REG 26 - Property Transactions 3 - Like Kind/Involentary Conversions

Question 1

Hogan exchanged a business-use machine having an original cost of $100,000 and accumulated depreciation of $30,000 for business-use equipment owned by Baker having a fair market value of $80,000 plus $1,000 cash. Baker assumed a $2,000 outstanding debt on the machine. What taxable gain should Hogan recognize? 
 A.   $0  
 B.   $3,000 
 C.   $10,000 
 D.   $11,000

Answer 1

This is a qualified like-kind exchange because a machine was exchanged for equipment and Hogan's use for each is for business purposes. 
  Amount Realized:       
    Equipment received   $80,000    
    Cash  1,000    
    Debt relief   2,000     
    Total    $ 83,000  
  Adjusted Basis:      
    Cost  $100,000    
    Depreciation   (30,000)     
          (70,000)   
  Realized Gain    $13,000  

Debt relief and the cash received are both considered to be boot received, which is a total of $3,000. The recognized gain is the lower of the realized gain, $13,000, or boot received, $3,000.

Question 2

T/F: Replacement property in an involuntary conversion must be like kind property.

Answer 2

False.
The replacement property must be similar or related in the service or use made by the taxpayer.
This means the end use of the replacement property must be similar to the use of the converted property.

Question 3

T/F: Replacement property in an involuntary conversion must be purchased within two years of the close of the conversion.

Answer 3

False.
The replacement must be made within two years from the END of the tax year in which the gain is realized.
The replacement period is extended to three years if the conversion was a condemnation of business realty.

Question 4

In year 1, a taxpayer sold real property for $200,000, receiving $100,000 at closing and $100,000 plus accrued interest at the prime rate in the next year. The buyer also assumed a $50,000 mortgage on the property. The taxpayer's adjusted basis was $75,000, and the taxpayer incurred $10,000 of selling expenses. If this transaction qualifies for installment sale treatment, what is the gross profit on the sale?
 A.   $115,000 
 B.   $125,000 
 C.   $165,000 
 D.   $175,000

Answer 4

C. The gross profit on the sale is the amount realized less the property’s adjusted basis. The amount realized is $200,000 + $50,000 debt relief - $10,000 selling expenses, or $240,000. The $240,000 is reduced by the basis of $75,000 to produce the gross profit of $165,000.

Question 5

Aviary Corp., a sole proprietorship, sold a building for $600,000. Aviary received a down payment of $120,000 as well as annual principal payments of $120,000 for each of the subsequent four years. Aviary purchased the building for $500,000 and claimed depreciation of $80,000. What amount of gain should Aviary report in the year of sale using the installment method? 
 A. $180,000
 B. $120,000
 C. $54,000
 D. $36,000

Answer 5

D. Aviary’s basis in the building is $420,000 ($500,000 cost - $80,000 depreciation). Aviary’s gain on the sale of the building is $180,000 ($600,000 amount realized - $420,000 basis). On the installment basis, the $180,000 gain is reported pro-rata as payments are received. In the year of sale, 20% ($120,000/$600,000) of the total payments of $600,000 are received. Thus, 20% of the gain is recognized, or $36,000 ($180,000 x 20%).

Question 6

A married couple purchased their principal residence for $300,000. They spent $40,000 on improvements. After living in it for 10 years, the couple sold the home for $650,000 and paid $36,000 in real estate commissions. What gain should the couple recognize on their joint return? 
 A.   $0 
 B.   $ 60,000 
 C.   $274,000 
 D.   $310,000

Answer 6

A. Since this is a married couple that meets the ownership and use test they can exclude up to $500,000 of gain on the sale of a principal residence. Thus, none of the $274,000 gain is included in income.

Question 7

T/F: An installment sale cannot be used to defer the recognition of gains on the sale of inventory.

Answer 7

True

Question 8

T/F: The gross profit percentage in an installment sale is the amount of the realized gain divided by the liabilities assumed by the buyer of the property.

Answer 8

False.
A “gross profit percentage” is multipled by the cash received to determine the gain recognized.

Gross profit= sales price less basis of asset sold
GP %= gross profit / contract price