Tax Ch 11 Taxation of Capital Assets Flashcards
(42 cards)
ASSET CATEGORIZATION
ASSET CATEGORIZATION
All assets are capital assets except:
- Accounts receivable
- Creative works in hands of the creator
- Inventory
- Depreciable real or personal property held for use in a trade
or business or for the production of income, held long-term
When a taxpayer sells an asset in exchange for cash, a realization event occurs.
a. True b. False
a. True
The amount realized on a sale includes cash and the fair market value of any other property received.
a. True b. False
a. True
Unrecaptured Section 1250 depreciation applies to all depreciable property.
a. True b. False
b. False
Capital gains are taxed at the same rate under the AMT system as they are under the regular income tax system.
a. True b. False
a. True
$3,000 of net capital losses may be recognized against other income each year.
a. True b. False
a. True
A single taxpayer can deduct up to $50,000 of the loss from a small business stock as an ordinary loss if certain requirements are met.
a. True b. False
a. True
Which of the following statements concerning the taxation of assets is correct?
a. Ordinary income may qualify for a special 0% rate.
b. Capital gains are always taxed at the taxpayer’s marginal tax rate
c. Gains on Section 1231 assets are taxed at ordinary rates, and losses are taxed at capital rates.
d. Gains on Section 1231 assets are taxed at long-term capital gains tax rates, and losses are taxed at ordinary income tax rates
The correct answer is d.
When an asset is classified as a Section 1231 asset, gains are capital (and are subject to the long-term capital gains rate due to the holding period requirement) and losses are ordinary.
Ordinary income is taxed at ordinary rates, and capital gains can qualify for a special 0% capital gains tax rate if the taxpayer
held the asset for more than one year, and the taxpayer’s taxable income is below the threshold amount.
Which of the following statements correctly identifies when income is subject to tax?
a. Capital gains must be realized before they can be recognized on a tax return.
b. Realization occurs when the gain on an asset is reflected on the taxpayer’s return.
c. As a general rule, realized gains are not recognized unless a provision in the IRC requires recognition.
d. Recognition occurs when an asset has been sold or exchanged.
The correct answer is a.
Before capital gains can be recognized on the tax return, they must be realized.
Realization occurs when an asset is sold or exchanged, and recognition occurs when the gain on the asset is included on the
taxpayer’s return.
As a general rule, realized gains must be recognized unless a provision in the IRC exempts the gain from taxation, or defers the gain to a future tax period.
All of the following are included in the amount realized upon disposition of an asset except:
a. The cash received.
b. The fair market value of property received in the exchange.
c. A transfer of obligation to pay debt from the seller to the buyer.
d. The taxpayer’s adjusted basis.
The correct answer is d.
The taxpayer’s adjusted basis is subtracted from the amount realized to calculate gain or loss
. The amount realized includes the cash received, plus the fair market value of property received in the exchange, plus any liabilities shed in the transaction
Anastasia purchased a home in Connecticut three years ago for $300,000. She had been working in Connecticut for the past 10 years. Yesterday, her employer decided to transfer her to the San Diego, California branch, effective next month. Unfortunately, the real estate market has weakened over the past few years, and Anastasia is only able to sell her home for $270,000. Which of the following statements correctly identifies her tax consequences of the sale:
a. Anastasia is not permitted to deduct the loss on her income tax return.
b. Anastasia’s loss will be reflected as a long-term capital loss on her tax return.
c. Anastasia’s loss will be reflected as a short-term capital loss on her tax return.
d. Anastasia will recognize an ordinary loss of $30,000
The correct answer is a.
The loss on the sale of the home was a personal loss, which is not deductible. Only losses associated with
the active conduct of a trade or business, or with the production of income may be deducted by individual
taxpayers
Gus purchased a home for $300,000 three years ago, and was recently transferred by his employer to an office located across the country. He made $20,000 of improvements to the residence, but if he sold the home today, he would only be able to receive $260,000 for the house due to a weak real estate market.
Instead of selling the home and realizing a loss, Gus rents the home to a tenant.
What is Gus’s basis for depreciation purposes?
a. $260,000.
b. $270,000.
c. $300,000.
d. $320,000.
The correct answer is a.
When an asset is converted from a personal use to a production of income use, the basis for purposes of depreciation is the lower of the fair market value on the date of conversion or the taxpayer’s adjusted basis in the home.
Gus’s adjusted basis in the home is $320,000 ($300,000 cost basis plus $20,000 in improvements), but the fair market value of the home on the date it was converted was $260,000.
The difference of $60,000 is deemed to be a personal expense and will not qualify for depreciation deductions.
Which of the following statements concerning the taxation of assets is correct?
Ordinary income may qualify for a special 0% rate.
Capital gains are always taxed at the taxpayers marginal tax rate.
Gains on Section 1231 assets are taxed at ordinary rates, and losses are taxed at capital rates.
Gains on Section 1231 assets are taxed at long-term capital gains tax rates, and losses are taxed at ordinary income tax rates.
Gains on Section 1231 assets are taxed at long-term capital gains tax rates, and losses are taxed at ordinary income tax rates.
Rationale
When an asset is classified as a Section 1231 asset, gains are capital (and are subject to the long-term capital gains rate due to the holding period requirement) and losses are ordinary. Ordinary income is taxed at ordinary rates, and capital gains can qualify for a special 0% capital gains tax rate if the taxpayer held the asset for more than one year, and the taxpayer’s taxable income is below the threshold amount.
Tatum loaned $10,000 to her close friend and business associate, Channing, so that Channing could start up a home-based business. Tatum is not in the business of money lending. Channing agreed to pay interest on the loan annually at a rate of 6 percent, and the principal was due in a lump sum on maturity 10 years later. After 4 years of making payments, Channing informs Tatum in year 5 that he has filed for bankruptcy and will not be able to make any future interest ($600 per year) or principal payment, causing the debt to become wholly worthless.
What is the income tax consequence for Tatum?
Tatum will recognize an ordinary income tax loss of $10,000 for Year 5.
Tatum will recognize an ordinary income tax loss of $10,600 for Year 5.
Tatum will recognize a short-term capital loss of $10,000 for Year 5.
Tatum will recognize a long-term capital loss of $10,000 for Year 5.
Tatum will recognize a short-term capital loss of $10,000 for Year 5.
Rationale
This is a personal debt that has become wholly worthless.
Therefore, Tatum can deduct the amount of the outstanding debt, $10,000, as a short-term capital loss.
All personal debts that become worthless must be deducted as a short-term capital loss.
Tatum cannot deduct the $600 of lost interest for year 5. Since she is a cash basis taxpayer, she never received the interest payment, and therefore never included it in her income. Recall that, generally, deductions are only allowed for items that are already included in the taxpayer’s income.
Gus purchased a home for $300,000 three years ago, and was recently transferred by his employer to an office located across the country. He made $20,000 of improvements to the residence, but if he sold the home today, he would only be able to receive $260,000 for the house due to a weak real estate market. Instead of selling the home and realizing a loss,
Gus rents the home to a tenant. What is Gus’s basis for depreciation purposes?
$260,000.
$270,000.
$300,000.
$320,000
$260,000.
Rationale
When an asset is converted from a personal use to a production of income use, the basis for purposes of depreciation is the lower of the fair market value on the date of conversion or the taxpayer’s adjusted basis in the home.
Gus’s adjusted basis in the home is $320,000 ($300,000 cost basis plus $20,000 in improvements), but the fair market value of the home on the date it was converted was $260,000.
The difference of $60,000 is deemed to be a personal expense and will not qualify for depreciation deductions.
Elton is in the 32% marginal tax bracket. He recently sold a gold coin for $12,000 that he purchased six months ago for $2,000.
How much federal income tax will Elton pay on this transaction (assume that his income is below the threshold for the 3.8% net investment income tax)?
$1,000.
$1,500.
$2,800.
$3,200.
$3,200.
Rationale
While a coin is a collectible, and collectibles with long-term holding periods are taxed at a 28% capital gains tax rate, Elton had a short-term holding period for the coin, and therefore the transaction will be classified as a short-term capital gain to which his marginal tax bracket will apply. Elton will therefore pay $3,200 [32% x ($12,000 - $2,000)] on the gain
On September 20 of Year 1, Henry purchased 1,000 shares of Tudor Enterprises, Inc. common stock for $25,000. He sold the shares for $35,000 on September 20 of Year 2.
Which of the following statements correctly identifies the tax consequences of this transaction?
Henry will recognize a $10,000 ordinary gain on the sale.
Henry will recognize a $10,000 short-term capital gain on the sale.
Henry will recognize a $10,000 long-term capital gain on the sale.
Henry will not be required to recognize the gain on the transaction.
Henry will recognize a $10,000 short-term capital gain on the sale.
Rationale
Henry’s holding period equals one year. Since it is not more than one year, it does not qualify for long-term capital gain treatment.
Wilson gave his granddaughter, Monique, stock worth $500,000 this year in addition to a previous gift equal to the annual gift tax exclusion. He purchased the stock for $250,000 several years earlier, and felt that the value would increase substantially in the near future.
Since he had already used up his lifetime gift-tax exemption in prior tax years, Wilson paid $200,000 in gift taxes on the transfer. If Monique sells the stock for $750,000 six months after the transfer, which of the following statements is correct?
Monique will realize a $400,000 long-term capital gain.
Monique will realize a $250,000 long-term capital gain.
Monique will realize a $500,000 long-term capital gain.
Monique will realize a $250,000 short-term capital gain.
Monique will realize a $400,000 long-term capital gain.
Rationale
Monique received the stock by gift, so she qualifies for a carryover basis.
Wilson’s original basis in the property was $250,000.
Since Wilson paid gift tax on the transfer of appreciated property, Monique is permitted to increase her basis by the portion of the gift tax paid that represents gain.
The portion of the gift that represents gain is 50% ($250,000 appreciation in the property divided by $500,000 fair market value of the property as of the date of gift). 50% of the gift taxes paid equals $100,000.
Monique’s basis, therefore, is $350,000.
If she sells the stock six months after the transfer for $750,000, she will realize a $400,000 gain.
Because Wilson transferred appreciated property to Monique, his holding period is added to Monique’s holding period for the asset, transforming the gain into a long-term capital gain.
Two years ago, Belinda purchased 100 shares of Pennsylvania Railroad, Inc. for $15,000. Unfortunately, the value of the shares has dropped to $10,000. Belinda’s daughter, Carli, was heading off to college, and Belinda was tired of waiting for a return on the stock. Belinda gave the stock to Carli when it was worth $10,000 to help fund Carli’s education. If Carli sells the shares for $12,000 three months after the transfer, what is the amount and character of her gain or loss?
$0.
$2,000 short-term capital gain.
$3,000 long-term capital loss.
$3,000 short-term capital loss
$0.
Rationale
Belinda gave loss property to her daughter. When a taxpayer gifts property with a loss to someone else, and the recipient sells the property for an amount between the donor’s adjusted basis and the fair market value of the stock on the date of the gift, no gain or loss is recognized.
In this example, the no-gain, no-loss corridor is from $10,000 (the fair market value of the stock on the date of the gift) to $15,000 (the adjusted basis in the hands of the donor).
If Carli sold the stock for any amount between $10 and $15 thousand dollars, she is not required to recognize any gain, and she is prohibited from recognizing any loss on the transaction.
Since there is no gain or loss, there is no need to categorize the tax result as either long-term or short-term.
Several years before his marriage to Kelsey, Sterling purchased a vacation home in a remote shoreline community for $250,000. After their marriage, Sterling needed some cash to invest in a new business opportunity, so he sold the house to his wife, Kelsey, for its current fair market value, $750,000. Nine months after purchasing the house, Kelsey sold it for $1 million.
What is the amount and nature of Kelsey’s taxable gain on the sale of the home?
$250,000 short-term capital gain.
$250,000 long-term capital gain.
$750,000 short-term capital gain.
$750,000 long-term capital gain.
750,000 long-term capital gain.
Rationale
Even though Sterling sold the home to Kelsey for its full fair market value, at the time of the sale Sterling and Kelsey were married.
IRC Section 1041 requires all transfers between spouses to be treated as gifts for income tax purposes, and when a gift of appreciated property is made, a carry-over basis results.
Consequently, even though Kelsey paid $750,000 for the home, her basis in the home is $250,000.
When Kelsey sells the house for $1 million, her gain is $750,000 ($1 million - $250,000), and the gain is characterized as a long-term capital gain.
The holding period of both the husband and wife are added together to determine whether the holding period is long-term or short-term. If this were their principal residence they may get relief under IRC Section 121.
Andy gave 1,000 shares of Meade Productions, Inc. to his son, Woody. Andy paid $15,000 for the shares, and they were worth $12,000 at the time he transferred them to Woody.
If Woody sells the shares for $13,000, how much capital has the family lost on a permanent basis?
$1,000.
$2,000.
$13,000.
$15,000.
$2,000.
Rationale
Since loss basis property was given away, and the asset was sold for less than the donor’s cost basis, the difference between the donor’s cost basis and the sales price represents a permanent loss of capital for the family.
Andy should have sold the shares and given the proceeds to Woody.
If he did this, he would have been able to recognize a loss, recouping capital for tax purposes, while still giving the same benefit to his son.
Assume that Ajamu, a 32% bracket taxpayer, held original issue stock in a qualified small business, which he acquired on October 5, 2011, and sold in November of 2024. His adjusted basis in the 1,000 shares is $10,000. He sells all the shares to an unrelated party for $20,000.
How much federal income tax will he pay on this transaction?
$0.
$1,500.
$2,000.
$3,200
0.
Rationale
This is a small stock acquired after September 27, 2010, which the taxpayer held for at least 5 years. His gain is $10,000 and the entire gain is excluded.
As the end of the year was approaching, Trixie reviewed her stock portfolio and decided to sell her holdings in Windsor Industries on December 28th of Year 1. The shares were purchased two years ago. Her basis in the shares was $20,000 and the market value of the shares was $18,000. Trixie wanted to use the $2,000 loss to help her minimize taxes for Year 1. On January 10th, Year 2, Windsor Industries announced new initiatives, and Trixie has second guessed her decision to sell the shares in the company. She buys back the 1,000 shares for $17,000 on January 11th.
Assuming that Trixie had no other capital transactions for Year 1, what is the impact of this transaction on Trixie’s Year 1 income tax return?
The sale of Windsor Enterprises will not impact Trixie’s AGI for Year 1.
The sale will generate a $2,000 short-term capital loss that will reduce Trixie’s AGI.
The sale will generate a $2,000 long-term capital loss that will reduce Trixie’s AGI.
The sale will trigger an ordinary loss deduction for $2,000.
???
Clarabelle sold a farm with an adjusted basis of $200,000 to Horace for $500,000. In addition, Horace agreed to assume the note on the farm, which had a remaining balance of $50,000.
Not taking into consideration any potential depreciation recapture, what is the amount realized in the transaction from Clarabelle’s perspective?
$200,000.
$350,000.
$500,000.
$550,000.
$550,000.
