term capital gain
Since a leasehold is not listed, it will be a capital asset. The difference between long-term and short-term capital gain is defined as one year or less for short term. The taxpayer held the lease for 16 months; therefore, it is long term.

Capital assets are defined by exclusion; that is, the Internal Revenue Code (IRC) lists items that are not capital assets. All else would then be capital. The items listed as not capital items are as follows:
Property held for resale (inventory)
Depreciable property or real property used in a trade or business
Accounts or notes receivable acquired in normal business operations
A copyright or a literary, artistic, or musical composition in the hands of the creator or anyone who assumes the creator’s basis (property received through gift)
U.S. government publications received from the government other than by purchase at the price that it is offered for sale to the public
Certain commodities derivative instruments held by a commodities derivatives dealer
Any hedging transaction that is clearly identified as such before the close of the day on which it is acquired, originated, or entered into
Supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer

Question 13

A taxpayer purchased 5 acres of land for $200,000 and placed in service other tangible business assets that cost $15,000. Disregarding business income limitations and assuming that the annual Section 179 (election to expense certain depreciable business assets) limit is $500,000 for 2016, what maximum amount of cost recovery can the taxpayer claim this year?

A.
$215,000

B.
$200,000

C.
$15,000

D.
$25,000

Answer 13

C.
$15,000

Land is not depreciable and does not qualify for Section 179 automatic expensing. The only assets in this problem that qualify for Section 179 are the other tangible business assets that cost $15,000. Because the $15,000 is less than the overall limit of $500,000, all $15,000 of the other tangible business assets are allowed as Section 179 expenses.

Question 14

Which of the following is deductible from a decedent’s gross estate?

A. Expenses of administering and settling the estate
B. State inheritance or estate tax

A.
I only

B.
II only

C.
Both I and II

D.
Neither I nor II

Answer 14

C.
Both I and II

IRC Section 2053 details the deductions allowed against a decedent’s gross estate. Administrative expenses and state estate taxes are specifically allowed.

Question 15

An individual reports the following capital transactions in the current year:

Short-term capital gain $ 1,000
Short-term capital loss 11,000
Long-term capital gain 10,000
Long-term capital loss 6,000

What amount is deducted in arriving at adjusted gross income?

A.
$10,000

B.
$6,000

C.
$3,000

D.
$0

Answer 15

C.
$3,000

If capital losses exceed capital gains, for an individual, the amount of the capital loss that can be claimed to lower income is limited to $3,000. Any amount not used carries forward indefinitely. All short-term capital gains and losses are netted together and then all long-term capital gains and losses are netted together. Then the short term is netted with the long term.

In this example, the short-term items net to a short-term capital loss of $10,000. The long-term capital items net to a long-term capital gain of $4,000. The $4,000 long-term capital gain is eliminated by the $10,000 short-term capital loss resulting in a net $6,000 short-term capital loss. The taxpayer may use $3,000 of the short-term loss to reduce taxable income. The balance unused, $3,000, is a carryover to the next year.

Question 16

Rock Crab, Inc., purchases the following assets during the year:

Computer           $ 3,000
Computer desk        1,000
Office furniture     4,000
Delivery van        25,000
What should be reported as the cost basis for MACRS 5-year property?

A.
$3,000

B.
$25,000

C.
$28,000

D.
$33,000

Answer 16

C.
$28,000 (3+25)

There are six recovery periods for personal property: 3, 5, 7, 10, 15, and 20 years. The 5- and 7-year properties are the most common:

The 5-year class includes automobiles, general-purpose light trucks, computers, and office machinery (typewriters, calculators, copiers, etc.).
The 7-year class includes heavy, special-purpose trucks, and office furniture and fixtures (desks, filing cabinets, etc.).
Thus, the computer at $3,000 plus the delivery van at $25,000 would total $28,000 and be reported as MACRS 5-year property.

Question 17

Kate Lemon purchased a diamond pin for $6,000 in Year 1. In Year 10, when the value was $11,000, she gave it to her daughter, Ann. No gift tax was paid. If Ann sells the pin for $12,000, Ann’s recognized gain is:

A.
$1,000.

B.
$5,000.

C.
$6,000.

D.
$0.

Answer 17

C.
$6,000.

The basis of property acquired by gift is the donor’s basis if the property is sold at a gain:

$12,000 sale - $6,000 basis (cost to Kate) = $6,000 taxable gain for Ann

Question 18

Prime Corporation’s building was destroyed by a tornado. The fair market value of the building at the time of the tornado was $400,000 and its adjusted basis was $350,000.
The insurance proceeds totaled $500,000 as follows:
$400,000 for the building
$100,000 for lost profits during rebuilding
Prime does not defer any gain under the involuntary conversion provisions of IRC Section 1033.

What amount of the insurance proceeds is taxable to Prime?

A.
$0

B.
$50,000

C.
$100,000

D.
$150,000

Answer 18

D. $150,000

Insurance proceeds that are not fully reinvested into replacement property will be subject to taxation. In this case, zero was reinvested into property. The building is treated as a sale of property. Proceeds received of $400,000 minus adjusted basis of $350,000 leaves a $50,000 gain. The additional $100,000 of insurance proceeds was to replace lost business during the rebuilding phase. By the nature of being a replacement of earnings, the full $100,000 is taxable. The gain of $50,000 plus the lost earnings of $100,000 totals $150,000.

Question 19

Jan, an unmarried individual, gave the following outright gifts in 2016:

Donee Amount Use by Donee
Jones $20,000 Down payment on house
Craig 20,000 College tuition
Kande 5,000 Vacation trip

Jan’s 2016 exclusions for gift tax purposes total:

A.
$39,000.

B.
$33,000.

C.
$20,000.

D.
$14,000.

Answer 19

B.
$33,000.

A taxpayer is allowed an annual exclusion of $14,000 per donee during the tax year. If a gift of tuition payments had been made directly to the college versus to Craig, then the entire amount of tuition payments would be excluded. Therefore, an exclusion of $14,000 each is available for the gifts to Jones and Craig, and the entire $5,000 to Kande is excluded. The total of the exclusions is $33,000 (($14,000 × 2) + $5,000).

Question 20

A taxpayer purchased and placed in service during the year a $761,000 piece of equipment. The equipment is 7-year property. The first-year depreciation for 7-year property is 14.29%. There is an allowable Section 179 limit of $500,000. What amount is the maximum allowable depreciation without using bonus depreciation?

A.
$25,000

B.
$37,297

C.
$500,000

D.
$537,297

Answer 20

D.
$537,297

A taxpayer who elects to expense under Section 179 must reduce the depreciable basis of the Section 179 property by the amount of the Section 179 expense deduction. The maximum allowable depreciation is calculated (rounded) as follows:

Basis of property $761,000
Less: Section 179 expense (500,000)
Adjusted basis $261,000
1st-year MACRS rate × 14.29%
1st-year depreciation $ 37,297
Section 179 expense 500,000
Maximum allowable depreciation $537,297

Question 21

Cobb created a $500,000 trust that provided his mother with an income interest for her life and the remainder interest to go to his sister at the death of his mother. Cobb expressly retained the power to revoke both the income interest and the remainder interest at any time.

The income interest at the trust’s creation:

A.
is a gift of present interest.

B.
is a gift of a future interest.

C.
is not a completed gift.

D.
is a complete gift to the mother but not to the sister.

Answer 21

C.
is not a completed gift.

The income interest would not be a completed gift at the trust’s creation because the grantor retained the power to revoke the trust.

To be a completed gift, the grantor must relinquish all dominion and control over the transferred property. Generally, if any right is retained to revoke or change the disposition of the property the gift is not complete. A transfer in trust can be a complete gift if it is irrevocable and the grantor does not retain any powers over the trust.

A gift that is not complete is not subject to gift tax.

Question 22

On January 1, Fast, Inc., entered into a covenant not to compete with Swift, Inc., for a period of 5 years, with an option by Swift to extend it to 7 years. What is the amortization period of the covenant for tax purposes?

A.
5 years

B.
7 years

C.
15 years

D.
17 years

Answer 22

C.
15 years

A covenant not to compete that is acquired with the purchase of a business is considered to be a Section 197 intangible eligible for 15-year amortization.

Question 23

Rita Ryan died leaving a will naming her children, John and Dale, as the sole beneficiaries. In her will, Rita designated John as the executor of her estate and excused John from posting a bond as executor. At the time of Rita’s death, she owned a parcel of land with her sister, Ann, as joint tenants with right of survivor­ship. In general, John as executor, must:

A.
post a bond despite the provision to the contrary in Rita’s will.

B.
serve without compensation because John is also a named beneficiary in the will.

C.
file a final account of the administration of the estate.

D.
relinquish the duties because of the conflict of interest as executor and beneficiary.

Answer 23

C.
file a final account of the administration of the estate.

A beneficiary may also serve as an executor for the estate. There are many responsibilities of an executor, one of which is filing a final account of the administration of the estate. The other answer choices may be possibilities but are not necessarily required.

Question 24

Mark Olds sold a delivery truck (business use) at a loss. The truck had been held for three years. The loss on the sale of the delivery truck is classified as a:

A.
capital loss.

B.
Section 1231 loss.

C.
Section 1245 loss.

D.
Section 1250 loss.

Answer 24

B.
Section 1231 loss.

Depreciable property used in a business is a Section 1231 asset. Section 1245 only applies to the sale of personal property at a gain. Section 1250 applies to the sale of real property at a gain.

Question 25

Grayson Nolan purchased a duplex and lives in one part and uses the other part as a retail store. Grayson purchased bedroom furniture for $4,000 for the residential part and office furniture for $5,000 for the retail store. What is the total amount of capital assets?

A.
$0

B.
$4,000

C.
$5,000

D.
$9,000

Answer 25

B.
$4,000

Only the personal use property is a capital asset. Business use property is not a capital asset.

IRC Section 1221

Question 26

On December 1, Year 4, Jim Miller placed in service office furniture (7-year life), which cost $28,000. Jim did not elect Section 179 expensing or bonus depreciation. The office furniture was the only asset purchased during the year. What amount can Jim claim as depreciation under MACRS for Year 4?

A.
$1,000

B.
$2,000

C.
$4,000

D.
$7,000

Answer 26

A.
$1,000

First-year depreciation under MACRS is based on double declining balance. A 7-year life would yield depreciation of 2/7 the first year. Because the purchase was made in December, the mid-quarter convention is used and 1-1/2 months of depreciation is recorded. Depreciation is $1,000 ($28,000 × 2/7 × 1.5/12).

Question 27

On March 1 of the previous year, a parent sold stock with a cost of $8,000 to their child, for $6,000, its fair market value. On September 30 of the current year, the child sold the same stock for $7,000 to Hancock, who is unrelated to the parent and child. What is the proper treatment for these transactions?

A.
Parent has a $2,000 recognized loss and child has $1,000 recognized gain.

B.
Parent has $2,000 recognized loss and child has $0 recognized gain.

C.
Parent has $0 recognized loss and child has $1,000 recognized gain.

D.
Parent has $0 recognized loss and child has $0 recognized gain.

Answer 27

D.
Parent has $0 recognized loss and child has $0 recognized gain.

Losses on sale transactions between related parties are not recognized. When the related party, who purchased the asset, sells to an outsider, then the gain is reduced by the loss previously unrecognized but not in excess of the gain. In other words, the related taxpayer may not be able to take all of the previous loss unrecognized.

In this problem, the parent cannot recognize the loss of $2,000 ($6,000 sales price − $8,000 basis) on the sale of the stock to the child. But when the child sells the stock to an unrelated party, Hancock, the child’s gain of $1,000 ($7,000 sales price − $6,000 basis) is reduced by the previous unrecognized loss of $2,000 down to zero, but NOT less than zero. The unused loss of $1,000 from the parent ($2,000 unrecognized loss − $1,000 loss used by the child) is lost forever. The correct answer is that the parent recognizes zero loss and the child has zero recognized gain.

Question 28

If a security becomes worthless in the current taxable year, it is treated as sold or exchanged on the:

A.
last day of the preceding taxable year.

B.
last day of the current taxable year.

C.
date it is deemed worthless.

D.
first day of the current taxable year.

Answer 28

B. last day of the current taxable year.

The gain or loss on a sale or trade of property is found by comparing the amount realized with the adjusted basis of the property.

If the amount realized from a sale or trade is more than the adjusted basis of the property that the taxpayer transfers, the difference is a gain, or
If the adjusted basis of the property that the taxpayer transfers is more than the amount realized, the difference is a loss.
Stocks, stock rights, and bonds (other than those held for sale by a securities dealer) that became worthless during the tax year are treated as though they were sold on the last day of the tax year. This affects whether the taxpayer’s capital loss is long term or short term.

Question 29

Smith made a gift of property to Thompson. Smith’s basis in the property was $1,200. The fair market value at the time of the gift was $1,400. Thompson sold the property for $2,500. What was the amount of Thompson’s gain on the disposition?

A.
$0

B.
$1,100

C.
$1,300

D.
$2,500

Answer 29

C.
$1,300

The basis in property acquired by gift is determined by reference to the basis in the hands of the transferor. Generally the basis is the same as the basis of the transferor (special rules apply if that basis is greater than the fair market value at the time of the gift).

In this case, the fair market value at the time of the gift ($1,400) is greater than Smith’s basis ($1,200) so Thompson’s basis is $1,200.

Thompson's gain on the disposition is computed as follows:
Sales price     $2,500
Less basis       1,200
Gain            $1,300
IRC Section 1015(a)

Question 30

John Evert exchanged land held as an investment for other land to be held as an investment. Relevant data is:
Property given by John
Basis $60,000
Value $90,000
Mortgage on land $10,000

                    Property received by John
                  Value                $65,000
                  Cash                 $15,000

What is John’s recognized gain or loss on the exchange?
A.
$15,000

B.
$25,000

C.
$30,000

D.
$55,000

Answer 30

B.
$25,000

             Value received          $65,000
                Mortgage relief          10,000
                Cash received            15,000

                Amount realized          90,000
                Less: Basis given        60,000
                Realized gain           $30,000

The realized gain is recognized to the extent of the boot (mortgage relief and cash received) $25,000.

Question 31

Farr made a gift of stock to her child, Pat. At the date of gift, Farr’s stock basis was $10,000 and the stock’s fair market value was $15,000. No gift taxes were paid. What is Pat’s basis in the stock for computing gain?

A.
$0

B.
$5,000

C.
$10,000

D.
$15,000

Answer 31

C. $10,000

Basis in property received as a gift is generally the same as the basis in the property in the hands of the donor. If gift taxes are paid, they are added to the basis. Special rules apply in the case of property with a fair market value less than the donor’s basis.

Farr gave Pat property with a basis of $10,000 and a fair market value of $15,000. Since there was no gift tax paid and the fair market value exceeds the basis, Pat has a basis of $10,000 in the property.

IRC Section 1015

Question 32

A taxpayer sold for $200,000 equipment that had an adjusted basis of $180,000. Through the date of the sale, the taxpayer had deducted $30,000 of depreciation. Of this amount, $17,000 was in excess of straight-line depreciation. What amount of gain would be recaptured under Section 1245 (“Gain from Dispositions of Certain Depreciable Property”)?

A.
$13,000

B.
$17,000

C.
$20,000

D.
$30,000

Answer 32

C. $20,000

Because the taxpayer sold equipment for $200,000 that had an adjusted basis of $180,000, the taxpayer has a gain of $20,000.

The taxpayer had taken $30,000 in depreciation on the equipment. IRC Section 1245 requires that a gain on the sale of equipment will be treated as ordinary income to the extent of all depreciation. Although a maximum of $30,000 could have been recaptured, the total gain in the sale was $20,000, limiting the depreciation recapture to $20,000.

Question 33

In 2016, Lisa Podkopova purchased $120,000 of equipment for use in her business. Lisa had taxable income of $20,000 and elected the maximum Section 179 expense deduction. In 2016, Lisa may deduct:

A.
$0.

B.
$25,000.

C.
$20,000.

D.
$120,000.

Answer 33

C.
$20,000.

The maximum amount Lisa may deduct under IRC Section 179 is $20,000. The maximum amount that can be elected to deduct for most Section 179 property placed in service in tax years beginning in 2016 is $500,000 ($535,000 for qualified enterprise zone property). This limit is reduced by the amount by which the cost of Section 179 property placed in service during the 2016 tax year exceeds $2,010,000. (The Section 179 spending cap is indexed to inflation in $10,000 increments for future years.) The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Any cost not deductible in one year under Section 179 because of this limit can be carried to the next year.

Question 34

Molly Smith died August 3, Year 2. Which of the following is an allowable deduction in computing her federal taxable estate?

A.
State income taxes paid prior to the date of death

B.
State death taxes paid by the estate

C.
Federal income tax paid by the estate on income earned during the administration of the estate

D.
Federal estate tax paid by the estate

Answer 34

B.
State death taxes paid by the estate

The estate is allowed a deduction for state death taxes paid.

IRC Section 2058

Federal income taxes and federal estate tax are not deductible by the estate. State income taxes paid prior to the date of death would not be deductible by the estate but would be deducted on the decedent’s final tax return.

Question 35

Lobster, Inc., incurs the following losses on disposition of business assets during the year:

Loss on the abandonment of office equipment $ 25,000
Loss on the sale of a building (straight-line depreciation taken in prior years of $200,000) 250,000
Loss on the sale of delivery trucks 15,000

What is the amount and character of the losses to be reported on Lobster’s tax return?

A.
$40,000 Section 1231 loss only

B.
$40,000 Section 1231 loss, $50,000 long-term capital loss

C.
$40,000 Section 1231 loss, $250,000 long-term capital loss

D.
$290,000 Section 1231 loss

Answer 35

D.
$290,000 Section 1231 loss

When business-use assets have been held for the long-term holding period, more than 1 year, and are sold at a loss, only Section 1231 is applicable. By definition, all Section 1231 losses are long-term ordinary losses because the assets had to have been held for over a year to be considered a Section 1231 asset. IRC Sections 1245 and 1250 are only applicable if the Section 1231 assets are sold at a gain. Therefore, all of the losses in this question are considered to be Section 1231 long-term ordinary losses.

Question 36

Under the unified rate schedule:

A.
lifetime taxable gifts are taxed on a noncumulative basis.

B.
transfers at death are taxed on a noncumulative basis.

C.
lifetime taxable gifts and transfers at death are taxed on a cumulative basis.

D.
the gift tax rates are 5% higher than the estate tax rates.

Answer 36

C.
lifetime taxable gifts and transfers at death are taxed on a cumulative basis.

The “unified rate schedule” referred to in this question means the unified transfer tax rate schedule which is imposed on taxable gifts made after 1976 and taxable estates for deaths after 1976.

The tax base for determining the estate tax (the unified transfer tax) is based on the taxable estate plus all post-1976 taxable gifts.

The tax base for determining the gift tax (the unified transfer tax) is based on all lifetime taxable gifts.

Therefore, lifetime taxable gifts and transfers at death are taxed on a cumulative basis.

Question 37

What amount of a decedent’s taxable estate is effectively tax-free in 2016 if the maximum applicable (unified) estate and gift tax credit is taken?

A.
$1,500,000

B.
$5,000,000

C.
$5,430,000

D.
$5,450,000

Answer 37

D.
$5,450,000

The inflation-adjusted amount of the exemption is $5,450,000 for 2016. The maximum gift tax rate is 40%, making the estate and gift tax credit unified. If a decedent’s taxable estate is equal to or less than $5,450,000 in 2016, the estate will pay no estate taxes.

Question 38

When business equipment such as machinery that has been held for 12 months or less is sold at a gain, how is the gain reported for taxes?

A.
Ordinary gains

B.
Short-term capital gains

C.
Long-term capital gains

D.
Gains on collectibles

Answer 38

A.
Ordinary gains

Fixed assets used in business that have been held for a short-term holding period are taxed as ordinary gains. Business assets include all furniture, equipment, and machinery used in a business venture. Ordinary gains are reported on IRS Form 4797.

Question 39

Which of the following assets would not be taxed at a rate of 28% (collectibles) if sold at a gain?

A.
Personal automobile

B.
Stamp collection

C.
Coin collection

D.
Fine art

Answer 39

A.
Personal automobile

Capital gains on long-term investments in collectibles are taxed at 28%. In the normal course of affairs, a driver’s personal automobile is not a collectible and a sale at a gain would be taxed at 15%/20%.

Question 40

In the current year, Tatum exchanged farmland for an office building. The farmland had a basis of $250,000, a fair market value (FMV) of $400,000, and was encumbered by a $120,000 mortgage. The office building had an FMV of $350,000 and was encumbered by a $70,000 mortgage. Each party assumed the other’s mortgage. What is the amount of Tatum’s recognized gain?

A.
$0

B.
$50,000

C.
$100,000

Incorrect D.
$150,000

Answer 40

B.
$50,000

Gain is recognized to the extent of boot (cash, other assets, or mortgages given up) received, but not to exceed the gain realized.
Fair value of assets received–Building $350,000
Mortgage given up 120,000
Mortgage assumed (70,000)
Net value received $400,000
Adjusted basis of farmland 250,000

Realized gain $150,000

Boot given: Mortgage assumed $(70,000)
Boot received: Mortgage given up 120,000
Net boot $ 50,000
Net boot is less than realized gain, therefore $50,000 is the recognized gain.

Question 41

Which of the following costs may be amortized over 60 months or expensed at the election of the taxpayer?

A.
Patents

B.
Goodwill

C.
Trademarks

D.
Research and experimental

Answer 41

D.
Research and experimental

Research and experimental expenses may be amortized over 60 months or longer. However, the taxpayer can choose to deduct the cost in the first year in which they are paid or incurred.

IRC Section 174(b)(2)

Question 42

Carter purchased 100 shares of stock for $50 per share. Ten years later, Carter died on February 1 and bequeathed the 100 shares of stock to a relative, Boone, when the stock had a market price of $100 per share. One year later, on April 1, the stock split 2-for-1. Boone gave 100 shares of the stock to another of Carter’s relatives, Dixon, on June 1 that same year, when the market value of the stock was $150 per share. What was Dixon’s basis in the 100 shares of stock when acquired on June 1?

A.
$5,000

B.
$5,100

C.
$10,000

D.
$15,000

Answer 42

A. $5,000

Capital stock inherited from a decedent gets a basis equal to its fair market value on the date of death (or six months after the date of death if the alternative valuation date is elected). The original purchase price is irrelevant.

When a taxpayer receives a stock dividend due to a 2-for-1 stock split, the basis in the original stock must be allocated between the old and the new shares.

Capital stock received as a gift gets carryover basis equal to the basis in the hands of the donor, as long as the fair market value at the date of the gift is greater than the basis. Special rules apply if the carryover basis is more than the fair market value at the date of the gift.

Boone inherited 100 shares of stock from Carter when the fair market value was $100 per share for a total basis of $10,000 (100 shares × $100 = $10,000). The next year, the stock had a 2-for-1 split, resulting in another 100 shares with a total basis of $10,000 for the 200 shares. When Boone gave 100 shares to Dixon, they had a basis of $5,000. This becomes Dixon’s basis, since the fair market value at the date of the gift ($150 per share) is more than the tax basis ($50 per share).

Inherited basis $10,000 ÷ 200 shares × 100 shares gift = $5,000 basis in 100 gift shares
IRC Sections 305 and 1014

Question 43

Murry created a $1,000,000 trust that provided his brother with an income interest for 10 years, after which the remainder interest passes to Murry’s sister. Murry retained the power to revoke the remainder interest at any time. The income interest was valued at $600,000.

The income interest:
A. is a gift of present interest.

B.
is a gift of a future interest.

C.
is not a completed gift.

D.
is a present gift to the brother and a future gift to the sister.

Answer 43

A. is a gift of present interest.

The income interest is a gift of a present interest because the gift is complete and enjoyment is immediate. The grantor only retained the power to revoke the remainder interest.

An unrestricted right to the immediate use of the income from property qualifies as a present interest. Only a present interest qualifies for the $14,000 annual exclusion from gift tax.

IRC Section 2503(b)

Question 44

Under IRC Section 267, which of the following are considered related parties?

A.
First cousin

B.
Sister

C.
Mother-in-law

D.
Brother-in-law

Answer 44

Only close relatives are included in the category of related parties, so only the sister is included. First cousins are not close enough relatives and in-laws are never related parties.

Question 45

In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Section 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Section 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year?

A.
$50,000 capital loss

B.
$68,000 capital loss

C.
$18,000 ordinary loss and $50,000 capital loss

D.
$50,000 ordinary loss and $18,000 capital loss

Answer 45

D.
$50,000 ordinary loss and $18,000 capital loss

The taxpayer is allowed to deduct a maximum of $50,000 as an ordinary loss under IRC Section 1244. The balance of the loss would then be a capital loss (($48,000 + $20,000) - $50,000 = $18,000).

Question 46

Sally Markey, who owns a heavy construction company, decided to spend some of her $2,000,000 2016 profit on several heavy-duty diesel trucks costing a total of $1,110,000 for her business. In order to lower her income taxes for the year, she decided to take the maximum IRC Section 179 deduction, bonus depreciation, and MACRS depreciation for 7-year property. No other capital assets were purchased during the year. What is the total deduction for the truck in 2016?

A.
$543,585

B.
$848,585

C.
$500,000

D.
$805,000

Answer 46

B. $848,585

The maximum amount that can be elected to deduct for most IRC Section 179 property placed in service in tax years beginning in 2016 is $500,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the 2016 tax year exceeds $2,010,000. (The Section 179 spending cap is indexed to inflation in $10,000 increments for future years.) The total cost that can be deducted each year after applying the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Any cost not deductible in one year under Section 179 because of this limit can be carried to the next year.

Sally’s total deduction for the trucks was $848,585:
Equipment purchase $1,110,000
2016 Section 179 (500,000)
50% bonus depreciation (($1,110,000 - $500,000) × 50%) (305,000)
Adjusted basis $ 305,000
1st-year depreciation ($305,000 × 0.1429) =($43,585)
Total expense for 2016 ($500,000 + $305,000 + $43,585) $848,585

Question 47

Hogan exchanged a business-use machine having an original cost of $100,000 and accumulated depreciation of $30,000 for business-use equipment owned by Baker having a fair market value of $80,000 plus $1,000 cash. Baker assumed a $2,000 outstanding debt on the machine. What taxable gain should Hogan recognize?

A.
$0

B.
$3,000

C.
$10,000

D.
$11,000

Answer 47

This transaction qualifies for Section 1031 tax-free exchange treatment because business-use personalty is being exchanged for other business-use personalty. In a Section 1031 tax-free exchange, the recognized gain is equal to the lesser of the realized gain or boot received. The boot received is $3,000 in this problem and is the recognized gain.
Amount realized:
FMV of asset received $80,000
Plus: Cash received 1,000 (boot)
Plus: Relief of liability 2,000 (boot)
Amount realized $83,000
Less: Adjusted basis
Purchase price $100,000
Less: Accum. depr. (30,000)
Adjusted basis (70,000)
Realized gain $13,000
Recognized gain To extent of boot received $ 3,000

Question 48

Four years ago, a self-employed taxpayer purchased office furniture for $30,000. During the current tax year, the taxpayer sold the furniture for $37,000. At the time of the sale, the taxpayer’s depreciation deductions totaled $20,700. What part of the gain is taxed as long-term capital gain?

A.
$0

B.
$7,000

C.
$20,700

D.
$27,700

Answer 48

B. $7,000

Since the facts show that the taxpayer had taken $20,700 in depreciation, the $30,000 in office furniture had been reduced to a basis of $9,300. The sale of the furniture at $37,000 produced a gain of $27,700 ($37,000 - $9,300).

All of the depreciation taken of $20,700 must be recovered as an ordinary gain. This results in a long-term capital gain of $7,000 ($27,700 - $20,700).

Question 49

Which of the following types of capitalized costs may be amortized over a 15-year period?

A.
Geological and geophysical

B.
Section 197 intangible

C.
Pollution control facilities

D.
Research and experimental

Answer 49

B. Section 197 intangible

Section 197 intangible costs include goodwill, going concern value, patents, copyrights, franchises, trademarks, trade names, and various other intangibles. Generally, these intangibles must have been obtained in a business acquisition.

The taxpayer must amortize these costs if the intangibles are held in connection with a trade or business, or in an activity engaged in for the production of income.

Geological and geophysical costs have an amortization period of 2–7 years, depending on the size of the entity. Pollution control facilities may be amortized over 5 years (60 months). Research and experimental costs have an optional write-off period of 5 to 10 years.

Question 50

Patty Cake owned real estate that was condemned by the state. Patty had purchased the property for $30,000 and received $50,000 from the state as a result of the condemnation. Patty purchased replacement real estate for $52,000. Patty’s basis in the new real estate is:

A.
$30,000.

B.
$32,000.

C.
$50,000.

D.
$52,000.

Answer 50

B.
$32,000.

New basis = New property cost – Deferred gain – Recognized gain

Patty’s basis is the cost of the replacement property less the deferred gain ($52,000 - $20,000 - 0 = $32,000).

IRC Section 1033

Question 51

Jackson, a single individual, inherited Bean Corp. common stock from Jackson’s parents. Bean is a qualified small business corporation under IRC Section 1244. The stock cost Jackson’s parents $20,000 and had a fair market value of $25,000 at the parents’ date of death. During the year, Bean declared bankruptcy and Jackson was informed that the stock was worthless. What amount may Jackson deduct as an ordinary versus capital loss in the current year?

A.
$0

B.
$3,000

C.
$20,000

D.
$25,000

Answer 51

A. $0

To qualify as 1244 stock, the stock must have been issued directly to the taxpayer by the qualifying small business corporation (i.e., not transferred from a prior owner). In this question, the stock was inherited from the taxpayer’s parents. This transfer from the parents to the taxpayer disqualifies the stock for Section 1244 tax treatment.

A loss from the sale, exchange or worthlessness of 1244 stock is treated as an ordinary loss, rather than a capital loss. This is normally advantageous since capital losses are limited to offsetting only $3,000 of ordinary income per year. Section 1244 losses can fully offset ordinary income and are included in the computation of a net operating loss as a business loss. Up to $50,000 ($100,000 for married filing joint) per year of losses may qualify as ordinary 1244 loss in a tax year. The excess is treated as a capital loss.

Question 52

Among which of the following related parties are losses from sales and exchanges not recognized for tax purposes?

A.
Father-in-law and son-in-law

B.
Brother-in-law and sister-in-law

C.
Grandfather and granddaughter

D.
Ancestors, lineal descendants, and all in-laws

Answer 52

C.
Grandfather and granddaughter

Losses from sales and exchanges between certain related parties are not recognized for tax purposes. Related parties are considered brother and sisters, half-brothers and half-sisters, spouses, ancestors (parents and grandparents), and lineal descendants. Relatives by marriage, or in-laws, are not considered related parties for tax purposes.

Question 53

A taxpayer purchased and placed in service during the year a $610,000 piece of equipment. The equipment is 7-year property. The first-year depreciation for 7-year property is 14.29%. There is an allowable Section 179 limit in 2016 of $500,000, with 50% bonus depreciation. What amount is the maximum allowable depreciation?

A.
$500,000

B.
$507,860

C.
$515,719

D.
$562,860

Answer 53

D. $562,860

The maximum amount that can be elected to deduct for most IRC Section 179 property placed in service in tax years beginning in 2016 is $500,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the 2016 tax year exceeds $2,010,000. (The Section 179 spending cap is indexed to inflation in $10,000 increments for future years.) The total cost that can be deducted each year after applying the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Any cost not deductible in one year under Section 179 because of this limit can be carried to the next year.

A taxpayer who elects to expense under Section 179 must reduce the depreciable basis of the Section 179 property by the amount of the Section 179 expense deduction. The maximum allowable depreciation is calculated as follows:

Basis of property $610,000
Less: Section 179 expense (500,000)
$110,000
Less: Bonus depreciation (55,000)
Adjusted basis $ 55,000
1st-year MACRS rate × 14.29%
1st-year depreciation $ 7,860
Section 179 expense 500,000
Bonus depreciation 55,000
Maximum allowable depreciation $562,860

Question 54

Which of the following is a capital asset?

A.
Inventory held primarily for sale to customers

B.
Accounts receivable

C.
A computer system used by the taxpayer in a personal accounting business

D.
Land held as an investment

Answer 54

D.
Land held as an investment

Capital assets include investment property such as land held as an investment. Capital assets do not include the following:

Property held for resale (inventory)
Real or depreciable property used in a trade or business
Accounts or notes receivable acquired in normal business operations

Question 55

What is the percentage depletion rate allowed by the Internal Revenue Code for the recovery of capital invested in mining coal?

A.
5%

B.
10%

C.
15%

D.
20%

Answer 55

B.
10%

The percentage depletion rate for coal mined in the United States is 10%. Some types of mining for clay are allowed a 5% depletion rate. The 15% rate for mining includes gold, silver, copper, and iron ore.

Question 56

Business equipment purchased in the current year has three methods of cost recovery available:

1. MACRS depreciation
2. 50% bonus depreciation for certain assets
3. Section 179 expensing
   In what order should these methods of cost recovery be applied to calculate the deduction?

A.
1, 2, 3

B.
3, 2, 1

C.
2, 3, 1

D.
2, 1, 3

Answer 56

B.
3, 2, 1

The Section 179 expensing should be applied first; 100% of the amount chosen is expensed and then reduces the basis in the property. The 50% bonus depreciation is applied to the adjusted basis (0.50 × Original cost − Section 179 expense), then that amount is deducted from the basis. The MACRS cost recovery depreciation is 14.29% for the first year for 7-year property. This rate is applied against the remaining basis after deducting the Section 179 expense and the 50% bonus depreciation.

Question 57

A personal services corporation may deduct payments made to owner-employees only in the year in which the:

A.
corporation is formed.

B.
expense is accrued on the books and records of the corporation.

C.
corporation makes a valid S election.

D.
owner-employee includes it in income.

Answer 57

D. owner-employee includes it in income.

A deduction for amounts paid or incurred to employee-owners of a PSC (personal services corporation) is limited to the applicable amount, which is any amount otherwise deductible by a PSC in a tax year that is includible (directly or indirectly) in the gross income of a taxpayer who is an employee-owner at any time during that year.

As a result, a PSC may deduct payments made to owner-employees only in the year in which the owner-employee includes it in income.

Question 58

Natalie inherited land from her Uncle Josh, who died January 3, Year 4. The basis to Josh was $1,000,000 and the value on January 3, Year 4, was $7,200,000. On July 3, Year 4, the value was $7,600,000. When the land was distributed to Natalie on June 3, Year 4, the value was $7,400,000. This land was Josh’s entire estate. Natalie’s basis for the estate is:

A.
$1,000,000.

B.
$7,200,000.

C.
$7,400,000.

D.
$7,600,000.

Answer 58

B.
$7,200,000.

In order to select the alternate valuation date of July 3, the valuation must be lower, resulting in reduced estate tax liability. Since the market value has risen, the value at time of death ($7,200,000) must be selected.

Question 59

When dealing with small corporations, how much stock must a shareholder own for them (shareholder and corporation) to be considered related parties?

A.
More than 5%

B.
More than 25%

C.
More than 45%

D.
More than 50%

Answer 59

D.
More than 50%

A corporation and a shareholder are related parties if the shareholder owns more than 50% by value of the outstanding stock of the corporation.

Question 60

In January Year 3, Brown sold land he had owned for many years on the installment basis. Installments are to be made semi-annually on the first day of March and September. $30,000 of each installment represents Brown’s profit. Brown is in the 33% bracket for Year 15. How much capital gains tax must Brown pay on the two installments he receives in Year 15?

A.
$9,000

B.
$12,000

C.
$19,800

D.
$21,000

Answer 60

A.
$9,000

Since the property sold was held more than 12 months, both installments are taxed at the 15% capital gains rate; thus, the capital gains tax is $9,000 ($60,000 × 0.15).

The current capital gains rates apply to installment sale proceeds collected after the effective date of the current rates even if the installment sale occurred before the effective date of the current rates.

Question 61

Chevy Corp. distributed depreciable personal property having a fair market value of $9,500 to its shareholders. The property had an adjusted basis of $5,000 to the corporation. Chevy had correctly deducted $3,000 in depreciation on the property. What is the amount of Chevy’s total recognized gain on the distribution and how much of this gain will be considered ordinary income?

A.
Total recognized gain: $4,500; Ordinary income: $0

B.
Total recognized gain: $4,500; Ordinary income: $3,000

C.
Total recognized gain: $4,500; Ordinary income: $4,500

D.
Total recognized gain: $9,500; Ordinary income: $0

Answer 61

B. Total recognized gain: $4,500; Ordinary income: $3,000

Fair market value          $9,500
Less: Adjusted basis        5,000
Recognized gain            $4,500
Depreciation recapture
   (ordinary income)       $3,000
When a corporation distributes property other than its own obligations to a shareholder and the property's FMV exceeds the corporation's adjusted basis of that property, the property is treated as sold at the time of distribution. Gain is recognized on the excess of the FMV over the adjusted basis of the property.

Question 62

Nina Co., a calendar-year taxpayer, placed in service office furniture costing $10,000 on February 1, Year 3. Additional office furniture costing $10,000 was placed in service on November 1, Year 3. These were the only assets purchased during the year. Under MACRS depreciation, the appropriate convention and amount is:

A.
mid-quarter $20,000.

B.
mid-quarter $10,000; half-year $10,000.

C.
half-year $20,000.

D.
mid-month $20,000.

Answer 62

A.
mid-quarter $20,000.

Normally the half-year convention applies to depreciate personal property placed in service. However, if more than 40% of the depreciable personal property is acquired in the last quarter of the year, the mid-quarter convention is used for all personal property acquired that year. For Nina Co., 50% of the depreciable assets were acquired in the fourth quarter of the year, triggering the mid-quarter requirement which is then applicable to all assets purchased during the year.

Question 63

Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under IRC Section 1245?

A.
$0

B.
$40,000

C.
$60,000

D.
$100,000

Answer 63

C. $60,000

Step 1: Determine the adjusted basis of the property by subtracting the accumulated depreciation of $60,000 from the purchase price of $160,000. The adjusted basis is $100,000.

Step 2: Determine the realized gain by subtracting the adjusted basis of $100,000 from the sales price of $200,000. The realized gain is $100,000.

Step 3: Determine the character of the realized gain of $100,000. IRC Section 1245 gain, ordinary income, is the lesser of the total realized gain of $100,000 or the total amount of depreciation taken of $60,000. Therefore, the Section 1245 ordinary income is $60,000.

Amount realized $200,000
Less: Adjusted basis
Purchase price $160,000
Less: Accum. depreciation (60,000)
Adjusted basis (100,000)
Realized gain $100,000
Section 1245 ordinary income (lesser of realized gain or depreciation) $ 60,000

Question 64

Simmons gives her child a gift of publicly traded stock with a basis of $40,000 and a fair market value of $30,000. No gift tax is paid. The child subsequently sells the stock for $36,000. What is the child’s recognized gain or loss, if any?

A.
$4,000 loss

B.
No gain or loss

C.
$6,000 gain

D.
$36,000 gain

Answer 64

B.
No gain or loss

Because of the special situation in this gift, neither a gain nor a loss can be computed on the sale of this stock received as a gift. In this situation, the selling price is less than the basis for gain and more than the basis for loss.

Question 65

Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during February of Year 4. No other property was placed into service during the year. What convention must Bent use to determine the depreciation deduction for the alternative minimum tax?

A.
Full-year

B.
Half-year

C.
Mid-quarter

D.
Mid-month

Answer 65

D.
Mid-month

For regular tax depreciation, taxpayers may use MACRS for residential rental property with a 27-1/2-year life and the mid-month convention or ADS using the straight-line method with a 40-year life and the mid-month convention. For alternative minimum tax purposes, however, depreciation is limited to the straight-line method over a period of 27-1/2 years and the mid-month convention. The half-year convention applies to personal property. The mid-quarter convention applies if more than 40% of all personal property is placed in service during the last quarter of the taxpayer’s year.

Question 66

Baker, an unmarried individual, sold a personal residence, which has an adjusted basis of $70,000, for $165,000. Baker owned and lived in the residence for seven years. Selling expenses were $10,000. Four weeks prior to the sale, Baker paid a handyman $1,000 to paint and fix up the residence. What is the amount of Baker’s recognized gain?

A.
$0

B.
$84,000

C.
$85,000

D.
$95,000

Answer 66

A.
$0

If a taxpayer has owned and occupied a personal residence for at least two out of the last five years, $250,000 of a gain may be excluded from income for a single taxpayer. As Baker’s gain does not exceed this amount, the amount of selling expenses and fixing-up costs is irrelevant. Baker’s recognized gain is zero.

Question 67

Alex Barbone inherited his mother’s house when she died in Year 4. The value of the house was $450,000 at the time of death, based on actual sales in the city. Her original basis in the house was $26,000 and she had lived there for 44 years. Alex had not lived in the house except for short visits. Alex paid $6,000 for taxes, insurance, and utilities for the next year. He also was advised by his real estate agent to spend $18,000 on maintenance and repairs, which he did. Unfortunately, the local market suffered a loss of 12% in the average sales price of houses. Alex was finally able to sell the house in Year 5 for $396,000, net of commissions and sales costs. What is the capital loss or gain on the sale of the house?

A.
$100,000 gain

B.
$54,000 loss

C.
$60,000 loss

D.
$78,000 loss

Answer 67

D.
$78,000 loss

The first key to this question is that Alex never lived in the house, meaning it had never been his residence. The second key is that Alex receives the house at the value when his mother died, reported at $450,000. Since he did not live there, the house was the same as a property held for sale or rent. All of the expenses paid by Alex are deductible against the sale of the house. The 12% decline in value meant a difference of $54,000 between the basis Alex received and the price received on sale ($450,000 − $396,000 = $54,000 loss). Additional costs paid in cash by Alex were $6,000 for taxes, insurance, and utilities, and $18,000 for maintenance and repairs. These three items resulted in a loss for tax purposes of $78,000 ($54,000 + $6,000 + $18,000 = $78,000).

Question 68

Property may be sold by a father to a daughter at any price. When is the transaction not allowed to be recognized for tax purposes?

A.
When the sale is for a profit

B.
When the father breaks even on the sale

C.
When the father loses money

D.
All of the answer choices are allowed.

Answer 68

C.
When the father loses money

If the father loses money on a sale to a close relative, the loss may not be recognized until a future date when the property is sold to an outside party.

Question 69

Hall was bequeathed 500 shares of common stock under his father’s will. Hall’s father had paid $2,500 for the stock 10 years ago. Fair market value of the stock on February 1, Year 1, the date of his father’s death, was $4,000 and had increased to $5,500 six months later. The executor of the estate elected the alternate valuation date for estate tax purposes. Hall sold the stock for $4,500 on June 1, Year 1, the date that the executor distributed the stock to him. How much income should Hall include in his individual income tax return for the inheritance of the 500 shares of stock that he received from his father’s estate?

A.
$5,500

B.
$4,000

C.
$2,500

D.
$0

Answer 69

D. $0

If the alternate value is chosen and the property is disposed of before the 6-month period has expired, that property shall be valued at the fair market value at the date of disposition, the sale price. Since Hall sold the stock before the 6-month period ended, his basis equals his sale price, and no gain or loss exists.

Question 70

Dove Corp. began operating a hardware store in the current year after constructing a building at a total cost of $100,000 on land previously acquired for $50,000. In the current year, the land had a fair market value of $60,000. Dove paid real estate taxes of $5,000 in the current year. What is the total depreciable basis of Dove’s business property?

A.
$100,000

B.
$150,000

C.
$155,000

D.
$160,000

Answer 70

A. $100,000

Depreciation is only allowed for property that is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence. Specifically, depreciation does not apply to inventories or stock in trade, or to land.

Dove Corp. began operating a hardware store in the current year after constructing a building at a total cost of $100,000 on land previously acquired for $50,000. The current fair market value of the land is irrelevant. Clearly, the land is not depreciable.

Dove Corp. also paid real estate taxes of $5,000. If they were paid during construction of the building, they would be capitalized as part of the construction cost for tax purposes. However, in this question we have two clues that this is not the intended result. First, the problem states the amount of “total” construction cost. Second, the answers do not give you the option of capitalizing the property taxes. Sometimes it is a process of elimination.

Question 71

Taylor owns 1,000 shares of Media Corporation common stock with a basis of $22,000 and a fair market value of $33,000. Media paid a nontaxable 10% common stock dividend. What is the basis for each share of Media common stock owned by Taylor after receipt of the dividend?

A.
$20

B.
$22

C.
$30

D.
$33

Answer 71

A.
$20

When a taxpayer receives additional stock due to a nontaxable stock dividend, the basis in the original stock must be allocated between the old and new shares.

Taylor owned 1,000 shares of Media Corporation with a basis of $22,000. A 10% nontaxable stock dividend gave Taylor an additional 100 shares of stock for a total of 1,100 shares with a basis of $22,000 and a basis per share of $20 ($22,000 ÷ 1,100 = $20)

Question 72

Zack Zell, single, had adjusted gross income of $50,000 before considering capital gains and losses. Zack had incurred a $4,000 long-term capital loss and also a $5,000 short-term capital loss during the year. What is Zach’s adjusted gross income after considering the capital losses?

A.
$50,000

B.
$47,000

C.
$44,000

D.
$41,000

Answer 72

B.
$47,000

Net capital losses are deductible to arrive at adjusted gross income, but the deduction is limited to $3,000 per year for individuals with the remaining $6,000 carried over to future years.

Question 73

Mel purchased 100 shares of common stock in X Corporation for $1,000. X distributed a nontaxable stock dividend and Mel received 20 shares of preferred stock as a result. On the date of the dividend, the common stock had a value of $19 per share and the preferred had a value of $5 per share. After the distribution of the preferred stock, Mel’s bases for the stock held in X Corporation are:

A.
$1,000 common and $0 preferred.

B.
$950 common and $50 preferred.

C.
$830 common and $170 preferred.

D.
$792 common and $208 preferred.

Answer 73

B.
$950 common and $50 preferred.

Because the stock dividend was nontaxable, the $1,000 original basis of Mel’s common stock must be allocated between the common and preferred shares based on their relative fair market value. Common stock has a value of $1,900 (100 × $19) and preferred has a value of $100 (20 × $5). $1,000 × (1,900 ÷ 2,000) = $950 basis of the common stock. $1,000 × (100 ÷ 2,000) = $50 basis of the preferred stock.

Question 74

Gem Corp. purchased all the assets of a sole proprietorship, including the following intangible assets:

Goodwill $50,000
Covenant not to compete 13,000
For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods?

A.
$63,000

B.
$50,000

C.
$13,000

D.
$0

Answer 74

A.
$63,000

Intangibles are qualifying assets acquired and held in connection with the conduct of a trade or business. These include goodwill, going-concern value, trademarks, and franchises. These intangibles are allowed to be amortized over 15 years. In this example, the goodwill of $50,000 plus the covenant not to compete of $13,000 equals $63,000 subject to amortization.

Question 75

A corporate taxpayer’s capital gains and losses are as follows:

Short-term capital gain $ 7,000
Short-term capital loss (43,000)
Long-term capital gain 9,000
Long-term capital loss 21,000

What amount of capital loss deduction is the taxpayer entitled to use to offset against ordinary income?

A.
$0

B.
$3,000

C.
$12,000

D.
$48,000

Answer 75

A.
$0

All short-term capital gains and losses are netted together and then all long-term capital gains and losses are netted together. Then the short term is netted with the long term.

For this corporate taxpayer, the short-term capital items net to $36,000 capital loss. The long-term items net to $12,000 capital loss. As the taxpayer does not have any capital gains to offset against the capital losses, none of the capital losses may be used to reduce business ordinary income per tax law. The capital losses may be carried back to offset capital gains for three years and forward five years.

Question 76

Dunn received 100 shares of stock as a gift from Dunn’s grandparent. The stock cost Dunn’s grandparent $32,000 and it was worth $27,000 at the time of the transfer to Dunn. Dunn sold the stock for $29,000. What amount of gain or loss should Dunn report from the sale of the stock?

A.
$0

B.
$2,000 gain

C.
$3,000 gain

D.
$3,000 loss

Answer 76

A.
$0

Because of the special situation in this gift, neither a gain nor a loss can be computed on the sale of this stock received as a gift. In this situation, the selling price is less than the basis for gain and more than the basis for loss.

Question 77

Jim Horn, single, purchased a residence on January 5, Year 3, for $50,000. On January 5, Year 4, Jim sold the residence for $300,000 and purchased a new residence on January 15, Year 4, for $320,000 due to a change in place of employment. Jim has a taxable gain on the sale of the residence of:

A.
$125,000.

B.
$230,000.

C.
$250,000.

D.
$0.

Answer 77

A.
$125,000.

Generally, single taxpayers may exclude $250,000 of gain on the sale of a principal residence. If the residence which was sold has not been occupied for at least two years, the $250,000 exclusion is prorated if the sale is due to a change in place of employment, health, or unforeseen circumstances as provided in the regulations. Jim can exclude only $125,000 of the gain since he lived in the residence only one year. Jim has a taxable gain of $125,000 ($300,000 − $50,000 − $125,000).

Question 78

Many family-controlled corporations have stockholders from various branches of the family. Which of the following groups of relatives would not be counted toward the constructive ownership of the biggest shareholder?

A.
His brothers

B.
His sisters

C.
His uncles

D.
His children

Answer 78

C.
His uncles

While ownership held by all of his brothers and sisters and his children would be counted, the holdings of the biggest shareholder’s uncle would not be counted.