Tax Consequences of the Disposition of Property - Review Questions Flashcards
Non-business bad debt losses are deducted as a ____ ____capital loss.
short-term
Bad debt losses from non-business debts are deductible only as short-term capital losses. It is only deductible in the year in which the debt becomes totally worthless.
What is the maximum rate on net capital gains (NCG)?
Choose the best answer.
1) 20%
2) 10%
3) 28%
4) 18%
3) 28%
The maximum rate on NCG was reduced to 28% in 1990. However, this tax reduction only benefited taxpayers whose tax rate exceeded 28%. Today, the 28% rate still applies to most collectibles, as well as the taxable portion of Section 1202 stock.
On October 1 of last year, Lisa died owning an asset with a FMV of $1,000,000 that she purchased in 1991 for $750,000. Bart inherited the asset from Lisa. When Bart sells the asset for $1,250,000 on August 20 of this year, what must he recognize?
Choose the best answer.
1) STCG of $500,000
2) LTCG of $500,000
3) STCG of $250,000
4) LTCG of $250,000
4) LTCG of $250,000
The holding period for inherited property is automatically long term. 1,250,000 − 1,000,000 = $250,000
Which of the following are considered selling expenses? (Check all that are true.)
1) Commissions
2) Repair Costs
3) Deed Preparation Costs
4) Legal Expenses
1) Commissions
3) Deed Preparation Costs
4) Legal Expenses
Selling expenses include commissions, advertising, deed preparation costs, and legal expenses incurred in connection with the sale.
If a taxpayer lives in his home for two years, it is considered a principal residence for Section 121 to apply.
Choose the best answer.
True
False
False
Whether property is used as the taxpayer’s principal residence is determined on a case-by-case basis for Section 121.
For purposes of Section 121, the destruction, theft, seizure, requisition, or condemnation of property is treated as a ____.
Sale
The destruction, theft, seizure, requisition, or condemnation of property is treated as a sale under Section 121. Thus, taxpayers may exclude a gain of up to $250,000 or $500,000 due to the involuntary conversion of a principal residence if the use and ownership test is satisfied.
Under the related parties rules of Section 267, why has Congress imposed the concept of constructive ownership?
Congress has imposed the concept of constructive ownership to prevent attempts to circumvent the related party rules by dispersing ownership of a corporation among family members or related entities while at the same time retaining economic control.
Thomas was paid $400,000 from his insurance company on January 20, 20X4, for an office building that was destroyed by a tornado on June 27, 20X3. Thomas Taxpayer’s adjusted basis in the destroyed property was $215,000. How long does Thomas have to purchase a replacement property? Also, what will be his realized gain, recognized gain, and new basis in the replacement property if he?
Purchases a replacement property for $375,000 on September 3, 20X5
Purchases a replacement property for $400,000 on October 15, 20X5
Purchases a replacement property for $420,000 on December 20, 20X5
Purchases a replacement property for $400,000 on January 5, 20X7
Thomas Taxpayer has until December 31, 20X6 to purchase the replacement property.
For A, B, C, and D) realized gain = $400,000 - $215,000 = $185,000
A) recognized gain = $25,000, basis = $215,000
B) recognized gain = $0, basis = $215,000
C) recognized gain = $0, basis = $235,000
D) recognized gain = $185,000, basis = $400,000 (past the tax-deferral reinvestment period)
Calculating Installment Sales:
For example, on May 1, 2023 John sold a rare art piece that he had bought several years ago at a cost of $22,000. The terms of the sale were a price of $56,000, with a 20% down payment on May 1, with the balance to be paid monthly over the next 5 years. The annual interest rate is 8%, compounded monthly. The first payment will be received on May 31st.
What are the total amounts that John must report in 2023 as (1) ordinary income and (2) capital gains?
First, calculate the GPP.
- The gross profit is $56,000 − $22,000 = $34,000.
- The GPP is gross profit divided by the sale amount — $34,000$56,000=.6071$34,000$56,000=.6071.
- This percentage must be multiplied times the down payment and the principal received on the loan payments; the aggregation of which will result in the amount required to be reported as capital gain.
Second, calculate the down payment, multiply the down payment times the GPP, and set the result aside as step 1 in determining the taxable gain. The down payment is 20% of $56,000 or $11,200. Multiplying that times the GPP, we arrive at $11,200 × .6071 = $6,799.52 $6,800. This amount is step 1 of the capital gain calculation.
Third, calculate the loan payment based on the terms (PV = - $44,800, N = 60 months, I = 8/12) and solve for payment {$908.38}. Note: Do NOT clear your calculator; this information is required for the amortization function. - Using the amortization function on your calculators calculate the interest received in the first 8 months (May 31 - Dec. 31) of the loan. This figure is what John must report as ordinary income: $2,273.99 (or approximately equal to $2,274).
(HP 12 C keystrokes: 8, f, amort.) - Now calculate principal received (on the HP 12C hit the x><y key) which is $4,993.07 (or approximately equal to $4,993). This amount represents the principal received from the loan payments and must be allocated between capital gain and return of basis. Multiplying the principal times the GPP, yields $4,993 X.6071 = $3,031.25 (or approximately equal to $3,031). This figure represents step 2 in calculating the capital gain.
Add step 1 (gain on down payment) $6,800 to step 2 (gain on principal from the total payments (P&I) $3,031, for an aggregated total of $9,831 reportable as capital gains.
The total money received by John $18,467.04 ($11,200 down payment and 8 payments of $908.38) must equal ordinary income plus capital gain plus return of basis.
Ordinary income = $2,274
Capital gain = $9,831
Return of basis = $6,362 ($4,400 from down payment and $1,962 from principal received $4,993 - $3,031)
Calculating Installment Sales with Recapture
On January 31, John sold an antique desk that he used in his business for $15,000. John’s original cost was $9,000, and John had taken a cost recovery of $5,064. The terms of the sale were 10% down, and the balance to be paid in 48 monthly payments at a rate of 7%, with the first payment beginning on February 28, that same year.
What must John report for that same year as ordinary income and capital gain?
The key to answering this question is to recognize that the prior cost recovery of $5,064 must be recaptured under section 1245 as ordinary income and be recognized fully in the year of the sale.
The GPP is calculated with profit based on the original cost basis, and not the adjusted basis. Said differently, you are just installing the 1231 gain.
- GPP=($15,000−$9,000)$15,000=40%GPP=($15,000−$9,000)$15,000=40%.
The breakdown of the 11 monthly payments in 2023 of P&I is equal to PV = - $13,500, N = 48, I = 7/12, PMT calculates to $323.27; using the amortization function, interest in year 1 (11 months) is $786.41, and principal collect in the first 11 months is $2,769.61.
Applying the GPP to the down payment of $1,500, as well as the principal amount of $2,769.61 yields $1,707.84 as capital gains.
The ordinary income will be the summation of the recapture ($5,064) and the interest income ($786.41), which equals a total of $5,850.41 reportable as ordinary income.
In March of the current year, Sarah Parker (a single taxpayer) sold her principal residence for a gross price of $550,000. Sarah purchased the house 18 years ago for $184,900. She has not made any improvements to the house, although she paid a real estate commission of $27,500 on the sale. Eighteen months later, Sarah bought a new residence for $224,900. What amount, if any, must be recognized on the sale of Sarah’s residence?
1) $0
2) $47,600
3) $87,600
4) $297,600
3) $87,600
The net proceeds ($550,000 − $27,500) of $522,500 less the basis of $184,900 leaves $337,600 as the realized gain. As a single taxpayer, Sarah meets the ownership and usage test so she may exclude $250,000 of gain. That leaves $87,600 as the recognized gain.
Four years ago, Cheryl bought office furniture for a total cost of $12,500. Using MACRS, Cheryl has taken $7,400 of cost recovery. In the current year, Cheryl sells the furniture for $6,000. How much will be taxed under Section 1245 as ordinary income and how much will be taxed as a Section 1231 capital gain?
1) $0 ordinary income, $0 capital gain
2) $0 ordinary income, $900 capital gain
3) $900 ordinary income, $0 capital gain
4) $5,100 ordinary income, $900 capital gain
3) $900 ordinary income, $0 capital gain
The adjusted basis of the furniture is $5,100 ($12,500 − $7,400). Therefore, a selling price of $6,000 will cause $900 ($6,000 − $5,100) of the prior depreciation to be recaptured under Section 1245 and taxed as ordinary income.
In 1994, your client purchased a commercial building for $2,000,000. This transaction did not include the cost of the land, which has been excluded from this question. Over the years, your client has taken $600,000 of cost recovery, and just sold the building in the current year for $3,000,000, net of transaction costs. How much will be taxed at 25% as an unrecaptured 1250 gain, and how much will be taxed as a 1231 gain?
1) $0 unrecaptured gain at 25%, $1,000,000 1231 capital gain
2) $0 unrecaptured gain at 25%, $1,600,000 1231 capital gain
3) $600,000 unrecaptured gain at 25%, $1,000,000 1231 capital gain
4) $1,600,000 unrecaptured gain at 25%, $0 1231 capital gain
3) $600,000 unrecaptured gain at 25%, $1,000,000 1231 capital gain
The adjusted basis of the property is $1,400,000 ($2,000,000 − $600,000). Therefore, a selling price of $3,000,000 will cause the entire amount of the depreciation ($600,000) to be taxed at 25% as unrecaptured gain and the $1,000,000 of gain above the original cost of $2,000,000 will be taxed more favorably as a 1231 capital gain.
Debra Johnson was paid $550,000 from her insurance company on January 10, 20X4, for an office building that was destroyed by a violent hurricane on September 26th, 20X3. Her basis was $325,000 in the destroyed property. Assuming she plans to reinvest $600,000 in a replacement property, 1) How long does she have to purchase the replacement property, 2) What is her realized gain, 3) What is her recognized gain, and 4) What is her basis in the new property?
1) – 1) 12/31/20X5; 2) $225,000; 3) $0; 4) $325,000
2) – 1) 12/31/20X5; 2) $275,000; 3) $0; 4) $325,000
3) – 1) 12/31/20X6; 2) $225,000; 3) $0; 4) $375,000
4) – 1) 12/31/20X6; 2) $275,000; 3) $0; 4) $375,000
3) – 1) 12/31/20X6; 2) $225,000; 3) $0; 4) $375,000
The taxpayer has until December 31st two full years after December 31st in the year the gain was recognized (01/10/20X4).The gain realized is the proceeds from insurance ($550,000) less the adjusted basis of ($325,000) = $225,000. The gain recognized will be zero as long as the reinvestment is made within the time permitted as well as the reinvested amount is at least the same amount as the proceeds. The substituted basis ($375,000) is increased by the additional $50,000 invested over and above the insurance proceeds.
On September 1, 20X4, Sara Moss sold a classic painting to her neighbor, Nancy Bonda. Sara’s basis in the painting was $6,000, and the terms of the sale were as follows:
The selling price was $22,000, equal to the fair market value at the time of the sale.
Nancy made a $4,000 down payment at the time of the sale.
Starting October 1, 20X4, Nancy began 39 monthly payments based on 7% interest, compounded monthly.
What are the amounts that Sara must recognize as ordinary income and capital gain in 20X4? 1) Ordinary Income 2) Capital Gain
1) – 1) $308; 2) $3,000
2) – 1) $308; 2) $3,814
3) – 1) $1,091; 2) $3,000
4) – 1) $1,091; 2) $3,814
2) – 1) $308; 2) $3,814
The Gross Profit Percentage (GPP) is profit divided by sales price: ($22,000 − $6,000)/$22,000 = 72.72%. This will be multiplied times the aggregation of the down payment and the principal received from the loan payments. The next step is amortization from the calculator:
18000 CHS PV
7 g 12÷(i)
39 n
PMT – calculator displays 517.37. (Monthly payment needed for amortization).
3 f AMORT(n) – calculator displays 307.77. (Interest, taxed as O.I.)
X><Y – calculator displays 1,244.33 (principal portion from monthly payments).
Then add down payment and principal and multiply time GPP to calculate capital gain. ($1,244.33 + $4,000) X.7272 = 3,813.68 ~ $3,814.
