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Flashcards in Module 6 Deck (44)
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1

Which of the following assets is NOT generally considered a capital asset?

A. Personal auto
B. U.S. government securities held for investment
C. A truck used in a business for deliveries
D. A personal residence

C.

The truck used in a business for deliveries is Section 1231 property, not a capital asset. A capital asset is any asset that is not a copyright or creative work, accounts or notes receivable, depreciable property used in a trade or business or for production of income (such as a computer), or inventory (remember ACID).

2

Dean, a single taxpayer in the highest marginal income tax bracket, bought a collection of vintage movie posters in an estate sale three years ago. If he sells the poster collection today at a gain, what is the maximum rate at which the gain will be taxed?

A. 37% B. 28% C. 20% D. 15%

B.

Vintage movie posters are considered a collectible. The maximum long-term capital gain (LTCG) rate for collectibles is 28% (not 15%/20%/25% as with other long-term capital assets). He purchased the posters three years ago, so they have been held long term.

3

Six years ago, Patti purchased a warehouse to store inventory needed for her retail business. She paid $250,000 for this warehouse and incurred legal fees of $10,000 to close the transaction. Subsequent to purchase, Patti added a new loading dock at a cost of $50,000. Assume she has claimed depreciation on the property of $70,000 and paid property taxes of $30,000 over these 6 years. If Patti were to sell the property today, what is her adjusted basis for purposes of determining any gain or loss?

A. $210,000 B. $240,000 C. $250,000 D. $280,000

B.

Patti’s original purchase amount of $250,000 is increased by legal fees of $10,000 and improvements of $50,000. From this amount ($310,000), the depreciation taken of $70,000 is applied to arrive at her adjusted basis of $240,000. The property taxes of $30,000 are expensed (deducted) annually and do not impact basis.

4

When a property’s basis is determined by the FMV less any deferred gain or plus any postponed loss, it is called

A. the adjusted basis.
B. the stepped-up basis.
C. the carryover basis.
D. the substituted basis.

D.

The property’s FMV less any deferred gain or plus any postponed loss is the substituted basis; its most notable application is a nontaxable exchange of qualifying real estate (also known as a like-kind exchange).

5

Jerry owns a rental office building that he purchased for $275,000. Recently, he incurred the costs of a new air-conditioning system for $11,300, replacement of the roof for $21,000, other miscellaneous repairs for $2,500, conversion of unused space to rental space for $16,700, cleaning services of $1,100, lawn services for $2,300, and construction to make the building handicap accessible for $23,800. Based on these expenditures, how much will be added to the cost basis of Jerry’s building and will be depreciated?

A. $72,800 B. $77,700 C. $51,800 D. $28,000

A.

Expenditures that materially extend the life of an asset or adapt it to a new use are considered improvements and are added to the cost basis of the asset and depreciated in accordance with the Internal Revenue Code. As a result, these expenditures include the new air-conditioning system, replacement of the roof, costs to convert unused space to rental space, and the costs to make the building handicap accessible ($11,300 + $21,000 + $16,700 + $23,800 = $72,800).

6

Brad and Cindy Moore have a new business and ask their planner for cost recovery options on some of their newly acquired business assets. Which methods, depending on their business, may be available to the Moores to achieve their goal of cost recovery?

I. Depreciation
II. Amortization
III. Depletion
IV. Leasing

I, II, & III

Statement IV is incorrect. Leasing is a form of income generation using an owned asset and not a method of cost recovery.

7

Ginny sold a file cabinet used in her business for $250. She purchased it for $400 and took a depreciation of $220. What is the amount and character of Ginny’s gain or loss recognized on this sale?

A. $70 ordinary income
B. $70 Section 1231 gain
C. $150 Section 1231 loss
D. $220 ordinary income and $150 Section 1231 loss

A.

The file cabinet is Section 1231 property and will be subject to depreciation recapture upon sale. This recapture (in this case) causes all of the gain to be taxable as ordinary income as follows:

Sales price/amount realized: $250
Original cost: $400
Less depreciation: ($220)
Equals adjusted basis: $180
Recognized gain/ordinary income (less than depreciation of $220): $70

8

Ann purchased a $200,000 machine to use in her business and took $140,000 of depreciation. She sold the machine for $240,000 several years later. Which of the following statements regarding Ann’s gain is CORRECT?

I. Ann will have a $180,000 Section 1231 gain.
II. Ann will have a $40,000 Section 1231 gain.
III. Ann will have a $140,000 Section 1245 gain

II & III

Ann’s total gain is $180,000 ($240,000 amount realized – $60,000 adjusted basis). However, the gain attributable to depreciation of $140,000 must be recaptured as ordinary income under Section 1245 (full recapture), leaving the remaining $40,000 of gain to be treated as Section 1231 (capital) gain

9

Last year, Black Enterprises, a sole proprietorship, had a Section 179 deduction carryover of $8,000. In the current year, the company elected Section 179 for an asset acquired at a cost of $10,000. Its net taxable income for the current year is $15,000 (without considering any of the Section 179 exceptions). What is Black’s Section 179 expense deduction for the current year (assuming no other income)?

A. $8,000 B. $10,000 C. $15,000 D. $18,000

C.

Black’s Section 179 expense deduction is limited to $15,000 or the net taxable income limitation. A Section 179 deduction cannot create a loss. It would still have a $3,000 ($8,000 – [$15,000 – $10,000]) Section 179 carryover from the previous year to be applied to future years.

10

Bernie has a client, Lance, who has acquired a capital asset. Lance plans to sell this rapidly appreciating property but wants to be certain of his timing to minimize the income tax on the disposition. To meet the long-term holding period for the preferential capital gains rate, what is the earliest date that Bernie should recommend the asset be sold if it was acquired March 15, 2020?

A. August 16, 2020
B. December 31, 2020
C. March 15, 2021
D. March 16, 2021

D.

To meet the long-term holding period, property must be held for more than one year (one year and a day). The date that the asset is acquired is not counted. In this example, the asset must be held until March 16, 2021.

11

In the current year, Linda is a single filer who had taxable income of $30,000. She incurred a $5,000 net short-term capital loss (STCL) and a $5,000 net long-term capital loss (LTCL). What is her LTCL carryover, if any, to the following year?

A. $0 B. $2,000 C. $4,000 D. $5,000

D.

The capital loss deduction is limited to $3,000 annually for all taxpayers except those who file as MFS. In calculating this deduction, STCLs are used first. Therefore, $3,000 of the STCL is used, and none of the long-term loss is used. As a result, $5,000 of the long-term loss is carried over with Linda’s total capital loss carryforward equaling $7,000 ($5,000 long term and $2,000 short term)

12

Bart and Walter have entered into an exchange of property. Bart gives Walter a lot that has an FMV of $15,000. In exchange, Walter forgives a $20,000 debt that Bart owes him. Bart acquired the lot in an estate auction for a bargain price of $6,000. What is Bart’s realized gain in this transaction?

A. $15,000 B. $14,000 C. $9,000 D. $6,000

B.

The gain realized is the difference between the amount realized and the adjusted basis. Bart had a total cost basis in the lot of $6,000. The FMV of the lot when he gave it to Walter was $15,000. If Bart had instead sold the lot at that time, he would have had a net gain of $9,000. In addition to this gain, he had a $20,000 debt forgiven for the price of the $15,000 lot. He not only earned the $9,000, but also received an additional $5,000 in noncash consideration (boot) because of the debt forgiveness that was in excess of the FMV of the lot, for a total gain of $14,000.

13

Which of the following is NOT a requirement for a nontaxable exchange?

A. The property is like-kind property.
B. The form of the transaction is an exchange.
C. The exchange cannot involve related parties.
D. Both the property transferred and the property received are held for productive use in a trade or business or held for investment.

C.

Related parties can enter into a nontaxable exchange, although disposition before a two-year holding period will trigger recognition of any deferred gain (boot).

14

On February 2 of the current year, a taxpayer exchanged a bank building, having an adjusted basis and an FMV of $600,000, subject to a mortgage of $275,000, for another bank building with an FMV of $800,000 and subject to a mortgage of $275,000. Transfers were made subject to the assumption of the outstanding mortgages. What amount of gain, if any, will the taxpayer recognize in the current year?

A. $0 B. $75,000 C. $200,000 D. $275,000

A.

The realized gain is $200,000 FMV of property received minus adjusted basis of property given = $800,000 – $600,000 = $200,000. The boot given equals the boot received. Recognized gain is the lesser of gain realized ($200,000) or net boot received ($0). Therefore, there is no recognized gain.

15

Jenny is a commercial real estate manager in Louisiana. She owns an apartment building that has an FMV of $300,000. She paid $100,000 for the building several years ago. Her brother, Buddy, owns an office building in California and agrees to trade buildings with her. The value of the office building in California is $300,000. The exchange officially took place last year. This year, Buddy sells the Louisiana apartment building for $300,000. How much gain must Jenny recognize this year?

A. $0 B. $100,000 C. $200,000 D. $300,000

C

When properties are traded and the use for the newly acquired property is the same as the old property, the Tax Code does not require the taxpayer to recognize any gain received in the exchange. The gain can be carried over into the future, unless the exchange is between related parties and one party sells their property within two years of the exchange. In such cases, both parties are required to recognize any gain or loss that was not recognized during the year that the exchange took place. Because Jenny received Buddy’s $300,000 office building last year, but had a $100,000 basis on her office building, she effectively gained $200,000 through the exchange. Buddy sold his building in the current year (within two years of the exchange), so Jenny must recognize her gain of $200,000 from the exchange this year.

16

John owned business property that was destroyed by a fire. His adjusted basis in the property was $10,000, and ABC Insurance Company sent him a check for $15,000 to cover his loss. If John buys qualified replacement property for $12,000, what is his realized and recognized gain?

A. $3,000 gain realized, $15,000 gain recognized
B. $5,000 gain realized, $3,000 gain recognized
C. $10,000 gain realized, $5,000 gain recognized
D. $15,000 gain realized, $15,000 gain recognized

B.

Gain realized equals $5,000, or the amount of the insurance proceeds received ($15,000) less John’s adjusted basis in the property ($10,000). His gain recognized equals $3,000, which is the difference between his amount realized of $15,000 and the $12,000 that was reinvested in qualified replacement property.

17

Terry purchased a tract of land for investment purposes and paid $200,000. (Land cannot be depreciated.) He sold the land many years later for $500,000 in an installment sale, receiving $50,000 as the first-year payment. How much gain must Terry recognize in the year of sale?

A. $20,000 B. $30,000 C. $50,000 D. $500,000

B.

Terry would recognize a capital gain of $30,000 in the year of sale, calculated as follows:

gross profit percentage (60%) = profit ($300,000) ÷ total contract price ($500,000)

gain recognized ($30,000) = gross profit percentage (60%) × installment payment ($50,000)

18

Jamie, a single taxpayer, bought a condo in Denver for $240,000 in early January 2019. At the end of January 2020, his company transferred him to Dallas, and Jamie sold his condo for $280,000. Because he is worried about being transferred again, Jamie decides not to reinvest the proceeds in a new home and rents a townhome temporarily. Which of the following statements concerning the taxable consequence of Jamie’s decision is CORRECT?

A. Jamie has no taxable gain.
B. Jamie has a taxable gain of $30,000.
C. Jamie has a taxable gain of $40,000.
D. If Jamie reinvests at least $241,000 in a new residence within two years, he would be able to defer the gain on his old residence

A.

Because Jamie owned his condo for one year and was forced to move because of a job change, he could exclude up to half ($125,000) of the Section 121 maximum gain exclusion ($250,000). Because his actual gain of $40,000 was less than $125,000, he has no recognized (taxable) gain. Section 121 eliminated the need for reinvestment to defer the gain.

19

Chris owns a vacation home that he plans to rent for 190 days this year. He also plans to use the home for personal use. What is the maximum number of days he can live in the home without jeopardizing the property’s status as for primarily rental use?

A. 14 days B. 19 days C. 95 days D. 190 days

B.

Because Chris will rent his vacation home for 190 days, he can use the home as a personal residence for up to 19 days (the greater of 14 days or 10% of rental use) without jeopardizing its status as primarily for rental use.

20

The substitute basis of the qualifying asset received in a like-kind exchange is the asset's

A) basis increased by the gain realized but not recognized.
B) fair market value increased by the gain realized but not recognized.
C) fair market value reduced by the gain realized but not recognized.
D) basis reduced by the gain realized but not recognized.

C.

The substitute basis of a qualifying asset received in a like-kind exchange is the asset's fair market value reduced by the gain realized but not recognized. The deferred gain reduces the basis of the acquired asset, such that when that asset is sold, there is a larger gain recognized.

21

Hugh owns and operates a construction company as a sole proprietorship. During February of the current year, he purchased and placed into service a truck with a cost of $14,200 plus sales tax of $800. The truck will be used exclusively in the business. Assume Hugh opts out of bonus depreciation and chooses to use the straight-line option under the Modified Accelerated Cost Recovery System (MACRS). What is the cost recovery deduction for the current year?

A) $1,420
B) $3,000
C) $1,500
D) $2,840

C.

The cost of $14,200 is increased by the acquisition cost of $800. This is multiplied by 10% (100% divided by five years = 20% per year × half-year convention = 10%). Remember that the straight-line method is an option available under the MACRS system.

22

This year, Hugh sold a classic automobile to his friend, Doug, on the following terms:

-The price was $40,000, equal to the fair market value.
-Hugh's basis in the automobile was $25,000.
-Starting this year, Doug will pay in five annual installments of $7,000 plus accrued interest.
-Doug will make a $5,000 down payment.

Ignoring interest income, what amount of gain will Hugh recognize for the current year?

A) $5,000
B) $4,500
C) $7,500
D) $8,571

B.

Hugh's gross profit percentage is 37.5%. This is multiplied by the $12,000 of payments received during the year. The profit on the sale was $15,000 divided by the $40,000 contract price, which equals a 37.5% gross profit percentage.

23

Jacob has an apartment building in Atlanta that he would like to exchange. Which of the following assets could Jacob receive in a like-kind exchange?

I. Farmland
II. Interest in a low-income housing limited partnership
III. Parking lot
IV. An apartment building in Tahiti

I & III

In a like-kind exchange, only real estate may be exchanged for real estate. The like-kind exchange rules specifically prohibit the exchange of U.S. realty for foreign realty.

24

Frank owns and operates a business as a sole proprietor. On August 7, 2021, he purchased equipment (seven-year property) at a cost of $1,165,000 to use in his business. He qualifies for and elects the maximum Section 179 expense deduction. Frank elects out of the bonus depreciation provision. What is the total amount of deductions that Frank can claim in 2021? Use the Modified Accelerated Cost Recovery System (MACRS) table found in the module.

A) $125,000
B) $0
C) $1,040,000
D) $1,066,434

D.

The maximum Section 179 expense is $1.05 million for 2021. This leaves $115,000 of remaining basis that is subject to depreciation, $115,000 times 14.29% equals $16,434. The Section 179 expense of $1.05 million combined with the $16,434 equals $1,066,434. (The MACRS table will be provided on the end-of-course exam.)

25

Carol, a single taxpayer, sold her home in March of the current tax year for $380,000. She had lived in the home as her principal residence for 14 years. She paid a broker's commission of $20,000. The cost, and basis, of the former home was $60,000. What is the amount of gain recognized by Carol on the sale?

A) $300,000
B) $70,000
C) $320,000
D) $50,000

D.

Remember that the commission paid reduces the gain realized. The gain realized from the sale is $300,000 ($380,000 sale price, reduced by the $20,000 commission and the basis of $60,000). After subtracting the $250,000 Section 121 exclusion, the gain recognized is $50,000.

26

During the current year, Sarah gave her daughter, Carol, 1,000 shares of publicly traded stock that Sarah purchased five years ago for $45,000. The stock was worth $100,000 at the time of gift. Sarah paid $41,000 in gift tax out of pocket as a result of this gift. What is Carol's basis in the stock?

A) $72,850
B) $45,000
C) $71,240
D) $71,650

D.

Because this is not loss property, a portion of the gift tax paid out of pocket by the donor can be added to the donor's basis of $45,000 to compute the basis in the hands of the donee. The percentage of the gift tax paid that can be added to the basis is the unrealized appreciation divided by the fair market value of the asset at the time of gift reduced by the gift tax annual exclusion taken. This percentage is multiplied by the gift tax paid out of pocket. In this situation, the appreciation of $55,000 is divided by the taxable value of the gift ($85,000—the $100,000 FMV reduced by the gift tax annual exclusion of $15,000) to give us 65%. This percentage is multiplied by the gift tax paid of $41,000 to equal $26,650. This is added to the original basis of $45,000 to give us $71,650.

27

A casualty loss deduction is treated as

A) an itemized deduction.
B) an adjustment to income.
C) a nondeductible item.
D) a deduction for AGI.

A.

A casualty loss deduction is treated as an itemized deduction, not a deduction for AGI. It is not deductible in arriving at the adjusted gross income.

28

Skip sold an automobile for $10,000 during the current tax year. The automobile had been used exclusively for business purposes. The cost basis was $18,000, which had been fully recovered through straight-line cost recovery deductions. The automobile was sold on an installment agreement, with a down payment of $1,000 and $2,000 principal payments beginning in the current year. What amount of gain must be recognized in the current year and next year, respectively?

A) $0 and $2,000
B) $3,000 and $2,000
C) $1,000 and $2,000
D) $10,000 and $0

D.

In an installment sale, any cost recovery recapture, $10,000 in this situation, is recognized in the year of disposition. All gain in this situation is cost recovery recapture. Remember that with Section 1245 property (predominantly personalty), it does not matter whether straight-line, Section 179, or accelerated depreciation was used. All depreciation is subject to recapture as ordinary income. In this scenario, all future payments received are essentially tax free because all $10,000 of gain has been recognized in the year of disposition.

29

Which of the following may be allowed as a like-kind exchange?

A) Farmland exchanged for farming equipment
B) An apartment building located in San Diego exchanged for an apartment building located in Acapulco, Mexico
C) A heifer exchanged for a bull
D) A parking lot exchanged for a shopping center

D.

An exchange of U.S. realty for foreign realty is not considered like-kind. The like-kind requirements were changed under TCJA and now limits exchanges to realty for realty. The like-kind requirement does not mean that the property transferred must be identical to the property received; it merely requires that realty be exchanged for realty.

30

Bill owns residential real estate that he purchased in 1980 for $201,500. Assume that the property is now fully depreciated, with an adjusted basis of zero. Bill used the Accelerated Cost Recovery System (ACRS) method to recover the cost of the property. If Bill sells the property for $300,000, what is the amount and character of the gain?

A) $98,500 Section 1250 gain and $201,500 Section 1231 gain
B) $201,500 unrecaptured Section 1250 income and $98,500 long-term capital gain
C) $98,500 unrecaptured Section 1250 income
D) $201,500 Section 1250 ordinary income and $98,500 Section 1231 gain

B.

Under Section 1250, only the excess depreciation is recaptured as ordinary income. When a property is fully depreciated, there is no excess depreciation. Thus, all gain on the sale—the difference between the $300,000 sale price and the adjusted basis of zero ($300,000)—is Section 1231 income, potential long-term capital gain. The gain attributable to straight-line depreciation (the unrecaptured Section 1250 income) is subject to a maximum rate of 25%, and the remaining gain of $98,500 is subject to a maximum 15% or 20% long-term capital gain rate.

31

Eleven months ago, Lynnette received 1,000 shares of stock from her uncle, Joseph. Joseph purchased the stock eight years ago for $12 per share. The fair market value on the date of the gift to Lynnette was $9 per share, and she sold the stock today for $5 per share. What is the amount and character of Lynnette's loss from the sale of the stock?

A) $7,000 long-term capital loss
B) $3,000 long-term capital loss
C) $4,000 short-term capital loss
D) $3,000 short-term capital loss

C.

There are two components to this question. What is the basis, and is there tacking of the holding period? When the fair market value on the date of the gift is less than the donor's basis in the asset, the donee's basis in the asset for purposes of determining a loss is the asset's FMV on the date of the gift. In this situation, the $9 per-share value on the date of the gift would be Lynnette's basis. The next issue is the "tacking" of the holding period. In a situation where the donee uses the FMV as the basis, there is no tacking of the holding period. In this situation, Lynnette used the FMV; thus, she uses her own holding period of 11 months. If the donee uses the donor's basis, then the holding period is tacked. In other words, the donor's holding period is added to ("tacked") the donee's holding period.

32

During the current tax year, Rod purchased a building for exclusive use in his manufacturing business. The cost of the property was $422,000, of which $122,000 was attributable to the land. Which of the following statements identifies the proper treatment of the expenditure?

A) The cost attributable to the building may be deducted under Section 179.
B) The $122,000 must be capitalized and may be depreciated.
C) The $122,000 must be capitalized and may not be depreciated.
D) The $300,000 attributable to the building may be currently deductible.

C.

The land may not be depreciated, as only "wasting" assets are subject to depreciation. The Section 179 expense election generally applies to personalty only, and is not available for most real estate. The cost of the building may not be currently deducted; it must be capitalized and depreciated because it has a useful life of over one year.

33

Three years ago, Sam received a gift of 100 shares of common stock from his uncle. The fair market value of the stock on the date of the gift was $12 per share. His uncle had purchased the stock four years earlier at $5 per share. Sam sold this stock for $17 per share last week. What was Sam's per-share basis in the stock when it was sold?

A) $12
B) $5
C) $17
D) $22

B.

If the fair market value on the date of the gift is greater than the donor's adjusted basis, the donor's adjusted basis is used as the recipient's basis. Note that the donor's holding period would be tacked to the donee's holding period.

34

A client sold an apartment building last year for $100,000, paying a sales commission of $5,000 plus $2,500 in closing costs. The building originally cost $80,000 20 years ago. Total straight-line depreciation of $40,000 had been taken. The building had a mortgage of $60,000 that was assumed by the buyer. The client is in the 24% marginal income tax bracket. What is the seller's adjusted cost basis?

A) $32,500
B) $40,000
C) $52,500
D) $37,500

B.

The seller's adjusted basis is the $80,000 purchase price, decreased by the $40,000 of straight-line depreciation. The mortgage has no bearing on the basis of the property.

35

During 2021, Judy, a sole proprietor, purchased new equipment (seven-year property) for her manufacturing business at a cost of $600,000. Judy is in a 12% marginal income tax bracket this year, and expects to be in that bracket for two more years. She is extremely confident that she will be in the highest marginal bracket after that. What advice would you give Judy regarding the use of bonus depreciation and cost recovery deductions?

A) Forgo bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.
B) Use the maximum bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.
C) Use the maximum bonus depreciation and elect the straight-line method.
D) Forgo bonus depreciation and elect the straight-line method.

D.

The fact pattern indicates that Judy is in the lowest marginal bracket for three years, and will be in the highest marginal bracket after that. It makes no sense to maximize the depreciation deduction in years when Judy is in the lowest marginal brackets. By forgoing bonus depreciation and using straight-line, more deductions are pushed into the last five years of the depreciation schedule, when Judy will be in the highest marginal bracket. Remember that because of the half-year convention, seven-year property is depreciated over eight years. Under TCJA, 100% bonus depreciation is allowed for all personalty. In other words, 100% of the cost is deducted in the first year.

36

Jerry owns a dry-cleaning business. During the current year, Jerry purchased and placed into service $730,000 of equipment. He had taxable income of $745,000. Jerry is in the highest marginal income tax bracket this year, and expects to be in that bracket for two more years. After that, he plans to semi-retire, but keep the business open for another five years. He expects to drop into the lowest marginal bracket when he semi-retires. What advice would you give Jerry regarding the use of Section 179, bonus depreciation, and cost recovery deductions?

A) Use the bonus depreciation provision.
B) Forgo Section 179 and bonus depreciation and elect the straight-line method.
C) Elect the maximum Section 179 and elect the straight-line method.
D) Forgo Section 179 and bonus depreciation and use the Modified Accelerated Cost Recovery System (MACRS) table.

A.

The fact pattern indicates that Jerry is in the highest marginal bracket for three years, and then will be in the lowest marginal bracket after that. It makes sense to maximize the depreciation deduction this year when Jerry is in the highest marginal bracket. By using the bonus depreciation provision, the entire $730,000 may be deducted in the year of acquisition.

37

Frank, a single taxpayer, owned a warehouse that he rented as commercial property. He acquired the property several years ago for $196,000. He used the straight-line method of cost recovery, which totaled $35,000. Frank sold the property in February of the current year for $230,000. Frank is single, and has taxable income (not including the real estate gain) of $475,000. What is the amount and nature of the gain on the sale?

A) $69,000 ordinary income
B) $35,000 unrecaptured Section 1250 gain; $34,000 long-term capital gain
C) $7,000 ordinary income
D) $34,000 Section 1231 gain; $35,000 ordinary income

B.

The entire gain of $69,000 is treated as Section 1231 gain, because there is no excess depreciation on the use of the straight-line method. So, $35,000 of the gain is subject to a maximum rate of 25%, as unrecaptured Section 1250 income, and the remaining $34,000 of gain is subject to the maximum regular long-term rate of 20%. The 20% long-term capital gain rate applies, as his taxable income is over the $445,850 breakpoint for the 20% rate. Note that Section 1250 recapture (ordinary income treatment) applies only to excess depreciation—in other words, the excess of an accelerated method over what would have been deducted if straight-line had been used. All realty placed in service after 1986 is depreciated using straight-line, and there is NO recapture (ordinary income) where straight-line depreciation was used.

38

During the current tax year, Jim purchased a warehouse for exclusive use in his manufacturing business. The cost of the property was $620,000, of which $100,000 was attributable to the land. Which of the following statements identify the proper treatment of the expenditure?

I. A portion of the cost attributable to the building may be deducted under Section 179.
II. The $100,000 attributable to the land must be capitalized and may not be depreciated.
III. The $520,000 attributable to the building must be capitalized and depreciated.
IV. The entire $620,000 must be capitalized and depreciated.

II & III

Land is not a depreciable asset—only "wasting" assets are subject to depreciation. The building must be capitalized and depreciated over a period of 39 years. Section 179 generally does not apply to realty; it applies to tangible personalty used in the active conduct of a trade or business.

39

Which of the following statements is accurate with respect to a like-kind exchange?

A) The amount of gain recognized will reduce the taxpayer's basis in the property received.
B) No gain will be recognized unless the taxpayer receives boot.
C) No gain will be recognized on the exchange of inventory.
D) Gain recognized is equal to the gain realized on the exchange plus the boot received.

B.

In a like-kind exchange, the gain recognized is always the lesser of the gain realized or the boot received. If there is no boot received, there is no gain recognized. Inventory is not eligible for like-kind exchange treatment—thus, gain would be recognized. The basis in the acquired property is the FMV of the acquired property, reduced by the gain realized but not recognized (the deferred gain).

40

Jim owns an apartment building with a fair market value of $225,000 and an adjusted basis of $85,000. He wants to acquire Frank's duplex, which has a fair market value of $240,000 and an adjusted basis of $130,000. In the exchange, Jim will pay Frank $15,000 in cash. What is Jim's substitute basis in the acquired duplex?

A) $100,000
B) $140,000
C) $240,000
D) $225,000

A.

Jim is receiving an FMV of $240,000 for the duplex. He is giving up an adjusted basis of $85,000 plus $15,000 cash. The difference between the $240,000 received and the $100,000 given up is the realized gain of $140,000. The gain recognized (the taxable amount reported on the income tax return) in a like-kind exchange is the lesser of gain realized ($140,000) or boot received ($0). The substitute basis in an asset acquired in a like-kind exchange is the FMV of the qualifying property received ($240,000) reduced by the gain realized, but not recognized ($140,000 – $0 = $140,000). Thus, $240,000 – $140,000 = $100,000.

41

Phillip's personal automobile was almost destroyed in an accident. The insurance company paid $6,000 on the claim. The auto's fair market value before the accident was $16,000, and the value after the accident was $1,000. His basis in the automobile was $12,000. Phillip's AGI is $42,500. What is the amount of Phillip's deductible casualty loss?

A) $1,750
B) $6,000
C) $1,650
D) $0

D.

Casualty losses are only deductible for damages sustained within a federally declared disaster area. Thus, there is no deduction for this loss. If the loss had been incurred in a federally declared disaster area (as a result of the disaster), the deductible casualty loss computation would begin with the lesser of the decrease in fair market value ($15,000 decrease in FMV) or the adjusted basis in the property. In this situation, the adjusted basis of $12,000 must be reduced by a $100 floor, the insurance of $6,000, and further reduced by 10% of the adjusted gross income. Thus, $12,000 reduced by $100, $6,000 insurance, and further reduced by $4,250, equals $1,650.

42

Marcus purchased a diamond ring for $15,000 10 years ago. It was stolen in March this year. The ring was purchased to celebrate achieving a significant promotion at work. The FMV at the time of the theft was $20,000. The ring was insured, and after the deductible, Marcus received $19,000 from the insurance company. Marcus replaced the ring with a new one for $20,000. Under Section 1033, what is Marcus's new basis in the replacement ring?

A) $19,000
B) $16,000
C) $20,000
D) $15,000

B.

Marcus's deferred gain on the new ring is $4,000. His new basis is the FMV of the property at acquisition minus the deferred gain ($20,000 − $4,000 = $16,000).

43

Which of the following statements regarding Section 1033 involuntary conversions is CORRECT?

I. For an owner-user, the replacement property must pass the functional use test.
II. The taxpayer use test provides less flexibility than the functional use test.

I only

Statement II is incorrect. The taxpayer use test provides more flexibility than the functional use test.

44

All of the following statements regarding the installment method of reporting gain from a disposition of property are correct except

A) the installment sale method may be used for securities sold in the secondary market.
B) the installment method permits the seller to spread out the taxable gain over more than one year.
C) the payments received under an installment sale may each include capital gains, return of capital, and interest.
D) an installment sale is a sale of property in which the seller receives at least one payment after the year of sale.

A.

The installment sale method cannot be used for inventory or securities traded in the secondary market.