Topic 3 Gains and Losses

Question 1

Realized gains are recognized unless there is specific exception.

T/F

Answer 1

True

Question 2

The adjusted basis is the cost basis less cost recovery deductions.

T/F

Answer 2

True

Question 3

An asset’s tax adjusted basis is usually greater than its book adjusted basis.

T/F

Answer 3

False

Because businesses generally use more highly accelerated depreciation methods for tax purposes than they do for book purposes, the tax-adjusted basis of a particular asset is likely to be lower than the book-adjusted basis.

Question 4

Accounts receivable and inventory are examples of ordinary assets.

T/F

Answer 4

True

Question 5

Which of the following is used in the calculation of the amount realized?

Cash given.
Liabilities assumed by seller.
Fair market value of other property received.
Accumulated depreciation.

Answer 5

Fair market value of other property received.

Amount realized =
\+ Cash Received
\+ Fair market value of the other property 
\+ Buyer's assumption of liability
- Selling Expense

Question 6

Which of the following realized gains results in a recognized gain?

Computer equipment traded for computer equipment.
Los Angeles office building for Nebraska farm land.
Sale to a related party at a gain.
Residential rental property destroyed in a hurricane.

Answer 6

Sale to a related party at a gain.

Realized gains, but not losses, on sales to related party are recognized.

Question 7

Which of the following realized gains results in a recognized gain?

Farm land traded for an office building.
Sale to a related party.
Involuntary conversion.
Iowa cropland exchanged for a Minnesota warehouse.

Answer 7

Sale to a related party.

Question 8

Sadie sold 10 shares of stock to her brother, George, for $500 sixteen months ago. Sadie had purchased the stock for $600 two years earlier. If George sells the stock for $700, what is the amount and character of his recognized gain or loss in the current year?

$0.
$100 short-term capital gain.
$100 long-term capital gain.
$200 short-term capital gain.

Answer 8

$100 long-term capital gain.

Sadie’s loss of $100 is deferred and her brother receives a dual basis in the stock. If he sells the stock at a gain, he receives a $600 carryover basis from Sadie. If he sells the stock at a loss he receives a $500 cost basis in the stock. George’s holding period begins when he buys the stock, so he receives a $100 ($700 proceed less $600 basis) long-term gain on the sale.

Question 9

Which of the following is true regarding disallowed losses between related taxpayers?

The tax laws essentially treat related parties as the same taxpayer.
The holding period of the seller carries over to the buyer.
The related person always receives a carryover basis.
The seller’s realized loss is deferred until the buyer sells the assets.

None of the choices are correct.

Answer 9

The tax laws essentially treat related parties as the same taxpayer.

Question 10

Alan Meer inherits a hotel from his grandmother, Mary, on February 11 of the current year. Mary bought the hotel for $730,000 three years ago. Mary deducted $27,000 of cost recovery on the hotel before her death. The fair market value of the hotel in February is $725,000. (Assume that the alternative valuation date is not used.)

a. What is Alan’s adjusted basis in the hotel?

Answer 10

$725,000. Alan will have an adjusted basis equal to the fair market value at the date of Mary’s death.

Question 11

Alan Meer inherits a hotel from his grandmother, Mary, on February 11 of the current year. Mary bought the hotel for $730,000 three years ago. Mary deducted $27,000 of cost recovery on the hotel before her death. The fair market value of the hotel in February is $725,000. (Assume that the alternative valuation date is not used.)

b. If the fair market value of the hotel at the time of Mary’s death was $500,000, what is Alan’s basis?

Answer 11

$500,000. Alan will have an adjusted basis equal to the fair market value at the date of death even though it is lower than Mary’s basis at the time of her death.

Question 12

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

a. Two years ago, White used its excess cash to purchase a piece of land as an investment.

Ordinary asset
Capital asset
§1231 asset

Answer 12

Capital, because it is held for investment.

Question 13

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

b. Two years ago, White purchased land and a warehouse. It uses these assets in its business.

Ordinary asset
Capital asset
§1231 asset

Answer 13

The land and building are both §1231 property because White uses the assets in its trade or business and has held the assets property for more than a year.

Question 14

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

c. Manufacturing machinery White purchased earlier this year.

Ordinary asset
Capital asset
§1231 asset

Answer 14

c. The property is ordinary even though it is used in a trade or business because it has been held for less than one year. Once White has held the machinery for more than a year, it will become §1231 property.

Question 15

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

d. Inventory White purchased 13 months ago that is ready to be shipped to a customer.

Ordinary asset
Capital asset
§1231 asset

Answer 15

d. Ordinary, because inventory is held in the ordinary course of business.

Question 16

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

e. Office equipment White has used in its business for the past three years.

Ordinary asset
Capital asset
§1231 asset

Answer 16

e. §1231, because the property is used in a trade or business and held for more than one year.

Question 17

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

f. 1,000 shares of stock in Black corporation that White purchased two years ago because it was a good investment.

Ordinary asset
Capital asset
§1231 asset

Answer 17

f. Capital, because it is held for investment.

Question 18

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

g. Account receivable from a customer with terms 2/10, net 30.

Ordinary asset
Capital asset
§1231 asset

Answer 18

g. Ordinary, because accounts receivable are created in the ordinary course of business.

Question 19

Identify each of White Corporation’s following assets as an ordinary, capital, or §1231 asset.

h. Machinery White held for three years and then sold at a loss of $10,000.

Ordinary asset
Capital asset
§1231 asset

Answer 19

h. §1231, because the property is used in a trade or business and held for more than one year.

Question 20

Shasta Corporation sold a piece of land to Bill for $45,000. Shasta bought the land two years ago for $30,600. What gain or loss does Shasta realize on the transaction?

Answer 20

$14,400, computed as follows:

Description Amount Explanation
(1) Amount Realized $ 45,000
(2) Adjusted Basis 30,600
Gain (Loss) Realized $ 14,400 (1) − (2)

Question 21

On September 30 of last year, Rex received some investment land from Holly as a gift. Holly’s adjusted basis was $50,000 and the land was valued at $40,000 at the time of the gift. Holly acquired the land five years ago. What is the amount and character of Rex’s recognized gain (loss) if he sells the land on May 12 this year at the following prices? (Enter NA if a situation is not applicable. Leave no answer blank. Enter zero if applicable.)
a. $32,000

Answer 21

($8,000) short-term capital loss, computed as follows:
Description Amount Explanation
(1) Amount Realized $32,000
(2) Adjusted Basis 40,000 Rex’s basis is the fair market value of the land at the date of the gift.
Gain (Loss) Recognized ($8,000 ) (1) − (2)

Rex’s holding period begins on the date of the gift because the loss basis (fair market value) is used to determine the gain or loss on the sale.

Question 22

On September 30 of last year, Rex received some investment land from Holly as a gift. Holly’s adjusted basis was $50,000 and the land was valued at $40,000 at the time of the gift. Holly acquired the land five years ago. What is the amount and character of Rex’s recognized gain (loss) if he sells the land on May 12 this year at the following prices? (Enter NA if a situation is not applicable. Leave no answer blank. Enter zero if applicable.)
b. $70,000

Answer 22

$20,000 long-term capital gain, computed as follows:

Description Amount Explanation

(1) Amount Realized $ 70,000
(2) Adjusted Basis 50,000 Rex’s basis is a carryover basis from the donor
Gain (Loss) Recognized $ 20,000 (1) − (2)

Rex’s holding period begins on the date that Holly acquired the stock because Rex’s basis is a carryover basis. Therefore, the character of the gain is long-term capital gain.

Question 23

On September 30 of last year, Rex received some investment land from Holly as a gift. Holly’s adjusted basis was $50,000 and the land was valued at $40,000 at the time of the gift. Holly acquired the land five years ago. What is the amount and character of Rex’s recognized gain (loss) if he sells the land on May 12 this year at the following prices? (Enter NA if a situation is not applicable. Leave no answer blank. Enter zero if applicable.)
c. $45,000

Answer 23

No gain or loss is realized.

Description Amount Explanation

(1) Amount Realized $ 45,000
(2) Adjusted Basis 45,000 Rex’s basis is deemed to be equal to the amount realized since the amount realized falls between the donor’s basis and the fair market value at the date of the gift.
Gain (Loss) Recognized $ 0 (1) − (2)

Question 24

Assume Steve owns some equipment that he uses personally and purchased two years ago for $4,000. On March 20, he converts the equipment into business-use property when the FMV of the equipment is $5,000. What is Steve’ initial basis in the equipment for business purposes?

Assume that the equipment that Steve converts from personal to business use has a FMV of $3,000 at the date of conversion. What is Steve’s basis in the equipment for business purposes?

Answer 24

Because the equipment appreciated in value before Steve converted it to business use, the basis is his original cost of $4,000.

The equipment declined in value before Steve converted it to business use. In order to Steve from converting his $1,000 personal loss into a business loss, his initial basis of business purposes will depend on whether he subsequently sells the equipment at a gain or loss. His initial basis for loss (and cost recovery) is the $3,000 FMV at the conversion date. His initial basis for gain is his $4,000 original cost.