Section 2: Income & Assets Unit 7: Capital Gains & Losses Flashcards
Question ID: 94849658 (Topic: Capital Gains and Losses)
Haley purchased stock in a mutual fund six years ago for $200. On January 1, she received a non-dividend distribution of $160. She did not include this amount in her income, but she reduced the basis of her stock to $40. On December 31, Haley received another non-dividend distribution of $60. What amount of gain, (if any), must Haley report from these transactions, and what is her new basis in the stock?
A. Basis: $40; long-term capital gain: $60.
B. Basis: $0; long-term capital gain: $20.
C. Basis: $60; no gain.
D. Basis: $0; no gain.
Correct Answer Explanation for B:
The first $40 of the non-dividend distribution reduces the basis of Haley’s stock to zero. She must report the other $20 as a long-term capital gain. The answer is figured as follows:
Beginning cost basis: $200
Minus non-dividend distribution: ($160)
New basis: $40
The second non-dividend distribution ($60) reduces her stock basis to $0.
The remaining $20 must be reported as a capital gain.
Question ID: 94815934 (Topic: Capital Gains and Losses)
When does an individual taxpayer’s capital loss carryover expire?
A. 5 years.
B. Never.
C. 10 years.
D. Upon the taxpayer’s death.
Correct Answer Explanation for D:
Capital losses can be carried forward indefinitely during a taxpayer’s lifetime. However, capital loss carryovers do expire upon a taxpayer’s death. The losses do not carryover to the taxpayer’s estate, because the decedent and estate are treated as separate tax entities. To learn more about capital gains and losses, see IRS Topic No. 409 Capital Gains and Losses.
Question ID: 94849703 (Topic: Capital Gains and Losses)
Jayden sold stock during the year and had a $24,000 capital gain. He is only a casual investor and not a stockbroker or securities dealer. His capital gains should be reported by using which forms?
A. Schedule D only.
B. Schedule D and Form 8949.
C. Schedule C.
D. Schedule B.
Correct Answer Explanation for B:
Jayden should use Schedule D and Form 8949 to report his capital gains and losses.
Question ID: 94850076 (Topic: Capital Gains and Losses)
Jenny owns stock that became worthless last year, because the corporation filed for bankruptcy. Her basis in the stock is $5,500, which is how much she originally paid. She did not sell the stock. The only other income she has for the year is $52,000 in wages. Is her loss deductible, and if so, how should she report the loss?
A. This loss should be reported as a bad debt deduction on Schedule A.
B. She cannot take a capital loss until she sells the stock to an unrelated buyer.
C. This loss should be reported as a casualty loss. She can take the entire $5,500 loss in the current year.
D. This loss should be reported as a capital loss, which would be limited to $3,000 in the current year. Any unused losses would be carried forward.
Correct Answer Explanation for D:
Jenny should report the loss as a capital loss; the loss would be limited to $3,000 in the current year, and she can carryover the unused loss indefinitely. If a taxpayer owns stock that becomes totally worthless, this would be reported as a capital loss on Schedule D. The stock does not have to be sold if the stock is truly worthless, because worthless securities have no market value. See more about the rules for worthless securities.
Question ID: 94849604 (Topic: Capital Gains and Losses)
Larry bought 140 shares of stock from his sister, Ezra, for $7,600. Her original cost basis on the stock was $10,000. Larry sold all the shares two years later through a stockbroker for $11,500. What is his recognized gain on the sale?
A. $2,400 gain.
B. $1,500 gain.
C. $6,100 gain.
D. $3,900 gain.
Correct Answer Explanation for B:
The sale between Larry and his sister is a related-party transaction, and is therefore subject to special rules. If, in a purchase or exchange, a taxpayer received property from a related person who had a loss that was not allowable and the taxpayer later sells the property at a gain, the taxpayer will recognize the gain only to the extent it is more than the loss previously disallowed to the related person. Although Ezra lost $2,400 in the original sale to her brother, the loss was not deductible. When Larry later sold the same stock to an unrelated party for $11,500, he realized a gain of $3,900. However, the recognized gain is only $1,500 (the portion of the gain that is more than the $2,400 loss not allowed to his sister).
Question ID: 94849568 (Topic: Capital Gains and Losses)
On January 1, Geneva paid $10,000 for 100 shares of stock in Agri-Barn, Inc. a start-up company. Six months after she bought it, she sold the stock to her brother, Henry, for $8,000, which was its current market value. Two months later, the stock suddenly shoots up in value, and on December 31, Henry sells all the stock to an unrelated party for $16,000. What gain or loss should Geneva and Henry recognize on their tax returns in the year of sale?
A. Geneva recognizes $2,000 capital loss; Henry recognizes $8,000 capital gain.
B. Geneva recognizes $0 capital loss; Henry recognizes $6,000 capital gain.
C. Geneva recognizes $2,000 capital loss; Henry recognizes $7,000 capital gain.
D. Geneva recognizes $0 capital loss; Henry recognizes $8,000 capital gain.
Correct Answer Explanation for B:
This is a related party transaction, and special rules apply. Geneva recognizes $0 capital loss; Henry recognizes $6,000 capital gain. This is because Geneva cannot claim a loss on the sale of stock to her own brother. Losses from sale or exchange of property, directly or indirectly, are disallowed between related parties. When the property is later sold to an unrelated party, any previously disallowed loss may be used to offset gain on that transaction. However, since Henry sold the stock at a profit, he would be able to use the basis of the original seller (his sister’s basis was $10,000, this is called a “transferred basis”) in order to calculate his own gain on the sale.
Question ID: 94849515 (Topic: Capital Gains and Losses)
Karen bought 50 shares of Roca-Cola, Inc. stock for $475 on March 31, 2023. On November 15, 2023, Karen received a non-taxable distribution of $155 on the 50 shares of stock she owned. She sold the stock for $300 on December 22, 2023. What is her gain or loss on the sale?
A. $175 capital gain
B. $175 capital loss
C. $20 capital gain
D. $20 capital loss
Correct Answer Explanation for D:
Karen has a $20 capital loss on the sale. Her loss in figured as follows:
Starting basis $475
Minus nontaxable distribution ($155)
Basis after distribution $320
Sale price $300
Loss ($20)
She has a capital loss of $20. Since she held the stock for less than a year, it would be treated as short-term. (Based on a prior EA exam question).
Question ID: 94849658 (Topic: Capital Gains and Losses)
Haley purchased stock in a mutual fund six years ago for $200. On January 1, she received a non-dividend distribution of $160. She did not include this amount in her income, but she reduced the basis of her stock to $40. On December 31, Haley received another non-dividend distribution of $60. What amount of gain, (if any), must Haley report from these transactions, and what is her new basis in the stock?
A. Basis: $0; long-term capital gain: $20.
B. Basis: $60; no gain.
C. Basis: $0; no gain.
D. Basis: $40; long-term capital gain: $60.
Correct Answer Explanation for A:
The first $40 of the non-dividend distribution reduces the basis of Haley’s stock to zero. She must report the other $20 as a long-term capital gain. The answer is figured as follows:
Beginning cost basis: $200
Minus non-dividend distribution: ($160)
New basis: $40
The second non-dividend distribution ($60) reduces her stock basis to $0.
The remaining $20 must be reported as a capital gain.
Question ID: 94849682 (Topic: Installment Sales)
Eveline sells a condo to her friend, Fred, for $200,000. Her basis was $150,000 and her gross profit is $50,000. Instead of using a lender, Eveline carries the note for her friend, and will receive five annual payments of $40,000, plus interest, until the note is paid off. She receives the first principal payment of $40,000 from Fred on December 30, 2023 She wants to use the installment method to report income from the sale. What is the amount of installment sale income that Eveline must report in the current year?
A. $40,000
B. $10,000
C. $8,000
D. $0
Correct Answer Explanation for B:
This is an example of an installment sale. Eveline’s gross profit percentage is 25% ($50,000 annual payments ÷ $200,000 sales price). Eveline would report 25% of each principal payment, (25% × $40,000) = $10,000, as installment sale income from the sale for the tax year she receives the payment (after subtracting interest, if any). The balance of each payment, exclusive of interest, is the tax-free return of her adjusted basis.
Note: The “installment method” only applies when a taxpayer has a gain on the sale. If the taxpayer incurs a loss on the sale, the installment method does not apply. For more information, see IRS Publication 537, Installment Sales.
Question ID: 94849618 (Topic: Installment Sales)
Cassie sells a plot of land with an adjusted basis of $150,000 on January 1, 2023, under an installment sale. The buyer agrees to pay $200,000, with a cash down payment of $50,000 and $30,000 (plus 4% interest) in each of the next five years. What is Cassie’s gross profit on the installment sale, and what amount is taxable in 2023?
A. Gross profit $25,000; $5,000 taxable.
B. Gross profit $50,000; $10,000 taxable.
C. Gross profit $50,000; $12,500 taxable.
D. Gross profit $25,000; $25,000 taxable.
Correct Answer Explanation for C:
This is an installment sale. Cassie’s overall gross profit is $50,000 ($200,000 selling price - $150,000 adjusted basis), and her gross profit percentage is 25% ($50,000 ÷ $200,000). She must report 25% of each payment received (excluding the portion representing interest income) as gain from the sale. Thus, $12,500 (25% of the $50,000 down payment) is taxable in the current year. For more information on installment sales, see IRS Publication 537, Installment Sales.
Question ID: 94849660 (Topic: Installment Sales)
Peggy sold two acres of land to her brother, Zeke on January 1. She realized a gain of $50,000 on the sale. Zeke agreed to pay her in five annual installments, and Peggy treats the sale as an installment sale. On November 1, eleven months after he purchased the land, Zeke sold the land to another person. Zeke plans to keep making installment payments based on their original agreement. How does this sale affect Peggy?
A. The installment sale method is disallowed to Peggy, and Peggy must report the entire gain of $50,000 on the sale, even though she has not received all the installment payments.
B. There is no effect to Peggy from Zeke’s sale of the land to another party.
C. The new sale invalidates the earlier sale and Peggy will not have to report any gain.
D. Both Zeke and Peggy will face IRS penalties for selling the land before the required two-year holding period for installment sales between related persons.
Correct Answer Explanation for A:
Installment sales to related persons are generally allowed. However, if a taxpayer sells property to a related person who then subsequently, the buyer sells or disposes of the property within two years of the original sale, the original seller will lose the benefit of installment sale reporting. Peggy must report the entire gain of $50,000, even though she has not received all of the installment payments.
Question ID: 94849533 (Topic: Installment Sales)
The installment sales method can’t be used for some types of transactions. Which of the following transactions would be allowable under the installment method?
A. Sale of real property.
B. Sale of stock or securities.
C. Sale of inventory.
D. Dealer sales.
Correct Answer Explanation for A:
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. The sale of real property or real estate is an allowable transaction under the installment sales method. Dealer sales, sales of inventory, and the sale of securities cannot be reported under the installment method.
To learn more about the rules for installment sales, see IRS Topic No. 705 Installment Sales.
Question ID: 94849635 (Topic: Installment Sales)
Mario sells a plot of farmland to his friend Natalie. The farmland has a basis of $70,000 and he sold it to Natalie for $140,000. Mario’s gross profit is $70,000. Rather than using a bank loan, Mario offers to carry the note for Natalie, the buyer. Mario receives a $28,000 down payment on June 1, 2023, from Natalie, as well as a notarized buyer’s note for $112,000. The note provides for four annual payments of $28,000 plus 7% interest. Exclusive of the interest income, what amount must Mario report as taxable gain in 2023?
A. $8,750
B. $0
C. $17,500
D. $14,000
Correct Answer Explanation for D:
This is an installment sale. In this example, Mario’s gross profit percentage on the sale is 50% ($70,000 ÷ $140,000). He must report as his installment gain this same percentage of each $28,000 payment received ($28,000 × 50% = $14,000). In each year a taxpayer receives a payment related to an installment sale, he must report the interest income and the applicable portion of his gain on the sale. The taxpayer does not include in income the part that is the return of his basis in the property. This is the “installment sale method” of recognizing income.
Note: The “installment sale method” for reporting taxable income on an installment sale only applies when the taxpayer has a gain on the sale of the property. It does not apply when the taxpayer sells property at a loss. For more information about installment sales, see IRS Publication 537, Installment Sales.
Question ID: 94849663 (Topic: Other Capital Asset Topics)
Praveen purchased a rental apartment building several years ago for $140,000. She made major improvements at a cost of $40,000 and deducted depreciation of $20,000. Praveen started having financial difficulties during the year, so she sold the building on December 10, 2023 for $200,000 cash and also received a used diesel truck with a fair market value of $40,000 from the buyer. The buyer also paid Praveen’s delinquent real estate taxes of $6,000 and assumed an existing mortgage of $34,000 on the building. Praveen also incurred selling expenses of $8,000. What is Praveen’s taxable gain on the sale?
A. $80,000
B. $112,000
C. $20,000
D. $104,000
Correct Answer Explanation for B:
Praveen’s basis in the property was $160,000 ($140,000 + $40,000 – $20,000). She received net proceeds of $272,000 ($200,000 + $40,000 + $34,000 + $6,000 – $8,000), resulting in a realized gain of $112,000.
- Melissa purchased 1,000 shares of Sunshine Foods, Inc. stock five years ago at $10 per share. She sold 900 shares on January 15, 2023, at $9 per share, resulting in a $900 loss. Melissa’s husband, Singh, purchased 900 shares of Sunshine Foods Inc. stock on February 10, 2023. Singh and Melissa keep their finances separate and will file separate tax returns. Which of the following statements is correct?
A. Melissa can deduct the $900 capital loss on her tax return.
B. Melissa has a wash sale, and her loss is not deductible.
C. Singh can deduct the loss on his separate tax return.
D. None of the above.
- The answer is B. Melissa’s capital loss is disallowed. Melissa has a wash sale because her spouse repurchased identical securities within 30 days. It does not matter if they file separate returns. If a taxpayer sells the stock and her spouse then repurchases identical stock within 30 days, the taxpayer
has a wash sale. The fact that the taxpayers file MFS is irrelevant—the wash sale rules still apply, even
if the taxpayers file separate returns.
