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
