M3 Gains and Losses

Question 1

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?

Answer 1

Land: Section 1231; Shed: Section 1231

Question 2

Which of the following items is a capital asset?

Answer 2

An automobile for personal use

Question 3

Which of the following is a capital asset?

Answer 3

Land held as an investment

Question 4

Capital assets include:

Answer 4

A manufacturing company’s investment in U.S. Treasury bonds.

Question 5

Which of the following sales should be reported as a capital gain?

Answer 5

Government bonds sold by an individual investor.

Question 6

Capital assets include which of the following items?

Answer 6

Land held for personal use.

Question 7

Lee qualified as head of a household for Year 9 tax purposes. Lee’s Year 9 taxable income
was $100,000, exclusive of capital gains and losses. Lee had a net long-term capital loss of
$8,000 in Year 9. What amount of this capital loss can Lee offset against Year 9 ordinary
income?

Answer 7

$3,000

The capital loss deduction is limited to $3,000 per year with the
excess carried forward indefinitely. In this case, Lee can deduct $3,000 against his
income and carry forward the remaining $5,000.

Question 8

Joe Hall owns a limousine for use in his personal service business of transporting
passengers to airports. The limousine’s adjusted basis is $40,000. In addition, Hall owns his
personal residence and furnishings, that together cost him $280,000. Hall’s capital assets
amount to:

Answer 8

$280,000

Question 9

Johnson borrowed $45,000 secured by land with a basis of $20,000. Johnson could not pay
the principal, so the bank foreclosed and sold the land for $35,000 as full settlement of the
debt. What income should Johnson recognize?

Answer 9

$25,000

Foreclosure of property with a nonrecourse, secured loan is
treated as a sale of the property. It is not cancellation of debt (COD) income because
the debtor is not personally liable for the debt. The amount realized is the amount of
the debt immediately prior to the foreclosure. Gain recognized = $45,000 outstanding
debt balance − $20,000 basis = $25,000.

Question 10

An individual taxpayer reported the following net long-term capital gains and losses:
Year Gain (loss)
1 $(5,000)
2 1,000
3 4,000
The amount of capital gain that the individual taxpayer should report in Year 3 is:

Answer 10

$4,000

In Year 1, the taxpayer deducts $3,000 of the net long-term
capital loss against other types of gross income and carries forward $2,000 of net longterm capital loss to Year 2. In Year 2, the taxpayer deducts $2,000 of a long-term
capital loss carryforward against Year 2’s $1,000 long-term capital gain, which yields a
$1,000 net long-term capital loss. The taxpayer deducts Year 2’s $1,000 net long-term
capital loss against other types of gross income in Year 2. In Year 3, no long-term
capital loss remains; therefore, the taxpayer reports $4,000 of net long-term capital
gain.

Question 11

An individual with gross income of $78,000 had the following gains and losses from capital
transactions during the current year:
Loss of $11,000 on the sale of principal residence held for five years;
Gain of $5,000 from the sale of securities held for four years;
Loss of $9,000 on the sale of municipal bonds held for seven months;
Loss of $4,000 on the sale of a painting held for investment for fifteen years.
What amount of the capital loss should the individual carry forward?

Answer 11

$5,000

The loss on the sale of the personal residence is not deductible
because it is a personal loss. The gains and losses on the remaining transactions are
capital gains and losses, which must be netted against each other to determine the
proper tax treatment. Netting of the gains and losses results in a net capital loss of
$8,000. Individuals may deduct a net capital loss of up to $3,000 ($1,500 for married
filing separately) against ordinary income. Because the individual had gross income of
$78,000, it is clear that the individual had ordinary income against which to deduct the
$3,000. After subtracting $3,000 of the net capital loss against ordinary income, there is
a remaining net capital loss of $5,000, which may be carried forward and deducted in
future years.

Question 12

A taxpayer lived in an apartment building and had a two-year lease that began 16 months
ago. The taxpayer’s landlord wanted to sell the building and offered the taxpayer $10,000 to
vacate the apartment immediately. The taxpayer’s lease on the apartment was a capital
asset but had no tax basis. If the taxpayer accepted the landlord’s offer, the gain or loss
would be which of the following?

Answer 12

A long-term capital gain.

A capital asset which is sold or exchanged more than one year
after the date of acquisition will generate either a long-term capital gain (if the capital
asset is sold at a price greater than acquisition cost) or a long-term capital loss (if the
capital asset is sold at a price less than the acquisition cost). In this question, the
lease-hold interest, which is a capital asset, was acquired more than a year ago, and
the basis (acquisition cost) in that capital asset is -0-. So, the receipt of $10,000 to
vacate the apartment will generate a $10,000 long-term capital gain.

Question 13

Decker, an individual, owns 100 percent of Acre, an S corporation. At the beginning of the
year, Decker’s basis in Acre was $25,000. Acre had ordinary income during the year in the
amount of $10,000 and a long-term capital loss in the amount of $4,000. Decker has no
other capital gains or losses during the year. What amount of the long-term capital loss may
Decker deduct this year?

Answer 13

$3,000

A deduction for a net capital loss is limited to the lesser of the net
capital loss or $3,000. Decker’s net long-term capital loss is $4,000, but the deduction
is limited to $3,000.

Question 14

Hall, a divorced person and custodian of her 12-year-old child, filed her current year federal
income tax return as head of a household. During the year, Hall sold an antique that she
bought 10 years ago to display in her home. Hall paid $800 for the antique and sold it for
$1,400, using the proceeds to pay a court-ordered judgment. This information was provided
to the CPA who prepared her return.
The $600 gain that Hall realized on the sale of the antique should be treated as:

Answer 14

Long-term capital gain.

The gain should be treated as a long-term capital gain because
the property was held for more than one year and was sold for more than it cost.

Question 15

An individual reports the following capital transactions in the current year:

Short-term capital gain- $1,000

Short-term capital loss- $ (11,00)

Long-term capital gain- $10,000

Long-term capital loss- $ (6,000)

What amount is deducted in arriving at adjusted gross income?

Answer 15

$3,000

Explanation
Choice “C” is correct. First, the long-term capital gains and losses are netted to arrive
at a net long-term capital gain of $4,000. Next, the short-term capital gains and losses
are netted to arrive at a net short-term capital loss of $10,000. The next step is to net
the net long-term capital gain of $4,000 with the net short-term capital loss of $10,000.
This results in a net capital loss of $6,000. Only $3,000 of that loss is currently
deductible against ordinary income. The remaining loss of $3,000 is carried forward
indefinitely.

Question 16

Marsha and Brad, married taxpayers filing jointly, had the following transactions during Year
9:

Gain on sale of stock purchased in Year 1 and sold in June, Year 9—$3,000

Ordinary income from employers— 80,000

Loss on sale of stock purchased in January, Year 9 and sold in March, Year 9— 20,000

What is the amount of the capital loss carryover to Year 10?

Answer 16

$14,000

Choice “C” is correct. In Year 9, Marsha and Brad had a net capital loss of $17,000, of
which an additional $3,000 can be used to offset income from other sources (for
example, the ordinary income from employment) in the current year. This would reduce
the carryforward to $14,000.

Question 17

Judy and Kevin Kales had the following stock sales during the current taxable year:

Crispy Crunch, Inc.
Gross Proceeds: $4,000
Basis: $5,000

Summer Solstice, Inc.
Gross Proceeds: $3,500 Basis: $3,000

Sealy & Sealy, Inc.
Gross Proceeds: $ 2,000 Basis: $10,000

Each stock was held for over 12 months. What amount should be reported on their current year tax return for capital gain/loss?

Answer 17

$3,000 loss

The Kales’ transactions net to a $8,500 loss on the sales. The
current year transactions should be netted first, then additional amounts up to $3,000
can be used to offset ordinary income.

Question 18

On February 1, year 1, a taxpayer purchased an option to buy 1,000 shares of XYZ Co. for
$200 per share. The taxpayer purchased the option for $50,000, which was to remain in
effect for six months. The market declined, and the taxpayer let the option lapse on August
1, year 1. The taxpayer would report which of the following as a capital loss on the year 1
income tax return?

Answer 18

$50,000 short term.

An option held by an investor is a capital asset. A capital asset
which is sold or exchanged within one year of acquisition will generate either a shortterm capital gain (if the capital asset is sold at a price greater than acquisition cost) or a
short-term capital loss (if the capital asset is sold at a price less than the acquisition
cost). The cost (or other basis) of worthless stock or securities is treated as a capital
loss as if they were sold on the last day of the taxable year in which they became
totally worthless. The option’s exercise price is irrelevant with respect to determining
loss on account of the lapse of the options.

In this question, the options, which were capital assets purchased for $50,000 on
February 1, Year 1, became worthless on the lapse date, August 1, Year 1. Thus, the
$50,000 capital loss is treated as having occurred on December 31, Year 1, the last
day of the taxable year in which the options became totally worthless. Because, as of
December 31, Year 1, the options had not been held for more than a year, the $50,000
capital loss will be reported on the income tax return as a short-term capital loss.

Question 19

A cash-basis taxpayer made a bona fide, nonbusiness loan to an acquaintance in Year 1. At
the end of Year 2, it is determined that the taxpayer will likely be able to collect only 20
percent of the principal, and no interest has been or will be collected. How should the loss
be treated for tax purposes in Year 2?

Answer 19

None of the loss is deductible in Year 2.

None of the loss is deductible. A nonbusiness bad debt must be
totally worthless to be deductible. A nonbusiness bad debt is treated as a short-term
capital loss in the year the debt becomes totally worthless.

Question 20

Individual Lark’s Year 2 brokerage account statement listed the following capital gains and
losses from the sale of stock investments:

Short-term capital gain- 6,000
Long-term capital gain-14,000
Short-term capital loss-4,000
Long-term capital loss-8,000

In addition, two stock investments became worthless in Year 2. Public Company X stock
was purchased on December 15, Year 1, for $5,000, and formal notification was received
by Lark on July, Year 2, that it was worthless. Private company Section 1244 stock was
issued to Lark for $10,000 in January, Year 1, and was determined to be worthless in
December, Year 2. What is Lark’s Year 2 net capital gain or loss before any capital loss
limitation?

Answer 20

$3,000 net capital gain.

First, the long-term capital gain of $14,000 is netted with the
long-term capital loss of $8,000. This results in a net long-term capital gain of $6,000.
Next, the short-term capital gain of $6,000 is netted with the short-term capital loss of
$4,000. This results in a net short-term capital gain of $2,000. Now add the net longterm capital gain of $6,000 and the net short-term capital gain of $2,000 to arrive at a
net capital gain of $8,000. This amount is reduced by the $5,000 worthless stock. So
the final net capital gain is $3,000. Note that the Section 1244 loss of $10,000 does not
affect this calculation because it is an ordinary loss and not a capital loss.

Question 21

An individual had the following capital gains and losses for the year:

Short-term capital loss $70,000

Long-term gain (unrecaptured Section 1250 at 25%)–$56,000

Collectibles gain (28% rate)–$10,000

Long-term gain (15% rate)—$20,000

What will be the net gain (loss) reported by the individual and at what applicable tax
rate(s)?

Answer 21

Long-term gain of $16,000 at the 15% rate.

Specific netting procedures for capital gains and losses are
outlined in the Internal Revenue Code for non-corporate taxpayers. Gains and losses
are netted within each tax rate group (e.g., the 15% rate group). The facts of this
question have already performed this step for us.

Question 22

An individual acquired 500 shares of stock on December 20, Year 1, for a personal portfolio.
On March 15, Year 2, the individual executed a short sale of 500 shares of the stock. On
December 21, Year 2, the individual delivered the 500 shares to cover the short sale. Which
of the following statements best characterizes the gain or loss on the short sale?

Answer 22

The transaction will be treated as a short-term capital asset sale.

A short sale of stock results in a capital asset sale. The holding
period is based on the date the short sale is executed, not the closing date of the short
sale when the stock is delivered. The taxpayer acquired the stock on December 20,
Year 1, and executed the short sale on March 15, Year 2, which is less than one year
so the holding period is short-term. The short sale results in a short-term capital gain.

Question 23

Emmett loaned Baker $10,000. Baker filed for bankruptcy last year, and Emmett was
notified that Emmett would receive $0.20 on the dollar. In the current year, Emmett received
$1,500 as the final settlement. The loan is nonbusiness. How should Emmett report the
loss?

Answer 23

$8,500 short-term capital loss in the current year.

Emmett should report the loss as an $8,500 short-term capital
loss in the current year. Nonbusiness bad debt losses are treated as short-term capital
losses in the year that the debt becomes totally worthless. Since Emmett received the
final settlement in the current year, the loss should be reported in the current year

Question 24

A corporate taxpayer’s capital gains and losses are as follows:

Short-term capital gain-$7,000

Short-term capital loss-$43,000

Long-term capital gain-$9,000

Long-term capital loss-$21,000

What amount of capital loss deduction is the taxpayer entitled to use to offset against
ordinary income?

Answer 24

$0

The net capital loss for the year is $48,000. None of that loss is
currently deductible against ordinary income. It can be carried back three years and
forward five years to offset net capital gains in other years.

Question 25

A C corporation has the following capital gains and capital losses for Years 1 and 2

Year 1:
Capital Gains- $250,000
Capital Losses-$300,000
Year 2:
Capital Gains-$ 425,000 Capital Losses-$350,000

If the C corporation had no capital gains or losses prior to Year 1, what is the minimum net
capital gain that can be reported for Year 2?

Answer 25

$25,000

The minimum net capital gain reported for Year 2 is $25,000.
For C corporations, capital gains can only offset capital losses. A net capital loss can
be carried back three years and forward five years to offset net capital gains in other
years.

Question 26

Aqua Corp. had an operating income of $500,000 and operating expenses of $350,000 in
the current year. Aqua had a long-term capital gain of $30,000 and a $50,000 short-term
capital loss. What is Aqua’s taxable income for the current year?

Answer 26

$150,000

Aqua Corp.’s operating income of $500,000 and operating
expenses of $350,000 are both taken into account in determining its taxable income for
the year, but its net capital loss of $20,000 ($50,000 capital loss netted against the
$30,000 capital gain) is not currently deductible. Instead, it is carried back three years
and forward five years to be used against net capital gains generated in those years.
Thus, Aqua Corp.’s taxable income is simply the $500,000 of operating income minus
the $350,000 of operating expenses, or $150,000.

Question 27

Baker Corp., a calendar year C corporation, realized taxable income of $36,000 from its
regular business operations for the calendar year. In addition, Baker had the following
capital gains and losses during the year.

Short-term capital gain- $8,500

Short-term capital loss-(4,000)

Long-term capital gain-1,500

Long-term capital loss-(3,500)

Baker did not realize any other capital gains or losses since it began operations. What is
Baker’s total taxable income for the year?

Answer 27

$38,500

Capital losses offset capital gains. If a corporation has net capital
gains, they are taxed at ordinary (corporate) income tax rates.