Reg 4 Flashcards
(192 cards)
1
Q
Smith made a gift of property to Thompson. Smith's basis in the property was $1,200. The fair market value at the time of the gift was $1,400. Thompson sold the property for $2,500. What was the amount of Thompson's gain on the disposition? a. $0 b. $2,500 c. $1,300 d. $1,100
A
Choice "c" is correct. The general rule for the basis on gifted property is that the donee receives the property with a rollover cost basis (equal to the donor's basis). An exception exists where the fair market value of the property at the time of the gift is less than the donor's basis. That is not the case in this question; thus, the calculation of the gain on the disposition of the property is: Amount realized $ 2,500 Basis (1,200) Gain recognized $ 1,300
2
Q
Leker exchanged a van that was used exclusively for business and had an adjusted tax basis of $20,000 for a new van. The new van had a fair market value of $10,000, and Leker also received $3,000 in cash. What was Leker's tax basis in the acquired van? a. $13,000 b. $7,000 c. $20,000 d. $17,000
A
Choice “d” is correct. $17,000 is the tax basis in the van.
The basis for like-kind exchanges is computed as follows:
Basis of old property $ 20,000
Less: Boot received (3,000)
New basis $ 17,000
Alternate calculation: FMV of new van $10,000 + deferred loss $7,000 = New basis $17,000.
The general rule is the gain is recognized to the extent boot is received. As the transaction results in a loss to Leker (he received an asset worth $10,000 plus $3,000 cash less a $20,000 tax basis equals $7,000 loss) no gain is recognized and the $3,000 received reduces his basis in the new asset.
3
Q
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 manufacturing company’s investment in U.S. Treasury bonds.
d.
A corporate real estate developer’s unimproved land that is to be subdivided to build homes, which will be sold to customers.
A
Choice “c” is correct. Investment assets of a taxpayer that are not inventory are capital assets. The manufacturing company would have capital assets including an investment in U.S. Treasury bonds.
4
Q
Conner purchased 300 shares of Zinco stock for $30,000, 20 years ago. On May 23 of the current year, Conner sold all the stock to his daughter Alice for $20,000, its then fair market value. Conner realized no other gain or loss during the year. On July 26 of the current year, Alice sold the 300 shares of Zinco for $25,000. What amount of the loss from the sale of Zinco stock can Conner deduct in the current year? a. $10,000 b. $3,000 c. $5,000 d. $0
A
Choice “d” is correct. Even though Conner has a realized loss of $10,000 on this transaction he cannot deduct the loss since it was incurred in a transaction with his daughter, a related party.
5
Q
Conner purchased 300 shares of Zinco stock for $30,000, 20 years ago. On May 23 of the current year, Conner sold all the stock to his daughter Alice for $20,000, its then fair market value. Conner realized no other gain or loss during the year. On July 26 of the current year, Alice sold the 300 shares of Zinco for $25,000. What was Alice's recognized gain or loss on her sale? a. $5,000 long-term gain. b. $5,000 long-term loss. c. $0 d. $5,000 short-term loss.
A
Choice “c” is correct. Alice has a realized gain of $5,000 on the transaction: $25,000 sales price less $20,000 purchase price. However, she can reduce the gain, but not below zero, by the amount of loss her father could not deduct on the sale to her. Thus, Alice can reduce her gain by up to $10,000, but not below zero. Here, the gain is $5,000, so it is reduced to zero. Conner should have sold the stock in the open market so that he could deduct the entire loss. Alice could then have purchased the stock in the open market.
6
Q
If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death? a. 3 b. 6 c. 9 d. 12
A
Choice “b” is correct.
Rule: The executor can elect to use an alternate valuation date rather than the decedent’s date of death to value the property included in the gross estate. The alternate date is generally six months after the decedent’s death or the earlier date of sale or distribution.
Note: The valuation of the assets in an estate impacts the recipient as basis of the inherited assets.
7
Q
In December, Year 10, Davis, a single taxpayer, purchased a new residence for $200,000. Davis lived in the new residence continuously from Year 10 until selling the new residence in July, Year 17 for $455,000. What amount of gain is recognized from the sale of the residence on Davis' Year 17 tax return? a. $455,000 b. $0 c. $5,000 d. $255,000
A
Choice "c" is correct. Provided Davis has lived in his home for a total of 2 years out of the 5 years preceding his sale of his residence, as a single taxpayer he may exclude up to $250,000 of gain on its sale. The basis on the residence sold in Year 17 is equal to its cost ($200,000). Selling Price $ 455,000 Less: Basis (200,000) Realized Gain 255,000 Less: Excluded Amount (250,000) Recognized Gain $ 5,000
8
Q
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?
A
Choice “b” is correct. In Year 1, no sale of stock occurred so there would be no loss. In Year 2, there is a $2,000 loss realized ($15,000 basis less $13,000 received), but it is not deductible because it is a wash sale. A wash sale occurs when a taxpayer sells stock at a loss and invests in substantially identical stock within 30 days before or after the sale. In this case, Smith reinvested in an additional 100 shares four days prior to selling 100 shares of the same stock at a loss. The $2,000 disallowed loss would, however, increase the basis of the new shares by $2,000.
9
Q
n Year 3, Fay sold 100 shares of Gym Co. stock to her son, Martin, for $11,000. Fay had paid $15,000 for the stock in Year 1. Subsequently in Year 3, Martin sold the stock to an unrelated third party for $16,000. What amount of gain from the sale of the stock to the third party should Martin report on his Year 3 income tax return? a. $5,000 b. $4,000 c. $0 d. $1,000
A
Choice “d” is correct. Losses between related parties are disallowed. Therefore, Fay’s $4,000 capital loss ($15,000 basis less $11,000 received) is disallowed because she sold the stock to her son, a related party. When her son sells the stock to an unrelated party, however, he can use the $4,000 disallowed loss to reduce any gain he realized from the sale (but not to create or increase a loss). His realized gain is $5,000 ($16,000 received less $11,000 basis), but he can reduce it by $4,000 to $1,000 using his mother’s disallowed loss. Employing the “Pass Key” in the text, Martin sold the stock for higher than Fay purchased it. The donor’s basis (i.e., $15,000) is, therefore, used to determine gain on the sale by Martin.
10
Q
Hall, a divorced person and custodian of her 12-year-old child, filed her Year 9 federal income tax return as head of a household. She submitted the following information to the CPA who prepared her Year 9 return: In June, Year 9, Hall's mother gifted her 100 shares of a listed stock. The donor's basis for this stock, which she bought in Year 1, was $4,000, and market value on the date of the gift was $3,000. Hall sold this stock in July, Year 9 for $3,500. The donor paid no gift tax. What was Hall's reportable gain or loss in Year 9 on the sale of the 100 shares of stock gifted to her? a. $0 b. $500 loss. c. $1,000 loss. d. $500 gain.
A
Choice “a” is correct.
Rule: The basis of property received as a gift in the hands of the donee depends on whether the selling price of the property is more or less than the basis for gain or loss.
If the property is sold at a gain, the basis to the donee is the same as it would be in the hands of the donor. If the property is sold at a loss, the basis to the donee is the same as it would be in the hands of the donor or the FV of the property at the date of the gift, whichever is lower. In some cases, such as this fact situation, there is neither gain nor loss on the sale of the gift, because the selling price is less than the basis for gain and more than the basis for loss.
11
Q
In a "like-kind" exchange of an investment asset for a similar asset that will also be held as an investment, no taxable gain or loss will be recognized on the transaction if both assets consist of: a. Convertible preferred stock. b. Partnership interests. c. Rental real estate located in different states. d. Convertible debentures.
A
Choice “c” is correct. No taxable gain or loss will be recognized on a like-kind exchange if both assets are tangible property. Rental real estate located in different states qualifies for a like-kind exchange.
Exception: If the same class of stock of the same corporation is exchanged, it will qualify for “substituted basis.”
12
Q
In Year 9, Joan Reed exchanged commercial real estate that she owned for other commercial real estate plus cash of $50,000. The following additional information pertains to this transaction: Property given up by Reed Fair value $ 500,000 Adjusted basis 300,000 Property received by Reed Fair value 450,000 What amount of gain should be recognized in Reed's Year 9 income tax return? a. $0 b. $50,000 c. $200,000 d. $100,000
A
Choice "b" is correct. $50,000 is Reed's recognized gain in Year 9.
Rule: Gain is only recognized on an exchange of "like-kind" property for the lesser of the amount of "gain realized" or the amount of "boot" received in the exchange.
Fair value of property received
$ 450,000
Amount of cash ("boot") received
50,000
Total amount realized
$ 500,000
Basis of property given up
(300,000)
Gain realized
$ 200,000
Gain recognized*
$ 50,000
* Gain recognized is the lesser of the amount of "gain realized" or amount of the "boot" received.
13
Q
Platt owns land that is operated as a parking lot. A shed was erected on the lot for the related transactions with customers. With regard to capital assets and Section 1231 assets, how should these assets be classified?
A
Choice “b” is correct. Because the parking lot and the shed constitute real estate and depreciable assets used in a trade or business, respectively, they are not capital assets per the definition below.
Note: The parking lot and shed will fall under Section 1231 (provided they are used in the business over 12 months) and possibly Section 1250 and 1245, respectively, upon sale of the assets.
Capital assets are defined as all property held by the taxpayer, except:
Property normally included in inventory or held for sale to customers in the ordinary course of business.
Depreciable property and real estate used in business.
Accounts and notes receivable arising from sales or services in the taxpayer’s business.
Copyrights, literary, musical, or artistic compositions held by the original artist. (Exception: Sales of musical compositions held by the original artist receive capital gain treatment.)
Treasury stock.
14
Q
Lee qualified as head of a household for Year 9 tax purposes. Lee's Year 9 taxable income was $100,000, exclusive of capital gains and losses. Lee had a net long-term loss of $8,000 in Year 9. What amount of this capital loss can Lee offset against Year 9 ordinary income? a. $0 b. $4,000 c. $8,000 d. $3,000
A
Choice “d” is correct. The capital loss deduction is limited to $3,000 per year with the excess carried forward indefinitely. In this case, Lee can deduct $3,000 against his income and carry forward the remaining $5,000.
15
Q
Greller owns 100 shares of Arden Corp., a publicly traded company, which Greller purchased on January 1, Year 1, for $10,000. On January 1, Year 3, Arden 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 Arden stock was $62 per share. On February 1, Year 3, Greller had his broker specifically sell the 100 shares of Arden stock received in the split when the FMV of the stock was $65 per share. What is the basis of the 100 shares of Arden sold? a. $6,500 b. $6,000 c. $6,200 d. $5,000
A
Choice “d” is correct. The receipt of a nontaxable stock dividend will require the shareholder to spread the basis of his original share over both the original shares and the new shares received resulting in the same total basis, but a lower basis per share of stock held. Therefore, Greller’s total basis remains the same, $10,000, but is now split between 200 shares (a 2-for-1 split and he originally owned 100 shares). Therefore, his basis per share goes from $100/share ($10,000/100) to $50/share ($10,000/200). Consequently, his basis in 100 share is 100 x $50 = $5,000.
16
Q
Farr made a gift of stock to her child, Pat. At the date of gift, Farr's stock basis was $10,000 and the stock's fair market value was $15,000. No gift taxes were paid. What is Pat's basis in the stock for computing gain? a. $0 b. $10,000 c. $15,000 d. $5,000
A
Choice “b” is correct. Property acquired as a gift generally retains the rollover cost basis that it had in the hands of the donor at the time of the gift. Basis is increased by any gift tax paid that is attributable to the net appreciation in the value of the gift. Since there were no gift taxes paid, Pat’s basis for computing a gain is the rollover cost (basis), $10,000.
17
Q
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. $2,000 c. $300 d. $750
A
Choice “a” is correct. The receipt of a nontaxable stock dividend will require the shareholder to spread the basis of his original shares over both the original shares and the new shares received, resulting in the same total basis but a lower basis per share of stock held. Therefore, Allen’s total basis remains the same, $10,000, but is now split between 200 shares (a 2-for-1 split and he originally owned 100 shares). Therefore, his basis per share goes from $100/share ($10,000/100) to $50/share ($10,000/200). Consequently, his basis in the 100 shares sold is 100 x $50 = $5,000. Calculate his gain as follows:
Amount realized ($65 x 100) $ 6,500
Adjusted basis (5,000 - calculated above) (5,000)
Realized & recognized gain $ 1,500
18
Q
Wallace purchased 500 shares of Kingpin, Inc. 15 years ago for $25,000. Wallace has worked as an owner/employee and owned 40% of the company throughout this time. This year, Kingpin, which is not an S corporation, redeemed 100% of Wallace's stock for $200,000. What is the treatment and amount of income or gain that Wallace should report? a. $200,000 long-term capital gain. b. $0 c. $175,000 ordinary income. d. $175,000 long-term capital gain.
A
Choice “d” is correct. An investment in a capital asset (e.g., stock) results in the income being capital (either a capital loss or a capital gain). Ownership percentage is not a factor in the calculation, and, in this question, nor is the fact that the corporation is not an S corporation. The calculation is simple: Wallace invested $25,000 in the stock and received $200,000 for 100% of his investment 15 years later. The capital gain is $175,000 ($200,000 - $25,000), and it is considered long-term because the stock was held for greater than one year.
19
Q
Which of the following sales should be reported as a capital gain?
a.
Sale of equipment.
b.
Real property subdivided and sold by a dealer.
c.
Government bonds sold by an individual investor.
d.
Sale of inventory.
A
Choice “c” is correct. Government bonds held by an individual investor are considered capital assets in the hands of the investor. When these types of security investments are sold, the resulting gain or loss is reported as capital.
20
Q
Starr, a self-employed individual, purchased a piece of equipment for use in Starr's business. The costs associated with the acquisition of the equipment were: Purchase price $ 55,000 Delivery charges 725 Installation fees 300 Sales tax 3,400 What is the depreciable basis of the equipment? a. $59,125 b. $55,000 c. $59,425 d. $58,400
A
Choice "c" is correct. The rules for depreciable basis in tax are generally the same as the GAAP rules for capitalizing an asset. The depreciable basis is the cost associated with the purchase of the asset and with getting the asset ready for its intended use. Further improvements are also capitalized, and the basis is reduced for any accumulated depreciation. In this case, the cost of obtaining the equipment and getting the equipment ready for its intended use includes all the items shown above, as follows: Purchase price $ 55,000 Delivery charges 725 Installation fees 300 Sales tax 3,400 Total depreciable basis $ 59,425
21
Q
Which of the following statements is the best definition of real property?
a.
Real property is land and everything permanently attached to it.
b.
Real property is land and intangible property in realized form.
c.
Real property is only land.
d.
Real property is all tangible property including land.
A
Choice “a” is correct. Real property includes land and all items permanently affixed to the land (e.g., buildings, paving, etc.)
22
Q
Gibson purchased stock with a fair market value of $14,000 from Gibson's adult child for $12,000. The child's cost basis in the stock at the date of sale was $16,000. Gibson sold the same stock to an unrelated party for $18,000. What is Gibson's recognized gain from the sale? a. $2,000 b. $4,000 c. $6,000 d. $0
A
Choice “a” is correct. Losses are disallowed on most related party sales transactions even if they were made at an arm’s length (FMV) price. The basis (and related gain or loss) of the (second) buying relative depends on whether the second relative’s resale price is higher, lower, or between the first relative’s basis and the lower selling price to the second relative. In this case, the $4,000 capital loss on the sale by Gibson’s adult child to Gibson [$12,000 SP - $16,000 Basis] is disallowed. Gibson’s basis is determined by his selling price to a third party. In this case, the selling price is $18,000, which is HIGHER than the original basis of Gibson’s adult child. Gibson’s basis in the stock is, therefore, his adult child’s basis of $16,000. Gibson’s recognized basis is calculated as follows:
Selling price $ 18,000
Basis (16,000)
Gain $ 2,000
23
Q
A heavy equipment dealer would like to trade some business assets in a nontaxable exchange. Which of the following exchanges would qualify as nontaxable?
a.
Investment securities for antiques to be held as investments.
b.
The company jet for a large truck to be used in the corporation.
c.
A road grader held in inventory for another road grader.
d.
A corporate office building for a vacant lot.
A
Rule: Nonrecognition treatment is accorded to a “like-kind” exchange of property used in the trade or business or held for investment (with the exception of inventory, stock, securities, partnership interests, and real property in different countries). “Like-kind” means the same type of investment (e.g., realty for realty or personalty for personalty, assuming the personal property falls within the same “asset class” for tax depreciation purposes).
Choice “d” is correct. The exchange of a corporate office building for a vacant lot qualifies for like-kind nonrecognition treatment. It is the exchange of realty for realty of property used in the trade or business or held for investment.
24
Q
In the current year, Tatum exchanged farmland for an office building. The farmland had a basis of $250,000, a fair market value (FMV) of $400,000, and was encumbered by a $120,000 mortgage. The office building had an FMV of $350,000 and was encumbered by a $70,000 mortgage. Each party assumed the other's mortgage. What is the amount of Tatum's recognized gain? a. $100,000 b. $0 c. $50,000 d. $150,000
A
Rule: Per IRC Section 1031, non-recognition treatment is accorded to a like-kind exchange of property used in a trade or business. “Like-kind” exchanges include exchanges of business property for business property, where like-kind is interpreted very broadly and refers to the nature or character of the property and not to its grade or quality.
Choice “c” is correct. The exchange in this question qualifies for Section 1031 treatment since the exchange appears to be business property for business property. However, the boot involved in the exchange (the mortgages) must be taken into account to determine the recognition or non-recognition of the gain realized on the exchange. In this transaction, the total consideration received by Tatum is the FMV of the property received of $350,000 plus the mortgage of $120,000 that was assumed by the other party, for a total of $470,000. The adjusted basis of the property given up was $250,000, and there is also $70,000 of mortgage given up by the other party (and assumed by Tatum), for a total of $320,000. The realized gain is thus $470,000 - $320,000 = $150,000. The recognized gain will be the lesser of realized gain or net boot received. The $120,000 of mortgage given up (and assumed by the other party) is treated as boot received, and the $70,000 of mortgage assumed is treated as boot given up. The net is $50,000 of boot received. The $50,000 of boot received is the recognized gain. The treatment is somewhat the same as if cash/boot had been received in the transaction.
25
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Terry, a taxpayer, purchased stock for $12,000. Later, Terry sold the stock to a relative for $8,000. What amount is the relative's gain or loss?
a.
$2,000 loss.
b.
$4,000 gain.
c.
$0.
d.
$2,000 gain.
```
Rule: IRC Section 267 controls the nonrecognition of realized losses on sales or exchanges of property to related parties. The most common related parties for individual taxpayers are members of a family (although there are certainly many other examples).
Choice "c" is correct. The loss realized on the transaction by Terry is $4,000 ($8,000 - $12,000). This transaction appears to qualify under Section 267. "Relative" is not defined in the question. Section 267 limits "family" to brothers and sisters, spouse, ancestor, and lineal descendants. However, the definition of relative is really irrelevant if the question is read closely. The question wants to know the relative's gain or loss, not Terry's gain or loss. Since all the relative did to this point was to buy the stock, the relative has no gain or loss.
26
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Aviary Corp. sold a building for $600,000. Aviary received a down payment of $120,000 as well as annual principal payments of $120,000 for each of the subsequent four years. Aviary purchased the building for $500,000 and claimed depreciation of $80,000. What amount of gain should Aviary report in the year of sale using the installment method?
a.
$36,000
b.
$120,000
c.
$54,000
d.
$180,000
```
Rule: Under the installment method, revenue is reported over the period in which the cash payments are received. The amount of cash received is multiplied by the gross profit percentage on the sale to determine the revenue (which retains its character as capital gain or ordinary income, depending on the transaction).
Choice "a" is correct. The gross profit percentage is calculated as follows:
Sales Price
$600,000
Original Cost
$500,000
Accumulated Depreciation
(80,000)
Adjusted Basis
(420,000)
Realized Gain on Sale
$180,000
Gross Profit Percentage = $180,000 ÷ $600,000 = 30%
Gain Recognized in Year of Sale:$120,000 [cash received] × 30%= $36,000
Choice "d" is incorrect. The answer option recognizes as income the total realized gain ($180,000) on the sale. As indicated in the rule above, under the installment method, revenue is reported over the period in which the cash payments are received. The amount of cash received is multiplied by the gross profit percentage on the sale to determine the revenue.
27
```
Wynn, a single individual age 60, sold Wynn's personal residence for $450,000. Wynn had owned Wynn's residence, which had a basis of $250,000, for six years. Within eight months of the sale, Wynn purchased a new residence for $400,000. What is Wynn's recognized gain from the sale of Wynn's personal residence?
a.
$0
b.
$200,000
c.
$75,000
d.
$50,000
```
Rule: The sale of a taxpayer's primary residence is subject to an exclusion from gross income for gain. A maximum of $250,000 gain exclusion is provided for all taxpayers other than married couples filing jointly. Married couples filing jointly have a maximum gain exclusion of $500,000. To qualify for the full exclusion, the taxpayers must have owned and used the property as a primary residence for two years or more during the five-year period ending on the date of the sale or exchange. There is no age requirement to receive the exclusion, and no roll-over to another house is required [these applied to an older tax law].
Choice "a" is correct. Wynn's realized gain on the sale of the home is $200,000 [$450,000 - $250,000]. Wynn has owned and used the residence as his primary residence for the last six years. [Note that the purchase of the new home is of no consequence to the recognizable gain on the sale of the old home.] As the realized gain is less than the maximum excludable gain of $250,000 and Wynn has owned and used the property for more than two out of the last five years, Wynn has zero recognized gain on the sale of his residence.
28
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Sands purchased 100 shares of Eastern Corp. stock for $18,000 on April 1 of the prior year. On February 1 of the current year, Sands sold 50 shares of Eastern for $7,000. Fifteen days later, Sands purchased 25 shares of Eastern for $3,750. What is the amount of Sand's recognized gain or loss?
a.
$0
b.
$500
c.
$2,000
d.
$1,000
```
```
Rule: A loss on a wash sale is disallowed for tax purposes. A wash sale exists when a security is sold for a loss and is repurchased within 30 days before or after the sale.
Choice "d" is correct. A wash sale exists in this case, but only a partial wash sale. Unfortunately, the dollar amounts for the recognized loss and wash sale (disallowed) loss are the same in this question (so the illustration can become somewhat confusing). Let's use 20X1 and 20X2 for illustration. On 4/1/X1, Sands purchased 100s of Eastern stock for $18,000 ($180/share). On 2/1/X2, Sands sold 50s of the stock for $7,000 ($140/share), creating a realized loss of $2,000 (50s * ($140 - $180)). Now, if Sands had stopped there, it would have also had a recognized loss of $2,000. However, on 2/16/X2 Sands repurchased half of the shares it had sold at a loss (25s/50s), and this was within the 30-day period indicated in the rule (above). Thus, half of the realized loss is not recognizable in year 2, and it becomes part of the basis of the 25s of Eastern stock owned by Sands [note that the 50s not initially sold by Sands has a basis of $180/share, or $9,000]. The calculation follows:
2/1/X2
Sell 50s
$7,000
Basis 50s
(9,000)
[$180 × 50 = $9,000, from the initial purchase]
Realized Loss
$(2,000)
[$40/share loss]
2/16/X2
Purchase 25s
$3,750
[Repurchased within 30 days of loss sale]
Add: Wash Sale Loss
1,000
[($140 - $180) × 25s = $1,000]
Resulting Basis of 25s
$4,750
Result: Sands owns 75s of Eastern stock. The first 50 shares (those that were not sold on 2/1/X2) has a basis of $9,000 in total ($180/share), and the 25 shares repurchased on 2/16/X2 has a basis of $4,750 ($190/share), the purchase price of the 25s plus the disallowed loss as a result of the wash sale rule.
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29
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Winkler, a CPA, provided accounting services to a client, Thompson. On December 15 of the same year, Thompson gave Winkler 100 shares of Foster Corp. as compensation for services. The adjusted basis of the stock was $4,000, and its fair market value at the time of transfer was $5,000. Two months later, Winkler sold the stock on February 15 for $7,500. What is the amount that Winkler should recognize as gain on the sale of stock?
a.
$5,000
b.
$1,000
c.
$2,500
d.
$0
```
Choice "c" is correct. The adjusted basis of the stock to Winkler was the $5,000 fair market value at the time of transfer (that same amount will be considered compensation in the form of property). The proceeds from the sale were $7,500. The gain on the sale of the stock was thus $2,500. The $4,000 adjusted basis of the stock to Thompson is irrelevant. Note that there is no "gift" here even though the word "gave" was used in the question.
30
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On February 1, Year 4, Hall learned that he was bequeathed 500 shares of common stock under his father's will. Hall's father had paid $2,500 for the stock in Year 1. Fair market value of the stock on February 1, Year 4, the date of his father's death, was $4,000 and had increased to $5,500 six months later. The executor of the estate elected the alternate valuation date for estate tax purposes. Hall sold the stock for $4,500 on June 1, Year 4, the date that the executor distributed the stock to him. How much income should Hall include in his Year 4 individual income tax return for the inheritance of the 500 shares of stock, which he received from his father's estate? [Assume that the estate tax rules in effect for 2011 and forward apply].
a.
$2,500
b.
$0
c.
$4,000
d.
$5,500
```
Choice "b" is correct. There is no income tax on the value of inherited property. The gain on the sale is the difference between the sales price of $4,500 and Hall's basis. Hall's basis is the alternate valuation elected by the executor. This is the value six months after date of death or date distributed if before six months. The property was distributed four months after death and the value that day ($4,500) is used for the basis. $4,500 - $4,500 = 0.
31
```
In the current year, Essex sold land with a basis of $80,000 to Yarrow for $100,000. Yarrow paid $25,000 down and agreed to pay $15,000 per year, plus interest, for the next five years, beginning in the second year. Under the installment method, what gain should Essex include in gross income for the year of sale?
a.
$25,000
b.
$5,000
c.
$20,000
d.
$15,000
```
Choice "b" is correct. Under the installment method, revenue is reported (recognized) over the period in which the cash payments are received. Included gross income is determined in 3 steps:
Step 1: Gross Profit:
Sale on Installment $ 100,000
Cost 80,000
Total Gross Profit $ 20,000
Step 2: Gross Profit Percentage:
Gross Profit/Sale on Installment ($20,000/$100,000) = 20%
Step 3: Taxable Gross Profit:
Collections ($25,000) x Gross Profit Percentage (20%) = $5,000
32
```
Hogan exchanged a business-use machine having an original cost of $100,000 and accumulated depreciation of $30,000 for business-use equipment owned by Baker having a fair market value of $80,000 plus $1,000 cash. Baker assumed a $2,000 outstanding debt on the machine. What taxable gain should Hogan recognize?
a.
$0
b.
$11,000
c.
$3,000
d.
$10,000
```
Choice "c" is correct. In a like-kind exchange, if property other than property qualifying for such exchange is received, (e.g., cash known as "boot"), the transaction, while not qualified for complete nonrecognition, produces recognized gain. The recognized gain is the lower of realized gain or the boot. Cancellation of debt is classified as "boot," so the total boot is $3,000 ($1,000 cash + $2,000 debt cancellation).
33
```
A married couple purchased their principal residence for $300,000. They spent $40,000 on improvements. After living in it for 10 years, the couple sold the home for $650,000 and paid $36,000 in real estate commissions. What gain should the couple recognize on their joint return?
a.
$274,000
b.
$310,000
c.
$60,000
d.
$0
```
```
Choice "d" is correct. The sale of the taxpayer's personal (primary or principal) residence is subject to an exclusion from gross income for gain of $500,000 married filing joint or $250,000 single. To qualify, the taxpayer must have owned and used the property as a principal residence for two years or more during the five year period ending on the date of the sale or exchange.
Taxpayer's Basis:
$ 300,000
Purchase price
40,000
Improvements
36,000
Real estate commissions
376,000
Ending basis
Sales Price:
650,000
Gain on sale:
$ 274,000
Under allowed $500,000 exclusion for married couple
```
34
Chris and Jennifer purchased their home in California on January 15, Year 1, for $160,000. During their ownership they made no capital improvements. On August 1, Year 4, the couple moved to Virginia from California and rented out that home. On June 30, Year 6; the couple contracted to sell the California rental home for $437,500. For the calendar Year 6, the couple will file a joint tax return. Disregarding any depreciation recapture rules, how should they treat the sale of the home for tax purposes?
a.
Realized gain of $437,500; not taxable due to the home exclusion.
b.
Realized and recognized gain of $277,500, taxable on Schedule D.
c.
Realized and recognized gain of $277,500; taxable on Schedule E.
d.
Realized gain of $277,500; not taxable due to the home exclusion.
Choice "d" is correct. Disregarding any depreciation recapture, Chris and Jennifer have a realized gain of $277,500. For tax purposes, this gain will not be recognized on their Year 6 tax return as it is excludable under the Homeowner's Exclusion. To qualify for the full exclusion of $500,000 for a joint return, the taxpayers must own and use the home as the principal residence for two years out of the five- year period ending on the date of the sale or exchange (and may not have any unqualified use after 2008).
35
```
A taxpayer lived in an apartment building and had a two-year lease that began 16 months ago. The taxpayer's landlord wanted to sell the building and offered the taxpayer $10,000 to vacate the apartment immediately. The taxpayer's lease on the apartment was a capital asset but had no tax basis. If the taxpayer accepted the landlord's offer, the gain or loss would be which of the following?
a.
A short-term capital gain.
b.
An ordinary gain.
c.
A short-term capital loss.
d.
A long-term capital gain.
```
Choice "d" is correct. A capital asset which is sold or exchanged more than one year after the date of acquisition will generate either a long-term capital gain (if the capital asset is sold at a price greater than acquisition cost) or a long-term capital loss (if the capital asset is sold at a price less than the acquisition cost). In this question, the lease-hold interest, which is a capital asset, was acquired more than a year ago, and the basis (acquisition cost) in that capital asset is -0-. So, the receipt of $10,000 to vacate the apartment will generate a $10,000 long-term capital gain.
36
```
Upon her grandfather's death, Jordan inherited 10 shares of Universal Corp. stock that had a fair market value of $5,000. Her grandfather acquired the shares in 1995 for $2,500. Four months after her grandfather's death, Jordan sold all her shares of Universal for $7,500. What was Jordan's recognized gain in the year of sale?
a.
$5,000 short-term capital gain.
b.
$2,500 short-term capital gain.
c.
$2,500 long-term capital gain.
d.
$5,000 long-term capital gain.
```
Choice "c" is correct. Unless the executor elects the "alternative valuation date" method (not applicable to this question), the basis of property acquired by bequest or by inheritance is the property's fair market value on the date of the decedent's death. The decedent's basis is irrelevant. Additionally, such acquired property is always considered to be "long-term" property, regardless of how long it has been held by the decedent and by the beneficiary or heir.
Calculation of gain realized and recognized:
Amount realized
$ 7,500
Less: Basis (date-of-death fair market value)
(5,000)
Long-term capital gain realized and recognized
$ 2,500
37
```
For an individual business owner, which of the following would typically be classified as a capital asset for federal income tax purposes?
a.
Inventory.
b.
Marketable securities.
c.
Machinery and equipment used in a business.
d.
Accounts receivable.
```
Choice "b" is correct. Capital assets include all marketable securities unless the taxpayer is a dealer.
38
```
Simmons gives her child a gift of publicly-traded stock with a basis of $40,000 and a fair market value of $30,000. No gift tax is paid. The child subsequently sells the stock for $36,000. What is the child’s recognized gain or loss, if any?
a.
$36,000 gain.
b.
$4,000 loss.
c.
No gain or loss.
d.
$6,000 gain.
```
Choice "c" is correct. This situation falls into the exception of the gift tax basis rule because the FMV at date of gift is lower than the donor's original basis. The donee then sold the stock at a price less than the donor's rollover cost basis but higher than the FMV on date of gift. Therefore, there is no gain or loss on the sale.
39
An individual entered into several exchanges during the current tax year. Which of the following exchanges is classified as like-kind?
a.
Common stock for common stock.
b.
Apartment building for unimproved land.
c.
Manufacturing equipment for factory building.
d.
Partnership interest for partnership interest.
Choice "b" is correct. Real property exchanged for other real property will be classified as a like-kind exchange (unless the property is in different countries).
40
```
Baker, an unmarried individual, sold a personal residence, which has an adjusted basis of $70,000, for $165,000. Baker owned and lived in the residence for seven years. Selling expenses were $10,000. Four weeks prior to the sale, Baker paid a handyman $1,000 to paint and fix up the residence. What is the amount of Baker's recognized gain?
a.
$84,000
b.
$0
c.
$95,000
d.
$85,000
```
Choice "b" is correct. This is a principal residence that the taxpayer has owned and lived in for the last seven years. This exceeds the requirement of at least two of the last five years. Baker may therefore exclude up to $250,000 of gain. The realized gain is $84,000 ($165,000 selling price – $70,000 adjusted basis – $10,000 selling expenses – $1,000 fix-up expenses incurred within 90 days of the sale). All of the realized gain is excluded, and none of it is recognized.
41
```
An individual reports the following capital transactions in the current year:
Short-term capital gain
$ 1,000
Short-term capital loss
$ (11,000)
Long-term capital gain
$ 10,000
Long-term capital loss
$ (6,000)
What amount is deducted in arriving at adjusted gross income?
a.
$0
b.
$10,000
c.
$6,000
d.
$3,000
```
Choice "d" is correct. First, the long-term capital gains and losses are netted to arrive at a net long-term capital gain of $4,000. Next, the short-term capital gains and losses are netted to arrive at a net short-term capital loss of $10,000. The next step is to net the net long-term capital gain of $4,000 with the net short-term capital loss of $10,000. This results in a net capital loss of $6,000. Only $3,000 of that loss is currently deductible against ordinary income. The remaining loss of $3,000 is carried forward indefinitely.
42
On March 1 of the previous year, a parent sold stock with a cost of $8,000 to their child, for $6,000, its fair market value. On September 30 of the current year, the child sold the same stock for $7,000 to Hancock, who is unrelated to the parent and child. What is the proper treatment for these transactions?
a.
Parent has $2,000 recognized loss and child has $0 recognized gain.
b.
Parent has $0 recognized loss and child has $1,000 recognized gain.
c.
Parent has $0 recognized loss and child has $0 recognized gain.
d.
Parent has a $2,000 recognized loss and child has $1,000 recognized gain.
Choice "c" is correct. The parent has a realized loss of $2,000 ($6,000 sale less $8,000 cost). However, none of this loss is recognized, because it is disallowed under the related party transaction rules. The child has a realized gain of $1,000 ($7,000 sale less $6,000 cost). This gain can be reduced (but not below zero) by the disallowed loss of the parent. Therefore, the recognized gain to the child is zero.
43
```
A sole proprietor of a farm implement store sold a truck for $15,000 that had been used to make service calls. The truck cost $30,000 three years ago, and $21,360 depreciation was taken. What is the appropriate classification of the $6,360 gain for tax purposes?
a.
Ordinary gain.
b.
Long-term capital gain.
c.
Short-term capital gain.
d.
Section 1231 (Property Used in the Trade or Business and Involuntary Conversions) gain.
```
Choice "a" is correct. The truck is a depreciable asset used in a trade or business. Therefore, it is a Section 1231 asset. It is also personal property, so the recapture rules of Section 1245 will apply to any gains. The truck was sold at a gain. However, that gain is less than the accumulated depreciation. Under the rules of Section 1245, the gain is all recaptured as an ordinary gain.
44
```
Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under Code Sec. 1245?
a.
$100,000
b.
$60,000
c.
$0
d.
$40,000
```
Choice "b" is correct. Under Sec. 1245, ordinary income is recognized on the gain to the extent of the accumulated depreciation. Any gain in excess of the original cost is capital gain.
45
Lobster, Inc. incurs the following losses on disposition of business assets during the year:
Loss on the abandonment of office equipment
$25,000
Loss on the sale of a building (straight-line
depreciation taken in prior years of $200,000)
250,000
Loss on the sale of delivery trucks
15,000
What is the amount and character of the losses to be reported on Lobster's tax return?
a.
$40,000 Section 1231 loss, $50,000 long-term capital loss.
b.
$40,000 Section 1231 loss only.
c.
$40,000 Section 1231 loss, $250,000 long-term capital loss.
d.
$290,000 Section 1231 loss.
Choice "d" is correct. Section 1231 assets are comprised principally of depreciable personal and real property used in the taxpayer's trade or business and held for over twelve months. Trade or business property and capital assets (held over twelve months) that have been involuntarily converted are also included. All of the assets listed in this problem are Section 1231 assets. Net 1231 losses (Sec. 1231 losses less Sec. 1231 gains) are treated as ordinary losses.
46
Which of the following conditions must be satisfied for a taxpayer to expense, in the year of purchase, under Internal Revenue Code Section 179, the cost of new or used tangible depreciable personal property?
I.
The property must be purchased for use in the taxpayer's active trade or business.
II.
The property must be purchased from an unrelated party.
Choice "d" is correct. To qualify for IRC Section 179, the property must be tangible personal property acquired by purchase from an unrelated party for use in the active conduct of a trade or business.
Statements I and II are both correct statements concerning the criteria for property to qualify under IRC Section 179.
47
```
A taxpayer purchased five acres of land for $20,000 and placed in service other tangible business assets that cost $100,000. Disregarding business income limitations and assuming that the annual Section 179 (Election to Expense Certain Depreciable Business Assets) limit is $108,000, what maximum amount of cost recovery can the taxpayer claim this year?
a.
$108,000
b.
$20,000
c.
$100,000
d.
$120,000
```
Choice "c" is correct. Under the election to expense certain depreciable business assets (sec. 179), the taxpayer may expense the cost of the depreciable asset up to the limitation, in this example $108,000. Therefore, only the cost of the depreciable tangible business assets can be expensed ($100,000).
48
```
Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during February, Year 8. No other property was placed into service during Year 8. What convention must Bent use to determine the depreciation deduction for the alternative minimum tax?
a.
Mid-month.
b.
Half-year.
c.
Mid-quarter.
d.
Full-year.
```
Choice "a" is correct. Real property (buildings) is subject to the mid-month convention under MACRS. Only personal property (machinery & equipment) is subject to the half-year and/or mid-quarter conventions.
49
```
Data Corp., a calendar year corporation, purchased and placed into service office equipment during November Year 1. No other equipment was placed into service during Year 1. Under the general MACRS depreciation system, what convention must Data use?
a.
Full-year.
b.
Mid-quarter.
c.
Mid-month.
d.
Half-year.
```
Choice "b" is correct. When a taxpayer places 40% or more of its property (other than certain qualifying real property) into service in the last quarter of the taxable year, the corporation must use the mid-quarter convention for MACRS depreciation purposes. With this method the acquisitions are segregated by quarter and treated as if placed in service in the middle of each respective quarter.
50
```
On August 1, Year 1, Graham purchased and placed into service an office building costing $264,000 including $30,000 for the land. What was Graham's MACRS deduction for the office building in Year 1?
a.
$6,000
b.
$9,600
c.
$3,600
d.
$2,250
```
Choice "d" is correct. Only the building is depreciable, so the depreciable portion is $264,000 less $30,000 land, for a net of $234,000. The MACRS rules provide a 39-year life, straight-line depreciation, and a "mid-month" acquisition convention that treats the property as acquired in the middle of the month, regardless of the actual date of acquisition. Therefore, the August 1, Year 1, service date provides a half-month's depreciation for August, plus a full month for September through December, for a total of 4.5 months for Year 1. ($234,000/39 years) × (4.5/12) = $2,250.
51
How is the depreciation deduction of nonresidential real property determined for regular tax purposes using MACRS?
a.
Straight-line method over 39 years.
b.
Straight-line method over 40 years.
c.
150% declining-balance method with a switch to the straight-line method over 39 years.
d.
150% declining-balance method with a switch to the straight-line method over 27.5 years.
Choice "a" is correct. Nonresidential realty is depreciated over 39 years straight-line if placed in service after May 1993.
52
In Year 6, an IRS agent completed an examination of a corporation's Year 5 tax return and proposed an adjustment that will result in an increase in taxable income for each of Years 1 through 5. All returns were filed on the original due date. The proposed adjustment relates to the disallowance of corporate jet usage for personal reasons. The agent does not find the error to be fraudulent or substantial in nature.
Which of the following statements regarding this adjustment is correct?
a.
The adjustment is improper because the statute of limitations has expired for several years of the adjustment.
b.
The adjustment is proper because it relates to a change in accounting method, which can be made retroactively irrespective of the statute of limitations.
c.
The adjustment is proper because there is no statute of limitations for improperly claiming personal expenses as business expenses.
d.
The adjustment is improper because an agent may only propose adjustments to the year under examination.
Choice "a" is correct. Unless there is a substantial 25% misstatement of income or fraud, the statue of limitations is generally three years from the later of the due date or filing date of a return. This adjustment is improper because there is no evidence of fraud or substantial misstatement and some of the years are old enough that the three year statute has expired.
53
```
The sale of which of the following types of business property should be reported as Section 1231 (Property Used in the Trade or Business and Involuntary Conversions) property?
a.
Land held for 18 months.
b.
Inventory held for resale.
c.
Machinery held for six months.
d.
Cattle held for 6 months.
```
Choice "a" is correct. 1231 Assets are depreciable personal property and real property used in a business and held for over 12 months. Land held for 18 months meets this definition.
54
```
A taxpayer sold for $200,000 equipment that had an adjusted basis of $180,000. Through the date of the sale, the taxpayer had deducted $30,000 of depreciation. Of this amount, $17,000 was in excess of straight-line depreciation. What amount of gain would be recaptured under Section 1245 (Gain from Dispositions of Certain Depreciable Property)?
a.
$13,000
b.
$20,000
c.
$30,000
d.
$17,000
```
Choice "b" is correct. Under Section 1245, the amount of depreciation in excess of straight-line depreciation is irrelevant (the "excess depreciation" rule is a Section 1250 rule and applies to real property). In this question, $30,000 of depreciation was deducted and, at first glance, the answer would appear to be $30,000. However, Section 1245 actually only requires that the lesser of the depreciation taken ($30,000) or the gain recognized ($200,000 - $180,000 = $20,000) be recaptured.
55
```
Four years ago, a self-employed taxpayer purchased office furniture for $30,000. During the current tax year, the taxpayer sold the furniture for $37,000. At the time of the sale, the taxpayer's depreciation deductions totaled $20,700. What part of the gain is taxed as long-term capital gain?
a.
$20,700
b.
$7,000
c.
$0
d.
$27,700
```
Choice "b" is correct. When property is sold, the realized gain is the difference between the proceeds and the adjusted basis, in this question, the difference between the $37,000 and $9,300 ($30,000 - $20,700), or $27,700. Under Section 1245 (office furniture qualifies as Section 1245 property because it is not real property), the total depreciation deducted will be recaptured as ordinary income, and the remainder (any amount in excess of the original cost) will be Section 1231 (taxed as a long-term capital) gain. In this question, the $20,700 of depreciation deductions is ordinary income and $7,000 ($37,000 - $30,000) is Section 1231 (taxed as a long-term capital) gain.
[Note: Section 1245 actually requires that the lesser of the depreciation taken ($20,700) or the gain recognized ($37,000 - an assumed $9,300 = $20,700) be recaptured. Normally, the two steps of the formula produce the same result.
56
```
Dove Corp. began operating a hardware store in the current year after constructing a building at a total cost of $100,000 on land previously acquired for $50,000. In the current year, the land had a fair market value of $60,000. Dove paid real estate taxes of $5,000 in the current year. What is the total depreciable basis of Dove's business property?
a.
$155,000
b.
$150,000
c.
$160,000
d.
$100,000
```
Choice "d" is correct. The only amount that may be depreciated is the $100,000 that Dove spent to construct the building. The $50,000 cost of the land is not depreciable as land is not a depreciable asset. The fair market value of the land ($60,000) is irrelevant for depreciation purposes. The real estate taxes ($5,000) are a deductible expense to the business that would not be capitalized.
57
```
Rock Crab, Inc. purchases the following assets during the year:
Computer $ 3,000
Computer desk 1,000
Office furniture 4,000
Delivery van 25,000
What should be reported as the cost basis for MACRS five-year property?
a.
$28,000
b.
$3,000
c.
$33,000
d.
$25,000
```
Choice "a" is correct. MACRS 5-year property includes automobiles, light trucks, computers, typewriters, copiers, duplicating equipment, and other such items. The cost basis of the MACRS 5-year property is $28,000, calculated as follows:
Computer $ 3,000
Delivery van 25,000
MACRS 5-year $ 28,000
58
```
Thompson's basis in Starlight Partnership was $60,000 at the beginning of the year. Thompson materially participates in the partnership's business. Thompson received $20,000 in cash distributions during the year. Thompson's share of Starlight's current operations was a $65,000 ordinary loss and a $15,000 net long-term capital gain. What is the amount of Thompson's deductible loss for the period?
a.
$55,000
b.
$40,000
c.
$65,000
d.
$15,000
```
Choice "a" is correct. A partner's deductible loss is limited to his basis plus any amounts that he is personally liable for ("at risk" provision).
Thompson's basis would be calculated as follows:
Beginning basis $ 60,000
Plus: Net LT capital gain 15,000
Less: Cash distribution (20,000)
Basis for determining allowable loss deduction $ 55,000
Thompson would be allowed to take a loss deduction for $55,000 of the $65,000 ordinary loss passed through to him from the partnership. The remaining $10,000 would be carried forward until additional basis became available.
59
```
Stone and Frazier decided to terminate the Woodwest Partnership as of December 31. On that date, Woodwest's balance sheet was as follows:
Cash $ 2,000
Equipment (adjusted basis) 2,000
Capital - Stone 3,000
Capital - Frazier 1,000
The fair market value of the equipment was $3,000. Frazier's outside basis in the partnership was $1,200. Upon liquidation, Frazier received $1,500 in cash. What gain should Frazier recognize?
a.
$0
b.
$500
c.
$250
d.
$300
```
Choice "d" is correct. In a complete liquidation of a partnership, the partner's basis in property received is the same as the adjusted basis of his partnership interest reduced for any monies actually received and is generally a nontaxable event. However, if a partner receives only money that exceeds his basis in the partnership, gain or loss is recognized. In this instance, Frazier's basis in his partnership interest was $1,200. He received $1,500 in cash in the liquidation. Frazier's gain is calculated as follows:
Amount realized $ 1,500
Basis in partnership interest (1,200)
Gain recognized $ 300
Note: Don't be confused by the term "outside basis." The term outside basis merely refers to the differences that may exist between the partner's share of the basis of the assets in the hands of the partnership (inside basis) and his basis in his partnership interest.
60
```
Barker acquired a 50% interest in Kode Partnership by contributing $20,000 cash and a building with an adjusted basis of $26,000 and a fair market value of $42,000. The building was subject to a $10,000 mortgage, which was assumed by Kode. The other partners contributed cash only. The basis of Barker's interest in Kode is:
a.
$52,000
b.
$36,000
c.
$62,000
d.
$41,000
```
Choice "d" is correct. A partner's basis in a newly formed partnership is determined as follows:
Cash contribution $ 20,000
Adjusted basis of non-cash property 26,000
Share of partnership liabilities assumed by other partners $10,000 × 50% (5,000)
Net total $ 41,000
61
```
At partnership inception, Black acquires a 50% interest in Decorators Partnership by contributing property with an adjusted basis of $250,000. Black recognizes a gain if:
I.
The fair market value of the contributed property exceeds its adjusted basis.
II.
The property is encumbered by a mortgage with a balance of $100,000.
a.
Neither I nor II.
b.
Both I and II.
c.
I only.
d.
II only.
```
Choice "a" is correct. The fair market value of property (high or low) is irrelevant in determining Black's basis in Decorators. The partner's adjusted basis is used.
Since the mortgage does not exceed Black's basis, he will not recognize a gain on the contribution of the encumbered property to Decorators.
62
On January 4, Year 1, Smith and White contributed $4,000 and $6,000 in cash, respectively, and formed the Macro General Partnership. The partnership agreement allocated profits and losses 40% to Smith and 60% to White. In Year 1, Macro purchased property from an unrelated seller for $10,000 cash and a $40,000 mortgage note that was the general liability of the partnership. Macro's liability:
a.
Increases Smith's partnership basis by $16,000.
b.
Increases Smith's partnership basis by $20,000.
c.
Has no effect on Smith's partnership basis.
d.
Increases Smith's partnership basis by $24,000.
Choice "a" is correct. A partner's basis in the partnership is increased by the partner's share of partnership liabilities (Smith is a 40% partner). Macro is obligated on the $40,000 mortgage; 40% x $40,000 = $16,000. Even though the partnership is obligated to repay the mortgage, as a partner Smith is jointly and severally liable on the debt.
63
```
Hart's adjusted basis in Best Partnership was $9,000 at the time he received the following nonliquidating distributions of partnership property:
Cash
$5,000
Land
Adjusted basis
7,000
Fair market value
10,000
What was the amount of Hart's basis in the land?
a.
$4,000
b.
$10,000
c.
$7,000
d.
$0
```
Choice "a" is correct. Hart must reduce his $9,000 original basis by the $5,000 cash distribution to a basis of $4,000. Smith's basis in the land is the lesser of the land's basis in the partnership's hands ($7,000) or Hart's remaining basis in his partnership interest in Best ($4,000 after the cash distribution).
64
```
Stone's basis in Ace Partnership was $70,000 at the time he received a nonliquidating distribution of partnership capital assets. These capital assets had an adjusted basis of $65,000 to Ace and a fair market value of $83,000. Ace had no unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was Stone's recognized gain or loss on the distribution?
a.
$5,000 capital loss.
b.
$13,000 capital gain.
c.
$0.
d.
$18,000 ordinary income.
```
Choice "c" is correct. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. The distribution of property with an adjusted basis of $65,000 to Stone from Ace will reduce Stone's basis in Ace partnership to $5,000 ($70,000 - $65,000). The fair market value of the property (high or low) is not relevant.
65
On January 3, Year 1, the partners' interests in the capital, profits, and losses of Able Partnership were:
% of capital,
profits, and losses
Dean
25%
Poe
30%
Ritt
45%
On February 4, Year 1, Poe sold her entire interest to an unrelated party. Dean sold his 25% interest in Able to another unrelated party on December 20, Year 1. No other transactions took place in Year 1. For tax purposes, which of the following statements is correct with respect to Able?
a.
Able did not terminate.
b.
Able terminated as of February 4, Year 1.
c.
Able terminated as of December 31, Year 1.
d.
Able terminated as of December 20, Year 1.
Choice "d" is correct. Among other events, a partnership terminates for income tax purposes when 50% or more of its interests change hands within 12 months. That threshold was reached for Able on December 20, at which time the partnership terminated for income tax purposes.
66
```
Curry's sale of her partnership interest causes a partnership termination. The partnership's business and financial operations are continued by the other members. What is (are) the effect(s) of the termination?
I.
There is a deemed distribution of assets to the remaining partners and the purchaser.
II.
There is a hypothetical recontribution of assets to a new partnership.
a.
I only.
b.
II only.
c.
Neither I nor II.
d.
Both I and II.
```
Choice "d" is correct.
Rule: When a partnership is terminated for tax purposes and its remaining partners decide to carry on the partnership business in a (deemed) new partnership, tax law treats this as a distribution of the prior partnership's assets followed by a recontribution of the (deemed) distributed assets to the new partnership.
67
Alt Partnership, a cash basis calendar year entity, began business on October 1, Year 1. Alt incurred and paid the following in Year 1:
Legal fees to prepare the partnership agreement $ 23,000
Accounting fees to prepare the representations in offering materials 15,000
Alt elected to amortize costs. What was the maximum amount that Alt could deduct on the Year 1 partnership return?
a.
$5,300
b.
$0
c.
$300
d.
$4,600
Choice "a" is correct. Eligible expenditures up to $5,000 can be deducted in the first year (with overall limitations). Additional expenditures are amortized over 180 months beginning with the date they begin business. Legal fees to prepare the partnership agreement ($23,000) are eligible for this treatment, but sales and promotional expenses ($15,000) are not deductible or amortizable.
The first year deduction is calculated as follows:
23,000
(5,000)
immediate deduction
18,000 /
180 months = $100 per month x 3 = 300 + 5,000 = $5,300
68
```
A guaranteed payment by a partnership to a partner for services rendered may include an agreement to pay:
I.
A salary of $5,000 monthly without regard to partnership income.
II.
A 25 percent interest in partnership profits.
a.
I only.
b.
II only.
c.
Both I and II.
d.
Neither I nor II.
```
Choice "a" is correct.
I.
A guaranteed payment is a salary or other payment to a partner that is not calculated with respect to partnership income.
II.
Since the 25% interest is calculated with respect to partnership profits, it is not a guaranteed payment.
69
```
Curry's adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000 and a fair market value of $9,000 to Vantage. What was the amount of Curry's basis in the land?
a.
$6,000
b.
$1,000
c.
$5,000
d.
$9,000
```
Choice "c" is correct. A partner who receives a distribution of non-cash property from a partnership takes the partnership's basis as his basis, but in no case an amount greater than his basis in his partnership interest. In this case Curry would ordinarily take a $6,000 basis in the land, but since his basis in the partnership interest is only $5,000, that is the basis of the land in his hands. Curry's partnership interest now has a basis of zero.
70
```
White has a one-third interest in the profits and losses of Rapid Partnership. Rapid's ordinary income for the current taxable year is $30,000, after a $3,000 deduction for a guaranteed payment made to White for services rendered. None of the $30,000 ordinary income was distributed to the partners. What is the total amount that White must include from Rapid as taxable income in his current year tax return?
a.
$11,000
b.
$10,000
c.
$13,000
d.
$3,000
```
Choice "c" is correct.
Rule: Partnership income is taxable to a partner whether or not it is distributed. White's share of Rapid's income is the sum of the $3,000 guaranteed payment and one-third of the partnership's net income of $30,000 ($10,000), for a total of $13,000.
71
```
On January 2, Year 1, Black acquired a 50% interest in New Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was Black's basis in New at January 2, Year 1?
a.
$7,500
b.
$3,500
c.
$5,500
d.
$4,000
```
Choice "c" is correct. A contributing partner's basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief.
Basis $ 7,000
Debt relief ($3,000 x 50%) (1,500)
Basis $ 5,500
72
```
Gray is a 50% partner in Fabco Partnership. Gray's tax basis in Fabco at the beginning of the year was $5,000. Fabco made no distributions to the partners during the year and recorded the following:
Ordinary income $ 20,000
Tax exempt income 8,000
Portfolio income 4,000
What is Gray's tax basis in Fabco at the end of the year?
a.
$10,000
b.
$16,000
c.
$12,000
d.
$21,000
```
Choice "d" is correct. A partner's basis is increased by the partner's share of partnership ordinary income, separately stated income, and tax exempt income. $5,000 + 50% x ($20,000 + $8,000 + $4,000) = $21,000.
73
```
On January 2, Year 1, Arch and Bean contribute cash equally to form the JK Partnership. Arch and Bean share profits and losses in a ratio of 75% to 25%, respectively. For Year 1, the partnership's ordinary income was $40,000. A distribution of $5,000 was made to Arch during Year 1. What is Arch's share of taxable income for Year 1?
a.
$5,000
b.
$20,000
c.
$30,000
d.
$10,000
```
Choice "c" is correct. Partners are taxed on their share of partnership income whether distributed or not. Arch must report 75% x $40,000, or $30,000.
74
```
Guaranteed payments made by a partnership to partners for services rendered to the partnership, that are deductible business expenses under the Internal Revenue Code, are:
I.
Deductible expenses on the U.S. Partnership Return of Income, Form 1065, in order to arrive at partnership income (loss).
II.
Included on schedules K-1 to be taxed as ordinary income to the partners.
a.
Neither I nor II.
b.
I only.
c.
II only.
d.
Both I and II.
```
Choice "d" is correct. Guaranteed payments to partners are deductible on Form 1065, Line 10, to arrive at partnership ordinary income. On Schedule K-1, guaranteed payments are shown as income on Line 5 and flow through as ordinary income.
75
```
At the beginning of the taxable year, Paul owned a 25% interest in Associates partnership. During the year, a new partner was admitted and Paul's interest was reduced to 20%. The partnership liabilities at January 1 were $150,000 but decreased to $100,000 at December 31. Paul's and the other partners' capital accounts are in proportion to their respective interests. Disregarding any income, loss or drawings for the taxable year, the basis of Paul's partnership interest at December 31 compared to the basis of his interest at January 1 was:
a.
Decreased by $37,500.
b.
Increased by $20,000.
c.
Decreased by $17,500.
d.
Decreased by $5,000.
```
Choice "c" is correct. Paul's partnership interest consists of his capital plus his share of liabilities. Paul's share of liabilities on January 1 was 25% x $150,000, or $37,500. On December 31 Paul's share was 20% x $100,000, or $20,000; a decrease during the year of $17,500.
76
```
Day's adjusted basis in LMN Partnership interest is $50,000. During the year Day received a nonliquidating distribution of $25,000 cash plus land with an adjusted basis of $15,000 to LMN and a fair market value of $20,000. How much is Day's basis in the land?
a.
$20,000
b.
$10,000
c.
$25,000
d.
$15,000
```
Choice "d" is correct. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. This basis cannot exceed the partner's partnership interest.
77
```
Pert contributed land with a fair market value of $20,000 to a new partnership in exchange for a 50% partnership interest. The land had an adjusted basis to Pert of $12,000 and was subject to a $4,000 mortgage, which the partnership assumed. What is the adjusted basis of Pert's partnership interest?
a.
$18,000
b.
$12,000
c.
$20,000
d.
$10,000
```
hoice "d" is correct. Pert's adjusted basis in the partnership is equal to the $12,000 adjusted basis of the land he contributed to the partnership less the 50% allocable percentage of the $4,000 mortgage assumed by the other partners.
Land basis $ 12,000
50%* × $4,000 mortgage (2,000)
Pert's basis in the partnership $ 10,000
* Other partners' percentage ownership
78
The method used to depreciate partnership property is an election made by:
a.
The "principal partner."
b.
Each individual partner.
c.
The partnership and may be any method approved by the IRS.
d.
The partnership and must be the same method used by the "principal partner."
Choice "c" is correct. Under entity theory, the partnership elects the depreciation method to be used and may use any method approved by the IRS.
79
```
Under Section 444 of the Internal Revenue Code, certain partnerships can elect to use a tax year different from their required tax year. One of the conditions for eligibility to make a Section 444 election is that the partnership must:
a.
Choose a tax year where the deferral period is not longer than three months.
b.
Be a limited partnership.
c.
Be a member of a tiered structure.
d.
Have less than 75 partners.
```
Choice "a" is correct. Sec. 444 permits a partnership to elect a tax year different from the required tax year if the deferral period (i.e., the number of months between the beginning of the tax year and the end of the required tax year) is 3 months or less.
80
```
In computing the ordinary income of a partnership, a deduction is allowed for:
a.
Guaranteed payments to partners.
b.
The first $100 of dividends received from qualifying domestic corporations.
c.
Contributions to recognized charities.
d.
Short-term capital losses.
```
Choice "a" is correct. Guaranteed payments to partners are deductible in arriving at the partnership's ordinary income. Ordinary income is the "taxable income" of the partnership excluding all items required to be separately-stated. Charitable contributions, dividend income, and capital losses are all separately-stated items.
81
When a partner's share of partnership liabilities increases, that partner's basis in the partnership:
a.
Increases by the partner's share of the increase.
b.
Decreases, but not to less than zero.
c.
Decreases by the partner's share of the increase.
d.
Is not affected.
Choice "a" is correct. When a partner's share of partnership liabilities increases, that partner's basis in the partnership increases by his share of the increase. Since the partner has unlimited liability, the partnership liabilities are treated as if the partner personally borrowed the money and then contributed it to the partnership.
82
```
Cobb, Danver, and Evans each owned a one-third interest in the capital and profits of their calendar-year partnership. On September 18, Year 5, Cobb and Danver sold their partnership interests to Frank and immediately withdrew from all participation in the partnership. On March 15, Year 6, Cobb and Danver received full payment from Frank for the sale of their partnership interests. For tax purposes, the partnership:
a.
Terminated on September 18, Year 5.
b.
Terminated on December 31, Year 5.
c.
Did not terminate.
d.
Terminated on March 15, Year 6.
```
Choice "a" is correct. A partnership terminates for tax purposes if within a 12-month period there is a sale or exchange of at least 50% of the total interest in partnership capital and profits. In this case, the partnership terminates September 18, Year 5, the date that 2/3 interest in the partnership is sold to new partner Frank.
83
```
On June 30, Year 8, Berk retired from his partnership. At that time, his capital account was $50,000 and his share of the partnership's liabilities was $30,000. Berk's retirement payments consisted of being relieved of his share of the partnership liabilities and receipt of cash payments of $5,000 per month for 18 months, commencing July 1, Year 8. Assuming Berk makes no election with regard to the recognition of gain from the retirement payments, he should report income therefrom of:
Year 8
Year 9
a.
$20,000
$20,000
b.
$13,333
$26,667
c.
--
$40,000
d.
$40,000
--
```
Choice "c" is correct. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions:
Berk's partnership basis on 6/30/Yr 8 $ 80,000
$5,000 x 6 months, Year 8 cash distributions nontaxable, basis reduction (30,000)
Relief of debt (30,000)
Berk's partnership basis on 12/31/Yr 8 20,000
$5,000 x 12 months, Year 9 distributions (60,000)
Negative basis (40,000)
Capital gain to eliminate negative basis 40,000
Berk's basis on 12/31/Yr 9, liquidated $ 0
84
```
Owen's tax basis in Regal Partnership was $18,000 at the time Owen received a nonliquidating distribution of $3,000 cash and land with an adjusted basis of $7,000 to Regal and a fair market value of $9,000. Regal did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. Disregarding any income, loss, or any other partnership distribution for the year, what was Owen's tax basis in Regal after the distribution?
a.
$7,000
b.
$6,000
c.
$9,000
d.
$8,000
```
Choice "d" is correct. In a nonliquidating distribution, the partner's basis is reduced first by the amount of cash received and then by the adjusted basis of any property received. Thus, Owen's basis after the distribution is determined as follows:
Owen's beginning basis $ 18,000
Cash received (3,000)
Basis of property received (7,000)
Owen's adjusted basis after the distribution $ 8,000
85
```
Bailey contributed land with a fair market value of $75,000 and an adjusted basis of $25,000 to the ABC Partnership in exchange for a 30% interest. The partnership assumed Bailey's $10,000 recourse mortgage on the land. What is Bailey's basis for his partnership interest?
a.
$18,000
b.
$75,000
c.
$65,000
d.
$15,000
```
Choice "a" is correct.
A partner's original basis for a partnership interest acquired by a contribution is the amount of cash plus the adjusted basis of any property contributed less the amount of incoming partner's liabilities assumed by the other partners. Bailey's basis is calculated as follows:
Adjusted basis of property contributed $ 25,000
Less: The amount of Bailey's debtassumed by the other partners (70% of $10,000) (7,000)
Bailey's basis $ 18,000
86
```
A partnership had four partners. Each partner contributed $100,000 cash. The partnership reported income for the year of $80,000 and distributed $10,000 to each partner. What was each partner's basis in the partnership at the end of the current year?
a.
$120,000
b.
$110,000
c.
$170,000
d.
$117,500
```
```
RULE: The basis in a partnership is increased by investment, pro-rata share of income, and liabilities for which the partner is personally liable. The basis of a partnership is decreased by distributions, pro-rata share of losses, and liabilities for which the partner is personally relieved of.
Choice "b" is correct. Per the above rule, each partner's basis in the partnership is $110,000 at the end of the current year, calculated as follows:
Contributions
$100,000
Pro-rata income allocation
20,000
[$80,000 / 4 partners]
Pro-rata income allocation
(10,000)
Basis at year-end
$110,000
Choice "c" is incorrect. The partnership reported income of $80,000, and this amount must be allocated pro-rata to each partner. The mistake made here is that the entire $80,000 was included for each partner as an increase in basis when it should only have been ¼ of that amount (or $20,000). Applying all other facts correctly, this answer was calculated as $100,000 + $80,000 - $10,000 = $170,000.
```
87
```
Kerr and Marcus form KM Partnership with a cash contribution of $80,000 from Kerr and a property contribution of land from Marcus. The land has a fair market value of $80,000 and an adjusted basis of $50,000 at the date of the contribution. Kerr and Marcus are equal partners. What is Marcus's basis immediately after formation?
a.
$50,000
b.
$65,000
c.
$0
d.
$80,000
```
RULE: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for a partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor's basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially allocated to the contributing partner upon the sale of that contributed property.
Choice "a" is correct. Per the above rule, Marcus' basis in the partnership immediately after formation is $50,000, which is Marcus' basis in the land at the date of contribution.
88
```
Smith received a one-third interest of a partnership by contributing $3,000 in cash, stock with a fair market value of $5,000 and a basis of $2,000, and a new computer that cost Smith $2,500. Which of the following amounts represents Smith's basis in the partnership?
a.
$7,500
b.
$3,000
c.
$10,500
d.
$5,500
```
Rule: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor's basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially-allocated to the contributing partner upon the sale of that contributed property.
Choice "a" is correct. Applying the rule above, Smith's basis in the partnership upon contribution is calculated as follows:
89
```
Walker transferred property used in a sole proprietorship to the WXYZ partnership in exchange for a one-fourth interest. The property had an original cost of $75,000, an adjusted tax basis to Walker of $20,000, and fair market value of $50,000. The partnership has no liabilities. What is Walker's basis in the partnership interest?
a.
$0
b.
$75,000
c.
$50,000
d.
$20,000
```
Choice "d" is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest. The partner's original basis for a partnership interest acquired by contribution of property is the adjusted tax basis of the property (unless the property is subject to excess liability, which is not the case in this question).
90
```
Olson, Wayne, and Hogan are equal partners in the OWH partnership. Olson's basis in the partnership interest is $70,000. Olson receives a liquidating distribution of $10,000 cash and land with a fair market value of $63,000, and a basis of $58,000. What is Olson's basis in the land?
a.
$63,000
b.
$70,000
c.
$58,000
d.
$60,000
```
```
Choice "d" is correct.
In a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest (as the partner is simply exchanging his partnership interest for the distributed assets), reduced by any monies received in the same transaction.
Olson's basis before distribution
$70,000
Less: Cash received
(10,000)
Remaining basis in partnership
60,000
Less: Allocate basis to land
(60,000)
Liquidated partnership basis
$ 0
```
91
```
The at-risk limitation provisions of the Internal Revenue Code may limit:
I.
A partner's deduction for his or her distributive share of partnership losses.
II.
A partnership's net operating loss carryover.
a.
II only.
b.
Neither I nor II.
c.
I only.
d.
Both I and II.
```
Choice "c" is correct. A partner's tax deduction for his or her distributive share of partnership losses is limited to the partner's adjusted basis in the partnership, which is increased by any partnership liabilities that he or she is personally liable for (called the "at-risk" provision). Any unused loss can be carried forward and used in a future year when basis becomes available; therefore, the at-risk limitation does not limit a partner's net operating loss carryover.
92
```
On December 31, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark's partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark's gain or loss on the sale of his partnership interest?
a.
Capital gain of $15,000.
b.
Capital loss of $10,000.
c.
Ordinary gain of $15,000.
d.
Ordinary loss of $10,000.
```
```
Choice "a" is correct. A partner who sells his interest in a partnership has a recognized gain or loss that is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest. If there are any partnership liabilities allocated to the interest and transferred to the buyer, they are considered part of the amount realized. Any gain that represents a partner's share of "hot assets" (unrealized receivables of appreciated inventory) is treated as ordinary income if cash is taken. Clark's capital gain on the sale is calculated as follows:
Amount realized on the sale:
Cash
$ 30,000
Liabilities relieved of
25,000
55,000
Less: Basis in the partnership
(40,000)
Capital gain on sale*
$ 15,000
* Note: The facts tell us that the partnership had no unrealized receivables or substantially appreciated inventory; therefore, there are no "hot assets" to cause Clark to categorize any of the gain as ordinary income. The entire gain is capital gain.
```
93
```
Reid, Welsh, and May are equal partners in the RWM partnership. Reid's basis in the partnership interest is $60,000. Reid receives a liquidating distribution of $61,000 cash and land with a fair market value of $14,000 and an adjusted basis of $12,000. What gain must Reid recognize upon the liquidation of his partnership interest?
a.
$13,000
b.
$15,000
c.
$0
d.
$1,000
```
```
Choice "d" is correct. With a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest, first reduced by any monies received. The partner will recognize gain only to the extent that money received exceeds the partner's basis in the partnership.
Basis before liquidating distribution
$ 60,000
Less: Cash received
(61,000)
Cash received in excess of basis
(1,000)
Gain to be recognized
1,000
Basis after gain recognition
$ 0
Note: The basis of the land to Reid is zero, as Reid has no remaining basis in the partnership to allocate to the land (i.e., Reid has exchanged his entire interest in the partnership for the cash and the land).
```
94
```
Baker is a partner in BDT with a partnership basis of $60,000. BDT made a liquidating distribution of land with an adjusted basis of $75,000 and a fair market value of $40,000 to Baker. What amount of gain or loss should Baker report?
a.
$20,000 loss.
b.
$0
c.
$35,000 loss.
d.
$15,000 gain.
```
Choice "b" is correct. In a complete liquidation of a partnership, a partner (Baker) recognizes gain only to the extent that the money received (if any) exceeds that partner's adjusted basis in the partnership immediately before the distribution. In this question, there is no money distributed, so there is no gain. The partner recognizes loss if only money, unrealized receivables, or inventory are received and if the basis of the assets received is less than the partner's basis in the partnership. In this question, there is no money, unrealized receivables, or inventory distributed, so there is no loss, regardless of the partner's basis in the partnership. Even though the land has a $40,000 fair market value, Baker's basis in the land is his $60,000 partnership basis, effectively giving him a $20,000 built-in loss that he can recognize by selling the land.
95
```
Nolan designed Timber Partnership's new building. Nolan received an interest in the partnership for the services. Nolan's normal billing for these services would be $80,000 and the fair market value of the partnership interest Nolan received is $120,000. What amount of income should Nolan report?
a.
$80,000
b.
$0
c.
$40,000
d.
$120,000
```
Choice "d" is correct. In this question, Nolan receives an interest in the partnership for services performed. The services are valued at the fair market value of what is received (the partnership interest) of $120,000, regardless of what Nolan's normal billing for these services might have been.
96
The CSU partnership distributed to each partner cash of $4,000, inventory with a basis of $4,000 and a fair market value (FMV) of $6,000, and land with an adjusted basis of $5,000 and an FMV of $3,000 in a liquidating distribution. Partner Chang had an outside basis in Chang's partnership interest of $12,000. In the second year after receiving the liquidating distribution, Chang sold the inventory for $5,000 and the land for $3,000. What income must Chang report upon the sale of these assets?
a.
$0 gain or loss.
b.
$1,000 ordinary gain and $1,000 capital loss.
c.
$1,000 ordinary gain and $0 capital loss.
d.
$0 ordinary gain and $1,000 capital loss.
Choice "b" is correct. In this liquidating distribution of a partnership, three different assets are distributed. The $4,000 cash distributed reduces Chang's (outside) basis in the partnership to $8,000. At that point, Chang's outside basis is less than the total (inside) basis of the remaining property distributed. The inventory gets $4,000 of basis first and Chang's outside basis is reduced to $4,000. The land gets the remaining $4,000 basis (whatever is left over). The sale of the inventory for $5,000 then produces a $1,000 ordinary gain ($5,000 - $4,000), and the sale of the land for $3,000 produces a $1,000 capital loss ($3,000 - $4,000).
97
The individual partner rather than the partnership makes which of the following elections?
a.
Nonrecognition treatment for involuntary conversion gains.
b.
Whether to take a deduction or credit for taxes paid to foreign countries.
c.
Code Section 179 deductions for tangible personal property.
d.
Election to amortize organizational costs.
Choice "b" is correct. Most elections that affect the calculation of taxable income of a partnership are made by the partnership itself rather than by an individual partner. For example, the elections as to methods of accounting, methods of depreciation and the Section 179 expensing of a limited amount of depreciable property, the election not to use installment method accounting, and similar elections are made by the partnership and apply to all partners. However, individual partners can make the election to take a deduction or a credit for taxes paid to foreign countries.
98
```
Molloy contributed $40,000 in cash in exchange for a one-third interest in the RST Partnership. In the first year of partnership operations, RST had taxable income of $60,000. In addition, Molloy received a $5,000 distribution of cash and, at the end of the partnership year, Molloy had a one-third share in the $18,000 of partnership recourse liabilities. What was Molloy's basis in RST at year-end?
a.
$61,000
b.
$71,000
c.
$55,000
d.
$101,000
```
Choice "a" is correct. Molloy's (adjusted) basis in the RST partnership includes its original cost ($40,000) plus its share of the partnership's taxable income ($60,000 x 1/3 = $20,000). The basis is reduced by cash distributions ($5,000) and increased by its share of the partnership's recourse liabilities (1/3 x $18,000 = $6,000). The total is $61,000.
99
```
Fern received $30,000 in cash and an automobile with an adjusted basis and market value of $20,000 in a proportionate liquidating distribution from EF Partnership. Fern's basis in the partnership interest was $60,000 before the distribution. What is Fern's basis in the automobile received in the liquidation?
a.
$30,000
b.
$10,000
c.
$20,000
d.
$0
```
Choice "a" is correct. In a complete liquidation of a partnership, the amount of cash distributed initially reduces the basis of the partner in the partnership (outside basis). In this question, the partner's $60,000 basis in the partnership is reduced to $30,000 by the $30,000 cash distribution. The $30,000 remaining partner basis in the partnership is given to the other property distributed (in this question, the only property distributed was the automobile).
100
A $100,000 increase in partnership liabilities is treated in which of the following ways?
a.
Increases each partner's basis in proportion to their ownership.
b.
Increases each partner's basis in the partnership by $100,000.
c.
Does not change any partner's basis in the partnership regardless of whether the liabilities are recourse or nonrecourse.
d.
Increases the partners' bases only if the liability is nonrecourse.
Rule: The partner's original basis is increased by the portion of the liabilities assumed by the partner, and this amount is equal to the partner's percentage ownership in the partnership.
Choice "a" is correct. A $100,000 increase in partnership liabilities generally increases each partner's basis in proportion to their ownership percentage. [Thus, a 25% partner will generally have a basis increase of $25,000 for an increase in partnership debt of $100,000.]
101
```
The adjusted basis of Smith's interest in EVA partnership was $230,000 immediately before receiving the following distribution in complete liquidation of EVA:
Basis
to
EVA Fair
market
value
Cash $ 150,000 $ 150,000
Real estate 120,000 146,000
What is Smith's basis in the real estate?
a.
$120,000
b.
$133,000
c.
$80,000
d.
$146,000
```
Rule: In a complete liquidation of a partnership, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership.
Choice "c" is correct. Smith's basis in the real estate is calculated as follows:
Smith's basis in EVA before liquidation $ 230,000
Cash received (150,000)
Smith's basis in the real estate $ 80,000
102
```
Dale was a 50% partner in D&P Partnership. Dale contributed $10,000 in cash upon the formation of the partnership. D&P borrowed $10,000 to purchase equipment. During the first year of operations, D&P had $15,000 net taxable income, $2,000 tax-exempt interest income, a $3,000 distribution to each partner, and a $4,000 reduction of debt. At the end of the first year of operation, what amount would be Dale's basis?
a.
$21,500
b.
$16,500
c.
$18,500
d.
$17,500
```
```
Rule: The partnership basis formula follows:
Basis = Capital Account + Partner's Share of Liabilities
Choice "c" is correct. Dale's basis at the end of the first year of operations is calculated as follows:
Initial contribution at formation
$ 10,000
Net taxable income
7,500
[$15,000 × 50%]
Tax exempt income
1,000
[$2,000 × 50%]
Distributions
(3,000)
[to each partner]
Increase in debt responsible for
5,000
[$10,000 × 50%]
Reduction in debt responsible for
(2,000)
[$4,000 × 50%]
Basis at year end
$ 18,500
```
103
```
On June 1, Year 1, Don Kerr received a 10% interest in the capital of Rev Company, a partnership, for services rendered. Rev's net assets on June 1, Year 1, had a basis of $35,000 and a fair market value of $50,000. What income must Kerr include in his Year 1 tax return for the partnership interest transferred to him by the other partners?
a.
$5,000 ordinary income.
b.
$3,500 ordinary income.
c.
$5,000 capital gain.
d.
$3,500 capital gain.
```
Rule: If a person receives an interest in the capital of a partnership as a result of prior employment service, the fair market value of the interest acquired represents ordinary income to the recipient and is his basis in the partnership interest acquired.
The partnership's net assets had a FMV of $50,000 as of June 1. Therefore, the FMV of the partnerships respective capital accounts was $50,000.
Total FMV of partnership capital accounts $ 50,000
Percentage received by Don Kerr 10%
Ordinary income to be reported $ 5,000
104
The following information pertains to Carr's admission to the Smith & Jones partnership on July 1, Year 8:
Carr's contribution of capital: 800 shares of Ed Corp. stock bought in 1975 for $30,000; fair market value $150,000 on July 1, Year 8.
Carr's interest in capital and profits of Smith & Jones: 25%.
Fair market value of net assets of Smith & Jones on July 1, Year 8 after Carr's admission: $600,000.
Carr's gain in Year 8 on the exchange of the Ed stock for Carr's partnership interest was:
a.
$0
b.
$120,000 Section 1231 gain.
c.
$120,000 long-term capital gain.
d.
$120,000 ordinary income.
Choice "a" is correct. $0.
Rule: There is no gain or loss recognized when a partner contributes property to a partnership in exchange for a partnership interest. Instead, the basis of the property contributed carries over and becomes the partnership's basis in the property. Likewise, the basis of the property contributed net of any related loans assumed by the other partners, becomes the new partner's basis in his partnership interest.
FMV of partner's interest received (25% × 600,000)
$150,000
Basis in property surrendered (stock acquired in Year 2)
30,000
Long term capital gain realized
$120,000
Long term capital gain recognized
$0
When the stock is later sold by the partnership, any gain recognition to the extent of the above unrecognized gain would be specifically allocated to the partner who contributed the property to the partnership.
105
Partnership Abel, Benz, Clark & Day is in the real estate and insurance business. Abel owns a 40% interest in the capital and profits of the partnership, while Benz, Clark, and Day each owns a 20% interest. All use a calendar year. At November 1 of the current year, the real estate and insurance business is separated, and two partnerships are formed: Partnership Abel & Benz takes over the real estate business, and Partnership Clark & Day takes over the insurance business. Which one of the following statements is correct for tax purposes?
a.
Informing Partnership Clark & Day, partners Clark and Day are subject to a penalty surtax if they contribute their entire distributions from Partnership Abel, Benz, Clark & Day.
b.
Partnership Abel & Benz is considered to be a continuation of Partnership Abel, Benz, Clark & Day.
c.
Before separating the two businesses into two distinct entities, Partnership Abel, Benz, Clark & Day must file a formal dissolution with the IRS on the prescribed form.
d.
Before separating the two businesses into two distinct entities, the partners must obtain approval from the IRS.
Choice "b" is correct. Partnership Abel & Benz is considered to be a continuation of partnership Abel, Benz, Clark, and Day as Abel (40%) and Benz (20%) constitute more than 50% of the old partnership.
106
```
Thompson's basis in Starlight Partnership was $60,000 at the beginning of the year. Thompson materially participates in the partnership's business. Thompson received $20,000 in cash distributions during the year. Thompson's share of Starlight's current operations was a $65,000 ordinary loss and a $15,000 net long-term capital gain. What is the amount of Thompson's deductible loss for the period?
a.
$55,000
b.
$65,000
c.
$40,000
d.
$15,000
```
Choice "a" is correct. A partner's deductible loss is limited to his basis plus any amounts that he is personally liable for ("at risk" provision).
Thompson's basis would be calculated as follows:
Beginning basis $ 60,000
Plus: Net LT capital gain 15,000
Less: Cash distribution (20,000)
Basis for determining allowable loss deduction $ 55,000
Thompson would be allowed to take a loss deduction for $55,000 of the $65,000 ordinary loss passed through to him from the partnership. The remaining $10,000 would be carried forward until additional basis became available.
107
```
Dale's distributive share of income from the calendar- year partnership of Dale & Eck was $50,000 in Year 1. On December 15, Year 1, Dale, who is a cash-basis taxpayer, received a $27,000 distribution of the partnership's Year 1 income, with the $23,000 balance paid to Dale in May Year 2. In addition, Dale received a $10,000 interest-free loan from the partnership in Year 1. This $10,000 is to be offset against Dale's share of Year 2 partnership income. What total amount of partnership income is taxable to Dale in Year 1?
a.
$50,000
b.
$37,000
c.
$27,000
d.
$60,000
```
Choice "a" is correct. The total amount of partnership income taxable to Dale in Year 1 is $50,000, which is his distributive share of partnership income.
Rule: A partner must include his allocated share of partnership income, even if not received in cash, in his tax return for his taxable year (usually calendar year) within which the taxable year of the partnership ends.
108
The basis to a partner of property distributed "in kind" in complete liquidation of the partner's interest is the:
a.
Adjusted basis of the property to the partnership.
b.
Adjusted basis of the partner's interest increased by any cash distributed to the partner in the same transaction.
c.
Fair market value of the property.
d.
Adjusted basis of the partner's interest reduced by any cash distributed to the partner in the same transaction.
Choice "d" is correct. Adjusted basis of the partner's interest reduced by any cash distributed to the partner in the same transaction.
Rule: Upon dissolution, the "basis" of property distributed to a partner will be the partner's "adjusted basis" in the partnership, net of any cash distributions (not FMV of property distributed).
109
The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date:
a.
The partner's holding period of the capital asset began.
b.
The partner is first credited with the proportionate share of partnership capital.
c.
The partner transfers the asset to the partnership.
d.
The partner is admitted to the partnership.
Choice "a" is correct.
Rule: The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date the partner's holding period of the capital asset began.
110
```
Under which of the following circumstances is a partnership that is not an electing large partnership considered terminated for income tax purposes?
I.
Fifty-five percent of the total interest in partnership capital and profits is sold within a 12-month period.
II.
The partnership's business and financial operations are discontinued.
a.
Both I and II.
b.
Neither I nor II.
c.
II only.
d.
I only.
```
Choice "a" is correct. Such a partnership will be terminated for income tax purposes when either fifty percent or more of the total interest in capital and profits is sold within a 12-month period or the partnership's business and financial operations are discontinued.
111
```
Strom acquired a 25 percent interest in Ace Partnership by contributing land having an adjusted basis of $16,000 and a fair market value of $50,000. The land was subject to a $24,000 mortgage, which was assumed by Ace. No other liabilities existed at the time of the contribution. What was Strom's basis in Ace?
a.
$16,000
b.
$0
c.
$26,000
d.
$32,000
```
Choice "b" is correct. Strom's basis in the land ($16,000) carries over as an element of his basis in Ace. The assumption by Ace of Strom's liabilities on the land ($24,000) is treated as a distribution of money to Strom, which reduces his basis temporarily to negative $8,000. Then, through his status as a partner of Ace, Strom is treated as re-assuming 25% of the liability, or $6,000, and this increases his basis temporarily to negative $2,000. Since it is impossible to have negative basis, Strom realizes a gain (usually capital) of $2,000, the amount necessary to bring his basis up to zero.
112
```
Dean is a 25% partner in Target Partnership. Dean's tax basis in Target on January 1, 20X1, was $20,000. At the end of 20X1, Dean received a nonliquidating cash distribution of $8,000 from Target. Target's 20X1 accounts recorded the following items:
Municipal bond interest income $ 12,000
Ordinary income 40,000
What was Dean's tax basis in Target on December 31, 20X1?
a.
$30,000
b.
$25,000
c.
$15,000
d.
$23,000
```
Choice "b" is correct. Dean's basis in Target is calculated by starting with his basis at January 1, 20X1 ($20,000) and adding his 25% share of partnership income items for the year. The nontaxable municipal bond income increases his basis as does the ordinary income. Target's income items include the municipal bond income ($12,000) plus the ordinary income ($40,000) for a total of $52,000, of which Dean's 25% share is $13,000. This is added to the beginning basis of $20,000, and the $8,000 cash distribution is deducted leaving a balance at December 31, 20X1, of $25,000.
113
```
Peters has a one-third interest in the Spano Partnership. During 20X1, Peters received a $16,000 guaranteed payment, which was deductible by the partnership, for services rendered to Spano. Spano reported a 20X1 operating loss of $70,000 before the guaranteed payment. What is(are) the net effect(s) of the guaranteed payment?
I.
The guaranteed payment increases Peters' tax basis in Spano by $16,000.
II.
The guaranteed payment increases Peters' ordinary income by $16,000.
a.
II only.
b.
Both I and II.
c.
I only.
d.
Neither I nor II.
```
Choice "a" is correct. The guaranteed payment increases Peters' ordinary income by $16,000 but does not affect Peters' tax basis because guaranteed payments are not undistributed earnings (they are distributed to the partner). The answer is "II only."
Rule: Guaranteed payments are reasonable compensation paid to a partner for services rendered without regard to the partner's ratio of income. They are allowable tax deductions to the partnership and ordinary income to the partner receiving them.
Note: A guaranteed payment will not increase a partner's basis in the partnership because the payment has been distributed to the partner.
114
```
Evan, a 25% partner in Vista Partnership, received a $20,000 guaranteed payment in 20X1 for deductible services rendered to the partnership. Guaranteed payments were not made to any other partner. Vista's 20X1 partnership income consisted of:
Net business income before guaranteed payments $ 80,000
Net long-term capital gains 10,000
What amount of income should Evan report from Vista Partnership on his 20X1 tax return?
a.
$22,500
b.
$27,500
c.
$20,000
d.
$37,500
```
Choice "d" is correct. Evan's income from Vista is $37,500, calculated as follows:
Partnership income before guaranteed payment to Evan $ 80,000
Deductible guaranteed payment to Evan (20,000)
Net taxable partnership income 60,000
Evan's share of partnership income 25%
Evan's amount of partnership income 15,000
Evan's 25% share of Vista's $10,000 capital gain 2,500
Evan's guaranteed payment from Vista 20,000
20X1 Vista income reportable on Evan's return $ 37,500
115
```
The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000.
What amount of taxable gain must Jody report as a result of this distribution?
a.
$0
b.
$20,000
c.
$5,000
d.
$10,000
```
Choice "a" is correct. The $20,000 current distribution of cash is first applied to Jody's $50,000 basis, reducing it to $30,000. The current distribution of property is then applied at its $40,000 basis. Since Jody's remaining basis is $30,000, only $30,000 is applied to the property distribution, resulting in $0 taxable gain to Jody and $0 remaining basis in the partnership.
116
```
The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000.
What is Jody's basis in the distributed property?
a.
$30,000
b.
$35,000
c.
$0
d.
$40,000
```
Choice "a" is correct. Jody's basis in the distributed property is $30,000, Jody's remaining basis in the partnership after the cash distribution:
Jody's partnership basis
$ 50,000
Cash distribution and Jody's basis in cash
(20,000)
$ 30,000
Property distribution and Jody's basis in the property
(30,000)
*
Jody's partnership basis after distributions
$ 0
* If the partner's basis in the partnership ($30,000) is less than the property's basis ($40,000), the partner's basis in the property is limited to her basis in the partnership ($30,000).
117
```
The adjusted basis of Vance's partnership interest in Lex Associates was $180,000 immediately before receiving the following distribution in complete liquidation of Lex:
Basis to Lex
Fair market
value
Cash
$100,000
$100,000
Real estate
70,000
96,000
What is Vance's basis in the real estate?
a.
$83,000
b.
$70,000
c.
$96,000
d.
$80,000
```
Choice "d" is correct. In a liquidating distribution, the $100,000 cash is applied first to the $180,000 partnership basis, reducing it to $80,000. Even though the partnership's basis in the real estate is only $70,000, Vance's basis in the real estate will be his partnership basis ($80,000) since this is the last asset distributed and it is a liquidating distribution (i.e., Vance's partnership basis must be reduced to zero). Neither Vance nor the partnership recognizes any gain or loss from the distribution.
118
```
Which of the following is both an item that is an allowable tax deduction to the partnership and is reported separately on the individual partner's Schedule K-1?
a.
Salaries paid to non-partner employees.
b.
Advertising expenditures.
c.
Guaranteed payments paid to partners.
d.
Depreciation on equipment used in the business.
```
Choice "c" is correct. A partnership calculates net business income or loss and passes each partner's distributive share through on the Schedule K-1. Guaranteed payments paid to partners for services rendered or for the use of capital, without regard to partnership income or profit and loss sharing ratios, are an allowable tax deduction to the partnership and are separately reported on Schedule K-1 for inclusion on the partner's tax return.
119
In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:
a.
A tax year of a principal partner having a 10% or greater interest.
b.
A tax year of one or more partners with a more than 50% interest in profits and capital.
c.
A tax year that results in the greatest aggregate deferral of income.
d.
A calendar year.
Rule: Per IRC Section 706(b), a partnership tax year must have the same taxable year as the common taxable year of the partners that, in the aggregate, have interest greater than 50%, which is determined based on the "testing day," the first day of the partnership's tax year (not considering the majority interest rule). Note: After a change is made to the "majority-interest" tax year end, the partnership does not have to change to another tax year for two years following the year of change. Exceptions to the rule exist. (1) If there is no "majority-interest" tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the partnership). (2) If the partnership is still unable to determine a tax year using the general rule or the first exception, then the tax year that causes the least aggregate deferral of income to the partners must be adopted.
Choice "b" is correct. In the absence of election to adopt an annual accounting period, the required tax year for a partnership is the tax year of one or more partners who, in aggregate, have more than 50% interest in profits and capital, per the majority interest rule.
120
```
Brown, a 50% partner in Brown & White, received a distribution of $12,500 in the current year. The partnership's income for the year was $25,000. What is the character of the payment that Brown received?
a.
Current distribution.
b.
Partial liquidation.
c.
Disproportionate distribution.
d.
Liquidating distribution.
```
Rule: IRC Section 731 controls the taxability of partnership distributions. A partner who receives a distribution from a partnership realizes gain only to the extent that he receives cash in excess of the adjusted basis of his interest in the partnership immediately before the distribution.
Choice "a" is correct. This distribution is a current distribution (a distribution other than in liquidation of an entire partnership interest). Brown is a 50% partner and he/she received ½ of the partnership's income in cash.
121
```
"Hot assets" of a partnership would include which of the following?
a.
Cash.
b.
Section 1231 assets.
c.
Unrealized receivables.
d.
Capital assets
```
Choice "c" is correct. As a general rule, a partner who sells or exchanges his or her partnership interest has a recognized capital gain or loss. The capital gain or loss is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest.
An exception to the capital gain treatment is on any gain that represents a partner's share of "hot assets". Any gain that represents a partner's share of hot assets is treated as ordinary income. Hot assets are: (1) Unrealized receivables and, (2) Appreciated inventory.
122
```
George and Martha are equal partners in G&M Partnership. At the beginning of the current tax year, the adjusted basis of George's partnership interest was $32,500, which included his share of $40,000 of partnership liabilities. During the tax year, the following information applied to G&M:
Operating loss $ 30,000
Interest and dividend income 8,000
Partnership liabilities at end of year 24,000
What was the basis of George's partnership interest at year end?
a.
$29,500
b.
$21,500
c.
$43,500
d.
$13,500
```
Choice "d" is correct. A partner's share of operating losses reduces that partner's basis. Likewise, a reduction in a partner's share of liabilities reduces basis. A partner's basis will increase by that partner's share of income such as dividends and interest.
Initial basis in partnership interest $ 32,500
Equal share of interest and dividends 4,000
Equal share of operating loss (15,000)
Share of decreased partnership liabilities at year end (8,000)
Basis of George's partnership interest at year end $ 13,500
123
```
As a general partner in Greenland Associates, an individual's share of partnership income for the current tax year is $25,000 ordinary business income and a $10,000 guaranteed payment. The individual also received $5,000 in cash distributions from the partnership. What income should the individual report from the interest in Greenland?
a.
$5,000
b.
$40,000
c.
$25,000
d.
$35,000
```
Choice "d" is correct. A partner must include in income their share of partnership income (even if not received) on their tax return in the taxable year within which the taxable year of the partnership ends. This income includes guaranteed payments.
Withdrawals/distributions are not a taxable event, yet will decrease the partner's basis.
124
```
In the current year, when Hoben's tax basis in Lynz Partnership interest was $10,000, Hoben received a liquidating distribution as follows:
Adjusted
tax basis Fair market
value
Marketable securities $ 5,000 $ 5,000
Land 25,000 27,000
Lynz had no appreciated inventory, unrealized receivables, or properties that had been contributed by its partners. What was Hoben's recognized gain on the distribution?
a.
$22,000
b.
$32,000
c.
$15,000
d.
$0
```
Choice "d" is correct. In a complete liquidation, the partner's basis for distributed property is the same as the adjusted basis of his/her partnership interest, reduced by any money actually received. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership. Therefore, the partner's basis in the distributed assets as part of the liquidation would be $10,000, with no immediate recognized gain.
125
```
Campbell acquired a 10% interest in Vogue Partnership by contributing a building with an adjusted basis of $40,000 and a fair market value of $90,000. The building was subject to a $60,000 mortgage that was assumed by Vogue. The other partners contributed cash only. The basis of Campbell's partnership interest in Vogue is:
a.
$34,000
b.
$84,000
c.
$30,000
d.
$0
```
Choice "d" is correct. A partner's initial basis in their partnership interest is determined by, among other items, the adjusted basis of appreciated property contributed. Such basis is reduced by liabilities assumed by the other partners.
When property that is subject to a liability is contributed to a partnership and the subsequent decrease in the partner's individual liability exceeds partnership basis, the excess amount is treated like taxable boot, which means there is a taxable gain to the partner.
Initial Basis:
$40,000
(basis in asset contributed to the partnership)
Less: liabilities assumed by others:
(54,000)
($60,000 in total liabilities less 10% retained)
Net Basis:
($14,000)
Excess liability, taxable to Campbell
Campbell's basis in partnership:
$0
126
```
Ken Karas owns an 80% interest in the capital and profits of the partnership of Karas & Keel. On July 1 of the current year, Karas bought surplus land from the partnership at the land's fair market value of $30,000. The partnership's basis in the land was $36,000. For the current calendar year end, the partnership's net income was $85,000, after recording the $6,000 loss on the sale of the land. Karas' distributive share of ordinary income from the partnership for the current year was:
a.
$72,800
b.
$91,000
c.
$63,200
d.
$68,000
```
Choice "a" is correct. Losses between a controlling partner (over 50% interest in capital and profits) and his controlled partnership from the sale or exchange of property are not allowed. Thus the disallowance of the $6,000 loss would make the ordinary income $91,000 and 80% of that is $72,800.
127
```
Kent King's adjusted basis for his partnership interest in Troy Partnership was $32,000. In complete liquidation of his interest in Troy, King received cash of $2,000 and realty having a fair market value of $25,000. Troy's adjusted basis for this realty was $15,000. King's basis for the realty after distribution is:
a.
$30,000
b.
$15,000
c.
$13,000
d.
$25,000
```
Choice "a" is correct. In a liquidating distribution, a partner's basis in the distributed property is the same as the adjusted basis of his partnership interest reduced for any monies actually received. King's basis in his partnership interest was $32,000 less $2,000 cash received, leaving $30,000 of basis to be allocated to the realty received.
128
```
Ball and Baig are equal partners in the firm of Games Associates. On January 1 of the current year, each partner's adjusted basis in Games was $50,000. During the year, Games borrowed $80,000 for which Ball and Baig are personally liable. Games sustained an operating loss of $30,000 for the current year. The basis of each partner's interest in Games at the end of the current year was:
a.
$35,000
b.
$65,000
c.
$50,000
d.
$75,000
```
Choice "d" is correct. A partner's basis in his partnership interest is the combination of his capital account and his share of liabilities that he is personally liable for. The beginning basis of $50,000 should be decreased by each partner's share of the $30,000 operating loss, or $15,000, and increased for each partner's share of the liabilities, or $40,000, for current calendar year end basis of $75,000.
129
```
At the beginning of the tax year, Martin Crouch contributed property to a new partnership in return for a 25% interest in capital and profits. The property contributed had a fair market value of $150,000, an adjusted basis of $100,000, and was subject to a $100,000 mortgage, which was assumed by the partnership. What was Martin's basis in the partnership as a result of the contribution?
a.
$0
b.
$100,000
c.
$150,000
d.
$25,000
```
```
Choice "d" is correct. Following the basis formula yields:
+
Cash
$ 0
+
Adjusted basis of property
100,000
−
Liabilities (amount assumed by other partners)
75,000
+
FMV of services rendered (if applicable)
0
+
Liabilities - other partner's liabilities assumed by the incoming partner
0
=
basis
$ 25,000
```
130
```
Turner, Reed, and Sumner are equal partners in TRS partnership. Turner contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000. Reed contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000. Sumner provided services worth $50,000. What amount of income is recognized as a result of the transfers?
a.
$90,000
b.
$50,000
c.
$150,000
d.
$60,000
```
Choice "b" is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest (note: when contributed property is subject to a liability, if the decrease in the contributing partner's individual basis exceeds the partner's partnership basis, the excess amount is treated like taxable boot and is a gain to that partner). So, given the facts in this question, Turner and Reed will recognize no income or gain.
On the other hand, the value of a partnership acquired for services is ordinary income to the partner rendering those services. So, Summer must recognize $50,000 of ordinary income on account of Summer's rendering to the partnership $50,000 worth of services in exchange for a partnership interest.
131
While preparing a partnership tax return, the accountant discovered that ABC Partnership distributed property to Anne, a partner, in a nonliquidating transfer. No money was distributed to Anne during the year, the property was in the partnership for over five years, and no debt was attached to the property. Anne had a basis in her partnership interest of $10,000. The partnership had an adjusted basis of $20,000 in the property distributed to Anne. Which of the following are the tax consequences to Anne?
a.
$0 gain, basis in the partnership is reduced to $0, and basis in the property received is $10,000.
b.
$10,000 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000.
c.
$0 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000.
d.
$10,000 gain, basis in the partnership is unchanged, and basis in the property received is $20,000.
Choice "a" is correct. General rules:
A nonliquidating distribution to a partner is nontaxable.
In nonliquidating distribution to a partner, the basis of property received will be the same as the basis in the hands of the partnership immediately prior to the nonliquidating distribution.
Distributions to a partner reduce the partner's basis by the cash the partner receives and by the partnership's adjusted basis in property which the partner receives.
Exception to the general rule (the exception does not apply to the facts set forth in the question): Gain is recognized only to the extent that cash (including the partner's share of partnership liabilities are assumed by other partners) distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution.
In this question, the partner received no cash, and the partner's share of partnership liabilities did not change. So, the partner will recognize no gain with respect to the distribution. Although the partnership's adjusted basis in the distributed property was $20,000, because the partner's basis in the partner's partnership interest was only $10,000, the adjusted basis of the property which the partner received will be limited to $10,000. The new basis in the partnership interest will be reduced from $10,000 to -0-.
132
```
Able and Baker are equal members in Apple, an LLC. Apple has elected not to be treated as a corporation. Able contributes $7,000 cash and Baker contributes a machine with a basis of $5,000 and a fair market value of $10,000, subject to a liability of $3,000. What is Apple's basis for the machine?
a.
$8,000
b.
$5,000
c.
$10,000
d.
$2,000
```
Choice "b" is correct. This LLC has elected not to be treated as a corporation. Therefore, the rules for partnerships will apply. The general rule is that the partnership's basis in the contributed property is the carryover basis of the contributor. So the $5,000 basis to Baker becomes the carryover $5,000 basis to Apple.
133
```
Gulde's tax basis in Chyme Partnership was $26,000 at the time Gulde received a liquidating distribution of $12,000 cash and land with an adjusted basis to Chyme of $10,000 and a fair market value of $30,000. Chyme did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was the amount of Gulde's basis in the land?
a.
$10,000
b.
$0
c.
$30,000
d.
$14,000
```
Choice "d" is correct. In a liquidating distribution, we have to "zero out to get out." Partnership basis starts at $26,000. The cash distribution of $12,000 reduces the partnership basis to $14,000. The land then is distributed with that basis of $14,000, as we zero out to get out.
134
```
In return for a 20% partnership interest, Skinner contributed $5,000 cash and land with a $12,000 basis and a $20,000 fair market value to the partnership. The land was subject to a $10,000 mortgage that the partnership assumed. In addition, the partnership had $20,000 in recourse liabilities that would be shared by partners according to their partnership interests. What amount represents Skinner's basis in the partnership interest?
a.
$21,000
b.
$19,000
c.
$13,000
d.
$27,000
```
Choice "c" is correct. Skinner's basis in partnership interest is calculated as follows:
Cash contributed
$ 5,000
Basis of land contributed
12,000
Less mortgage on land assumed by other partners (80% of $10,000)
(8,000)
Recourse liabilities assumed by Skinner (20% of $20,000)
4,000
Skinner's basis
$ 13,000
135
```
PDK, LLC had three members with equal ownership percentages. PDK elected to be treated as a partnership. For the tax year ending December 31, Year 1, PDK had the following income and expense items:
Revenues
$ 120,000
Interest income
6,000
Gain on sale of securities
8,000
Salaries
36,000
Guaranteed payments
10,000
Rent expense
21,000
Depreciation expense
18,000
Charitable contributions
3,000
What would PDK report as nonseparately stated income for Year 1 tax purposes?
a.
$35,000
b.
$51,000
c.
$43,000
d.
$30,000
```
```
Choice "a" is correct. Nonseparately stated income is calculated as follows:
Revenues
$ 120,000
Salaries
(36,000)
Guaranteed payments
(10,000)
Rent expense
(21,000)
Depreciation expense
(18,000)
Total nonseparately stated income
$ 35,000
Note: All other items listed in the question are separately stated.
```
136
When the AQR partnership was formed, partner Acre contributed land with a fair market value of $100,000 and a tax basis of $60,000 in exchange for a one-third interest in the partnership. The AQR partnership agreement specifies that each partner will share equally in the partnership's profits and losses. During its first year of operation, AQR sold the land to an unrelated third party for $160,000. What is the proper tax treatment of the sale?
a.
The first $40,000 of gain is allocated to Acre, and the remaining gain of $60,000 is shared equally by the other two partners.
b.
Each partner reports a capital gain of $33,333.
c.
The entire gain of $100,000 must be specifically allocated to Acre.
d.
The first $40,000 of gain is allocated to Acre, and the remaining gain of $60,000 is shared equally by all the partners in the partnership.
Choice "d" is correct. The difference between the tax basis of $60,000 and FMV of $100,000 on the date the partnership was formed is a built-in gain to partner Acre. Accordingly, the first $40,000 of gain is allocated to Acre and the remaining gain of $60,000 is then shared equally by all of the partners.
137
What is the tax treatment of net losses in excess of the at-risk amount for an activity?
a.
Any losses in excess of the at-risk amount are carried back two years against activities with income and then carried forward for 20 years.
b.
Any losses in excess of the at-risk amount are deducted currently against income from other activities; the remaining loss, if any, is carried forward without expiration.
c.
Any loss in excess of the at-risk amount is suspended and is deductible in the year in which the activity is disposed of in full.
d.
Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.
Choice "d" is correct. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity. The at-risk amount is also referred to as basis. Note that although we discuss this in the textbook for partnerships, the concept applies to all activities that have flow through income and losses.
138
```
Johnson, an individual, has a 50% interest in DEF Partnership. Johnson's adjusted basis at the beginning of the year was $14,000. The partnership's ordinary income for the current year was $6,000. Johnson received a nonliquidating distribution of $8,000 cash, and property with an adjusted basis of $12,000 and a fair market value of $15,000. What is the basis of the distributed property, other than cash, to Johnson?
a.
$15,000
b.
$12,000
c.
$9,000
d.
$6,000
```
Choice "c" is correct. The general rule is that the basis of property received in a nonliquidating distribution is the same as the basis in the hands of the partnership immediately prior to the distribution. However, it is limited to the partner's basis in the partnership. This property has an adjusted basis to the partnership of $12,000. Johnson's basis in the partnership at the beginning of the year is $14,000. This is increased by 50% of the ordinary income of $6,000 and reduced by the cash distribution of $8,000. Basis in the partnership is therefore $9,000 ($14,000 + $3,000 – $8,000) before the property distribution. The basis of the property received is limited to the $9,000 partnership basis. Note: This results in Johnson having a zero basis in the partnership after the property distribution.
139
```
Able, an individual, is a partner in CD Partnership with an adjusted basis of $30,000 for Able's partnership interest. Able received a non-liquidating distribution of $25,000 cash and property with an adjusted basis of $7,000, and a fair market value of $10,000. What amount of gain should Able recognize?
a.
$5,000
b.
$0
c.
$2,000
d.
$12,000
```
Choice "b" is correct. Gain is recognized only to the extent that cash distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution. Able's basis in the partnership immediately before the distribution is $30,000. The cash distribution is $25,000. This is not in excess of basis and there is a $5,000 basis remaining. Able's basis in the distributed property is the $5,000 remaining partnership basis.
140
John and Jane Dorian currently operate a very successful business selling pet supplies. Their CPA has advised them to consider forming an LLC. Which of the following would be a reason to select the LLC form?
a.
An LLC does not have “double taxation” if taxed as a partnership.
b.
The Dorians expect to have an initial public offering (IPO) of common stock in the next year.
c.
Members of an LLC do not have the right to amend the LLC operating agreement; only the “owner” members, Jane and John, could do this.
d.
The Dorians' LLC would be considered a disregarded entity for federal income tax purposes.
Choice "a" is correct. LLCs can select whether to be taxed as a partnership, corporation or sole proprietorship. An LLC with at least two owners is taxed as a partnership unless an election is made to be taxed as a corporation.
141
```
Anderson and Decker are equal members in Andek, an LLC, which has not elected to be treated as a corporation. Anderson contributes $7,000 cash, and Decker contributes a machine with an adjusted basis of $5,000 and fair market value of $10,000, subject to a liability of $3,000. What is Decker's basis in Andek?
a.
$5,000
b.
$2,000
c.
$3,500
d.
$10,000
```
Choice "c" is correct. This LLC has not elected to be treated as a corporation. Therefore, it will be treated as a partnership by default. Decker's basis will be the adjusted basis of the property contributed less 50% of the liability, which is assumed by the other partner. $5,000 – $1,500 = $3,500.
142
```
A distribution to an estate's sole beneficiary for the current calendar year equaled $15,000, the amount currently required to be distributed by the will. The estate's current year records were as follows:
Estate income
$40,000
Taxable interest
Estate disbursements
$34,000
Expenses attributable to taxable interest
What amount of the distribution was taxable to the beneficiary?
a.
$15,000
b.
$6,000
c.
$0
d.
$40,000
```
Choice "b" is correct. The amount of income an estate beneficiary reports from the estate is limited by the estate's distributable net income, $6,000 in this case. Because the estate distributed $15,000 to the beneficiary, all $6,000 of its distributable net income is taxed to the beneficiary, and the estate will have no taxable income to report. The $9,000 ($15,000 - $6,000) the beneficiary received in cash over the amount of taxable income is treated as a nontaxable distribution of principal.
143
```
Steve and Kay Briar, U.S. citizens, were married for the entire calendar year. During the year, Steve gave a $30,000 cash gift to his sister. The Briars made no other gifts in the year. They each signed a timely election to treat the $30,000 gift as made one-half by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the current year gift is taxable to the Briars?
a.
$2,000
b.
$30,000
c.
$0
d.
$28,000
```
Choice "a" is correct. A married couple can elect to treat taxable gifts as made half by each spouse for gift tax purposes. Every donor receives a $14,000 per person, per year, exclusion from the gift tax. Mr. and Mrs. Briar split Mr. Briar's $30,000 gift to his sister, for an effective gift of $15,000 each. Then each of them receives a $14,000 exclusion to reduce the taxable gift to $1,000. Because there are two deemed gifts, one from each spouse, the total taxable gift, ignoring the unified tax credit and the potential estate tax consequences, is $2,000.
144
```
A distribution from estate income, that was currently required, was made to the estate's sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary's gross income is limited to the estate's:
a.
Ordinary gross income.
b.
Capital gain income.
c.
Net investment income.
d.
Distributable net income.
```
Choice "d" is correct. Distributable net income is the upper limit on the amount of income that a beneficiary has to include in income from a trust distribution.
145
```
Lyon, a cash basis taxpayer, died on January 15 of the current taxable year. The estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir. The following pertains to the estate's income and disbursements in the current year:
Estate Income
$20,000
Taxable interest
10,000
Net long-term capital gains allocable to corpus
Estate Disbursements
$5,000
Administrative expenses attributable to taxable income
For the current taxable calendar year, what was the estate's distributable net income (DNI)?
a.
$30,000
b.
$20,000
c.
$15,000
d.
$25,000
```
Choice "c" is correct. A trust's distributable net income includes the taxable income of the trust ($20,000 interest income less $5,000 expenses, or $15,000). By definition, it does not include the $10,000 net long-term capital gains allocated to corpus.
146
```
Lyon, a cash basis taxpayer, died on January 15, Year 50. The estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir. The following pertains to the estate's income and disbursements in Year 50:
Estate Income
$20,000
Taxable interest
10,000
Net long-term capital gains allocable to corpus
Estate Disbursements
$5,000
Administrative expenses attributable to taxable income
Lyon's executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, U.S. Fiduciary Income Tax Return, for the estate's Year 50 calendar year?
a.
Wednesday, March 15, Year 51.
b.
Friday, September 15, Year 51.
c.
Monday, April 15, Year 51.
d.
Thursday, June 15, Year 51
```
Choice "c" is correct.
Rule: Form 1041 is due on the 15th day of the fourth month after the close of its taxable year.
Lyon's calendar Year 50 return would be due on April 15, Year 51.
147
```
A distribution from estate income, that was currently required, was made to the estate's sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary's gross income is limited to the estate's:
a.
Net investment income.
b.
Ordinary gross income.
c.
Distributable net income.
d.
Capital gain income.
```
Choice "c" is correct. Distributable net income is the upper limit on the amount of income that a beneficiary has to include in income from a trust distribution.
148
```
Bell, a cash basis calendar year taxpayer, died on June 1 of the current year. Prior to her death, Bell incurred $2,000 in medical expenses that were paid in the current year. If the executor files the appropriate waiver, the medical expenses are deductible on:
a.
Bell's final income tax return.
b.
The executor's income tax return.
c.
The estate tax return.
d.
The estate income tax return.
```
Choice "a" is correct. If the proper waiver is filed, medical expenses paid for the decedent by her executor within one year of her death can be deducted on the decedent's final income tax return.
149
```
Assuming the tax law in effect for 2014, what amount of a decedent's taxable estate is effectively tax-free if the maximum applicable estate and gift tax credit is taken?
a.
$5,340,000
b.
$0
c.
$14,000
d.
$2,081,800
```
Choice "a" is correct. The maximum amount that can be transferred pursuant to a death tax-free is $5,340,000 (2014).
150
```
Don and Linda Grant, U.S. citizens, were married for the entire calendar year. During the year, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in the year. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the applicable credit and estate tax consequences, what amount of the current year gift is taxable to the Grants for gift tax purposes?
a.
$46,000
b.
$32,000
c.
$60,000
d.
$0
```
Choice "b" is correct. A donor (person giving a gift) may exclude the first $14,000 of gifts made to each donee. A gift by either spouse may be treated as made one-half by each; this gift splitting creates a $28,000 exclusion per donee. Therefore, $60,000 - $28,000 = $32,000 is the amount of taxable gift made by the Grants.
151
```
Carter purchased 100 shares of stock for $50 per share. Ten years later, Carter died on February 1 and bequeathed the 100 shares of stock to a relative, Boone, when the stock had a market price of $100 per share. One year later, on April 1, the stock split 2 for 1. Boone gave 100 shares of the stock to another of Carter's relatives, Dixon, on June 1 that same year, when the market value of the stock was $150 per share. What was Dixon's basis in the 100 shares of stock when acquired on June 1?
a.
$15,000
b.
$5,000
c.
$5,100
d.
$10,000
```
Choice "b" is correct. This question combines the rules of estate taxation and gift taxation. Carter's investment in the stock was $50 per share when he died. Upon Carter's death, the stock received a step-up in basis to the fair market value at the date of death (or six months later, if the alternate lower valuation date was elected). Therefore, the stock's basis was $100 per share when it was transferred to Boone. [Note that no capital gain was reportable for the step-up in basis from $50 to $100; however, Carter's estate included the stock at its fair market value of $100/share for estate tax purposes and likely paid a large amount of estate tax on that.] Further, regardless of how long Carter owned the stock (i.e., it could have only been owned for one day), it was automatically deemed long-term property upon Carter's death. So, Boone had 100 shares of stock at a basis of $100/share when Boone received the inheritance. Then, there was a 2-for-1 stock split on April 1 of the following year. This transaction caused Boone to now have double the amount of shares (or, 200 shares) at half the basis per share (or, $50/share). [Note that the total basis remains unchanged (i.e., $100 x 100 shares = $10,000 and $50 x 200 shares = $10,000).] When Boone gifted the stock to Dixon (note: it would not have mattered if Dixon had not been a relative), the donee (Dixon) received the stock at the carryover basis of the donor (Boone). The 100 shares gifted to Dixon were shares from after the stock split; therefore, they have a basis of $50 per share, or a total basis of $5,000 for the 100 shares. [Note that Boone still has 100 shares at a basis of $50 as well.
152
Which of the following is an attribute exclusively of a complex trust?
a.
It distributes income to more than one beneficiary.
b.
It distributes corpus.
c.
It has a grantor that is not an individual.
d.
It has a beneficiary that is not an individual.
Choice "b" is correct. Complex trusts may accumulate current income, distribute principal, and provide for charitable contributions. Simple trusts may only make distributions from current income (not corpus, or principal), must distribute all income currently, and may not make charitable contributions. Either trust may have more than one beneficiary, have a grantor that is not an individual, or have beneficiaries that are not individuals.
153
```
Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created?
a.
Revocable.
b.
Complex.
c.
Simple.
d.
Grantor.
```
Choice "b" is correct. A complex trust may distribute principal, so this is the type of trust that was created.
154
```
Which of the following is allowed in the calculation of the taxable income of a simple trust?
a.
Exemption.
b.
Standard deduction.
c.
Brokerage commission for purchase of tax-exempt bonds.
d.
Charitable contribution.
```
Choice "a" is correct. An exemption of $300 is available for simple trusts.
155
Under which of the following circumstances is trust property with an independent trustee includible in the grantor's gross estate?
a.
The trust is revocable.
b.
The trustee has the power to distribute trust income.
c.
The trust is established for a minor.
d.
The income beneficiary disclaims the property, which then passes to the remainderman, the grantor's friend.
Choice "a" is correct. If a revocable trust is created by a grantor, the trust assets may be returned to the grantor upon the grantor's "revocation" of the trust (i.e., no "complete" gift exists); thus, the assets never left the control (or possible ownership) of the grantor and remain includible in the gross estate of the grantor.
156
Rule: Every transfer of money or property, whether real or personal, tangible or intangible, for less than adequate or full consideration is a gift. There are four items that qualify for unlimited exclusion from gift tax and qualify to be excluded from being reported on a gift tax return: (1) payments made directly to an educational institution for a donee's tuition, (2) payments made directly to a health care provider for medical care (3) charitable gifts, and (4) marital transfers. Relationship of the donee to the donor is not of consequence.
Choice "a" is correct. While payments made to the university for a cousin's tuition would be excluded from the requirement to file a gift tax return, the direct payment to the university for room and board is considered a gift and would require the filing of a gift tax return.
Which of the following payments would require the donor to file a gift tax return?
a.
$40,000 to a university for a cousin's room and board.
b.
$80,000 to a physician for a friend's surgery.
c.
$30,000 to a university for a spouse's tuition.
d.
$50,000 to a hospital for a parent's medical expenses.
157
```
During the current year, Mann, an unmarried U.S. citizen, made a $5,000 cash gift to an only child and also paid $25,000 in tuition expenses directly to a grandchild's university on the grandchild's behalf. Mann made no other lifetime transfers. Assume that the gift tax annual exclusion is $12,000. For gift tax purposes, what was Mann's taxable gift?
a.
$30,000
b.
$0
c.
$18,000
d.
$25,000
```
Rules: Every transfer of money or property, whether real or personal, tangible or intangible, for less than adequate or full consideration is a gift. A donor may exclude the maximum allowable amount of gifts according to the tax law each year made to each donee. In addition, there are four items that qualify for unlimited exclusion from gift tax: (1) payments made directly to an educational institution for a donee's tuition, (2) payments made directly to a health care provider for medical care, (3) charitable gifts, and (4) marital transfers. Relationship of the donee to the donor is not of consequence.
Choice "b" is correct. The information in the fact pattern tells us that the annual exclusion for the year in question is $12,000. Mann has gifted less than this amount (the $5,000 in the question), so the entire $5,000 is exempt from gift tax. The information in the fact pattern also tells us that Mann has paid $25,000 in tuition expenses directly to a grandchild's university on the grandchild's behalf. Per the above rule, payments made directly to an educational institution for a donee's tuition are excluded from gift tax. Therefore, zero gift tax applies to the transfers made by Mann.
158
```
George and Suzanne have been married for 40 years. Suzanne inherited $1,000,000 from her mother. Assume that the annual gift-tax exclusion is $12,000. What amount of the $1,000,000 can Suzanne give to George without incurring a gift-tax liability?
a.
$24,000
b.
$500,000
c.
$1,000,000
d.
$12,000
```
Rules: Every transfer of money or property, whether real or personal, tangible or intangible, for less than adequate or full consideration is a gift. A donor may exclude the maximum allowable amount of gifts according to the tax law each year made to each donee. In addition, there are four items that qualify for unlimited exclusion from gift tax: (1) payments made directly to an educational institution for a donee's tuition, (2) payments made directly to a health care provider for medical care, (3) charitable gifts, and (4) marital transfers. Relationship of the donee to the donor is not of consequence.
Choice "c" is correct. Per the above rule, marital transfers are excluded from gift tax. In this case, Suzanne inherited $1,000,000. Suzanne can give the entire $1,000,000 to George without incurring a gift tax liability.
159
```
When Jim and Nina became engaged in April of the current year, Jim gave Nina a ring that had a fair market value of $50,000. After their wedding in July that same year, Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Both Jim and Nina are U.S. citizens. What was the amount of Jim's current year marital deduction?
a.
$75,000
b.
$0
c.
$125,000
d.
$115,000
```
Choice "a" is correct. $75,000 was Jim's marital deduction for the current year.
Rule: Transfers between husband and wife (interspousal transfers) are not subject to taxation for gift tax or income tax purposes.
160
ncome in respect of a cash basis decedent:
a.
Receives a stepped-up basis in the decedent's estate.
b.
Must be included in the decedent's final income tax return.
c.
Cannot receive capital gain treatment.
d.
Covers income earned before the taxpayer's death but not collected until after death.
Choice "d" is correct. Income in respect of a decedent covers income earned before the taxpayer's death but not collected until after death.
161
Which one of the following is a valid deduction from a decedent's gross estate?
a.
Income tax paid on income earned and received after the decedent's death.
b.
Expenses of administering and settling the estate.
c.
Federal estate tax.
d.
Unified credit.
Choice "b" is correct. Expenses of administering and settling the estate are valid deductions from a decedent's gross estate.
162
Fred and Amy Kehl, both U.S. citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. Assuming the tax law in effect for 2014, the gross estate of the first spouse to die:
a.
Is governed by the federal statutory provisions relating to jointly held property, rather than by the decedent's interest in community property vested by state law, if the Kehls reside in a community property state.
b.
Includes only the property that had been acquired with the funds of the deceased spouse.
c.
Includes one-third of the value of all real estate owned by the Kehls, as the dower right in the case of the wife or courtesy right in the case of the husband.
d.
Includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration.
Choice "d" is correct. The gross estate of the first spouse to die includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration, as they are considered to have owned the property as joint tenants with right of survivorship.
163
```
An executor of a decedent's estate that has only U.S. citizens as beneficiaries is required to file a fiduciary income tax return, if the estate's gross income for the year is at least:
a.
$1,000
b.
$400
c.
$600
d.
$500
```
Choice "c" is correct.
Rule: A fiduciary must file a return on Form 1041 if the estate has gross income of $600 or more for the tax year and if none of the beneficiaries are nonresident aliens.
164
The charitable contribution deduction on an estate's fiduciary income tax return is allowable:
a.
If the decedent died intestate.
b.
To the extent of the same adjusted gross income limitation as that on an individual income tax return.
c.
Subject to the 2% threshold on miscellaneous itemized deductions.
d.
Only if the decedent's will specifically provides for the contribution.
Choice "d" is correct. The charitable contribution deduction on an estates fiduciary income tax return is allowable only if the decedent's will specifically provides for the contribution.
Rule: Estates are allowed an unlimited charitable deduction for amounts that are paid to recognized charities out of gross income under the terms of the governing instrument during the tax year.
165
```
On July 1, Year 1, Vega made a transfer by gift in an amount sufficient to require the filing of a gift tax return. Vega was still alive in Year 2. If Vega did not request an extension of time for filing the Year 1 gift tax return, the due date for filing was:
a.
April 15, Year 2.
b.
June 30, Year 2.
c.
March 15, Year 2.
d.
June 15, Year 2.
```
Choice "a" is correct. The due date for filing the gift tax return, assuming no extension was requested, was April 15, Year 2.
Rule: The return is due on or before the 15th day of the fourth month following the close of the tax year in which the gift was made. Form 709 is an annual return and its due date is April 15.
166
```
The standard deduction for a trust or an estate in the fiduciary income tax return is:
a.
$650
b.
$0
c.
$800
d.
$750
```
Choice "b" is correct.
| Rule: An estate or trust is not allowed a standard deduction in preparing the fiduciary income tax return.
167
Rule: An estate may choose the same accounting period as the decedent, or it may choose a calendar year or any fiscal year it wishes, with a few limited exceptions.
Rule: Trusts (except tax-exempt trusts) must adopt a calendar year.
168
```
During the taxable year, Blake transferred a corporate bond with a face amount and fair market value of $20,000 to a trust for the benefit of her 16-year old child. Annual interest on this bond is $2,000, which is to be accumulated in the trust and distributed to the child on reaching the age of 21. The bond is then to be distributed to the donor or her successor-in-interest in liquidation of the trust. Present value of the total interest to be received by the child is $8,710. The amount of the gift that is excludable from taxable gifts is:
a.
$13,000
b.
$8,710
c.
$0
d.
$20,000
```
Choice "c" is correct.
Rule: An amount will not be treated as an excluded gift or bequest if the governing instrument provides that the specific sum is payable only from the "income" of the estate or trust.
169
```
Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted?
a.
6
b.
3 1/2
c.
4 1/2
d.
9
```
Choice "d" is correct.
| Rule: The federal estate tax return is due 9 months after death, disregarding extensions.
170
The generation-skipping transfer tax is imposed:
a.
Instead of the estate tax.
b.
Instead of the gift tax.
c.
As a separate tax in addition to the gift and estate taxes.
d.
On transfers of future interest to beneficiaries who are more than one generation above the donor's generation.
Choice "c" is correct. The generation-skipping transfer tax is imposed in addition to any gift or estate tax that may result from a transfer.
171
Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible:
a.
On the fiduciary income tax return only if the estate tax deduction is waived for these expenses.
b.
Only on the fiduciary income tax return (Form 1041) and never on the federal estate tax return (Form 706).
c.
On both the fiduciary income tax return and on the estate tax return by adding a tax computed on the proportionate rates attributable to both returns.
d.
Only on the federal estate tax return and never on the fiduciary income tax return.
Choice "a" is correct. Administration expenses paid by the fiduciary of an estate are deductible on the "fiduciary income tax return" only if the estate tax deduction is waived for those expenses.
Rule: To deduct administration expenses, a statement must be filed with the income tax return stating that those deductions have not been taken on the decedent's estate tax return.
172
Which of the following requires filing a gift tax return, if the transfer exceeds the available annual gift tax exclusion?
a.
Campaign expenses paid to a political organization.
b.
Payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor.
c.
Medical expenses paid directly to a physician on behalf of an individual unrelated to the donor.
d.
Tuition paid directly to an accredited university on behalf of an individual unrelated to the donor.
Choice "b" is correct. Payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor.
173
The applicable credit and the amount of gift taxes payable on prior gifts made (after 1976) reduce the amount of calculated tentative estate tax to arrive at the amount of estate tax payable with the estate tax return (Form 706).
Note: Only gifts made after 1976 are added back to the gross estate to determine the taxable estate. The gift tax payable on these gifts are a subtraction to arrive at the Form 706 line item number 10, called gross estate tax.
Note: The unified credit cannot make estate tax less than zero.
174
For income tax purposes, the estate's initial taxable period for a decedent who died on October 24:
a.
Must be a calendar year beginning on January 1 of the year of the decedent's death.
b.
Must be a fiscal year beginning on the date of the decedent's death.
c.
May be either a calendar year, or a fiscal year beginning on October 1 of the year of the decedent's death.
d.
May be either a calendar year, or a fiscal year beginning on the date of the decedent's death.
Choice "d" is correct.
Rule: An estate may elect either a calendar year or a fiscal year for the estate income tax return. (Note: Trusts, with limited exceptions, must use a calendar year end.)
175
```
Gem Trust, a simple trust, reported the following items of income and expenses during the current year:
Interest income from corporate bonds
$ 4,000
Taxable dividend income
2,000
Trustee fees allocable to income
1,500
```
Choice "b" is correct. Distributable net income is computed as the trust's income less any expenses allocated to income. The $6,000 of income items, less the $1,500 of income-related expenses, produces DNI of $4,500. This means that the first $4,500 of distributions from the trust are taxable income to the recipient(s), with any additional distributions being considered nontaxable distributions of trust corpus. If less than $4,500 is distributed, the amount actually distributed is taxable to the recipient, and any remaining undistributed portion of the $4,500 would be taxable at the trust level.
176
```
If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death?
a.
9
b.
6
c.
3
d.
12
```
Choice "b" is correct.
| Rule: The alternate valuation date is the earlier of the date of distribution or six months after the date of death
177
```
Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted?
a.
6
b.
42
c.
9
d.
32
```
Choice "c" is correct.
Rule: The federal estate tax return is due 9 months after the date of the decedent's death. To remember this: It takes 9 months to be born and it takes 9 months to file the death tax return.
178
Under the provisions of a decedent's will, the following cash disbursements were made by the estate's executor:
I.
A charitable bequest to the American Red Cross.
II.
Payment of the decedent's funeral expenses.
What deduction(s) is(are) allowable in determining the decedent's taxable estate?
a.
Both I and II.
b.
I only.
c.
Neither I nor II.
d.
II only.
Choice "a" is correct. Charitable bequests to qualifying organizations and funeral expenses of the decedent are both allowable deductions in determining the taxable estate.
179
```
In the current year, Sayers, who is single, gave an outright gift of $50,000 to a friend, Johnson, who needed the money to pay medical expenses. In filing the current year gift tax return, Sayers was entitled to a maximum exclusion of:
a.
$50,000
b.
$28,000
c.
$0
d.
$14,000
```
Choice "d" is correct. Medical expenses paid directly to the health care provider qualify for an unlimited deduction, even if paid for unrelated persons. In this problem, the payment was made to the friend, not to the health care provider directly. The $14,000 annual exclusion per donee applies to all gifts other than future interests.
180
```
During the current year, a trust reports the following information:
Dividends $ 10,000
Interest from corporate bonds 12,000
Tax-exempt interest from state bonds 4,000
Capital gain (allocated to corpus) 2,000
Trustee fee (allocated to corpus) 6,000
What is the trust's accounting income?
a.
$26,000
b.
$34,000
c.
$28,000
d.
$22,000
```
Choice "a" is correct. The accounting income of the trust (normally just called income in Subchapter J of the IRC) is calculated as follows:
Dividends $ 10,000
Interest from corporate bonds 12,000
Tax-exempt interest from state bonds 4,000
Accounting income $ 26,000
The capital gain and trustee fee are not included in the trust's income since they are both allocated to corpus.
181
Mackenzie is the grantor of a trust over which Mackenzie has retained a discretionary power to receive income. Kelly, Mackenzie's child, receives all taxable income from the trust unless Mackenzie exercises the discretionary power. To whom is the income earned by the trust taxable?
a.
To Kelly and Mackenzie in proportion to the distributions paid to them from the trust.
b.
To Kelly as the beneficiary of the trust.
c.
To the trust to the extent it remains in the trust.
d.
To Mackenzie because he has retained a discretionary power.
Rule: IRC Sections 671-679 control the taxation of grantor trusts when the grantor of the trust retains the beneficial enjoyment or substantial control over the trust property or income. In that case, the grantor is taxed on the trust income. The trust is disregarded for income tax purposes. The grantor is taxed on the income if he/she retains (1) the beneficial enjoyment of the corpus or (2) the power to dispose of the trust income without the approval or consent of any adverse party.
Choice "d" is correct. Income earned by the grantor trust is taxable to the grantor (Mackenzie) since he/she retained discretionary power to receive the taxable income from the trust. The fact that the discretionary power may not actually be exercised is irrelevant.
182
Copper Trust, a simple trust, reported the following income and expenses during the current year:
Interest income from corporate bonds $ 10,000
Rental income from properties 5,000
Trust fees allocable to income 2,000
Real estate taxes related to income - producing property 2,000
What is Copper's distributable net income (DNI) for the current year?
a.
$11,000
b.
$10,000
c.
$5,000
d.
$15,000
Choice "a" is correct. Distributable net income is computed as the trust's income less any expenses allocable to income. The $15,000 of income items less the $4,000 of income-related expenses produced DNI of $11,000.
183
```
Joan is going to gift her best friend's son $15,000 during the current tax year, and when she passes away, she will gift her home to him. Which of the following is correct with regard to these gifts during the current year, assuming that the cash is given and Joan does not die during the current year?
Cash
Home
a.
Incomplete gift
Completed gift
b.
Completed gift
Completed gift
c.
Completed gift
Incomplete gift
d.
Incomplete gift
Incomplete gift
```
Choice "c" is correct. If Joan gives her best friend's son $15,000 during the year, it would be a completed gift, eligible for the annual gift tax exclusion. Any amount in excess of the exclusion amount would be a taxable gift. Given that Joan did not pass away during the current year, the gift of her home is not a completed gift. Until all such actions take place, the son has no right to the home. (Advanced planning techniques could be used with trusts, etc. but the facts of the question do not make that possible.)
184
The answer to each of the following questions would be irrelevant in determining whether a tuition payment made on behalf of another individual is excludible for gift tax purposes, except:
a.
Was the tuition payment made directly to the educational organization?
b.
Was the tuition payment made for a family member?
c.
Was the qualifying educational organization located in a foreign country?
d.
Was the tuition payment made for a part-time student?
Choice "a" is correct. This question asks the reader to identify the listed question whose answer is relevant. The answer to each of listed questions "d", "c", and "b" is irrelevant. Only the answer to listed question "a" is relevant. Tuition payments made directly to a qualifying foreign or domestic educational organization qualify for an unlimited exclusion from the gift tax. The payments can be for the benefit of any student (not just the donor's family members), and the student can be enrolled either full-time or part-time (per the next to the last sentence of U.S. Treasury Regulation section 25.2503-6(b)(2)).
185
```
What is the due date of a federal estate tax return (Form 706), for a taxpayer who died on May 15, Year 2, assuming that a request for an extension of time is not filed?
a.
December 31, Year 2
b.
September 15, Year 2
c.
January 31, Year 3
d.
February 15, Year 3
```
Choice "d" is correct. Unless an extension is filed, Form 706 is due exactly nine months after the decedent's death, which is February 15, Year 3.
186
```
Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?
a.
Grantor.
b.
Complex.
c.
Pre-need funeral.
d.
Simple.
```
Choice "a" is correct. When the creator is treated as the owner of a trust, it is referred to as a grantor trust.
187
Joe is the trustee of a trust set up for his father. Under the Internal Revenue Code, when Joe prepares the annual trust tax return, Form 1041, he:
a.
Must obtain the written permission of the beneficiary prior to signing as a tax return preparer.
b.
May not sign the return unless he receives additional compensation for the tax return.
c.
Is not considered a tax return preparer.
d.
Is considered a tax return preparer because his father is the grantor of the trust.
Choice "c" is correct. Joe is the trustee of the trust. He is not a tax return preparer because he is not preparing the return for compensation.
188
```
A trust has distributable net income of $14,000 and distributes $20,000 to the sole beneficiary. What amounts are taxable to the trust and to the beneficiary?
Trust
Beneficiary
a.
$14,000
$0
b.
$0
$20,000
c.
$0
$14,000
d.
$14,000
$20,000
```
Choice "c" is correct. The income distribution deduction is the lesser of the actual distribution to beneficiary or distributable net income (DNI). If DNI is $14,000 and the distribution to the beneficiary is $20,000, the income distribution deduction is $14,000. This, in effect, shifts the taxation of $14,000 from the trust to the beneficiary.
189
```
As of the beginning of Year 3, Wolf, Inc. has a written accounting policy to expense amounts paid for tangible property costing up to $8,000. Wolf also has an applicable financial statement for the year. During Year 3, Wolf pays $12,000 for three pieces of office furniture that cost $4,000 each and have an economic life of five years. Under the de minimis rule, how much can Wolf deduct for tax purposes in Year 3?
a.
$4,000
b.
$12,000
c.
$0
d.
$1,500
```
Choice "b" is correct. The de minimis rule will apply because Wolf does have a written policy to expense certain property as of the beginning of the year. Because they do have an applicable financial statement, the de minimis rule allows the company to expense items costing up to $5,000 each. These three items cost $4,000 each, so all $12,000 ($4,000 × 3) can be expensed and deducted.
190
```
As of the beginning of Year 3, Wolf, Inc. has a written accounting policy to expense amounts paid for tangible property costing up to $8,000. Wolf does not have an applicable financial statement for the year. During Year 3, Wolf pays $12,000 for three pieces of office furniture that cost $4,000 each and have an economic life of five years. Under the de minimis rule, how much can Wolf deduct for tax purposes in Year 3?
a.
$0
b.
$1,500
c.
$4,000
d.
$12,000
```
Choice "a" is correct. The de minimis rule will apply because Wolf does have a written policy to expense certain property as of the beginning of the year. Because they do not have an applicable financial statement, the de minimis rule allows the company to expense items costing up to $500 each. These three items cost $4,000 each, which is in excess of $500 each. Therefore, none of these costs can be expensed under the de minimis rule.
191
```
Davis, Inc. has had an average annual gross receipts of $8.5 million during Years 1 through 3. During Year 4, Davis pays $9,250 for repairs and improvements on a building it owns with an unadjusted basis of $700,000. The costs do not qualify as routine maintenance. Under the safe harbor rules, how much can Davis deduct as repairs and maintenance in Year 4?
a.
$5,000
b.
$0
c.
$9,250
d.
$500
```
Choice "c" is correct. Davis is a qualifying small taxpayer because the average annual gross receipts during the preceding 3 years are below $10 million. The building is a qualifying building because the unadjusted basis is below $1 million. Therefore, Davis may deduct improvements that do not exceed the lesser of $10,000 or $14,000 (2% of $700,000 unadjusted basis of the building). The improvement of $9,250 is below the $10,000 threshold, so it can be deducted in Year 4. (Note: Because Davis is a qualifying small taxpayer, the amounts will qualify even though they are not considered routine maintenance.)
192
```
Davis, Inc. has had an average annual gross receipts of $15 million during Years 1 through 3. During Year 4, Davis pays $9,250 for repairs and improvements on a building it owns with an unadjusted basis of $700,000. The costs do not qualify as routine maintenance. Under the safe harbor rules, how much can Davis deduct as repairs and maintenance in Year 4?
a.
$0
b.
$5,000
c.
$500
d.
$9,250
```
Choice "a" is correct. Davis is not a qualifying small taxpayer because the average annual gross receipts during the preceding three years are not below $10 million. The building is a qualifying building because the unadjusted basis is below $1 million. But that is not relevant because the taxpayer is not a qualifying small taxpayer. Therefore, the only safe harbor for Davis is the routine small maintenance, and the facts tell us that the improvements do not qualify. Consequently, Davis may not deduct any of these amounts under the safe harbor rules in Year 4. (Note: Because Davis will not qualify under the safe harbor rules, the normal rules will apply. Therefore, the costs must be capitalized if they result in a betterment, adaptation, or restoration of the unit of property [UOP].)
