Taxes and Tax Shelters
The "Wash Sale Rule" applies to sales of securities at a loss, that are repurchased within: A30 days B45 days C60 days D90 days
The best answer is A. Under the wash sale rule, if a security is sold at a loss, but is repurchased between 30 days prior to the sale until 30 days after the sale, the loss deduction is disallowed. To avoid the rule, wait 31 days.
A general partner refinances an existing housing limited partnership by obtaining a new 10%, $1,000,000, 30 year mortgage on the property. The general partner is using the proceeds to pay off the old 10%, $700,000, 15 year mortgage. Which statements are TRUE? I The interest expenses allocable to the limited partners will increase II The interest expenses allocable to the limited partners will decrease III The limited partner's tax basis in the venture increases IV The limited partner's tax basis in the venture decreases AI and III BI and IV CII and III DII and IV
The best answer is A. By refinancing the building with a larger mortgage ($1,000,000 new mortgage, replacing the old $700,000 mortgage), the general partner is obtaining $300,000 of extra cash that can be distributed to the limited partners. Since there is a higher mortgage balance, the interest expenses allocable to the limited partners will increase (not decrease). The higher mortgage balance increases the limited partners' basis (non-recourse financing adds to the basis in real estate investments). As the basis increases, the total amount of potential deductions that may be taken increases.
A customer owns 200 shares of ABC, purchased 2 years ago at $50 per share. The current market value of ABC stock is $60 per share. If the customer gifts the stock to his son, the result is the: I donor may have gift tax liability II recipient may have gift tax liability III cost basis to the gift recipient is $50 per share IV cost basis to the gift recipient is $60 per share AI and III BI and IV CII and III DII and IV
The best answer is A. If a gift of securities is made to a family member, the recipient assumes the donor's cost basis in that security (in this case $50 per share). However, the donor must pay gift tax on the entire dollar amount of the gift, subject to an annual exclusion of $15,000 in 2021.
An investor buys a 10% municipal bond in the secondary market on an 8% basis. If the bond is held to maturity, considering income and capital gains taxes, the investor's after-tax yield will be: A8% B10% Cmore than 8% but less than 10% Dless than 8%
The best answer is A. Municipal bonds purchased at a premium, whether in the primary or secondary market, are subject to amortization of the premium. Every year, the investor's non-taxable interest income is reduced by the amortization amount. At the same time, the bond's cost basis is reduced by the amortization amount. At maturity, there is no capital gain or loss on the bond since the adjusted cost basis has been amortized to $1,000 and the bond is redeemed at $1,000. Thus, the after-tax yield on the bond will simply be the 8% yield to maturity that was quoted. Thus, after considering all taxes, the basis quoted for a municipal premium bond will be the return received by the investor. In contrast, for a municipal discount bond, after considering all taxes, the return received by the investor will be lower than the stated basis because the portion of the investment return attributable to the market discount is taxable.
The lower 15% tax rate applies to: I cash dividends received from stock investments II stock dividends received from stock investments III stock splits received from stock investments AI only BI and II CII and III DI, II, III
The best answer is A. Only cash dividends received from stock investments (both common and preferred) qualify for the lower 15% tax rate (or 20% for individuals in the highest tax bracket). Stock dividends and stock splits are not taxable as income, rather for tax purposes, the cost basis per share is reduced for the distribution and the number of shares is increased proportionately.
The Internal Rate of Return: I considers the time value of money II does not consider the time value of money III represents the implicit rate of return that a limited partnership is expected to yield to the partners IV represents the rate at which the partnership is expected to return cash to the partners AI and III BI and IV CII and III DII and IV
The best answer is A. The evaluation method used for direct participation programs that considers the time value of money is the "Internal Rate of Return" (IRR). This method finds the implicit interest rate that discounts the projected cash flows from the program to a present value of "0." This interest rate represents the implicit rate of return that the program is expected to return. Internal Rate of Return does not measure the rate at which cash is returned to the partners, since partnership cash flows may either be retained in the partnership; or may be distributed to the partners; at the discretion of the general partner.
Which statements are TRUE regarding dividend and capital gain distributions made by mutual funds that have been reinvested in additional fund shares? I The dividend distribution is taxable II The dividend distribution is tax deferred III The capital gain distribution is taxable IV The capital gain distribution is tax deferred AI and III BI and IV CII and III DII and IV
The best answer is A. Mutual fund capital gains and dividend distributions are taxable to the shareholder in the year they are distributed by the fund, whether or not the distributions are automatically reinvested in new fund shares.
Amortization of the premium on a municipal bond is an accounting process that decreases the security's: A par value B book value C cost value D appraised value
The best answer is B. Amortization of a premium on a municipal bond, by definition, is a process whereby the book value of a bond purchased at a premium is decreased over the holding period of that security. Amortization may occur for either of 2 reasons: If the municipal bond is issued at a premium ("an original issue premium bond"), the Internal Revenue Code mandates that the premium be amortized. Each year, the amortization amount is a reduction of the interest income earned on that bond (which is not taxable by the Federal Government), and the bond's cost basis (not cost value) for tax purposes is decreased. If the bond is held to maturity, the bond's adjusted cost basis at redemption will be par; and there will be no capital gain or loss. If the municipal bond is purchased at a premium in the secondary market, the market premium must be amortized under the tax code. By doing so, the purchaser shows a reduction of non-taxable interest income each year equal to the amortization amount, and reduces the bond's cost basis each year. If the bond is held to maturity, the bond's adjusted cost basis is par and there is no capital gain or loss.
A customer buys $100,000 face amount of G.O. bonds in the secondary market at 90 and $100,000 face amount of Revenue bonds in the secondary market at 110. The investor opts not to accrete the G.O. bonds. If the bonds are held to maturity, the tax consequences are: A capital gains tax on the G.O. bonds; capital loss on the Revenue bonds B a gain taxed as interest income on the G.O. bonds; no gain or loss on the Revenue bonds C capital loss on both the G.O. and Revenue bonds D no gain or loss on both the G.O. and Revenue bonds
The best answer is B. Investors that purchase municipal discount bonds in the secondary market have the option of accreting the bonds. If there is no accretion, the bonds are valued at cost. If they are held to maturity, there is a taxable gain at that point (with no accretion). The gain is taxed as interest income, though, and not as a capital gains. Municipal premium bonds purchased in the secondary market must be amortized. If they are held to maturity, the full premium has been amortized and the adjusted basis is par. Since the bonds are redeemed at par, there is no capital gain or loss.
A customer buys a corporate bond from a dealer, paying 104 net, plus $40 of accrued interest. The customer chooses not to amortize the bond premium for tax purposes. For tax purposes, the customer's cost basis in the bond is: A96 B100 C104 D108
The best answer is C. Accrued interest paid is not included in the customer's cost basis in the bond. Rather it is a offset against other interest received by the customer in that tax year. The cost basis is the price paid for the bond, inclusive of any mark-up or commission paid by the customer.
Which of the following is (are) taxable in the year of receipt? I Interest earned from investments II Cash dividends from investments III Stock dividends from investments AI only BII only CI and II DI, II, III
The best answer is C. Cash dividends and interest are taxable each year (unless the interest is exempt). Stock dividends and stock splits are treated as a "return of capital." The cost basis of the shares is reduced proportionately and the number of shares is increased for the stock dividend or stock split.
A customer buys an oil and gas limited partnership interest by contributing $20,000 and signing a $20,000 non-recourse note. The customer's tax basis is: A0 B$10,000 C$20,000 D$40,000
The best answer is C. Investors are not at risk for non-recourse financing so it is excluded from the basis (with the exception of real estate programs which are exempt from the at risk rule). Only the $20,000 cash contribution is included in the basis, so potential tax deductions are reduced.
A customer owns a money market mutual fund. The customer exchanges the money fund shares for growth shares within the same family of funds. Which statements are TRUE? I The exchange is a non-taxable event II The exchange is a taxable event III When the shares are invested in the growth shares, a new cost basis is established IV The cost basis for the growth shares is the same as the cost basis for the money fund shares AI and III BI and IV CII and III DII and IV
The best answer is C. The sale of mutual fund shares results in a tax event, whether or not the funds are reinvested in another fund. If the sale proceeds are more than the investor's cost basis in that fund, tax is due. When the proceeds are invested in another fund, a new cost basis is established at that point.
Which of the following items are included as deductible passive losses on the income tax returns of limited partnership investors? I Interest payments on secured debt II Principal payments on secured debt III Intangible drilling costs IV Depletion allowances AI and II only BIII and IV only CI, III, IV DI, II, III, IV
The best answer is C. Interest payments on loans, intangible drilling costs (the cost of drilling for oil and gas), and depletion allowances (the recovery of monies paid to buy the oil or gas reserve) are all tax deductible items under the Internal Revenue Code since they are "ordinary and necessary business expenses." Repayment of principal on a loan is not tax deductible.
All of the following are needed to determine the annual accretion amount on an original issue municipal discount bond EXCEPT: A.Dated date B.Maturity date C.Acquisition cost D.Sale price
The best answer is D. The annual accretion amount on an original issue discount bond is based on the difference between the original acquisition cost of the bond and par value at maturity. The sale price is used to compute gain or loss, but is not needed to compute the annual accretion amount. The dated date is needed since accretion starts from this date. The maturity date is needed since accretion stops at this date.
A customer buys 1 ABC Jan 50 Call @ $3 when the market price is $51. The customer exercises the call when the market rises to $53. The tax consequence is: Ano gain or loss Ba $300 capital gain Ca cost basis in the stock of $5,000 Da cost basis in the stock of $5,300
The best answer is D. When a call is exercised, the customer is buying the stock (no taxable event occurs until those shares are sold). The call premium paid is considered to be part of the acquisition cost of the stock. For tax purposes, the customer is buying the stock at the strike price + call premium paid ($50 + $3) with the stock's holding period commencing on the exercise date.
A customer sells 1 ABC Jan 50 Call @ $3 when the market price is $51. The customer is assigned when the market rises to $53. The tax consequence is a: A$300 capital gain B$300 capital loss Ccost basis of $5,300 Dsales proceeds of $5,300
The best answer is D. When a call option is exercised by the holder, the Options Clearing Corporation "assigns" the contract to any one of the individuals or firms that sold that option on a random basis. When a call contract is assigned, the writer is selling the stock (no taxable event occurs until those shares are bought). The call premium received is considered to be part of the sales proceeds of the stock sale. For tax purposes, the customer is selling the stock at the strike price + call premium received ($50 + $3). Notice that this is the same as the breakeven.
A customer buys 100 shares of XYZ stock at $43 per share. The customer then sells 1 XYZ $45 Call contract for a premium of $500. The call contract expires unexercised. After expiration, the customer's cost basis in the XYZ shares is: A$3,800 B$4,000 C$4,200 D$4,300
The best answer is D. The expiration of the call contracts results in a short term capital gain to the writer of $500, taxable in that year. The cost basis of the stock position is unaffected at $43 per share, for a total cost basis for 100 shares of $4,300. Notice that this tax treatment is the one that is most beneficial to the IRS; and worst for the investor. The call premium is taxed as a short term capital gain at expiration; it cannot be used to reduce the cost basis of the long stock position, which has the same effect as increasing the potential capital gain on the stock and deferring taxation to the time when the stock is sold.
