Module 6 Tax Consequences of Property Transactions Flashcards
In January of 1996, Lawrence, then age 55, sold his principal residence in Seattle and took advantage of the once-in-a-lifetime exclusion available under Section 121. At that time, the maximum exclusion was $125,000. He excluded his entire gain on the sale, which was $100,000. Later that year, he purchased a new residence in Denver that he used as his principal residence. Earlier this year, he sold the Denver residence for a realized gain of $200,000.
What is the maximum amount of gain, if any, that Lawrence may exclude under Section 121?
A)
$0
B)
$25,000
C)
$175,000
D)
$200,000
d
Use of the once-in-a-lifetime exclusion prior to May 7, 1997, does not preclude use of the full Section 121 exclusion for sales after that date. Thus, Lawrence may exclude the entire gain of $200,000. His gain recognized (the taxable gain) would be $0.
LO 6.2.5
A taxpayer’s personal residence was severely damaged as a result of a hurricane. The area was declared a federal disaster area. A portion of the damage will be covered by insurance. Which of the following statements is accurate regarding the casualty loss deduction in this situation?
It is reduced by the amount of insurance coverage.
It is reduced by a $100 floor per occurrence and 20% of AGI.
It is based on the greater of the decrease in the fair market value of the residence or the adjusted basis of the residence.
It is treated as an itemized deduction.
A)
I and III
B)
II and IV
C)
II, III, and IV
D)
I and IV
d
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
In February, Perry purchased a new computer (five-year property) for use in his business. The cost of the computer was $4,300, while freight and setup charges totaled $600. What is the first-year cost recovery deduction using the MACRS table?
A)
$980
B)
$490
C)
$790
D)
$430
a
The freight and setup charges of $600 must be capitalized—that is, added to the cost of the computer—to give a total basis of $4,900. The first-year deduction using the MACRS table is 20%. Thus, 20% times $4,900 equals $980. Please note that the MACRS table has all applicable conventions already built into the table; therefore, no adjustment is necessary for the half-year convention. Note that bonus depreciation is not used, as the fact pattern states to use the MACRS table.
LO 6.1.3
Which of the following dispositions of Section 1245 property would result in the immediate recapture of some or all of the previous depreciation deduction taken by the taxpayer?
A)
Distribution by bequest
B)
Disposition in a tax-free transaction
C)
Disposition by gift
D)
Installment sale
d
Section 1245 property includes all depreciable tangible personal property used in a trade or business. Section 1245 of the Tax Code requires any recognized gain to be treated as ordinary income to the extent of depreciation taken on the property and occurs when there is a taxable event regarding such property. An installment sale is an example of a triggering taxable event for purposes of Section 1245 recapture.
LO 6.1.4
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)
$490
D)
$430
a
A computer is five-year property. The first-year deduction using the MACRS table is 20%. Thus, 20% times $4,900 equals $980. Please note that the MACRS table has all applicable conventions already built into the table—thus, no adjustment is necessary for the half-year convention. If the MACRS table is not available, remember that the table reflects a 200% declining balance method, with a half-year convention. A computer is five-year property. (Copiers, automobiles, 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). Twice the straight-line rate is 40%. So, 40% times the basis of $4,900 is $1,960, but the half-year convention limits the deduction to half of a full year’s depreciation in the year of acquisition. Thus, half of $1,960 equals $980. If Eric had not opted out of the bonus depreciation, the entire $10,000 would be depreciated in the first year.
LO 6.1.3
On April 1 of the current tax year, Elisha sold her principal residence for a total price of $501,000: $301,000 was in cash, with the buyer assuming a $200,000 mortgage on the house. Elisha purchased the house 15 years ago for $290,000, but she has an adjusted basis of $80,000. She has not made any improvements to the house. To assist in the sale of the residence, she incurred costs of $1,500 for repairs three weeks before the sale occurred. Realtor commissions of $31,000 resulted from the sale. On May 1 of the current tax year, Elisha bought a new residence for $260,000. What amount, if any, must be recognized on the sale of Elisha’s residence?
A)
$140,000
B)
$388,500
C)
$390,000
D)
$0
a Explanation
The answer is computed as follows.
Gain 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.
Gain recognized (amount subject to income tax):
Gain realized $390,000
Less exclusion 250,000
Gain recognized $140,000
LO 6.1.2
Cara has a basis of $6,000 in a classic Mercedes that she purchased several years ago. This year, she sold the Mercedes to a business associate for $18,000. The buyer made the first of six annual installments of $3,000 this year. What is the amount of gain recognized in the current year?
A)
$12,000
B)
$2,000
C)
$3,000
D)
$1,000
b
The gross profit percentage is the profit on the sale ($12,000) divided by the contract, or sale, price of $18,000, or 66.67%. The gross profit percentage is multiplied by the payment received in the current year ($3,000) to give a gain recognized of $2,000.
LO 6.2.4
Caley, a single taxpayer, purchased and immediately moved into her principal residence on July 1, 2018. The cost of the residence was $450,000. She used the residence as her principal residence through July 1, 2020. On August 1, 2020, she converted the property into a rental property.
She sells the residence for $700,000 on January 1, 2023, after claiming $42,000 in depreciation deductions. What is the amount of Caley’s taxable gain recognized from the transaction?
A)
$250,000
B)
$0
C)
$42,000
D)
$292,000
c
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
A tune-up on a business automobile should be
A)
partially nondeductible.
B)
currently deductible.
C)
completely nondeductible.
D)
depreciated over the life of the automobile.
b
The cost of a repair (which maintains the asset in normal working condition) to a business asset is currently deductible.
LO 6.1.2
During the current tax year, Jim purchased a fully finished small warehouse for exclusive use in his manufacturing business. The cost of the property was $122,000, of which $32,000 was attributable to the land. Which of the following statements identifies the proper treatment of the expenditure?
A)
The entire $122,000 is currently deductible.
B)
The $32,000 must be capitalized and may not be depreciated.
C)
The $90,000 attributable to the building may be deducted under Section 179.
D)
The $90,000 attributable to the building may be currently deductible.
b During the current tax year, Jim purchased a fully finished small warehouse for exclusive use in his manufacturing business. The cost of the property was $122,000, of which $32,000 was attributable to the land. Which of the following statements identifies the proper treatment of the expenditure?
A)
The entire $122,000 is currently deductible.
B)
The $32,000 must be capitalized and may not be depreciated.
C)
The $90,000 attributable to the building may be deducted under Section 179.
D)
The $90,000 attributable to the building may be currently deductible.
A cost associated with the acquisition of a fixed asset that is used in a business
A)
is never deductible.
B)
must be capitalized.
C)
is currently deductible in most situations.
D)
is currently deductible if the cost is de minimis.
b
A cost associated with the acquisition of a fixed asset that is used in a business must be capitalized—that is, it must be added to the basis of the asset and it is not currently deductible. There is no de minimis test for capitalizing an acquisition cost.
LO 6.1.1
Last month, Amanda received 100 shares of stock from her aunt, Martha, as an inheritance. Martha purchased the stock 10 years ago for $150 per share. The fair market value on the date of Martha’s death was $65 per share, and the fair market value six months after the date of death was $70 per share. Assume that the administrator did not elect the alternate valuation date. Amanda sold the stock this month for $90 per share. What is Amanda’s per-share gain or loss in the acquired stock?
A)
$25 per share short-term capital gain
B)
$60 per share long-term capital loss
C)
$20 per share long-term capital loss
D)
$25 per share long-term capital gain
d
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 $65 per share. The holding period of an asset acquired from a decedent is presumed to be long term. Thus, even though Amanda held the stock for only a month or so, she still has a long-term capital gain.
LO 6.1.2
Bill owns residential real estate that he purchased in 1980 for $201,500. Assume that the property is now fully depreciated, with an adjusted basis of zero. Bill used the Accelerated Cost Recovery System (ACRS) method to recover the cost of the property. If Bill sells the property for $300,000, what is the amount and character of the gain?
A)
$201,500 Section 1250 ordinary income and $98,500 Section 1231 gain
B)
$98,500 Section 1250 gain and $201,500 Section 1231 gain
C)
$98,500 unrecaptured Section 1250 income
D)
$201,500 unrecaptured Section 1250 income and $98,500 long-term capital gain
d
Under Section 1250, only the excess depreciation is recaptured as ordinary income. When a property is fully depreciated, there is no excess depreciation. Thus, all gain on the sale—the difference between the $300,000 sale price and the adjusted basis of zero ($300,000)—is Section 1231 income, potential long-term capital gain. The gain attributable to straight-line depreciation (the unrecaptured Section 1250 income) is subject to a maximum rate of 25%, and the remaining gain of $98,500 is subject to a maximum 15% or 20% long-term capital gain rate.
LO 6.1.4
Jacob has an apartment building in Atlanta that he would like to exchange. Which of the following assets could Jacob receive in a like-kind exchange?
Farmland
Interest in a low-income housing limited partnership
Parking lot
An apartment building in Tahiti
A)
II, III, and IV
B)
I and III
C)
II and III
D)
III and IV
b
In a like-kind exchange, only real estate may be exchanged for real estate. The like-kind exchange rules specifically prohibit the exchange of U.S. realty for foreign realty.
LO 6.2.2
Gregg received 100 shares of stock from his aunt, Erica. Erica purchased the stock eight years ago for $12 per share.
Gregg received the stock as a gift from Erica two years ago, when the fair market value of the stock was $15 per share, and he sold the stock this year for $19 per share.
What was Gregg’s per-share basis in the stock?
A)
$19
B)
Cannot be determined
C)
$15
D)
$12
d
In the case of an asset received as a gift, if 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, Erica had purchased the stock for $12 per share and had gifted it to Gregg when the fair market value was $15 per share. Gregg subsequently sold the stock for $19 per share. Thus, the carryover basis from Erica would be $12 per share.
LO 6.1.1
Danny personal automobile was partially destroyed in an accident. The auto’s fair market value was $20,000, and his basis in it was $25,500. The value of the automobile after the accident was $5,000. His insurance paid him $2,000 as a result of the accident. Danny’s AGI is $52,000. What is the amount of Danny’s deductible casualty loss?
A)
$0
B)
$7,700
C)
$18,200
D)
$12,900
a
Casualty losses are deductible only if the damage was sustained as a result of a disaster in a federally declared disaster area. If this were an allowable loss (i.e., the damage was a result of a hurricane or severe storm in a federally declared disaster area), the calculation would be as follows. The deductible casualty loss calculation begins with the lesser of the decrease in fair market value ($15,000) or the adjusted basis in the property ($25,500). In this situation, the decrease in fair market value of $15,000 must be reduced by the insurance payment of $2,000, a $100 floor, and further reduced by 10% of the adjusted gross income. Thus, $15,000 reduced by $2,000, $100, and further reduced by $5,200, equals $7,700.
LO 6.2.3
Phillip’s classic automobile was completely destroyed in an earthquake that was declared a federal disaster. Unfortunately, his insurance paid only $12,000, while the fair market value was $22,000. His basis in the automobile was $17,000. Phillip’s AGI is $35,000.
What is the amount, if any, of Phillip’s deductible casualty loss?
A)
$1,500
B)
$6,000
C)
$0
D)
$1,400
d The deduction is based on the lesser of basis or the decrease in FMV—reduced by the insurance, the $100 floor per occurrence, and 10% of AGI.
Lesser of decrease in FMV ($22,000) or
adjusted basis ($17,000)
$17,000
Less insurance coverage (12,000)
$5,000
Less $100 floor (100)
$4,900
Less 10% of AGI (3,500)
Deductible loss on Schedule A $1,400
LO 6.2.3
In November 2021, George’s rental real estate was condemned by the city under the eminent domain statute to allow for a new overpass to be built. He received the condemnation payment from the city later that month. If there were a gain on the conversion, when would the replacement period end?
A)
November 30, 2024
B)
November 30, 2023
C)
December 31, 2023
D)
December 31, 2024
d
The replacement period for condemned real estate used in a trade or business or held for investment purposes ends on the last day of the third taxable year following the year in which any part of the gain on the condemnation is realized.
LO 6.2.3
During the current tax year, Riley, a single taxpayer, has a $10,000 short-term capital loss and a $10,000 long-term capital gain, both from the sales of securities. Riley also has a $15,000 long-term capital gain from the sale of collectibles. Riley is in a 37% marginal income tax bracket. What is the income tax result from these transactions?
A)
$15,000 collectibles gain taxed at 28%
B)
$5,000 of collectibles gain taxed at 28%, and $10,000 of long-term capital gain taxed at 20%
C)
$15,000 collectibles gain taxed at 25%
D)
$5,000 of collectibles gain taxed at 25%, and $10,000 of long-term capital gain taxed at 15%
b
The $10,000 short-term capital loss is first used against the collectibles gain—the gain that would be taxed at the highest rate (28%). This leaves $5,000 of collectibles gain, taxed at 28%, and $10,000 of long-term capital gain from the sale of securities, taxed at 20%. The long-term gain from the securities is taxed at 20% because Riley is in the 37% marginal income tax bracket. That gives him taxable income in excess of the breakpoint for the 20% rate—taxable income in excess of $459,750 (for 2023).
LO 6.2.1
taxpayer purchases a new computer for use in his consulting business. He incurs sales tax and shipping charges in connection with the purchase. Which of the following correctly describes the treatment of the sales tax and shipping charges?
A)
Both are currently deductible.
B)
Both are capitalized.
C)
The sales tax is capitalized, and the shipping charges are currently deductible.
D)
The sales tax is currently deductible, and the shipping charges are capitalized.
b
Any cost associated with the acquisition of an asset must be capitalized (added to basis). This would include both the shipping charges and the sales tax.
Any cost associated with the acquisition of an asset may not be currently deducted.
LO 6.1.1
Settings
Dave owns equipment that has an adjusted basis of $10,000 and a fair market value of $75,000. Through an exchange, he acquires new equipment from Rachel that has a fair market value of $60,000 and an adjusted basis of $35,000. In the exchange, Dave receives $15,000 from Rachel. What is the amount of gain or loss, if any, recognized by Dave in the exchange?
A)
$50,000
B)
$10,000
C)
$15,000
D)
$65,000
d
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
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
d
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
This year, Hugh sold a classic automobile to his friend, Doug, on the following terms:
The price was $40,000, equal to the fair market value.
Hugh’s basis in the automobile was $25,000.
Starting this year, Doug will pay in five annual installments of $7,000 plus accrued interest.
Doug will make a $5,000 down payment.
Ignoring interest income, what amount of gain will Hugh recognize for the current year?
A)
$4,500
B)
$5,000
C)
$7,500
D)
$8,571
a
Hugh’s gross profit percentage is 37.5%. This is multiplied by the $12,000 of payments received during the year. The profit on the sale was $15,000 divided by the $40,000 contract price, which equals a 37.5% gross profit percentage.
LO 6.2.4
Which of the following statements is accurate about a like-kind exchange?
A)
No gain will be recognized unless the taxpayer receives boot.
B)
No gain will be recognized on the exchange of personalty.
C)
The amount of gain recognized will reduce the taxpayer’s basis in the property received.
D)
Gain recognized is equal to the gain realized on the exchange plus the boot received.
a
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
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.
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
Eric purchased a painting for $200,000. He sold the artwork 5 years later for $500,000 in an installment sale, receiving $50,000 as the first-year payment. How much gain must Eric recognize in the year of sale?
A)
$50,000
B)
$30,000
C)
$20,000
D)
$500,000
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
An office building with an adjusted tax basis of $120,000 was destroyed by fire on January 2 of last year. On January 15 of the current year, the insurance company paid the owner $200,000. The owner reinvested $190,000 in a new office building. What is the basis of the new building under Section 1033 (the involuntary conversion rules)?
A)
$190,000
B)
$120,000
C)
$180,000
D)
$110,000
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
Several years ago, Jack purchased a duplex to use as a rental property. The cost of the duplex was $79,500. He paid an attorney $800 to draft the legal documents related to the purchase. He paid $7,500 for improvements in the first year and this year paid $1,900 for various repairs to the property. He claimed a first-year cost recovery deduction of $3,000.
What is Jack’s adjusted basis in the duplex?
A)
$82,100
B)
$84,800
C)
$87,800
D)
$82,900
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
Under the installment sale method, when must a seller-lender recognize all of the gain remaining in an installment note?
When an installment sale is canceled
When the lender makes a gift of the installment note to the debtor
When the lender sells the installment note to a third party
A)
I only
B)
I, II, and III
C)
II and III
D)
III only
All of these statements are correct.
LO 6.2.4
During the current tax year, Robin has a short-term capital loss of $13,000 from the sale of mutual funds. She also has a long-term capital gain of $6,200 from the sale of an antique clock and has unrecaptured Section 1250 income of $17,000. Robin is in the 35% marginal income tax bracket. What is the tax result from these transactions?
A)
$10,200 unrecaptured Section 1250 income taxed at 25%
B)
$6,800 short-term capital loss carryforward and $17,000 unrecaptured Section 1250 income taxed at 25%
C)
$14,200 of unrecaptured section 1250 income taxed at 25%
D)
$4,000 unrecaptured Section 1250 income taxed at 25% and $6,200 collectibles gain taxed at 28%
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
All of the following statements regarding straight-line depreciation are correct except
A)
taxpayers using straight-line depreciation must generally use the half-year convention.
B)
straight-line depreciation is the most complex form of depreciation.
C)
straight-line depreciation assumes that depreciation is uniform throughout the useful life of the asset.
D)
with straight-line depreciation, the asset’s cost or adjusted basis, less the residual or salvage value, is deducted in equal annual installments over the asset’s useful life.
b
Straight-line depreciation is the simplest form of depreciation.
LO 6.1.3
Anne is the owner of 1,000 shares of the GRQ Mutual Fund Group. Recently, because of favorable market conditions, she sold 1,000 shares of the fund for a market price well in excess of her adjusted cost basis. She is now interested in computing her gain on these shares. Anne uses the specific identification method to determine basis.
Which of the following is an income tax implication for Anne in the sale of her mutual fund shares?
A)
The gain is computed by subtracting the documented basis of identified shares from their sale price.
B)
The gain is computed using the excess of the fair market value over the cost of those shares last purchased.
C)
The gain is computed using the excess of the fair market value over the cost of those shares first purchased.
D)
The gain is computed according to the average cost of all shares as compared to the total sale proceeds.
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
Carol, a single taxpayer, sold her home in March of the current tax year for $380,000. She had lived in the home as her principal residence for 14 years. She paid a broker’s commission of $20,000. The cost, and basis, of the former home was $60,000. What is the amount of gain recognized by Carol on the sale?
A)
$70,000
B)
$320,000
C)
$300,000
D)
$50,000
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
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)
Commercial rental property in Detroit
B)
Residential rental property in Mexico
C)
A residence in which he will live
D)
A piece of manufacturing equipment for his business
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
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 $15,000 ordinary loss.
C)
a $8,000 long-term capital gain and a $7,000 ordinary loss.
D)
a $7,000 long-term capital gain and a $8,000 ordinary gain.
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
During the current tax year, Carolyn has Section 1231 gains of $14,000 and Section 1231 losses of $3,000. Four years ago, Carolyn reported a net Section 1231 gain of $6,000. Three years ago, Carolyn had a Section 1231 loss of $4,000. Which of the following correctly describes the amount and treatment of the gain?
A)
$11,000 treated as ordinary income
B)
$11,000 treated as capital gain income
C)
$7,000 treated as capital gain; $4,000 treated as ordinary income
D)
$7,000 treated as ordinary gain; $4,000 treated as capital gain
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
During the current year, Holly has Section 1231 losses totaling $10,000. She also has $4,000 of Section 1231 gains. Four years ago, Holly reported a net Section 1231 gain of $5,000. These are the only two years in which Holly has had Section 1231 gains or losses. What is the character of the current year’s Section 1231 gains and losses?
A)
$1,000 capital loss, $5,000 ordinary loss
B)
$6,000 capital loss
C)
$6,000 ordinary loss
D)
$5,000 capital loss, $1,000 ordinary loss
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
During the current year, Vern has Section 1231 gains totaling $29,000. He also has $8,000 of Section 1231 losses. Last year, Vern reported a net Section 1231 loss of $12,000. These are the only two years in which Vern has had Section 1231 gains or losses.
What is the amount and character of the current year’s Section 1231 gains and losses?
A)
$9,000 ordinary income, $12,000 long-term capital gain
B)
$21,000 long-term capital gain
C)
$9,000 long-term capital gain, $12,000 ordinary income
D)
$9,000 long-term capital gain
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
Helen’s personal residence was damaged by a severe storm. The area affected by the storm was declared a federal disaster area. The fair market value of the home prior to the storm was $365,000. The fair market value of the home after the storm was $300,000. Her insurance paid $25,000. The basis in the home was $290,000. Helen’s AGI is $200,000. What is the amount, if any, of Helen’s deductible casualty loss?
A)
$19,900
B)
$245,000
C)
$0
D)
$20,000
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
Under the Modified Accelerated Cost Recovery System (MACRS), real estate is depreciated under which of the following methods?
A)
Straight-line method
B)
200% declining balance method
C)
Sum-of-the-years’ digits method
D)
150% declining balance method
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
In April of the current year, Mel sold his principal residence for a total price of $408,000. Mel sold the house due to a job transfer out of state. He received the house as a gift 18 months ago when its fair market value was $375,000, and the donor’s basis was $50,000. He completed a room addition for $20,000. He paid realtor commissions of $23,000 on the sale. What amount, if any, must be recognized on the sale of Mel’s residence?
A)
$127,500
B)
$0
C)
$315,000
D)
$13,000
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
A casualty loss deduction is treated as
A)
an adjustment to income.
B)
a nondeductible item.
C)
a deduction for AGI.
D)
an itemized deduction.
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
Several years ago, Ben purchased equipment at a cost of $11,000 to use in his dry-cleaning business. He used the straight-line method of cost recovery. He deducted $7,074 of cost recovery. He sold the equipment earlier this year for $12,000. What is the amount and nature (character) of the gain resulting from this disposition?
A)
$1,000 Section 1245 gain; $7,074 Section 1231 gain
B)
No Section 1245 gain; $8,074 Section 1231 gain
C)
$7,074 Section 1245 gain; $1,000 Section 1231 gain
D)
$8,074 Section 1245 gain; no Section 1231 gain
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
Frank inherited 100 shares of stock from his uncle, Jesse. Jesse purchased the stock eight years ago for $12 per share. The fair market value on the date of Jesse’s death was $9 per share, and the fair market value six months after the date of death was $10 per share.
Assume the administrator elected the alternate valuation date. What is Frank’s per-share basis in the acquired stock?
A)
$10.00
B)
$9.50
C)
$12.00
D)
$9.00
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
On June 1, 2021, Hugh and Judy, both age 45, moved into a new house that they had custom-built at a cost of $524,000. Because of a slow real estate market in their area, Hugh and Judy were unable to sell their previous home until January 1, 2023. Their previous home, which they had lived in for 15 years, sold for a price of $916,000. Their basis in their old home was $312,000.
How much gain, if any, must Hugh and Judy recognize for tax purposes as a result of this sale?
A)
$104,000
B)
$0
C)
$92,000
D)
$604,000
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
Four years ago, David purchased a condominium to use as a rental property. The cost of the property was $165,000. He paid an attorney $1,800 to draft the legal documents required for the purchase of the property. He paid $6,500 to replace the wiring and patio before he could rent the property. Last year, he paid $2,200 to repair damage caused by the former tenants. He has claimed cost recovery deductions of $24,600. What is David’s adjusted basis in the condo?
A)
$140,400
B)
$150,900
C)
$142,200
D)
$148,700
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
Six years ago, Holly purchased an office building for her retail business at a cost of $200,000. She paid $5,000 in legal fees associated with the acquisition. She paid $10,000 to remodel the interior to make the building suit her purpose. She has paid $18,000 for property taxes and $20,000 for utilities during the five years. She has taken cost recovery deductions of $35,000. She also paid $40,000 interest on the mortgage note. What is Holly’s current adjusted basis in the warehouse?
A)
$220,000
B)
$180,000
C)
$165,000
D)
$170,000
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
This year, Randy sold a classic painting to his neighbor, Norm, under the following terms:
The price was $22,000, equal to the fair market value.
Randy’s basis in the painting was $5,000.
Starting this year, Norm will pay in five annual installments of $4,000 plus accrued interest.
Norm will make a $2,000 down payment.
Ignoring interest income, what amount of gain will Randy recognize for the current year?
A)
$4,636
B)
$3,000
C)
$4,500
D)
$2,000
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
For which of the following transactions does immediate recognition of remaining gain on an installment sale occur?
Blake entered into an installment sale with Jake when he sold Jake a motorcycle but canceled the installment sale one year into the three-year installment sale term.
Sarah entered into an installment sale with her sister, Josie, when she sold her an undeveloped lot but gifted the note to Josie three months later.
Josh needed cash immediately and sold his installment note he had on equipment he sold to Trevor to the bank.
Les needed a loan from the bank and used the installment notes he had for cars he sold to three customers as collateral for the loan.
A)
IV only
B)
II and III
C)
I and III
D)
I, II, III, and IV
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
Six years ago, Holly purchased an office building for her retail business at a cost of $200,000. She paid $5,000 in legal fees associated with the acquisition. She paid $10,000 to remodel the interior to make the building suit her purpose. She has paid $18,000 for property taxes and $20,000 for utilities during the five years. She has taken cost recovery deductions of $35,000. She also paid $40,000 interest on the mortgage note. What is Holly’s current adjusted basis in the warehouse?
A)
$165,000
B)
$220,000
C)
$170,000
D)
$180,000
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
Two years ago, Morton purchased equipment (seven-year property) for use in his business at a cost of $12,000. Cost recovery deductions totaled $7,392. The equipment was sold for $13,000.
What is the amount of cost recovery deductions, if any, that must be recaptured?
A)
$1,392
B)
$6,000
C)
$7,392
D)
$4,608
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
Jeff received 100 shares of stock from his aunt, Diane. Diane purchased the stock seven years ago for $12 per share. Assume that Jeff received the stock as a gift from Diane two years ago, when the fair market value was $8 per share, and assume that he sold the stock this year for $6 per share. What was Jeff’s per-share basis in the stock?
A)
$12
B)
$8
C)
$6
D)
Basis cannot be determined
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
A taxpayer’s personal residence was severely damaged as a result of a hurricane. The area was declared a federal disaster area. A portion of the damage will be covered by insurance. Which of the following statements is accurate regarding the casualty loss deduction in this situation?
It is reduced by the amount of insurance coverage.
It is reduced by a $100 floor per occurrence and 20% of AGI.
It is based on the greater of the decrease in the fair market value of the residence or the adjusted basis of the residence.
It is treated as an itemized deduction.
A)
I and IV
B)
II and IV
C)
II, III, and IV
D)
I and III
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
Dave owns equipment that has an adjusted basis of $10,000 and a fair market value of $75,000. Through an exchange, he acquires new equipment from Rachel that has a fair market value of $60,000 and an adjusted basis of $35,000. In the exchange, Dave receives $15,000 from Rachel. What is the amount of gain or loss, if any, recognized by Dave in the exchange?
A)
$50,000
B)
$10,000
C)
$65,000
D)
$15,000
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
During June 2023, Judy, a sole proprietor, purchased new equipment for her business at a cost of $640,000. She has net income (without regard to the Section 179 deduction) from the sole proprietorship of $206,000. She also has wages from a part-time clerking position of $14,000. What is the maximum Section 179 deduction that Judy may claim with respect to the equipment?
A)
$220,000
B)
$206,000
C)
$510,000
D)
$640,000
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
Four years ago, Janice purchased a duplex for investment purposes at a cost of $120,000. Legal fees for acquisition were $2,000. Prior to renting out the property, Janice paid $8,000 to tear down a wall, renovate, and transform two bedrooms into a master suite. She has since taken cost recovery deductions in the amount of $19,500 and paid $2,000 in property taxes.
What is Janice’s current adjusted basis in the duplex?
A)
$108,500
B)
$100,500
C)
$90,500
D)
$110,500
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
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
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
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.
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.
Caley, a single taxpayer, purchased and immediately moved into her principal residence on July 1, 2018. The cost of the residence was $450,000. She used the residence as her principal residence through July 1, 2020. On August 1, 2020, she converted the property into a rental property.
She sells the residence for $700,000 on January 1, 2023, after claiming $42,000 in depreciation deductions. What is the amount of Caley’s taxable gain recognized from the transaction?
A)
$292,000
B)
$0
C)
$250,000
D)
$42,000
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
Martin and Jan, both age 43, have lived in their house for 12 years but must move to another city at the end of the year due to Jan’s change of employment. The original cost of their house was $75,000. The fair market value of their house is $410,000. They have located a single-family home priced at $330,000 in the city to which they are moving. They are trying to decide what they should do with their present house when they move. Which of the following alternatives would be the most appropriate for them and would offer the greatest tax savings?
A)
Renting their house now and selling it when they are both age 55 so that the gain will be excluded
B)
Selling their house through an installment sale to defer any gain
C)
Selling their house and excluding the gain
D)
Making a like-kind exchange of their house for the single-family home to defer any gain
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
Which of the following statements regarding replacement property in a Section 1033 exchange is CORRECT?
In the taxpayer use test, the taxpayer’s use of the replacement property and of the involuntarily converted property must be the same.
For the functional use test, the owner-investor’s properties must be used in similar endeavors as the previously held properties.
A)
I only
B)
II only
C)
Both I and II
D)
Neither I nor II
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
Last year, Julio purchased the following shares of Calendars, Inc., stock:
Date # of Basis
January 10 100 $3,000
May 5 100 $4,000
July 27 200 $10,000
On August 22 of this year, Julio sold all of the shares for $19,000. What was Julio’s gain or loss on the sale of the stock?
A)
$2,000 STCG
B)
$4,000 STCG
C)
$2,000 LTCG
D)
$1,000 STCL
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
Frank owns and operates a business as a sole proprietor. On August 7, 2023, he purchased equipment (seven-year property) at a cost of $1,275,000 to use in his business. He qualifies for and elects the maximum Section 179 expense deduction. Frank elects out of the bonus depreciation provision. What is the total amount of deductions that Frank can claim in 2023? Use the Modified Accelerated Cost Recovery System (MACRS) table found in the module.
A)
$0
B)
$1,176,434
C)
$1,080,000
D)
$125,000
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
During the current year, Chuck has Section 1231 gains totaling $14,000. He also has $3,000 of Section 1231 losses. Four years ago, Chuck reported a net Section 1231 loss of $7,000. These are the only two years in which Chuck has had Section 1231 gains or losses.
What is the amount and character of the current year’s Section 1231 gains and losses?
A)
$4,000 ordinary income, $7,000 long-term capital gain
B)
$11,000 long-term capital gain
C)
$4,000 long-term capital gain
D)
$7,000 ordinary income, $4,000 long-term capital gain
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
Ken (a single taxpayer), age 28, holds the following securities:
Stock Purchase Date Fair Market Value Cost Basis
ABC (300 shares) Oct. 3, 2005 $12,200 $5,500
DEF (500 shares) Feb. 15, 2023 $22,600 $15,600
GHI (100 shares) June 2, 2008 $4,350 $6,250
LMN (700 shares) Dec. 9, 2022 $19,360 $28,560
XYZ small-cap fund (500 shares) Oct. 20, 2013 $1,200 $3,700
VWL (750 shares, §1244 stock) July 17, 2007 $4,050 $115,600
Bonds Purchase Date Fair Market Value Cost Basis
EE savings bonds May 1, 2014 $8,500 $6,000
If Ken sells ABC, DEF, GHI, and LMN on July 1, 2023, at their fair market values, what is the net capital gain or loss (ignoring commissions) from the security sales?
A)
Net long-term gain of $4,800 and net short-term loss of $2,200
B)
Net long-term gain of $2,600
C)
Net short-term gain of $2,600
D)
Net short-term loss of $2,500 and net long-term gain of $5,100
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
Georgina would like to exchange her small warehouse for an apartment building. In the exchange Georgina is contemplating, she will receive $100,000 cash. Georgina’s warehouse has a fair market value of $300,000 and an adjusted basis of $105,000. The apartment building she is considering has a fair market value of $200,000 and an adjusted basis of $62,000.
What is the substituted basis of the acquired asset?
A)
$200,000
B)
$105,000
C)
$195,000
D)
$300,000
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
Carol, a single taxpayer, sold her home in March of the current tax year for $380,000. She had lived in the home as her principal residence for 14 years. She paid a broker’s commission of $20,000. The cost, and basis, of the former home was $60,000. What is the amount of gain recognized by Carol on the sale?
A)
$320,000
B)
$300,000
C)
$70,000
D)
$50,000
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
Four years ago, David purchased a condominium to use as a rental property. The cost of the property was $165,000. He paid an attorney $1,800 to draft the legal documents required for the purchase of the property. He paid $6,500 to replace the wiring and patio before he could rent the property. Last year, he paid $2,200 to repair damage caused by the former tenants. He has claimed cost recovery deductions of $24,600. What is David’s adjusted basis in the condo?
A)
$148,700
B)
$140,400
C)
$150,900
D)
$142,200
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
Which of the following statements is accurate about a like-kind exchange?
A)
Gain recognized is equal to the gain realized on the exchange plus the boot received.
B)
No gain will be recognized unless the taxpayer receives boot.
C)
No gain will be recognized on the exchange of personalty.
D)
The amount of gain recognized will reduce the taxpayer’s basis in the property received.
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
Frank inherited 100 shares of stock from his uncle, Jesse. Jesse purchased the stock eight years ago for $12 per share. The fair market value on the date of Jesse’s death was $9 per share, and the fair market value six months after the date of death was $10 per share.
Assume the administrator elected the alternate valuation date. What is Frank’s per-share basis in the acquired stock?
A)
$12.00
B)
$9.50
C)
$9.00
D)
$10.00
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
In which of the following situations may the installment method of accounting be used?
A)
Mary sells a vacant lot to her friend for a loss. Mary will receive payments over four years.
B)
Mike sells a classic convertible automobile to a coworker for an $8,000 gain. The sales price will be paid to Mike in a lump sum next year.
C)
Kalila sells IBM stock to her neighbor. Kalila will receive half of the sale price this year and half next year.
D)
Elena is a used car dealer and reports her gains using the installment method if the buyer does not pay cash.
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
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
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
John is a contractor who has just purchased a tractor for use in his business. John paid $25,000 plus $1,250 in sales tax for the tractor. The local municipality also imposes an annual personal property tax of $500 per year. The tractor has an expected useful life of five years. What is John’s basis in the tractor for depreciation purposes?
A)
$26,750
B)
$25,500
C)
$26,250
D)
$25,000
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
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
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
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
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
Marcus purchased a diamond ring for $15,000 10 years ago. It was stolen in March of this year. The ring was purchased to celebrate achieving a significant promotion at work. The FMV at the time of the theft was $20,000. The ring was insured, and, after the deductible, Marcus received $19,000 from the insurance company in October of this year. Under Section 1033, how does Marcus account for the $4,000 realized gain on his income taxes?
A)
Marcus must purchase the qualified replacement property before the end of this year for his realized gain to not be recognized.
B)
Marcus must use the taxpayer-use test in determining whether the replacement property qualifies under Section Under 1033.
C)
If Marcus purchases another ring for $19,000 or more, his realized gain is not recognized.
D)
Marcus has three years from the end of this year to replace the property without having to recognize any realized gain.
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
Which of the following statements regarding installment sales is CORRECT?
An installment sale is any sale of property in which the seller will receive at least two payments 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.
A)
I only
B)
Both I and II
C)
II only
D)
Neither I nor II
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
In March of the current year, Susan sold her principal residence for $408,000. Susan sold the house due to a job transfer out of state. Susan received the house as a gift 18 months ago when its fair market value was $375,000, and the donor’s basis was $50,000. She made $20,000 of improvements to the house. She paid real estate broker commissions of $23,000. What amount, if any, must be recognized on the sale of Susan’s residence?
A)
$65,000
B)
$85,000
C)
$10,000
D)
$127,500
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
Rhea had the following capital transactions during the current tax year:
Short-term capital gain $1,000
Short-term capital loss $2,700
Long-term capital gain $6,500
Long-term capital loss $1,800
What is the amount of Rhea’s net capital gain or loss on her Schedule D?
A)
Net short-term capital loss of $1,700 and net long-term gain of $4,700
B)
Net long-term gain of $3,000
C)
Net long-term gain of $1,700 and net short-term capital loss of $4,700
D)
Net short-term gain of $3,000
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
Edward had the following capital transactions during the current year:
Long-term capital gain $3,200
Long-term capital loss ($3,600)
Short-term capital gain $4,500
Short-term capital loss ($3,400)
Which of the following describes the net capital gain or loss reportable by Edward for the current tax year?
A)
$900 net short-term capital gain; $200 net short-term capital loss
B)
$7,700 net capital gain; $7,000 net capital loss
C)
$700 net short-term capital gain
D)
$1,100 net short-term capital gain; $400 net long-term capital loss
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
Laci received 100 shares of stock from her grandfather, Richard. Richard purchased the stock eight years ago for $12 per share. Laci received the stock as a gift from her grandfather two months ago when the fair market value was $8 per share, and she sold the stock this week for $6 per share. What is Laci’s gain or loss from the sale of the stock?
A)
$400 long-term capital loss
B)
$600 short-term capital loss
C)
$200 short-term capital loss
D)
$600 long-term capital loss
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
Which of the following statements regarding replacement property under Section 1033 is CORRECT?
For an owner-user, the taxpayer’s use of the replacement property and of the involuntarily converted property must be the same (functional-use test).
The owner-investor’s properties must be used in similar endeavors as the previously held properties (taxpayer-use test).
A)
I only
B)
Both I and II
C)
II only
D)
Neither I nor II
Both statements are correct.
LO 6.2.3
During 2023, Stanton purchased several items of depreciable, tangible personalty—with a total cost of $3.04 million—for use in his business. Stanton has taxable (earned) income from his sole proprietorship of $360,000 (without regard to the Section 179 expense). He also has wages from a part-time job of $55,000.
What is the maximum Section 179 expense amount that Stanton may deduct in the current year?
A)
$360,000
B)
$930,000
C)
$415,000
D)
$1,080,000
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
On April 1 of the current tax year, Susan sold her principal residence for a total price of $501,000: $301,000 was in cash, with the buyer assuming a $200,000 mortgage on the house. Susan purchased the house 15 years ago for $290,000, but she has an adjusted basis of $80,000. She has not made any improvements to the house. To assist in the sale of the residence, she incurred costs of $1,500 for repairs three weeks before the sale occurred. Realtor commissions of $31,000 resulted from the sale. On May 1 of the current tax year, Susan bought a new residence for $260,000. What amount, if any, must be realized on the sale of Susan Sharp’s residence?
A)
$421,000
B)
$169,000
C)
$180,000
D)
$390,000
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
Dave owns equipment that has an adjusted basis of $10,000 and a fair market value of $75,000. Through an exchange, he acquires new equipment from Rachel that has a fair market value of $60,000 and an adjusted basis of $35,000. In the exchange, Dave receives $15,000 from Rachel. What is Dave’s substitute basis in the acquired property?
A)
$15,000
B)
$10,000
C)
$75,000
D)
$35,000
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
This year, Fay, who is single, has a short-term capital loss carryover of $5,000 and a long-term capital loss carryover of $40,000 (both carried over from the previous year). Her net short-term gain for this year is $6,000. Her net long-term gain for this year is $5,000. If her adjusted gross income before considering capital gains and losses is $94,000 this year, what will it be after considering her capital gains and losses?
A)
$91,000
B)
$94,000
C)
$93,000
D)
$60,000
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
If Marla, who is single, had $2,000 in net long-term capital gains and $4,000 in net short-term capital losses, what effect will these results have on her income taxes?
A)
Her net capital loss for the year will be $2,000, which may be deducted from her ordinary income.
B)
The $2,000 net gain will be taxed at a rate of 20%. The $4,000 net loss will be allowed to reduce her taxable income.
C)
Her net capital loss for the year will be $2,000, which must be carried forward to a year in which she has capital gains.
D)
The $2,000 net long-term gain will be taxed at Marla’s ordinary income tax rate.
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
Suzy, a single taxpayer, sells her residential rental property in the current year for $400,000. Suzy acquired the property in ten years ago for $300,000 and has been depreciating it using the straight-line method for realty under MACRS. Assume the amount of depreciation taken is $114,000. Suzy has taxable income of $190,000 and is in the 32% marginal income tax bracket.
What is the amount and character of the gain recognized as a result of the sale?
A)
$214,000 gain taxed at 25%
B)
$114,000 gain taxed at 25%, $100,000 gain taxed at 15%
C)
$214,000 gain taxed at 15%
D)
$114,000 gain taxed at 28%, $100,000 gain taxed at 15%
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.
Steven owned a duplex that he rented to tenants. He acquired the property several years ago for $296,000. He used the straight-line method of cost recovery, which totaled $75,000. Steven sold the property in February of the current year for $330,000. Steven is in the 32% marginal income tax bracket. What is the amount and nature of the gain on the sale?
A)
$34,000 regular long-term capital gain; $75,000 Section 1250 recapture
B)
$75,000 long-term capital gain
C)
$75,000 Section 1250 recapture
D)
$34,000 regular long-term capital gain; $75,000 unrecaptured Section 1250 income
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
Skip sold an automobile for $10,000 during the current tax year. The automobile had been used exclusively for business purposes. The cost basis was $18,000, which had been fully recovered through straight-line cost recovery deductions. The automobile was sold on an installment agreement, with a down payment of $1,000 and $2,000 principal payments beginning in the current year. What amount of gain must be recognized in the current year and next year, respectively?
A)
$10,000 and $0
B)
$1,000 and $2,000
C)
$0 and $2,000
D)
$3,000 and $2,000
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
In February, Jeremy purchased a new computer (five-year property) for use in his business. The cost of the computer was $4,300, while freight and setup charges totaled $600.
What is the first-year cost recovery deduction using the straight-line method?
A)
$490
B)
$430
C)
$860
D)
$790
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
During the current year, Sarah gave her daughter, Carol, 1,000 shares of publicly traded stock that Sarah purchased five years ago for $45,000. The stock was worth $100,000 at the time of gift. Sarah paid $41,000 in gift tax out of pocket as a result of this gift. What is Carol’s basis in the stock?
A)
$45,000
B)
$71,240
C)
$72,859
D)
$72,169
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
A taxpayer holds a lease on property that she uses as a warehouse for her manufacturing business. The interest would be classified as
A)
personal use property.
B)
property used in a trade or business.
C)
property held as a real estate investment.
D)
property held for the production of income.
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
during the current year, William purchased office furniture for his real estate offices at a total cost of $185,000. Due to a down real estate market, he only has taxable (earned) income of $15,000 from this sole proprietorship (without regard to the Section 179 expense). He took a part-time teaching job and has wages of $5,000.
What is the maximum Section 179 expense amount that William may deduct in the current year?
A)
$15,000
B)
$20,000
C)
$185,000
D)
$5,000
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
VUE Corp. entered into an equipment expansion in 2023. All of the equipment purchased totaled $215,000. Corporate taxable income before the election was $25,000. What is the maximum Section 179 expense election available to VUE Corp. in 2023?
A)
$215,000
B)
$190,000
C)
$0
D)
$25,000
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
During the current year, Peter has Section 1231 gains totaling $8,000. He also has $1,000 of Section 1231 losses. Four years ago, Peter reported a net Section 1231 loss of $2,000. These are the only two years in which Peter has had Section 1231 gains or losses.
What is the amount and character of the current year’s Section 1231 gains and losses?
A)
$5,000 ordinary income, $2,000 long-term capital gain
B)
$7,000 ordinary income
C)
$2,000 ordinary income, $5,000 long-term capital gain
D)
$7,000 long-term capital gain
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
Billy received 100 shares of stock from his uncle, Ray. Ray purchased the stock eight years ago for $12 per share. The fair market value on the date of Ray’s death was $9 per share, and the fair market value six months after the date of death was $10 per share.
Assume that Billy inherited the stock and that the administrator did not elect the alternate valuation date. What is Billy’s per-share basis in the acquired stock?
A)
$12.00
B)
$10.00
C)
$9.00
D)
$9.50
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
A taxpayer purchases a new computer for use in his consulting business. He incurs sales taxes and shipping charges in connection with the purchase. Which of the following correctly describes the treatment of the sales taxes and shipping charges?
A)
The sales taxes are capitalized, and the shipping charges are currently deductible.
B)
Both are capitalized.
C)
Both are currently deductible.
D)
The sales taxes are currently deductible, and the shipping charges are capitalized.
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
Bob is involved in a like-kind exchange. In the exchange, he assumes a mortgage of $15,000, is relieved of a mortgage of $26,000, and receives $7,000 in cash. How much boot did Bob receive in the transaction?
A)
$18,000
B)
$33,000
C)
$11,000
D)
$7,000
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
Dr. John Welch, a dentist, is a single taxpayer. For the 2023 tax year, he has a taxable income of $300,000. Included in the taxable income is $50,000 of net long-term capital gains from the sale of an antique clock collection. At what rate will his net capital gain be taxed?
A)
25%
B)
35%
C)
28%
D)
20%
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
Hugh owns and operates a construction company as a sole proprietorship. During February of the current year, he purchased and placed into service a truck with a cost of $14,200 plus sales tax of $800. The truck will be used exclusively in the business. Assume Hugh opts out of bonus depreciation and chooses to use the straight-line option under the Modified Accelerated Cost Recovery System (MACRS). What is the cost recovery deduction for the current year?
A)
$2,840
B)
$1,420
C)
$1,500
D)
$3,000
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
Warren owns and operates a bookstore as a sole proprietorship. During January of the current year, he purchased and placed into service office equipment (seven-year property) with a cost of $13,300 plus sales tax of $700. The equipment will be used exclusively in the business. Warren elected to use the straight-line method, and opted out of bonus depreciation. What is Warren’s adjusted basis in the equipment after the first year?
A)
$12,000
B)
$11,970
C)
$13,000
D)
$11,400
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
A client sold an apartment building last year for $100,000, paying a sales commission of $5,000 plus $2,500 in closing costs. The building originally cost $80,000 20 years ago. Total straight-line depreciation of $40,000 had been taken. The building had a mortgage of $60,000 that was assumed by the buyer. The client is in the 32% marginal income tax bracket. What is the amount and nature of the gain resulting from the sale?
A)
$60,000 gain: $40,000 Section 1250 recapture (ordinary income) and $20,000 of 25% long-term capital gain
B)
$60,000 gain: $40,000 of unrecaptured Section 1250 gain (25% long-term capital gain) and $20,000 of 15% long-term capital gain
C)
$52,500 gain: $40,000 of 25% long-term capital gain and $12,500 of 15% long-term capital gain
D)
$52,500 gain: $40,000 Section 1250 recapture (ordinary income) and $12,500 of 15% long-term capital gain
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
This year, Marshall sold several securities that left him with the following types of gains and losses:
Long-term capital gain: $4,000
Short-term capital gain: $900
Long-term capital loss: $1,100
Short-term capital loss: $500
What is the net capital gain or loss on Marshall’s security sales?
A)
Net long-term gain of $1,320
B)
Net long-term gain of $2,900 and net short-term gain of $400
C)
Net long-term gain of $1,160 and net short-term gain of $400
D)
Net long-term loss of $700
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
A client sold an apartment building last year for $100,000, paying a sales commission of $5,000 plus $2,500 in closing costs. The building originally cost $80,000 20 years ago. Total straight-line depreciation of $40,000 had been taken. The building had a mortgage of $60,000 that was assumed by the buyer. The client is in the 24% marginal income tax bracket. What is the purchaser’s cost basis?
A)
$70,000
B)
$100,000
C)
$92,500
D)
$107,500
b
The purchaser’s cost basis is simply what the purchaser paid for the property—$100,000.
LO 6.1.2
Three years ago, Mort purchased equipment for use in his business at a cost of $26,000. He claimed a Section 179 deduction in the year of acquisition of $10,000, and has since claimed cost recovery deductions totaling $7,604. The equipment was sold for $18,000. What is the amount of cost recovery deductions that must be recaptured?
A)
$8,396
B)
$9,604
C)
$0
D)
$7,604
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
On April 1 of the current tax year, Miriam sold her principal residence for a total price of $501,000: $301,000 was in cash, with the buyer assuming a $200,000 mortgage on the house. Miriam purchased the house 15 years ago for $290,000, but she has an adjusted basis of $80,000 due to a Section 1034 rollover. She has not made any improvements to the house. To assist in the sale of the residence, she incurred costs of $1,500 for repairs three weeks before the sale occurred. Realtor commissions of $31,000 resulted from the sale. On May 1 of the current tax year, Miriam bought a new residence for $260,000.
What is Miriam’s basis in the new residence?
A)
$140,000
B)
$10,000
C)
$290,000
D)
$260,000
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
Which of the following may be allowed as a like-kind exchange?
A)
Farmland exchanged for farming equipment
B)
An apartment building located in San Diego exchanged for an apartment building located in Acapulco, Mexico
C)
A parking lot exchanged for a shopping center
D)
A heifer exchanged for a bull
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
This year, Harold sold a rare painting to his neighbor, Ken, on the following terms:
The price was $6,000, equal to the fair market value.
Harold’s basis in the painting was $4,000.
Ken will pay in six annual installments of $1,000 plus accrued interest.
Ken will make the first installment payment this year.
Ignoring interest income, what amount of gain will Harold recognize for the current year?
A)
$6,000
B)
$667
C)
$333
D)
$1,000
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
The substitute basis of the qualifying asset received in a like-kind exchange is the asset’s
A)
fair market value increased by the gain realized but not recognized.
B)
fair market value reduced by the gain realized but not recognized.
C)
basis reduced by the gain realized but not recognized.
D)
basis increased by the gain realized but not recognized.
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
Ethel had the following from securities transactions during the current year:
Long-term capital gain: $6,400
Long-term capital loss: $2,200
Short-term capital gain: $2,300
Short-term capital loss: $5,500
Which of the following describes the net capital gain or loss reportable by Ethel for the current tax year?
A)
$1,000 net long-term capital gain
B)
$900 net long-term capital gain; $100 net short-term capital loss
C)
$1,000 net long-term capital loss
D)
$4,200 net long-term capital gain; $3,200 net short-term capital loss
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
Eleven months ago, Lynnette received 1,000 shares of stock from her uncle, Joseph. Joseph purchased the stock eight years ago for $12 per share. The fair market value on the date of the gift to Lynnette was $9 per share, and she sold the stock today for $5 per share. What is the amount and character of Lynnette’s loss from the sale of the stock?
A)
$7,000 long-term capital loss
B)
$4,000 short-term capital loss
C)
$3,000 short-term capital loss
D)
$3,000 long-term capital loss
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
During the current tax year, Rod purchased a building for exclusive use in his manufacturing business. The cost of the property was $422,000, of which $122,000 was attributable to the land. Which of the following statements identifies the proper treatment of the expenditure?
A)
The $122,000 must be capitalized and may be depreciated.
B)
The cost attributable to the building may be deducted under Section 179.
C)
The $122,000 must be capitalized and may not be depreciated.
D)
The $300,000 attributable to the building may be currently deductible.
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
During the current tax year, Jamie sold several securities that resulted in the following types of gains and losses: a long-term capital loss of $6,700; a short-term capital loss of $7,000; a long-term capital gain of $1,900; and a short-term capital gain of $9,200. What is the net capital gain or loss on Jamie’s security sales?
A)
Net long-term loss of $4,800; net short-term gain of $2,200
B)
Net short-term gain of $7,300; net long-term loss of $300
C)
Net short term loss of $3,800
D)
Net long-term loss of $2,600
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
Three years ago, Sam received a gift of 100 shares of common stock from his uncle. The fair market value of the stock on the date of the gift was $12 per share. His uncle had purchased the stock four years earlier at $5 per share. Sam sold this stock for $17 per share last week. What was Sam’s per-share basis in the stock when it was sold?
A)
$17
B)
$12
C)
$5
D)
$22
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
In the current tax year, Fay has short-term capital loss carryovers of $5,000 and long-term capital loss carryovers of $40,000, both carried over from the previous year. Her net short-term gain for this year is $6,000, and her net long-term gain for this year is $5,000. How much of her gain for this year will be taxable?
A)
$1,000
B)
$6,000
C)
$0
D)
$5,000
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.
Your client is contemplating the exchange of two parcels of investment land for two similar parcels. Given the following details of the proposed transactions, compute the amount of recognized gain and loss, if any, on both parcels if your client does the exchanges.
Parcel A: There were 10 acres of land acquired 15 years ago with a current basis of $50,000. In exchange, your client will receive 8 acres of land (FMV $80,000) and $20,000 of cash.
Parcel B: There were 20 acres of land acquired 2 years ago with a current basis of $100,000. In exchange, your client will receive 12 acres of land (FMV $75,000) and $10,000 of cash.
A)
Parcel A recognized gain: $20,000; Parcel B recognized loss: $0
B)
Parcel A recognized gain: $50,000; Parcel B recognized loss: $10,000
C)
Parcel A recognized gain: $20,000; Parcel B recognized loss: $15,000
D)
Parcel A recognized gain: $20,000; Parcel B recognized loss: $10,000
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
Jane owns a printing business. She wants to trade her old copiers for new fax machines. In the contemplated exchange, Jane will pay $750 in cash. Additional information related to the transaction is given as follows:
The copiers have an adjusted basis of $1,500.
The copiers have a fair market value of $1,000.
The fax machines have a fair market value of $1,750.
What is Jane’s recognized gain or loss in this exchange?
A)
($250)
B)
$500
C)
($500)
D)
$0
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
Susan received 100 shares of stock as a gift from her uncle, Carl. Carl purchased the stock 15 years ago for $12 per share. Susan received the stock from Carl two months ago, when the fair market value of the stock was $15 per share, and she sold the stock this week for $19 per share. What is the amount and character of Susan’s gain from the sale of the stock?
A)
$700 short-term capital gain
B)
$400 long-term capital gain
C)
$400 short-term capital gain
D)
$700 long-term capital gain
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
Which of the following statements is accurate with respect to a like-kind exchange?
A)
No gain will be recognized on the exchange of inventory.
B)
No gain will be recognized unless the taxpayer receives boot.
C)
The amount of gain recognized will reduce the taxpayer’s basis in the property received.
D)
Gain recognized is equal to the gain realized on the exchange plus the boot received.
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
A client sold an apartment building last year for $100,000, paying a sales commission of $5,000 plus $2,500 in closing costs. The building originally cost $80,000 20 years ago. Total straight-line depreciation of $40,000 had been taken. The building had a mortgage of $60,000 that was assumed by the buyer. The client is in the 24% marginal income tax bracket. What is the seller’s adjusted cost basis?
A)
$37,500
B)
$40,000
C)
$52,500
D)
$32,500
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
Jim owns an apartment building with a fair market value of $225,000 and an adjusted basis of $85,000. He wants to acquire Frank’s duplex, which has a fair market value of $240,000 and an adjusted basis of $130,000. In the exchange, Jim will pay Frank $15,000 in cash. What is Jim’s substitute basis in the acquired duplex?
A)
$240,000
B)
$140,000
C)
$100,000
D)
$225,000
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
Phillip’s personal automobile was almost destroyed in an accident. The insurance company paid $6,000 on the claim. The auto’s fair market value before the accident was $16,000, and the value after the accident was $1,000. His basis in the automobile was $12,000. Phillip’s AGI is $42,500. What is the amount of Phillip’s deductible casualty loss?
A)
$6,000
B)
$1,750
C)
$0
D)
$1,650
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
During 2023, Judy, a sole proprietor, purchased new equipment (seven-year property) for her manufacturing business at a cost of $600,000. Judy is in a 12% marginal income tax bracket this year, and expects to be in that bracket for two more years. She is extremely confident that she will be in the highest marginal bracket after that. What advice would you give Judy regarding the use of bonus depreciation and cost recovery deductions?
A)
Forgo bonus depreciation and elect the straight-line method.
B)
Use the maximum bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.
C)
Forgo bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.
D)
Use the maximum bonus depreciation and elect the straight-line method.
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
In February, Bryan purchased a new high-speed copier for use in his printing business. The cost of the copier was $8,250, sales taxes were $550, and installation charges totaled $1,200. Assume that Bryan opts out of the bonus depreciation provision. What is the first-year cost recovery deduction using the straight-line method?
A)
$1,000
B)
$945
C)
$2,000
D)
$880
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
Marcus purchased a diamond ring for $15,000 10 years ago. It was stolen in March this year. The ring was purchased to celebrate achieving a significant promotion at work. The FMV at the time of the theft was $20,000. The ring was insured, and after the deductible, Marcus received $19,000 from the insurance company. Marcus replaced the ring with a new one for $20,000. Under Section 1033, what is Marcus’s new basis in the replacement ring?
A)
$15,000
B)
$20,000
C)
$16,000
D)
$19,000
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
Jerry owns a dry-cleaning business. During the current year, Jerry purchased and placed into service $730,000 of equipment. He had taxable income of $745,000. Jerry is in the highest marginal income tax bracket this year, and expects to be in that bracket for two more years. After that, he plans to semi-retire, but keep the business open for another five years. He expects to drop into the lowest marginal bracket when he semi-retires. What advice would you give Jerry regarding the use of Section 179, bonus depreciation, and cost recovery deductions?
A)
Use the bonus depreciation provision.
B)
Forgo Section 179 and bonus depreciation and elect the straight-line method.
C)
Elect the maximum Section 179 and elect the straight-line method.
D)
Forgo Section 179 and bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.
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
Which of the following statements regarding Section 1033 involuntary conversions is CORRECT?
For an owner-user, the replacement property must pass the functional use test.
The taxpayer use test provides less flexibility than the functional use test.
A)
I only
B)
Neither I nor II
C)
II only
D)
Both I and II
a
Statement II is incorrect. The taxpayer use test provides more flexibility than the functional use test.
LO 6.2.3
John owns a classic automobile that had a cost basis of $32,000. John paid $38,000 to have the automobile fully restored. John sells the automobile through an installment sale for $100,000. John is to receive a $25,000 down payment in the current year, and $15,000 per year for five years, beginning this year. What amount of gain must John recognize during the current year?
A)
$12,800
B)
$4,500
C)
$12,000
D)
$7,500
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
Frank, a single taxpayer, owned a warehouse that he rented as commercial property. He acquired the property several years ago for $196,000. He used the straight-line method of cost recovery, which totaled $35,000. Frank sold the property in February of the current year for $230,000. Frank is single, and has taxable income (not including the real estate gain) of $475,000. What is the amount and nature of the gain on the sale?
A)
$69,000 ordinary income
B)
$7,000 ordinary income
C)
$34,000 Section 1231 gain; $35,000 ordinary income
D)
$35,000 unrecaptured Section 1250 gain; $34,000 long-term capital gain
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
Which of the following dispositions of Section 1245 recapture property would result in the immediate recapture of some or all of previous depreciation deductions?
A)
A transfer at death
B)
A gift of the property
C)
A distribution by a partnership to its partners
D)
A sale for cash and an interest-bearing note
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
Max is selling a truck that he uses in his business. He has taken $5,000 of depreciation on the truck and wants to use the installment sale method to sell the truck to Jerry for a down payment and an installment note over 36 months. He paid $40,000 for the truck and is selling it for $38,000. What are the tax consequences of this transaction?
Max must recapture $3,000 of the Section 1245 depreciation taken as ordinary income in the year of the sale.
Max has $5,000 of depreciation recapture taxed at the 25% tax rate.
A)
Both I and II
B)
Neither I nor II
C)
I only
D)
II only
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
Which of the following rules regarding the sale of Section 1231 property is CORRECT?
When Section 1231 property is sold for more than the purchase price, the gain is afforded capital gain treatment and taxed using capital gain tax rates.
When Section 1231 property is sold at a loss, the loss is treated as a capital loss.
A)
II only
B)
I only
C)
Neither I nor II
D)
Both I and II
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
All of the following statements regarding the installment method of reporting gain from a disposition of property are correct except
A)
an installment sale is a sale of property in which the seller receives at least one payment after the year of sale.
B)
the payments received under an installment sale may each include capital gains, return of capital, and interest.
C)
the installment method permits the seller to spread out the taxable gain over more than one year.
D)
the installment sale method may be used for securities sold in the secondary market.
d
The installment sale method cannot be used for inventory or securities traded in the secondary market.
LO 6.2.4
Blake, a sole proprietor, is selling several business assets. He has been told by a friend that the items he is selling are not capital assets and are subject to the ordinary income tax rate. You are his financial planner and tell him that the gains on Section 1231 assets can be treated as capital gains for income tax purposes subject to certain rules. Which of the assets Blake sold are Section 1231 assets?
A)
The building and land sold when Blake’s business moved to a new location
B)
A copyright on the theme song Blake’s company uses in its advertising that Blake wrote
C)
Blake’s inventory of electric guitars his business manufactures
D)
Accounts receivable
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
Helen purchased an antique cabinet as an investment for $30,000 a few years ago. On January 15 of this year, she sold the cabinet to an art museum for $120,000 in an installment sale. She received a down payment of $12,000 and a note requiring monthly principal payments (to begin in March of this year) of $5,000. What amount of gain must Helen recognize for the current year?
A)
$42,500
B)
$50,000
C)
$46,500
D)
$62,000
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
During 2023, your client, Bob, purchased several items of equipment with a total cost of $265,000 for use in his sole proprietorship. Bob has taxable (earned) income from his Schedule C business of $112,000 (without regard to the Section 179 expense). He also has wages from a part-time job of $10,000. What is the maximum amount of Section 179 expense that Bob may deduct in the current year?
A)
$265,000
B)
$112,000
C)
$1,160,000
D)
$122,000
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
On December 20, 2006, Jody moved into a condominium that she owns and had rented to tenants since July 1, 1999. Her cost basis in the condo was $238,440. Jody took depreciation deductions totaling $54,000 for the period that she rented the property. After moving in, she used the residence as her principal residence. Jody sells the property on August 1, 2023, for $538,000. Jody is in the highest marginal income tax bracket for the current year. What is the amount and character of the recognized gain resulting from the sale?
A)
$353,560 “regular” long-term capital gain
B)
$54,000 of ordinary income; $49,560 of “regular” long-term capital gain
C)
$54,000 of unrecaptured Section 1250 income; $49,560 of “regular” long-term capital gain
D)
$54,000 of unrecaptured Section 1250 income; $299,560 of “regular” long-term capital gain
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
During the current tax year, Jim purchased a warehouse for exclusive use in his manufacturing business. The cost of the property was $620,000, of which $100,000 was attributable to the land. Which of the following statements identify the proper treatment of the expenditure?
A portion of the cost attributable to the building may be deducted under Section 179.
The $100,000 attributable to the land must be capitalized and may not be depreciated.
The $520,000 attributable to the building must be capitalized and depreciated.
The entire $620,000 must be capitalized and depreciated.
A)
IV only
B)
II and III
C)
I and II
D)
II only
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
Mary has owned her principal residence for over six years. Two years ago, she married John, who immediately moved into the residence. John has never used the Section 121 exclusion. If Mary sells the residence this year and John and Mary file a joint return, which of the following statements is CORRECT with respect to the availability of the Section 121 exclusion?
A)
The maximum exclusion is $500,000 because Mary has at least two years of ownership, and both spouses meet the use requirement.
B)
The maximum exclusion is $250,000 because John is not an owner of the residence.
C)
The maximum exclusion is $250,000 because that is the maximum exclusion for an individual who was single when the residence was purchased.
D)
The maximum exclusion is $500,000 because that is the amount always available for married taxpayers who file jointly.
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
