MCQ's Subunit 9 Sept 2023

Question 1

John Budd is the sole shareholder of Ral Corp., an accrual-basis taxpayer engaged in wholesaling operations. Ral’s retained earnings at January 1, 2023, amounted to $1 million. For the year ended December 31, 2023, Ral’s book income before federal income tax was $300,000. Included in the computation of this $300,000 was the following:

What amount is deductible in Ral’s 2023 return for purchase of the dealer’s franchise?

A. $6,000
B. $0
C. $1,600
D. $1,200

Answer 1

C. $1,600

The cost of certain intangibles acquired (not created) in connection with the conduct of a trade or business or income-producing activity is amortized over a 15-year period, beginning with the month in which the intangible is acquired. A franchise is a qualified intangible. Thus, Ral may deduct $1,600 ($48,000 ÷ 15 × 6/12).

Question 2

Mr. Smith, a single taxpayer, died in Year 4. His Year 4 taxable income of $40,000 included the following stock transactions:

What is the amount of the capital loss deduction for Year 4 and the amount of the capital loss carryover to the decedent’s estate?

Answer 2

Capital Loss Deduction = $3,000
Carryover = $0

Individuals and other noncorporate taxpayers may deduct up to $3,000 of a capital loss against ordinary income. Any excess capital loss may be carried over for an unlimited time period until the loss is exhausted. However, there can be no carryover from a decedent to his or her estate. Therefore, $3,000 of Mr. Smith’s capital loss may be deducted, and there is no carryover.

Question 3

In 2023, Roe Corp. purchased and placed in service a machine to be used in its manufacturing operations. This machine cost $2,891,000. What portion of the cost may Roe elect to treat as a Sec. 179 expense rather than as a capital expenditure?

A. $1,080,000
B. $1,160,000
C. $1,159,000
D. $1,079,000

Answer 3

C. $1,159,000

A taxpayer may treat up to $1,160,000 of the cost of Sec. 179 property acquired during 2023 as an expense rather than as a capital expenditure. The amount deductible under Sec. 179 must be reduced by the amount by which the cost of Sec. 179 property placed in service during the year exceeds $2,890,000. Thus, $1,160,000 is reduced by $1,000 ($2,891,000 – $2,890,000) to find the allowable Sec. 179 deduction.

Question 4

Capital assets include

A. Seven-year MACRS property used in a corporation’s trade or business.

B. A corporation’s accounts receivable from the sale of its inventory.

C. A corporate real estate developer’s unimproved land that is to be subdivided to build homes, which will be sold to customers.

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

Answer 4

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

Capital assets are all property held by a taxpayer not excluded by the IRC. Among the items excluded are accounts receivable, depreciable property, and real property used in a trade or business. The investment in U.S. Treasury bonds is a capital asset.

Question 5

In June of the current year, Susan’s mother gave her 100 shares of a listed stock. The donor’s basis for this stock, which she bought 10 years ago, was $4,000, and market value on the date of the gift was $3,000. Susan sold this stock in July of the current year for $3,500. The donor paid no gift tax. What was Susan’s reportable gain or loss in the current year on the sale of the 100 shares of stock gifted to her?

A. $500 loss.
B. $1,000 loss.
C. $0
D. $500 gain.

Answer 5

C. $0

To compute gain, a donee’s basis is the same as the donor’s basis, adjusted for gift tax. For computing loss, the lower of the donor’s adjusted basis or the FMV of the property is used. If the property is later transferred for more than FMV at the date of the gift but for less than the donor’s basis at the date of the gift, no gain (loss) is recognized. Therefore, Susan reports neither gain nor loss.

Question 6

During the current year, all of the following events occurred: On June 1, Ben Rork sold 500 shares of Kul Corp. stock. Rork had received this stock on May 1 as a bequest from the estate of his uncle, who died on March 1. Rork’s basis was determined by reference to the stock’s fair market value on March 1. Rork’s holding period for this stock was

A. Short-term if sold at a gain; long-term if sold at a loss.
B. Short-term.
C. Long-term if sold at a gain; short-term if sold at a loss.
D. Long-term.

Answer 6

D. Long-term.

Under Sec. 1223(11), if property acquired from a decedent is sold or otherwise disposed of by the recipient within 12 months of the decedent’s death, then the property is considered to have been held for more than 12 months. Therefore, under Sec. 1223(3), it is long-term and subject to the maximum tax rate of the applicable ordinary income breakpoint.

Question 6

On July 1 of the current year, Mr. A, a cash-method taxpayer, sold a painting for which he received $50,000 in cash and a note with a face value of $50,000 and a fair market value of $35,000. He paid a commission of $5,000 on the sale. Mr. A had acquired the painting 15 years ago, and his basis was $5,000. What is A’s recognized gain for the current year?

A. $90,000
B. $75,000
C. $95,000
D. $50,000

Answer 6

B. $75,000

The amount realized under Sec. 1001 includes money received plus the fair market value of other property. Mr. A realized $85,000 ($50,000 cash + $35,000 note). Commissions reduce the amount realized under Reg. 1.263(a)-2. Consequently, Mr. A recognized a gain of $75,000.

Question 6

The uniform capitalization method must be used by

A. II only.
B. Neither I nor II.
C. I only.
D. Both I and II.

Answer 6

C. I only.

A taxpayer that produces tangible personal property must capitalize all of the direct costs of producing the property and an allocable share of indirect costs. A retailer that acquires property for resale must also capitalize the costs. However, an exception from the UNICAP rules exists for producers and resellers with annual gross receipts for the 3 preceding years of not more than $29 million.

Question 7

Sam purchased 100 shares of stock in Year 1 for $2,500. The company had no earnings and profits in Year 2 or Year 3. In Year 3, he received a return of capital distribution on that stock of $2,000, and in Year 4, he received a second return of capital distribution on that stock of $2,000. What amount should he report on his Year 4 tax return?

A. $2,000 as return of capital income.
B. $1,500 as ordinary dividend income.
C. Nothing until the shares are sold.
D. $1,500 as long-term capital gain income.

Answer 7

D. $1,500 as long-term capital gain income.

A return of capital is a tax-free distribution that reduces a stock’s basis by the amount of the distribution. If a shareholder’s basis is reduced to zero because of a tax-free return of capital, any excess amounts received are treated as a capital gain.

Question 8

Allen owns 100 shares of Prime Corp., a publicly-traded company, which Allen purchased on January 1, Year 1, for $10,000. On January 1, Year 3, Prime declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Prime stock was $62 per share. On February 1, Year 3, Allen had his broker specifically sell the 100 shares of Prime stock received in the split when the FMV of the stock was $65 per share. What amount should Allen recognize as long-term capital gain income on his Form 1040, U.S. Individual Income Tax Return, for Year 3?

A. $1,500
B. $300
C. $2,000
D. $750

Answer 8

A. $1,500

The basis in the old stock is “split” and allocated to the new stock. Therefore, the basis in the new stock is $50 per share ($10,000 ÷ 200 shares), and the total basis in sold shares is $5,000 ($50 × 100 shares). Gain is any excess of the amount realized over adjusted basis. All gain realized is currently recognized unless an exception applies. Therefore, the recognized gain is $1,500 [$6,500 – $5,000].

Question 9

In Year 1, Janice had the following transactions in Jacky, Inc., common stock:

What is Janice’s deductible capital loss?

A. $700
B. $1,400
C. $400
D. $1,100

Answer 9

D. $1,100

A current loss realized on a wash sale of securities is not recognized. A wash sale occurs when substantially the same securities are purchased within 30 days before or after being sold at a loss. On May 12, Janice sold 500 shares, which resulted in a potential capital loss deduction of $1,000. With the wash sale rule in place, the loss is deferred until the replacement shares are sold. Since Janice repurchased 250 shares within 30 days, the capital loss from 250 shares (half of the 500 shares) cannot be deducted. Thus, $500 of the capital loss is disallowed (deferred) and the rest of the capital loss ($500) is recognized. The disallowed loss is added to the basis of the stock repurchased in the wash sale. Therefore, the basis of 250 repurchased shares is $6,000 (250 repurchased shares × $22 purchase price + $500 disallowed loss). The new cost basis of the stock is $24 ($6,000 ÷ 250 shares). On October 15, Janice sold 100 shares of the stock. Thus, she recognizes a capital loss of $600 [100 shares × ($24 new basis – $18 selling price)]. Therefore, Janice’s total deductible capital loss is $1,100 ($500 from the first sale + $600 from the second sale).

500 * $25 = $12,500
500 * $23 = $11,500
$12,500 - $11,500 = $1,000
$1,000/2 = $500

250 * $22 = $5,500
$5,500 + $500 = $6,000
$6,000/250 = $24

100 * ($24 - $18)
100 * $6 = $600

$600 + $500 = $1,100

Question 10

With regard to depreciation computations made under the general MACRS method, the half-year convention provides that

A. Depreciation will be allowed in the last year of the property’s economic life only if the property is disposed of after June 30 of the year of disposition for calendar-year corporations.

B. Depreciation will be allowed in the first year of acquisition of the property only if the property is placed in service no later than June 30 for calendar-year corporations.

C. One-half of the first year’s depreciation is allowed in the year in which the property is placed in service, regardless of when the property is placed in service during the year, and a half-year’s depreciation is allowed for the year in which the property is disposed of.

D. The deduction will be based on the number of months the property was in service, so that one-half month’s depreciation is allowed for the month in which the property is placed in service and for the month in which it is disposed of.

Answer 10

C. One-half of the first year’s depreciation is allowed in the year in which the property is placed in service, regardless of when the property is placed in service during the year, and a half-year’s depreciation is allowed for the year in which the property is disposed of.

The half-year convention applies to all property placed in service after 1986 except for residential rental and nonresidential real property (to which the mid-month convention applies) and except when the mid-quarter convention applies. Under the half-year convention, all property to which it applies is treated as placed in service or disposed of at the midpoint of the year.

Question 11

Sand purchased 100 shares of Eastern Corp. stock for $18,000 on April 1 of the prior year. On February 1 of the current year, Sand sold 50 shares of Eastern for $7,000. Fifteen days later, Sand purchased 25 shares of Eastern for $3,750. What is the amount of Sand’s recognized gain or loss?

A. $1,000
B. $500
C. $2,000
D. $0

Answer 11

A. $1,000

A current loss realized on a wash sale of securities is not recognized. A wash sale occurs when substantially the same securities are purchased within 30 days before or after being sold at a loss. Although Sand sold 50 shares of Eastern on February 1, it reacquired 25 more shares of Eastern less than 30 days later. Thus, the 25 shares that Sand reacquired 15 days later do not contribute to the recognized loss on February 1. If the total realized loss on February 1 is $2,000 ($9,000 basis of shares sold – $7,000 sales price), only half is recognized because only half is not subsequently reacquired.

$18,000/100 = $180
50 * $180 = $9,000
$9,000 - $7,000 = $2,000
$2,000/2 = $1,000

Question 12

Bennet purchased a tract of land for $20,000 in Year 1 when he heard that a new highway was going to be constructed through the property and that the land would soon be worth $200,000. Highway engineers surveyed the property and indicated that he would probably get $175,000. The highway project was abandoned in Year 3 and the value of the land fell to $15,000. Even though there has been no sale, Bennet can claim a loss in Year 3 of

A. $180,000
B. $160,000
C. $0
D. $5,000

Answer 12

C. $0

Because Bennet has not sold, exchanged, or otherwise disposed of the land, he has not realized a loss. Therefore, he cannot claim any loss in Year 3. When the land is sold or exchanged, his realized loss or gain will be equal to the amount realized minus his adjusted basis.

Question 13

Dunn received 100 shares of stock as a gift from Dunn’s grandparent. The stock cost Dunn’s grandparent $32,000, and it was worth $27,000 at the time of the transfer to Dunn. Dunn sold the stock for $29,000. What amount of gain or loss should Dunn report from the sale of the stock?

A. $2,000 gain.
B. $3,000 loss.
C. $0
D. $3,000 gain.

Answer 13

C. $0

If the FMV on the date of the gift is less than the donor’s basis, the donee has a dual basis for the property.

1. Loss basis. The FMV at the date of the gift is used if the property is later transferred at a loss.
2. Gain basis. The donor’s basis is used if the property is later transferred at a gain.
3. If the property is later transferred for more than FMV at the date of the gift but for less than the donor’s basis at the date of the gift, no gain (loss) is recognized.

Therefore, Dunn does not report any gain or loss ($32,000 gain basis > $29,000 sale price > $27,000 loss basis).

Question 14

Bluff purchased equipment for business use for $35,000 and made $1,000 of improvements to the equipment. After deducting depreciation of $5,000, Bluff gave the equipment to Russett for business use. At the time the gift was made, the equipment had a fair market value of $32,000. Ignoring gift tax consequences, what is Russett’s basis in the equipment?

A. $35,000
B. $32,000
C. $31,000
D. $36,000

Answer 14

C. $31,000

According to IRS Publication 551, if the FMV of the property is equal to or greater than the donor’s adjusted basis, the donee’s basis is the donor’s adjusted basis at the time the donee received the gift. The fair market value at the date of the gift is $32,000, while the donor’s adjusted basis is $31,000 ($35,000 cost + $1,000 improvements – $5,000 depreciation). Thus, Russett’s basis is equal to Bluff’s adjusted basis of $31,000.

Question 15

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 6 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?

A. $150,000 long term.
B. $200,000 short term.
C. $50,000 long term.
D. $50,000 short term.

Answer 15

D. $50,000 short term.

The taxpayer’s basis in the option is the cost basis, or $50,000. Therefore, when the option lapsed, it became worthless, and the taxpayer realized a loss of $50,000. Since the taxpayer purchased the option on February 1, Year 1, and it lapsed on August 1 of the same year, the taxpayer held the asset for less than 1 year and the capital loss is short-term.

Question 16

Which one of the following statements is true with regard to an individual taxpayer who has elected to amortize the premium on a bond that yields taxable interest?

A. The bond’s basis is reduced by the amortization.
B. The amortization is treated as an itemized deduction.
C. The amortization is not treated as a reduction of taxable income.
D. The bond’s basis is increased by the amortization.

Answer 16

A. The bond’s basis is reduced by the amortization.

An election may be made to amortize the premium on a bond yielding taxable interest income. If the premium is amortized, the basis of the bond must be reduced by the amount of premium that is amortized.

Question 17

Fred Berk bought a plot of land with a cash payment of $40,000 and a $50,000 mortgage. In addition, Berk paid $200 for a title insurance policy. Berk’s basis in this land is

A. $40,200
B. $40,000
C. $90,000
D. $90,200

Answer 17

D. $90,200

The basis of property is its cost. Cost includes cash paid and any debt to which the property is subject, regardless of whether the debt is recourse or nonrecourse. In addition, basis includes expenditures for major improvements and costs to acquire title.

Question 18

Which of the following costs is includible in inventory under the uniform capitalization rules for merchandise manufactured by a company for sale to its customers?

A. Selling expenses.
B. Advertising.
C. General legal fees.
D. Engineering.

Answer 18

D. Engineering.

A manufacturer capitalizes costs for construction of real or tangible personal property to be used or sold in a trade or business. Both direct and most allocable indirect costs necessary to prepare the inventory for its intended use must be capitalized. Therefore, the engineering costs are direct costs that are related to the construction or creation of the inventory to be sold by the manufacturer.

Question 19

On February 16, Year 1, Fred Samson purchased 100 shares of Oscar Corporation stock at $40 per share. On July 28, Year 5, he sold the 100 shares at $25 per share. On August 10, Year 5, his wife purchased 50 shares of Oscar Corporation at $30 per share. These are the only capital asset transactions by the Samsons during Year 5. In computing his taxable income for Year 5, Fred may deduct, from his ordinary income of $15,000, a capital loss in the amount of

A. $375
B. $750
C. $1,500
D. $1,000

Answer 19

B. $750

Fred sold 100 shares of stock on July 28, and his wife subsequently purchased 50 shares of the same corporation’s stock on August 10. Consequently, 50 of the shares Fred sold are not eligible for the capital loss deduction because this would be considered a wash sale (spouses are treated as the same taxpayer for this purpose). Under Sec. 1091, a wash sale occurs when substantially the same securities are purchased within 30 days of being sold for a loss. A capital loss deduction is available for the other 50 shares. The sale of 50 shares resulted in a $750 loss. The full amount of the loss is deductible.

Question 20

Which of the following conditions must be satisfied for a taxpayer to expense, in the year of purchase, under Internal Revenue Code Sec. 179, the cost of new or used tangible depreciable personal property?

A. II only.
B. Both I and II.
C. Neither I nor II.
D. I only.

Answer 20

B. Both I and II.

In order for a property to be expensed under Sec. 179, it must be both purchased for use in the taxpayer’s active trade or business as well as be purchased from an unrelated party.

Question 21

Soft Cream sells franchises to independent operators. In the current year, it sold a franchise to Edward Trent, charging an initial fee of $20,000 and a monthly fee of 2% of sales. Soft Cream retains the right to control such matters as employee and management training, quality control and promotion, and the purchase of ingredients. Mr. Trent’s current-year sales amounted to $200,000. From the transactions with Trent, Soft Cream, an accrual-basis taxpayer, should include in its computation of taxable income

A. Ordinary income of $24,000.
B. Long-term capital gain of $20,000, ordinary income of $4,000.
C. Long-term capital gain of $24,000.
D. Long-term capital gain of $4,000, ordinary income of $20,000.

Answer 21

A. Ordinary income of $24,000.

The transfer of a franchise is not treated as a sale or exchange of a capital asset if the transferor retains significant power, rights, or continuing interest with respect to the franchise. The right to control employee and management training, quality control and promotion, and the purchase of ingredients constitutes significant power, rights, and continuing interest. Therefore, the transfer is not a sale but merely a licensing agreement, and all the income ($20,000 initial fee and $4,000 monthly fee) is ordinary income.

Question 22

Capital losses incurred by a married couple filing a joint return

A. Are not allowable losses.
B. Will be allowed only to the extent of capital gains.
C. Will be allowed to the extent of capital gains, plus up to $3,000 of ordinary income.
D. May be carried forward up to a maximum of 5 years.

Answer 22

C. Will be allowed to the extent of capital gains, plus up to $3,000 of ordinary income.

The amount of capital losses that can be deducted is the lesser of the excess of capital losses over capital gains or $3,000 [Sec. 1211(b)]. The maximum amount in excess of capital gains allowed as a deduction is $3,000 ($1,500 for married taxpayers filing separately).

Question 23

Lewis Brown bought four lots of land for $100,000. On the date of purchase, the lots had the following fair market values:

What is the basis to Lewis of Lot #3?

A. $31,250
B. $25,000
C. $20,625
D. $16,500

Answer 23

D. $16,500

When more than one asset is purchased for a lump sum, the basis of each is computed by apportioning the total cost based on the relative FMV of each asset. Lot #3 has a FMV that is 16.5% of the FMV of all of the lots purchased [$20,625 ÷ ($25,000 + $31,250 + $20,625 + $48,125)]. Thus, the basis of Lot #3 is $16,500 ($100,000 × 16.5%).

Question 24

A beneficiary acquired property from a decedent. The fair market value at the date of the decedent’s death was $100,000. The decedent had paid $130,000 for the property. Estate taxes attributed to the property were $2,000. The beneficiary sold the property 2 years after receipt from the estate. What is the basis of the property for the beneficiary?

A. $100,000
B. $102,000
C. $130,000
D. $132,000

Answer 24

A. $100,000

Basis is the FMV on the date of death or 6 months after if the executor elects the alternate valuation date for the estate tax return.

Question 25

Which of the following types of costs are required to be capitalized under the Uniform Capitalization Rules of Code Sec. 263A?

A. Marketing.
B. Distribution.
C. Warehousing.
D. Office maintenance.

Answer 25

C. Warehousing.

UNICAP rules require the capitalization of all expenses necessary to bring the asset to its intended use. Storage of an asset prior to its intended use would qualify as a cost incurred to bring it to its full use and should be capitalized under UNICAP.

Question 26

On August 1 of the current year, 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 the current year?

A. $9,600
B. $6,000
C. $3,600
D. $2,250

Answer 26

D. $2,250

Under MACRS, an office building is nonresidential real estate having a 39-year recovery period and is depreciated using the straight-line depreciation method. The land is not depreciable. The cost of the office building ($234,000) is divided by 39 years to yield $6,000. Because of the mid-month convention, 4.5 months of depreciation, or $2,250, is deductible in the year of purchase.

Question 27

All of the following statements are correct regarding bonus depreciation except

A. Only new property is eligible for bonus depreciation.

B. Qualified property would not include any property used by a regulated public utility company or any property used in a real property trade or business.

C. First-year bonus depreciation is 80% for qualified property placed in service in 2023.

D. The property cannot be acquired from a related party.

Answer 27

A. Only new property is eligible for bonus depreciation.

Property is eligible for the additional depreciation if it is the taxpayer’s first use. It allows the property to be new or used.

Question 28

Browne, a self-employed taxpayer, had 2023 business taxable income of $1,100,000 prior to any expense deduction for equipment purchases. In 2023, Browne purchased and placed into service, for business use, office machinery costing $1,175,000. This was Browne’s only 2023 capital expenditure. Browne’s business establishment was not in an economically distressed area. Browne made a proper and timely expense election to deduct the maximum amount. Browne was not a member of any pass-through entity. What is Browne’s deduction under the election?

A. $1,100,000
B. $1,175,000
C. $1,160,000
D. $2,890,000

Answer 28

A. $1,100,000

Tangible and depreciable personal property can be expensed by up to $1,160,000 in 2023, the year of acquisition. This amount is reduced when the amount of Sec. 179 property placed in service in a given year exceeds $2,890,000. Since this limit does not apply, the maximum deduction would be $1,160,000; however, there are other limits. Section 179(b)(3)(A) limits the deduction to taxable income derived from the active conduct of any trade or business. In this case, the maximum deduction is $1,100,000.

Question 29

In 2023, Micro Corp. purchased a machine to be used in its business. The machine qualifies as Sec. 179 property. The cost of the machine is $3,430,000. What is the amount of Sec. 179 deduction that Micro Corp. may take in 2023?

A. $0
B. $620,000
C. $540,000
D. $1,160,000

Answer 29

B. $620,000

The maximum dollar amount that may be deducted under Sec. 179 is $1,160,000 in 2023 for the cost of qualifying depreciable tangible property placed in service in the year 2023. The phase-out threshold for eligible property placed in service is $2,890,000 in 2023. Thus, the $1,160,000 maximum Sec. 179 deduction is reduced (but not below zero) by the amount that the cost of qualifying property placed in service during the year exceeds $2,890,000. Thus, the Sec. 179 deduction is $620,000 [$1,160,000 - ($3,430,000 - $2,890,000)].

Question 30

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, which together cost him $280,000. Hall’s capital assets amount to

A. $320,000
B. $280,000
C. $40,000
D. $0

Answer 30

B. $280,000

Capital assets include all property held by a taxpayer unless excluded by the IRC, such as property used in a trade or business. Personal-use property, such as a residence, is a capital asset.

Question 31

Which of the following is a capital asset?

A. Inventory held primarily for sale to customers.
B. Accounts receivable.
C. A computer system used by the taxpayer in a personal accounting business.
D. Land held as an investment.

Answer 31

D. Land held as an investment.

All property is classified as a capital asset unless specifically excluded. Accounts receivable, inventory, and depreciable property or real estate used in a business are not capital assets. Land held as an investment, however, is a capital asset unless it is held by a dealer (the general rule and not an exception is being tested).

Question 32

For 2023, Mr. G has a short-term capital loss of $4,000, a short-term capital gain of $1,900, a short-term capital loss carryover from 2021 of $700, a long-term capital gain of $800 from property held for 3 years, and a long-term capital loss of $1,500 from property held for 4 years. Mr. G is in the 15% breakpoint basket. What is Mr. G’s deductible loss in 2023?

A. $0
B. $2,800
C. $3,000
D. $3,500

Answer 32

C. $3,000

Short-term capital gains and losses and long-term capital gains and losses are first netted to determine the capital loss deduction. The carryover from 2021 retains its character as a short-term capital loss and is netted with the other short-term transactions.

Since the loss computed above exceeds $3,000, the amount deductible is limited to the lesser of $3,000 or taxable income (Sec. 1211). Long-term capital losses of $500 are carried forward to the 28% basket.

Question 33

Bob sold securities in Year 1. The sales resulted in a capital loss of $7,000. He had no other capital transactions. He and his wife Gloria decide to file separate returns for Year 1. His taxable income was $26,000. What amount of capital loss can he deduct on his Year 1 return and what amount can he carry over to Year 2?

A. $4,000 in Year 1 and $3,000 carry over to Year 2.
B. $7,000 in Year 1 and $0 carry over to Year 2.
C. $1,500 in Year 1 and $5,500 carry over to Year 2.
D. $3,000 in Year 1 and $4,000 carry over to Year 2.

Answer 33

C. $1,500 in Year 1 and $5,500 carry over to Year 2.

If capital losses exceed capital gains for the tax year, the excess is taken into account as negative taxable income for up to $3,000 ($1,500 if married filing a separate return). Thus, Bob will deduct $1,500 in Year 1, and carry over $5,500 to Year 2.

Question 34

Ian Broke frequently traded on the stock market. On November 1, Year 1, when stock prices were very high, Broke sold short (sold without owning any stock by borrowing from the broker) 100 shares of Ducko, Inc. On July 1, Year 2, Broke purchased 100 shares of Ducko and delivered them on December 1, Year 2. Broke also purchased 100 shares of High Tech, Inc., on February 1, Year 1. He sold 100 shares of High Tech short on December 1, Year 1. Broke delivered these 100 shares on September 1, Year 2. Broke is in the 35% income tax bracket. What is Broke’s character of gain or loss realized on the sales?

A. Short-term capital gain or loss in Year 1 and short-term capital gain or loss in Year 2.

B. Short-term capital gain or loss in Year 2.

C. Long-term capital gain or loss in Year 1 and short-term capital gain or loss in Year 2.

D. Long-term capital gain or loss in Year 1.

Answer 34

A. Short-term capital gain or loss in Year 1 and short-term capital gain or loss in Year 2.

Under Section 1233, the holding period of the property in a short sale if the taxpayer does not own substantially identical property prior to the short sale runs from the date the property was purchased to the date the short sale is closed out. If the taxpayer owns substantially identical property prior to the short sale, the holding period runs from the date the property was originally purchased to the date of the short sale.

Accordingly, the holding period of the shares of Ducko. Inc runs from July 1, Year 2, to December 1, Year 2 (short term). And that of the shares of High Tech, Inc runs from February 1, Year 1, to December 1, Year 1 (short term). Ian has capital gain or loss on both sales as the properties (stocks) used to close the short sale are both capital assets. As such, Ian should realize short-term capital gain or loss on the High Tech sale in Year 1 and short-term capital gain or loss on the Ducko sale in Year 2.

Question 35

In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Sec. 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Sec. 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year?

A. $50,000 capital loss.
B. $50,000 ordinary loss and $18,000 capital loss.
C. $18,000 ordinary loss and $50,000 capital loss.
D. $68,000 capital loss.

Answer 35

B. $50,000 ordinary loss and $18,000 capital loss.

Up to $50,000 of loss realized on disposition or worthlessness of Sec. 1244 stock is treated as an ordinary loss. This limit applies to Sec. 1244 stock held in all corporations. The remaining $18,000 ($48,000 + $20,000 – $50,000) is a capital loss.

Question 36

Martin filed a timely return on April 15. Martin inadvertently omitted income that amounted to 30% of his gross income stated on the return. The statute of limitations for Martin’s return would end after how many years?

A. 3 years.
B. Unlimited.
C. 7 years.
D. 6 years.

Answer 36

D. 6 years.

The general statute of limitations (S/L) for assessment of a deficiency is 3 years from the date the return was filed. However, the S/L is 6 years if there is omission of items of more than 25% of gross income stated in the return. Only items completely omitted are counted.

Question 37

On January 3 of the current year, Wilson purchased 300 shares of common stock in Corporation Why for $120 per share. Four months later, he purchased 100 additional shares at $180 per share. On December 10 of the current year, Wilson received a 10% nontaxable stock dividend. The new and the old stock are identical. What is the amount of Wilson’s basis in each share of stock of Corporation Why stock after the stock dividend?

A. 330 shares at $120 a share and 110 shares at $180 a share.
B. 440 shares at $123 a share.
C. 330 shares at $120 a share and 110 shares at $164 a share.
D. 330 shares at $109 a share and 110 shares at $164 a share.

Answer 37

D. 330 shares at $109 a share and 110 shares at $164 a share.

The stock dividend made by Corporation Why is a tax-free distribution. The basis of the new stock is determined by allocating the basis of the old stock between the new stock and the old stock. This allocation of basis in the stock is made based on the relative fair market values on the date of distribution for each of the two different blocks of stock, rather than by averaging them. Wilson owns 330 (300 + 30) shares with a basis of $36,000, or $109 per share and 110 (100 + 10) shares with a basis of $18,000, or $164 per share.

Question 38

Lemon owned 2,000 shares of Spectrol Corp. common stock that were purchased in Year 1 at $10.50 per share. In Year 4, Lemon received a 5% non-taxable dividend of Spectrol common stock. In Year 5, the stock split 2-for-1. In the current year Lemon sold 800 shares. What is Lemon’s basis in the 800 shares of stock sold?

A. $4,000
B. $8,400
C. $16,800
D. $8,000

Answer 38

A. $4,000

The $4,000 basis in the 800 shares of stock sold is calculated as follows:

1. Lemon purchased 2,000 shares at $10.50 per share in Year 1; thus, total basis in the 2,000 shares is $21,000.
2. The basis of stock acquired in a nontaxable distribution (e.g., stock dividend) is allocated a portion of the basis of the stock upon which the distribution was made. Thus, per share basis is $10.00 {$21,000 ÷ [2,000 shares purchased × 1.05 (5% stock dividend)]}.
3. The 2-for-1 stock split increases stock shares to 4,200 (2,100 shares × 2); however, basis for each share decreases to $5 ($21,000 original basis ÷ 4,200 shares).
4. The basis of the 800 shares is $4,000 (800 shares of stock sold × $5 share basis).

Question 39

Which of the following taxpayers may use the cash method of accounting?

A. A qualified personal service corporation.
B. A C corporation with annual gross receipts of $70,000,000.
C. A tax shelter.
D. A non-small business manufacturer.

Answer 39

A. A qualified personal service corporation.

The cash method of accounting is only permitted for certain taxpayers. The following taxpayers use the accrual method of accounting as their overall method of accounting for tax purposes: (1) C corporations, unless they are small C corporations or personal service corporations; (2) partnerships that have a C corporation as a partner; (3) trusts that are subject to the tax on unrelated income; and (4) tax shelters. Any entity that is not a tax shelter and has average gross receipts of not more than $29 million may also use the cash method of accounting, i.e., small C corporations. An entity meets the $29 million gross receipts test if the annual gross receipts for the 3 tax years ending with the prior tax year do not exceed $29 million. Taxpayers that are required to use inventories must use the accrual method to account for purchases and sales.

Question 40

When an attorney, a CPA, or an enrolled agent knows that a client has backdated a document that the client wants the representative to submit to the IRS, the representative has a duty to do which of the following?

A. Instruct the client to provide a document that is dated appropriately.

B. Advise the client promptly of such noncompliance, error, or omission, as well as the consequences under the revenue laws.

C. Notify the local district attorney of a possible crime.

D. Submit the document (providing the client has provided the representative a document declaring him or her free from malpractice liability).

Answer 40

B. Advise the client promptly of such noncompliance, error, or omission, as well as the consequences under the revenue laws.

Section 10.21 of Treasury Department Circular 230 requires an attorney, a certified public accountant, or an enrolled agent who knows that a client has not complied with the revenue laws of the United States to promptly advise the client of the noncompliance and advise the client of the consequences for the noncompliance under the revenue laws.

Question 41

Mr. E, a sole proprietor, is in the process of selling his retail store. Based on the following list of assets used in his business, what is the total amount of E’s capital assets?

The goodwill is not being amortized.

A. $200,000
B. $0
C. $80,000
D. $30,000

Answer 41

D. $30,000

Under Sec. 1221, a capital asset is defined as any property held by the taxpayer (whether or not it is connected with his or her trade or business) that is not specifically excluded by Sec. 1221. Land used in a business, accounts receivable, inventories, and copyrights created by the owner are specifically excluded. Buildings and furniture and fixtures are excluded as depreciable property used in a business. E’s only capital asset is the goodwill ($30,000) acquired in 1990. This goodwill is not eligible to be amortized under Sec. 197, since it was acquired before July 25, 1991 (the earliest date that Sec. 197 applies to goodwill).

Question 42

Which one of the following is not a qualifying person for purposes of the Child and Dependent Care Credit?

A. Dependent who was mentally unable to care for himself or herself and for whom the taxpayer can claim an exemption.

B. Spouse who was physically unable to care for himself or herself.

C. Dependent who was age 12 when the care was provided and for whom the taxpayer can claim an exemption.

D. Child who was under age 13 when the care was provided, but who lived with the taxpayer’s former spouse all year.

Answer 42

D. Child who was under age 13 when the care was provided, but who lived with the taxpayer’s former spouse all year.

The IRC allows a credit for employment-related expenses for an individual who maintains a household that includes as a member one or more qualifying individuals. A qualifying individual is a dependent of the taxpayer who is under the age of 13, a dependent who is physically handicapped, or a spouse who is incapable of caring for himself or herself. The credit is available to a former spouse who has custody of a child who is under age 13. However, the child will not be a qualifying individual for the other parent.

Question 43

In 2023, Walt Sheen purchased and placed in service a packaging machine at a cost of $2,894,000. He had $1,050,000 taxable income from his business before considering the deduction allowed under Sec. 179. What is Walt’s allowable Sec. 179 deduction for 2023?

A. $1,156,000
B. $2,894,000
C. $1,050,000
D. $1,160,000

Answer 43

C. $1,050,000

Section 179 allows a taxpayer to treat up to $1,160,000 of the cost of Sec. 179 property acquired in 2023 as an expense rather than as a capital expenditure. There are certain limitations that can reduce the allowable deduction. One limitation is that the amount deductible under Sec. 179 must be reduced by the amount by which the cost of Sec. 179 property placed in service during the year exceeds $2,890,000. Walt’s deduction is reduced from $1,160,000 + $1,156,000 – $1,050,000 by this limitation. Another limitation is that the total cost that can be deducted is limited to the taxable income from the active conduct of any trade or business during the tax year. Walt had only $1,050,000 of taxable income. Because this amount is smaller than either the general rule or the limitation based on property placed in service, his deduction is limited to $1,050,000. The remaining $106,000 ($1,156,000 - $1,050,000) may be carried forward.

Question 44

Mr. J bought an asset on June 19, 2022. What is the earliest date on which Mr. J could have sold that asset and qualified for long-term capital gain or loss treatment?

A. June 20, 2023.
B. June 19, 2023.
C. December 20, 2022.
D. December 19, 2022.

Answer 44

A. June 20, 2023.

Long-term capital gain or loss treatment is provided if the asset is held for more than 1 year. The general rule is that the date the property is acquired is excluded and the date that the property is disposed of is included in this computation of the holding period. Since Mr. J bought the asset on June 19, 2022, his holding period is treated as beginning June 20, 2022. Exactly 1 year is considered to have expired on June 19, 2023. Therefore, on June 20, 2023, more than 1 year has passed, which would satisfy the long-term holding period requirement.

Question 45

Rock Crab, Inc., purchases the following assets during the year:

What should be reported as the cost basis for MACRS 5-year property?

A. $3,000
B. $33,000
C. $28,000
D. $25,000

Answer 45

C. $28,000

Under MACRS, personal property is assigned a recovery period of either 3, 5, 7, 10, 15, or 20 years. Common 5-year property includes computers, office machinery (e.g., copier), cars, trucks, and R&E equipment. Office furniture is 7-year property.
The computer and delivery van are 5-year property for a total of $28,000 ($3,000 computer plus $25,000 delivery van).

Question 46

Al Oran bought a paved vacant lot adjacent to his retail store for use as a customers’ parking lot at a cost of $15,000. In addition, Oran bought new store fixtures costing $8,000. What portion of these assets constitutes capital assets?

A. $23,000
B. $8,000
C. $0
D. $15,000

Answer 46

C. $0

Capital assets are all property held by a taxpayer not excluded by IRC definition. Real property used in a trade or business is specifically excluded, as is depreciable business property such as the store fixtures.

Question 47

At December 31, Year 2, the following assets were among those owned by Rea:

Total capital assets amounted to

A. $216,000
B. $22,000
C. $222,000
D. $16,000

Answer 47

C. $222,000

Capital assets include all property held by a taxpayer unless excluded by the IRC. Excluded are inventory (e.g., stock in trade held by a broker for sale to customers), depreciable business property, real property used in a trade or business, copyrights and artistic compositions created by the owner, accounts and notes receivable, and certain U.S. government publications acquired at reduced cost. Personal use property, such as a residence, is a capital asset.

Question 48

Earl Cook, who worked as a machinist for Precision Corp., lent Precision $1,000 in Year 1. Cook did not own any of Precision’s stock, and the loan was not a condition of employment. In Year 5, Precision declared bankruptcy, and Cook’s note receivable from Precision became worthless. What loss can Cook claim on his Year 5 income tax return?

A. $500 long-term capital loss.
B. $1,000 business bad debt.
C. $1,000 short-term capital loss.
D. $0

Answer 48

C. $1,000 short-term capital loss.

When a nonbusiness bad debt becomes worthless, the loss that results is treated as a short-term capital loss. A nonbusiness bad debt is one that arises other than in connection with a trade or business of the taxpayer.

Question 49

A taxpayer purchased 5 acres of land for $20,000 and placed in service other tangible business assets that cost $542,000. Disregarding business income limitations and assuming that the annual Sec. 179 (Election to Expense Certain Depreciable Business Assets) limit is $1,160,000, what maximum amount of cost recovery can the taxpayer claim this year?

A. $20,000
B. $562,000
C. $542,000
D. $1,160,000

Answer 49

C. $542,000

Section 179 property is tangible personal property that is depreciable and is Sec. 1245 property. Since land is not depreciable, it is not Sec. 179 property. Therefore the only Sec. 179 property that can be expensed is the $542,000 of other tangible business assets.

Question 50

Taylor owns 1,000 shares of Media Corporation common stock with a basis of $22,000 and a fair market value of $33,000. Media paid a nontaxable 10% common stock dividend. What is the basis for each share of Media common stock owned by Taylor after receipt of the dividend?

A. $30
B. $33
C. $20
D. $22

Answer 50

C. $20

The basis of the new stock is determined by allocating the basis of the old stock between the new stock and the old stock. Taylor owns 1,000 shares with a basis of $22,000, or $22 per share. After the dividend, Taylor owns 1,100 shares with a basis of $20 per share ($22,000 ÷ 1,100 shares).

Question 51

Ms. Pear owned 1,000 shares of YZ Corporation which she had purchased in Year 1 at a cost of $12 per share. In Year 3, she received a nontaxable 20% stock dividend. The shares were identical to those she already held. She ended the year owning 1,200 shares. In Year 5, the stock split 2 for 1 which increased her holdings to 2,400 shares at the end of the year. In Year 8, she sold 400 shares. What was her basis in the 400 shares of stock sold?

A. $4,800
B. $4,000
C. $2,400
D. $2,000

Answer 51

D. $2,000

A distribution of common stock as a stock dividend on common stock is generally a tax-free distribution. The same is true for a stock split. The basis of the original stock is allocated between it and the distributed stock based on their relative fair market values. Here, all the stock has the same fair market value, so the basis per share is calculated as total basis divided by total number of shares. Ms. Pear’s total number of shares is 2,400. Her basis is $5 per share ($12,000 ÷ 2,400 shares = $5).

Question 52

Which one of the following is a capital asset when a business was built by the taxpayer?

A. Land used as a parking lot for customers.
B. Delivery truck.
C. Machinery used in business.
D. Goodwill.

Answer 52

D. Goodwill.

Capital assets include all property held by a taxpayer unless excluded by the IRC. Goodwill is not excluded unless it was acquired in connection with a trade or business. Goodwill acquired is thus treated as amortizable property, which is not a capital asset. Internally generated goodwill, however, is a capital asset.

Question 53

In 2023, Micro Corp. purchased a machine to be used in its business. The machine qualifies as Sec. 179 property. The cost of the machine is $3,430,000. What is the amount of Sec. 179 deduction that Micro Corp. may take in 2023?

A. $1,160,000
B. $0
C. $620,000
D. $540,000

Answer 53

C. $620,000

The maximum dollar amount that may be deducted under Sec. 179 is $1,160,000 in 2023 for the cost of qualifying depreciable tangible property placed in service in the year 2023. The phase-out threshold for eligible property placed in service is $2,890,000 in 2023. Thus, the $1,160,000 maximum Sec. 179 deduction is reduced (but not below zero) by the amount that the cost of qualifying property placed in service during the year exceeds $2,890,000. Thus, the Sec. 179 deduction is $620,000 [$1,160,000 - ($3,430,000 - $2,890,000)].

Question 54

Kerry Orange owned a 20% interest for 20 years in the T & T Partnership, which owns no unrealized receivables or inventory items. In the current year, he sold his interest for $30,000 and was relieved of his share of partnership liabilities of $2,200. At the date of sale, Orange’s total basis in his partnership interest was $24,000. What gain or loss should Orange report?

A. $8,200 ordinary income.
B. $3,800 ordinary income.
C. $6,000 capital gain.
D. $8,200 capital gain.

Answer 54

D. $8,200 capital gain.

Gain or loss on the sale of a partnership interest is capital gain or loss under Sec. 741. Liabilities assumed by the purchaser are part of the amount realized on the sale. Therefore, Orange is considered to have received $32,200 for his partnership interest ($30,000 + $2,200). His capital gain is $8,200 ($32,200 – $24,000).

Question 55

Amy owns 200 shares of common stock of Barn Corp., which she purchased in Year 1 for $12,000. In Year 2, Barn declared a 2-for-1 stock split when the fair market value of the stock was $72 per share. In Year 3, Amy received a 20% nontaxable stock dividend. What is the amount of Amy’s basis in each share of common stock of Barn after the stock dividend in Year 3?

A. $25
B. $72
C. $50
D. $30

Answer 55

A. $25

A distribution of common stock in a stock split and as a stock dividend is generally a tax-free distribution. The basis of the original stock is allocated to the total number of stocks after the distribution. Amy’s total number of shares after the stock dividend distribution and the stock split is 480 (200 × 2 × 1.2). Her basis is $25 per share ($12,000 ÷ 480 = $25).

Question 56

If an exempt organization is a charitable trust, then unrelated business income is

A. Taxed at rates applicable to corporations.
B. Subject to tax even if this income is less than $1,000.
C. Not subject to tax.
D. Subject to tax only for the amount of this income in excess of $1,000.

Answer 56

D. Subject to tax only for the amount of this income in excess of $1,000.

UBI, net of a $1,000 UBI exemption allowed by Sec. 512(b)(12), of an exempt organization is subject to tax.

Question 57

Xylo, a calendar-year C corporation, acquired the assets of Yerke, also a calendar-year C corporation, on March 1 of the current year. One of the assets acquired was a trademark to which Xylo properly allocated $1,200,000 of the purchase price. What is Xylo’s amortization deduction for the current year?

A. $120,000
B. $80,000
C. $66,667
D. $30,000

Answer 57

C. $66,667

The cost of trademarks acquired in connection with the conduct of a trade or business or income-producing activity is amortized over a 15-year period, beginning with the later of the month in which the intangible is acquired or business begins. The amortization for the current year, therefore, is $66,667 {[($1,200,000 ÷ 15 years) ÷ 12 months] × 10 months}.

Question 58

During the current year, an individual taxpayer completed the following stock transactions related to Alpha Corp. stock:

The 1,000 shares sold on June 10 had been purchased on May 15. What is the maximum amount, if any, that the taxpayer can deduct in the current year?

A. $0
B. $2,000
C. $3,000
D. $8,000

Answer 58

A. $0

To prevent abusive transactions in which a taxpayer sells property at a loss but quickly repurchases the property, leaving the taxpayer in the position of still having the property but with the benefit of recognizing a loss, a current loss realized on a wash sale of securities is not recognized. A wash sale occurs when substantially the same securities are purchased within 30 days before or after being sold at a loss.

1. The disallowed loss is added to the basis of the stock purchased in the wash sale.
2. The holding period includes that of the originally purchased stock.
3. Spouses are treated as one person.

The stock sold on June 10 was purchased less than 30 days prior on May 15; therefore, the disallowed loss is added to the basis of the stock purchased in the wash sale.

Question 59

Which of the following statements best describes the applicability of a constitutionally valid Internal Revenue Code section on the various courts?

A. Only the Tax Court is bound to the Code section. All other courts may waiver from the Code section.

B. District, claims, and appellate courts are bound by the Code section. The Supreme and Tax Courts are not bound by it.

C. Only the Supreme Court is not bound to follow the Code section. All other courts are bound to the Code section.

D. All courts are bound by the Code section.

Answer 59

D. All courts are bound by the Code section.

The Internal Revenue Code is the body of tax statutes enacted by Congress as the law of federal taxation. Because it is federal law, it is binding on all federal courts.

Question 60

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, which together cost him $280,000. Hall’s capital assets amount to

A. $280,000
B. $40,000
C. $320,000
D. $0

Answer 60

A. $280,000

Capital assets include all property held by a taxpayer unless excluded by the IRC, such as property used in a trade or business. Personal-use property, such as a residence, is a capital asset.

Question 61

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?

A. $8,500 ordinary loss in the current year.
B. $8,500 short-term capital loss in the current year.
C. No loss should be reported because no deduction is permitted.
D. $8,000 short-term capital loss last year and $500 capital loss in the current year.

Answer 61

C. No loss should be reported because no deduction is permitted.

A taxpayer is entitled to a deduction when a nonbusiness debt becomes totally worthless during the tax year. No deduction is allowed for a nonbusiness debt which is recoverable in part during the taxable year. Unlike business bad debts, no deduction is permitted unless and until the nonbusiness debt becomes totally worthless. A bad debt deduction is not permitted for a nonbusiness debt that is only partially worthless. A nonbusiness bad debt that is totally worthless is treated as a short-term capital loss.

Question 62

On June 1, Year 1, Mr. Smart purchased investment land. On January 31, Year 2, Mr. Smart traded the land plus cash for some other investment land in a non-taxable exchange. On August 15, Year 2, he sold the land received in the non-taxable exchange for a gain. What is the character of Mr. Smart’s gain for Year 2?

A. Part short-term capital gain and part long-term capital gain.
B. Short-term capital gain.
C. Ordinary income.
D. Long-term capital gain.

Answer 62

D. Long-term capital gain.

If property received in an exchange has the same basis in whole or in part as that of the property given (and if the property given is a capital asset or a Sec. 1231 asset), the holding period of the property received includes the period for which the property given was held. Thus, when the property is sold, the holding period includes the holding period of the property exchanged, and capital assets held more than 1 year are treated as long-term.

Question 63

Estie Tate is in the real estate business. She purchased a vacant office building for the purpose of reselling it. Estie’s sister, not a real estate dealer, owns a large tract of residential land she purchased 7 years ago as an investment. Winfield Nestar is a tax lawyer. He converted an apartment building into condominiums and is trying to sell them. He also owns a tract of land that is zoned for business use and was received in payment for his fees last year. Nestar subdivided this land and is selling it as an office park. Which of the following will produce capital gain or loss?

A. Estie’s sister’s subdivision of the residential land into five lots and sale to five purchasers.

B. Estie’s sale of the office building.

C. Nestar’s sale of the office park lots.

D. Nestar’s sale of the condominiums to the residents.

Answer 63

A. Estie’s sister’s subdivision of the residential land into five lots and sale to five purchasers.

Generally, the subdivision of land into parcels converts the parcels into property held primarily for sale to customers, so the property is not a capital asset and the gain therefore is ordinary income. Nevertheless, Sec. 1237 provides that land held by a taxpayer other than a corporation is not deemed to be held primarily for sale to customers solely because the taxpayer subdivided the land for purposes of sale.

The land will be considered a capital asset only if the following requirements are met:

The taxpayer must not have previously held the land for sale to customers; in the same year in which the sale occurs, the taxpayer must not hold any other real property for sale to customers; no substantial improvements may have been made on the land while held by the taxpayer; and the land must have been held by the taxpayer for at least 5 years. Since Estie’s sister meets all of the requirements, her subdivision and sale will produce capital gain or loss.

Question 64

Mr. Pine purchased a small office building. Included in his costs were the following:

What is Mr. Pine’s basis in the property?

A. $355,000
B. $353,000
C. $359,000
D. $350,000

Answer 64

B. $353,000

The basis of property is its original cost. The cost of property includes debt to which the property is subject (Crane, 331 U.S. 1, 1947). Further, the cost of property includes necessary expenses paid in connection with the acquisition of the property. The attorney fees and title insurance are included in the cost of the property. The fire insurance premiums and rent expense, however, are not paid in connection with the acquisition of the property. Thus, the basis is $353,000 ($50,000 cash payment + $300,000 mortgage assumed + $2,000 title insurance + $1,000 attorney fees).

Question 65

Under a divorce settlement, Joan transferred her 50% ownership of their personal residence to Jim. The joint basis of the residence was $200,000. At the time of the transfer, the property’s fair market value was $300,000. What was Joan’s recognized gain and Jim’s basis for the residence?

Answer 65

Recognized Gain = $0
Basis = $200,000

Property transferred to a spouse or former spouse incident to divorce is treated as a transfer by gift. No gain is recognized on property or monetary amounts gifted to others; thus, no gain is recognized on this transfer. The donee’s basis in property acquired by gift is the donor’s basis increased for any gift tax paid attributable to appreciation. Therefore, Jim’s basis is equal to $200,000.

Question 66

On September 1, Year 1, Sam purchased for $9,200 cash a $10,000 bond with 10% annual interest that matures in Year 11. Sam did not elect to accrue market discount currently as interest income. On September 2, Year 2, Sam sold the bond for $9,400. The amount and character of gain Sam must recognize in Year 2 from this transaction is

A. $80 ordinary income; $120 long-term capital gain.
B. $80 ordinary income; $120 short-term capital gain.
C. $200 short-term capital gain.
D. $600 long-term capital loss.

Answer 66

A. $80 ordinary income; $120 long-term capital gain.

Section 1276(a)(1) requires that gain on the disposition of any market discount bond be treated as ordinary income to the extent that the market discount could have been accrued as interest. In this case, the market discount was $800 ($10,000 – $9,200). The accrued market discount is the amount bearing the same ratio to the market discount as the number of days the taxpayer held the bond bears to the number of days from acquisition to maturity. The accrued market discount is $80 [$800 × (1 year ÷ 10 years)]. The total gain was $200 ($9,400 – $9,200), so the gain consists of $80 ordinary income and $120 long-term capital gain. The holding period is measured beginning on the day after purchase (i.e., September 2, Year 1) and includes the date sold (i.e., September 2, Year 2) for a total of 366 days (i.e., longer than 1 year).

Question 67

The IRS requested client records from a CPA who does not have possession or control of the records. According to Treasury Circular 230, the CPA must

A. Obtain the records from the client and submit them to the IRS.

B. Require the client to submit the records to the IRS or withdraw from the engagement.

C. Contact all third parties associated with the records, such as banks and employers, to obtain the requested records for submission to the IRS.

D. Notify the IRS of the identity of any person who, according to the CPA’s belief, could have the records.

Answer 67

D. Notify the IRS of the identity of any person who, according to the CPA’s belief, could have the records.

A practitioner is required to provide information regarding the identity of persons that the practitioner reasonably believes may have possession or control of the requested documents if the practitioner does not have possession or control of the documents.

Question 68

At the first of the year, Jane purchased a piece of equipment for $250,000 for use in her business. She incurred freight charges of $3,500, installation charges of $2,500, and maintenance costs of $5,000 for the year. At the end of the year, Jane was offered $200,000 for the equipment. During the year, she incurred depreciation of $25,000. If Jane sells the equipment, after a year of ownership, what is the amount of gain (loss) realized on the transaction?

A. $31,000 loss.
B. $56,000 loss.
C. $36,000 loss.
D. $26,000 loss.

Answer 68

A. $31,000 loss.

Gain (loss) recognized on a transaction equals the amount realized minus the adjusted basis. Jane will receive $200,000 (amount realized) if she agrees to sell the equipment. The adjusted basis equals the cost basis of the equipment minus depreciation recognized during the year. The cost basis of the equipment equals the purchase price ($250,000) plus the freight charges ($3,500) and the installation charges ($2,500). Maintenance costs are not a capital expenditure, as they are recognized in the normal course of business. Therefore, the adjusted basis of the machinery is $231,000 ($256,000 – $25,000). Thus, the amount of loss realized on the transaction is $31,000 ($200,000 amount realized – $231,000 adjusted basis). All realized gains (losses) are recognized unless the IRC expressly provides otherwise.

Question 69

Ryan exchanged a car that he used in his business for the past 3 years for a new truck with a FMV of $25,000. This transaction took place at the end of the year. The adjusted basis of the car was $8,000 at the beginning of the year of disposition. Ryan paid $4,000 cash and assumed a note payable of $10,000 to be paid in $2,000 increments over the next 5 years. Ryan’s depreciation on the car for the year of disposition was $2,500. What is the gain (loss) recognized on the transaction?

A. $3,000 gain.
B. $11,000 gain.
C. $15,500 gain.
D. $5,500 gain.

Answer 69

D. $5,500 gain.

Gain (loss) recognized on a transaction equals the amount realized minus the adjusted basis. The amount realized is the FMV of the truck received ($25,000) minus the cash consideration given up ($4,000) and the liabilities assumed ($10,000). Thus, the amount realized on the transaction is $11,000. The adjusted basis of the car given up equals the adjusted basis at the beginning of the year ($8,000) minus the depreciation recognized for the year ($2,500). Thus, the adjusted basis of the car at the end of the year is $5,500. The amount of gain recognized on the transaction is $5,500 ($11,000 – $5,500). All realized gains are recognized unless the IRC expressly provides otherwise.

Question 70

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?

Answer 70

Year 1 = $0
Year 2 = $0

The January 3, Year 2, sale was a wash sale because substantially the same stock (as that sold at a loss) was purchased within 30 days before or after being sold at a loss. The $2,000 loss realized on the wash sale is not recognized in Year 1 or Year 2. The disallowed loss is added to the basis of the stock purchased in the wash sale.

Question 71

Under the common law, which of the following defenses, if used by a CPA, would best avoid liability in an action for negligence brought by a client?

A. The CPA’s negligence was not the proximate cause of the client’s losses.
B. The client was comparatively negligent.
C. The accuracy of the CPA’s work was not guaranteed.
D. The client was contributorily negligent.

Answer 71

A. The CPA’s negligence was not the proximate cause of the client’s losses.

A plaintiff-client must prove all of the following elements of negligence: (1) the CPA owed the client a duty, (2) the CPA breached this duty, (3) the CPA’s breach actually and proximately caused the client’s injury, and (4) the client suffered damages. Proximate cause is a chain of causation that is not interrupted by a new, independent cause. Moreover, the injury would not have occurred without the proximate cause. However, actual causation is insufficient. The injury also must have been reasonably foreseeable. Thus, the concept of proximate cause limits liability to foreseeable damages. Accordingly, lack of proof of proximate cause precludes any recovery of damages.

Question 72

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?

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

B. The transaction will be treated as a 40% short-term/60% long-term capital asset sale.

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

D. The transaction will be treated as ordinary income because of the March short sale.

Answer 72

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

A short sale occurs when the taxpayer sells property the taxpayer does not own (or owns but does not wish to sell). The sale is made in two steps: (1) the taxpayer borrows property and delivers it to a buyer (i.e., March 15, Year 2, transaction), and (2) at a later date, the taxpayer either buys substantially identical property and delivers it to the lender or makes delivery out of property the taxpayer held at the time of the sale. The taxpayer does not realize gain or loss until delivery of property to close the short sale (i.e., December 21, Year 2). The taxpayer will have a capital gain or loss if the property used to close the short sale is a capital asset. If, prior to the short sale, the taxpayer owns identical property (as is the case here, with a stock-for-stock transaction), then the holding period ends on the date of the short sale. Thus, the sale is a short-term capital asset sale because the holding period is shorter than 12 months [December 20, Year 1 (original purchase date), to March 15, Year 2 (sale date)].

Question 73

In 2023, Emil Gow won $18,000 in a state lottery and spent $800 for the purchase of lottery tickets. Emil elected the standard deduction on his 2023 income tax return. The amount of lottery winnings that should be included in Emil’s 2023 gross income is

A. $18,000
B. $0
C. $17,200
D. $3,350

Answer 73

A. $18,000

Gambling winnings (whether legal or illegal) are included in gross income. Therefore, Emil must include the full $18,000 in gross income. Gambling losses, i.e., amounts spent on nonwinning tickets, may be deductible but only as an itemized deduction to the extent of gambling winnings.

Question 74

A reportable transaction is one with respect to which additional information is required to be included with a federal income tax return because the transaction is of a type, according to an IRS determination, that has

A. A significant tax impact on future years’ returns.
B. The potential for tax avoidance or evasion.
C. A potential impact on more than one taxpayer.
D. A significant tax impact in the return year.

Answer 74

B. The potential for tax avoidance or evasion.

There are five categories of reportable transactions: listed transactions, transactions of interest, Sec. 165 loss transaction, a transaction with contractual protection, and a confidential transaction. A transaction of interest is a transaction that the IRS and Treasury Department believe has the potential for tax avoidance or evasion, but for which there is not enough information to determine if it should be identified as a tax avoidance transaction.

Question 75

In Year 1, Iris King bought a diamond necklace for her own use at a cost of $10,000. In Year 6, when the fair market value was $12,000, Iris gave this necklace to her daughter, Ruth. No gift tax was due. Ruth’s holding period for this gift

A. Starts in Year 1.

B. Depends on whether the necklace is sold by Ruth at a gain or at a loss.

C. Starts in Year 6.

D. Is irrelevant because Ruth received the necklace for no consideration of money or money’s worth.

Answer 75

A. Starts in Year 1.

The basis of property acquired by gift is generally the same as the basis in the hands of the donor. The holding period of property that has a transferred/carryover basis includes the holding period of the prior owner. Ruth’s holding period, therefore, begins in Year 1 when Iris purchased the necklace.

Question 76

On March 1, Year 1, Roland Doe bought 200 shares of Gummit stock at $40 per share. On April 1, Year 2, Roland sold short (sold without delivering) 100 shares of Gummit stock for $50 per share. On December 1, Year 2, Roland bought 100 shares of Gummit stock for $60 per share and closed the short sale by delivering this stock. What is the resulting character of this short sale by Roland Doe and the date any gain or loss will be recognized?

Answer 76

Character = Long-term capital gain/loss
Date recognized = December 1, Year 2

Section 1233 states that the holding period of the property from the short sale when the taxpayer owns substantially identical property runs from the date the property is originally purchased to the date of the short sale. As such, the stock was held long term (March 1, Year 1 - April 1, Year 2). The taxpayer has a capital gain or loss as the property (stock) used to close the short sale is a capital asset. Also, gain or loss from a short sale is not recognized until Roland closes the short sale by delivering the stock on December 1, Year 2.

Question 77

A taxpayer lived in an apartment building and had a 2-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?

A. A short-term capital gain.
B. An ordinary gain.
C. A long-term capital gain.
D. A short-term capital loss.

Answer 77

C. A long-term capital gain.

Since the lease is a capital asset with no tax basis and the taxpayer would receive $10,000 to vacate the apartment immediately, the taxpayer would have a realized gain of $10,000 ($10,000 cash – $0 adjusted basis). The lease was held for 16 months, therefore, the capital gain is long-term.

Question 78

Donny owns and leases a coal mine to Brian. The lease agreement states that Brian will pay Donny $4 per ton royalty on coal mined. What is Brian’s percentage depletion deduction for the current year from the information given below?

A. $24,000
B. $20,000
C. $22,000
D. $25,000

Answer 78

B. $20,000

Section 611(a) authorizes a reasonable allowance for depletion of mines, oil and gas wells, other natural deposits, and timber. Percentage depletion (for other than oil and gas wells) is provided in Sec. 613 as the specified percentage (10% for coal) of the gross income from the property (excluding any rents or royalties paid or incurred by the taxpayer with respect to the property). This depletion allowance may not exceed 50% of the taxpayer’s taxable income from the property computed before the allowance for depletion. Percentage depletion is the lesser of

Brian’s percentage depletion deduction is thus limited to $20,000 (50% of his taxable income).

Question 79

A married individual invested in Section 1244 small business stock in Year 1. In Year 7, the individual sold the stock at a loss of $157,000. There were no other stock transactions during Year 7. If the taxpayer files a joint return, how much loss can the taxpayer deduct in Year 7?

A. $3,000
B. $157,000
C. $53,000
D. $103,000

Answer 79

D. $103,000

Up to $100,000 (if filing a joint return) of loss realized on disposition or worthlessness of Sec. 1244 stock is treated as an ordinary loss. The remaining $57,000 ($157,000 – $100,000) is a capital loss. However, for the current year, the taxpayer can only deduct a $3,000 capital loss against the ordinary income since there is no capital gain to offset. Therefore, in Year 7, the taxpayer is able to deduct a $103,000 loss ($100,000 Sec. 1244 loss + $3,000 capital loss). The remaining loss must be carried forward.

Question 80

During Year 1, Mr. F acquired 100 shares of stock in ABC Corporation for $500. During Year 3, he sold the stock for $1,000. His adjusted basis in the stock at the time of sale was $500, and he had no other capital gains or losses during the year. What is the amount and character of income to be reported on F’s income tax return for Year 3?

A. $500 ordinary income.
B. $500 long-term capital gain.
C. $500 short-term capital gain.
D. $500 tax-exempt income.

Answer 80

B. $500 long-term capital gain.

F’s gain is the amount realized less the adjusted basis of the stock. The amount realized is the $1,000 selling price. The adjusted basis is the original $500 purchase price. Therefore, his gain is $500 ($1,000 – $500).
Stock acquired as an investment or by a trader is a capital asset. The character of the gain is long-term capital gain. Under Sec. 1222(3), long-term capital gain is gain from the sale or exchange of a capital asset held for more than 1 year.

Question 81

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

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

A. Short-term loss of $3,000 at the ordinary rate, long-term capital gain of $10,000 at the 15% rate, collectibles gain of $10,000 at the 28% rate, and Section 1250 gain of $56,000 at the 25% rate.

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

C. Short-term loss of $3,000 at the ordinary rate and long-term capital gain of $86,000 at the 15% rate.

D. Long-term capital gain of $3,000 at the 15% rate, collectibles gain of $10,000 at the 28% rate, and Section 1250 gain of $56,000 at the 25% rate.

Answer 81

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

The short-term capital loss will be used first to offset net gain for the highest long-term rate basket, then to offset the next highest rate basket and so on. The $70,000 loss will entirely offset the $10,000 collectibles gain and the $56,000 unrecaptured Section 1250 gain. The remaining $4,000 will partially offset the $20,000 15% long-term gain leaving $16,000 of long-term gain at a 15% rate.

Question 82

Don invested in Ho Ho Mutual Fund by purchasing 100 shares on March 1, Year 1. On the first day of every month, the Ho Ho fund pays a dividend that Don elected to have reinvested in the Ho Ho fund. Don received five additional shares each month. On April 15, Year 2, Don sold his entire interest (165 total shares) in the Ho Ho fund. How many of the Ho Ho fund shares sold by Don qualify for the long-term holding period?

A. 100
B. 110
C. 105
D. 165

Answer 82

C. 105

The holding period of an asset for purposes of long-term gain treatment is 1 year from the date of acquisition, not including the day of acquisition but including the day of disposition. In this case, the only dividend reinvestment received more than 1 year away from the date of sale was the one received 4/1/Yr 1. The other shares were received less than 1 year from the date of sale.