Tax Ch. 13 Non-taxable Exchanges

Question 1

Assets held for personal use qualify for like-kind exchange treatment.

a. True b. False

Answer 1

b. False

Question 2

IRC Section 1031 requires that exchanged properties have the same use.

a. True b. False

Answer 2

b. False

Question 3

If the only asset a taxpayer receives in a like-kind exchange is like-kind property, there will not be any immediate tax consequences.

a. True b. False

Answer 3

a. True

Question 4

The sale of property as a result of the owner’s bankruptcy is an example of an involuntary conversion.

a. True b. False

Answer 4

b. False

Question 5

Replacement property must only satisfy the functional use test.

a. True b. False

Answer 5

b. False

Question 6

Taxpayers who lose property by eminent domain have three years from the date of the conversion to replace the property.

a. True b. False

Answer 6

b. False

Question 7

Of the three types of insurance contracts, life insurance contracts offer the best tax benefits to owners.

a. True b. False

Answer 7

a. True

Question 8

A MEC may be exchanged for either a MEC or an annuity, but it may not be exchanged for a life insurance policy.

a. True b. False

Answer 8

a. True

Question 9

Married couples may exclude up to $500,000 of gain under Section 121.

a. True b. False

Answer 9

a. True

Question 10

All taxpayers are entitled to a reduced exclusion if they have not lived in their principal residence for two years.

a. True b. False

Answer 10

b. False

Question 11

If a taxpayer’s principal residence was acquired within the last five years by a like-kind exchange, nonrecognition of gain under Section 121 is not available.

a. True b. False

Answer 11

a. True

Question 12

A transfer to the insured is one of the exceptions to the transfer-for-value rule.

a. True b. False

Answer 12

a. True

Question 13

A transfer to the insured is one of the exceptions to the transfer-for-value rule.

a. True

Answer 13

b. False

Question 14

Which of the following could qualify as a residence, for principal residence exclusion from gain?

1. A condominium.
2. An RV.
3. A boat.
4. Vacant land adjacent to personal residence regularly used by the taxpayer.

a. 4 only.
b. 1 and 4.
c. 1, 2, and 3.
d. 1, 2, 3, and 4.

Answer 14

The correct answer is d.

All qualify if used as a personal residence.

The vacant land will qualify if sold with the residence

Question 15

Meg wants to sell her rental beach home and purchase rental property in the mountains. Her friend, Ryan, tells her he can do a nonsimultaneous tax-free exchange as long as the fair market value of mountain property is equal to or greater than the fair market value of the beach property.
How long after selling his beach property does Meg have to identify and purchase the mountain property?

a. The mountain property must be identified within 45 days of the closing of the beach property and must be closed within 180 days of the closing of the beach property.

b. The mountain property must be identified within 30 days of the closing of the beach property and must be closed within 120 days of the closing of the beach property.

c. The mountain property must be identified within 60 days of the closing of the beach property and must be closed within 180 days of the closing of the beach property.

d. The mountain property must be identified within 90 days of the closing of the beach property and must be closed within 180 days of the closing of the beach property.

Answer 15

The correct answer is a.

The taxpayer in a nonsimultaneous exchange must identify the replacement property within 45 days of the sale of the original property and close on the replacement property within 180 days of the closing of the original property.

Question 16

In which of the following circumstances would a taxpayer be able to get a partial exemption for the sale of a principal residence when the taxpayer did not meet the two year ownership and use test?

a. The taxpayer decides to move from Florida to Arizona to possibly look for a new job.

b. The taxpayer changes jobs to a town that is 10 miles away from the former house and 10 miles away from the former job.

c. The taxpayer sold the house in Milwaukee because the gray days were affecting her sunny disposition and general health.

d. The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for three days.

Answer 16

The correct answer is d.The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for three days.

Option d is consistent with the unforeseen circumstances approved by the IRS (see Exhibit 13.6).
Option a does not qualify because the taxpayer did not have a job when the residence was sold.

Option b does not qualify because the move did not meet the distance requirement.

Option c is not correct because general
health does not qualify.

Question 17

Steven, a single taxpayer, has been transferred by his company to Portland. He sold his house for $650,000 and he had an adjusted basis of $330,000. Steven owned and lived in the home for 18 months.
What is his capital gain from the sale of the personal residence?

a. $0.
b. $132,500 LTCG.
c. $187,500 LTCG.
d. $320,000 LTCG.

Answer 17

The correct answer is b

He gets a partial exemption of $187,500

Gain $320,000
Less Exemption $187,500 ($250,000 x 18/24)
Equals $132,500

Question 18

Assume Liv and Tyler, who are married and file a joint tax return, bought a ski condo 10 years ago for $100,000. They treated it as a vacation home for eight years but used it as their personal residence for the last two years.

They recently sold the condo for $450,000.

How much gain can they exclude from the sale of their personal residence?

a. $70,000.
b. $210,000.
c. $250,000.
d. $350,000.

Answer 18

The correct answer is a.

The gain must be allocated among qualified and nonqualified use.

The gain allocated to nonqualified use is calculated by dividing the periods of nonqualified use during the time the taxpayer owned the
property by the total periods of ownership (not including any periods prior to January 1, 2009).

The gain allocated to nonqualified (vacation) use is 8 out of 10 years or 80%.

Therefore, they can exclude 20% of the gain (up to the maximum exclusion of $500,000 for MFJ). $450,000 - $100,000 = $350,000 gain x
0.20 = $70,000

Question 19

Grant enters into a 1031 exchange with Cary. Grant’s business building has a basis of $300,000 and he takes Cary’s raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Grant also pays Cary $50,000 in cash.

What is Cary’s basis in the new asset?

$200,000.
$250,000.
$300,000.
$430,000

Answer 19

$430,000.
Rationale

Cary has a carryover basis.
Analysis: First get economics straight.
$800,000 - $250,000 (mortgage) = $550,000 - $50,000 cash = FMV of Grant’s asset $500,000.

Question 20

Zena worked at a company that had purchased a $100,000 key person policy on her life. When Zena left the company, the employer offered to sell her the policy. Zena purchased the policy from the employer for $17,000. Zena continued to make the premium payments which were a total of $7,000. When Zena died, her daughter Rochelle received the policy proceeds from the insurance company.
What are the income tax consequences for Rochelle?

Rochelle will receive the policy proceeds income tax-free.

Rochelle must recognize ordinary income of $76,000.

Rochelle must recognize capital gains of $76,000.

Rochelle must recognize capital gains of $76,000 and ordinary income of $24,000.

Answer 20

Rochelle will receive the policy proceeds income tax-free

Rationale

The sale of an existing life insurance policy is a transfer-for-value, which causes the death benefit is to be taxed (as ordinary income) to the extent that it exceeds the owner’s cost basis in the policy. However, a sale to the insured is an exception to the transfer-for value rules, which allows the death benefit to remain income tax free

Question 21

Nedra owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Annette. The basis of Nedra’s vacant lot is $40,000. She gives Annette $20,000 cash plus the vacant lot in exchange for Annette’s property, which is worth $36,000. Annette’s basis in her original asset is $10,000.

What is Annette’s adjusted basis in the new asset?

$6,000.
$10,000.
$16,000.
$26,000.

Answer 21

$10,000.
Rationale

She has a carryover basis. See analysis:

Question 22

f a transaction meets all of the requirements of a Section 1031 like-kind exchange, which of the following is true?

Like-kind exchange treatment is absolutely mandatory.
Like-kind exchange treatment requires an affirmative election.
Like-kind exchange treatment is completely discretionary.
None of the above are true.

Answer 22

Like-kind exchange treatment is absolutely mandatory.
Rationale

Like-kind exchange treatment is mandatory if all of the requirements are met.

Question 23

Steven, a single taxpayer, has been transferred by his company to Portland. He sold his house for $650,000 and he had an adjusted basis of $330,000. Steven owned and lived in the home for 18 months.

What is his capital gain from the sale of the personal residence?

$0.$320,000$187,500$132,500

$132,500 LTCG.

$187,500 LTCG.

$320,000 LTCG.

Answer 23

132,500 LTCG.

Rationale

He gets a partial exemption of $187,500.
Gain $320,000
Less Exemption $187,500 ($250,000 x 18/24)
Equals $132,500

Question 24

Twenty years ago Anne Marie purchased a life insurance policy to provide for her young children in the event of her death. Since the children are now grown, she would like to exchange the life insurance policy for an annuity that will provide her with additional income in her retirement years.

Which of the following is true regarding the exchange of the life insurance policy for the annuity?

The exchange will result in recognition of gain.

The exchange of a life insurance policy for an annuity is not permitted.

The exchange will be tax free.

The exchange will be a transfer-for-value.

Answer 24

The exchange will be tax free.

Rationale

Under IRC Section 1035, a life insurance policy can be exchanged tax free for another life insurance policy, a modified endowment contract, or an annuity.

Question 25

Nedra owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Annette. The basis of Nedra’s vacant lot is $40,000. She gives Annette $20,000 cash plus the vacant lot in exchange for Annette’s property, which is worth $36,000. Annette’s basis in her original asset is $10,000.

What is Nedra’s basis in the new asset?

$24,000.
$40,000.
$44,000.
$60,000.

Answer 25

$60,000.

Rationale

Nedra’s new basis equals her old basis ($40,000) plus the boot that she paid to Annette ($20,000).

Question 26

Which of the following is not a like-kind exchange?

A bank building for unimproved land.

A business building in Mexico for a shopping center in Peru.

A lot in California for a lot in Oregon.

A truck for a tractor.

Answer 26

A truck for a tractor.

Rationale

Only real estate qualifies for like-kind exchange treatment after 2017.

Question 27

Nedra owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Annette. The basis of Nedra’s vacant lot is $40,000. She gives Annette $20,000 cash plus the vacant lot in exchange for Annette’s property, which is worth $36,000.
Annette’s basis in her original asset is $10,000.
What is Nedra’s gain or loss?

No gain or loss.
$24,000 loss realized and recognized.
$24,000 loss realized, but not recognized.
$44,000 loss realized and recognized.

Answer 27

$24,000 loss realized, but not recognized.

Rationale

The total value of all property (like-kind and boot) exchanged by the parties must be equal.
The value of Annette’s property is $36,000 and she receives Nedra’s land plus $20,000 in exchange for it; therefore, Nedra’s land must be valued at $16,000.

Nedra will realize a $24,000 loss ($16,000 - $40,000). Losses are not recognized in a tax-free exchange; rather, they are deferred to the new asset and added to the basis.

Question 28

Assume Liv and Tyler, who are married and file a joint tax return, bought a ski condo 10 years ago for $100,000. They treated it as a vacation home for eight years but used it as their personal residence for the last two years. They recently sold the condo for $450,000.

How much gain can they exclude from the sale of their personal residence?

$70,000.
$210,000.
$250,000.
$350,000.

Answer 28

$70,000.
Rationale

The gain must be allocated among qualified and nonqualified use. The gain allocated to nonqualified use is calculated by dividing the periods of nonqualified use during the time the taxpayer owned the property by the total periods of ownership (not including any periods prior to January 1, 2009).
The gain allocated to nonqualified (vacation) use is 8 out of 10 years or 80%.
Therefore, they can exclude 20% of the gain (up to the maximum exclusion of $500,000 for MFJ). $450,000 - $100,000 = $350,000 gain x 0.20 = $70,000.

Question 29

Nedra owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Annette. The basis of Nedra’s vacant lot is $40,000. She gives Annette $20,000 cash plus the vacant lot in exchange for Annette’s property, which is worth $36,000. Annette’s basis in her original asset is $10,000.

What is Annette’s gain or loss?

$20,000 gain recognized.
$26,000 gain realized and recognized.
$0 gain recognized.
$0 loss recognized

Answer 29

20,000 gain recognized.

Rationale

Annette must recognize gain to the extent of boot paid to her ($20,000).

Question 30

Grant enters into a 1031 exchange with Cary. Grant’s business building has a basis of $300,000 and he takes Cary’s raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Grant also pays Cary $50,000 in cash.

What is Cary’s recognized gain or loss?

$50,000.
$250,000 gain.
$300,000 gain.
$300,000 loss.

Answer 30

$300,000 gain.
Rationale

Cary must recognize boot as gain to extent of deferred gain ($250,000 + $50,000).
Analysis: Get economics straight.
$800,000 - $250,000 (mortgage) = $550,000 - $50,000 Cash = FMV of Grant’s asset $500,000.

Question 31

Nedra owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Annette. The basis of Nedra’s vacant lot is $40,000. She gives Annette $20,000 cash plus the vacant lot in exchange for Annette’s property, which is worth $36,000. Annette’s basis in her original asset is $10,000.

What is Nedra’s deferred gain or loss?

$0.
$16,000.
$24,000.
$40,000.

Answer 31

24,000.
Rationale

The total value of all property (like-kind and boot) exchanged by the parties must be equal.

The value of Annette’s property is $36,000 and she receives Nedra’s land plus $20,000 in exchange for it; therefore, Nedra’s land must be valued at $16,000.

Nedra will realize a $24,000 loss ($16,000 - $40,000). Losses are not recognized in a tax-free exchange; rather, they are deferred to the new asset and added to the basis.

Question 32

Grant enters into a 1031 exchange with Cary. Grant’s business building has a basis of $300,000 and he takes Cary’s raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Grant also pays Cary $50,000 in cash.

What is Grant’s recognized gain or loss?

$0.
$50,000 loss.
$200,000 gain.
$250,000 gain

Answer 32

$0.

Rationale
Grant is moving up therefore recognizes no gain.

Analysis: First, get economics straight.
$800,000 - $250,000 (mortgage) = $550,000 - $50,000 cash = FMV of Grant’s asset $500,000.

Question 33

In which of the following circumstances would a taxpayer be able to get a partial exemption for the sale of a principal residence when the taxpayer did not meet the two year ownership and use test?

The taxpayer decides to move from Florida to Arizona to possibly look for a new job.

The taxpayer changes jobs to a town that is 10 miles away from the former house and 10 miles away from the former job.

The taxpayer sold the house in Milwaukee because the grey days were affecting her sunny disposition and general health.

The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for 3 days.

Answer 33

The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for 3 days.

Rationale

Option d is consistent with the unforeseen circumstances approved by the IRS (see Exhibit 13.6). Option a does not qualify because the taxpayer did not have a job when the residence was sold. Option b does not qualify because the move did not meet the distance requirement. Option c is not correct because general health does not qualify.

Question 34

Grant enters into a 1031 exchange with Cary. Grant’s business building has a basis of $300,000 and he takes Cary’s raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Grant also pays Cary $50,000 in cash.

What is Grant’s basis in the new asset?

$300,000.
$350,000.
$600,000.
$700,000.

Answer 34

$600,000.
Rationale

Old basis plus boot given equals $600,000.
Analysis: Get economics straight.
$800,000 - $250,000 (mortgage) = $550,000 - $50,000 Cash = FMV of Grant’s asset $500,000.