Module 6 Tax Consequences of Property Transactions Flashcards

Question

Which of the following statements is CORRECT regarding the use of the installment sale method of accounting for income tax purposes? A) It may be used only if the payments are to be received over at least a two-year period. B) The installment sale method is available for use by most dealers. C) A taxpayer may not avoid the use of the installment sale method if there is an installment sale. D) Any cost recovery recapture is recognized in the year of the installment sale.

Answer 1

d A requirement of the installment sale method is that any cost recovery recapture be recognized (taxed) in the year of the sale. Only the remaining gain (the gain in excess of the cost recovery recapture) is eligible for installment reporting. An installment sale is a sale in which a payment on the purchase price is received in a year later than the year of sale. It is possible for the taxpayer to affirmatively elect out of installment sale treatment by making an election when filing the tax return for the year of sale. The use of the installment sale method is not available for sales of property by dealers; dealers are required to recognize all gain from an installment sale in the year of sale, except for sales of farm property, certain timeshares, and residential lots. LO 6.2.4

Answer 2

b Eric would recognize a capital gain of $30,000 in the year of sale, calculated as follows: Gross profit percentage (60%) = profit ($300,000) ÷ total contract price ($500,000). Gain recognized ($30,000) = gross profit percentage (60%) × installment payment ($50,000). LO 6.2.4b

Answer 3

b Gain realized equals $80,000, and gain recognized equals $10,000 ($200,000 amount realized − $190,000 amount reinvested). This is a net postponed gain of $70,000 ($80,000 − $10,000). The basis of the new building equals $120,000 ($190,000 − $70,000). LO 6.2.3

Answer 4

b The cost of the duplex of $79,500 is increased by the capitalized costs (i.e., $800 for the attorney's fees and $7,500 for improvements). This amount would be reduced by the cost recovery deduction of $3,000, leaving an adjusted basis of $84,800. The repairs of $1,900 represent a current deduction and therefore do not impact the basis of the property. LO 6.1.2

Answer 5

All of these statements are correct. LO 6.2.4

Answer 6

a The short-term capital loss is first used to offset the collectibles gain of $6,200. This leaves a short-term capital loss of $6,800. This is next used to offset the 25% gain. The $17,000 is offset by the $6,800 remaining capital loss. This leaves $10,200 of unrecaptured Section 1250 income, taxed at a maximum 25% rate. This is the most favorable manner of offsetting the capital losses against the capital gains. LO 6.1.4

Answer 7

b Straight-line depreciation is the simplest form of depreciation. LO 6.1.3

Answer 8

a When using the specific identification method of computing basis in the sale of mutual fund shares, it is necessary to identify the shares being sold based on their purchase date. The documented basis of those shares is then used to compute the gain (or loss) realized. LO 6.2.1

Answer 9

d Remember that the commission paid reduces the gain realized. The gain realized from the sale is $300,000 ($380,000 sale price, reduced by the $20,000 commission and the basis of $60,000). After subtracting the $250,000 Section 121 exclusion, the gain recognized is $50,000. LO 6.2.5

Answer 10

a An exchange of an apartment building for commercial rental property may be a like-kind exchange. As long as qualifying real property (property used in a trade or business or held for investment purposes) is exchanged for qualifying real property, the exchange is like-kind. LO 6.2.2

Answer 11

d When the taxpayer has a net Section 1231 gain for the year, the lookback rule may recapture some or all of the net gain as ordinary income. To the extent the lookback rule does not apply, the net gain is treated as a long-term capital gain. When determining how much of the gain is treated as capital gain and how much must be treated as ordinary gain, the taxpayer is looking back to the five previous taxable years, not including the current taxable year. LO 6.1.4

Answer 12

c The current Section 1231 gain ($11,000) is treated as ordinary income to the extent of unrecaptured Section 1231 losses during the five-year lookback period. There are $4,000 of unrecaptured Section 1231 losses during the lookback period. Thus, $4,000 is ordinary income, and the remaining $7,000 is treated as long-term capital gain. LO 6.1.4

Answer 13

c The Section 1231 lookback rule only applies if there are current-year net Section 1231 gains and unrecaptured Section 1231 losses during the five-year lookback period. In this case, there are current-year Section 1231 losses. The general rule is that Section 1231 losses are treated as ordinary losses. LO 6.1.4

Answer 14

c Section 1231 gains $29,000 Less Section 1231 losses (8,000) Net Section 1231 gain $21,000 Lesser of: (a) Unrecaptured net Section 1231 losses claimed during the lookback period $12,000 (b) Current year's net Section 1231 gain $21,000 Current year's net Section 1231 gain required to be characterized as ordinary income $12,000 The remaining gain of $9,000 is treated as long-term capital gain. In a Section 1231 lookback situation, there is ordinary income to the extent of the unrecaptured Section 1231 losses during the five-year lookback period. Any remaining gain is treated as long-term capital gain. LO 6.1.4

Answer 15

a The deductible casualty loss computation begins with the lesser of the decrease in fair market value or the adjusted basis in the property. In this situation, the decrease in fair market value of $65,000 must be reduced by the insurance recovery of $25,000 and by the $100 floor. This is further reduced by 10% of the adjusted gross income. Thus, $65,000 reduced by the insurance of $25,000, reduced by the $100 floor per occurrence, and further reduced by $20,000 equals $19,900. LO 6.2.3

Answer 16

a Under the MACRS, real estate is depreciated using the straight-line method, with a mid-month convention, while personalty is generally subject to a 200% declining balance method, with a half-year convention. Note that the taxpayer may elect the straight-line method for personalty. The MACRS system applies for all property placed in service after 1986. LO 6.1.3

Answer 17

a Explanation Sale price $408,000 Selling expenses ($23,000) Total amount realized $385,000 Less adjusted basis ($70,000) Gain realized $315,000 Gain recognized: Gain realized $315,000 Less allowable exclusion ($187,500) Gain recognized $127,500 The allowable exclusion is the full exclusion of $250,000 multiplied by 75%—18 months of use divided by the 24-month requirement. The basis is the $50,000, increased by the improvement of $20,000. The donor's basis is used as the carryover basis. The gain recognized is the amount of gain that is subject to tax. LO 6.2.5

Answer 18

d A casualty loss deduction is treated as an itemized deduction, not a deduction for AGI. It is not deductible in arriving at the adjusted gross income. LO 6.2.3

Answer 19

c The gain realized and recognized is the difference between the $12,000 amount realized from the sale, reduced by the adjusted basis of $3,926. Thus, the total gain is $8,074. The Section 1245 cost recovery recapture is the lesser of the cost recovery deductions taken ($7,074) or the gain realized ($8,074). Thus, the Section 1245 recapture is $7,074. The remaining $1,000 of gain is attributable to actual appreciation of the asset; therefore, there is $1,000 of Section 1231 gain. The Section 1245 income is treated as ordinary income, while the Section 1231 income generally receives long-term capital gain treatment. For Section 1245 property, it makes no difference whether straight-line or accelerated depreciation were used. LO 6.1.4

Answer 20

a The basis of property acquired by inheritance where the administrator elects the alternate valuation date is the fair market value on that alternate valuation date. Thus, in this situation, the fair market value of $10 as of the alternate valuation date would be Frank's basis in the inherited property. LO 6.1.1a

Answer 21

a The gain realized is $604,000. This is the difference between the sales price of the residence—$916,000—and the basis of $312,000. They lived in the new home for only 19 months before the old home sold. Thus, for the previous home, they meet the two-out-of-five-year rule allowing for up to a $500,000 exclusion of gain on the sale of a principal residence under Section 121. The realized gain of $604,000, reduced by the $500,000 exclusion, leaves a gain recognized (subject to tax) of $104,000. LO 6.2.5

Answer 22

d The cost of the condominium of $165,000 is increased by the capitalized costs. The capitalized costs would include $1,800 for the attorney's fees and $6,500 for improvements. Even if the $6,500 for wiring and patio replacement were considered repairs, they would be capitalized in this situation because they were incurred before placing the property in service (making it available to rent).This amount would be reduced by the cost recovery deductions of $24,600, to leave an adjusted basis of $148,700. The repairs of $2,200 represent a current deduction and therefore do not impact the basis of the property. LO 6.1.2

Answer 23

b The $200,000 cost is increased by the capitalized costs: legal fees of $5,000 and improvements of $10,000. The cost recovery deductions reduce the adjusted basis to $180,000. The property taxes, utilities, and interest are currently deductible items and therefore do not affect basis. LO 6.1.2

Answer 24

a The profit on the sale of $17,000 divided by the $22,000 contract price equals a 77.27% gross profit percentage. This is multiplied by the $6,000 of payments received during the year to calculate the amount of gain recognized ($4,636): $ 17,000 profit $ 22,000 contract price = 77.27 % × $ 6,000 payments = $ 4,636 recognized LO 6.2.4

Answer 25

d Under the installment sale method, immediate recognition of remaining gain occurs with the following: At the time an installment sale is canceled When there is a gift of an installment sale to the obligor-debtor when there is a sale of the installment note to another party when an installment note is pledged as collateral for a loan If an installment obligation is canceled, it is treated as a disposition. To discourage sham transactions between related parties, when an installment sale is canceled, gain is immediately recognized. LO 6.2.4

Answer 26

d The $200,000 cost is increased by the capitalized costs: legal fees of $5,000 and improvements of $10,000. The cost recovery deductions reduce the adjusted basis to $180,000. The property taxes, utilities, and interest are currently deductible items and therefore do not affect basis. LO 6.1.2

Answer 27

c The cost basis of the property, $12,000, would be reduced by the cost recovery deductions taken ($7,392). This leaves an adjusted basis of $4,608. When the property subsequently sold for $13,000, the difference between the sales price ($13,000) and the adjusted basis of $4,608 was the gain realized ($8,392). The recapture is the lesser of the gain realized ($8,392) or the cost recovery deductions taken ($7,392). The remaining $1,000 gain is Section 1231 gain. LO 6.1.3

Answer 28

b When the fair market value on the date of the gift is less than the donor's basis in the asset, the donee's basis in the asset for purposes of determining a loss is the asset's fair market value on the date of the gift. In this situation, the $8 per share value on the date of the gift would be Jeff's basis. LO 6.1.2

Answer 29

a The individual casualty loss deduction, an itemized deduction, is based on the lesser of the decrease in FMV or the adjusted basis of the asset. This amount is then reduced by insurance coverage, a $100 floor per occurrence, and 10% of AGI. Remember that the casualty loss deduction is allowed only for damage sustained in a federally declared disaster area. LO 6.2.3

Answer 30

c In the exchange, Dave received new equipment with a fair market value of $60,000 and cash of $15,000. He gave up an adjusted basis in his property of $10,000. The difference between $75,000 and $10,000 is the gain realized, $65,000. Because this is not realty, it is not eligible for 1031 exchange treatment. Thus, the transaction is treated as a sale and subsequent purchase. The entire gain of $65,000 is recognized and taxable. LO 6.2.2

Answer 31

a The Section 179 deduction is subject to a taxable (earned) income limitation. However, for this purpose, wages received (even from a completely unrelated source) are considered to be from the active conduct of a trade or business. With only $220,000 of earned income, only $220,000 may be deducted under Section 179. The maximum Section 179 deduction is $1.16 million (2023), and the property placed in service limitation was increased to $2.89 million. LO 6.1.5

Answer 32

d The adjusted basis is the original cost basis of $130,000 (including the legal fees and improvements that must be capitalized) reduced by the cost recovery deductions. The property taxes paid are a current deduction and thus do not impact the adjusted basis. LO 6.1.2

Answer 33

a In September, Eric purchased a new computer for use in his business. The cost of the computer was $4,300, while freight and setup charges totaled $600. Assume that Eric opts out of the bonus depreciation provision. What is the cost recovery deduction using the Modified Accelerated Cost Recovery System (MACRS)? A) $980 B) $790 C) $430 D) $490

Answer 34

c Bradley, Inc., sold some land on June 30 of the current year for a $15,000 gain. The land was originally purchased three years ago and was classified as a Section 1231 asset. This was the only asset sale for this year. In the previous year, Bradley, Inc., had an $8,000 net Section 1231 loss. For the current year, Bradley's net Section 1231 gain is treated as A) a $15,000 ordinary gain. B) a $8,000 long-term capital gain and a $7,000 ordinary loss. C) a $7,000 long-term capital gain and a $8,000 ordinary gain. D) a $15,000 ordinary loss.

Answer 35

d In this situation, there is a gain realized of $292,000. Since Caley used the residence as a principal residence for two of the preceding five years, she qualifies for the full Section 121 exclusion of $250,000. This leaves the $42,000 of gain resulting from depreciation deductions as the taxable gain. LO 6.2.5

Answer 36

c They may exclude the full gain from the residence under the Section 121 rules. They have owned and lived in the residence for at least two of the five previous years. Making a like-kind exchange of their house for the single-family home to defer any gain is incorrect because the like-kind exchange rules do not allow for an exchange of personal use property. Renting their house now and selling it when they are both age 55 so that the gain will be excluded is incorrect because of the two years out of five years ownership and use rule. Selling their house through an installment sale to defer any gain., although a possibility, is not as beneficial from a tax standpoint because the gain realized would be recognized over a period of years. The purchase of the new residence is irrelevant under Section 121. LO 6.2.4

Answer 37

d Neither statement is correct. In the functional use test, the taxpayer's use of the replacement property and of the involuntarily converted property must be the same. In the taxpayer use test, the owner-investor's properties must be used in similar endeavors as the previously held properties. LO 6.2.3

Answer 38

c Because Julio owned all of the shares for more than one year, his holding period is long term. He has a $2,000 LTCG ($19,000 – $17,000). LO 6.2.1

Answer 39

b The maximum Section 179 expense is $1.16 million for 2023. This leaves $115,000 of remaining basis that is subject to depreciation, $115,000 times 14.29% equals $16,434. The Section 179 expense of $1.16 million combined with the $16,434 equals $1,176,434. (The MACRS table will be provided on the end-of-course exam.) LO 6.1.5

Answer 40

d Of the current year's $11,000 Section 1231 gain, $7,000 is treated as ordinary income. This is due to the $7,000 of unrecaptured Section 1231 losses during the five-year lookback period. The remaining $4,000 of current Section 1231 gain is treated as long-term capital gain. LO 6.1.4

Answer 41

b The long-term items (ABC and GHI) are netted, leaving a long-term capital gain of $4,800. The short-term items (DEF and LMN) are netted, leaving a short-term capital loss of $2,200. These are netted, leaving a net long-term capital gain of $2,600. LO 6.2.1

Answer 42

b Calculate Georgina's realized gain or loss: FMV of property received ($200,000) and boot (cash—$100,000) received $300,000 Less adjusted basis of property given ($105,000) ($105,000) Realized gain or loss $195,000 Calculate Georgina's recognized gain or loss: Lesser of realized gain ($195,000) or boot received ($100,000 cash) $100,000 Calculate gain realized but not recognized: Gain realized $195,000 Less gain recognized (100,000) Gain realized but not recognized $95,000 Calculate the substituted basis in the acquired asset: FMV of qualifying property received $200,000 Less gain realized but not recognized (95,000) Substituted basis in property received $105,000 LO 6.2.2

Answer 43

d Remember that the commission paid reduces the gain realized. The gain realized from the sale is $300,000 ($380,000 sale price, reduced by the $20,000 commission and the basis of $60,000). After subtracting the $250,000 Section 121 exclusion, the gain recognized is $50,000. LO 6.2.5

Answer 44

a The cost of the condominium of $165,000 is increased by the capitalized costs. The capitalized costs would include $1,800 for the attorney's fees and $6,500 for improvements. Even if the $6,500 for wiring and patio replacement were considered repairs, they would be capitalized in this situation because they were incurred before placing the property in service (making it available to rent).This amount would be reduced by the cost recovery deductions of $24,600, to leave an adjusted basis of $148,700. The repairs of $2,200 represent a current deduction and therefore do not impact the basis of the property. LO 6.1.2

Answer 45

b In a like-kind exchange, the gain recognized is always the lesser of the gain realized or the boot received. If there is no boot received, there is no gain recognized. Personalty (equipment, for example) is no longer eligible for like-kind exchange treatment as a result of TCJA, thus gain would be recognized. The basis in the acquired property is the FMV of the acquired property, reduced by the gain realized but not recognized (the deferred gain). LO 6.2.2

Answer 46

d The basis of property acquired by inheritance where the administrator elects the alternate valuation date is the fair market value on that alternate valuation date. Thus, in this situation, the fair market value of $10 as of the alternate valuation date would be Frank's basis in the inherited property. LO 6.1.1

Answer 47

b A casual sale of an asset does qualify for installment sale treatment. An installment sale is a sale in which a payment will be received in a year later than the installment sale. In this situation, there would be no gain recognized in the current year, and all gain would be recognized next year when Mike receives the payment for the auto. The installment method of accounting cannot however be used to report the sale of inventory, such as car dealerships. LO 6.2.4

Answer 48

c Jimmy owns an apartment building in Cleveland. He would like to exchange his apartment building for another asset in a like-kind exchange. Which of the following assets could Jimmy receive to qualify for like-kind exchange treatment? A) Residential rental property in Mexico B) A piece of manufacturing equipment for his business C) Commercial rental property in Detroit D) A residence in which he will live

Answer 49

c The $25,000 cost is increased by the capitalized cost (the sales tax) of $1,250. The payment of a personal property tax has no impact on the basis. LO 6.1.2

Answer 50

b On June 1, 2023, Hugh and Justine, both age 45, moved into a new house with a purchase price of $380,000. Hugh and Justine sold their previous home in January 2023. Their previous home sold for $650,000. Their basis in their old home was $305,000. They had lived in the old home for eight years. How much gain, if any, must Hugh and Justine recognize for tax purposes as a result of this sale? A) $270,000 B) $0 C) $345,000 D) $20,000

Answer 51

d Under the installment sale method, immediate recognition of remaining gain occurs with the following: At the time an installment sale is canceled When there is a gift of an installment sale to the obligor-debtor when there is a sale of the installment note to another party when an installment note is pledged as collateral for a loan If an installment obligation is canceled, it is treated as a disposition. To discourage sham transactions between related parties, when an installment sale is canceled, gain is immediately recognized. LO 6.2.4

Answer 52

c If the amount reinvested in the replacement property equals or exceeds the amount realized, the realized gain is not recognized. Normally, the taxpayer has two years from the end of the taxable year in which any gain is realized from an involuntary conversion (e.g., theft) to replace the property. However, if a condemnation of real property by a governmental authority is the reason for the conversion, this period is extended to three years from the end of the taxable year in which any gain is realized. Because this was a personal use item, Marcus will apply the functional-use test, not the taxpayer-use test. LO 6.2.3

Answer 53

c An installment sale is any sale of property in which the seller will receive at least one payment after the close of the tax year in which the sale occurs. An installment sale allows the taxpayer to spread out the gain as the payments are received. LO 6.2.4

Answer 54

d Explanation $127,500 is the correct answer, and is computed as follows. Note: We use the donor's basis of $50,000 as Susan's basis, because the fair market value on the date of the gift was greater than the donor's basis. The $50,000 was increased by the $20,000 of improvements to equal the $70,000 basis. Gain realized: Amount realized: Sale price $408,000 Less selling expenses (23,000) Total amount realized $385,000 Less adjusted basis (70,000) Gain realized $315,000 Gain recognized: Gain realized $315,000 Less allowable exclusion (187,500) Gain recognized $127,500 The allowable exclusion is the full exclusion of $250,000 multiplied by 75%—18 months of use divided by the 24-month requirement. LO 6.2.5

Answer 55

b The long-term items are netted, leaving a long-term capital gain of $4,700. The short-term items are netted, leaving a short-term capital loss of $1,700. The long-term capital gain is netted with the short-term capital loss to result in a net long-term capital gain of $3,000. LO 6.2.1

Answer 56

c Long-term transactions are netted together, as are short-term transactions. The long-term capital loss is $400 ($3,600 – $3,200). The short-term capital gain is $1,100 ($4,500 – $3,400). The short-term capital gain is netted with the long-term capital loss ($1,100 – $400) to result in a net short-term capital gain of $700. LO 6.2.1

Answer 57

c When the fair market value on the date of the gift is less than the donor's basis in the asset, the donee's basis in the asset for purposes of determining a loss is the asset's fair market value on the date of the gift. In this situation, the $8-per-share value on the date of the gift would be Laci's basis. When the stock sold at $6 per share, this was a $2-per-share loss. When the recipient of the gift takes the FMV on the date of the gift as her basis, there is no tacking of the holding period. The holding period begins on the day the asset is received. LO 6.1.1

Answer 58

Both statements are correct. LO 6.2.3

Answer 59

c The Section 179 expense is first limited by the amount of qualifying property placed in service during the tax year. To the extent that the taxpayer purchases and places into service more than $2.89 million (2023) of qualifying property during the tax year, the benefit of the Section 179 election is reduced on a dollar-for-dollar basis. In this situation, Stanton placed an excess $150,000 of property into service. This reduces the maximum election from $1.16 million to $1.01 million—this is the maximum Section 179 expense of $1.16 million reduced by the dollar amount of property placed into service in excess of $2.89 million. The Section 179 expense election is then limited to the taxpayer's taxable, or earned, income. Because the business is a sole proprietorship, for purposes of Section 179, salary or wages received as an employee are considered to be from the active conduct of a trade or business. Thus, the total earned income in this situation is $415,000. The maximum Section 179 expense election is $1.01 million, but for Stanton, the current year deduction is limited to his earned income of $415,000. LO 6.1.5

Answer 60

d The answer is computed as follows: Gain realized: Amount realized: Sale price $501,000 Selling expenses (31,000) Total amount realized $470,000 Less adjusted basis (80,000) Gain realized $390,000 Note that the repairs do not impact the basis in the residence. Also, the mortgage assumption by the buyer is part of the sales price. LO 6.1.2

Answer 61

c Only realty is eligible for like-kind exchange tax treatment. Thus, Dave is deemed to have sold his equipment for $75,000 and purchased the new equipment for $75,000. LO 6.2.2

Answer 62

a Fay can apply her short-term capital loss carryover to all current short-term gains. She has a net short-term gain for the year of $1,000 ($6,000 gain − $5,000 carryover). Her net long-term loss is $35,000 ($5,000 gain − $40,000 carryover). To calculate net capital gains for the year, aggregate the long-term and short-term gains and losses, which is $35,000 long-term loss − $1,000 short-term gain, equaling $34,000 net capital loss. Taxpayers may reduce their ordinary income by $3,000 each year for capital losses ($1,500 if married filing separately). Therefore, Fay's adjusted gross income will be $91,000 ($94,000 − $3,000). LO 6.2.1

Answer 63

a To calculate the net capital gain/loss for the year, the taxpayer aggregates all short-term and long-term capital gains and/or losses. In this scenario, the overall net capital loss for the year is $2,000. When the result is a net capital loss, the taxpayer can apply up to $3,000 of the loss (per year) against ordinary income ($1,500, if married filing separately). LO 6.2.1

Answer 64

b There is $114,000 of unrecaptured Section 1250 income, creating 25% long-term capital gain; and $100,000 of regular long-term capital gain (at taxable income of $190,000, it is 15% rate). Calculate the gain realized and recognized: Amount realized $400,000 Less adjusted basis (186,000) Gain realized and recognized $214,000 Calculate the unrecaptured Section 1250 (25% LTCG) income: Lesser of: (a) Straight-line depreciation taken $114,000 (b) Gain realized and recognized $214,000 Lesser of these two amounts $114,000 Calculate the regular long-term capital gain: Gain recognized $214,000 Less unrecaptured Section 1250 income (25% long-term capital gain) (114,000) Regular long-term capital gain $100,000 In this example, we have total gain recognized (Section 1231 gain) of $214,000, comprised of $114,000 of unrecaptured Section 1250 income and taxed at a maximum rate of 25%, and $100,000 of regular long-term capital gain, eligible for the maximum 15% or 20% long-term capital gain rates. The gain created by the straight-line depreciation on realty is unrecaptured Section 1250 income, subject to a maximum rate of 25%. The gain created by actual appreciation of the asset is regular long-term capital gain under Section 1231.

Answer 65

d The entire gain of $109,000 is treated as Section 1231 gain. $75,000 of the gain is created by the cost recovery deductions, and is subject to a maximum rate of 25% as unrecaptured Section 1250 income. The remaining $34,000 of gain is created by actual appreciation of the duplex, and is subject to the regular long-term capital gain rate of 15%. LO 6.1.4

Answer 66

a In an installment sale, any cost recovery recapture, $10,000 in this situation, is recognized in the year of disposition. All gain in this situation is cost recovery recapture. Remember that with Section 1245 property (predominantly personalty), it does not matter whether straight-line, Section 179, or accelerated depreciation was used. All depreciation is subject to recapture as ordinary income. In this scenario, all future payments received are essentially tax free because all $10,000 of gain has been recognized in the year of disposition. LO 6.2.4

Answer 67

a The freight and setup charges of $600 must be capitalized (i.e., added to the cost of the computer) to give a total basis of $4,900. The straight-line rate for five-year property is 20% (100% divided by 5), but the half-year convention limits the deduction to 50% in the year of acquisition. Thus, $4,900 times 10% equals $490. Note that bonus depreciation is not used, as the fact pattern states to use straight-line. LO 6.1.3

Answer 68

d Because this is not loss property, a portion of the gift tax paid out of pocket by the donor can be added to the donor's basis of $45,000 to compute the basis in the hands of the donee. The percentage of the gift tax paid that can be added to the basis is the unrealized appreciation divided by the fair market value of the asset at the time of gift reduced by the gift tax annual exclusion taken. This percentage is multiplied by the gift tax paid out of pocket. In this situation, the appreciation of $55,000 is divided by the taxable value of the gift ($83,000—the $100,000 FMV reduced by the gift tax annual exclusion of $17,000 in 2023) to give us 66.27%. This percentage is multiplied by the gift tax paid of $41,000 to equal $27,168. This is added to the original basis of $45,000 to give us $72,169. The formula is shown as follows: donor's basis + appreciation FMV − gift tax exclusion × gift tax paid = donee's basis LO 6.1.2

Answer 69

b The building is not personal use property. Because the building is used in her manufacturing business, it is property used in a trade or business. However, property held for the production of income generally involves a lower level of activity than does property used in a trade or business. As part of a business, this building would not be property held for the production of income. LO 6.1.1

Answer 70

b The Section 179 deduction is subject to a taxable (earned) income limitation. Because the business is a sole proprietorship, wages received (even from a completely unrelated source) are considered to be from the active conduct of a trade or business. With only $20,000 of earned income, only $20,000 may be used. LO 6.1.5

Answer 71

d The maximum Section 179 election amount available to VUE Corp. is $25,000. The election is limited to the lesser of the cost of the asset, the amount of business taxable income, or the annual Section 179 election amount for 2023 ($1,160,000). LO 6.1.5

Answer 72

c Explanation Section 1231 gains $8,000 Less Section 1231 losses (1,000) Current year net Section 1231 gain $7,000 Lesser of: (a) Unrecaptured net Section 1231 losses claimed during the lookback period $2,000 (b) Current year's net Section 1231 gain $7,000 Current year's net Section 1231 gain characterized as ordinary income $2,000 LO 6.1.4

Answer 73

c The basis of property acquired by inheritance is simply the fair market value on the date of the decedent's death. In this case, that value was $9 per share. LO 6.1.2

Answer 74

b Any cost associated with the acquisition of an asset must be capitalized. This would include both the shipping and the taxes. LO 6.1.1

Answer 75

a The net debt relief is considered to be boot, as is the cash received. The net debt relief of $11,000 plus the cash received of $7,000 equals $18,000. LO 6.2.2

Answer 76

c The long-term capital gain rate for collectibles is 28% if the taxpayer is in a marginal income tax bracket greater than 28%. John's taxable income places him in the 35% marginal income tax bracket, so his collectibles gain is taxed at 28%. LO 6.1.1

Answer 77

c The cost of $14,200 is increased by the acquisition cost of $800. This is multiplied by 10% (100% divided by five years = 20% per year × half-year convention = 10%). Remember that the straight-line method is an option available under the MACRS system. LO 6.1.3

Answer 78

c The $700 sales tax must be capitalized to give a basis of $14,000. The straight-line rate for seven-year property is 14.29% (100% divided by seven), but the half-year convention limits the deduction to 7.14% in the year of acquisition. Thus, $14,000 times 7.14% equals $1,000. The straight-line method is an option under the Modified Accelerated Cost Recovery System (MACRS). When computing straight-line depreciation, the half-year convention must be used. The $14,000 is reduced by the first-year cost recovery deduction of $1,000, which equals $13,000 as the adjusted basis. LO 6.1.3

Answer 79

c The gain on the sale is $52,500; the $100,000 sale price reduced by the commissions and closing costs to leave a $92,500 amount realized. The adjusted basis of the property is subtracted from the amount realized to give us a gain of $52,000. The gain attributable to the straight-line depreciation is unrecaptured Section 1250 gain—taxed at a maximum LTCG rate of $25%. The gain attributable to actual appreciation—$12,500—is regular LTCG, taxed at a 15% rate for a single taxpayer with taxable income between $38,600 and $425,800. LO 6.1.4

Answer 80

b The long-term gain and loss are netted, leaving a long-term gain of $2,900. Short-term gains and losses are netted, leaving a short-term gain of $400. These are left separate due to the disparate tax treatment of short-term versus long-term gains. LO 6.2.1

Answer 81

b The purchaser's cost basis is simply what the purchaser paid for the property—$100,000. LO 6.1.2

Answer 82

b The cost basis of the property, $26,000, would be reduced by the Section 179 and cost recovery deductions taken, $17,604. This leaves an adjusted basis of $8,396. When the property is subsequently sold for $18,000, the difference between the sales price ($18,000) and the adjusted basis of $8,396 is the gain realized of $9,604. The recapture is the lesser of the gain realized of $9,604 or the cost recovery deductions taken of $17,604. LO 6.1.4

Answer 83

d The sale of the old residence and the use of the Section 121 exclusion has no effect on the basis of the new residence. LO 6.1.2

Answer 84

c An exchange of U.S. realty for foreign realty is not considered like-kind. The like-kind requirements were changed under TCJA and now limits exchanges to realty for realty. The like-kind requirement does not mean that the property transferred must be identical to the property received; it merely requires that realty be exchanged for realty. LO 6.2.2

Answer 85

c The profit on the sale of $2,000 divided by the $6,000 contract price equals a 33.33% gross profit percentage. This is multiplied by the $1,000 of payments received during the year to calculate the amount of gain recognized ($333): $ 2,000 profit $ 6,000 contract price = 33.33 % × $ 1,000 payments = $ 333 recognized LO 6.2.4

Answer 86

b The substitute basis of a qualifying asset received in a like-kind exchange is the asset's fair market value reduced by the gain realized but not recognized. The deferred gain reduces the basis of the acquired asset, such that when that asset is sold, there is a larger gain recognized. LO 6.2.2

Answer 87

a Long-term transactions are netted together, as are short-term transactions. The net long-term capital gain is $4,200 ($6,400 – $2,200). The net short-term capital loss is $3,200 ($2,300 – $5,500). The net short-term capital loss is netted with the net long-term capital gain ($4,200 – $3,200) to result in a net long-term capital gain of $1,000. LO 6.2.1

Answer 88

b There are two components to this question. What is the basis, and is there tacking of the holding period? When the fair market value on the date of the gift is less than the donor's basis in the asset, the donee's basis in the asset for purposes of determining a loss is the asset's FMV on the date of the gift. In this situation, the $9 per-share value on the date of the gift would be Lynnette's basis. The next issue is the "tacking" of the holding period. In a situation where the donee uses the FMV as the basis, there is no tacking of the holding period. In this situation, Lynnette used the FMV; thus, she uses her own holding period of 11 months. If the donee uses the donor's basis, then the holding period is tacked. In other words, the donor's holding period is added to ("tacked") the donee's holding period. LO 6.1.1

Answer 89

c The land may not be depreciated, as only "wasting" assets are subject to depreciation. The Section 179 expense election generally applies to personalty only, and is not available for most real estate. The cost of the building may not be currently deducted; it must be capitalized and depreciated because it has a useful life of over one year. LO 6.1.1

Answer 90

d The long-term items are netted, leaving a long-term capital loss of $4,800. The short-term items are netted, leaving a short-term capital gain of $2,200. These are netted, leaving a net long-term capital loss of $2,600. LO 6.2.1

Answer 91

c If the fair market value on the date of the gift is greater than the donor's adjusted basis, the donor's adjusted basis is used as the recipient's basis. Note that the donor's holding period would be tacked to the donee's holding period. LO 6.1.2

Answer 92

c Fay can apply her short-term capital loss carryover to all current short-term capital gains, which results in a net short-term capital gain for this year of $1,000 ($6,000 gain − $5,000 carryover). She is then left with a net long-term capital loss of $35,000 ($5,000 gain − $40,000 carryover). To calculate net capital gains for the year, aggregate the long-term and short-term gains or losses, which in this case equals $35,000 long-term loss − $1,000 short-term gain, or a $34,000 net capital loss. She has no net gain and, as such, pays no taxes on any of the capital transactions she made this year.

Answer 93

a The realized gain in Parcel A is $50,000 and the recognized gain (the lesser of the gain realized or the boot received) is $20,000. The realized loss in Parcel B is $15,000. However, there is no loss recognized (deducted) in a like-kind exchange. LO 6.2.2

Answer 94

c Jane is paying $750 plus the adjusted basis of $1,500 ($2,250); compared to the fair market value of the property received of $1,750, thus yielding a $500 loss. Because this is not real estate, this is not a like-kind exchange. This exchange is simply treated as a sale of the asset. A loss on a Section 1231 asset may be recognized in the year of the loss. Personalty does not qualify for tax-deferred Section 1031 like-kind exchange treatment. LO 6.1.2

Answer 95

d In the case of an asset received as a gift, where the fair market value on the date of the gift is greater than the donor's adjusted basis, the recipient has a carryover basis. In this case, Uncle Carl had purchased the stock for $12 per share and had gifted it to Susan when the fair market value was $15 per share. Susan subsequently sold the stock for $19 per share. Thus, the carryover basis from Uncle Carl would be $12 per share. In a situation where the recipient of the gift takes the donor's basis, the holding period is tacked. In other words, the donor's holding period is added to the donee's holding period. Thus, Susan is treated as holding the stock for over 15 years. LO 6.1.2

Answer 96

b In a like-kind exchange, the gain recognized is always the lesser of the gain realized or the boot received. If there is no boot received, there is no gain recognized. Inventory is not eligible for like-kind exchange treatment—thus, gain would be recognized. The basis in the acquired property is the FMV of the acquired property, reduced by the gain realized but not recognized (the deferred gain). LO 6.2.2

Answer 97

b The seller's adjusted basis is the $80,000 purchase price, decreased by the $40,000 of straight-line depreciation. The mortgage has no bearing on the basis of the property. LO 6.1.2

Answer 98

c Jim is receiving an FMV of $240,000 for the duplex. He is giving up an adjusted basis of $85,000 plus $15,000 cash. The difference between the $240,000 received and the $100,000 given up is the realized gain of $140,000. The gain recognized (the taxable amount reported on the income tax return) in a like-kind exchange is the lesser of gain realized ($140,000) or boot received ($0). The substitute basis in an asset acquired in a like-kind exchange is the FMV of the qualifying property received ($240,000) reduced by the gain realized, but not recognized ($140,000 – $0 = $140,000). Thus, $240,000 – $140,000 = $100,000. LO 6.2.2

Answer 99

c Casualty losses are only deductible for damages sustained within a federally declared disaster area. Thus, there is no deduction for this loss. If the loss had been incurred in a federally declared disaster area (as a result of the disaster), the deductible casualty loss computation would begin with the lesser of the decrease in fair market value ($15,000 decrease in FMV) or the adjusted basis in the property. In this situation, the adjusted basis of $12,000 must be reduced by a $100 floor, the insurance of $6,000, and further reduced by 10% of the adjusted gross income. Thus, $12,000 reduced by $100, $6,000 insurance, and further reduced by $4,250, equals $1,650. LO 6.2.3

Answer 100

a The fact pattern indicates that Judy is in the lowest marginal bracket for three years, and will be in the highest marginal bracket after that. It makes no sense to maximize the depreciation deduction in years when Judy is in the lowest marginal brackets. By forgoing bonus depreciation and using straight-line, more deductions are pushed into the last five years of the depreciation schedule, when Judy will be in the highest marginal bracket. Remember that because of the half-year convention, seven-year property is depreciated over eight years. Under TCJA, 100% bonus depreciation is allowed for all personalty. In other words, 100% of the cost is deducted in the first year. LO 6.1.3

Answer 101

a The installation charges of $1,200 and the sales taxes of $550 must be capitalized—that is, added to the cost of the copier to give a total basis of $10,000. A copier is five-year property. (Copiers, cars, computers, and computer peripherals are five-year properties; furniture and other equipment are seven-year properties.) The straight-line rate for five-year property is 20% (100% divided by five), but the half-year convention limits the deduction to half of a full year's depreciation in the year of acquisition. Thus, $10,000 times 10% equals $1,000. If Bryan had not opted out of bonus depreciation, the entire $10,000 would be depreciated in the first year. LO 6.1.3

Answer 102

c Marcus's deferred gain on the new ring is $4,000. His new basis is the FMV of the property at acquisition minus the deferred gain ($20,000 − $4,000 = $16,000). LO 6.2.3

Answer 103

a Explanation The fact pattern indicates that Jerry is in the highest marginal bracket for three years, and then will be in the lowest marginal bracket after that. It makes sense to maximize the depreciation deduction this year when Jerry is in the highest marginal bracket. By using the bonus depreciation provision, the entire $730,000 may be deducted in the year of acquisition. LO 6.1.3

Answer 104

a Statement II is incorrect. The taxpayer use test provides more flexibility than the functional use test. LO 6.2.3

Answer 105

c The profit on the sale was $30,000 divided by the $100,000 contract price, which equals a 30% gross profit percentage. This is multiplied by the $40,000 of payments received during the year to calculate the amount of gain recognized, $12,000. The $38,000 of restoration costs are capitalized, added to basis, to give us the $70,000 basis. LO 6.2.4

Answer 106

d The entire gain of $69,000 is treated as Section 1231 gain, because there is no excess depreciation on the use of the straight-line method. So, $35,000 of the gain is subject to a maximum rate of 25%, as unrecaptured Section 1250 income, and the remaining $34,000 of gain is subject to the maximum regular long-term rate of 20%. The 20% long-term capital gain rate applies, as his taxable income is over the $492,300 breakpoint for the 20% rate. Note that Section 1250 recapture (ordinary income treatment) applies only to excess depreciation—in other words, the excess of an accelerated method over what would have been deducted if straight-line had been used. All realty placed in service after 1986 is depreciated using straight-line, and there is NO recapture (ordinary income) where straight-line depreciation was used. LO 6.1.4

Answer 107

d Explanation A sale of Section 1245 property at a gain will result in Section 1245 recapture. None of the other choices are considered taxable dispositions that would trigger recapture of depreciation (cost recovery) deductions. LO 6.1.4

Answer 108

c Statement I is correct. Gain recaptured under Section 1245 (depreciable personal property used in a trade or business) is taxed as ordinary income and is not eligible for installment sale treatment. Therefore, these amounts are fully recognized (taxable) as ordinary income in the year of sale. Unrecaptured Section 1250 depreciation occurs only on depreciable real property (real estate) used in a trade or business. LO 6.2.4

Answer 109

b Statement II is incorrect. When Section 1231 property is sold at a loss, the loss is treated as an ordinary loss, not a capital loss. LO 6.1.4

Answer 110

d The installment sale method cannot be used for inventory or securities traded in the secondary market. LO 6.2.4

Answer 111

a The building and land sold when Blake's business moved to a new location qualify under Section 1231 as depreciable personal or real property used in business or for the production of income. The building portion of the property was depreciable property. While they are not considered capital assets, under Section 1231 they are taxed using capital gain rates, subject to the Section 1245 and 1250 rules for depreciation recapture rules. Losses are always ordinary and not subject to the $3,000 ($1,500 for MFS) ordinary loss limitation. Accounts receivable, inventory, and copyrights and other creative works held by the creator are all ordinary assets that would result in ordinary income tax (not capital gain) if sold at a gain. LO 6.1.4

Answer 112

c Step 1: Calculate gross profit percentage: profit divided by sale price. $ 90,000 $ / 120,000 = 75 % Step 2: Calculate payments received in current year. $12,000 down payment + (10 × $5,000) = $12,000 + $50,000 = $62,000 (payments received) Step 3: Calculate gain recognized for current year. gross profit percentage × payments received = gain recognized 75% × $62,000 = $46,500 LO 6.2.4

Answer 113

d The Section 179 expense election is limited to the taxable (earned) income of the taxpayer. For purposes of Section 179, salary or wages received as an employee, even from a completely unrelated source, are also considered to be from the active conduct of the trade or business. Thus, the total taxable (earned) income in this situation is $122,000. The maximum Section 179 expense election is $1.16 million (for 2023), but for Bob, it is limited to his earned or taxable income of $122,000. LO 6.1.5

Answer 114

c Jody's gain realized (the actual economic gain) from the sale is $353,560 ($538,000 of sales proceeds reduced by the adjusted basis of $184,400). Of this $353,560 of gain, the first $54,000 is recognized as unrecaptured Section 1250 gain, taxed at 25%. Unrecaptured Section 1250 gain is the gain created by the straight-line depreciation. This leaves $299,560 of gain to account for. Jody used the condo as her principal residence for two full years—thus, she is eligible to exclude $250,000 under Section 121. This leaves $49,560 of long-term capital gain to be recognized at a 20% rate (because she is in the highest marginal income tax bracket, her taxable income exceeds the $492,300 breakpoint for the 20% LTCG rate). The recognized gain is the gain on which Jody will pay taxes. Note that the nonqualified use provision does not come into play here as there was no nonqualified use after 2008. LO 6.2.5

Answer 115

b Land is not a depreciable asset—only "wasting" assets are subject to depreciation. The building must be capitalized and depreciated over a period of 39 years. Section 179 generally does not apply to realty; it applies to tangible personalty used in the active conduct of a trade or business. LO 6.1.5

Answer 116

a Currently, Section 121 allows for a gain exclusion, of up to $500,000 for taxpayers married filing jointly, to any taxpayer who satisfies certain tests, known as the ownership test and the use test. To satisfy the ownership test, the home must have been owned and used as a principal residence for at least two of the five years preceding the date of sale. (Note: These years do not have to be consecutive; they only have to add up to at least two years.) Either spouse can meet the ownership test, but both must meet the use (two-out-of-five-year) test. This is likely not difficult for most married couples (applies even to those living in the house and then getting married), but it can be burdensome for individuals who are divorced or in the process of a divorce. LO 6.2.5