Tax Ch 10 Basic Rules, Depreciation

Question 1

Amortization is cost recovery for intangible assets.

a. True b. False

Answer 1

a. True

Question 2

The Section 179 election allows business owners to expense property placed in service during the year instead of capitalizing it.

a. True b. False

Answer 2

a. True

Question 3

Section 179 treatment cannot result in a loss for the business.

a. True b. False

Answer 3

a. True

Question 4

Five years ago, Carlton purchased 1,000 shares of Ickingham Industries, Inc. for $10 per share. He signed an agreement with the company which allowed the company to use his dividend payments to purchase additional shares for him. Over the last 5 years, Carlton received a total of $1,200 in dividend payments, which purchased an additional 100 shares of stock. If Carlton sells all of his shares for $24,000, what is his taxable gain?

a. $0
. b. $12,800.
c. $14,000.
d. $24,000

Answer 4

The correct answer is b.

Carlton’s adjusted basis in the shares equals the initial purchase price of the shares, $10,000 plus the dividends that were reinvested of $1,200 since Carlton was required to pay tax on the dividend
payments the year they were made.

When he sells the shares, he has an amount realized of $24,000, less
his adjusted basis of $11,200, which equals a taxable gain of $12,800

Question 5

Which of the following items is not included in the cost basis of an investment?

a. Cash used to purchase the investment.
b. Recourse debt incurred in purchasing the investment.
c. Nonrecourse debt incurred in purchasing the investment.
d. The fair market value of property transferred to acquire the investment.

Answer 5

The correct answer is c.

Nonrecourse debt is generally not included in basis because a taxpayer is not personally obligated to
repay the loan. All of the other items are included in the determination of a taxpayer’s basis in their
investment.

Question 6

When Uncle Phil died in 2023, he left his estate to his ungrateful cousin, Will. Uncle Phil’s cost basis in his property was $2 million but, due to turbulent political and economic times, it was only worth $1 million at his death. Uncle Phil had reinvested approximately $250,000 of dividends during his holding period, and his estate paid $500,000 in transfer taxes at his death. What is Will’s basis in the property?

a. $1,000,000.
b. $2,000,000.
c. $2,250,000.
d. $2,750,000.

Answer 6

The correct answer is a.

Section 1014 can result in a step-down in basis as well as a step-up in basis.

Since the property was worth $1 million as of the date of Uncle Phil’s death, that is the basis of the property in Will’s hands despite the fact that Uncle Phil had $2,250,000 in after-tax capital invested in the property and his estate paid transfer taxes of $500,000.

Question 7

Two months after Hillary purchased Jazz Acres for $25,000, she died. The fair market value of Jazz Acres as of the date of Hillary’s death was $32,000. She left Jazz Acres to her daughter, Vivian. Since Vivian was the only beneficiary of the estate and there were no estate taxes due, the title to the property was transferred to Vivian within one month of Hillary’s death. Two weeks after receiving title to the property, Vivian sold Jazz Acres for $35,000.

What is the amount of taxable gain that Vivian will realize on the sale?

a. $3,000.
b. $7,000.
c. $10,000.
d. $35,000.

Answer 7

The correct answer is a.

When Hillary died the basis of Jazz Acres qualified for a step-to fair market values under IRC Section 1014.

Vivian’s basis in the property is therefore $32,000.

Since she sold the property for $35,000 and her basis was $32,000, Vivian’s gain is $3,000.

Question 8

All of the following statements concerning depreciation are correct except:

a. Depreciation is a method of cost recovery that allows a taxpayer to receive their capital back over the useful life of an asset.

b. Assets purchased for personal use are eligible for depreciation deductions

. c. Depreciation deductions cause a downward adjustment in the taxpayer’s basis.

d. Depreciation on real estate is taken on a straight-line basis.

Answer 8

The correct answer is b.

Assets purchased for personal use are not eligible for depreciation deductions – only assets used in a trade or business or for the production of income qualify for depreciation deductions.

All of the other statements are correct.

Question 9

Two months after Hillary purchased Jazz Acres for $25,000, she died. The fair market value of Jazz Acres as of the date of Hillary’s death was $32,000. She left Jazz Acres to her daughter, Vivian. Since Vivian was the only beneficiary of the estate and there were no estate taxes due, the title to the property was transferred to Vivian within one month of Hillary’s death. Two weeks after receiving title to the property, Vivian sold Jazz Acres for $35,000.

What is the amount of taxable gain that Vivian will realize on the sale?

3,000.
$7,000.
$10,000.
$35,000.

Answer 9

$3,000.
Rationale

When Hillary died, the basis of Jazz Acres qualified for a step-to fair market values under IRC Section 1014. Vivian’s basis in the property is therefore $32,000. Since she sold the property for $35,000 and her basis was $32,000, Vivian’s gain is $3,000.

Question 10

Two years ago, Amanda purchased 100 shares of Quick Produce, Inc. for $15,000. Unfortunately, the value of the shares has dropped to $10,000. Amanda gave the stock to her daughter, Daphna, when it was worth $10,000.

If Daphna sells the shares for $17,000 three months after the transfer, what is the amount and character of her gain or loss?

$2,000 short-term capital gain.
$2,000 long-term capital gain.
$7,000 short-term capital gain.
$7,000 long-term capital gain.

Answer 10

2,000 long-term capital gain.

Rationale

Amanda gave property subject to a loss to her daughter, Daphna, but Daphna sold the property at a price greater than the donor’s adjusted basis in the property.

Since the sale price exceeded the donor’s adjusted basis, the donor’s basis transfers to the donee, and is referred to as the gain basis.

Daphna sold the stock for $17,000 and Amanda’s basis (that carried over to Daphna) was $15,000, so Daphna’s gain is $2,000.

Whenever gain basis is used to determine the tax result, the donor’s holding period tacks on to the donee’s holding period.

Daphna’s gain will be a long-term capital gain, since Amanda held the shares for over one year prior to the gift.

Question 11

All of the following statements concerning depreciation are correct except:

Depreciation is a method of cost recovery that allows a taxpayer to receive their capital back over the useful life of an asset.

Assets purchased for personal use are eligible for depreciation deductions.

Depreciation deductions cause a downward adjustment in the taxpayer’s basis.

Depreciation on real estate is taken on a straight-line basis.

Answer 11

Assets purchased for personal use are eligible for depreciation deductions.

Rationale

Assets purchased for personal use are not eligible for depreciation deductions – only assets used in a trade or business or for the production of income qualify for depreciation deductions. All of the other statements are correct.

Question 12

Which of the following assets qualifies as a Section 1231 asset?

Greeting cards held by the owner of a gift shop for sale to customers.

A bicycle owned by a 12-year-old child.

An apartment building held for rental to tenants.

Artwork prominently displayed in a taxpayer’s summer residence.

Answer 12

An apartment building held for rental to tenants.

Rationale

The only asset that is listed that qualifies for depreciation deductions is the apartment building held for rental to tenants. Many individuals automatically classify real estate as a capital asset, but depreciable real estate held for productive use in a trade or business or for the production of income is classified as a Section 1231 asset. The greeting cards in option a are ordinary income assets (inventory), and the bicycle and artwork in options b and d are capital assets.

Question 13

Several years before his marriage to Maddie, Paul purchased a vacation home in a remote shoreline community for $300,000. After their marriage, Paul needed some cash to invest in a new business opportunity, so he sold the house to his wife Maddie for its current fair market value, $800,000. Nine months after purchasing the house, Maddie sold it for $1.05 million.

What is the amount of Maddie’s taxable gain on the sale of the home?

$0 capital gain.
$250,000 capital gain.
$500,000 capital gain.
$750,000 capital gain.

Answer 13

$750,000 capital gain
.
Rationale

Even though Paul sold the home to Maddie for it’s fair market value, at the time of the sale Paul and Maddie were married.

IRC Section 1041 requires all transfers between spouses to be treated as gifts for income tax purposes, and when a gift of appreciated property is made, a carryover basis results.

Consequently, even though Maddie paid $800,000 for the home, her basis in the home is $300,000.

When Maddie sells the house for $1.05 million, her gain is $750,000 ($1.05 million - $300,000), and the gain is characterized as a long-term capital gain.

If this were their principal residence, they may get relief under IRC Section 121.

Question 14

Tanya gave her nephew, Liam, 100 shares of Bridge Corporation stock that she purchased 6 months ago for $10,000. At the time of the gift, the fair market value of the stock was $12,000.

Which of the following statements concerning the stock is correct?

If Tanya sold the stock, she would have realized a long- term capital gain.

Liam’s basis in the stock is $10,000.

Liam’s basis in the stock is $12,000.

If Liam sells the stock at a price between $10,000 and $12,000m he will realize no gain or loss on the sale.

Answer 14

Liam’s basis in the stock is $10,000.

Rationale

Since Tanya transferred appreciated property to Liam by gift, her basis carries over to Liam.

Liam has a $10,000 basis in the stock. Since the FMV of the stock was higher than Tanya’s basis at the time of the gift, Liam will not have a double basis.

Question 15

Milton, an independent consultant for Initech, Inc., purchased a new, red video camera to match his red stapler. He plans to use the camera primarily for personal purposes, but will occasionally use it (perhaps 25% of the time) to complete assignments that he has accepted from Initech, a client. Which of the following statements concerning the red camera is correct?

If Milton purchases the camera through Initech, he will be able to depreciate the full cost of the camera.

Milton will not be eligible to claim MACRS depreciation deductions for the camera because his business use is less than 50%.

Since he purchased the camera to match the red stapler in his office, he can depreciate the full cost of the camera over the appropriate class life.

Milton can depreciate 25% of the cost of the camera, since the camera is used for business purposes 25% of the time.

Answer 15

Milton will not be eligible to claim MACRS depreciation deductions for the camera because his business use is less than 50%.

Rationale

Video cameras are listed property. In order to qualify for MACRS depreciation deductions on listed property, the property must be used for business purposes more than 50% of the time.
Provided that the property is used primarily for business purposes, the owner may take MACRS depreciation deductions for that portion of the property that is used for business.

Since Milton used the property primarily for personal, not business purposes, he may not claim MACRS depreciation deductions; he must instead use straight-line depreciation under ADS.

Question 16

Wilson runs an oil and gas operations consulting practice, and has had a very good year. Oil prices, as well as the demand for his services, have risen. Given the windfall profits his firm received this year, in December of 2024, Wilson decided to redecorate his office and upgrade the computer system used by himself and his employees. The cost of the office equipment is $40,000 and the computer upgrade cost $20,000.

Assuming Wilson has purchased no other depreciable assets in 2024, the net income from his consulting practice was $500,000, and Wilson would like to minimize his exposure to income taxes, how should he treat the new purchases for income tax purposes?

Wilson should deduct the entire cost of the office equipment and computer upgrades against this year’s business income.

Wilson must use the mid-month convention in determining depreciation deductions, since he placed the upgrades in service in December.

Wilson must use the mid-quarter convention in determining depreciation deductions, since he placed the upgrades in service in December.

Wilson must use the mid-year convention in determining depreciation deductions, since he placed the upgrades in service in the second half of the year.

Answer 16

Wilson should deduct the entire cost of the office equipment and computer upgrades against this year’s business income.

Rationale

Wilson qualifies for the Section 179 election, allowing him to immediately expense the cost of up to $1,220,000 for 2024 (as indexed) against his business income.

Since Wilson had business income to offset with the deduction, and he did not put more than $3,050,000 for 2024 of depreciable property in service this year, and he has expressed a desire to minimize his exposure to income tax this year, he qualifies for the immediate expense election.

Question 17

wo years ago, Dale purchased 100 shares of Stonewall, Inc., a start-up company, for $10,000. Unfortunately, Stonewall’s business model did not perform as expected, and the value of the shares has dropped to $6,000. Dale’s son, Brian, recently realized a large capital gain on an investment he held, so Dale gave his shares of Stonewall, Inc. to Brian when they were worth $6,000.

If Brian sells the shares for $3,000 thirteen months after the transfer, what is the amount of his gain or loss?

No gain or loss.
$3,000 capital loss.
$4,000 capital loss.
$7,000 capital loss.

Answer 17

3,000 capital loss.

Rationale

Dale gave loss property to his son.

When a taxpayer transfers property with a loss to someone else, and the recipient sells the property for less than the fair market value as of the date of the gift, the basis in the hands of the donee for purposes of calculating loss is the fair market value of the property as of the date of the gift.

This is referred to as the “loss basis” in the property. Since the fair market value of the property was $6,000 on the date of the gift, and Brian sold the property for $3,000, his loss is a $3,000 capital loss.

Question 18

Two years ago, Ida purchased 100 shares of Pennsylvania Railroad, Inc. for $20,000. Unfortunately, the value of the shares has dropped to $15,000. Ida’s daughter, Amy, was heading off to college, and Ida was tired of waiting for a return on the stock. Ida gave the stock to Amy when it was worth $15,000 to help fund Amy’s education.

If Amy sells the shares for $17,000 three months after the transfer, what is the amount of her gain or loss?

$0.
$2,000 capital gain.
$3,000 capital loss.
$3,000 ordinary income.
Confidence of your answer

Answer 18

$0.

Rationale

Ida gave loss property to her daughter.

When a taxpayer transfers property with a loss to someone else, and the recipient sells the property for an amount between the donor’s adjusted basis and the fair market value of the stock on the date of the gift, no gain or loss is recognized.

In this question, the no-gain, no-loss corridor is from $15,000 (the fair market value of the stock on the date of the gift) to $20,000 (the adjusted basis in the hands of the donor).

If Amy sold the stock for any amount between $15 and $20 thousand dollars, she is not required to recognize any gain, and she is prohibited from recognizing any loss on the transaction.

Question 19

Christopher recently purchased Quarry City Industrial Park, a commercial, industrial and office community, as an investment. The complex is already rented out to tenants, and Christopher will continue to lease the property to industrial and office space tenants while he owns the property.

Which of the following statements concerning the depreciation deductions that can be taken on the property is correct?

Christopher cannot take depreciation deductions on real property, so the land and buildings are not eligible for depreciation.

Christopher can depreciate the cost allocable to the buildings (but not the land) over a 20-year period.

Christopher can depreciate the cost allocable to the buildings (but not the land) over a 27.5-year period.

Christopher can depreciate the cost allocable to the buildings (but not the land) over a 39-year period.

Answer 19

Christopher can depreciate the cost allocable to the buildings (but not the land) over a 39-year period.

Rationale

Commercial rental property is depreciated on a straight-line basis over a 39-year period. Depreciation deductions are allowed for the structures, but not the land.

Question 20

When Uncle Phil died in 2024, he left his estate to his ungrateful cousin, Will. Uncle Phil’s cost basis in his property was $2 million but, due to turbulent political and economic times, it was only worth $1 million at his death. Uncle Phil had reinvested approximately $250,000 of dividends during his holding period, and his estate paid $500,000 in transfer taxes at his death.

What is Will’s basis in the property?

$1,000,000.
$2,000,000.
$2,250,000.
$2,750,000.

Answer 20

$1,000,000.

Rationale

Section 1014 can result in a step-down in basis as well as a step-up in basis.

Since the property was worth $1 million as of the date of Uncle Phil’s death, that is the basis of the property in Will’s hands despite the fact that Uncle Phil had $2,250,000 in after-tax capital invested in the property and his estate paid transfer taxes of $500,000.

Question 21

Which of the following items is not included in the cost basis of an investment?

Cash used to purchase the investment.

Recourse debt incurred in purchasing the investment.

Nonrecourse debt incurred in purchasing the investment.

The fair market value of property transferred to acquire the investment

Answer 21

Nonrecourse debt incurred in purchasing the investment.

Rationale

Nonrecourse debt is generally not included in basis because a taxpayer is not personally obligated to repay the loan. All of the other items are included in the determination of a taxpayer’s basis in their investment.

Question 22

Mark gave his granddaughter, Jan, stock worth $500,000 this year, in addition to a previous gift in the amount of the annual exclusion. He purchased the stock for $250,000 several years earlier, and felt that the value would increase substantially in the near future. Since he had already used up his lifetime gift-tax exemption in prior tax years, Mark paid $200,000 in gift taxes on the transfer.

If Jan sells the stock for $750,000 six months after the transfer, which of the following statements is correct?

Jan will realize a $250,000 capital gain.
Jan will realize a $300,000 capital gain.
Jan will realize a $400,000 capital gain.
Jan will realize a $500,000 capital gain.

Answer 22

Jan will realize a $400,000 capital gain.

Rationale

Jan received the stock by gift, so she qualifies for a carry-over basis.

Mark’s original basis in the property was $250,000.
Jan sells for $750,000
the appreciation from the gift date of $500.,000 to sell is = $750,000

Since Mark paid gift tax on the transfer, Jan is permitted to increase her basis by the portion of the gift tax paid that represents gain.

The portion of the gift that represents gain is 50% ($250,000 appreciation in the property divided by $500,000 fair market value of the property as of the date of gift). 50% of the gift taxes paid equals $100,000.

Jan’s basis, therefore, is $350,000. If she sells the stock six months after the transfer for $750,000, she will realize a $400,000 gain.

Question 23

Five years ago, Carlton purchased 1,000 shares of Ickingham Industries, Inc. for $10 per share. He signed an agreement with the company which allowed the company to use his dividend payments to purchase additional shares for him. Over the last 5 years, Carlton received a total of $1,200 in dividend payments, which purchased an additional 100 shares of stock.

If Carlton sells all of his shares for $24,000, what is his taxable gain?
$0.
$12,800.
$14,000.
$24,000.

Answer 23

$12,800.

Rationale

Carlton’s adjusted basis in the shares equals the initial purchase price of the shares, $10,000 plus the dividends that were reinvested of $1,200 since Carlton was required to pay tax on the dividend payments the year they were made. When he sells the shares, he has an amount realized of $24,000, less his adjusted basis of $11,200, which equals a taxable gain of $12,800.

Question 24

Grape Corporation purchased a machine in December of the current year. This was the only asset purchased during the current year. The machine was placed in service in February of the following year. No assets were purchased in the following year.

Grape Corporation’s cost recovery would begin:

A. In the current year using a mid-quarter convention.
B. In the current year using a half-year convention.
C. In the following year using a mid-quarter convention.
D. In the following year using a half-year convention.
E. None of the choices.

Answer 24

Solution: The correct answer is D.

Cost recovery begins the year the equipment is placed into service.

Machinery follows half-year convention per MACRS tables.

Question 25

Marc, Inc. placed into service a machine in the current year that cost $3,280,000. What is the maximum Section 179 expense that Marc, Inc. could take for 2024?

A. $230,000
B. $990,000
C. $1,220,000
D. $3,050,000

Answer 25

Solution: The correct answer is B.

Max = $1,220,000 reduced $1 for $1 in excess of the threshold of $3,050,000.

$3,280,000 - $3,050,000 = $230,000

$1,220,000 - $230,000 = $990,000

Question 26

John purchased a new car on June 5, of the current year, at a cost of $12,000. John used the car 100% for personal use. Determine John’s cost recovery deduction in the current year.

A. $0
B. $1,920
C. $2,400
D. $2,960
E. $7,660

Answer 26

Solution: The correct answer is A.

No cost recovery is allowed because the car is used 100% for personal use.

Question 27

In the current year, Chee gives stock (basis of $36,000; fair market value of $30,000) to his nephew and pays a gift tax of $3,000 on the transfer. The nephew’s basis in the stock is:

A. $0 for gain and $0 for loss.
B. $30,000 for gain and $30,000 for loss.
C. $36,000 for gain and $30,000 for loss.
D. $36,300 for gain and $30,300 for loss.
E. None of the choices.

Answer 27

Solution: The correct answer is C.

The donee’s gain basis of $36,000 is the same as that of the donor.

The donee’s loss basis of $30,000 is the lower of the donor’s adjusted basis or fair market value on the date of the gift.

The gift tax paid is only proportionally added based on the appreciation when the asset is gifted to the donor.

Question 28

Tobin inherited 100 acres of land on the death of his father. A Federal estate tax return was filed and the land was valued at $300,000 (its fair market value at the date of the death). The father had originally acquired the land in 1963 for $19,000 and prior to his death had made permanent improvements of $6,000.

What is Tobin’s basis in the land?

A. $19,000
B. $25,000
C. $300,000
D. $325,000

Answer 28

Solution: The correct answer is C.

The basis of the property is its fair market value at the date of the death.