Exam Questions - Tax Flashcards
Exam Tip
Which of the following is a capital asset? a) A copyright on a textbook owned by the author.
b) A painting owned by an art collector.
c) Office furniture used in a business.
d) A note receivable.
Answer: B
A painting owned by an art collector is a capital asset.
Explanation:
A painting owned by an art collector is a capital asset, while one owned by the artist or a copyright held by the author is an ordinary income asset.
Office furniture used in a business is depreciable property used in a trade or business, so it is Section 1231 property rather than a capital asset.
Notes receivable is specifically excluded from being a capital asset under Section 1221.
Pat buys a new machine costing $58,000. She pays freight of $6,000 to get the new machine to her factory. She has also paid an additional 5% of the purchase price for sales tax. She hired a local company to install the equipment and paid them $10,000. What is Pat’s basis in her new machine?
a) $64,000
b) $66,900
c) $74,000
d) $76,900
Answer: D
Pat’s basis in her new machine is equal to the total costs associated with obtaining the machine and installing it in her factory. Therefore, her basis is $76,900 ($58,000 + $6,000 + $2,900 + $10,000).
Aunt Suzie recently died and left her niece, Jean, 1,000 shares of ABC stock. Suzie acquired the stock on December 12, 2023, for $25 per share. Suzie dies February 14, 2024. Assume that Jean sold the stock for $28 per share on February 28, 2024. What is the nature of her gain?
a) Short-term capital gain.
b) Long-term capital gain.
c) Part short-term capital gain, part long-term capital gain.
d) Ordinary income.
Answer: B
The gain on all inherited assets is considered long-term capital gain, regardless of the holding period.
Mike gifted 100 shares of ABC stock to James. Mike (the donor) had a basis in the stock of $40 per share. At the time of the gift, the FMV of each share was $65. What is James’ basis in the 100 shares of stock?
a) $25 per share for a total of $2,500
b) $40 per share for a total of $4,000
c) $65 per share for a total of $6,500
d) $105 per share for a total of $10,500
Answer: B
Under the general rule, James’ basis is equal to the basis of the donor (Mike).
Mike gifted 100 shares of ABC stock to James. Mike (the donor) had a basis in the stock of $40 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $65. If James sells the ABC stock for $90 per share 10 months after the date of the gift, what will his gain or loss be?
a) $2,500 long-term capital gain
b) $2,500 short-term capital gain
c) $5,000 long-term capital gain
d) $9,000 short-term capital gain
Answer: C
James’ basis in the stock is $40 per share for a total basis of $4,000. The total sale price was $9,000 ($90 × 100 shares). Therefore, James’ gain is $5,000 ($9,000 - $4,000). The gain is long-term capital gain because James’ holding period tacks onto that of the donor.
Allison gifted 100 shares of XYZ stock to Joe. Allison (the donor) had a basis in the stock of $55 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $40. What are the tax consequences to Joe if he sells the stock 2 years after the date of the gift for $48 per share?
a) $700 loss
b) $800 gain
c) $1,500 gain
d) No gain or loss
Answer: D
There is no gain or loss because the amount realized from the sale ($4,800) is more than the FMV at the date of the gift ($4,000), but less than the donor’s adjusted basis in the stock ($5,500).
Donna gifted 100 shares of DDD stock to Colin. Donna (the donor) had a basis in the stock of $40 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $65. Donna paid $2,600 in gift tax on the transfer of the shares of stock and the annual exclusion did not apply to this transfer. What is Colin’s basis in the DDD stock?
a) $25 per share or $2,500 total.
b) $40 per share or $4,000 total.
c) $50 per share or $5,000 total.
d) $65 per share or $6,500 total.
Answer: C
Colin gets to add $1,000 to Donna’s basis because Donna paid gift tax on the transfer. Colin’s adjusted basis is calculated as follows:
$4,000 + [(2,600 ÷ 6,500) × 2,600] = $5,000.
Capital Gains on Gifted Property
Brody and Tanya recently sold some land they owned for $150,000. They received the land five years ago as a wedding gift from Brody’s Aunt Jeanette. Aunt Jeanette purchased the land many years ago for $20,000 and at the time of the gift, the property was worth $100,000, and Aunt Jeanette paid $47,000 in gift tax (the annual exclusion did not apply to this transfer). What is the long-term capital gain on the sale of the property?
a) $42,400.
b) $50,000.
c) $92,400.
d) $130,000.
Answer: C
In general, when a donor makes a gift of property other than cash to a donee, the donee will take the property at the donor’s adjusted basis. The gain is calculated as follows:
$20,000 + [(47,000 ÷ 80,000) × 80,000] = $57,600.
The gain on the asset would be $150,000 - $57,600 = $92,400.
Carl and Caroline are getting a divorce. As part of the overall negotiations, Carl agrees to pay Caroline $200 per month and transfer to Caroline the ownership of a second home (not their personal residence) that has a value of $300,000, a mortgage of $140,000, and an adjusted taxable basis of $185,000. They have owned the property for three years. Assuming that they get the divorce and within three months Caroline sells the second home for $310,000, what are her tax consequences?
a) $10,000 STCG; $115,000 LTCG
b) $125,000 LTCG
c) $125,000 STCG
d) No recognized gain due to $250,000 exemption.
e) $10,000 STCG
Answer: B
This is not Section 121 personal residence. The transferee in a divorce takes the basis of the transferor ($185,000) and the holding period tacks on.
Calculation:
$310,000 (sale price)
$185,000 (adjusted taxable basis)
= $125,000 long-term capital gain.
Melanie purchased 100 shares of LawnCare Inc. for $5,000 three years ago. Last week, she sold those shares to her sibling, Isaiah, for $4,200. Isaiah sells the shares today for $4,300. Which of the following best represents Isaiah’s sale?
a) $100 Long-term capital gain
b) $100 Short-term capital gain
c) $700 Short-term capital loss
d) No tax loss or gain
Answer: D
The transferor’s loss is forever lost in a related party transaction. Isaiah takes the shares with the adjusted basis of $4,200, and since the sale price is only $4,300, there is no taxable gain or loss due to the related party rules.
Jack and Jill, who are married filing jointly, purchased a personal residence 18 months ago for $685,000. Jack and Jill sold the residence today for $925,000 and want to know the tax consequences of this transaction. They were required to move because of their employment. How much gain must Jack and Jill recognize this year?
a) $0
b) $240,000
c) $375,000
d) $925,000
Answer: A
Because Jack and Jill sold their house due to employment reasons, they are eligible for a reduced exclusion even though they did not meet the two-year rule. Jack and Jill realized a gain of $240,000 on the sale of their house ($925,000 - $685,000). They are eligible, however, for a reduced exclusion of $375,000 ($500,000 × 18/24). Because their reduced exclusion exceeds their realized gain, they will not have any recognized gain on the sale of their home. They owned and used the house for 18 months out of 24 months; therefore, they have a reduced exclusion equal to 75% of $500,000.
Rufus and Jiya purchased a beachfront residence to rent out for the next year until they retire and move there permanently. The purchase price was $300,000 and rents collected over the rental year totaled $45,000. Upon retirement, they promptly moved into the beach home and lived there for four years before downsizing to be closer to family. If their sales price was $500,000, how much of the gain is taxable?
a) $0
b) $20,000
c) $40,000
d) $200,000
Answer: C
The $40,000 is taxable because that is the appreciation attributable to the non-qualified use period. (1 year of non-qualified use ÷ 5 years of ownership) × ($200,000 of appreciation) = $40,000. Only the qualified use as a principal residence qualifies for the exemption, making the remaining $160,000 nontaxable. The first year they owned the property was for rental use, a non-qualified use for Section 121 gain exclusion.
Bill owns 1,000 shares of KMA stock. He bought it in 1998 for $40,000 ($40.00 per share). The current FMV of the stock is $32,000. Bill sells the KMA stock to his brother Jack Hass for $32,000. Jack sells the KMA stock to Gerry Brennan (a friend) for $38,500 six months later. What are the tax consequences for Bill and Jack?
a) $8,000 LTCL to Bill; $6,500 LTCG to Jack
b) $8,000 LTCL to Bill; $6,500 STCG to Jack
c) No gain or loss to Bill; no gain or loss to Jack
d) No gain or loss to Bill; $3,500 LTCL to Jack
Answer: C
This is really Section 267 in action. A transferor in a Section 267 transaction cannot take a loss. If the FMV is below the transferor’s basis, the transferee’s basis is FMV for losses and the transferor’s basis for gains. In this case, there was no loss for Bill because the loss is disallowed under Section 267. Jack had no gain or loss because he had a dual basis and sold the stock at a price between the gain and loss basis.
Which of the following is not a Section 1231 asset?
a) Copyright owned by an author
b) Timber
c) Coal
d) Same-sex livestock
Answer: A
Copyrights owned by the author of the copyrighted work are not depreciable assets used in a trade or business. Therefore, they are not considered Section 1231 assets.
Roscoe sells equipment used in his business for $18,000. He had originally purchased the equipment for $15,000 and had taken $7,000 of depreciation. What is the Section 1231 gain for Roscoe?
a) $11,000
b) $8,000
c) $7,000
d) $3,000
Answer: D
This is Section 1245 depreciable property used in a trade or business. To determine any Section 1231 gain, the full amount of depreciation must be recaptured as ordinary income. Therefore, only when the sale price exceeds the original purchase price will there be a Section 1231 gain. The calculation is as follows:
$18,000 (sale price) - $8,000 (adjusted taxable basis) = $10,000 (gain).
$10,000 (gain) - $7,000 (Section 1245 recapture) = $3,000 (Section 1231 gain).
In the above question, how much of the gain is taxed as ordinary income?
a) $0
b) $11,000
c) $3,000
d) $7,000
Answer: D
The $7,000 of depreciation is recaptured as ordinary income under Section 1245.
Section 1031 Exchange
Jack and Jill exchange like-kind real estate assets as listed below:
Jack’s Old Asset: FMV $50,000, Adjusted Taxable Basis $23,000
Jill’s Old Asset: FMV $70,000
If Jack pays Jill cash of $20,000 plus Jack’s old asset, how much gain does Jack have to recognize?
a) $0
b) $20,000
c) $23,000
d) $27,000
Answer: A
Jack has exchanged his real estate asset for a more valuable asset. Therefore, Jack recognizes no gain and adds the boot paid ($20,000) to the old basis, continuing to defer the $27,000 of gain.
In the previous problem, what is Jack’s basis in his new asset?
a) $20,000
b) $23,000
c) $27,000
d) $43,000
Answer: D
Jack’s basis is determined by adding the boot that he paid ($20,000) to the basis in his old asset ($23,000) for a total of $43,000.
In the previous problem, assume Jill’s adjusted basis in her old asset was $45,000. How much gain must Jill recognize?
a) $5,000
b) $10,000
c) $15,000
d) $20,000
Answer: D
Recall that the FMV of Jill’s old asset was $70,000. Given that her basis was $45,000, she had $25,000 of deferred gain related to her old asset. Because she received boot of $20,000, she must recognize that amount in gain. Jill still has remaining deferred gain of $5,000 relating to the new asset.
In the previous problem, how much is Jill’s basis in her new asset given that her basis in her old asset was $45,000?
a) $50,000
b) $25,000
c) $20,000
d) $45,000
Answer: D
Jill still has a $45,000 basis in her new asset because she recognized gain on the boot that she received, but she did not receive boot in excess of her deferred gain.
In the previous problem, assume Jill’s basis in the old asset was $55,000. How much gain must Jill recognize on the transaction?
a) $5,000
b) $10,000
c) $15,000
d) $20,000
Answer: C
If Jill’s old asset had an FMV of $70,000 and her basis was $55,000, then she had $15,000 of deferred gain in her old asset. She received $20,000 of boot from Jack, but she is only required to recognize gain on the receipt of boot to the extent of the deferred gain. The excess $5,000 of boot will reduce her basis in the new asset to $50,000.
In the previous problem, what is Jill’s basis in her new asset if her basis in the old asset was $55,000?
a) $50,000
b) $45,000
c) $40,000
d) $35,000
Answer: A
Jill’s basis in her old asset was $55,000 and she had $5,000 of excess boot (over the deferred gain related to the old asset). Therefore, her $55,000 carryover basis is reduced by $5,000, for a basis in the new asset of $50,000.
Section 1033
Boudreaux’s office building was completely demolished by Hurricane Cindy. When the building was destroyed (August 29, YR1), the building had an FMV of $1,000,000 and Boudreaux’s adjusted basis in the building was $450,000. Assuming that Boudreaux’s insurance adjustor determines on February 14, YR2, that Boudreaux should be paid $1,000,000, what is the last date he can reinvest under Section 1033 to avoid recognition of gain?
a) August 29, YR3
b) August 29, YR4
c) December 31, YR3
d) December 31, YR4
Answer: D
Reinvestments under Section 1033 related to natural disasters must be made by the end of the year of realization plus two years. Therefore, Boudreaux must reinvest by December 31, YR4. Realization occurred when the claim was finally determined, which was February 14, YR2.
Section 1033
In the above problem, how much cash must Boudreaux invest in order to avoid recognition?
a) $0
b) $450,000
c) $550,000
d) $1,000,000
Answer: A
There is no requirement to invest cash; however, Boudreaux must replace the destroyed property with property that has a fair market value (FMV) of at least $1,000,000. Therefore, no additional cash investment is required, but the replacement property must be of equal or greater value to avoid recognition of gain.
Section 1035
Which of the following are correct tax-free exchanges?
Life Insurance for Life Insurance
Life Insurance for an Annuity
An Annuity for an Annuity
An Annuity for a Life Insurance Policy
a) 1 only
b) 1 and 2 only
c) 1, 2, and 3 only
d) 1, 2, 3, and 4
Answer: C
The only option that is not a tax-free exchange of like-kind assets under Section 1035 is an annuity exchanged for a life insurance policy. Therefore, exchanges 1, 2, and 3 are valid tax-free exchanges, while 4 is not.
Standard Deduction
Bob and Barbara are married and file a joint tax return. Bob is 68 years old and Barbara is 67 years old. Barbara is legally blind. What is Bob and Barbara’s standard deduction?
a) $29,200
b) $30,750
c) $32,300
d) $33,850
Answer: D
Bob and Barbara are entitled to a standard deduction of $33,850. They are entitled to the basic standard deduction for taxpayers married filing jointly ($29,200), plus one additional deduction for Bob since he is age 65 or older ($1,550), and two additional deductions for Barbara since she is age 65 or older and blind ($1,550 + $1,550).
Taxation of Distributions
On April 30, Ava, age 60, received a distribution from her qualified plan of $150,000. She had an adjusted basis in the plan of $500,000 and the fair market value of the account as of April 30 was $625,000. Calculate the taxable amount of the distribution without regard to any applicable penalty.
a) Not taxable.
b) $30,000 taxable.
c) $120,000 taxable.
d) $150,000 taxable.
Answer: B
To calculate the amount of the distribution that is a return of adjusted basis, the adjusted basis in the plan is divided by the fair market value of the plan as of the day of the distribution. This ratio is then multiplied by the gross distribution amount. As such, $120,000 ($500,000 ÷ $625,000 × $150,000) of the $150,000 distribution is a return of adjusted taxable basis. Accordingly, $30,000 ($150,000 - $120,000) will be subject to income tax.
Taxation of Social Security Benefits
Uli and Violet are married and have $30,000 of income. In addition, they have Social Security benefits of $20,000. What amount of their Social Security benefits must be included in their taxable income?
a) $0
b) $4,000
c) $11,000
d) $20,000
Answer: B
Uli and Violet must include the lesser of:
0.50($20,000) = $10,000, or
0.50 [$30,000 + 0.50($20,000) - $32,000] = $4,000
Therefore, they would have $4,000 of Social Security benefits included in taxable income.
Taxation of Social Security Benefits
Yanni and Zelda, a married couple, have income of $45,000 and Social Security benefits of $20,000. What amount of their Social Security benefits must be included in their taxable income?
a) $9,350
b) $11,500
c) $15,350
d) $17,000
Answer: C
Yanni and Zelda must include the lesser of:
0.85($20,000) = $17,000, or
0.85($45,000 + $10,000 - $44,000) = $9,350 plus the lesser of:
$6,000, or
0.50($45,000 + $10,000 - $32,000) = $11,500
Therefore, Yanni and Zelda must include $15,350 ($9,350 + $6,000) of their Social Security benefits in their taxable income.
Aidan loans $11,000 to his sister, Avril. Why would interest not be imputed on this loan?
a) Interest would not be imputed because the loan is less than the amount of the annual exclusion.
b) Interest would not be imputed because loans of $100,000 or less are exempt from both income tax and gift tax consequences.
c) Interest would not be imputed if Avril has unearned income of $500.
d) Interest would not be imputed if Avril’s earned income is less than $1,000.
Answer: C
Interest is not imputed because whether interest is imputed on this loan is based on Avril’s level of unearned income, not earned income. Loans of less than $10,000 are exempt from both income tax and gift tax consequences.
Sally is awarded $75,000 in compensatory damages for harm to her reputation. In addition, she was awarded $200,000 in punitive damages. How much of these awards must Sally recognize in income?
a) $0
b) $75,000
c) $200,000
d) $275,000
Answer: D
Only compensatory damages for bodily injury are excludable from gross income. Compensatory damages without bodily injury are includable, as are punitive damages. Therefore, Sally must recognize $275,000 in income.
David invests in a limited partnership and pays $250,000 for a 10% interest in the partnership. David receives a K-1 showing his proportional share of losses as $75,000. This is his only investment. How much of the loss is suspended under the at-risk rules?
a) $0
b) $75,000
c) $175,000
d) $250,000
Answer: A
David has $250,000 at risk. Therefore, he is not required to suspend any of his share of the partnership’s losses under the at-risk rules.
Continuing with the previous question, how much of the loss is suspended under the passive activity rules?
a) $0
b) $75,000
c) $175,000
d) $250,000
Answer: B
David’s losses will be suspended under passive activity rules because he has no passive activity gains to offset.
Anna has a salary of $50,000 and two investments, Limited Partnership Investment A and B. She does not materially participate in either investment. Her basis in the partnerships is: LLPA - $50,000; LLP B - $25,000.
LLP A had a $75,000 gain in the current year and LLP B had a $100,000 loss. What is the net gain or loss for the two investments that will be recognized on the current tax return?
a) $3,000 loss
b) $25,000 loss
c) $0 gain or loss
d) $50,000 gain
Answer: D
The investments are passive activities. Therefore, the loss is limited to the at-risk amount and netted against passive activity income. LLP B’s loss is limited to $25,000, and the net gain will be $50,000 ($75,000 - $25,000).
Christian has the following investments:
Publicly traded Limited Partnership A - $10,000 loss
Publicly traded Limited Partnership B - $15,000 gain
Nonpublicly traded Limited Partnership - $22,000 loss
Nonpublicly traded partnership - $16,000 gain
Christian does not materially participate in these investments. Assuming Christian has the appropriate amount at risk to take any necessary losses, what is the total suspended loss for the current year?
a) $1,000 suspended loss
b) $6,000 suspended loss
c) $10,000 suspended loss
d) $16,000 suspended loss
Answer: D
The nonpublicly traded partnerships can be netted together, leaving a suspended loss of $6,000. The publicly traded partnerships cannot be netted, so the $10,000 loss for Partnership A is suspended, resulting in a total suspended loss of $16,000.
John filed his tax return on April 15. At that time, he owed $900 on a total tax liability of $10,000, and he submitted a check for $900 with his tax return. Which of the following penalties will apply to John?
a) Failure to file.
b) Failure to pay.
c) Underpayment of estimated tax.
d) None of the above.
Answer: D
John paid 90% of his tax liability when he filed his return, so he paid over 90% of his tax liability. Therefore, no underpayment penalty applies.
At the beginning of the current year, Ellie’s basis in her LLP interest was $150,000. At the end of the year, Ellie received a K-1 from the partnership that showed the following:
Cash withdrawal of $30,000
LLP income of $17,500
Dividend income of $5,000
Short-term capital loss of $1,400
Charitable contributions of $2,900
What is Ellie’s basis in her LLP interest at the beginning of the next year?
a) $31,400
b) $76,400
c) $138,200
d) $150,000
Answer: C
Ellie’s basis is $138,200. Her basis increases by the LLP income of $17,500 and the dividend income of $5,000. It is reduced by the cash withdrawal, short-term capital loss, and charitable contributions. Therefore, her basis is $138,200 ($150,000 + $17,500 + $5,000 - $30,000 - $1,400 - $2,900).
Hee Company (a C corporation) owns 15% of Haw Company. During the year, Haw Company paid a $45,000 dividend to Hee Company. Assuming that Hee Company does not receive dividends from any other corporation, how much will Hee Company’s dividends-received deduction be?
a) $6,750
b) $22,500
c) $36,000
d) $45,000
Answer: B
Hee will include the $45,000 of dividend income in its gross income but is entitled to a dividends-received deduction of 50%, equating to $22,500 ($45,000 × 50%).
During the year, Susan purchased 24 shares of an S corporation’s 200 shares of common stock outstanding. She held the shares for 219 days during the taxable year. If the S corporation reported taxable income of $300,000, what must Susan include on her personal income tax return?
a) $21,600
b) $36,000
c) $43,200
d) $72,000
Answer: A
Susan must include $21,600 on Schedule E of her personal income tax return. She held a 12% interest in the corporation for 219 days during the year. The calculation is: $300,000 × (24 ÷ 200) × (219 ÷ 365) = $21,600.
Question 1:
Which of the following entities provides limited liability for all owners?
Limited Partnership
Corporation
S corporation
a) 3 only
b) 1 and 2 only
c) 2 and 3 only
d) 1, 2, and 3
Answer: C
Limited partnerships only provide limited liability for limited partners, whereas corporations and S corporations provide limited liability for all owners.
Allison is a doctor who is investing in a new business that she expects to experience losses in the first year. Allison is concerned about protecting her personal assets. Which entity would you recommend?
a) Sole proprietorship
b) S corporation
c) C corporation
d) Partnership
Answer: B
An S corporation provides flow-through accounting so she can offset ordinary income with business losses while also protecting her personal assets.
Pat owns 100% of PH, Inc. PH, Inc. owns 80% of RM, Inc. RM, Inc. pays dividends. Which of the following entities would benefit the most from RM’s dividend payments?
a) S corporation
b) C corporation
c) Sole proprietorship
d) LLC
Answer: B
C corporations are entitled to a dividends-received deduction of 100% if they own 80% or more of the company paying the dividend.
