Flashcards in Chapter 4 Deck (75):
Capital assets include:
Investment assets of a taxpayer that are not inventory are capital assets. The manufacturing company would have capital assets including an investment in U.S. Treasury bonds.
Per the above information and rule, real property not used in a trade or business (e.g., land held for investment) is a capital asset.
If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death?
Rule: The executor can elect to use an alternate valuation date rather than the decedent's date of death to value the property included in the gross estate. The alternate date is generally six months after the decedent's death or the earlier date of sale or distribution.
Note: The valuation of the assets in an estate impacts the recipient as basis of the inherited assets.
Smith, an individual calendar-year taxpayer, purchased 100 shares of Core Co. common stock for $15,000 on December 15, Year 1, and an additional 100 shares for $13,000 on December 30, Year 1. On January 3, Year 2, Smith sold the shares purchased on December 15, Year 1, for $13,000. What amount of loss from the sale of Core's stock is deductible on Smith's Year 1 and Year 2 income tax returns?
In Year 1, no sale of stock occurred so there would be no loss. In Year 2, there is a $2,000 loss realized ($15,000 basis less $13,000 received), but it is not deductible because it is a wash sale. A wash sale occurs when a taxpayer sells stock at a loss and invests in substantially identical stock within 30 days before or after the sale. In this case, Smith reinvested in an additional 100 shares four days prior to selling 100 shares of the same stock at a loss. The $2,000 disallowed loss would, however, increase the basis of the new shares by $2,000.
In a "like-kind" exchange of an investment asset for a similar asset that will also be held as an investment, no taxable gain or loss will be recognized on the transaction if both assets consist of:
No taxable gain or loss will be recognized on a like-kind exchange if both assets are tangible property. Rental real estate located in different states qualifies for a like-kind exchange.
In order to meet the "like-kind exchange" requirements for nonrecognition of gain or loss, the property exchanged must be tangible property. Convertible debentures, convertible preferred stock, and partnership interests are not considered tangible property.
Exception: If the same class of stock of the same corporation is exchanged, it will qualify for "substituted basis."
Which of the following sales should be reported as a capital gain?
Government bonds held by an individual investor are considered capital assets in the hands of the investor. When these types of security investments are sold, the resulting gain or loss is reported as capital.
Which of the following statements is the best definition of real property?
Real property includes land and all items permanently affixed to the land (e.g., buildings, paving, etc.)
Which of the following items is a capital asset?
An automobile for personal use is a capital asset.
Rule: Capital assets include property (real and personal) held by the taxpayer for investment, such as:
Personal automobile of the taxpayer
Furniture and fixtures in the home of the taxpayer
Stocks and securities of all types (except those held by dealers)
Personal property of a taxpayer not used in a trade or business
Real property not used in a trade or business
Interest in a partnership
Goodwill of a corporation
Copyrights, literary, musical, or artistic compositions purchased
Other assets held for investment
Items that are NOT capital assets include:
Property normally included in inventory or held for sale to customers in the ordinary course of business
Depreciable personal property and real estate used in a trade or business
Accounts and notes receivable arising from sales or services in the taxpayer's business
Copyrights, literary, musical, or artistic compositions held by the original artist (with the exception of musical compositions held by the original artist)
Treasury stock (not an ordinary asset and not subject to capital gains treatment)
A heavy equipment dealer would like to trade some business assets in a nontaxable exchange. Which of the following exchanges would qualify as nontaxable?
Rule: Nonrecognition treatment is accorded to a "like-kind" exchange of property used in the trade or business or held for investment (with the exception of inventory, stock, securities, partnership interests, and real property in different countries). "Like-kind" means the same type of investment (e.g., realty for realty or personalty for personalty, assuming the personal property falls within the same "asset class" for tax depreciation purposes).
The exchange of a corporate office building for a vacant lot qualifies for like-kind nonrecognition treatment. It is the exchange of realty for realty of property used in the trade or business or held for investment.
What is the calculation for Like Kind Exchanges?
(FMV of new auto + boot received - boot paid) - adjusted basis of old
LESSER of Realized Gain (from above) or boot received/relief of liabilities (this is considered boot received)
Basis of New Property:
Adjusted Basis of property given up + Gain Recognized - Boot Received + Boot Paid
Wynn, a single individual age 60, sold Wynn's personal residence for $450,000. Wynn had owned Wynn's residence, which had a basis of $250,000, for six years. Within eight months of the sale, Wynn purchased a new residence for $400,000. What is Wynn's recognized gain from the sale of Wynn's personal residence?
Rule: The sale of a taxpayer's primary residence is subject to an exclusion from gross income for gain. A maximum of $250,000 gain exclusion is provided for all taxpayers other than married couples filing jointly. Married couples filing jointly have a maximum gain exclusion of $500,000. To qualify for the full exclusion, the taxpayers must have owned and used the property as a primary residence for two years or more during the five-year period ending on the date of the sale or exchange. There is no age requirement to receive the exclusion, and no roll-over to another house is required [these applied to an older tax law].
How do you calculate the installment method?
sale on installment - COGS (basis) = Gross Profit
Gross Profit / sale on installment = Gross Profit %
cash received X Gross Profit Percentage = gain
Inheritance of property is ALWAYS considered:
Additionally, such acquired property is always considered to be "long-term" property, regardless of how long it has been held by the decedent and by the beneficiary or heir.
Stock is specifically excluded from?
Like kind exchanges
Like kind exchanges have to be:
real property for real property (equipment would not work)
Baker, an unmarried individual, sold a personal residence, which has an adjusted basis of $70,000, for $165,000. Baker owned and lived in the residence for seven years. Selling expenses were $10,000. Four weeks prior to the sale, Baker paid a handyman $1,000 to paint and fix up the residence. What is the amount of Baker's recognized gain?
This is a principal residence that the taxpayer has owned and lived in for the last seven years. This exceeds the requirement of at least two of the last five years. Baker may therefore exclude up to $250,000 of gain. The realized gain is $84,000 ($165,000 selling price – $70,000 adjusted basis – $10,000 selling expenses – $1,000 fix-up expenses incurred within 90 days of the sale). All of the realized gain is excluded, and none of it is recognized.
A sole proprietor of a farm implement store sold a truck for $15,000 that had been used to make service calls. The truck cost $30,000 three years ago, and $21,360 depreciation was taken. What is the appropriate classification of the $6,360 gain for tax purposes?
The truck is a depreciable asset used in a trade or business. Therefore, it is a Section 1231 asset. It is also personal property, so the recapture rules of Section 1245 will apply to any gains. The truck was sold at a gain. However, that gain is less than the accumulated depreciation. Under the rules of Section 1245, the gain is all recaptured as an ordinary gain.
Which of the following items qualifies for treatment under Section 1231 (Property Used in the Trade or Business and Involuntary Conversions)?
1231 assets are all depreciable assets and all real property used in a trade or business and held over 12 months. The computer fits this definition.
Which of the following is a disadvantage of a revocable trust?
If a trust is revocable, then a completed gift has not taken place. Therefore, the assets of the trust are still included in the estate of the grantor.
If a security becomes worthless in the current taxable year, it is treated as sold or exchanged on:
The rule is that a worthless security is treated as being sold or exchanged on the last day of the year it becomes worthless.
Which of the following conditions must be satisfied for a taxpayer to expense, in the year of purchase, under Internal Revenue Code Section 179, the cost of new or used tangible depreciable personal property?
To qualify for IRC Section 179, the property must be tangible personal property acquired by purchase from an unrelated party for use in the active conduct of a trade or business.
Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during February, Year 8. No other property was placed into service during Year 8. What convention must Bent use to determine the depreciation deduction for the alternative minimum tax?
Real property (buildings) is subject to the mid-month convention under MACRS. Only personal property (machinery & equipment) is subject to the half-year and/or mid-quarter conventions.
Data Corp., a calendar year corporation, purchased and placed into service office equipment during November Year 1. No other equipment was placed into service during Year 1. Under the general MACRS depreciation system, what convention must Data use?
When a taxpayer places 40% or more of its property (other than certain qualifying real property) into service in the last quarter of the taxable year, the corporation must use the mid-quarter convention for MACRS depreciation purposes. With this method the acquisitions are segregated by quarter and treated as if placed in service in the middle of each respective quarter.
On August 1, Year 1, Graham purchased and placed into service an office building costing $264,000 including $30,000 for the land. What was Graham's MACRS deduction for the office building in Year 1?
Only the building is depreciable, so the depreciable portion is $264,000 less $30,000 land, for a net of $234,000. The MACRS rules provide a 39-year life, straight-line depreciation, and a "mid-month" acquisition convention that treats the property as acquired in the middle of the month, regardless of the actual date of acquisition. Therefore, the August 1, Year 1, service date provides a half-month's depreciation for August, plus a full month for September through December, for a total of 4.5 months for Year 1. ($234,000/39 years) × (4.5/12) = $2,250.
How is the depreciation deduction of nonresidential real property determined for regular tax purposes using MACRS?
Nonresidential realty is depreciated over 39 years straight-line if placed in service after May 1993.
Platt owns land that is operated as a parking lot. A shed was erected on the lot for the related transactions with customers. With regard to capital assets and Section 1231 assets, how should these assets be classified?
Because the parking lot and the shed constitute real estate and depreciable assets used in a trade or business, they are not capital assets per the definition below.
Note: The parking lot and shed will fall under Section 1231 (provided they are used in the business over 12 months) and possibly Section 1250 and 1245, respectively, upon sale of the assets.
In Year 6, an IRS agent completed an examination of a corporation's Year 5 tax return and proposed an adjustment that will result in an increase in taxable income for each of Years 1 through 5. All returns were filed on the original due date. The proposed adjustment relates to the disallowance of corporate jet usage for personal reasons. The agent does not find the error to be fraudulent or substantial in nature.
Which of the following statements regarding this adjustment is correct?
Unless there is a substantial 25% misstatement of income or fraud, the statue of limitations is generally three years from the later of the due date or filing date of a return. This adjustment is improper because there is no evidence of fraud or substantial misstatement and some of the years are old enough that the three year statute has expired.
What should be reported as the cost basis for MACRS five-year property?
MACRS 5-year property includes automobiles, light trucks, computers, typewriters, copiers, duplicating equipment, and other such items.
*note that salvage value is usually ignored
MACRS 7-year property?
includes office furniture and fixtures, equipment and property with no ADR midpoint classified elsewhere, and railroad track
*note that salvage value is usually ignored
Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under Code Sec. 1245?
Under Sec. 1245, ordinary income is recognized on the gain to the extent of the accumulated depreciation. Any gain in excess of the original cost is capital gain.
A taxpayer sold for $200,000 equipment that had an adjusted basis of $180,000. Through the date of the sale, the taxpayer had deducted $30,000 of depreciation. Of this amount, $17,000 was in excess of straight-line depreciation. What amount of gain would be recaptured under Section 1245 (Gain from Dispositions of Certain Depreciable Property)?
Under Section 1245, the amount of depreciation in excess of straight-line depreciation is irrelevant (the "excess depreciation" rule is a Section 1250 rule and applies to real property). In this question, $30,000 of depreciation was deducted and, at first glance, the answer would appear to be $30,000. However, Section 1245 actually only requires that the lesser of the depreciation taken ($30,000) or the gain recognized ($200,000 - $180,000 = $20,000) be recaptured.
Capital assets include which of the following items?
Assets held for personal use are capital assets
For a PARTNER, the basis formula is:
Rollover Cost Basis
- (Liabilities Assumed by OTHER partners, this will be less than 100%, note that the partner taking this ON would add this in, it is only subtracted from the partner putting it IN)
Net Basis (note that if this is below zero it is considered BOOT)
Gain (is any BOOT from above)
Basis (CANNOT be below zero)
A partner's deductible loss is limited to?
his basis plus any amounts that he is personally liable for ("at risk" provision).
Among other events, a partnership terminates for income tax purposes when?
50% or more of its interests change hands within 12 months
What is (are) the effect(s) of the partnership termination?
Rule: When a partnership is terminated for tax purposes and its remaining partners decide to carry on the partnership business in a (deemed) new partnership, tax law treats this as a distribution of the prior partnership's assets followed by a recontribution of the (deemed) distributed assets to the new partnership.
A guaranteed payment is?
a salary or other payment to a partner that is not calculated with respect to partnership income.
Curry's adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000 and a fair market value of $9,000 to Vantage. What was the amount of Curry's basis in the land?
A partner who receives a distribution of non-cash property from a partnership takes the partnership's basis as his basis, but in no case an amount greater than his basis in his partnership interest. In this case Curry would ordinarily take a $6,000 basis in the land, but since his basis in the partnership interest is only $5,000, that is the basis of the land in his hands. Curry's partnership interest now has a basis of zero.
White has a one-third interest in the profits and losses of Rapid Partnership. Rapid's ordinary income for the current taxable year is $30,000, after a $3,000 deduction for a guaranteed payment made to White for services rendered. None of the $30,000 ordinary income was distributed to the partners. What is the total amount that White must include from Rapid as taxable income in his current year tax return?
Rule: Partnership income is taxable to a partner whether or not it is distributed. White's share of Rapid's income is the sum of the $3,000 guaranteed payment and one-third of the partnership's net income of $30,000 ($10,000), for a total of $13,000.
Guaranteed payments made by a partnership to partners for services rendered to the partnership, that are deductible business expenses under the Internal Revenue Code, are:
Guaranteed payments to partners are deductible on Form 1065, Line 10, to arrive at partnership ordinary income. On Schedule K-1, guaranteed payments are shown as income on Line 5 and flow through as ordinary income.
Rule: Guaranteed payments are reasonable compensation paid to a partner for services rendered without regard to the partner's ratio of income. They are allowable tax deductions to the partnership and ordinary income to the partner receiving them.
Note: A guaranteed payment will not increase a partner's basis in the partnership because the payment has been distributed to the partner.
Day's adjusted basis in LMN Partnership interest is $50,000. During the year Day received a nonliquidating distribution of $25,000 cash plus land with an adjusted basis of $15,000 to LMN and a fair market value of $20,000. How much is Day's basis in the land?
In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. This basis cannot exceed the partner's partnership interest.
Therefore, it would be 15,000
Pert contributed land with a fair market value of $20,000 to a new partnership in exchange for a 50% partnership interest. The land had an adjusted basis to Pert of $12,000 and was subject to a $4,000 mortgage, which the partnership assumed. What is the adjusted basis of Pert's partnership interest?
Pert's adjusted basis in the partnership is equal to the $12,000 adjusted basis of the land he contributed to the partnership less the 50% allocable percentage of the $4,000 mortgage assumed by the other partners.
Under Section 444 of the Internal Revenue Code, certain partnerships can elect to use a tax year different from their required tax year. One of the conditions for eligibility to make a Section 444 election is that the partnership must:
Sec. 444 permits a partnership to elect a tax year different from the required tax year if the deferral period (i.e., the number of months between the beginning of the tax year and the end of the required tax year) is 3 months or less.
In computing the ordinary income of a partnership, a deduction is allowed for:
Guaranteed payments to partners are deductible in arriving at the partnership's ordinary income. Ordinary income is the "taxable income" of the partnership excluding all items required to be separately-stated. Charitable contributions, dividend income, and capital losses are all separately-stated items.
When a partner's share of partnership liabilities increases, that partner's basis in the partnership:
When a partner's share of partnership liabilities increases, that partner's basis in the partnership increases by his share of the increase. Since the partner has unlimited liability, the partnership liabilities are treated as if the partner personally borrowed the money and then contributed it to the partnership.
A partnership had four partners. Each partner contributed $100,000 cash. The partnership reported income for the year of $80,000 and distributed $10,000 to each partner. What was each partner's basis in the partnership at the end of the current year?
RULE: The basis in a partnership is increased by investment, pro-rata share of income, and liabilities for which the partner is personally liable. The basis of a partnership is decreased by distributions, pro-rata share of losses, and liabilities for which the partner is personally relieved of.
In a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest because?
To get out, you have to zero out and this will take you to zero
note that this is because it is a LIQUIDATING distribution
The at-risk limitation provisions of the Internal Revenue Code may limit:
A partner's tax deduction for his or her distributive share of partnership losses is limited to the partner's adjusted basis in the partnership, which is increased by any partnership liabilities that he or she is personally liable for (called the "at-risk" provision). Any unused loss can be carried forward and used in a future year when basis becomes available; therefore, the at-risk limitation does not limit a partner's net operating loss carryover.
Nolan designed Timber Partnership's new building. Nolan received an interest in the partnership for the services. Nolan's normal billing for these services would be $80,000 and the fair market value of the partnership interest Nolan received is $120,000. What amount of income should Nolan report?
Nolan receives an interest in the partnership for services performed. The services are valued at the fair market value of what is received (the partnership interest) of $120,000, regardless of what Nolan's normal billing for these services might have been.
Payments are payments to partners for:
Under the Internal Revenue Code, guaranteed payments are payments to partners for services rendered or the use of capital without regard to partnership income.
The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date:
Rule: The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date the partner's holding period of the capital asset began.
On June 1, Year 1, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock's net assets at that date had an adjusted basis of $70,000 and a fair market value of $100,000. In Kelly's Year 1 income tax return, what amount must Kelly include as income from transfer of partnership interest?
Kelly must include as ordinary income the fair market value of the asset received, a 10% interest in a partnership valued at $100,000, or $10,000. It is ordinary income since Kelly provided services for the partnership interest.
When a partner sells his partnership interest, what kind of gain or loss on the sale occurs?
CAPITAL gain or loss TO the extent that there are Sec. 751(a) hot assets (unrealized receivables or substantially appreciated inventory), the partner must recognize ordinary income or loss. In this case, the partnership has no Sec. 751 assets.
Ken Karas owns an 80% interest in the capital and profits of the partnership of Karas & Keel. On July 1 of the current year, Karas bought surplus land from the partnership at the land's fair market value of $30,000. The partnership's basis in the land was $36,000. For the current calendar year end, the partnership's net income was $85,000, after recording the $6,000 loss on the sale of the land. Karas' distributive share of ordinary income from the partnership for the current year was:
Losses between a controlling partner (over 50% interest in capital and profits) and his controlled partnership from the sale or exchange of property are not allowed. Thus the disallowance of the $6,000 loss would make the ordinary income $91,000 and 80% of that is $72,800.
What is the tax treatment of net losses in excess of the at-risk amount for an activity?
Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity. The at-risk amount is also referred to as basis. Note that although we discuss this in the textbook for partnerships, the concept applies to all activities that have flow through income and losses.
How much can someone gift another person without it being taxable?
14,000 or 28,000 for married couples
Does a trust's distributable net income include net long-term capital gains allocated to corpus?
Lyon, a cash basis taxpayer, died on January 15, Year 50.Lyon's executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, U.S. Fiduciary Income Tax Return, for the estate's Year 50 calendar year?
Rule: Form 1041 is due on the 15th day of the fourth month after the close of its taxable year.
Lyon's calendar Year 50 return would be due on April 15, Year 51.
A distribution from estate income, that was currently required, was made to the estate's sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary's gross income is limited to the estate's:
Distributable net income is the upper limit on the amount of income that a beneficiary has to include in income from a trust distribution.
Assuming the tax law in effect for 2016, what amount of a decedent's taxable estate is effectively tax-free if the maximum applicable estate and gift tax credit is taken?
The maximum amount that can be transferred pursuant to a death tax-free is $5,450,000 (2016).
Which of the following is an attribute exclusively of a complex trust?
Complex trusts may accumulate current income, distribute principal, and provide for charitable contributions. Simple trusts may only make distributions from current income (not corpus, or principal), must distribute all income currently, and may not make charitable contributions. Either trust may have more than one beneficiary, have a grantor that is not an individual, or have beneficiaries that are not individuals.
Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created?
A complex trust may distribute principal, so this is the type of trust that was created
Which of the following is allowed in the calculation of the taxable income of a simple trust?
An exemption of $300 is available for simple trusts.
Under which of the following circumstances is trust property with an independent trustee includible in the grantor's gross estate?
If a revocable trust is created by a grantor, the trust assets may be returned to the grantor upon the grantor's "revocation" of the trust (i.e., no "complete" gift exists); thus, the assets never left the control (or possible ownership) of the grantor and remain includible in the gross estate of the grantor.
Which of the following payments would require the donor to file a gift tax return?
Rule: Every transfer of money or property, whether real or personal, tangible or intangible, for less than adequate or full consideration is a gift. There are four items that qualify for unlimited exclusion from gift tax and qualify to be excluded from being reported on a gift tax return: (1) payments made directly to an educational institution for a donee's tuition, (2) payments made directly to a health care provider for medical care (3) charitable gifts, and (4) marital transfers. Relationship of the donee to the donor is not of consequence
Income in respect of a cash basis decedent:
Income in respect of a decedent covers income earned before the taxpayer's death but not collected until after death.
Fred and Amy Kehl, both U.S. citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. Assuming the tax law in effect for 2016, the gross estate of the first spouse to die:
The gross estate of the first spouse to die includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration, as they are considered to have owned the property as joint tenants with right of survivorship.
An executor of a decedent's estate that has only U.S. citizens as beneficiaries is required to file a fiduciary income tax return, if the estate's gross income for the year is at least:
Rule: A fiduciary must file a return on Form 1041 if the estate has gross income of $600 or more for the tax year and if none of the beneficiaries are nonresident aliens.
The charitable contribution deduction on an estate's fiduciary income tax return is allowable:
The charitable contribution deduction on an estates fiduciary income tax return is allowable only if the decedent's will specifically provides for the contribution.
Rule: Estates are allowed an unlimited charitable deduction for amounts that are paid to recognized charities out of gross income under the terms of the governing instrument during the tax year.
Which of the following fiduciary entities are required to use the calendar year as their taxable period for income tax purposes?
Rule: An estate may choose the same accounting period as the decedent, or it may choose a calendar year or any fiscal year it wishes, with a few limited exceptions.
Rule: Trusts (except tax-exempt trusts) must adopt a calendar year.
Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted?
Rule: The federal estate tax return is due 9 months after death, disregarding extensions.
The generation-skipping transfer tax is imposed:
The generation-skipping transfer tax is imposed on transfers of future interest who are two generations or more below the donor's generation. The generation-skipping transfer tax is imposed in addition to any gift or estate tax that may result from a transfer.
Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible:
Administration expenses paid by the fiduciary of an estate are deductible on the "fiduciary income tax return" only if the estate tax deduction is waived for those expenses.
Rule: To deduct administration expenses, a statement must be filed with the income tax return stating that those deductions have not been taken on the decedent's estate tax return.
Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?
When the creator is treated as the owner of a trust, it is referred to as a grantor trust