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.
