Related Parties, Business Property, and Installment Sales Flashcards
1
Q
During 2019, Judy sold a pleasure boat that had an adjusted basis to her of $60,000 to Terry for $100,000. Terry paid $20,000 as a down payment and agreed to pay $20,000 per year plus interest for the next 4 years. What is the amount of gain to be included in Judy’s gross income for 2019? A. $8,000 B. $24,000 C. $20,000 D. $16,000
A
$8,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total amount the seller will ultimately collect from the buyer. Judy’s gross profit is $40,000 ($100,000 sales price – $60,000 adjusted basis). Since $20,000 was received in the year of sale, the gain is $8,000.
$40,000 gross profit / $100,000 contract price * $20,000 = $8,000
2
Q
Mr. Pickle purchased property from Mr. Apple by assuming an existing mortgage of $12,000 and agreeing to pay an additional $6,000, plus interest, over the next 3 years. Mr. Apple had an adjusted basis of $8,800 in the building and paid selling expenses totaling $1,200. What were the sales price and the contract price in this transaction?
Sales Price
Contract Price
A. $18,000 $6,000 B. $6,000 $12,000 C. $18,000 $9,200 D. $18,000 $8,000
A
$18,000
$8,000
Answer (D) is correct.
The sales price includes any cash paid, relief of seller’s liability by buyer, and any installment note given by the buyer. Here, the sales price is $18,000 ($12,000 relief of liability + $6,000 installment note). The contract price is the total amount the seller will ultimately collect from the buyer. However, if an existing mortgage assumed by the buyer exceeds the adjusted basis of the property, such excess (reduced by selling expenses) is treated as a payment and must be included both in the contract price and in the first year’s payment received. The contract price is $8,000 ($6,000 note + $3,200 mortgage in excess of basis – $1,200 selling expenses).
3
Q
Robert sold his Lebec Corporation stock to his sister Karen for $8,000. Robert’s cost basis in the stock was $15,000. Karen later sold this stock to Dana, an unrelated party, for $15,500. What is Karen’s realized gain? A. $500 B. $7,000 C. $0 D. $7,500
A
$7,500
Answer (D) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Brothers and sisters are related parties. Robert realized a $7,000 ($15,000 cost basis in stock – $8,000 sales price to Karen) loss on the sale but may not deduct it. On the subsequent sale, Karen realized a $7,500 gain ($15,500 sales price – $8,000 basis). However, she does not have to recognize the entire gain because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property. Karen would recognize a $500 gain.
4
Q
Bob and Naomi (husband and wife) sold their boat for $75,000, with a gross profit of $25,000. What is Bob and Naomi’s gross profit percentage for this sale? A. 33 1/3% B. 3% C. 30% D. 25%
A
33 1/3%
Answer (A) is correct.
To calculate the gross profit percentage, the taxpayer should take the profit realized from the sale and divide by the sale price. In this example, Bob and Naomi’s gross profit percentage from this sale is 33 1/3% ($25,000 ÷ $75,000).
5
Q
In January Year 1, Mr. Chow purchased a $13,000 car to use 100% in his accounting business. His MACRS deductions for the car were $2,600 in Year 1 and $4,160 in Year 2. He did not take the Sec. 179 deduction or additional first-year depreciation on the car. In Year 3, he took $1,248 (1/2 year) MACRS depreciation and sold the car in May for $6,500. What is the amount and character of Mr. Chow’s gain on the sale? A. $1,508 capital gain. B. $4,992 ordinary income. C. $8,008 capital gain. D. $1,508 ordinary income.
A
$1,508 ordinary income.
Answer (D) is correct.
Under Sec. 1001, the gain realized and recognized on the sale of property is the excess of the amount realized over its adjusted basis. Mr. Chow’s adjusted basis is $4,992 ($13,000 cost – $8,008 depreciation). The gain realized on the sale is $1,508 ($6,500 sales price – $4,992 adjusted basis). Sec. 1245 requires the recapture of ordinary income up to the amount of depreciation taken. Because the amount of realized gain is less than the amount of depreciation, the entire gain is recaptured and is ordinary income.
6
Q
Dennis and Martha sell their lake house (which they have owned for 10 years and spend each summer in) for $250,000. Their original cost was $175,000, and they had improvements of $25,000. They have never used the house as a business or rental property. They agreed to take $50,000 down and finance the balance. Monthly payments are to begin next year. How much capital gain must they report in the year of sale? A. $10,000 B. $50,000 C. $0 D. $15,000
A
$10,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears the total amount to the seller. Gross profit, $50,000, is found by subtracting the adjusted basis, $200,000 ($175,000 original cost + $25,000 improvements) from the sales price, $250,000. Next, the gross profit percentage, 20%, is found by dividing the gross profit, $50,000, by the sales price ($250,000). The capital gain is found by multiplying the gross profit percentage, 20%, by the down payment, $50,000. The capital gain is $10,000.
7
Q
A gain on the disposition of Sec. 1245 property is treated as ordinary income to the extent of
A. The difference between the amount realized over the cost of the property.
B. Excess of the accelerated depreciation allowed or allowable over the depreciation figured for the same period using the straight-line method.
C. Depreciation allowed or allowable.
D. Excess of the appreciated value over depreciation allowed or allowable using the straight-line method.
A
Depreciation allowed or allowable.
Answer (C) is correct.
A gain on the disposition of Sec. 1245 property is treated as ordinary income to the extent of the total amount of depreciation allowed or allowable. The recaptured gain cannot exceed the amount of the realized gain.
8
Q
In an installment sale, if the buyer assumes a mortgage that is greater than the installment sale basis of the property sold,
A. There is never a profit or a loss.
B. The gross profit percentage is always 100%.
C. The gain is treated as short-term capital gain.
D. The transaction is disqualified as an installment sale.
A
he gross profit percentage is always 100%.
Answer (B) is correct.
In an installment sale when the buyer assumes a mortgage that is greater than the basis of the asset, the seller is required to recognize the excess mortgage as a payment in year of sale and also increase the contract price by the amount of the excess. If the contract price was not increased, the gross profit percentage would be greater than 100%. The amount of increase in the contract price will make the contract price equal to the gross profit, thus giving a gross profit percentage of 100%.
9
Q
During the current year, Mr. Boyette built and occupied a manufacturing plant for use in his business. All of the following assets located in the building are Sec. 1245 property EXCEPT
A. The office furniture.
B. The packaging machine in the shipping department.
C. The large mainframe computer system used by Boyette’s research department.
D. The elevators and escalators.
A
The elevators and escalators.
Answer (D) is correct.
Section 1245 property is property depreciable under Sec. 167 or 168 which is either personal property, specified real property, or most recovery property under Sec. 168. Whether a building is Sec. 1245 property depends on the year it is placed in service, whether it is commercial or residential, and the method of its depreciation. Elevators and escalators placed in service after 1986 are not Sec. 1245 property and are treated as part of the building, which is Sec. 1250 property.
10
Q
Belle Corporation, a cash-basis taxpayer, sold King Company some equipment on February 1, Year 1, which had been used in Belle’s business operations. The selling price was $50,000 to be paid in two equal installments – the first on January 1, Year 2 and the second on December 1, Year 2. The adjusted basis of the equipment was $40,000 after considering depreciation taken to the date of sale of $5,000. Belle made no election regarding the sale on its Year 1 return. The amount and character of the gain Belle will report on its Year 1 federal income tax return is
A. No gain or loss.
B. A $5,000 gain, of which $2,500 is Sec. 1231 gain and $2,500 is ordinary income.
C. A $10,000 gain, of which $5,000 is ordinary income and $5,000 is Sec. 1231 gain.
D. A $5,000 gain, of which all $5,000 is ordinary income.
A
A $5,000 gain, of which all $5,000 is ordinary income.
Answer (D) is correct.
The realized gain from the sale of the equipment is $10,000. Since the equipment is Sec. 1245 property, the realized gain is characterized as ordinary income to the extent of any depreciation that has been taken and must be fully recognized in the year of sale without regard to the timing of payments [Sec. 453(i)]. $5,000 of depreciation was taken, so $5,000 of the realized gain must be recognized as ordinary income in Year 1. All of the remaining gain is Sec. 1231 gain, and will be recognized when payments are received (the installment method is required absent an election not to use it).
Sales proceeds
$ 50,000
Less: Adjusted basis
(40,000)
Realized gain
$ 10,000
Recognized gain in Year 1 is Sec. 1245 recapture of $5,000.
11
Q
Cheryl sold a boat, which had cost her $3,600, for $6,000. The boat was not used in a trade or business or held for rent. Cheryl accepted a $1,800 down payment and an installment obligation calling for 30 monthly payments of $140, plus interest. After receiving 8 months’ payments, Cheryl sold the installment obligation for $2,500. What was Cheryl’s gain or loss on the disposition of the installment obligation? A. $(420) B. $652 C. $2,192 D. $820
A
$652
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The adjusted basis of the obligation is equal to the face amount of the obligation reduced by the gross profit that would be realized if the holder collected the face amount [Sec. 453B(b)]. The face amount is $3,080 [($140 × 30) – ($140 × 8)]. The basis is $1,848 [$3,080 face amount × (100% – 40% gross profit percentage)].
Since Cheryl sold the installment obligation, the excess of the amount realized over Cheryl’s basis in the obligation is recognized as income on the transfer. This amount of income is $652 ($2,500 amount realized – $1,848 basis). The gain is treated as resulting from the sale or exchange of the property in respect of which the installment obligation was originally held.
12
Q
Mr. X acquired a machine for use in his business, on January 5, Year 1, for $30,000. Depreciation was taken on the asset using the MACRS rules in the following amounts: Year 1 $6,000 Year 2 $9,600 Year 3 $2,880 Mr. X sold the machine on January 26, Year 3, for $32,000. What is the amount and character of X’s gain on the disposition of the asset?
Sec. 1231 Gain
Sec. 1245 Gain
A.
$20,480
$0
B.
$2,000
$18,480
C.
$0
$20,480
D.
$18,480
$2,000
A
$2,000
$18,480
Answer (B) is correct.
The realized gain from the sale of the machine is $20,480 [$32,000 sale price – ($30,000 cost – $18,480 total depreciation)]. Because the machine is Sec. 1245 property, the recognized gain is characterized as ordinary to the extent of any depreciation that has been taken. Thus, $18,480 will be classified as ordinary income due to depreciation recapture, and the remaining gain of $2,000 ($20,480 realized gain – $18,480 ordinary income) will be classified as Sec. 1231 gain.
13
Q
Which of the following items is NOT Sec. 1245 property? (All have been subject to an allowance for depreciation.)
A. Storage facility used in connection with the distribution of petroleum products.
B. Storage facility used for the bulk storage of fungible commodities.
C. Amortized certified pollution control facility.
D. Storage facility used to store oranges that have been sorted and boxed.
A
Storage facility used to store oranges that have been sorted and boxed.
Answer (D) is correct.
Section 1245 property generally includes depreciable personal property, but not most buildings. Some real property is included as Sec. 1245 property, especially certain storage facilities. A storage facility used to store oranges that have been sorted and boxed is not Sec. 1245 property. It is Sec. 1250 property because it is not listed in Sec. 1245(a)(3).
14
Q
All of the following statements with respect to the disposition of Sec. 1245 depreciable property are true EXCEPT
A. In figuring the deductions affecting the recomputed basis of Sec. 1245 property, it is necessary to include any basis adjustment that was made for the investment credit.
B. Amounts deducted under the Sec. 179 deduction are recovered as ordinary income to the extent of any gain on a sale or disposition.
C. Section 1245 property includes an elevator or escalator placed in service before 1987.
D. Gain is treated as ordinary income to the extent of excess depreciation over the depreciation that would have been available under the straight-line method.
A
Gain is treated as ordinary income to the extent of excess depreciation over the depreciation that would have been available under the straight-line method.
Answer (D) is correct.
The method of depreciation makes no difference in the calculation of ordinary income. Any depreciation taken must be recaptured as ordinary income.
15
Q
Allen purchased a trademark on January 1 of last year for $150,000 and began amortizing it over the required 15-year period. On January 2 of this year, Allen sold the trademark for $200,000. How much of Allen’s gain on the sale of the trademark is Sec. 1245 gain? A. $10,000 B. $5,000 C. $60,000 D. $50,000
A
$10,000
Answer (A) is correct.
Under Sec. 197, a trademark is an intangible asset that is amortizable over a 15-year period, beginning in the month of acquisition. Total amortization for the period January 1 of last year through January 2 of this year equals $10,000 ($150,000 ÷ 15). Allen’s realized gain is $60,000 [$200,000 sales price – ($150,000 cost – $10,000 amortization)]. Section 1245 requires the gain to be recognized as ordinary income to the extent of the amortization taken. Therefore, $10,000 of the $60,000 gain is Sec. 1245 gain [Sec. 1245(a)(3)].
16
Q
You sold a residential lot 2 years ago and reported the $20,000 capital gain on the installment method. In the third year of payments, the buyer defaulted and you had to repossess the lot. In the first year you reported $5,000 ($10,000 × 50%) and $3,000 ($6,000 × 50%) in the second year. No payments were received in the third year, and you spent $2,500 in legal fees to repossess the property. What is the taxable gain you must report on the repossession? A. $8,000 B. $9,500 C. $0 D. $4,000
A
$8,000 Answer (A) is correct. If you repossess your property after making an installment sale, you must figure the following amounts: (1) Your gain (or loss) on the repossession and (2) your basis in the repossessed property. The rules for figuring these amounts depend on the kind of property you repossess. The rules for repossessions of personal property differ from those for real property. The taxable gain for the repossession of real property is figured using the following schedule. 1) Payments received before repossession $16,000 2) Minus: Gain reported 8,000 3) Gain on repossession $ 8,000 4) Gross profit on sale $20,000 5) Gain reported (line 2) $8,000 6) Plus: Repossession costs 2,500 10,500 7) Subtract line 6 from line 4 $ 9,500 8) Taxable gain (lesser of line 3 or 7) $ 8,000
17
Q
You purchased a heating, ventilating, and air conditioning (HVAC) unit for your rental property on December 15. It was delivered on December 28 and was installed and ready for use on January 2. When should the HVAC unit be considered placed in service? A. January 2. B. December 15. C. December 31. D. December 28.
A
January 2.
Answer (A) is correct.
Publication 946 states, “You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity.”
18
Q
Larry sold stock with a cost basis of $10,500 to his son for $8,500. Larry cannot deduct the $2,000 loss. His son sold the same stock to an unrelated party for $15,000, realizing a gain. What is his son’s reportable gain? A. $2,000. B. $6,500. C. $4,500. D. No gain.
A
$4,500.
Answer (C) is correct.
Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include a father and a son. Larry realized a $2,000 loss on the sale but may not deduct it. On the subsequent sale, his son realized a $6,500 gain. However, he recognizes only a $4,500 reportable gain. The disallowed loss is used to offset the subsequent gain on the sale of the property ($6,500 realized gain – $2,000 disallowed loss).
19
Q
Sue sold land to her brother Sam for $6,000. Sue’s basis in the land was $7,000. She cannot deduct the $1,000 loss. Sam sold the same land to an unrelated party for $5,500, realizing a loss of $500. What amount of loss can Sam deduct? A. $0 B. $1,000 C. $500 D. $1,500
A
$500
Answer (C) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Loss realized on a subsequent sale to a third party is recognized, but the previously disallowed loss is not added to it. Sam’s basis in the property is the sale price of $6,000. He is permitted a loss of $500; however, Sue’s unrecognized loss of $1,000 is not.
20
Q
During 2019, Marcus sold real property that had an adjusted basis to him of $120,000 to Andrew for $250,000. On the sale, Marcus had depreciation recapture of $20,000, which he correctly reported as ordinary income. Andrew paid $50,000 as a down payment and agreed to pay $25,000 per year plus interest for the next 8 years beginning January 9, 2020. Marcus incurred selling expenses of $15,000. For 2019, what is the amount of capital gain from this transaction to be included by Marcus in his gross income? A. $19,000 B. $23,000 C. $22,000 D. $11,000
A
$19,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Section 453(i) requires full recognition of depreciation recapture and an addition of the amount treated as ordinary income to the basis of the property for determining gain or loss. Marcus’s gross profit is $95,000 [$250,000 sales price – ($120,000 adjusted basis + $20,000 depreciation recapture) – $15,000 selling expenses]. Since $50,000 was received in the year of the sale, the gain is $19,000.
$95,000 gross profit / $250,000 contract price * $50,000 = $19,000
21
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
$2,000
Answer (A) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Gibson’s adult child realized a $4,000 loss ($16,000 – $12,000) on the sale but may not deduct it. On the subsequent sale, Gibson realized a $6,000 gain ($18,000 sales price – $12,000 basis). However, he only recognizes a gain of $2,000 ($18,000 – $16,000) because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property.
22
Q
In February 2019, Auto Repair, Inc., sold a car with a basis of $12,000 to Mark, its 55% shareholder, for $10,000. In June 2019, Mark sold the car to an unrelated party for $15,000. What is the amount of Mark’s recognized gain? A. $0 B. $3,000 C. $5,000 D. $2,000
A
$3,000
Answer (B) is correct.
Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Auto Repair, Inc., realized a $2,000 loss ($12,000 basis – $10,000 sales price to Mark) but may not deduct it. On the subsequent sale, Mark realized a $5,000 gain ($15,000 sales price – $10,000 basis). However, he recognizes only a $3,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($5,000 realized gain – $2,000 disallowed loss).
23
Q
In July, Tommy Tromboni sold for $10,000 a printing press used in his business that originally cost him $10,000. His adjusted basis at the time of the sale was $1,000, and Tommy paid $1,000 in selling expenses. What is the amount of the gain that would be ordinary income under Sec. 1245? A. $10,000 B. $8,000 C. $0 D. $9,000
A
$8,000
Answer (B) is correct.
Under Sec. 1001, the gain realized and recognized on the sale of property is the excess of the amount realized over its adjusted basis. Selling expenses also reduce the gain recognized. Thus, Tommy recognizes
Money received
$10,000
Less: Adjusted basis of printing press
(1,000)
Selling expenses
(1,000)
Realized and recognized gain
$ 8,000
Section 1245 requires the recapture of ordinary income up to the amount of depreciation taken. Thus, the full $8,000 recognized gain must be recaptured as ordinary income since $9,000 of depreciation expense was incurred ($10,000 original basis – $1,000 ending basis).
24
Q
Harry sold 100 acres of land that he had owned for over 30 years. His original cost was $100,000. He sold the property for $500,000 and had settlement costs of $50,000. He received a $150,000 down payment with the balance to be paid over 10 years. His gross profit percentage is? A. 80% B. 70% C. 50% D. 60%
A
70%
Answer (B) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Harry’s gross profit is $350,000 ($500,000 sales price – $100,000 adjusted basis – $50,000 selling expenses). Therefore, the gross profit percentage is 70% ($350,000 ÷ $500,000).
25
With respect to the disposition of an installment obligation, which of the following is false?
A. No gain or loss is recognized on the transfer of an installment obligation between a husband and wife if incident to a divorce.
B. If an installment obligation is canceled, it is not treated as a disposition.
C. A gift of an installment obligation is considered a disposition.
D. If the obligation is sold, the gain or loss is the difference between the basis in the obligation and the amount realized.
If an installment obligation is canceled, it is not treated as a disposition.
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The main purpose of Sec. 453B is to prevent the shifting of income between taxpayers. Section 453B(a) expressly requires recognition whether the obligation is sold or otherwise disposed of. Cancellation of an installment obligation is a disposition of the obligation.
26
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Arlene sold property with an adjusted basis of $35,000 to Sandy for $50,000. Sandy paid cash of $5,000 and assumed an existing mortgage of $20,000. Sandy signed an installment note for the $25,000 balance at 8% interest. Payments on the note were to be made at the rate of $5,000 a year plus interest beginning 1 year after the date of the contract. Arlene did not elect out of the installment method. What is the amount of gain that Arlene should include in the first year after the date of the contract?
A. $1,500
B. $4,500
C. $5,000
D. $2,500
```
$2,500
Answer (D) is correct.
The installment method is a special method of reporting gains (not losses) from sales of property for which at least one payment is received in a tax year after the year of sale. Under the installment method, gain from an installment sale is prorated and recognized over the years in which payments are received. The amount of gain from an installment sale that is taxable in a given year is calculated by multiplying the payments received in that year by the gross profit ratio for the sale. The gross profit ratio is equal to the anticipated gross profit divided by the total contract price. The gross profit is equal to the selling price of the property minus its adjusted basis. The total contract price is equal to the selling price minus that portion of qualifying indebtedness assumed by, or taken subject to, the buyer that does not exceed the seller’s basis in the property (adjusted to reflect commissions and other selling expenses). Arlene realized a $15,000 gain ($50,000 sale price – $35,000 adjusted basis) on the sale, and this amount serves as the anticipated gross profit in the gross profit ratio. The total contract price is $30,000 ($50,000 selling price – $20,000 mortgage assumed by buyer). Accordingly, the gross profit ratio is 50% ($15,000 gain on the sale ÷ $30,000 contract price), and a $2,500 gain is recognized ($5,000 payment × 50%).
27
Fact Pattern: Conner purchased 300 shares of Zinco stock for $30,000 in 2000. On May 23, 2019, Conner sold all the stock to his daughter Alice for $20,000, its fair market value at the time. Conner realized no other gain or loss during 2019. On July 26, 2019, 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 loss.
B. $5,000 short-term loss.
C. $5,000 long-term gain.
D. $0
$0
Answer (D) is correct.
The $5,000 realized gain ($25,000 proceeds – $20,000 basis) is recognized only to the extent it exceeds the previously disallowed loss of $10,000. Since the realized gain on the sale to an unrelated third party is less than the amount of disallowed loss, no gain is recognized.
28
During the year, Michael sold the following assets he used in his business.
Machinery:
Sales price
$22,500
Original cost
20,000
Accumulated depreciation
7,500
Computer equipment:
Sales price
17,000
Original cost
14,000
Accumulated depreciation
8,000
Michael had a net Sec. 1231 loss in the previous year of $4,000. What is the amount and character of his gain for the current year?
A. $8,000 ordinary income; $26,000 capital gain.
B. $19,500 ordinary income; $1,500 capital gain.
C. $0 ordinary income; $21,000 capital gain.
D. $15,500 ordinary income; $1,500 capital gain.
$19,500 ordinary income; $1,500 capital gain.
Answer (B) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year, or an involuntarily converted nonpersonal capital asset (i.e., held in connection with a trade or business or a transaction entered into for profit) held for more than 1 year. A taxpayer who has a net Sec. 1231 gain (i.e., excess of Sec. 1231 gains over Sec. 1231 losses) for the tax year must review the five most recent preceding tax years for possible recapture of net Sec. 1231 losses for such years. If there were any net Sec. 1231 losses during such period, the taxpayer must treat the current year’s net Sec. 1231 gain as ordinary income to the extent of the amount of unrecaptured net Sec. 1231 losses for that past period [Code Sec. 1231(c)]. The losses are to be recaptured on a first-in, first-out (FIFO) basis. Michael realizes a total gain of $21,000, where $10,000 [$22,500 sales price – ($20,000 original cost – $7,500 depreciation)] comes from machinery and $11,000 [$17,000 sales price – ($14,000 orginal cost – $8,000 depreciation)] comes from computer equipment. Since the assets also qualify as Sec. 1245 property, this Sec. 1231 gain is recharacterized as ordinary income to the extent of depreciation recaptured ($7,500 machinery + $8,000 computer equipment = $15,500) and to the extent of any unaccounted for Sec. 1231 loss ($4,000). The remaining $1,500 ($21,000 gain – $15,500 depreciation recaptured – $4,000 loss) is recognized as a Sec. 1231 gain.
29
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In 2010, Sally sold a personal residence on the installment method. She needed cash in 2019, so she sold the note for $7,500 when the balance due her was $9,000. Her gross profit percentage was 47.5%. How much profit must Sally report on the disposition of the obligation?
A. $7,500
B. $0
C. $3,225
D. $2,775
```
$2,775
Answer (D) is correct.
The balance due to Sally was $9,000. The basis of the receivable is $4,725 [$9,000 × (1 – 47.5%)]. The amount realized is $7,500, and therefore Sally recognizes a profit of $2,775 ($7,500 – $4,725).
30
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In April 2019, Pamela sold stock with a cost basis of $15,000 to Lisa, her sister, for $10,000. In September 2019, Lisa sold the same shares of stock to their cousin, Niki, for $8,000. What is the amount of Pamela’s deductible loss for 2019?
A. $7,000
B. $5,000
C. $2,000
D. $0
```
$0
Answer (D) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Sisters are related parties for this purpose. Thus, Pamela’s loss of $5,000 on the sale of stock is disallowed.
31
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In January 2017, Ms. Doering purchased a $10,000 car to use 100% in her real estate business. Her MACRS deductions for the car were $2,000 in 2017 and $3,200 in 2018. She did not elect the Sec. 179 deduction. In 2019, she took a $960 (1/2-year) MACRS depreciation and sold the car in May for $7,000. What is the amount and character of her gain on the sale of her business auto?
A. $3,160 capital gain.
B. $3,160 ordinary income.
C. $6,160 ordinary income.
D. $2,200 capital gain.
```
$3,160 ordinary income.
Answer (B) is correct.
Under Sec. 1001, the gain realized and recognized on the sale of property is the excess of the amount realized over the adjusted basis. Ms. Doering’s adjusted basis is $3,840 ($10,000 cost – $6,160 depreciation taken). The gain realized on the sale is $3,160 ($7,000 – $3,840). Section 1245 requires the recapture of ordinary income up to the amount of depreciation taken. Because the amount of depreciation taken exceeds the realized gain, the entire gain is recaptured and is ordinary income.
32
```
Jim and Jean purchased a vacation home in 2012 for $100,000. They sold the property for $500,000 in 2019 and received a down payment of $200,000. They took a mortgage from the purchaser for the remaining $300,000. What is Jim and Jean’s gross profit percentage on this sale?
A. 80%.
B. None of the answers are correct.
C. 60%.
D. 40%.
```
80%.
Answer (A) is correct.
The gross profit percent is the difference between the price the property was sold for and the price the property was purchased at, divided by the price for which the property was sold, multiplied by 100. The gross profit percent for Jim and Jean is calculated below.
$500,000 - $100,000 / $500,000 * 100 = 80%
33
```
Ethel and George sold an investment property they purchased 10 years ago for $300,000. The property was sold for $700,000 with a down payment of $140,000. What is the gross profit percentage?
A. None of the answers are correct.
B. 28.57%.
C. 22.86%.
D. 57.14%.
```
57.14%.
Answer (D) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer (Publication 537). Ethel and George’s gross profit is $400,000 ($700,000 sales price – $300,000 adjusted basis). Therefore, their gross profit percentage is 57.14% ($400,000 ÷ $700,000).
34
```
Gregory sold his stock in a corporation to his sister for $9,000. His cost basis in the stock was $17,000. His sister later sold the stock to an unrelated party for $19,500. What is his sister’s realized gain?
A. $10,500
B. $8,000
C. $0
D. $2,500
```
$10,500
Answer (A) is correct.
Note that the question asks for realized gain, not recognized gain. The realized gain is simply the $19,500 amount realized minus the sister’s basis in the stock of $9,000, or $10,500. However, this gain can be offset by the loss that was disallowed when Gregory first sold his stock to his sister, which was $8,000. Thus, the recognized gain would be $10,500 minus $8,000, or $2,500.
35
Each of the following situations would be considered a disposition of an installment obligation EXCEPT
A. An installment obligation for which you accept part payment on the balance of the buyer’s installment debt to you and forgive the rest of the debt.
B. An installment obligation assumed by a new buyer at a rate of interest higher than the rate paid by the original buyer.
C. An installment obligation that you give as a gift.
D. An installment obligation that has become unenforceable.
An installment obligation assumed by a new buyer at a rate of interest higher than the rate paid by the original buyer.
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The main purpose of Sec. 453B is to prevent the shifting of income between taxpayers. Section 453B(a) expressly requires recognition whether the obligation is sold or otherwise disposed of. An installment obligation assumed by a new buyer does not cause a shift in income and is therefore not a disposition of an installment obligation.
36
```
Frank sold his Ranier Corporation stock to his sister Bernie for $8,000. Frank’s cost basis in the stock was $15,000. Bernie later sold this stock to Wendy, an unrelated party, for $15,500. What is Bernie’s recognized gain or loss?
A. $(7,500)
B. $(7,000)
C. $0
D. $500
```
$500
Answer (D) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Brothers and sisters are related parties. Frank realized a $7,000 ($15,000 basis – $8,000 sales price to Bernie) loss on the sale but may not deduct it. On the subsequent sale, Bernie realized a $7,500 gain ($15,500 sales price – $8,000 basis). However, she does not have to recognize $7,000 of the gain because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property ($7,500 realized gain – $7,000 disallowed loss = $500 recognized gain).
37
```
Mark owned 100% of the stock in Gathers Corporation. In 2019, Gathers Corporation sold a computer with an adjusted basis of $5,000 and a fair market value of $8,000 to Mark’s Uncle Seth for $4,000. What is the amount of Gathers Corporation’s deductible loss on the sale of this computer in 2019?
A. $0
B. $(1,000)
C. $(4,000)
D. $(3,000)
```
$(1,000)
Answer (B) is correct.
Tax laws limit tax avoidance between related parties. Losses realized on sale or exchange of property to a related person is not recognized. The transferee takes a cost basis. Uncles, however, are not considered related parties for federal income tax purposes. Gathers may recognize a loss on the sale of $1,000 ($4,000 selling price – $5,000 basis).
38
Jim sells stock that he purchased in 2006 to his brother John for a $500 loss. He also sells a truck purchased in 2017 to ABC Corporation, his 100%-owned C corporation, for a profit of $800, including $500 of depreciation recapture. What is the effect of these transactions on Jim’s 2019 tax return?
A. A loss of $500 on the stock and $800 ordinary gain on the truck.
B. A loss of $500 on the stock and no gain on the truck.
C. A disallowed loss on the stock and $800 ordinary gain on the truck.
D. A disallowed loss on the stock, $500 ordinary gain, and $300 long-term capital gain on the truck.
A disallowed loss on the stock and $800 ordinary gain on the truck.
Answer (C) is correct.
The loss on the sale of a capital asset (such as stock) is not allowed when sold to a member of the individual’s family [Sec. 267(b)]. Capital gain treatment is denied when depreciable property is sold between related taxpayers [Sec. 1239(a)]. This rule pertains to sales or exchanges between the following:
A person and all entities controlled by such person
A taxpayer and any trust of which the taxpayer is a beneficiary unless the beneficiary’s interest is because of a remote possibility to a contingency
An executor of an estate and a beneficiary of the estate, unless the sale or exchange is in satisfaction of a monetary value bequeathed to the beneficiary (Sec. 1293)
39
On July 1 of the current year, Daniel Wright owned stock (held for investment) purchased 2 years earlier at a cost of $10,000 and with a fair market value of $7,000. On this date, he sold the stock to his son, William, for $7,000. William sold the stock for $6,000 to an unrelated person on November 1 of the current year. How should William report the stock sale on his current-year tax return?
A. As a short-term capital loss of $4,000.
B. As a long-term capital loss of $4,000.
C. As a short-term capital loss of $1,000.
D. As a long-term capital loss of $1,000.
As a short-term capital loss of $1,000.
Answer (C) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. A father and son are related parties for this purpose. Thus, Daniel’s loss of $3,000 ($10,000 stock – $7,000 sales price to William) on the sale of the stock to William is disallowed. William takes as his basis for the stock the cost of $7,000. Since William’s stock basis is determined by his cost (not by reference to Daniel’s cost), there is no carryover of Daniel’s holding period to William. Therefore, upon the sale of the stock to an unrelated party for $6,000, William realizes a short-term loss of $1,000 ($6,000 sales price – $7,000 basis), since he held the stock for only 4 months.
40
```
During the current year, Ms. C sold a building used in her business. Her records reflect the following information:
Cost of building
$ 90,000
Cost of new roof
15,000
Depreciation deducted
35,000
Cash received on sale
145,000
Taxes assumed by buyer
7,000
Mortgage assumed by buyer
25,000
Selling expenses
6,000
What is the amount of Ms. C’s realized gain on the sale?
A. $101,000
B. $90,000
C. $30,000
D. $66,000
```
```
$101,000
Answer (A) is correct.
Under Sec. 1001, the gain on the sale or other disposition of property is the excess of the amount realized over the adjusted basis. Any capital repairs, such as a new roof, are added to the adjusted basis. The amount realized is the sum of any money received plus the fair market value of the nonmoney property received. The amount realized includes relief from liabilities and, in this case, the assumption of the mortgage and real estate taxes by the buyer. The full amount of the realized gain is recognized unless all or some portion thereof is specifically excluded by another statute. The realized gain equals the recognized gain in an outright sale. Ms. C’s realized gain is calculated as follows:
Cash received
$145,000
Plus:
Real estate taxes assumed
7,000
Mortgage assumed
25,000
Amount realized
$177,000
Minus:
Adjusted basis of building
(70,000)
Selling expenses
(6,000)
Realized and recognized gain
$101,000
```
41
```
Trudy Holiday has been selling greeting cards for several years as a sole proprietor. In May of Year 3, she purchased land and a building to use in the greeting card business. In October of Year 3, she sold the entire business, including inventory held since Year 1 and the land and building. Trudy’s automobile, used exclusively in her business and purchased in Year 1, was swallowed by a sinkhole before the sale in Year 3. Which of the following is a Sec. 1231 asset?
A. The building.
B. The inventory acquired in Year 1.
C. The land.
D. The automobile.
```
The automobile.
Answer (D) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year, and nonpersonal capital assets, held more than 1 year, which are involuntarily converted. Trudy’s business automobile is Sec. 1231 property because it was held long term and was involuntarily converted.
42
```
Mr. Bradshaw sold property that had an adjusted basis to him of $19,000. The buyer assumed Bradshaw’s existing mortgage of $15,000 and agreed to pay an additional $10,000 consisting of a cash down payment of $5,000 and payments of $1,000, plus interest, per year for the next 5 years. Mr. Bradshaw paid selling expenses totaling $1,000. What is Bradshaw’s gross profit percentage?
A. 50%
B. 20%
C. 60%
D. 40%
```
50%
Answer (A) is correct.
The gross profit percentage is the proportion of gross profit in relation to total contract price. The gross profit is the selling price reduced by the adjusted basis of the property and any selling expenses. The contract price is the total amount the seller will ultimately collect from the buyer, ignoring interest. Mr. Bradshaw’s gross profit is $5,000 ($25,000 sales price – $19,000 basis – $1,000 selling expenses). The contract price totals $10,000. Thus, the gross profit percentage is 50% ($5,000 gross profit ÷ $10,000 contract price).
43
The following property is all used in a trade or business and has been held in excess of 1 year. Which property will NOT qualify for gains or losses from Sec. 1231 property upon its disposition by sale or exchange?
A. Property includible in inventory.
B. Business property condemned for public use.
C. Property held for production of rent and royalties.
D. Depreciable property used in a trade or business.
Property includible in inventory.
Answer (A) is correct.
Gains and losses receive special treatment under Sec. 1231. Property that qualifies under Sec. 1231 generally must have been held for more than 1 year and either have been used in a trade or business or be an involuntarily converted nonpersonal capital asset. Inventory is specifically excluded.
44
Which of the following assets will NOT qualify for gain or loss treatment under Sec. 1231?
A. Factory machine acquired March 1, 2018; sold August 1, 2019.
B. Sculpture acquired August 1, 2018, by an investor for the purpose of making a profit on it; destroyed in a fire on September 1, 2019.
C. Land used as a parking lot acquired August 1, 2018; sold September 1, 2019.
D. Personal automobile acquired August 1, 2018; destroyed in a collision on September 1, 2019.
Personal automobile acquired August 1, 2018; destroyed in a collision on September 1, 2019.
Answer (D) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year or an involuntarily converted nonpersonal capital asset (i.e., held in connection with a trade or business or a transaction entered into for profit) held for more than 1 year. The personal automobile is a personal-use capital asset and does not qualify for treatment under Sec. 1231.
45
John owned a printing business and sold the following assets in 2019:
Printing press:
Sales price
$25,000
Original cost
20,000
Allowed or allowable depreciation
8,000
Computer equipment:
Sales price
$30,000
Original cost
28,000
Allowed or allowable depreciation
14,000
John had a net Section 1231 loss of $6,000 in 2018. What is the amount and character of John’s gain for 2019?
A. $22,000 ordinary income; $7,000 capital gain.
B. $14,000 ordinary income; $15,000 capital gain.
C. $0 ordinary income; $29,000 capital gain.
D. $28,000 ordinary income; $1,000 capital gain.
$28,000 ordinary income; $1,000 capital gain.
Answer (D) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year, or an involuntarily converted nonpersonal capital asset (i.e., held in connection with a trade or business or a transaction entered into for profit) held for more than 1 year. A taxpayer who has a net Sec. 1231 gain (i.e., excess of Sec. 1231 gains over Sec. 1231 losses) for the tax year must review the 5 most recent preceding tax years for possible recapture of net Sec. 1231 losses for such years. The taxpayer must treat the current year’s net Sec. 1231 gain as ordinary income to the extent of the amount of unrecaptured net Sec. 1231 losses for that past period [Sec. 1231(c)]. The losses are recaptured on a FIFO basis. John realizes a total gain of $29,000, where $13,000 [$25,000 sales price – ($20,000 original cost – $8,000 depreciation)] comes from a printing press and $16,000 [$30,000 sales price – ($28,000 original cost – $14,000 depreciation)] comes from computer equipment. Since the assets also qualify as Sec. 1245 property, this Sec. 1231 gain is recharacterized as ordinary income to the extent of depreciation recaptured ($8,000 printing press + $14,000 computer equipment = $22,000) and to the extent of any unaccounted for Sec. 1231 loss ($6,000). The remaining $1,000 ($29,000 gain – $22,000 depreciation recaptured – $6,000 loss) is recognized as a Sec. 1231 gain.
46
```
Mr. Smith decided to retire from his business in 2019. Included in his assets was a large delivery truck for which he had paid $35,000 in 2015. Mr. Smith had offers to buy his truck for $25,000 from two local truck dealers. He decided instead to sell his truck for $15,000 to his long-time employee, John Pine, as partial compensation for John’s helping Mr. Smith wind up his business. What is John’s basis in the truck?
A. None of the answers are correct.
B. $35,000.
C. $25,000.
D. $15,000.
```
$25,000.
Answer (C) is correct.
If an employer transfers property to an employee at less than its fair market value, whether or not the transfer is in the form of a sale or exchange, the difference may be income to the purchaser as compensation for personal services (Reg. Sec. 1.61-2). The basis of the property will be the amount paid increased by the amount previously included in income. John will recognize $10,000 ($25,000 FMV – $15,000 paid) of income on the employee bargain purchase. His basis will be $25,000 ($15,000 cash paid + $10,000 income recognized).
47
Keith, a business taxpayer, sold the following business assets during 2019:
Machinery:
Sales price
$45,000
Original cost
40,000
Accumulated depreciation
15,000
Computer equipment:
Sales price
34,000
Original cost
28,000
Accumulated depreciation
16,000
Keith had net Sec. 1231 losses in 2018 of $8,000. What is the amount and character of Keith’s gain for 2019?
A. $0 ordinary income; $42,000 Sec. 1231 gain.
B. $16,000 ordinary income; $26,000 Sec. 1231 gain.
C. $31,000 ordinary income; $11,000 Sec. 1231 gain.
D. $39,000 ordinary income; $3,000 Sec. 1231 gain.
$39,000 ordinary income; $3,000 Sec. 1231 gain.
Answer (D) is correct.
Section 1231 property is depreciable or real property used in a trade or business and held for more than 1 year or an involuntarily converted nonpersonal capital asset (i.e., held in connection with a trade or business or a transaction entered into for profit) held for more than 1 year. A taxpayer who has a net Sec. 1231 gain (i.e., excess of Sec. 1231 gains over Sec. 1231 losses) for the tax year must review the 5 most recent preceding tax years for possible recapture of net Sec. 1231 losses for such years. If there were any net Sec. 1231 losses during this period, the taxpayer must treat the current year’s net Sec. 1231 gain as ordinary income to the extent of the amount of unrecaptured net Sec. 1231 losses for that past period [Code Sec. 1231(c)]. The losses are to be recaptured on a first-in, first-out (FIFO) basis. Keith realizes a total gain of $42,000, where $20,000 [$45,000 sales price – ($40,000 original cost – $15,000 depreciation)] comes from machinery and $22,000 [$34,000 sales price – ($28,000 original cost – $16,000 depreciation)] comes from computer equipment. Since the assets also qualify as Sec. 1245 property, this Sec. 1231 gain is recharacterized as ordinary income to the extent of depreciation recaptured ($15,000 machinery + $16,000 computer equipment = $31,000) and to the extent of any unaccounted for Sec. 1231 loss ($8,000). The remaining $3,000 ($42,000 gain – $31,000 depreciation – $8,000 loss) is recognized as a Sec. 1231 gain.
48
```
In 2018, Ricardo sold a piece of unimproved real estate to Cliff for $20,000. Ricardo acquired the property in 1997 at a cost of $10,000. During 2018, Ricardo received $4,000 cash and Cliff’s note in the amount of $16,000 for the remainder of the selling price, payable in subsequent years. Ricardo reported the sale using the installment method. In 2019, before Cliff made any further payments, Ricardo transferred the installment obligation to his wife incident to a divorce. What is the amount of gain (or loss) Ricardo should report on his tax return for 2019?
A. $7,000
B. $0
C. $(1,000)
D. $9,000
```
$0
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). However, in certain instances, a disposition of the obligation may result in the transferee treating subsequent payments in the same manner as the transferor would have. A transfer between spouses incident to a divorce qualifies as one of the exceptions. Therefore, Ricardo does not recognize any gain (or loss) on his tax return.
49
```
In December of 2017, Bob sold land to Natalie for $80,000. He reported the sale using the installment method. At the time of the sale, the land had an adjusted basis of $20,000. Natalie made a down payment of $25,000 in 2017 and agreed to pay $11,000 per year plus interest for the next 5 years. The payments were to be made May 1 of each year. Before the 2019 payment was made, Bob sold the installment obligation for $30,000. What is Bob’s gain (or loss) for 2019 on the sale of the installment obligation?
A. $(10,500)
B. $22,500
C. $19,000
D. $(14,000)
```
$19,000
Answer (C) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The adjusted basis of the obligation is equal to the face amount of the obligation reduced by the gross profit that would be realized if the holder collected the face amount [Sec. 453B(b)]. The basis is $11,000 [$44,000 face amount × (100% – 75% gross profit percentage)].
Since Bob sold the installment obligation, the excess of the amount realized over Bob’s basis in the obligation is recognized as income on the transfer. This amount of income is $19,000 ($30,000 amount realized – $11,000 basis). The gain is treated as resulting from the sale or exchange of the property in respect of which the installment obligation was originally held.
50
```
During Year 1, Frank sold a piece of land with an adjusted basis of $110,000 to Tony for $200,000. Tony paid $50,000 as a down payment in Year 1 and agreed to pay $30,000 per year plus interest for the next 5 years beginning in January of Year 2. Frank incurred selling expenses of $10,000. What is the amount of gain to be included in Frank’s gross income for Year 1?
A. $20,000
B. $50,000
C. $18,000
D. $22,500
```
$20,000
Answer (A) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Frank’s gross profit is $80,000 ($200,000 sales price – $110,000 adjusted basis – $10,000 selling expenses). Since $50,000 was received in the year of sale, the gain is $20,000.
$80,000 gross profit / $200,000 contract price * $50,000 = $20,000
51
Geena paid $10,000 for stock in a start-up company. A few months after she bought it, she sold the stock to her brother Henry for $8,000, its current value. Later, he sold the stock to an unrelated party for $15,000. What gain or loss should Geena and Henry recognize on their tax returns in the year of sale?
A. Geena recognizes $0 loss; Henry recognizes $5,000 gain.
B. Geena recognizes $0 loss; Henry recognizes $7,000 gain.
C. Geena recognizes $2,000 loss; Henry recognizes $5,000 gain.
D. Geena recognizes $2,000 loss; Henry recognizes $7,000 gain.
Geena recognizes $0 loss; Henry recognizes $5,000 gain.
Answer (A) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Siblings are related parties for this purpose. Thus, Geena’s loss of $2,000 ($10,000 stock – $8,000 sales price to Henry) on the sale of the stock is disallowed. On the subsequent sale, Henry realized a $7,000 gain ($15,000 sales price – $8,000 basis). However, he recognizes only a $5,000 gain [Sec. 257(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($7,000 realized gain – $2,000 disallowed loss).
52
```
The owner of unimproved land with a basis of $40,000 sold the property for $100,000 in 2014. The seller accepted a note for the entire $100,000 sales price. In 2019, when the buyer still owed $10,000, the note was sold for $9,000 cash. How should the disposition of the note be reported on the seller’s 2019 return?
A. $2,000 capital gain.
B. $5,000 capital gain.
C. $1,000 capital loss.
D. $5,000 ordinary income.
```
$5,000 capital gain.
Answer (B) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The adjusted basis of the obligation is equal to the face amount of the obligation reduced by the gross profit that would be realized if the holder collected the face amount [Sec. 453B(b)]. The basis is $4,000 [$10,000 face amount × (100% – 60% gross profit percentage)]. Since the seller sold the installment obligation, the excess of the amount realized over the seller’s basis in the obligation is recognized as income on the transfer. This amount of income is $5,000 ($9,000 amount realized – $4,000 basis). The gain is treated as resulting from the sale or exchange of the property in respect of which the installment obligation was originally held. If the original sale resulted in a capital gain or loss, the disposition of the obligation will result in a capital gain or loss.
53
```
Alf owns all of the shares of Waxman Corporation, a manufacturer of finished leather products. Alf also owns a 60% partnership interest and his friend Richard owns a 40% partnership interest in York Real Estate Rentals, LLC. York owns and leases warehouse space to numerous businesses. In 2019, York sold a building with an adjusted basis of $100,000 to Waxman for $80,000. What is the amount of York’s deductible loss in 2019 from this transaction?
A. $(12,000)
B. $0
C. $(20,000)
D. $(8,000)
```
$0
Answer (B) is correct.
Loss realized on sale or exchange of property to a related person is not recognized. The transferee takes a cost basis. There is no adding of holding periods. Controlled entities (50% ownership) are considered related parties for tax purposes. Because Alf owns more than 50% of the corporation and the partnership, York is not able to recognize any loss from the transaction.
54
```
In March, Marcia sold stock with a cost basis of $12,000 to Lea, her sister, for $10,500. In October, Lea sold the same shares of stock to their cousin, Natalie, for $8,750. What is the amount of Lea’s deductible loss for the year?
A. $1,750
B. $0
C. $3,250
D. $1,500
```
$1,750
Answer (A) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Sisters are related parties for this purpose. Thus, Marcia’s loss of $1,500 ($12,000 cost basis – $10,500 sales price to Lea) on the sale of the stock is disallowed. Lea takes as her basis for the stock the cost of $10,500. A cousin is not a related party for Sec. 267 purposes. Therefore, upon the sale of the stock to an unrelated party for $8,750, Lea recognizes a $1,750 loss ($8,750 amount realized – $10,500 basis).
55
```
In May, Evan sold stock with a cost basis of $15,000 to Gina, his sister, for $13,500. In October, Gina sold the same shares of stock to their cousin, Diane, for $10,000. What is the amount of Gina’s deductible loss for the year?
A. $2,500
B. $3,500
C. $1,500
D. $0
```
$3,500
Answer (B) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Sisters are related parties for this purpose. Thus, Evan’s loss of $1,500 ($15,000 cost basis – $13,500 sales price to Gina) on the sale of the stock is disallowed. Gina takes as her basis for the stock the cost of $13,500. A cousin is not a related party for Sec. 267 purposes. Therefore, upon the sale of the stock to an unrelated party for $10,000, Gina recognizes a $3,500 loss ($10,000 amount realized – $13,500 basis).
56
```
In October of Year 1, Rocky sold land for $100,000 on the installment method to Natasha. At the time of the sale, the land had an adjusted basis of $40,000. In Year 1, Natasha made a down payment of $20,000 and agreed to pay $16,000 per year plus interest for the next 5 years. The payments were to be made May 1 of each year. In March of Year 3, before the Year 3 payment was made, Rocky sold the installment obligation for $35,000. What is the amount of Rocky’s gain or (loss) for Year 3 on the sale of the installment obligation?
A. $9,400
B. $(29,000)
C. $(3,400)
D. $11,000
```
$9,400
Answer (A) is correct.
Section 453B provides that, when an installment obligation is disposed of, gain or loss is recognized to the extent of the difference between the basis of the obligation and the amount realized (or the fair market value of the obligation if disposed of other than by sale or exchange). The adjusted basis of the obligation is equal to the face amount of the obligation reduced by the gross profit that would be realized if the holder collected the face amount [Sec. 453B(b)]. The basis is $25,600 [$64,000 face amount × (100% – 60% gross profit percentage)].
Since Rocky sold the installment obligation, the excess of the amount realized over Rocky’s basis in the obligation is recognized as income on the transfer. This amount of income is $9,400 ($35,000 amount realized – $25,600 basis). The gain is treated as resulting from the sale or exchange of the property in respect of which the installment obligation was originally held.
57
```
The Quick Torch Insurance Agency owns the land and building in which its offices are located. The agency also owns its office furniture, company cars, office equipment, and client files. Which of the following is NOT Sec. 1245 property?
A. The company cars.
B. The office equipment.
C. The office furniture.
D. The client files.
```
The client files.
Answer (D) is correct.
Section 1245 property includes property depreciable under Sec. 167, which is either personal property or specified real property, and most recovery property under Sec. 168. Client files are not Sec. 1245 property because they are neither depreciable nor recovery property.
58
AK Rabbits bought an office building 15 years ago for $2,000,000. Rabbits spent an additional $1,000,000 to renovate the plumbing and heating systems in the building before renting it in March of the same year. Rabbits chose to use straight-line depreciation and claimed a total of $896,875 in depreciation. On December 31 of the current year, the office building had a fair market value of $3,300,000. Rabbits exchanged the office building for an apartment house owned by Fox Corporation with a fair market value of $2,800,000 and basis to Fox of $2,000,000. In the exchange, Fox assumed a $500,000 liability on the office building. Gain or loss on the exchange will be reported
A. $300,000 Sec. 1231 gain; $896,875 Sec. 1245 gain.
B. $500,000 Sec. 1231 gain.
C. $1,196,875 Sec. 1231 gain.
D. $500,000 Sec. 1250 gain.
```
$500,000 Sec. 1231 gain.
Answer (B) is correct.
The realized gain on this exchange was $1,196,875. Since both properties are real property held for use in a trade or business or for investment, the transaction is a like-kind exchange under Sec. 1031. Gain is recognized to the extent of boot received (relief from a liability) of $500,000. Since the office building was depreciated on a straight-line basis, it is considered Sec. 1250 property. Section 1250 recapture is limited to depreciation taken in excess of straight-line depreciation. There is no excess depreciation, so Sec. 1250 does not apply and all the recognized gain is Sec. 1231 gain.
Original cost of office building
$ 2,000,000
Renovation
1,000,000
Depreciation
(896,875)
Adjusted basis of office building
$ 2,103,125
FMV of property received
$ 2,800,000
Liability assumed by Fox
500,000
Amount realized
$ 3,300,000
Adjusted basis of office building
(2,103,125)
Realized gain
$ 1,196,875
Recognized gain under Sec. 1231
$ 500,000
```
59
```
Margaret, a widow, sold 100 acres of land she and her husband paid $20,000 for 15 years ago. He died in the current year. As of the date of his death, the land was valued at $100,000 for estate tax purposes. Margaret sold the land for $200,000 on an installment basis. What is her gross profit percentage?
A. 60%
B. 50%
C. 90%
D. 70%
```
70%
Answer (D) is correct.
Publication 537 explains how to calculate the gross profit percentage. It states, “A certain percentage of each payment [received] . . . is reported as gain from the sale. It is called the ‘Gross profit percentage’ and is figured by dividing your gross profit from the sale by the contract price. . . . Gross profit is the total gain you report on the installment method. To figure your gross profit, subtract your installment sale basis from the selling price. . . . The contract price is the total of all principal payments you are to receive on the installment sale.”
Publication 551 states, “A qualified joint interest is any interest in property held by husband and wife as either of the following.
Tenants by the entirety.
Joint tenants with right of survivorship if husband and wife are the only joint tenants.
As the surviving spouse, your basis in property you owned with your spouse as a qualified joint interest is the cost of your half of the property with certain adjustments. Decrease the cost by any deductions allowed to you for depreciation and depletion. Increase the reduced cost by your basis in the half you inherited.” Thus, Margaret’s adjusted basis at the time of sale is $60,000 [$10,000 + 50% ($100,000)]. Her gross profit percentage, then, is 70% [($200,000 – $60,000) ÷ $200,000].
Authors’ comment: If Margaret lived in a community property state, her basis would be $100,000 and 50% would be the correct answer.
60
```
Among which of the following related parties are losses from sales and exchanges recognized for tax purposes?
A. Brother and sister.
B. Grandfather and granddaughter.
C. Father-in-law and son-in-law.
D. Lineal descendants.
```
Father-in-law and son-in-law.
Answer (C) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. A father-in-law and a son-in-law are not considered related parties for purposes of Sec. 267, so losses between the two may be recognized.
61
```
Jordan sold a building used in his business. His books and records reflect the following information for the year:
Original cost of building
$75,000
Improvements made to building
25,000
Broker’s commissions paid on sale
5,000
Cash received on sale
50,000
Total property taxes paid by Jordan
1,500
Portion of property taxes imposed on purchaser
and reimbursed to Jordan by purchaser
under IRC 164(d)
500
Mortgage assumed by buyer
40,000
Accumulated depreciation
35,000
Fair market value of other property received
10,000
What is Jordan’s recognized gain on the sale of the property?
A. $35,500
B. $30,000
C. $35,000
D. $30,500
```
```
$30,000
Answer (B) is correct.
Under Sec. 1001, the gain on the sale or other disposition of property is the excess of the amount realized over the adjusted basis. Any capital repairs, such as a new roof, are added to the adjusted basis. The amount realized is the sum of any money received plus the fair market value of the nonmoney property received. The amount realized includes relief from liabilities and, in this case, the assumption of the mortgage. When calculating amount realized, the seller does not include the reimbursement for real property taxes treated under Sec. 164(d) as imposed on the purchaser. The property taxes paid by Jordan are not included in either amount realized or adjusted basis because they are deductible expenses. The full amount of the realized gain is recognized unless all or some portion thereof is specifically excluded by another statute. Jordan’s recognized gain is calculated as follows:
Cash received
$ 50,000
FMV of other property
10,000
Mortgage assumed
40,000
Amount realized
$100,000
Less:
Adjusted basis
(65,000)
Commissions
(5,000)
```
$ 30,000
62
Mary Brown purchased an apartment building on January 1, 1986, for $200,000. The building was depreciated using the straight-line method. On December 31 of the current year, the building was sold for $210,000 when the asset basis net of accumulated depreciation was $140,000. On her current-year tax return, Brown should report
A. Section 1231 gain of $70,000.
B. Section 1231 gain of $10,000 and ordinary income of $60,000.
C. Section 1231 gain of $60,000 and ordinary income of $10,000.
D. Ordinary income of $70,000.
Section 1231 gain of $70,000.
Answer (A) is correct.
When depreciable property used in a trade or business is sold by a noncorporate owner at a gain, first Sec. 1245 and Sec. 1250 are applied; then the balance of the gain not recaptured as ordinary income is Sec. 1231 gain. In this case, Sec. 1245 does not apply (the building is residential rental property acquired before 1987), and Sec. 1250 recapture is limited to the excess of accelerated depreciation taken by the taxpayer over straight-line depreciation. Since the building was depreciated on the straight-line method, the entire $70,000 gain ($210,000 sales price – $140,000 asset basis) is Sec. 1231 gain. In addition, the straight-line depreciation of $60,000 ($200,000 purchase price – $140,000 basis net of accumulated depreciation) is unrecaptured Sec. 1250 gain and is taxed at the capital gains rate of 25% as opposed to the lower capital gain rates for the other $10,000 LTCG.
63
Taxpayers Rita and Bernard are in the process of executing a divorce agreement, which will include a property settlement. Under the property settlement, Bernard will transfer stock with a basis of $50,000 and a FMV of $30,000 to Rita. What is the tax consequence of this transaction to Bernard’s income, and what is Rita’s basis in the stock?
Bernard’s income
Rita’s basis
```
A.
$0 gain (loss)
$50,000
B.
$20,000 loss
$30,000
C.
$20,000 gain
$50,000
D.
$0 gain (loss)
$30,000
```
$0 gain (loss)
$50,000
Answer (A) is correct.
Property settlements in a divorce are not taxable. If the transfer of property is incident to divorce, the adjusted basis to the transferee is the same as the transferor’s adjusted basis.
64
```
During 2017, Joshua sold land with an adjusted basis to him of $120,000 to Caleb for $200,000. In 2017, Caleb made a down payment of $80,000 and agreed to pay $30,000 per year plus interest for the next 4 years beginning January 2018. After Caleb made the payment in 2018, Joshua and Caleb agreed to reduce the overall sales price to $185,000 and the yearly payments to $25,000. What is the amount that Joshua should include in income for 2019?
A. $8,400
B. $7,000
C. $10,000
D. $12,000
```
$7,000
Answer (B) is correct.
Under Sec. 453, income recognized on an installment sale is the proportion of payments received in the year that the gross profit bears to the total contract price. The gross profit is generally the selling price less the basis in the property and less selling expenses. However, when a gain is deferred or excluded, the gross profit must be subtracted by this nonrecognized portion of gain to calculate the gross profit percentage properly. The contract price is the selling price reduced by any indebtedness the buyer assumed or took.
If the selling price is reduced at a later date, the gross profit on the sale will also change. The gross profit percentage must be recalculated for the remaining periods by using the reduced sales price and subtracting the gross profit already recognized. The amount includible in 2019 is determined as follows:
```
Gross profit ($185,000 sales price –
$120,000 basis)
$65,000
Less: Gain recognized to date [$110,000
payments × ($80,000 original gross profit
÷ $200,000 original sales price)]
(44,000)
Remaining gain
$21,000
Adjusted gross profit ratio ($21,000 remaining
gain ÷ $75,000 remaining payments)
28%
Multiplied by: Payment received in 2019
25,000
Gain recognized in 2019
$ 7,000
```
65
```
Donald sold a piece of land with an adjusted basis of $45,000 to Mickey for $125,000. On May 11, Mickey paid $25,000 as a down payment and agreed to pay $20,000 per year plus interest for the next 5 years with the first installment payment being made on October 31. Donald incurred selling expenses of $5,000. What is the amount of gain to be included in Donald’s gross income for the year?
A. $9,000
B. $45,000
C. $15,000
D. $27,000
```
$27,000
Answer (D) is correct.
The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Donald’s gross profit is $75,000 ($125,000 sales price – $45,000 adjusted basis – $5,000 selling expenses). Since $45,000 ($25,000 down payment + $20,000 first installment) was received in the year of sale, the gain is $27,000.
$75,000 gross profit / $125,000 contract price * $45,00 = $27,000
66
```
Allen sold stock, a capital asset, he had purchased for $40,000 to his granddaughter Alice for $30,000. Later, Alice sold the stock to an unrelated party for $45,000. What is the amount of Alice’s recognized gain?
A. $5,000
B. $15,000
C. $0
D. $10,000
```
$5,000
Answer (A) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Grandfathers and granddaughters are related parties. Allen realized a $10,000 ($40,000 – $30,000) loss on the sale but may not deduct it. On the subsequent sale, Alice realized a $15,000 gain ($45,000 sales price – $30,000 basis). However, she recognizes only a $5,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($15,000 realized gain – $10,000 disallowed loss).
67
```
Mildred and John purchased 40 acres of undeveloped land 40 years ago for $120,000. They paid personal real estate taxes of $50,000, which they elected to add to the property’s basis. They sold the property for $600,000, having total settlement costs of $70,000. The settlement costs are allowable as an expense of sale. Mildred and John received a down payment of $100,000 with the balance to be paid over 15 years. What is their gross profit percentage?
A. 82%
B. 68.33%
C. 72%
D. 60%
```
60%
Answer (D) is correct.
The gross profit percentage is the ratio of the gross profit to the total contract price. The gross profit is the sales price reduced by any selling expenses and adjusted basis ($600,000 sales price – $70,000 selling expenses – $170,000 adjusted basis = $360,000 gross profit). The total contract price is the amount that will be collected, $600,000. The gross profit percentage is then calculated as follows:
68
```
Mr. Adamson changed jobs and sold his car that he had used 60% for business. Mr. Adamson had purchased the car for $12,000 and sold it for $10,000. He had claimed $2,000 depreciation on the car. What is the taxable gain or deductible loss on the sale, assuming no replacement vehicle was acquired?
A. $2,000 gain.
B. $0
C. $800 loss.
D. $800 gain.
```
$800 gain.
Answer (D) is correct.
Since the taxpayer used the car for both business and personal reasons, the business and personal portions must be computed separately. The adjusted basis of the car for personal use was 40% of the original cost of $12,000, or $4,800. The adjusted basis of the business portion of the car was $5,200 [($12,000 cost × 60%) – $2,000 depreciation]. There was a realized loss of $800 on the personal portion of the car and a realized gain of $800 on the business portion of the car. A loss on the sale of personal use property is not deductible (Sec. 165), so there is a recognized gain on the sale of $800.
Personal
Business
```
(40%)
(60%)
Sales proceeds
$ 4,000
$ 6,000
Less: Adjusted basis
(4,800)
(5,200)
Realized gain (loss)
$ (800)
$ 800
Recognized gain (loss)
$ 0
$ 800
```
69
```
In Year 1, Ray sold land with a basis of $40,000 for $100,000. He received a $20,000 down payment and the buyer’s note for $80,000. In Year 2, he received the first of four annual payments of $20,000 each, plus 12% interest. What is the gain to be reported in Year 2?
A. None.
B. $12,000
C. $8,000
D. $20,000
```
$12,000
Answer (B) is correct.
The transaction qualifies for treatment as an installment sale. The amount of gain under Sec. 453 is the proportion of the payments received in the year that the gross profit bears to the total contract price. The contract price is the total amount the seller will ultimately collect from the buyer. Ray’s gross profit is $60,000 ($100,000 sales price – $40,000 adjusted basis). Since $20,000 was received in Year 2, the gain is $12,000.
$60,000 gross profit / $100,000 contract price * $20,000 = $12,000
70
```
In May of the current year, Automatic, Inc., sold land with a basis to Automatic of $10,000 to Jack, its 60% shareholder, for $8,000. In July, Jack sold the land to an unrelated party for $11,000. What is the amount of Jack’s recognized gain?
A. $2,000
B. $0
C. $3,000
D. $1,000
```
$1,000
Answer (D) is correct.
Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Automatic, Inc., realized a $2,000 loss ($10,000 basis – $8,000 sales price to Jack) on the sale but may not deduct it. On the subsequent sale, Jack realized a $3,000 gain ($11,000 sales price – $8,000 basis). However, he recognizes only a $1,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($3,000 realized gain – $2,000 disallowed loss).
71
If the fair market value of Sec. 1245 property is greater than its basis, which of the following transactions will give rise to Sec. 1245 income?
A. None of the answers are correct.
B. A Sec. 351 exchange with a newly formed corporation for all of its stock.
C. Disposition by gift.
D. Disposition at death.
None of the answers are correct.
Answer (A) is correct.
The general rule of Sec. 1245(a) is that it applies notwithstanding any other section of the Code.
