Tax Planning- Chapter 10 & 11 practice problems, Tax Planning C. 12 & 13 Practice questions, Tax Planning- Ch. 14 & 15 Practice Questions
Two years ago, Olive purchased 100 shares of Pennsylvania Railroad, Inc. for $15,000. Unfortunately, the value of the shares has dropped to $10,000. Olive's daughter, Angie, was heading off to college, and Olive was tired of waiting for a return on the stock. Olive gave the stock to Angie when it was worth $10,000 to help fund Angie's education. If Angie sells the shares for $12,000 three months after the transfer, what is the amount and character of her gain or loss?
$0 **Olive gave loss property to her daughter. When a taxpayer transfers 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 Angie 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.
Joe enters into a 1031 exchange with Colin. Joe's business building has a basis of $300,000 and he takes Colin's raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Joe also pays Colin $50,000 in cash. What is Joe's recognized gain or loss?
$0. Joe is moving up therefore recognizes no gain. Analysis: First, get economics straight. $800,000 - $250,000 (mortgage) = $550,000 - $50,000 cash = FMV of Joe's asset $500,000. Joe - Old Asset Collin - Old Asset FMV $500,000 FMV $800,000 Adj. Basis $300,000 Adj. Basis $430,000 Pot. gain* $200,000 Pot. Gain* $370,000 Boot Mortgage - $250,000 Boot Cash- $50,000 Colin recognizes $300,000 gain and has a carryover basis. Joe - New Asset Collin - New Asset FMV $800,000 FMV $500,000 Adj. Basis $600,000 Adj. Basis $430,000 Pot. gain* $200,000 Pot. Gain* $70,000
Assume that Ajamu, a 32% bracket taxpayer, held original issue stock in a qualified small business, which he acquired on October 5, 2010 and sold in November of 2018. 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. **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.
Uncle Richard died in 2018, he left his estate to his ungrateful cousin, Henry. Richard's cost basis in his property was $2 million but, due to turbulent political and economic times, it was only worth $1 million at his death. Richard had reinvested approximately $250,000 of dividends during his holding period, and his estate paid $500,000 in transfer taxes at his death. What is Henry's basis in the property?
$1,000,000. **Section 1014 can result in a step-down in basis as well as a step-up in basis. Since the property was worth $1 million as of the date of Uncle Richard's death, that is the basis of the property in Henry's hands despite the fact that Uncle Richard had $2,250,000 in after-tax capital invested in the property and his estate paid transfer taxes of $500,000.
James sold a lathe that was used in his business operations (that he ran as a sole proprietor) for $5,000. The machine was originally purchased for $12,500 and James had claimed $6,000 of depreciation deductions over a span of four years. What will James include on his tax return as a result of the sale?
$1,500 ordinary loss. The lathe is a Section 1231 asset. Losses on Section 1231 assets are treated as ordinary losses for income tax purposes.
Laura owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Anne. The basis of Laura's vacant lot is $40,000. She gives Anne $20,000 cash plus the vacant lot in exchange for Anne's property, which is worth $36,000. Anne's basis in her original asset is $10,000. What is Anne's adjusted basis in the new asset?
$10,000. She has a carryover basis. See analysis: Laura - Old Asset Anne - Old Asset FMV $16,000 FMV $36,000 Adj. Basis $40,000 Adj. Basis $10,000 Pot. Loss $24,000 Pot. Gain $26,000 Boot to Anne - $20,000 Laura - New Asset Anne - New Asset FMV $36,000 FMV $16,000 Adj. Basis $60,000 Adj. Basis $10,000 Pot. Loss $24,000 Pot.Gain $6,000 Laura's new basis is $40,000 plus $20,000.
In 2018, Elizabeth (a surviving spouse) has an AMTI of $650,000. What is Elizabeth's AMT exemption this year?
$109,400. Because Elizabeth's AMTI is not above the AMT phaseout threshold amount of $1,000,000, she has no adjustment.
Ross is an individual investor in rental real estate. He actively participates in the activity. His AGI is $125,000 for the current year and the rental real estate business had a loss of $30,000. What is Ross's available loss against ordinary income assuming he has the required amount at risk?
$12,500. Individual investors are allowed a loss of $25,000 against ordinary income. However, this amount is phased out between $100,000 - $150,000. Since Ross's AGI is midway between the two points - he is only entitled to a loss of $12,500 against ordinary income. The rest is suspended under the passive activity rules.
Five years ago, Frederick purchased 1,000 shares of Ickingham Industries, Inc. for $10 per share. He signed an agreement with the company which allowed the company to use his dividend payments to purchase additional shares for him. Over the last 5 years, Frederick received a total of $1,200 in dividend payments, which purchased an additional 100 shares of stock. If Frederick sells all of his shares for $24,000, what is his taxable gain?
$12,800 **Frederick's adjusted basis in the shares equals the initial purchase price of the shares, $10,000 plus the dividends that were reinvested of $1,200 since Frederick was required to pay tax on the dividend payments the year they were made. When he sells the shares, he has an amount realized of $24,000, less his adjusted basis of $11,200, which equals a taxable gain of $12,800.
Bob, a single taxpayer, has been transferred by his company to Portland. He sold his house for $650,000 and he had an adjusted basis of $330,000. He owned and lived in the home for 18 months. What is his capital gain from the sale of the personal residence?
$132,500 LTCG. He gets a partial exemption of $187,500. GAIN $320,000 LESS EXEMPTION $187,500 ($250,000 x 18/24) EQUALS $132,500
Assume John and Mary bought a ski condo 10 years ago for $100,000. They treated it as a vacation home for 8 years but used it as their personal residence for the last 2 years. They recently sold the condo for $450,000. How much gain can they exclude from the sale of their personal residence?
$140,000 Their nonqualified use (vacation home) is 3 out of the last 5 years or 60%. Therefore, they can exclude 40% of the gain. $450,000 - $100,000 = $350,000 x 0.40 = $140,000.
Rich sold his home this year, and is preparing his income tax return. He sold the house for $650,000. It was purchased for $250,000 20 years ago (after he was married to Mary Jane), and they have used it as their principal residence ever since. Rich ran a business from the home, using one room regularly and exclusively for business purposes. Over the 20 year holding period, Rich had claimed $15,000 of depreciation deductions on the home office. What portion of the gain, if any, will be subject to income tax?
$15,000. Even though the home was Rich and Mary Jane's principal residence, and they otherwise meet the qualification rules for the Section 121 exclusion of gain on the sale of a home, Rich depreciated the property. Real property that has been depreciated on a straight-line basis is subject to recapture at a flat 25% rate (and is referred to as unrecaptured Section 1250 depreciation). Therefore, $15,000 will be subject to income tax at a 25% rate, and the remaining gain will be eligible for the Section 121 exclusion.
Kate is a 20 percent limited partner in DreamOn, LP a local spa. Kate invested $105,000 in DreamOn. During DreamOn's first two years of business the total losses were $300,000 in Year 1 and $200,000 in Year 2. If the total business loss for the current year is $100,000 what is Kate's suspended loss due to at risk rules for the current year?
$15,000. Kate's suspended risk is $15,000. Her at-risk amount at the beginning of this year was $5,000 ($105,000 - $60,000 in Year 1 - $40,000 in Year 2). Her allocated loss for Year 3 is $20,000. Therefore, $15,000 will be suspended under the at-risk rules because she only has $5,000 at risk.
Lisa is a 10 percent owner in HKAccounting, LLC, a review company for the CPA exam. She is also a 20 percent owner in MyPuppy, LLC a rescue organization for dogs. She does not materially participate in either company. Her at-risk and loss/income for the current year is as follows: • HKAccounting - At-risk = $800,000; Income of $150,000 • MyPuppy - At-risk = $200,000; Loss of $350,000 Lisa also has wage income of $75,000. How much of the loss can she write off in the current year?
$150,000 Her actual loss available is $150,000 of the $350,000 from MyPuppy. Of the $350,000 loss from MyPuppy $150,000 will be suspended because of the at-risk rules (she only has $200,000 at risk) and $50,000 will be suspended because of the passive loss rules (she only has $150,000 of passive income).
John owns a building in a blighted downtown area that, until recently, served as his principal residence. He originally purchased the building for $200,000. When he moved out and converted the building to an office building, the fair market value of the building was $150,000. What is John's basis for purposes of determining his depreciation deductions on the building?
$150,000. John can claim the lower of his cost basis or the fair market value at the date of conversion as his basis for depreciation purposes.
As the end of the year was approaching, Edward reviewed his stock portfolio and decided to sell his holdings in Windsor Industries on December 28th of Year 1. The shares were purchased two years ago. His basis in the shares was $20,000 and the market value of the shares was $18,000. Edward wanted to use the $2,000 loss to help him minimize taxes for Year 1. On January 10th, Year 2 Windsor Industries announced new initiatives, and Edward has second guessed his decision to sell the shares in the company. He buys back the 1,000 shares for $17,000 on January 11th. What is Edward's basis in the shares after he buys them back on January 11th?
$19,000. **Since Edward purchased and sold the same security within a 30-day period, the sale is considered to be a washsale transaction, and the loss may not be claimed. The disallowed loss is added to Edward's basis in the replacement shares. Edward paid $17,000 for the replacement shares, and the disallowed loss was $2,000 so his basis in the shares is $19,000.
Andy gave 1,000 shares of Meade Productions, Inc. to his son, John. Andy paid $15,000 for the shares, and they were worth $12,000 at the time he transferred them to John. If John sells the shares for $13,000, how much capital has the family lost on a permanent basis?
$2,000 **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 John. 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.
Two years ago, Amanda purchased 100 shares of Quick Produce, Inc. for $15,000. Unfortunately, the value of the shares has dropped to $10,000. Amanda gave the stock to her daughter, Daphna, when it was worth $10,000. If Daphna sells the shares for $17,000 three months after the transfer, what is the amount and character of his gain or loss?
$2,000 long-term capital gain. **Amanda gave property subject to a loss to her daughter, Daphna, but Daphna sold the property at a price greater than the donor's adjusted basis in the property. Since the sale price exceeded the donor's adjusted basis, the donor's basis transfers to the donee, and is referred to as the gain basis. Daphna sold the stock for $17,000 and Amanda's basis (that carried over to Daphna) was $15,000, so Daphna's gain is $2,000. Whenever gain basis is used to determine the tax result, the donor's holding period tacks on to the donee's holding period. Daphna's gain will be a long-term capital gain, since Amanda held the shares for over one year prior to the gift.
Laura owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Anne. The basis of Laura's vacant lot is $40,000. She gives Anne $20,000 cash plus the vacant lot in exchange for Anne's property, which is worth $36,000. Anne's basis in her original asset is $10,000. What is Anne's gain or loss?
$20,000 gain recognized. Anne must recognize gain to the extent of boot paid to her ($20,000).
HHH Company grants Henry one incentive stock option (ISO) on January 10, 2017. The exercise price is $10. The market price on the exercise date (June 12, 2018) is $33. What is the AMT consequence when Henry exercises the ISO?
$23 AMT gain. $33 - $10 = $23
Laura owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Anne. The basis of Laura's vacant lot is $40,000. She gives Anne $20,000 cash plus the vacant lot in exchange for Anne's property, which is worth $36,000. Anne's basis in her original asset is $10,000. What's Laura's gain or loss?
$24,000 loss realized, but not recognized. Losses are not recognized in a tax-free exchange; rather, they are deferred to the new asset and added to the basis.
Laura owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Anne. The basis of Laura's vacant lot is $40,000. She gives Anne $20,000 cash plus the vacant lot in exchange for Anne's property, which is worth $36,000. Anne's basis in her original asset is $10,000. What is Laura's deferred gain or loss?
$24,000. See analysis: Laura - Old Asset Anne - Old Asset FMV $16,000 FMV $36,000 Adj. Basis $40,000 Adj. Basis $10,000 Pot. Loss* $24,000 Pot. Gain* $26,000 Boot to Anne - $20,000 Laura - New Asset Anne - New Asset FMV $36,000 FMV $16,000 Adj. Basis $60,000 Adj. Basis $10,000 Pot. Loss* $24,000 Pot.Gain* $6,000 Laura's new basis is $40,000 plus $20,000.
Harold 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, Harold rents the home to a tenant. What is Harold's basis for depreciation purposes?
$260,000. **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. Harold'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.
Ken is in the 32% marginal tax bracket. He recently sold a coin for $110,000 that he had purchased eight years earlier for $10,000. How much federal income tax will Ken pay on this transaction?
$28,000. **A coin is a collectible item, and long-term capital gains on collectibles are subject to a flat capital gains tax rate of 28%. Therefore, Ken's tax on this transaction equals $28,000 [28% x ($110,000 - $10,000)].
Two months after Tom purchased Greenacre for $30,000, he died. The fair market value of Greenacre as of the date of Tom's death was $32,000. He left Greenacre to his son, Kevin. Since Kevin was the only beneficiary of the estate and there were no estate taxes due, the title to the property was transferred to Kevin within one month of Tom's death. Two weeks after receiving title to the property, Kevin sold Greenacre for $35,000. What is the amount and type of income that Kevin will report on the sale?
$3,000 long-term capital gain. **When Tom died the basis of Greenacre qualified for a step-to fair market values under IRC Section 1014. Kevin's basis in the property is therefore $32,000. Since he sold the property for $35,000 and his basis was $32,000, Kevin's gain in $3,000. Even though Tom purchased the property three and a half-months before it was sold, Kevin's gain will be a long-term capital gain. Any property received through the estate of a decedent automatically qualifies for long-term capital gains treatment.
Two years ago, Vernon purchased 100 shares of Stairwell Refitters, Inc., a start-up company, for $12,000. Unfortunately, Stairwell Refitter's business model did not perform as expected, and the value of the shares has dropped to $8,000. Vernon's son, Dudley, recently realized a large capital gain on an investment he held, so Vernon gave his shares of Stairwell Refitters, Inc. to Dudley when they were worth $8,000. If Dudley sells the shares for $5,000 thirteen months after the transfer, what is the amount and character of his gain or loss?
$3,000 long-term capital loss. **Vernon gave loss property to his son. When a taxpayer transfers property with a loss to someone else, and the recipient sells the property for less than the fair market value as of the date of the gift, the basis in the hands of the donee for purposes of calculating loss is the fair market value of the property as of the date of the gift. This is referred to as the "loss basis" in the property. When loss basis is used to calculate loss, the holding period is deemed to begin at the date of the gift - the donor's holding period does not tack on to the donee's holding period to determine the nature of the loss. Since the fair market value of the property was $8,000 on the date of the gift, and Dudley sold the property for $5,000 thirteen months after receiving it, Dudley's loss is a $3,000 long-term capital loss.
Twenty years ago, William purchased a desk, which he used in his law practice for $8,000. The desk has been fully depreciated; and when he retired, William sold the desk to Harry for $3,000. What will William include on his tax return as a result of the sale?
$3,000 taxed at ordinary rates. The desk is a Section 1231 asset. The amount realized of $3,000 less the adjusted basis of $0 equals a gain of $3,000. Section 1231 gains are usually taxed as long-term capital gains, but before capital gains tax rates can apply the depreciation recapture rules of Section 1245 must be taken into consideration. Section 1245 requires the taxpayer to recognize the gain to the extent of the depreciation as ordinary income, resulting in a recapture of depreciation claimed over the years. In this case, the total depreciation claimed was $8,000 and the gain was $3,000. Since the gain was less than the depreciation taken, the full gain is taxed at ordinary rates due to the imposition of the Section 1245 depreciation recapture rule.
Michael 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 Michael pay on this transaction?
$3,200. **While a coin is a collectible, and collectibles with long-term holding periods are taxed at a 28% capital gains tax rate, Michael 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. Michael will therefore pay $3,200 [32% x ($12,000 - $2,000)] on the gain.
Joe enters into a 1031 exchange with Colin. Joe's business building has a basis of $300,000 and he takes Colin's raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Joe also pays Colin $50,000 in cash. What is Colin's recognized gain or loss?
$300,000 gain. Colin must recognize boot as gain to extent of deferred gain ($250,000 + $50,000). Analysis: Get economics straight. $800,000 - $250,000 (mortgage) = $550,000 - $50,000 Cash = FMV of Joe's asset $500,000.
Cody owns a 10 percent interest in CreativeWorks, LLP. Cody originally invested $500,000 and has personally taken losses from the partnership of $200,000. The partnership took out a nonrecourse loan of $800,000. What is Cody's at-risk amount?
$300,000. Cody's at-risk amount is the amount he invested less the losses he has taken - $300,000 ($500,000 - 200,000). He does not get to increase his basis for the nonrecourse debt.
In 2018, Chel (a surviving spouse) has an AMTI of $1,289,000. What is Chel's AMT exemption this year?
$37,125. Because Chel's AMTI is above the AMT phaseout threshold amount, her AMT exemption must be reduced. Chel's exemption is reduced by 25% of the amount that her AMTI exceeds $1,000,000 (the threshold). Therefore, Chel's exemption must be reduced by $72,275 [($1,289,100 - $1,000,000) x 0.25]. However, the amount of the exemption is only $109,400. Therefore, Chel is entitled to an AMT exemption this year of $37,125.
Joe enters into a 1031 exchange with Colin. Joe's business building has a basis of $300,000 and he takes Colin's raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Joe also pays Colin $50,000 in cash. What is Colin's basis in the new asset?
$430,000. Colin has a carryover basis. Analysis: First get economics straight. $800,000 - $250,000 (mortgage) = $550,000 - $50,000 cash = FMV of Joe's asset $500,000.
Gavin, a single individual, who is an executive at IT Consulting, Inc., was granted 1,500 ISOs on IT's stock two years ago when the price per share was $25. The last few years have resulted in tremendous growth for IT Consulting and the stock is now trading at $55 per share. Gavin exercised the ISOs, but did not sell the stock - he plans on holding the shares for at least a year so he can pay the lower capital gains tax rate on the growth. How much will Gavin have to add to his taxable income when computing AMTI as a result of this transaction?
$45,000. Even though exercise of the options results in no taxable event for regular tax purposes this year, Gavin will have to add $45,000 [($55 - $25) x 1,500] to his taxable income when computing AMTI. If there are no other transactions this year that could reduce AMTI, it is likely that Gavin will become an AMT taxpayer for the year, since the tax preference item - the gain on the exercise of the ISO - is greater than his exemption for AMT purposes.
Earlier this month, Jennifer's apartment house in California was completely destroyed by a forest fire that found its way into the city. She had originally purchased the apartment house for $500,000, and had claimed $100,000 in straight-line depreciation deductions. At the time of the fire, the fair market value of the building was $750,000 and the insurance company gave her a check for the full value. Instead of building on the same site, about 6 months after the fire Jennifer used the insurance proceeds to purchase a new apartment building for $800,000. Within two weeks of purchasing the new building, a real estate investor offered to purchase the new building from her for $1 million. If Jennifer sells the new building to the investor, what is her long-term capital gain for income tax purposes?
$450,000. The apartment building is Section 1231 property (real depreciable property used in a trade or business). When a nontaxable exchange occurs, the basis and recapture potential in the original property is carried over to the new property. Jennifer's basis in the new property is $450,000 (her original cost basis of $500,000 less $100,000 in depreciation plus the $50,000 that she added in addition to the insurance proceeds). If she sold the building for $1 million, she would have realized a $550,000 gain. This gain, however, is subject to the depreciation recapture provisions of Section 1250, and un-recaptured Section 1250 depreciation. There was no accelerated depreciation on the property, so there will be no ordinary income triggered under Section 1250. The straight-line depreciation of $100,000 however will be subject to tax at 25%, leaving the remaining $450,000 gain available for long-term capital gains tax treatment.
Donny died owning a 15 percent interest in EngraveIt, LLC, a local trophy engraving shop. At his death, his basis in the business was $800,000, and he had suspended losses of $600,000. The fair market value of his interest in the business was $950,000 at the time of his death. What is Donny's suspended loss deduction on his final income tax return?
$450,000. The suspended loss deduction on Donny's final income tax return is calculated by reducing the suspended loss ($600,000) by the amount of the step-up in basis, or $150,000 ($950,000 - $800,000).
Kali is a 20 percent owner in CheerSquad, LLC, a local gym for middle school and high school cheerleaders. The gym provides private coaches to help young cheerleaders learn stunts and improve their overall cheer performance. Kali does not materially participate. Kali contributed $200,000 initially. During the prior years she has been allocated $200,000 in income and $300,000 in losses. After a freak accident during the current year in which one of the cheerleaders was critically injured doing a stunt, the business lost many customers. The business allocated a $150,000 loss to Kali for the current year. What is Kali's suspended loss due to at-risk rules?
$50,000. Kali's at-risk amount before the current year's allocation is $200,000 contribution + $200,000 income - $300,000 in losses = $100,000 at risk. Therefore, she will be able to utilize $100,000 of the current year's loss against her remaining basis and $50,000 will be suspended due to at-risk rules. Note that if this is her only activity, all losses otherwise deductible will be suspended under the passive activity rules.
Mark purchased an apartment building for $1.5 million, several years ago. He has claimed depreciation deductions totaling $750,000 during the holding period, and straight-line depreciation would have been $700,000. How much ordinary income will Mark recognize for income tax purposes if he sells the building for $2 million?
$50,000. The apartment building is a Section 1231 asset, which generally means that gains from the sale or disposition of the property are capital gains, and losses are treated as ordinary losses. Before capital gains tax treatment can be applied, however, depreciation recapture must be taken into account. Since an apartment building is real property, the recapture rules that apply may be found in Section 1250. Section 1250 states that the gain on the sale of real Section 1231 property is taxed at ordinary rates to the extent that the depreciation claimed exceeds straight-line depreciation. In this case, the gain is $1,250,000 ($2 million amount realized less $750,00 adjusted basis). The depreciation in excess of straight-line depreciation is $50,000 ($750,000 - $700,000). Therefore, $50,000 of the gain will be taxed at ordinary rates pursuant to the depreciation recapture rules of Section 1250.
During her working years, Marge ran an antique sales and appraisal service that was very successful in the local community. When she retired, she kept some of the display cases in order to display her own collections in her home. The display cases were originally purchased for the business at a cost of $15,000 and were fully depreciated by the time Marge retired. Marge died last month, and the display cases were valued in her estate at $8,000. If Marge's daughter, Kelly, inherits the display cases, and sells them for $8,500 two months after Marge's death, what is the income tax treatment on the sale?
$500 long-term capital gain. Even though the display cases were Section 1231 assets in Marge's hands, and were subject to depreciation recapture, once they ran through Marge's estate, they qualified for a Section 1014 step-to fair market value in basis, which eliminates the recapture potential. If Kelly sells the cases for $8,500 two months after Marge's death, her gain is $500 due to the step-up in basis. Since all assets passing through an estate and receiving a step-up in basis qualify for long-term capital gains treatment, the gain will be characterized as a long-term gain.
Michael purchased an apartment building for $2 million several years ago. He has claimed depreciation deductions totaling $950,000 during the holding period, and straight-line depreciation would have been $900,000. What is Michael's long-term capital gain (taxed at the highest capital gains tax rate) that will be recognized for income tax purposes if he sells the building for $2.5 million?
$500,000. The apartment building is a Section 1231 asset, which generally means that gains from the sale or disposition of the property are capital gains, and losses are treated as ordinary losses. Before capital gains tax treatment can be applied, however, depreciation recapture must be taken into account. Since an apartment building is real property, the recapture rules that apply may be found in Section 1250. Section 1250 states that the gain on the sale of real Section 1231 property is taxed at ordinary rates to the extent that the depreciation claimed exceeds straight-line depreciation. The straight-line depreciation claimed is treated as "unrecaptured Section 1250 gain" and is taxed at a flat 25% rate. Any gain remaining after the ordinary income recapture and the unrecaptured Section 1250 gain is taxed at long-term capital gains tax rates. In this case, the gain is $1,450,000 ($2.5 million amount realized less $1,050,000 adjusted basis). The depreciation in excess of straight-line depreciation is $50,000 ($950,000 - $900,000), which is taxed at ordinary tax rates. The straight-line depreciation, or unrecaptured Section 1250 gain, of $900,000 is taxed at a flat 25%, and the remaining $500,000 of the gain will qualify as a long-term capital gain.
Ajamu, a single individual, was an investor in a company that became worthless this year, and suffered an $80,000 capital loss. He initially invested in the company five years ago when it was starting up, and the company had $500,000 in initial capitalization. Assuming that Ajamu had no other capital transactions this year and has $100,000 of ordinary income, how much will his AGI for this year decline as a result of this loss?
$53,000. **He has a 1244 loss of $50,000 plus a long-term capital loss of $30,000 of which he can take $3,000 this year. Thus, his AGI for this year will decline $53,000 as a result of this loss. The stock that generated the loss qualified as Section 1244 stock, since Ajamu was one of the original investors in a company that was initially capitalized with less than $1 million. Consequently, the first $50,000 of the loss is treated as an ordinary loss under Section 1244 and the remaining $30,000 loss is treated as a capital loss. The $50,000 ordinary loss can offset Ajamu's AGI in full, but the capital loss can only offset AGI by up to $3,000 per year. This year, therefore, the total reduction in Ajamu's AGI as a result of this transaction is $53,000, and he can carry forward the additional $27,000 loss and use that against income in future years.
John sold a farm with an adjusted basis of $200,000 to Isaac for $500,000. In addition, Isaac 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 John's perspective?
$550,000. **The amount realized equals the cash plus the value of liabilities shed, which in this case equals $550,000 ($500,000 in cash plus $50,000 of liabilities shed). John's basis of $200,000 can be subtracted from this amount to calculate his gain, which equals $350,000.
In 2018, Alan (a single taxpayer) has an AMTI of $554,300. What is Alan's exemption this year?
$56,725. Because Alan's AMTI is above the AMT phaseout threshold amount, his AMT exemption must be reduced. Alan's exemption is reduced by 25% of the amount that his AMT exceeds $500,000 (the threshold). Therefore, Alan's exemption must be reduced by $13,575 [($554,300 - $500,000) x 0.25]. As a result, Alan is entitled to an exemption of $56,725 ($70,300 - $13,575).
Laura owns a vacant lot used in her business. She exchanges it for a property with a small storage facility on it owned by Anne. The basis of Laura's vacant lot is $40,000. She gives Anne $20,000 cash plus the vacant lot in exchange for Anne's property, which is worth $36,000. Anne's basis in her original asset is $10,000. What is Laura's basis in the new asset?
$60,000. Laura's new basis equals her old basis ($40,000) plus the boot that she paid to Anne ($20,000).
Joe enters into a 1031 exchange with Colin. Joe's business building has a basis of $300,000 and he takes Colin's raw land worth $800,000 with an assumable mortgage of $250,000 and a basis of $430,000. Joe also pays Colin $50,000 in cash. What is Joe's basis in the new asset?
$600,000. Old basis plus boot given equals $600,000. Analysis: Get economics straight. $800,000 - $250,000 (mortgage) = $550,000 - $50,000 Cash = FMV of Joe's asset $500,000.
In 2018, Larry (a single taxpayer) has an AMTI of $175,000. What is Larry's AMT exemption this year?
$70,300. Because Larry's AMTI is not above the AMT Phaseout threshold amount, his AMT exemption is $70,300.
Vicky is a 15 percent owner in DesignCreative, LLC, a very successful web developing business. She is also a 15 percent owner in SafeHarbor, LLC, an internet-based virus protection service. She materially participates in DesignCreative, but does not materially participate in SafeHarbor. Her at-risk and loss/ income for the current year is as follows: • DesignCreative - At-risk = $600,000; Income of $250,000 • Safe Harbor - At-risk = $75,000; Loss of $200,000 What amount of loss is suspended because of the passive activity income rules?
$75,000. Vicky will not be allowed to take any loss for the current year. Of the $200,000 loss from SafeHarbor $125,000 will be suspended because of the at-risk rules (she only has $75,000 at risk) and $75,000 will be suspended because of the passive loss rules (she does not have any passive income to offset the loss since she materially participates in DesignCreative).
Several years before his marriage to Marie, Patrick purchased a vacation home in a remote shoreline community for $250,000. After their marriage, Patrick needed some cash to invest in a new business opportunity, so he sold the house to his wife Marie for its current fair market value, $750,000. Nine months after purchasing the house, Marie sold it for $1 million. What is the amount and nature of Marie's taxable gain on the sale of the home?
$750,000 long-term capital gain.
Ten years ago, Chelsea purchased an industrial sewing machine used in her business, Froggie Dolls, LLC, for $10,000. She had taken depreciation deductions of $9,000 over this period, and sold the machine for $12,000 after she purchased a new state-of-the-art industrial sewing machine. How much ordinary income will Chelsea recognize on the sale of the machine?
$9,000. The sewing machine is a Section 1231 asset. The amount Chelsea realized on the sale was $12,000, and after subtracting her adjusted basis of $1,000 we find her gain to be $11,000. The sewing machine was personal property, so the recapture rules of Section 1245 apply. Section 1245 requires the gain, to the extent of depreciation claimed, to be reported as ordinary income on the taxpayer's return. The total depreciation that Chelsea claimed on the asset was $9,000 and her gain was $11,000 so all of the depreciation is recaptured, and will be taxed at ordinary rates.
Prior to returning to work for a Fortune 500 company, Randy ran a consulting practice. He had purchased office furniture and modern artwork for his office; and when he closed the practice to return to the corporate world, he kept the furniture and art, which was fully depreciated. One painting that he used in the business has recently gone up substantially in value. Randy purchased it for $400, depreciated it fully, and the fair market value of the painting is now $10,000. The local art museum has an exhibit dedicated to the artist that created the painting, and since he was not using the art, Randy donated the painting to the museum. What is Randy's charitable deduction (without taking into consideration any ceiling imposed by his contribution base) for income tax purposes?
$9,600 Randy is generally entitled to a fair market value deduction for contributions of artwork to a charitable organization that will use it in its tax-exempt purpose. The potential depreciation recapture, however, must be subtracted from the fair market value to determine the tax deduction. Since the artwork was fully depreciated, Randy must deduct $400 from the fair market value of $10,000 to arrive at the charitable deduction of $9,600.
Which of the following is not considered passive income? A) Annuity payments. B) Rental activities. C) Real estate activities. D) A limited partner's distributive share of partnership income.
A) Annuity payments. Annuity payments are portfolio income. Rental and real estate activities are passive income unless an exception applies. A limited partner's distributive share of partnership income is passive income.
George, age 50, has deductible medical expenses of $12,000 under the regular tax system and an AGI of $100,000. What are the tax consequences for computing George's AMTI? A) George's AMTI is not affected by his medical expenses. B) $300 of George's medical expenses must be added back to compute his AMTI. C) $2,500 of George's medical expenses must be added back to compute his AMTI. D) All of George's medical expenses must be deducted to compute his AMTI.
A) George's AMTI is not affected by his medical expenses. Medical and dental expenses are deductible for AMT purposes only to the extent that they exceed 7.5% of the taxpayer's adjusted gross income for 2017 and 2018. The threshold is 10% for years after 2018.
If a transaction meets all of the requirements of a 1031 tax-free exchange, which of the following is true? A) Like-kind exchange treatment is absolutely mandatory. B) Like-kind exchange treatment requires an affirmative election. C) Like-kind exchange treatment is completely discretionary. D) None of the above are true.
A) Like-kind exchange treatment is absolutely mandatory. Like-kind exchange treatment is mandatory if all of the requirements are met.
Custom Framing, Inc., a C corporation, sold a machine used to cut wood used in their picture frames for $2,700. They originally purchased the machine for $2,000 and had taken $1,400 in depreciation deductions. When the company that made the machine went out of business, the machine became a collectors item, and the company sold the machine for more than they paid for it to purchase other equipment. Which of the following statements concerning the tax impact of the sale transaction is correct? A) The company will recognize $2,100 of ordinary income. B) The company will recognize $1,400 of ordinary income. C) The company will recognize a capital gain of $700 that will be taxed at the favorable longterm capital gains tax rate. D) The company will recognize a short-term capital gain of $700.
A) The company will recognize $2,100 of ordinary income. C corporations do not qualify for the favorable capital gains tax rate, so any gain on the sale or disposition of property is taxed at ordinary rates. In this case, the adjusted basis of $600 is deducted from the amount realized of $2,700 resulting in a gain of $2,100 which will be taxed at ordinary income tax rates.
John became an AMT taxpayer last year. As a result, he had to add several items to his taxable income in arriving at alternative minimum taxable income. Which of the following items will result in an AMT credit that can be used to offset future regular tax liability? A) $7,000 in property taxes paid on his principal residence. B) $80,000 difference between the fair market value of stock and the strike price in the incentive stock option used to purchase the stock. C) $3,000 in interest on private activity municipal bonds. D) $2,000 above the AGI threshold for medical expenses.
B) $80,000 difference between the fair market value of stock and the strike price in the incentive stock option used to purchase the stock. The inclusion of the difference between the fair market value and exercise price of the stock options will result in a credit that John can use against future regular income tax liability. The other items are adjustments made to his itemized deductions, which result in permanent differences in tax liability as a result of the imposition of the AMT.
Which of the following is true regarding AMT? A) Interest for home acquisition indebtedness deducted for regular tax purposes must be added back. B) A taxpayer who has deductible medical expenses for regular tax purposes of $10,000 will have an add-back for AMT purposes. C) Municipal bond interest must be added back for AMT purposes. D) Charitable contributions deducted for regular income tax purposes are limited to 30%.
B) A taxpayer who has deductible medical expenses for regular tax purposes of $10,000 will have an add-back for AMT purposes. Medical expenses are allowed in amounts over 7.5% of AGI for 2017 and 2018. For AMT purposes, they are allowed in amounts over 7.5% of AGI (10% beyond 2018). There is no add back. Interest deducted for home acquisition indebtedness is not an add-back for AMT; however, it is if the loan is a home equity loan. Charitable contributions are not added back for AMT purposes. Municipal bonds in general are not added back for AMT purposes, however, private activity bonds are.
All of the following statements concerning depreciation are correct EXCEPT: A) Depreciation is a method of cost recovery that allows a taxpayer to receive his capital back over the useful life of an asset. B) Assets purchased for personal use are eligible for depreciation deductions. C) Depreciation deductions cause a downward adjustment in the taxpayer's basis. D) Depreciation on real estate is taken on a straight-line basis.
B) Assets purchased for personal use are eligible for depreciation deductions. **Assets purchased for personal use are not eligible for depreciation deductions - only assets used in a trade or business or for the production of income qualify for depreciation deductions. All of the other statements are correct.
The alternative minimum tax (AMT) was originally designed to: A) Create a more user-friendly tax system. B) Curb abuses by high-income taxpayers. C) Provide additional credits to certain low-income taxpayers. D) Give taxpayers a choice of which tax to pay.
B) Curb abuses by high-income taxpayers. The AMT was enacted in 1986 to curb perceived abuses by high-income taxpayers trying to minimize their current income tax liability.
Paul, David, Kristina, and Rachel are partners in MovieMakers, LLC. They all participate in the business to some extent and there are no other employees. Given the following activities, which of these individuals are clearly material participants? • Paul has a job outside of the business but does provide about 125 hours a year to help market the business. • David devotes all of his time to the business and generally devotes 60 hours per week to the business. • Kristina has materially participated in the business for the last 7 years, however she only dedicated about 50 hours this year because she had a baby in January. • Rachel devotes very little time to the business and only helps on an as-needed basis. She rarely helps more than 2 or 3 hours per month. A) David only. B) David and Kristina. C) David and Paul. D) David, Kristina, Paul and Rachel.
B) David and Kristina. David and Kristina both meet one of the seven tests for material participation. It is unlikely that Paul and Rachel meet the "facts and circumstances" test. The seven tests for material participation are: 1. The taxpayer dedicates more than 500 hours of effort to the activity each year. 2. The taxpayer dedicates more than 100 hours to the activity, but no less than anyone else. 3. The taxpayer dedicates more than 100 hours to each of several activities, and more than 500 hour in total for those activities not including any activity for which he is a material participant. 4. The taxpayer is the only person substantially participating in the operation of the activity. 5. The taxpayer has materially participated in the activity for 5 out of the last 10 years. 6. If the activity is a personal service activity, the taxpayer has materially participated in that personal service activity for at least 3 years. A personal service activity includes any trade or business where capital is not a material income producing factor, and professional services (law, accountancy, medicine, engineering, performing arts, and the like). 7. The facts and circumstances surrounding the case indicate that the taxpayer has been regularly, continuously, and substantially involved in the activity. David meets rule 1 and Kristina meets rule 5.
James and Ryann are good friends. They decide to open a sports equipment store together because of their love of the outdoors. They each own 50 percent in SportsCrazy, LLC, which is taxed as a partnership. Ryann manages the business. James has a thriving tax practice and therefore does not participate in the operation of the business. Which of the following is true? A) Only the income distributed to Ryann is considered passive income. B) Only the income distributed to James is considered passive income. C) The income distributed to both Ryann and James is considered passive income. D) The income distributed to both Ryann and James is considered active income.
B) Only the income distributed to James is considered passive income. The distributive share of the partnership income that Ryann receives will be considered active income since Ryann materially participates in the conduct of SportsCrazy business. James's distributive share of the partnership income will be treated as passive income/loss since James is not materially participating in the conduct of the business activities.
Which of the following would be added to a taxpayer's regular taxable income to arrive at alternative minimum taxable income? A) Receipt of interest on public purpose municipal bonds. B) Receipt of interest on private activity municipal bonds. C) Exercise of nonqualified stock options. D) Sale of the shares purchased through the exercise of incentive stock options.
B) Receipt of interest on private activity municipal bonds. While private activity municipal bonds generate interest that is exempt for regular income tax purposes, once a taxpayer is subject to the AMT, the interest generated by these bonds is taxable, and must be added to alternative minimum taxable income. The interest earned on public purpose municipal bonds is always exempt from tax under the regular or AMT system. The exercise of a non-qualified stock option will generate ordinary income which is taxed for regular income tax purposes, but would not have to be added back to calculate AMTI. The sale of shares purchased through the exercise of incentive stock options generates a negative adjustment to AMTI.
Which of the following assets qualifies as a Section 1231 asset? A) Greeting cards held by the owner of a gift shop for sale to customers. B) A bicycle owned by a 12 year old child. C) An apartment building held for rental to tenants. D) Artwork prominently displayed in a taxpayer's summer residence.
C) An apartment building held for rental to tenants. **The only asset that is listed that qualifies for depreciation deductions is the apartment building held for rental to tenants. Many individuals automatically classify real estate as a capital asset, but depreciable real estate held for productive use in a trade or business or for the production of income is classified as a Section 1231 asset. The greeting cards in option a are ordinary income assets (inventory), and the bicycle and artwork in options b and d are capital assets.
All of the following statements about the alternative minimum tax (AMT) are correct, EXCEPT: A) The AMT is designed primarily to change the timing of tax payments to more current. B) Some adjustments made for AMT purposes result in a permanent increase in tax. C) As an alternative to the regular income tax system, a taxpayer may elect to pay tax based on the AMT calculation. D) The AMT frustrates efforts by taxpayers to participate in activities that reduce or eliminate their current tax liability.
C) As an alternative to the regular income tax system, a taxpayer may elect to pay tax based on the AMT calculation. If the calculated tax due is greater under the AMT, the taxpayer must pay the higher amount. The AMT is not a voluntary alternative to the regular tax system. It is a mandatory alternative, and applies only when the AMT tax exceeds the regular tax imposed on the taxpayer.
Jaime and Barbara are owners in NurseStat, LLC a staffing agency for nurses. They operate the business on a part-time basis. Jaime puts in about 20 hours per week and Barbara puts in about 25 hours per week. Although they are married, they file married filing separately. Which of the following is true? A) Only Jaime is considered a material participant. B) Only Barbara is considered a material participant. C) Both Barbara and Jaime are considered a material participant. D) Neither Barbara nor Jaime are considered a material participant.
C) Both Barbara and Jaime are considered a material participant. For married taxpayers, the participation of both spouses may be combined when calculating the number of hours necessary to meet the material participation tests. Unlike most other provisions in the Code, the hours of involvement by the spouse may be used to determine material participation even if the couple files separately for income tax purposes. They are material participants in the enterprise with 2340 hours between them.
Edward was winding down his business and sold a machine, which he used in the business, to a former business associate, Philip, for $40,000. The machine originally cost $100,000 and Edward's adjusted basis in the machine was $20,000. The sale agreement requires Philip to pay for the machine in five equal annual installments, plus interest. Which of the following statements concerning this transaction is correct? A) Out of each installment sale payment, the gain on the sale will be treated as ordinary income until all of the depreciation recapture has been accounted for. B) Edward may recognize any depreciation recapture over the term of the installment note in the same proportion as recognition of gain. C) Edward must recognize all depreciation recapture immediately as ordinary income. D) The installment reporting provisions exempt Edward from ordinary income tax treatment of depreciation recapture.
C) Edward must recognize all depreciation recapture immediately as ordinary income. When an asset subject to depreciation recapture is sold on an installment note basis, the ordinary income depreciation recapture, to the extent of the gain, must be recognized in the year of sale regardless of when the payments on the note are received.
Darrin is the owner and manager of RUActive Bike Rental, LLC. RUActive rents bicycles to tourists at a resort that helps individuals lose weight. Most customers stay at the resort for two weeks, therefore, most bike rentals are for a period of 12 days. Darrin and his wife are the only two workers at the rental location. Which of the following is true for Darrin? A) The activity is passive because it is a rental activity. B) The activity is active because the average rental period is less than 14 days. C) The activity is active because the average rental period is 30 days or less and Darrin provides significant personal services. D) The activity is active because the rental period is inconsequential.
C) The activity is active because the average rental period is 30 days or less and Darrin provides significant personal services. The activity is active because Darrin meets one of the rental activity exceptions - the average rental period is 30 days or less and Darrin provides significant personal services.
All of the following adjustments or preferences will result in a permanent increase in tax when a taxpayer becomes an AMT taxpayer EXCEPT: A) Miscellaneous itemized deductions. B) State income taxes. C) The gain on stock underlying ISOs from the date of grant to the date of exercise. D) All of the above.
C) The gain on stock underlying ISOs from the date of grant to the date of exercise. The inclusion of the gain on ISOs from date of grant to date of exercise creates a credit that can be used against future regular income tax liability. All of the itemized deduction adjustments result in a permanent increase in tax liability when a taxpayer falls into the AMT system.
Which of the following statements correctly identifies when income is subject to tax?
Capital gains must be realized before they can be recognized on a tax return. **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.
Christopher recently purchased Quarry City Industrial Park, a commercial, industrial and office community, as an investment. The complex is already rented out to tenants, and Christopher will continue to lease the property to industrial and office space tenants while he owns the property. Which of the following statements concerning the depreciation deductions that can be taken on the property is correct?
Christopher can depreciate the cost allocable to the buildings (but not the land) over a 39 year period. **Commercial rental property is depreciated on a straight-line basis over a 39 year period. Depreciation deductions are allowed for the structures, but not the land.
Christopher purchased a home in Connecticut three years ago for $300,000. He had been working in Connecticut for the past 10 years. Yesterday, his employer decided to transfer him to the San Diego, California branch, effective next month. Unfortunately, the real estate market has weakened over the past few years, and Christopher is only able to sell his home for $270,000. Which of the following statements correctly identifies his tax consequences of the sale:
Christopher is not permitted to deduct the loss on his income tax return. **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.
Which of the following could qualify as a residence, for personal residence exclusion from gain? 1. A condominium. 2. An RV. 3. A boat. 4. Vacant land adjacent to personal residence regularly used by the taxpayer. A) 4 only. B) 1 and 4. C) 1, 2, and 3. D) 1, 2, 3, and 4.
D) 1, 2, 3, and 4. All qualify if used as a personal residence. The vacant land will qualify if sold with the residence.
Your client, who has a taxable income of $200,000, is concerned about being subject to the alternative minimum tax (AMT). The following income and deductions were included in computing taxable income. Select the one item that may be added to (or subtracted from) regular taxable income in calculating the AMT. A) A long-term capital gain of $90,000. B) A cash contribution to your client's church of $18,000. C) Dividend income of $80,000. D) A state income tax deduction of $8,000.
D) A state income tax deduction of $8,000. Answer d is correct because no taxes are deductible for AMT purposes. Answers a, b, and c are included for both regular and AMT purposes.
Which of the following is not a like-kind exchange? A) A bank building for unimproved land. B) A business building in Mexico for a shopping center in Peru. C) A lot in California for a lot in Oregon. D) A truck for a tractor.
D) A truck for a tractor. Only real estate qualifies for like-kind exchange treatment after 2017.
Which of the following deductions would be fully allowed in calculating a 40-year old single taxpayer's AMT for 2018? A) Interest on a mortgage with a principal balance of $500,000. The mortgage was originally taken out for $400,000, and was almost immediately refinanced to acquire $100,000 in home equity. B) Interest on passive activity bonds. C) Real estate taxes paid on the taxpayer's principal residence. D) Casualty losses in excess of 10% of AGI for a declared disaster.
D) Casualty losses in excess of 10% of AGI for a declared disaster. While deductible for regular tax purposes, the interest on the $500,000 mortgage must be reduced by the percentage that represents financing above the original mortgage, which in this case is $100,000. Interest on passive activity bonds must be added back in calculating AMTI. State and local taxes are not deductible once a taxpayer becomes an AMT taxpayer, but casualty losses may be claimed following the same rules that apply for regular tax purposes.
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 taxpayers 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.
D) Gains on Section 1231 assets are taxed at long-term capital gains tax rates, and losses are taxed at ordinary income tax rates. **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 marginal tax rate on ordinary income is equal or less than 12%.
Which of the following is true regarding real estate activities? A) Real estate activities are always passive. B) An individual investor in rental real estate can always consider their real estate activities as active businesses. C) Closely held C corporations that participate in real estate activities will always be considered active businesses. D) Real estate professionals may be allowed to consider their real estate activities as active in some circumstances.
D) Real estate professionals may be allowed to consider their real estate activities as active in some circumstances. Real estate activities are generally passive, but exceptions do apply. An individual investor in rental real estate will be subject to the passive income rules; however, some exceptions apply. Closely held C corporations are also eligible if more than 50% of the gross receipts of the corporation are derived from real property trades or businesses in which the corporation materially participates.
Isabel is a 10 percent owner in Bubbles, LLC, a local pub that specializes in serving caviar and champagne. Which of the following will increase her basis? A) Isabel takes a cash distribution of income. B) Isabel is allocated a business loss. C) The business borrows nonrecourse debt. D) The business borrows recourse debt.
D) The business borrows recourse debt. The borrowing of recourse debt will increase her basis. The borrowing of nonrecourse debt does not change her basis. The distribution of income and the allocation of a loss will both decrease her basis.
Which of the following statements concerning the taxation of incentive stock options (ISOs) is correct? A) On the date of exercise, the difference between the fair market value of the stock and the exercise price is included in regular taxable income. B) If the taxpayer sells the stock acquired by exercising an ISO more than one year after the date the option was granted, the gain will be taxed at capital gains tax rates. C) The sale of stock acquired by exercising an ISO will trigger a potential AMT tax for the taxpayer. D) The grant of ISOs to a taxpayer does not result in a taxable event for regular or AMT tax purposes.
D) The grant of ISOs to a taxpayer does not result in a taxable event for regular or AMT tax purposes. When an ISO is exercised, there is no regular tax consequence, but the difference between the fair market value on the date of exercise and the strike price becomes an AMT preference. In order to achieve capital gains treatment on the exercise of an ISO, the taxpayer must hold the stock 2 years from the date of the grant and one year from the date of exercise, making option B incorrect. Option C is incorrect since it is the exercise of the option, not the sale of the stock, that triggers a potential AMT tax. Since ISOs must be issued with a strike price equal to fair market value on the date of the grant, they will never create a taxable event on issuance.
Ada is a 12 percent owner in SoccerStart, LLC a coaching service for young soccer players. She is also a 15 percent owner in HandsOn, LLC a successful chain of nail salons. She does not materially participate in either business. Her at-risk and loss/income for the current year is as follows: • SoccerStart - At-risk = $150,000; Loss of $250,000 • HandsOn - At-risk = $25,000; Income of $100,000 She also has wage income of $50,000 and capital gain income of $20,000. Which of the following statements is true? A) The loss suspended because of the at-risk rules is $75,000 and the loss suspended because of the passive loss rules is $75,000. B) The loss suspended because of the at-risk rules is $75,000 and the loss suspended because of the passive loss rules is $0. C) The loss suspended because of the at-risk rules is $50,000 and the loss suspended because of the passive loss rules is $100,000. D) The loss suspended because of the at-risk rules is $100,000 and the loss suspended because of the passive loss rules is $50,000.
D) The loss suspended because of the at-risk rules is $100,000 and the loss suspended because of the passive loss rules is $50,000. Of the $250,000 loss from SoccerStart $100,000 will be suspended because of the at-risk rules (she only has $150,000 at risk) and $50,000 will be suspended because of the passive loss rules (she only has $100,000 of passive income).
Which of the following statements properly describes the income tax treatment of asset sales? A) The sale of classic movies on DVDs by Movie Emporia (a retail movie distributor) will generate income subject to capital gains tax. B) The sale of Big Box Mart stock by an individual investor generates ordinary income. C) The sale of a desk, which was used for 10 years in a business, at a loss will result in a capital loss. D) The sale of a typewriter used for 10 years in a trade or business at a gain (after recapturing any depreciation) will generate a capital gain.
D) The sale of a typewriter used for 10 years in a trade or business at a gain (after recapturing any depreciation) will generate a capital gain. A typewriter used in a trade or business is a Section 1231 asset, and the sale of a Section 1231 asset at a gain is treated as a capital gain. The sale of DVDs by a retail distributor is a sale of inventory, which generates ordinary income. Big Box Mart stock held by an individual investor is a capital asset, which will generate a capital gain or loss upon sale. While short-term capital gains are taxed at ordinary rates, the gain/loss is still considered a capital gain/loss and is subject to special limitations. Finally, the sale of a desk used for 10 years in a business at a loss will result in an ordinary loss, since the desk is a Section 1231 asset.
In which of the following circumstances would a taxpayer be able to get a partial exemption for the sale of a personal residence when the taxpayer did not meet the two year ownership and use test? A) The taxpayer decides to move from Florida to Arizona to possibly look for a new job. B) The taxpayer changes jobs to a town that is 10 miles away from the former house and 10 miles away from the former job. C) The taxpayer sold the house in Milwaukee because the grey days were affecting her sunny disposition and general health. D) The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for 3 days.
D) The taxpayer suffered anxiety attacks after a home invasion where the taxpayer was held at gunpoint for 3 days. Option d is consistent with the unforeseen circumstances approved by the IRS (see Exhibit 13.6). Option a does not qualify because the taxpayer did not have a job when the residence was sold. Option b does not qualify because the move did not meet the distance requirement. Option c is not correct because general health does not qualify.
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.
D) The taxpayer's adjusted basis. **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.
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 short-term capital gain on the sale. **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.
Jacob loaned $10,000 to his close friend and business associate, Luke, so that Luke could start up a home-based business. Jacob is not in the business of money lending. Luke paid 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, Luke informs Jacob in Year 5 that he has filed for bankruptcy and will not be able to make any future interest ($500 per year) or principal payment, causing the debt to become wholly worthless. What is the income tax consequence for Jacob?
Jacob will recognize a short-term capital loss of $10,000 for Year 5. **This is a personal debt that has become wholly worthless. Therefore, Jacob 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. Jacob cannot deduct the $500 of lost interest for Year 5. Since he is a cash basis taxpayer, he never received the interest payment, and therefore never included it in his income. Recall that, generally, deductions are only allowed for items that are already included in the taxpayer's income.
Mike gave his granddaughter, Jordan, stock worth $500,000 this year. 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, Mike paid $200,000 in gift taxes on the transfer. If Jordan sells the stock for $750,000 six months after the transfer, which of the following statements is correct?
Jordan will realize a $400,000 long-term capital gain. **Jordan received the stock by gift, so she qualifies for a carry-over basis. Mike's original basis in the property was $250,000. Since Mike paid gift tax on the transfer, Jordan 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. Jordan'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 Mike transferred appreciated property to Jordan, his holding period is added to Jordan's holding period for the asset, transforming the gain into a longterm capital gain.
Kevin engaged in several capital transactions this year. He had a short-term capital gain of $400; a short-term capital loss of $600; a long-term capital gain of $800 and a long-term capital loss of $500. How will Kevin report these items on his income tax return?
Kevin will report a net long-term capital gain of $100. **Short-term capital losses can be netted against short-term capital gains, and long-term capital losses can be netted against long-term capital gains. Since there is a short-term loss of $200 and a long-term gain of $300, the short and long-term summary results can be netted together. In this case, since the long-term capital gain was larger on an absolute basis, the character of the resulting net gain is a long-term capital gain. Short-Term Long-Term Gains $400 $800 Losses <$600> <$500> Net <$200> $300 NSTCL <$200> NLTCG $300 NLTCG $100
Tanya gave her nephew, Liam, 100 shares of Bridge Corporation stock that she purchased 6 months ago for $10,000. At the time of the gift, the fair market value of the stock was $12,000. Which of the following statements concerning the stock is correct?
Liam's basis in the stock is $10,000. **Since Tanya transferred appreciated property to Liam by gift, her basis carries over to Liam. Liam has a $10,000 basis in the stock.
Milton, an independent consultant for Initech, Inc., purchased a new, red video camera to match his red stapler. He plans to use the camera primarily for personal purposes, but will occasionally use it (perhaps 25% of the time) to complete assignments that he has accepted from Initech, a client. Which of the following statements concerning the red camera is correct?
Milton will not be eligible to claim depreciation deductions for the camera because his wage is less than 50%. **Video cameras are listed property. In order to qualify for depreciation deductions on listed property, the property must be used for business purposes more than 50% of the time. Provided that the property is used primarily for business purposes, the owner may take depreciation deductions for that portion of the property that is used for business. Since Milton used the property primarily for personal, not business purposes, he may not claim depreciation deductions.
After 35 years in business for herself, Daisy retired and closed the doors of her office. She gave her desk to her niece, Molly, who recently completed her degree in a similar field and is opening up her practice. Daisy originally paid $12,000 for the desk, and it was fully depreciated by the time she gave it to Molly. Molly used the desk for two years, and then sold it (for $6,000) when she decided to redecorate her office. How will Molly treat the proceeds from the sale of the gift for income tax purposes?
Molly will recognize $6,000 of ordinary income on the sale. When a gift of Section 1231 property is made, the depreciation recapture potential, as well as the taxpayer's basis, is carried over to the new owner. Molly received the desk with a basis of zero, and a potential for up to $12,000 of depreciation recapture. Since Molly sold the desk for $6,000 the entire sales proceeds will constitute depreciation recapture and will be taxed at ordinary income tax rates.
Which of the following items is not included in the cost basis of an investment?
Nonrecourse debt incurred in purchasing the investment **Non-recourse debt is generally not included in basis because a taxpayer is not personally obligated to repay the loan. All of the other items are included in the determination of a taxpayer's basis in their investment.
Rennie, a 12 year old middle school student, just agreed to take over a paper route to deliver Newsday to his extended neighborhood on a daily basis. To deliver the papers, he purchases a new bike with a specially equipped basket to transport the papers each morning. How is the bike classified for income tax purposes?
The bike is a Section 1231 asset. Since the bike is depreciable personal property used in the conduct of trade or business activity, the bike is considered a Section 1231 asset. Even though it is used to generate ordinary income, the fact that Rennie could claim depreciation on the bike makes it a Section 1231 asset.
Philip wants to sell his rental beach home and purchase rental property in the mountains. His friend, Randy, tells him he can do a nonsimultaneous tax-free exchange as long as the fair market value of mountain property is equal to or greater than the fair market value of the beach property. How long after selling his beach property does he have to identify and purchase the mountain property?
The mountain property must be identified within 45 days of the closing of the beach property and must be closed within 180 days of the closing of the beach property. The taxpayer in a nonsimultaneous exchange must identify the replacement property within 45 days of the sale of the original property and close on the replacement property within 180 days of the closing of the original property.
As the end of the year was approaching, Edward reviewed his stock portfolio and decided to sell his holdings in Windsor Industries on December 28th of Year 1. The shares were purchased two years ago. His basis in the shares was $20,000 and the market value of the shares was $18,000. Edward wanted to use the $2,000 loss to help him minimize taxes for Year 1. On January 10th, Year 2, Windsor Industries announced new initiatives, and Edward has second guessed his decision to sell the shares in the company. He buys back the 1,000 shares for $17,000 on January 11th. Assuming that Edward had no other capital transactions for Year 1, what is the impact of this transaction on Edward's Year 1 income tax return?
The sale of Windsor Enterprises will not impact Edward's AGI for Year 1. **Since Edward purchased and sold the same security within a 30-day period, the sale is considered to be a washsale transaction, and the loss may not be claimed in the current period.
Wilson runs an oil and gas operations consulting practice, and has had a very good year. Oil prices, as well as the demand for his services, have risen. Given the windfall profits his firm received this year, in December of 2018 Wilson decided to redecorate his office and upgrade the computer system used by himself and his employees. The cost of the office equipment is $40,000 and the computer upgrade cost $20,000. Assuming Wilson has purchased no other depreciable assets in 2018, the net income from his consulting practice was $500,000, and Wilson would like to minimize his exposure to income taxes, how should he treat the new purchases for income tax purposes?
Wilson should deduct the entire cost of the office equipment and computer upgrades against this year's business income. **Wilson qualifies for the Section 179 election, allowing him to immediately expense the cost of up to $1,000,000 for 2018 (as indexed) against his business income. Since Wilson had business income to offset with the deduction, and he did not put more than $2,500,000 for 2018 of depreciable property in service this year, and he has expressed a desire to minimize his exposure to income tax this year, he qualifies for the immediate expense election.
