Tax Consequences of the Disposition of Property - Examples Flashcards

Question

Unforeseen Circumstances - Ownership and Use Tests

Answer 1

For example, Tim, a single taxpayer who purchased his home on March 1, 2023 for $500,000, recently became ill and sold his home in order to move closer to a relative who could care for him. Tim sold his principal residence on August 12, 2023, for $620,000, realizing a gain of $120,000. Because he owned and occupied the residence for 164 days and the sale was due to a change in his health, he may exclude $56,164 ($250,000 × 164/730).

Answer 2

For example, the Koch's principal residence, with an adjusted basis of $200,000, has been used and owned by them for nine years. The house is destroyed by a hurricane and the Koch's receive insurance proceeds of $820,000. Four months later, they purchase another residence for $900,000. The Koch's have a realized gain of $620,000 and may exclude $500,000 under Section 121. The remaining $120,000 gain may be deferred and the basis of their replacement residence is $780,000 ($900,000 − $120,000). Because the amount realized is reduced by the gain excluded, the Koch's could have deferred the $120,000 gain in the above example by investing $320,000 in a replacement residence. If gain due to the involuntary conversion of a principal residence is deferred under Section 1033, the holding period of the replacement residence includes the holding period of the converted property for purposes of satisfying the use and ownership tests of Section 121. The Koch's satisfy the use and ownership requirements for Section 121 with respect to their new residence in the above example because gain is deferred under Section 1033.

Answer 3

For example, Nora's principal residence, with an adjusted basis of $70,000, was destroyed by a flood in May 2023. The area was declared by the President to be a federal disaster area. All the contents of her home, including a Steinway grand piano with a basis of $25,000 and a fair market value (FMV) of $30,000, were destroyed. Nora received the following payments from the insurance company in July 2023: $200,000 for the house, $25,000 for personal property contents with an adjusted basis of $15,000, and $30,000 for the piano, which was separately scheduled property in the insurance policy. The $10,000 ($25,000 − $15,000) gain on the unscheduled personal property is excluded from gross income. The $135,000 gain attributable to the house and the piano is excluded under Section 121.

Answer 4

For example, Paula, a business consultant, owns residences in Boston and Philadelphia. She plans to sell both residences in two years and purchase a new residence in California. The Boston residence has a fair market value (FMV) that is $200,000 greater than its basis. The residence in Philadelphia has not appreciated. Paula should plan her activities in a manner that will allow her to occupy the Boston residence more than the Philadelphia residence so the Boston residence will qualify as her principal residence and thus be eligible for the tax exclusion under Section 121.

Answer 5

For example, Kate purchased a house in 2005 for $200,000 and uses 15% of the house as an office. The office is used on a regular and exclusive basis and is her principal place of business. Depreciation of $3,400 has been deducted when she sells the house for net proceeds of $430,000. Her gain is $233,400 ($430,000 − $196,600), and she may exclude $230,000 but must recognize $3,400 of the gain.

Answer 6

For example, Leslie realizes $10,000 in short-term capital gains (STCGs) through dealings in the stock market during the current year. Realizing that STCGs are fully includible in gross income unless they are offset against realized capital losses, Leslie analyzes her portfolio to determine whether she owns any stocks that have declined in value. She finds that the fair market value (FMV) of her Edison Corporation common stock is only $8,000, even though she originally purchased it for $16,000. Despite this paper loss on the stock, Leslie feels that Edison Corporation is still a good investment and wants to retain the stock. If Leslie attempts to take advantage of the paper loss on the Edison stock by selling the stock she owns and repurchasing a similar number of shares of Edison common stock within the 61-day period, the loss is disallowed.

Answer 7

For example, Ingrid enters into the following transactions with regard to Pacific Corporation common stock: January 4, 2013 Purchases 600 shares $30,000 October 2, 2023 Purchases 400 shares $10,000 October 12, 2023 Sells original 600 shares $12,000 October 20, 2023 Purchases 200 shares $5,000 October 25, 2023 Purchases 300 shares $8,400 Because Ingrid purchases more than 600 shares within the 61-day period before and after the date of sale (the purchases made on October 2, 20 and 25), the entire loss of $18,000 ($30,000 − $12,000) is postponed. Four hundred shares (two-thirds of the number of shares sold) are purchased on October 2 and 200 shares (one-third) are purchased on October 20. Thus, the basis of the 400 shares of stock purchased on October 2 is $22,000 [$10,000 purchase price + ($18,000 disallowed loss × 0.667)]. The basis of the 200 shares of stock purchased on October 20 is $11,000 [$5,000 + ($18,000 disallowed loss × 0.333)]. Both of these blocks of stock have a holding period that starts on January 4, 2013.The basis of the 300 shares of stock purchased on October 25 is its purchase price of $8,400. Its holding period begins on October 25, 2023.

Answer 8

For example, if a taxpayer does not own more than 50% of a corporation's stock, the individual and the corporation are not related, and a loss on the sale of business or investment property between the two is deductible. Occasionally individuals might attempt to circumvent the related party rules by dispersing the ownership of a corporation (for example, among close family members) while retaining economic control. To prevent these tactics, Section 267 contains constructive ownership rules whereby a taxpayer is deemed to own stock owned by certain other persons.

Answer 9

For example, assume three separate scenarios in which Sam sells a tract of land during the current year. In each case assume that Sam purchased the land from his father, Frank, for $10,000. Frank's basis at the time of the original sale was $15,000 in each case. Thus, Frank's $5,000 loss on each land sale was disallowed. Scenario 1 Scenario 2 Scenario 3 Selling price $17,000 $12,000 $ 8,000 Minus: Sam's basis (10,000) (10,000) (10,000) Sam's realized gain (loss) $ 7,000 $ 2,000 $(2,000) Minus: Frank's disallowed loss (up to Sam's gain) (5,000) (2,000) 0 Sam's recognized gain (loss) $2,000 $0 $(2,000) In Scenario 1, Sam and Frank together have incurred an aggregate gain of $2,000 ($17,000 − $15,000). Thus, Frank's full disallowed loss reduces Sam's subsequent gain. In Scenario 2, the aggregate economic loss incurred by Sam and Frank is actually $3,000 ($12,000 − $15,000). However, the actual amount of the tax loss recognized for Sam and Frank is zero. In Scenario 3, the actual tax loss would have been $7,000 ($8,000 − $15,000) instead of $2,000 if Frank had held the land until its eventual sale.

Answer 10

For example, Michelle owns 100% of the outstanding stock of Hill Corporation. Michelle is a cash method taxpayer and Hill Corporation is an accrual method taxpayer. Both taxpayers are calendar-year taxpayers. In a bona fide transaction, Hill borrows some funds from Michelle. By the end of the current year, $8,000 interest had accrued on the loan. However, Hill Corporation does not pay the interest to Michelle until February of the following year. Because Michelle is a cash method taxpayer, she reports the interest income when she receives it in the following year. Although Hill is an accrual method taxpayer, it must defer the deduction for the interest expense until it pays the interest in February of the following year. The results are the same if Hill Corporation is a personal service corporation and Michelle is an employee and owns any of the Hill stock.

Answer 11

For example, if Jones sells land with a fair market value of $500,000 and a basis of $50,000 to a public conservation charity for $200,000, what has occurred is a part sale and part gift. In this case, Jones would be treated as having sold the land, and must declare a gain of $150,000 ($200,000-$50,000). The remainder of the value is a gift to the charity with a zero basis. The problem with this sort of sale or exchange is that no loss can be recognized in such a part sale—part gift transaction. If Jones had a basis of $250,000 in the land, he would have no gain since the basis exceeds the proceeds, but the $50,000 loss would not be declared.

Answer 12

For example, ABC Corp. wishes to reward its CEO. For $7,000, the company sells him a company-owned automobile with a basis of $5,000 and a fair market value of $15,000. The results of this bargain sale are: 1. Deduction for the company of $8,000 for compensation paid to the CEO. 2. The CEO's basis in the automobile is $15,000 ($7,000 he paid and the compensation of $8,000 on which he was taxed).