80) Everest Corp. acquires a machine (seven-year property) on January 10, 2013 at a cost of $2,015,000. Everest makes the election to expense the maximum amount under Sec. 179, but elects out of bonus depreciation.

a.     Assume that the taxable income from trade or business is $1,000,000.

        (1) What is the amount of the Section 179 expensing deduction for the current year?

        (2) What is the amount of the Section 179 carryover to the next tax year?

        (3) What is the amount of depreciation allowed?

b.     Assume instead that the taxable income from trade or business is $400,000.

        (1) What is the amount of the Section 179 expensing deduction for the current year?

        (2) What is the amount of the Section 179 carryover to the next tax year?

        (3) What is the amount of depreciation allowed this year?        

Answer: 
a. (1)Sec. 179 ceiling:                                                                                                       $500,000

        Minus: Equipment cost exceeding $2,000,000                                                 ( 15,000)

        Allowable 179 deduction                                                                                      $485,000

        Taxable income for the year                                                                              $1,000,000

        Sec. 179 expense (lesser of two preceding amounts)                                     $485,000

        (2) None. There is no carryover because there was no taxable income limitation.

        (3) Basis for depreciation:

        Cost                                                                                                                           $2,015,000

        Sec. 179 deduction                                                                                                  ( 485,000)

        Minus: Basis to depreciate                                                                                 $1,530,000

        Depreciation ($1,530,000 × 0.1429)                                                                     $218,637

        Sec. 179 expense allowed                                                                                        485,000

        Total deductions                                                                                                      $703,637

b.     (1) Sec. 179 ceiling:                                                                                                   $500,000

        Minus: Equipment cost exceeding $2,000,000                                                 ( 15,000)

        Equals amount over threshold                                                                            $485,000

        Taxable income for the year                                                                                  $400,000

        Sec. 179 expense (lesser of two preceding amounts)                                     $400,000

        (2) $485,000 allowable – $400,000 currently deductible = $85,000 carryover.

        (3) Basis for depreciation:

        Cost                                                                                                                           $2,015,000

        Sec. 179 potential deduction (including amount carried over)                 (485,000)

        Minus: Basis to depreciate                                                                                 $1,530,000

        Depreciation ($1,530,000 × 0.1429)                                                                     $218,637

        Sec. 179 expense allowed                                                                                        400,000

        Total deductions                                                                                                     $618,637

Page Ref.:  I:10-6 through I:10-8; Examples I:10-7 and I:10-8

Objective:  1


81) In August 2013, Tianshu acquires and places into service 7-year business equipment (tangible personal property qualifying under Sec. 179) for $270,000. This is the only asset that she purchased during the year; her taxable income from her trade or business is $130,000. She decides to limit her 179 election to the maximum amount allowable in her business for the current year. What is her maximum cost recovery (Sec. 179 and depreciation) deduction for 2013?

Answer:  Section 179 immediate expensing (limited to income) $130,000

MACRS depreciation:

                ($270,000 – $130,000) = $140,000 × .1429 =                   20,006

Total depreciation                                                                           $150,006

Page Ref.:  I:10-6 through I:10-8; Examples I:10-7 and I:10-8

Objective:  1

82) On June 30, 2013, Temika purchased office furniture costing $259,000 and computers with a cost of $400,000. She uses Sec. 179. Her business income is $900,000 without considering Sec. 179. How should she allocate the 179 election in order to maximize her total cost recovery deductions (depreciation and Sec. 179) for 2013 (assume that bonus depreciation is not available)?

Answer:  If Temika assigns the Section 179 deduction first to the office furniture, then to the computers:

Office furniture – Sec. 179                                                              $259,000

Computers- Sec. 179 (500,000 – 259,000)                                     241,000

Computers-depreciation (.2 × (400,000 – 241,000)                      31,800

Total cost recovery                                                                           $531,800

If Temika assigns the Section 179 deduction first to the computers, then to the furniture:

Computers – Sec. 179                                                                      $400,000

Office Furniture (500,000 – 400,000)                                             100,000

Depreciation on office furniture

[(259,000 – 100,000) × .1429]                                                              22,721

Total cost recovery                                                                           $522,721

Temika should allocate the Sec. 179 deduction first to the office furniture to maximize her cost recovery deductions.

Page Ref.:  I:10-6 through I:10-8; Example I:10-7

Objective:  1

83) Mehmet, a calendar-year taxpayer, acquires 5-year tangible personal property in 2013 and does not use Sec. 179. Bonus depreciation is not available. Mehmet places the property in service on the following schedule:

Date placed in service                        Acquisition Cost

January 15                                                $50,000

May 25                                                    $100,000

November 8                                           $200,000

What is the total depreciation for 2012?

Answer: 

Placed in Service                  MACRS Depreciation

January 15                           $50,000 × .35                  =    $17,500

May 25                                  $100,000 × .25               =    $25,000

November 8                         $200,000 × .05               =    $10,000

                                                                                                 $52,500

More than 40% of the assets are placed in service in the last quarter of the year so the mid-quarter convention must be used.

Page Ref.:  I:10-8 and I:10-9; Example I:10-11

Objective:  1

84) Greta, a calendar-year taxpayer, acquires 5-year tangible personal property in 2013 and places the property in service on the following schedule:

Date placed in service                        Acquisition Cost

January 15                                               $ 80,000

May 25                                                       $30,000

November 8                                           $508,000

Greta elects to expense the maximum under Section 179, and selects the property placed into service on November 8. Her business ‘s taxable income before section 179 is $900,000. What is the total cost recovery deduction (depreciation and Sec. 179) for 2013?

Answer: 

Placed in Service                  Section 179            MACRS Depreciation

January 15                                                           $80,000 × .20 =         $16,000

May 25                                                                  $30,000 × .20 =            $6,000

November 8                        $500,000               $8,000 × .20 =             $ 1,600

                                                $500,000                          +                         $23,600    = $523,600

Page Ref.:  I:10-9; Example I:10-12

Objective:  1

85) During the year 2013, a calendar year taxpayer, Marvelous Munchies, a chain of specialty food shops, purchased equipment as follows:

Date                                   Asset                                Cost     

March 3                        Refrigerators                     600,000

October 9                      Equipment                     1,200,000

Assume the property is all 5-year property. Marvelous Munchies does not use Sec. 179, and bonus depreciation is not available. What is the maximum depreciation that may be deducted for the assets this year, 2013, assuming the alternative depreciation system is not chosen?

Answer:  The mid-quarter convention must be used because $1,200,000/$1,800,000 or 66 2/3% of the assets were purchased in the last quarter of the year.

$600,000 × .35           =     $210,000

$1,200,000 × .05        =         60,000

Total                                    $270,000

Page Ref.:  I:10-9; Example I:10-12

Objective:  1

86) On May 1, 2008, Empire Properties Corp., a calendar year taxpayer, purchased an apartment building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2013.

a.    What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2008?

b.    What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2013?

Answer: 
a.    $600,000 × .02273 = $13,638. p. C-7. Table 7 in Appendix C.

b.    $600,000 × .03636 × 8.5/12 = $15,453. p. C-7. Table 7 in Appendix C.

Page Ref.:  I:10-10

Objective:  1

87) On May 1, 2011, Empire Properties Corp., a calendar year taxpayer, purchased an office building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2013.

a.    What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2011?

b.    What was the corporation’s depreciation for the building, using statutory percentages under MACRS

 for 2013?

Answer: 
a.    $600,000 × .01605 = $9,630. p. C-9. Table 9 in Appendix C.

b.    $600,000 × .02564 × 8.5/12 = $10,897. p. C-9. Table 9 in Appendix C.

Page Ref.:  I:10-10; Example I:10-15

Objective:  1

88) In January of 2013, Brett purchased a Porsche for $100,000 to be used in his business.  Brett drove the car 83 percent of the time for business. What is the maximum amount (including regular MACRS depreciation, bonus depreciation and Section 179 expensing) that Brett may deduct in 2013?

Answer:   $11,160 × .83 = $9,263.

Page Ref.:  I:10-13 and I:10-14; Example I:10-24

Objective:  1

89) Stellar Corporation purchased all of the assets of Bellavia Company as of January 1 this year for $1 million.  Included in the assets acquired are the following intangible assets:

AssetUseful LifeCost
Patent10 year$120,000
Covenant not to complete3 years30,000
GoodwillIndefinite300,000

What is Stellar’s maximum amortization deduction for the year?

Answer:  The assets are Sec. 179 acquisition-related intangibles so regardless of their legal or economic lives, they must be amortized over 15 years.

Patent $120,000/15$8,000
Covenant not to compete $30,000/152,000
Goodwill $300,000/1520,000
Total amortization deduction$30,000

Page Ref.:  I:10-18; Example I:10-29

Objective:  2

90) Jack purchases land which he plans on developing as a golf course. The land costs $20,000,000 and the cost of clearing the land, earthmoving, constructing hazards, bunkers and greens, and installing irrigation systems will cost an additional $6,000,000. What tax issues should Jack consider?

Answer:  Are the costs of constructing the course considered depreciable land improvements or are they considered part of the cost of land, and not depreciable?

Page Ref.:  I:10-2

Objective:  1

91) Debbie’s Donuts is planning a major expansion over the next several months, opening many new locations around the state. The company will be spending several million dollars on new equipment and furnishings. The company is debating whether to push to get them all opened by December 2013 or whether to gradually roll out the new locations from December through March. Discuss the tax considerations that should be taken into account.

Answer:  A significant consideration is the availability of bonus depreciation. For qualifying property placed in service by December 31, 2013, bonus depreciation is 50%, allowing the much of the cost of all of the qualifying equipment and furnishings to be deducted in 2013.  Bonus depreciation is scheduled to expire as December 31, 2013.

Page Ref.:  I:10-8

Objective:  1

92) Eduardo is planning to purchase some new pizza ovens for his business. He knows that there are various incentives in the tax law to acquire new assets in 2013. Discuss the tax incentives available and the issues to consider in deciding whether to elect them.

Answer:  There are two potential incentives for new depreciable personal property acquired in 2013. The Section 179 expensing is currently $500,000, with a phaseout starting at $2,000,000.  Sec. 179 is limited by the taxpayer’s preliminary taxable income.  Second, for new personal property (the original use of the asset begins with the taxpayer), 50% bonus depreciation is available. Bonus depreciation, unless extended by Congress, expire as of December 31, 2013. The taxpayer is assumed to choose to use bonus depreciation on a qualifying asset and must elect out of it if he does not wish to apply it. On the other hand, the taxpayer must elect to apply Section 179 expensing. The decision of the taxpayer should be based on his marginal tax rate in the current year versus expected marginal tax rate in future years, taking time value of money into account.

Page Ref.:  I:10-6 through I:10-8

Objective:  1

93) Bert, a self-employed attorney, is considering either purchasing or leasing a $50,000 automobile for use in his business. What are the issues he should consider in making his decision?

Answer:  Bert should be aware of the fact that in addition to being considered listed property and, therefore, subject to some limitations when it comes to depreciation methods, automobiles are also subject to the luxury automobile depreciation limits. Depreciation on automobiles used more than 50% of the time for trade or business is the lesser of MACRS depreciation or a specific statutory ceiling. Depreciation on automobiles used 50% or less in trade or business is the lesser of ADS straight-line depreciation or the specific statutory ceiling. On the other hand, lease payments are fully deductible (subject to usage percentages). However, an “inclusion amount” obtained from an IRS table must be included in gross income.

Page Ref.:  I:10-13 through I:10-16

Objective:  1

94) Why would a taxpayer elect to capitalize and amortize intangible drilling costs (IDCs) rather than expense such costs?

Answer:  An election to expense IDCs reduces pre-depletion taxable income and thus results in a smaller percentage depletion deduction. Capitalization and amortization of such costs would generally result in a higher pre-depletion taxable income, which would result in a higher percentage depletion deduction if it was anticipated that this limitation would apply.  Otherwise, it would be more beneficial to expense the IDCs since the higher of percentage or cost depletion is utilized.

Page Ref.:  I:10-23

Objective:  3

95) Discuss the options available regarding treatment of an amount paid in excess of the FMV of an acquired company’s net assets in a business combination.

Answer:  Any amount paid in excess of the FMV of the acquired company’s net assets may be treated as a payment for goodwill, a payment for a covenant not to compete, and/or a payment for some other type of intangible asset. The sales agreement should specify the amount of the purchase price allocated to each type of asset. Under current tax law, a wide variety of intangible assets are subject to amortization. Within reason, the purchaser should attempt to have greater amounts allocated to those assets that will provide large current depreciation or amortization deductions. Since intangibles are given a 15 year life, there will be a tendency to allocate more of the purchase price to tangible personal property.

Page Ref.:  I:10-24

Objective:  4

96) Why would a taxpayer elect to use the alternative depreciation system rather than the MACRS rules?

Answer:  Use of the alternative depreciation system would be preferred if the taxpayer anticipates losses over the next few years or if the taxpayer has an NOL carryover or substantial business credit carryovers. Use of alternative depreciation would result in lower depreciation charges, thus resulting in higher taxable income to offset anticipated losses or the NOL carryover, resulting in low taxes or no taxes. Without election of the alternative depreciation system, the NOL carryovers might be lost. Thus, the alternative method permits use of the NOL carryovers and also results in higher depreciation in later years of the asset’s life when higher deductions may be preferred due to higher marginal rates.

Page Ref.:  I:10-24

Objective:  4

Chapter I11 

1) A taxpayer’s tax year must coincide with the year used to keep the taxpayer’s books and records.

Answer:  TRUE

Page Ref.:  I:11-2

Objective:  1

2) A fiscal year is a 12-month period that ends on the last day of any month other than December.

Answer:  TRUE

Page Ref.:  I:11-2

Objective:  1

3) A partnership must generally use the same tax year of the partners who own the majority of partnership income and capital.

Answer:  TRUE

Page Ref.:  I:11-2

Objective:  1

4) If the majority of the partners do not have the same tax year, the partnership must use the tax year of its principal partners.

Answer:  TRUE

Page Ref.:  I:11-2

Objective:  1

5) All C corporations can elect a tax year other than a calendar year.

Answer:  FALSE

Explanation:  Personal service corporations are generally required to use a calendar year.

Page Ref.:  I:11-2

Objective:  1

6) An improper election to use a fiscal year automatically places the taxpayer on the calendar year.

Answer:  TRUE

Page Ref.:  I:11-3

Objective:  1

7) If Jett Corporation receives a charter in 2011 but does not begin operations and file its first tax return until 2013, Jett may elect a fiscal year on the 2013 return.

Answer:  FALSE

Explanation:  Since tax returns were required for 2011 and 2012, the returns are not timely filed and the election may not be made.

Page Ref.:  I:11-3; Example I:11-2

Objective:  1

8) Partnerships, S corporations, and personal service corporations may elect a taxable year which results in a tax deferral of four months or less.

Answer:  FALSE

Explanation:  A tax deferral of three months or less is allowed.

Page Ref.:  I:11-3

Objective:  1

9) Except in a few specific circumstances, once adopted, an accounting period may be changed without IRS approval.

Answer:  FALSE

Explanation:  IRS permission must be requested for most changes in accounting method.

Page Ref.:  I:11-4

Objective:  1

10) A newly married person may change tax years to conform to that of his or her spouse so that a joint return may be filed.

Answer:  TRUE

Page Ref.:  I:11-5

Objective:  1

11) Generally, an income tax return covers an accounting period of 12 months.

Answer:  TRUE

Page Ref.:  I:11-5

Objective:  1

12) A subsidiary corporation filing a consolidated return with its parent corporation must change its accounting period to conform with its parent’s tax year.

Answer:  TRUE

Page Ref.:  I:11-5

Objective:  1

13) The final tax return of Marjorie, a single taxpayer on the calendar basis, who died on July 15, 2013, is due on April 15, 2014 (ignoring extensions).

Answer:  TRUE

Page Ref.:  I:11-6; Example I:11-9

Objective:  1

14) Taxpayers who change from one accounting period to another must annualize their income for the resulting short period.

Answer:  TRUE

Page Ref.:  I:11-6

Objective:  1

15) Generally, if inventories are an income-producing factor to the business, the accrual method must be used for sales and cost of goods sold.

Answer:  TRUE

Page Ref.:  I:11-7

Objective:  2

16) Alvin, a practicing attorney who also owns an office supplies store, may use the cash basis for his practice and the accrual basis for his office supplies store.

Answer:  TRUE

Explanation:  The fact that an overall accounting method is used in one trade or business does not mean that the same method must be used in a second trade or business or for nonbusiness income and deductions.

Page Ref.:  I:11-7; Example I:11-11

Objective:  2

17) A taxpayer must use the same accounting method on the personal tax return that the taxpayer uses in the taxpayer’s trade or business.

Answer:  FALSE

Explanation:  The fact that an overall accounting method is used in one trade or business does not mean that the same method must be used in a second trade or business or for nonbusiness income and deductions.

Page Ref.:  I:11-7; Example I:11-11

Objective:  2

18) C corporations and partnerships with a corporate partner may use the cash method of accounting if average annual gross receipts for the three preceding tax years do not exceed $10 million.

Answer:  FALSE

Explanation:  The average gross receipts must not exceed $5 million.

Page Ref.:  I:11-8

Objective:  2

19) Under the cash method of accounting, income is reported for the tax year in which payments are actually or constructively received.

Answer:  TRUE

Page Ref.:  I:11-8

Objective:  2

20) Under the cash method of accounting, all expenses are deductible when paid.

Answer:  FALSE

Explanation:  If the benefits of the expenditure extend significantly beyond the end of the tax year, the expenditure must be capitalized and deducted over period benefited.

Page Ref.:  I:11-8

Objective:  2

21) Points paid on a mortgage to buy a personal residence are deductible in the year paid.

Answer:  TRUE

Page Ref.:  I:11-8

Objective:  2

22) Under the cash method of accounting, payment by credit card entitles the taxpayer to deduct the expenditure at the time the charge is made.

Answer:  TRUE

Explanation:  Payment by credit card is considered equivalent to borrowing money to pay the bill.

Page Ref.:  I:11-9

Objective:  2

23) If a cash basis taxpayer gives a note in payment of an expense, the deduction may not be taken until the note is paid.

Answer:  TRUE

Explanation:  The taxpayer cannot take the deduction until the note is paid.

Page Ref.:  I:11-9

Objective:  2

24) The all-events test requires that the accrual-basis taxpayer report income when all events have occurred that fix the taxpayer’s right to the income and when the amount can be determined with reasonable accuracy.

Answer:  TRUE

Page Ref.:  I:11-9

Objective:  2

25) Under the accrual method of accounting, the two tests to determine when income must be reported and expenses deducted are the all-events test and the economic performance test.

Answer:  TRUE

Page Ref.:  I:11-9

Objective:  2

26) One criterion which will permit a deduction for an expenditure by the accrual-basis taxpayer prior to economic performance is that either the amount is not material or the earlier accrual of the item results in a better matching of income and expense.

Answer:  TRUE

Page Ref.:  I:11-9

Objective:  2

27) A taxpayer who uses the cash method in computing gross income from his or her business must use the cash method in computing expenses of such business.

Answer:  TRUE

Explanation:  See “Key Point” in text.

Page Ref.:  I:11-10

Objective:  2

28) A business which provides a warranty on goods sold will deduct a reserve for warranty expense consistent with the reporting on its financial statements.

Answer:  FALSE

Explanation:  Expenses for reserves do not satisfy the all events and economic performance requirements for accrual.

Page Ref.:  I:11-10

Objective:  2

29) A taxpayer may use a combination of accounting methods as long as income is clearly reflected.

Answer:  TRUE

Explanation:  This flexibility allows smaller businesses with inventories to use a hybrid method.

Page Ref.:  I:11-10

Objective:  2

30) A taxpayer who uses the LIFO method of inventory valuation may use the lower of cost or market method.

Answer:  FALSE

Explanation:  Lower of cost or market is not permitted with the LIFO inventory method.

Page Ref.:  I:11-11

Objective:  3

31) The uniform capitalization rules (UNICAP) require the capitalization of some overhead costs that are expensed for financial accounting purposes.

Answer:  TRUE

Explanation:  UNICAP is a more comprehensive capitalization requirement.

Page Ref.:  I:11-11

Objective:  3

32) Many taxpayers use the LIFO method of inventory valuation because during inflationary periods, LIFO normally results in the lowest inventory value and hence the lowest taxable income.

Answer:  TRUE

Page Ref.:  I:11-12

Objective:  3

33) A taxpayer may use the FIFO or average cost methods for financial statement purposes, while using the LIFO method for tax purposes.

Answer:  FALSE

Explanation:  Once LIFO has been elected for tax purposes, the taxpayer’s financial reports must also be prepared using LIFO.

Page Ref.:  I:11-12

Objective:  3

34) For tax purposes, the lower of cost or market method must ordinarily be applied to each separate inventory item.

Answer:  TRUE

Page Ref.:  I:11-14

Objective:  3

35) For tax purposes, “market” for purposes of applying the lower of cost or market method means the price at which the taxpayer can sell the inventory item.

Answer:  FALSE

Explanation:  Market means the price at which the taxpayer can replace the inventory item.

Page Ref.:  I:11-14

Objective:  3

36) Contracts for services including accounting, legal and architectural services do not qualify for long-term contract treatment.

Answer:  TRUE

Explanation:  Long-term contracts include building, installation, construction or manufacturing contracts that are not completed in the same tax year in which they begin.

Page Ref.:  I:11-15

Objective:  4

37) A taxpayer must use the same accounting method, either percentage of completion or completed contract method, for all long-term contracts in the same trade or business.

Answer:  TRUE

Page Ref.:  I:11-15

Objective:  4

38) The installment method is not applicable to sales of inventory and marketable securities.

Answer:  TRUE

Page Ref.:  I:11-18

Objective:  4

39) The installment sale method may be used on the sale of property at a loss.

Answer:  FALSE

Explanation:  The installment sale method is not allowed when property is sold at a loss.

Page Ref.:  I:11-21

Objective:  4

40) Interest is not imputed on a gift loan between two individuals totaling $12,000 except when the borrowed funds are used to purchase income-producing property.

Answer:  FALSE

Explanation:  Interest is not imputed on a gift loan totaling $10,000 or less unless the proceeds are used to purchased income-producing property.

Page Ref.:  I:11-24

Objective:  5

41) Interest is not imputed on a gift loan between two individuals totaling $100,000 except when the borrowed funds are used to purchase income-producing property.

Answer:  FALSE

Explanation:  The use of the funds does not determine the necessity to impute interest; however, the imputed interest is limited to net investment income.

Page Ref.:  I:11-24

Objective:  5

42) In general, a change in accounting method must be approved by the IRS.

Answer:  TRUE

Page Ref.:  I:11-26

Objective:  6

43) A new business is established.  It is not a seasonal business.  All of the following are acceptable accounting tax years with the exception of

A) an S corporation year ending October 31.

B) a C corporation (not a personal service corporation) tax year ending on February 15.

C) a C corporation (not a personal service corporation) tax year ending on April 30.

D) a partnership tax year ending on October 31 with three equal partners whose tax years end on September 30, October 31, and November 30.

Answer:  B

Explanation:  B) A fiscal year ends on the last day of a month.

Page Ref.:  I:11-2

Objective:  1

44) When preparing a tax return for a short period, the taxpayer should annualize the income if the short period return

A) is the last return for a decedent who died on June 15.

B) is the first return for a corporation created on June 1.

C) is the last return for a partnership, which was terminated on October 12.

D) is a return for June 1 to December 31, for a corporation changing from a fiscal year to a calendar year.

Answer:  D

Explanation:  D) Annualization is required for a change in accounting period.

Page Ref.:  I:11-6

Objective:  1

45) Emma, a single taxpayer, obtains permission to change from a calendar year to a fiscal year ending June 30, 2013. During the six months ending June 30, 2013, she earns $40,000 and has $8,000 of itemized deductions. What is the amount of her annualized income?

A) $32,150

B) $30,050

C) $60,100

D) $64,300

Answer:  C

Explanation:  C)

Gross income$40,000
Minus: Itemized deductions( 8,000)
Minus: Personal exemption ($3,900 × 6/12)( 1,950)
Modified taxable income$30,050
Annualized income (12/6 × $30,050)$60,100

Page Ref.:  I:11-6; Example I:11-10

Objective:  1

46) All of the following statements are true except:

A) once adopted, an accounting period normally cannot be changed without approval by the IRS.

B) taxpayers who change from one accounting period to another must annualize their income for the resulting short period.

C) taxpayers filing an initial tax return are required to annualize the year’s income and prorate exemptions and credits.

D) an existing partnership can change its tax year without prior approval if the partners with a majority interest have the same tax year to which the partnership changes.

Answer:  C

Explanation:  C) Taxpayers filing an initial tax return and executors filing a taxpayer’s final return or corporations filing their last return are not required to annualize the year’s income, nor are personal exemptions or tax credits prorated.

Page Ref.:  I:11-4 through I:11-6

Objective:  1

47) Which of the following partnerships can elect the cash basis method of accounting?

A) a CPA firm with average revenues of $20 million

B) a chocolate manufacturer with average revenues of $3 million

C) a cleaning service partnership generating average revenues of $5.5 million whose partners are Joe, Larry and Smith Inc.

D) None of the above.

Answer:  A

Explanation:  A) A professional service partnership is not limited by size of revenues.

Page Ref.:  I:11-7 and I:11-8

Objective:  2

48) Under the cash method of accounting, all of the following are true with the exception of:

A) Fixed assets are always expensed as the taxpayer pays for the assets.

B) Gross income includes the value of property received.

C) To some extent, a taxpayer may control the year in which an expense is deductible by choosing when to make the payment.

D) Income is reported in the tax year in which payments are actually or constructively received.

Answer:  A

Explanation:  A) Taxpayers who use the cash receipts and disbursements method are required to capitalize fixed assets when Sec. 179 is not elected and to recover the cost through depreciation or amortization.

Page Ref.:  I:11-8

Objective:  2

49) For purposes of the accrual method of accounting, the economic performance test is met when

A) the property or services are actually provided.

B) the amount of the item can be reasonably estimated.

C) all events have occurred that establish the fact of a liability.

D) all events have occurred that fix the taxpayer’s right to receive income.

Answer:  A

Explanation:  A) While exceptions apply, the key criteria for satisfaction of economic performance is actual provision of the property or services.

Page Ref.:  I:11-9

Objective:  2

50) Under UNICAP, all of the following overhead costs are included in inventory except

A) factory utilities, rent, insurance and depreciation.

B) officers’ salaries and factory administration.

C) research and experimentation.

D) factory payroll, purchasing and warehouse costs.

Answer:  C

Explanation:  C) Nonmanufacturing costs are not included in inventory.

Page Ref.:  I:11-11 and I:11-12

Objective:  3

51) Which of the following statements regarding UNICAP is incorrect?

A) The UNICAP rules result in more costs being included in inventory for tax purposes than for financial accounting.

B) Taxpayers with gross receipts averaging more than $10,000,000 or more for the prior three years must apply the UNICAP provisions.

C) Interest must be included in inventory if the property produced is real property or long-lived property.

D) UNICAP requires that advertising and selling costs be allocated between inventory and cost of sales.

Answer:  D

Explanation:  D) Nonmanufacturing costs are not included in inventory.

Page Ref.:  I:11-11 and I:11-12

Objective:  3

52) In 2013, Richard’s Department Store changes its inventory method from FIFO to LIFO. Richard’s uses the simplified LIFO method. Richard’s year-end inventory under FIFO is as follows: 2012- $300,000; 2013 – $350,000. The 2012 price index is 110% and the 2013 index is 120%. The 2013 layer is

A) $19,097.

B) $20,833.

C) $22,727.

D) $50,000.

Answer:  C

Explanation:  C) Year-end inventories                                  $    350,000

                                                                                                            ×(110/120)

2013 inventories

      at 2012 price levels                                                                      320,833

Layer added in 2013

      at 2012 prices (320,833 – 300,000)                                             20,833

                                                                                                            ×(120/110)

Layer added at 2013 prices                                                       $      22,727

Page Ref.:  I:11-13 and I:11-14; Example I:11-19

Objective:  3

53) Inventory may be valued on the tax return at the lower of cost or market unless

A) replacement cost is higher than historical cost.

B) the taxpayer determines inventory cost using the LIFO method.

C) the taxpayer determines inventory cost using the FIFO method.

D) the cash method of accounting is used by the taxpayer.

Answer:  B

Explanation:  B) Taxpayers who use the LIFO inventory valuation method may not use the lower of cost or market method.

Page Ref.:  I:11-14

Objective:  3

54) When accounting for long-term contracts (other than those for services), all of the following accounting methods may be acceptable with the exception of

A) the cash method of accounting.

B) the completed contract method.

C) the percentage of completion method.

D) the modified percentage of completion method.

Answer:  A

Explanation:  A) Long-term contracts must be accounted for by using the percentage of completion method, the modified percentage of completion method, or, in certain circumstances, the completed contract method.

Page Ref.:  I:11-15

Objective:  4

55) Under the percentage of completion method, gross income is reported

A) when the contract is completed.

B) using a percentage that is determined by dividing current year costs by the expected total revenue.

C) based on the portion of work that is incomplete.

D) based on the portion of work that has been completed.

Answer:  D

Explanation:  D) Under the percentage of completion method of reporting income, the taxpayer reports a percentage of the gross income from a long-term contract based on the portion of work that has been completed.

Page Ref.:  I:11-16

Objective:  4

56) This year, Hamilton, a local manufacturer of off-shore drilling platforms, entered into a contract to construct a drilling platform that will be placed in the North Atlantic Ocean. The total contract price is $5,000,000, and Hamilton estimates the total construction cost at $3,000,000. Actual costs incurred this year are $600,000. If Hamilton uses the percentage of completion method, the gross profit for this year is

A) $0.

B) $400,000.

C) $600,000.

D) $2,000,000.

Answer:  B

Explanation:  B)

Percentage completed: $600,000/$3,000,000   20%
Revenue—$5,000,000 × .20 =$1,000,000
Costs to date     600,000
Gross profit$ 400,000

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

57) Bergeron is a local manufacturer of off-shore drilling platforms. This year, Bergeron entered into a contract to construct a drilling platform, which will be placed in the North Atlantic Ocean. The total contract price is $5,000,000, and Bergeron estimates the total construction cost at $2,000,000. Actual costs incurred this year are $600,000. If Bergeron uses the completed contract method, the gross profit for this year is

A) $0.

B) $400,000.

C) $600,000.

D) $2,000,000.

Answer:  A

Explanation:  A) Under the completed contract method, revenues and costs are not recognized until the contract is completed.

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

58) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,300,000. Under the completed contract method the gross profit for year 1 is

A) $0.

B) $300,000.

C) $350,000.

D) $700,000.

Answer:  A

Explanation:  A) Under the completed contract method, revenues and costs are not recognized until the contract is completed.

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

59) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,300,000. Under the completed contract method the gross profit for year 2 is

A) $0.

B) $300,000.

C) $350,000.

D) $700,000.

Answer:  B

Explanation:  B) $2,500,000 – ($900,000 + $1,300,000) = $300,000

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

60) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,100,000. Under the percentage of completion method year 1’s gross profit is

A) $0.

B) $300,000.

C) $350,000.

D) $700,000.

Answer:  C

Explanation:  C)

Percentage completed: $900,000/$1,800,000   50%
Revenue—$2,500,000 × .50 =$1,250,000
Costs to date     900,000
Gross profit$ 350,000

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

61) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,100,000. Under the percentage of completion method year 2’s gross profit is

A) $150,000.

B) $500,000.

C) $700,000.

D) $350,000.

Answer:  A

Explanation:  A)

 Year 1Year 2
Percentage completed: $900,000/$1,800,000   50%100%
Revenuee(1)$1,250,000$1,250,000
Costs incurred     900,0001,100,000
Gross profit$ 350,000$150,000

(1) Year 1 revenue = 50% × $2,500,000; Year 2 revenue = $2,500,000 – $1,250,000 previously recognized

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

62) The look-back interest adjustment involves the

A) calculation of interest on an installment sale.

B) calculation of gross profit on an installment sale collection.

C) calculation of additional tax due if actual cost rather than estimated cost had been used on the percentage of completion method.

D) calculation of interest on additional tax that would have been due if actual cost rather than estimated cost had been used on the percentage of completion method.

Answer:  D

Explanation:  D) When a contract is completed that has been accounted for under the percentage of completion method or the modified percentage of completion method, a computation is made to determine whether the tax paid each year during the contract is more or less than the tax that would have been paid if the actual total cost of the contract had been used rather than the estimated cost.

Page Ref.:  I:11-17

Objective:  4

63) This year, a contractor agrees to build a building for $2,000,000, which will be completed by the end of next year. The builder’s cost is estimated to be $1,700,000. The actual costs this year are $800,000 and next year’s actual costs are $800,000. If the tax rate is 20% and the interest rate is 10%, the look back interest for the percentage of completion method is

A) $ 0.

B) $1,176.

C) $2,000.

D) $6,000.

Answer:  A

Explanation:  A) Because the term of the contract is less than two years, look back interest is not applicable.

Page Ref.:  I:11-17

Objective:  4

64) An installment sale is best defined as

A) any disposition of property in which at least three payments are received.

B) any disposition of property in which the installment method is elected by the taxpayer.

C) any disposition of property where at least one payment is received after the close of the taxable year in which disposition occurs.

D) any disposition of publicly traded property or inventory where at least one payment is received after the close of the taxable year in which disposition occurs.

Answer:  C

Explanation:  C) An installment sale is any disposition of property where at least one payment is received after the close of the taxable year in which the disposition occurs.

Page Ref.:  I:11-18

Objective:  4

65) The installment method may be used for sales of all kinds of property with the exception of

A) real property.

B) personal property.

C) capital assets.

D) marketable securities.

Answer:  D

Explanation:  D) The installment method is not applicable to sales of inventory or marketable securities.

Page Ref.:  I:11-18

Objective:  4

66) The installment sale method can be used for all of the following transactions except

A) the sale of an antique by a collector.

B) the sale of shares of publicly-traded corporate stock.

C) the sale of farmland used in a farming business.

D) the sale of a boat held for personal use.

Answer:  B

Explanation:  B) Taxpayers may not use the installment method for sales of marketable securities.

Page Ref.:  I:11-18

Objective:  4

67) The installment sale method can be used for all of the following transactions except

A) the sale of an painting by an art collector.

B) the sale of a sole proprietor’s office building.

C) the sale of an individual’s personal car.

D) the sale of a yacht by a shipbuilder.

Answer:  D

Explanation:  D) The installment sale method cannot be used for the sale of inventory.

Page Ref.:  I:11-18

Objective:  4

68) Freida is an accrual-basis taxpayer who owns a furniture store. The furniture store had the following sales of inventory:

 Year of saleInstallment salesProfitCollections in 2013
2011$60,000$30,000$20,000
2012100,00050,00030,000
2013250,000125,00040,000

For tax purposes, Freida should report gross profit for 2013 of

A) $40,000.

B) $65,000.

C) $90,000.

D) $125,00.

Answer:  D

Explanation:  D) Taxpayers may not use the installment method for sales of inventory.

Page Ref.:  I:11-18

Objective:  4

69) Which of the following conditions are required for the use of the installment method?

A) The taxpayer must realize a gain on the sale of the property.

B) The taxpayer cannot be on the cash method.

C) The value of the obligations received is determinable at the date of sale.

D) All of the above are required.

Answer:  A

Explanation:  A) The installment method cannot be used for transactions resulting in a loss.

Page Ref.:  I:11-17 through I:11-21

Objective:  4

70) Kyle sold land on the installment basis for $100,000. His basis in the land was $70,000. Kyle received a $40,000 down payment and a real estate installment sale contract calling for $60,000 in additional payments in future years. In addition, Kyle paid $6,000 in commissions on the sale. What is the gross profit to be recognized in the current year?

A) $0

B) $9,600

C) $12,000

D) $24,000

Answer:  B

Explanation:  B) Gross profit is $24,000 ($100,000 – $70,000 – $6,000). Contract price is $100,000. Profit percentage is 24% ($24,000 /$100,000). Cash collected $40,000 × .24 = $9,600.

Page Ref.:  I:11-18

Objective:  4

71) Kevin sold property with an adjusted basis of $58,000. The buyer assumed Kevin’s existing mortgage of $40,000 and agreed to pay an additional $60,000 consisting of a cash down payment of $40,000, and payments of $4,000, plus interest, per year for the next 5 years. Kevin paid selling expenses totaling $2,000. What is Kevin’s gross profit percentage?

A) 33 1/3%

B) 40%

C) 60%

D) 66 2/3%

Answer:  D

Explanation:  D) Gross profit is $40,000 ($40,000 + 60,000 – 58,000 – 2,000). Contract price is $60,000. Profit percentage is 66 2/3% ($40,000 /$60,000).

Page Ref.:  I:11-18

Objective:  4

72) This year, John purchased property from William by assuming an existing mortgage of $40,000 and agreed to pay an additional $60,000, plus interest, in the 3 years following the year of sale (i.e. $20,000 annual payments for three years, plus interest). William had an adjusted basis of $44,000 in the building. What are the sales price and the contract price in this transaction?

A)

Sales PriceContract Price
$40,000$60,000

B)

Sales PriceContract Price
$100,000$40,000

C)

Sales PriceContract Price
$100,000$60,000

D)

Sales PriceContract Price
$100,000$100,000

Answer:  C

Explanation:  C) The selling price is $40,000 mortgage assumed + $60,000 future annual payments = $100,000. The contract price is the $60,000 in future payments.

Page Ref.:  I:11-18

Objective:  4

73) On July 25 of this year, Raj sold land with a cost of $15,000 for $40,000. Raj collected $20,000 this year and is scheduled to receive $5,000 each year for four years starting next year plus an acceptable rate of interest. Raj’s gain recognized this year is

A) $7,500.

B) $12,500.

C) $20,000.

D) $25,000.

Answer:  B

Explanation:  B)

Selling price$40,000
Minus: Adjusted basis( 15,000)
Gross profit$25,000
Gross profit percentage -$25,000/$40,000 =62.5%
Collection this year$20,000
Times: Gross profit percentage× 0.625
Gain reported this year$12,500

Page Ref.:  I:11-18

Objective:  4

74) On June 11, of last year, Derrick sold land with a cost of $15,000 for $45,000. Derrick collected $20,000 last year and is scheduled to receive $5,000 each year for five years starting this year plus an acceptable rate of interest. Derrick receives the $5,000 installment required this year.  Derrick’s recognized gain this year is

A) $0.

B) $1,667.

C) $3,333.

D) $5,000.

Answer:  C

Explanation:  C)

Selling price$45,000
Minus: Adjusted basis( 15,000)
Gross profit$30,000
Gross profit percentage -$30,000/$45,000 =66.67%
Collection this year$  5,000
Times: Gross profit percentage× 0.6667
Gain reported this year$  3,333

Page Ref.:  I:11-18

Objective:  4

75) Sela sold a machine for $140,000. The machine originally cost $90,000 and $10,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $20,000 cash down and agreed to pay $10,000 per year for eight years plus interest. Selling expenses are $10,000. The total gross profit for installment sale recognition purposes is

A) $30,000.

B) $40,000.

C) $50,000.

D) $60,000.

Answer:  B

Explanation:  B)

Selling price [40,000 + 20,000 + (10,000 × 8)]$140,000 
Minus:  Selling expenses( 10,000)
Minus:  Depreciation recapture( 10,000)
Minus:  Adjusted basis ($90,000 – $10,000)( 80,000)
Gross profit$ 40,000

Page Ref.:  I:11-19; Example I:11-23

Objective:  4

76) Malea sold a machine for $140,000. The machine originally cost $90,000 and $10,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $20,000 cash down and agreed to pay $10,000 per year for eight years plus interest. Selling expenses are $10,000. The contract price is

A) $40,000.

B) $80,000.

C) $100,000.

D) $130,000.

Answer:  C

Explanation:  C) The contract price is the greater of (1) the gross profit on the sale or (2) the selling price reduced by the existing mortgage assumed by the buyer:

(1) Gross profit on sale—$140,000 selling price less $10,000 selling expenses less $10,000 depreciation recapture less adjusted basis of $80,000 = $40,000.

(2) Selling price less mortgage assumed by purchase —$140,000 – $40,000 = $100,000.

Page Ref.:  I:11-19; Example I:11-23

Objective:  4

77) On June 11, two years ago, Gia sold land with a cost of $15,000 for $45,000. Gia collected $20,000 initially and is scheduled to receive $5,000 each year for five years starting last year plus an acceptable rate of interest. This year, Gia decided to sell one installment note to a bank that agreed to pay $4,100. As a result of the sale of the note, Gia must report

A) $0.

B) $1,667 gain.

C) $2,433 gain.

D) ($900) loss.

Answer:  C

Explanation:  C)

Selling price$45,000
Minus: Adjusted basis( 15,000)
Gross profit$30,000
Gross profit percentage – $30,000/$45,000 =66.67%

Basis of installment note:

[$5,000 × (100% – 66.67%)] =$ 1,667
Sale price of note$ 4,100
Minus: Basis of note ( 1,667)
Gain on sale of note$ 2,433

Page Ref.:  I:11-19; Example I:11-24

Objective:  4

78) On May 18, of last year, Carter sells unlisted stock with a cost of $24,000 for $60,000. Carter collects $20,000 initially and is scheduled to receive $10,000 each year for four years starting this year plus an acceptable rate of interest. After receiving the first $10,000 scheduled installment payment, Carter is unable to collect any further payments. After incurring legal fees of $1,000, Carter recovers a portion of the stock valued at $26,000. As a result of the repossession, Carter must report

A) ordinary income of $9,000.

B) capital gain of $9,000.

C) ordinary income of $13,000.

D) capital gain of $13,000.

Answer:  D

Explanation:  D)

Market value at recovery$26,000
Minus: Basis of remaining     3 notes ($30,000 × 0.40)( 12,000)
Subtotal$ 14,000
Legal fees(   1,000)
Capital gain$13,000

Page Ref.:  I:11-20; Example I:11-26

Objective:  4

79) On May 18, of last year, Yuji sold unlisted stock with a cost of $12,000 for $30,000. Yuji collected $10,000 initially and is scheduled to receive $5,000 each year for four years starting this year plus an acceptable rate of interest. After receiving the first scheduled $5,000 payment, Yuji was unable to collect any further payments. After incurring legal fees of $500, Yuji recovered a portion of the stock valued at $13,000. Yuji’s basis in the recovered stock is

A) $6,500.

B) $7,000.

C) $12,500.

D) $13,000.

Answer:  D

Explanation:  D) The basis of the recovered stock is FMV at date of recovery.

Page Ref.:  I:11-20; Example I:11-26

Objective:  4

80) Andrew sold land to Becca, Andrew’s daughter. The fair market value of the land was $300,000 (basis $250,000). Becca agreed to pay Andrew $300,000 over 8 years. Becca immediately sold the land to Olga for $300,000 cash. The gain of $50,000 must be recognized

A) by Becca in installments.

B) by Becca when Becca sells to Olga.

C) by Andrew when Andrew sells to Becca.

D) by Andrew when Becca sells to Olga.

Answer:  D

Explanation:  D) In the case of related parties, the first seller (Andrew) is required to report the gain in the year (or years) in which proceeds are received by the second seller (Becca) if resale of the property takes place within two years of the initial sale.

Page Ref.:  I:11-21

Objective:  4

81) On September 2, of this year, Keshawn sold land to Rex, his nephew, for $400,000. Keshawn’s basis in the land was $100,000. Rex agreed to pay his uncle $40,000 this year, and $60,000 each year for the next six years plus interest. One month later, Rex sold the land to Theo, an unrelated party, for $450,000. Based on this information, Keshawn must report

A) $0. Rex reports gain of $300,000.

B) gain of $225,000 this year.

C) gain of $225,000 this year plus interest in following six years.

D) gain of $30,000 this year, and gain in each of the following six years of $45,000 plus interest.

Answer:  D

Explanation:  D) A nephew is not considered a related person. Calculation of gain under installment sale rules does not change for Kevin as a result of nephew’s resale of land.

Selling price$400,000 
Minus: Adjusted basis( 100,000)
Gross profit$300,000
Gross profit percentage -$300,000/$400,000 =75%

$40,000 × .75 = $30,000

$60,000 × .75 = $45,000

Page Ref.:  I:11-21

Objective:  4

82) All of the following are considered related for purposes of Section 453(e) installment sales except

A) parents.

B) children.

C) sister.

D) controlled corporation.

Answer:  C

Explanation:  C) For purposes of Sec. 453(e), the term related person includes a spouse, children, grandchildren, and parents. Controlled corporations, partnerships, estates, and trusts are also covered. A sister is not related.

Page Ref.:  I:11-21

Objective:  4

83) All of the following transactions are exempt from rules regarding imputed interest with the exception of

A) taxpayer purchases newly issued bond for $700 (face value of $1,000).

B) taxpayer sells land for $135,000 with payment due in 5 years and no stated interest.

C) taxpayer sells his home gym equipment for $2,800 with payment due in one year and no stated interest.

D) taxpayer purchases a sailboat costing $2,500 for week-end boating trips; the full price payable in five months and no stated interest.

Answer:  B

Explanation:  B) Debt subject to original issue discount provisions, sales of property for $3,000 or less, and sales where all of the payments are due within six months are exempt from the imputed interest rules.

Page Ref.:  I:11-22

Objective:  4

84) Jennifer made interest-free gift loans to each of her four children as follows:

John borrowed $9,500 to purchase an automobile. His net investment income is $1,500.

Rick borrowed $50,000 to purchase a trailer. His net investment income is $900.

Bert borrowed $25,000 to purchase stock. His net investment income is $1,200.

Elizabeth borrowed $110,000 to purchase a home. Her net investment income is $800.

Assuming a 5% interest rate, on which loans must interest be imputed?

A) loan to John and Bert

B) loan to Bert and Elizabeth

C) loan to Rick, Bert, and Elizabeth

D) All of the loans are subject to the imputed interest rules.

Answer:  B

Explanation:  B) There is no interest on the John’s loan because it falls under the $10,000 rule. Although Rick’s loan is subject to the rules, using the $100,000 exception, the imputed interest is the lesser of the computed imputed interest or the net investment income. However, since his net investment income is less than $1,000, there is no imputed interest. The $100,000 exception does not prevent imputed interest on Bert’s loan and there is no exception to escape interest on Elizabeth’s loan.

Page Ref.:  I:11-24 and I:11-25; Example I:11-33

Objective:  5

85) Imputation of interest could be required on all of the following loans with the exception of

A) a loan between a partnership and a 55% partner.

B) a loan between a mother and son.

C) a loan between an employer and employee.

D) a loan between two best friends.

Answer:  D

Explanation:  D) Friends are not considered related parties.

Page Ref.:  I:11-24

Objective:  5

86) Prior Corp. plans to change its method of accounting for supplies.  Both the old and new methods are acceptable.  Which of the following statements is correct regarding the change?

A) The taxpayer will need to amend prior returns to reflect the new method.

B) The taxpayer will report the full amount of change in the current tax return.

C) The taxpayer will report the net adjustment over four years.

D) The taxpayer will report the net adjustment and pay the tax when it files the Form 3115.

Answer:  C

Explanation:  C) In the case of voluntary changes, the net adjustment is normally spread across four years.

Page Ref.:  I:11-26 and I:11-27

Objective:  6

87) Lloyd Corporation, a calendar year accrual basis taxpayer, pays its insurance premium each year on June 1, the anniversary of the policy. The premium paid this year is $9,600 while last year’s was $9,000. How much of is Lloyd’s deduction for insurance this year?

Answer:  Strict application of accrual basis accounting requires that the insurance deduction is $9,600 × 7/12 = $5,600 plus $9,000 × 5/12 = $3,750 for a total of $9,350. However, since all of the requirements for economic performance are met, Lloyd may deduct all $9,600 assuming this practice is consistently followed each year.

Page Ref.:  I:11-9; Example I:11-16

Objective:  2

88) In 2013 Anika Co. adopted the simplified dollar-value LIFO method. Inventory under FIFO in 2012 and 2013 is $400,000 and $600,000, respectively. The Consumer Price Index for 2012 is 115 and the Consumer Price Index in 2013 is 125 percent. How much is Anika’s inventory at the end of year 2013 under simplified LIFO?

Answer: 

Convert 2013 inventory to 2012 prices               600,000 × 1.15/1.25 = $552,000

Incremental inventory at 2012 base price          552,000 – 400,000 = $152,000

Incremental inventory at 2013 base price          152,000 × 1.25/1.15 = $165,217

Ending inventory:

Base inventory (2012)                                               $400,000

2013 layer at 2012 base price                                   165,217

2013 ending inventory                                             $565,217

Page Ref.:  I:11-13 and I:11-14; Example I:11-19

Objective:  3

89) In 2013, Modern Construction Company entered into a contract to construct a building for $5,000,000. The estimated cost to complete the building is $4,000,000 and the project will be completed in 2014. Modern incurred actual construction costs of $1,600,000 and $1,800,000 in 2013 and 2014, respectively. How much gross profit is recognized using the percentage-of-completion method in 2013 and 2014?

Answer:                                                 2013                                       2014

Revenue                                           $2,000,000                           $3,000,000

Costs                                                (1,600,000)                           (1,800,000)

Gross profit                                     $   400,000                           $1,200,000

2013: (1,600,000 / 4,000,000) × 5,000,000 = 2,000,000 revenue

2014: $5,000,000 – 2,000,000 = 3,000,000 revenue

Page Ref.:  I:11-16; Example I:11-21

Objective:  4

90) Tonya sold publicly-traded stock with an adjusted basis of $76,000 for $90,000. Tonya received a down payment of $15,000 with the balance due in equal payments over the next four years. What is the amount of gross profit to be recognized in the year of sale?

Answer:  The installment method does not apply to publicly-traded stock. Therefore, the gross profit or gain to be recognized is $90,000 – $76,000 = $14,000.

Page Ref.:  I:11-18

Objective:  4

91) Natalie sold a machine for $140,000. The machine originally cost $95,000 and $15,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $30,000 cash down and agreed to pay $10,000 per year for seven years plus interest. Selling expenses are $10,000. What is the amount of gain to be reported in the year of sale?

Answer:  The selling price is $140,000. The gross profit from the sale is $35,000 ($140,000 – $80,000 adjusted basis – $10,000 selling expenses – $15,000 of depreciation recapture). The contract price is $140,000 – $40,000 lien = $100,000. The gross profit percentage is $35,000/$100,000 = 35%.The gain reported in the year of sale is:

Collections of principal received during the year                    $30,000

Plus: Excess mortgage                                                                               -0 –

Total                                                                                                       $30,000

Times Gross Profit Percentage                                                            35 %

Gross Profit in year of sale                                                              $10,500

Plus: Depreciation recapture                                                          _15,000

Gain reported in year of sale                                                          $25,500

Page Ref.:  I:11-18 and I:11-19; Example I:11-23

Objective:  4

92) Marissa sold stock of a non-publicly traded corporation with an adjusted basis of $36,000 for $48,000. Marissa received a down payment of $12,000 with the balance due in equal payments over the next two years.

a.     What is the amount of gross profit to be recognized in the year of sale?

b.     Assume that the buyer defaulted on the final payment. Marissa sued and was able to repossess the stock. The fair market value of the stock on the date of repossession is $36,000; legal fees were $1,500. What is the gain or loss on the repossession?

Answer: 

a.     Gross profit is $12,000 ($48,000 – 36,000). Contract price is $48,000. The gross profit percentage

        is 25% ($12,000 ÷ $48,000). Thus, in year one, the gross profit recognized is $12,000 × .25 =

        $4,000.

b.     Market value at recovery                                  $36,000

        Minus: Basis of remaining

              1 note ($18,000 × 0.75)                               ( 13,500)

        Subtotal                                                                 $22,500

        Legal fees                                                              (  1,500)

        Capital gain                                                         $21,000

Page Ref.:  I:11-20; Example I:11-26

Objective:  4

93) Nick sells land with a $7,000 adjusted basis for $10,000. Nick receives a $2,000 down payment with the balance of $8,000 due the following year. Nick is unable to collect the remaining $8,000 and, after incurring legal fees of $500, he repossesses the land when it has a fair market value of $9,000.

a.     What is the amount of gain that Nick must report in the first year?

b.     What is the amount of gain that Nick must report in the second year?

c.     What is the basis in the repossessed stock?

Answer: 

a.     The gross profit percentage is $3,000/$10,000 or 30%. Therefore, in the first year, $2,000 × .30 or $600 is recognized as capital gain.

b.     The adjusted basis of the $8,000 installment note is $8,000 × .70 = $5,600. His gain is $9,000 – 5,600 – $500 = $2,900.

c.     The basis of the land is its FMV at the time it is repossessed or $9,000.

Page Ref.:  I:11-20; Example I:11-26

Objective:  4

94) Emily made the following interest free loans to her children:

$10,000 to Erin for a down payment on a new home. Her net investment income for the year is $1,300.

$50,000 to Sasha to purchase stock. Her net investment income for the year is $800.

$60,000 to Tim to purchase a new car. His net investment income for the year is $2,800.

The applicable federal interest rate on similar loans is 5%. What is the amount of interest income that Anita must report from these transactions?

Answer:  The total interest income is $2,800:

Loan to Erin—None of the imputed interest is reported on the loan to Erin since the loan was for $10,000 or less and income-producing property was not purchased.

Loan to Sasha—None of the imputed interest is reported on the loan to Sasha since the loan was for $100,000 or less and Sasha’s net investment income is less than $1,000.

Loan to Tim—The imputed interest on the loan to Tim is the lesser of the computed imputed interest of $3,000 ($60,000 × .05) or Tim’s net investment income of $2,800.

Page Ref.:  I:11-24 and I:11-25; Example I:11-33

Objective:  5

95) Winnie made a $70,000 interest-free loan to her son, Tod, who used the money to retire a mortgage on his personal residence. Tod’s only source of income was salary of $35,000 and $990 interest income on a savings account. The relevant Federal interest rate was 5% and the loan was outstanding all year long.

What amount must Winnie include as interest income as a result of this transaction?

Answer:  None.  Since the loan is for $100,000 or less, the amount of the imputed interest income to Winnie is the lesser of the computed imputed interest ($70,000 × .05 = $3,500) or Tod’s net investment income of $990. Since the amount ($990) is less than $1,000, the imputed interest may be ignored.

Page Ref.:  I:11-24 and I:11-25; Example I:11-33

Objective:  5

96) Which entities may elect a fiscal year? Discuss how certain tax entities may circumvent the requirement of using a calendar year.

Answer:  C corporations, other than personal service corporations, are permitted fiscal years. Partnerships, S corporations, and personal service corporations may elect a taxable year that result in a tax deferral of three months or less. Electing partnerships and S corporations must then make an annual required payment to offset the tax deferral that will accrue to partners or S corporation shareholders. Businesses with a natural business year are exempt from the requirement of required payments.

The required payment is calculated using the highest tax rate for individuals, the previous year’s taxable income, and a deferral ratio. No payment is required if the amount due is $500 or less.

Page Ref.:  I:11-2 through I:11-4

Objective:  1

97) Generally, economic performance must occur before an expense may be deducted. In some cases, this requirement of economic performance may be waived. Discuss the conditions under which economic performance may be waived and an earlier deduction may be allowed.

Answer:  Economic performance requirement may be waived and a deduction may still be allowed if all the following five conditions are met:

1.     The all-events test is satisfied.

2.     Economic performance occurs within a reasonable period (but in no event more than 8 1/2 months) after the close of the tax year.

3.     The deduction is recurring in nature, and the taxpayer consistently treats items of the same type as incurred in the tax year in which the all-events test is met.

4.     The taxpayer is not a tax shelter.

5.     Either the amount is not material or the earlier accrual of the item results in a better matching of income and expense.

Page Ref.:  I:11-9

Objective:  2

98) What is the significance of the Thor Power Tool Co. case?

Answer:  In Thor Power Tool Co., the company wrote off the cost of obsolete parts even though these parts were kept on hand and their asking price was not reduced. While this practice adhered to generally-accepted accounting principles, the Supreme Court ruled that the practice did not clearly reflect income. Thus, in cases where the best accounting practice conflicts with the clear reflection of income, the standard of clear reflection of income will prevail. Where Regulations do not specify the treatment of an item or when the Regulations provide more than one alternative accounting method, generally accepted accounting principles may be used.

Page Ref.:  I:11-11

Objective:  3

99) Xerxes Manufacturing, in its first year of operations, produces solar panels which are sold through large building supply and home improvement stores. Xerxes’ year-end results include the following:

Office rent and utilities                                                                             $15,000

Salaries of office staff                                                                                100,000

Salaries of factory workers                                                                      500,000

Direct materials used in production of solar panels                       400,000

Factory rent                                                                                                    30,000

Factory utilities                                                                                             10,000

You are preparing Xerxes’ first year tax return.  Xerxes has elected a calendar year as its tax accounting period and the accrual method. What additional information would you need to prepare the tax return?

Answer:  You need to allocate production costs between ending inventory and cost of goods sold

.

How many units were sold?  How many units are in ending inventory?  How much of the office salaries, rent and utilities should be allocated to inventory?

What are the duties of the office staff?

What cost flow assumption is to be used?

Page Ref.:  I:11-11 and I:11-12

Objective:  3

100) Doug is going to sell land for $100,000. The terms of the sale include $20,000 down and $20,000 plus interest for the next 4 years. He wishes to recognize income using the installment method. Both his brother and his son wish to buy the land from him. What are the tax considerations?

Answer:  The proposed transaction will be treated as an installment sale.  Doug should be aware of the fact that if he sells to his son and his son resells the property within 2 years, that sale will trigger immediate recognition of income for Doug since his son is related to him according to Section 453. Doug’s brother is not a related party for purposes of Section 453.

Page Ref.:  I:11-21

Objective:  4

101) Discuss the purpose of the imputed interest rules.

Answer:  Prior to enactment of the imputed interest rules, property sold on the installment method might provide for little or no interest. Rather than charging interest, which was 100% taxable, the seller would charge a higher price for the property sold. If the property sold was a capital asset, the result was to reduce the interest income reported by the seller and to increase the amount of favorably taxed capital gain, thus converting what was in reality interest income into capital gain. Under current law, interest is imputed in a deferred payment contract where no interest or a low rate of interest is provided.

Page Ref.:  I:11-22

Objective:  5

102) Arnie is negotiating the sale of land to Phil.  Arnie’s basis in the land is $3,000,000, and it currently has a fair market value of $5,000,000.  Phil wants to pay the purchase price over three years.  Arnie suggests that Phil pays $2,000,000 at closing, then pay $1,200,000 each of the next three years.  Arnie would not require that Phil pay any interest under these terms.  Discuss the tax issues that Arnie should consider.

Answer:  The IRS may argue that Arnie is attempting to convert ordinary income (the interest not charged) into capital gain.  Interest will need to be imputed.

Page Ref.:  I:11-22

Objective:  5

103) Jared wants his daughter, Jacqueline, to learn about the stock market.  He loans Jacqueline $30,000, but does not require Jacqueline to pay interest.  Jared tells Jacqueline that she can repay him from the proceeds of future stock sales.  Discuss the tax issues that Jared should consider.

Answer:  This is considered a gift loan.  Jared will have to impute interest income. But the amount would be limited to Jacqueline’s net investment income.  If her net investment income is less than $1,000, Jared will not have to impute interest.

Page Ref.:  I:11-24

Objective:  5

Chapter I12 

1) Realized gain or loss must be recognized unless a specific Code section provides for nonrecognition treatment.

Answer:  TRUE

Explanation:  Unless a provision in the tax law provides an exclusion of gain, a disallowance of loss or a deferral of either, a realized gain or loss will be recognized.

Page Ref.:  I:12-2

Objective:  1

2) In a like-kind exchange, both the property transferred and the property received must be held either for productive use in a trade or business or for investment.

Answer:  TRUE

Explanation:  Personal use property does not qualify as like-kind property.

Page Ref.:  I:12-2

Objective:  1

3) The exchange of a personal-use automobile for stock in an automobile manufacturer held as an investment qualifies for like-kind treatment.

Answer:  FALSE

Explanation:  The two assets are not of “like-kind,” and personal-use assets and marketable securities do not qualify.

Page Ref.:  I:12-2; Example I:12-2

Objective:  1

4) If an exchange qualifies as a like-kind exchange, nonrecognition of gain or loss is elective.

Answer:  FALSE

Explanation:  Like-kind treatment is mandatory if the transaction meets the terms of Section 1031.

Page Ref.:  I:12-2

Objective:  1

5) Real property exchanged for personal property qualifies as a like-kind exchange.

Answer:  FALSE

Explanation:  An exchange is not like-kind if one class of property is exchanged for another class.

Page Ref.:  I:12-3

Objective:  1

6) An investor exchanges an office building located in Niagara Falls, NY for an office building located in Niagara Falls, Ontario.  The exchange does not qualify as like-kind.

Answer:  TRUE

Explanation:  Transfers of real property in the U.S. for real property outside the U.S. are not like-kind.

Page Ref.:  I:12-3

Objective:  1

7) An exchange of inventory for inventory of a like kind qualifies as a like-kind exchange.

Answer:  FALSE

Explanation:  An exchange of inventory or securities does not qualify as a like-kind exchange.

Page Ref.:  I:12-4

Objective:  1

8) The exchange of a partnership interest for an interest in another partnership qualifies as a like-kind exchange.

Answer:  FALSE

Explanation:  Partnership interests, along with inventory and marketable securities, are disqualified assets.

Page Ref.:  I:12-4

Objective:  1

9) A sale of property and subsequent purchase of like-kind property may be treated as a like-kind exchange if the two transactions are interdependent.

Answer:  TRUE

Explanation:  The tax law does allow for a three party exchange if structured properly.

Page Ref.:  I:12-5

Objective:  1

10) For purposes of nontaxable exchanges, cash and non-like-kind property constitute boot.

Answer:  TRUE

Explanation:  The addition of cash or non-like-kind property is needed when the qualifying like-kind properties being exchanged are not of equal value.  Any cash or other property which is not like-kind is treated as boot.

Page Ref.:  I:12-6

Objective:  1

11) The receipt of boot as part of a nontaxable exchange causes a realized loss to be recognized.

Answer:  FALSE

Explanation:  Receipt of boot will only cause recognition if gain is realized on the underlying exchange.

Page Ref.:  I:12-6

Objective:  1

12) Where non-like-kind property other than cash is received as boot, the amount of the boot is the property’s fair market value.

Answer:  TRUE

Explanation:  Non-cash boot is always received at fair market value.

Page Ref.:  I:12-6

Objective:  1

13) If each party in a like-kind exchange assumes a liability of the other party, only the net liability given or received is boot.

Answer:  TRUE

Explanation:  The exchange of liabilities is netted to determine which party is deemed to have received boot and which party is deemed to have paid boot.

Page Ref.:  I:12-7

Objective:  1

14) The basis of non-like-kind property received is the basis in the hands of the transferor at the date of the exchange.

Answer:  FALSE

Explanation:  Boot is received at fair market value.

Page Ref.:  I:12-8

Objective:  1

15) If related taxpayers exchange property qualifying for a like-kind exchange, the properties must be retained for three years after the exchange to prevent recognition of gain resulting from the original exchange on a subsequent disposition of the property.

Answer:  FALSE

Explanation:  The property must be retained for two years.

Page Ref.:  I:12-8

Objective:  1

16) The holding period of like-kind property received in a nontaxable exchange begins on the day of the exchange.

Answer:  FALSE

Explanation:  The holding period includes the holding period of the like-kind property if that property is a capital asset or 1231 property.

Page Ref.:  I:12-9

Objective:  1

17) The holding period for boot property received begins on the day after the date of the exchange.

Answer:  TRUE

Explanation:  While the like-kind property may have a carryover holding period, boot received starts a new holding period.

Page Ref.:  I:12-10

Objective:  1

18) The involuntary conversion provisions which allow deferral of gain are mandatory.

Answer:  FALSE

Explanation:  If a gain is realized on an involuntary conversion, deferral is elective.

Page Ref.:  I:12-10 Key Point

Objective:  2

19) If a gain is realized on the involuntary conversion of property, the gain may be deferred if qualifying replacement property is acquired within a specified time period at a cost equal to or greater than the amount realized on the involuntary conversion.

Answer:  TRUE

Explanation:  The ability to defer the full gain requires the acquisition of qualifying replacement property with the full proceeds realized within the replacement period.

Page Ref.:  I:12-10

Objective:  2

20) All or part of gain realized on an involuntary conversion is deferred but not permanently excluded if qualifying replacement property is acquired within the requisite period of time.

Answer:  TRUE

Explanation:  A taxpayer can elect deferral of realized gain due to an involuntary conversion if similar property or property related in service is acquired within a specific time period.

Page Ref.:  I:12-10

Objective:  2

21) In an involuntary conversion, the basis of replacement property is its cost reduced by the gain deferred.

Answer:  TRUE

Explanation:  The basis of the replacement asset will be its cost reduced by the gain deferred due to the involuntary conversion election.

Page Ref.:  I:12-10

Objective:  2

22) A taxpayer may elect to defer recognition of a loss resulting from an involuntary conversion.

Answer:  FALSE

Explanation:  Section 1033 does not apply to losses.

Page Ref.:  I:12-11

Objective:  2

23) If the threat of condemnation exists and the taxpayer has reasonable grounds to believe that the property will be condemned, the taxpayer may elect to defer gain even if the taxpayer sells the property to a party other than the governmental unit that is threatening to condemn the property.

Answer:  TRUE

Explanation:  The general involuntary conversion provisions are modified in the case of condemnation.  One such modification allows the sale of property to a third party when threat of condemnation exists.

Page Ref.:  I:12-11

Objective:  2

24) When the cost of replacement property is less than the amount realized on an involuntary conversion, gain will be recognized.  The recognized gain will be equal to the amount realized over the cost of the replacement property, but not more than the total realized gain.

Answer:  TRUE

Explanation:  Proceeds from an involuntary conversion that are not invested in qualifying replacement property will trigger gain recognition equal to the excess proceeds or the realized gain, if less.

Page Ref.:  I:12-12

Objective:  2

25) If property is involuntarily converted into similar property, the basis and holding period of the converted property carry over to the basis and holding period of the replacement property.

Answer:  TRUE

Explanation:  Because the gain on the original asset is deferred into the replacement property under the involuntary conversion provisions, the holding period and basis of the original asset also carry over to the replacement asset.

Page Ref.:  I:12-12

Objective:  2

26) If the taxpayer elects to defer the gain on an involuntary conversion, the holding period of the replacement property begins on the date of purchase.

Answer:  FALSE

Explanation:  The holding period includes the holding period of the converted property.

Page Ref.:  I:12-12

Objective:  2

27) Replacing a building with land qualifies as replacement property under the involuntary conversion rules relevant to a casualty.

Answer:  FALSE

Explanation:  Qualification of replacement property is based on a functional use test.

Page Ref.:  I:12-13

Objective:  2

28) If real property used in a trade or business or held for investment is condemned, it must be replaced with property having a similar functional use.

Answer:  FALSE

Explanation:  The like-kind replacement property rules apply in the case of a condemnation of real property used in a trade or business or held for investment purposes.

Page Ref.:  I:12-14

Objective:  2

29) Vector Inc.’s office building burns down on October 31, 2013.  Vector, a calendar year taxpayer, finally settles with the insurance company on February 3, 2014.  In order to defer the gain realized on the building, Vector must acquire another office building by February 3, 2016.

Answer:  FALSE

Explanation:  The deadline for replacement is the end of the second tax year after the year in which the gain is realized.  The deadline will be December 31, 2016.

Page Ref.:  I:12-15; Example I:12-47

Objective:  2

30) An involuntary conversion is due to the condemnation of real property held for productive use in a trade or business or for investment.  The replacement period will end three years after the close of the first tax year in which any part of the gain is realized.

Answer:  TRUE

Explanation:  An extra year is added to the replacement period for condemnation of real estate.

Page Ref.:  I:12-15

Objective:  2

31) A loss on the sale of a taxpayer’s personal residence is deductible if the taxpayer owned and lived in the home for two of five years.

Answer:  FALSE

Explanation:  A loss is disallowed because the residence is a personal-use asset.

Page Ref.:  I:12-16

Objective:  3

32) In order for the gain on the sale of a personal residence to be excluded under Section 121, a replacement residence must be purchased within two years.

Answer:  FALSE

Explanation:  There is no requirement for a replacement residence.

Page Ref.:  I:12-16

Objective:  3

33) In the case of married taxpayers, an individual may claim the Sec. 121 exclusion even if the individual’s spouse used the exclusion within the past two years.

Answer:  TRUE

Explanation:  The exclusion is now determined on an individual basis.

Page Ref.:  I:12-17; Example I:12-54

Objective:  3

34) The taxpayer must be occupying the residence at the time of the sale in order for Sec. 121 to apply.

Answer:  FALSE

Explanation:  The home must be the taxpayer’s principal residence for two of the five years before the sale.

Page Ref.:  I:12-16 and I:12-17

Objective:  3

35) If a principal residence is sold before satisfying the ownership and use tests, part of the gain may be excluded if the sale is due to a change in employment, health, or unforeseen circumstances.

Answer:  TRUE

Explanation:  Under specified circumstances a taxpayer may be allowed partial exclusion if the two-year test is not met.

Page Ref.:  I:12-19

Objective:  3

36) All of the following qualify as a like-kind exchange except

A) an apartment building held for investment for farmland used in a trade or business.

B) a printer used in trade or business for a computer used in trade or business.

C) improved real estate held for investment for unimproved real estate held for investment.

D) an airplane used in trade or business for a general purpose truck used in trade or business.

Answer:  D

Explanation:  D) Real property used in business or for investment exchanged for any real property qualifies as do computers and peripherals. An airplane and a truck are in different general asset classes and are, therefore, not like-kind property.

Page Ref.:  I:12-3 and I:12-4; Example I:12-3, I:12-4, I:12-7, and I:12-8

Objective:  1

37) Which of the following statements with respect to a like-kind exchange is false?

A) Property of one class must be exchanged for property of the same class.

B) An exchange of inventory does not qualify as a like-kind exchange.

C) Personal property must be exchanged for personal property.

D) Sale of property and subsequent purchase of like-kind property will always qualify as a like-kind exchange.

Answer:  D

Explanation:  D) Sale of property and subsequent purchase of like-kind property only qualifies if the two transactions are interdependent.

Page Ref.:  I:12-3 through I:12-5

Objective:  1

38) A owns a ranch in Wyoming, which B offers to purchase. A is not willing to sell the ranch but is willing to exchange the ranch for an apartment complex in Louisiana. The complex is available for sale. B purchases the apartment complex in Louisiana from C and transfers it to A in exchange for A’s ranch. The ranch and the complex each have a $1,000,000 fair market value. Which of the following is true?

A) The transaction qualifies as a like-kind exchange for B but not for A.

B) The transaction qualifies as a like-kind exchange for both B and A.

C) The transaction qualifies as a like-kind exchange for A but not for B.

D) The transaction does not qualify as a like-kind exchange for either B or A.

Answer:  C

Explanation:  C) The exchange is like-kind for A because she exchanges real property used in business (the ranch) for investment property (the complex) in a direct exchange. The transaction is not a like-kind exchange for B because she acquired the apartment complex for resale.

Page Ref.:  I:12-5; Example I:12-14

Objective:  1

39) Dean exchanges business equipment with a $120,000 adjusted basis for $40,000 cash and business equipment with a $140,000 FMV. What is the amount of gain which Dean recognizes on the exchange?

A) $0

B) $20,000

C) $40,000

D) $60,000

Answer:  C

Explanation:  C) Amount Realized ($40,000 + $140,000) – Adjusted Basis ($120,000) = $60,000 gain realized. Gain is recognized to the extent of boot received—$40,000.

Page Ref.:  I:12-6; Example I:12-17

Objective:  1

40) Daniella exchanges business equipment with a $100,000 adjusted basis for $10,000 cash and business equipment with a $96,000 FMV. What is the amount of gain recognized on the exchange?

A) $0

B) $4,000

C) $6,000

D) $10,000

Answer:  C

Explanation:  C) Amount Realized ($10,000 + $96,000) – Adjusted Basis ($100,000) = $6,000 gain realized. Gain recognized to the lesser of realized gain ($6,000) or boot received ($10,000).

Page Ref.:  I:12-6; Example I:12-18

Objective:  1

41) Gena exchanges land held as an investment with a $60,000 basis for other land with a $80,000 FMV and a motorcycle with a $10,000 FMV. The acquired land is to be held for investment and the motorcycle is for personal use. What is the amount of recognized gain?

A) $0

B) $10,000

C) $20,000

D) $30,000

Answer:  B

Explanation:  B) The realized gain is $30,000 [($80,000 + $10,000) amount realized – $60,000 adjusted basis]. Gain is recognized to the extent of the lesser of gain realized or boot received—the motorcycle ($10,000) is non-like-kind property and is considered boot.

Page Ref.:  I:12-6; Example I:12-19

Objective:  1

42) Pamela owns land for investment purposes.  The land is worth $300,000 (basis of $260,000 to Pamela).  Pamela exchanges the land, plus $20,000 cash, for a warehouse to be used in her business.  The FMV of the warehouse is $400,000, but the warehouse is subject to a mortgage of $80,000, which is assumed by Pamela.  Pamela must recognize a gain of

A) $ -0-.

B) $ 40,000.

C) $ 120,000.

D) $ 140,000.

Answer:  A

Explanation:  A) Like-kind property was exchanged. Pamela received no boot so none of the gain is recognized.

Page Ref.:  I:12-7

Objective:  1

43) Bob owns a warehouse that is used in business while Rebecca owns land. Bob exchanges the warehouse for the land, which will be held for investment. The FMV of the warehouse is $440,000 (basis $240,000), but the warehouse is subject to a mortgage of $80,000, which is assumed by Rebecca. Bob receives $40,000 cash and the land, which has a FMV of $320,000.  Bob realizes a gain (loss) on the exchange of

A) $80,000.

B) $120,000.

C) $190,000.

D) $200,000.

Answer:  D

Explanation:  D)

Property received:           Land (FMV)           Cash           Debt assumed by Rebecca           Total$320,000 40,000     80,000 $440,000
Minus: Basis of warehouse given up:(240,000)
Gain realized$200,000

Page Ref.:  I:12-7; Example I:12-21

Objective:  1

44) Emily owns land for investment purposes that has a FMV of $300,000 (basis of $260,000).  She exchanges the land, plus $40,000 cash, for a warehouse to be used in her business.  The warehouse is worth $420,000, but is subject to a mortgage of $80,000 which Emily will assume.  The gain realized by Emily on the exchange is

A) $40,000.

B) $ 80,000.

C) $ 120,000.

D) $ 160,000.

Answer:  A

Explanation:  A)

FMV of warehouse received$420,000
Minus: Basis given up:           Land           Cash           Debt assumed(260,000) (  40,000) (  80,000)
Gain realized by Emily$  40,000

Page Ref.:  I:12-7; Example I:12-21

Objective:  1

45) Glen owns a building that is used in business.  The building is worth $200,000, but is subject to a mortgage of $40,000.  Glen’s basis in the building is $120,000.  Glen exchanges the building for investment land worth $150,000 plus $10,000 cash.  In addition, the other party assumes the mortgage which will be held for investment.  Glen must recognize a gain of

A) $0.

B) $10,000.

C) $50,000.

D) $80,000.

Answer:  C

Explanation:  C)

Property received:           Land (FMV)           Cash           Debt assumed by other party           Total$150,000 10,000     40,000 $200,000
Minus: Basis of building given up:(120,000)
Gain realized$80,000
Gain recognized—Lesser of: Boot received = cash + debt relief = $50,000, or Realized gain of $80,000$50,000  

Page Ref.:  I:12-7; Example I:12-21

Objective:  1

46) Kai owns an apartment building held for investment purposes.  The apartment building is worth $500,000, although it is subject to a mortgage of $100,000.  Kai’s basis in the apartment building is $380,000.  Kai exchanges the apartment building for an office building.  The office building has an FMV of $350,000. Kai receives $50,000 cash in addition to receiving the office building, and the other party assumes the apartment building mortgage. What is Kai’s recognized gain on this exchange?

A) $-0-

B) $50,000

C) $120,000

D) $150,000

Answer:  C

Explanation:  C)

Cash received$   50,000
Liability transferred100,000
Office building received 350,000
Total consideration received$500,000
Basis of apartment building 380,000
Gain realized$120,000

Gain recognized equals the lesser of boot received or gain realized.

The total boot received is $150,000 (100,000 debt relief + 50,000 cash), so the gain recognized is $120,000.

Page Ref.:  I:12-7; Example I:12-22

Objective:  1

47) In a nontaxable exchange, Henri traded in a truck having an adjusted basis of $8,500 and a FMV of $10,000, for a new truck having a FMV of $15,000. In addition, Henri paid cash of $5,000. What is Henri’s basis in the new truck?

A) $ 5,000

B) $ 8,500

C) $ 13,500

D) $15,000

Answer:  C

Explanation:  C) Gain realized is $1,500 [$15,000 amount realized less ($8,500 + $5,000) adjusted basis of property given]. No boot was received, so no gain is recognized. Basis is $15,000 FMV of new truck less $1,500 unrecognized gain = $13,500. Or, an alternative way to calculate the basis in the truck is to total the adjusted basis of property exchanged ($8,500 truck plus $5,000 cash paid) or $13,500.

Page Ref.:  I:12-7

Objective:  1

48) Bobbie exchanges business equipment (adjusted basis $160,000) for other business equipment that has a FMV of $140,000. Bobbie also receives $30,000 cash. Bobbie’s basis in the new equipment is

A) $130,000.

B) $140,000.

C) $160,000.

D) $170,000.

Answer:  B

Explanation:  B) The gain realized is $170,000 (FMV of new equipment plus $30,000 cash) – $160,000 adjusted basis of old equipment = $10,000. She must recognize gain to the extent of the lesser of the boot received or the realized gain so the full $10,000 realized gain is recognized. The basis of the new equipment is [$160,000 (old basis) – 30,000 (boot received) + 10,000 (gain recognized)] = $140,000 or the FMV of property received less unrecognized gain of $0 = $140,000.

Page Ref.:  I:12-7

Objective:  1

49) Jason owns a warehouse that is used in business.  The FMV of the warehouse is $200,000 (basis $120,000), and the warehouse is subject to a mortgage of $40,000.  Jason exchanges the warehouse for land valued at $150,000.  The other party also pays him $10,000 cash and assumes the mortgage on the warehouse.  Jason’s basis in the land received will be

A) $120,000.

B) $150,000.

C) $180,000.

D) $200,000.

Answer:  A

Explanation:  A) Gain realized is $80,000 [($150,000 + $40,000 + $10,000) amount realized less $120,000 adjusted basis]. Gain is recognized to the extent of boot received—$40,000 + $10,000 = $50,000. The basis of the land is $120,000:

(1) FMV of property received ($150,000) less unrecognized gain ($30,000), or

(2) $120,000 basis of property exchanged – $50,000 boot received + $50,000 gain recognized.

Page Ref.:  I:12-7

Objective:  1

50) Laurie owns land held for investment. The land’s FMV is $150,000. Laurie’s basis in the land is $130,000.  Laurie exchanges the land, plus $20,000 of cash, for a warehouse owned by Trey. The warehouse is worth $210,000, but is subject to a mortgage of $40,000 which Laurie will assume. Trey’s basis in the warehouse is $120,000. Laurie’s basis in the warehouse received will be

A) $150,000.

B) $170,000.

C) $190,000.

D) $210,000.

Answer:  C

Explanation:  C)

Basis of property exchanged:        Land        Cash        Debt$130,000 20,000 40,000
Basis of warehouse received:$190,000

Or FMV of property received ($210,000) less unrecognized gain ($20,000)

Page Ref.:  I:12-7

Objective:  1

51) Rosa exchanges business equipment with a $60,000 adjusted basis for a like-kind piece of equipment with a $100,000 FMV and $20,000 of marketable securities. What is Rosa’s basis for the new equipment?

A) $60,000

B) $80,000

C) $100,000

D) $120,000

Answer:  A

Explanation:  A) $60,000 basis of property exchanged – $20,000 boot received + $20,000 gain recognized = $60,000

Page Ref.:  I:12-8; Example I:12-26

Objective:  1

52) If there is a like-kind exchange of property between related parties, how long do they have to wait to dispose of the property received in order to avoid having to recognize any gain on the exchange?

A) 6 months

B) 1 year

C) 2 years

D) no waiting period

Answer:  C

Explanation:  C) Exchanges of property between related parties are not like-kind exchanges under current law if either party disposes of the property within two years of the exchange.

Page Ref.:  I:12-8

Objective:  1

53) Rolf exchanges an office building worth $150,000 for investment land worth $175,000.  He also provided stock worth $25,000.  Rolf’s adjusted basis in the building and stock is $130,000 and $11,000, respectively.  How much gain will Rolf recognize on the exchange?

A) $-0-

B) $14,000

C) $20,000

D) $34,000

Answer:  B

Explanation:  B) The stock exchanged by Rolf is not qualifying like-kind property so its gain must be recognized in the normal manner.

Page Ref.:  I:12-9; Example I:12-28

Objective:  1

54) Yael exchanges an office building worth $150,000 for investment land worth $175,000.  He also provided

stock worth $25,000.  Yael’s adjusted basis in the building and stock is $180,000 and $11,000, respectively. How much gain or loss will Yael recognize on the exchange?

A) $-0-

B) ($30,000)

C) ($16,000)

D) $14,000

Answer:  D

Explanation:  D) As part of the exchange, Yael exchanged non-like-kind property (the stock).  He will recognized the gain on the stock, but cannot recognize the loss realized on the like-kind property.

Page Ref.:  I:12-9; Example I:12-30

Objective:  1

55) Which of the following statements is not true with regard to like-kind exchanges?

A) Nonrecognition of gains and losses is mandatory if the exchange is a like-kind exchange.

B) The holding period of like-kind property received includes the holding period of the property exchanged.

C) A loss is always recognized if the taxpayer transfers non-like-kind personal use property in an otherwise like-kind exchange.

D) The basis of property received in an exchange is equal to the basis of the property exchanged less the boot received plus the gain recognized and less any loss recognized.

Answer:  C

Explanation:  C) While gain or loss equal to the difference between the FMV and the adjusted basis of the non-like-kind property surrendered must ordinarily be recognized, if non-like-kind property is a personal use asset, the loss is not recognized.

Page Ref.:  I:12-10; Topic Review I:12-1

Objective:  1

56) All of the following are true except:

A) A nonsimultaneous exchange may never qualify as a like-kind exchange.

B) Nonrecognition of gains and losses is mandatory if the exchange is a like-kind exchange.

C) A loss may be recognized on non-like-kind property (boot) if the taxpayer transfers the boot in an otherwise like-kind exchange. 

D) The holding period of like-kind property received includes the holding period of the property exchanged.

Answer:  A

Explanation:  A) A nonsimultaneous exchange can qualify as like-kind exchange if the transactions are interdependent.

Page Ref.:  I:12-10; Topic Review I:12-1

Objective:  1

57) Cassie owns a Rembrandt painting she acquired on June 1, 2008 as an investment. She exchanges the painting on September 5, 2013, for a Picasso sculpture and marketable securities to be held as an investment. On what date does the sculpture’s holding period begin?

A) June 1, 2008

B) June 2, 2008

C) September 5, 2013

D) September 6, 2013

Answer:  A

Explanation:  A) It is a qualifying like-kind exchange so the holding period carries over to the qualifying replacement property.

Page Ref.:  I:12-9; Example I:12-31

Objective:  1

58) Stephanie’s building, which was used in her business, was destroyed in a fire. Stephanie’s adjusted basis in the building was $175,000, and its FMV was $210,000. Stephanie filed an insurance claim and was reimbursed $200,000. In that same year, Stephanie invested $180,000 of the insurance proceeds in another business building. If the proper election is made, Stephanie will recognize gain of

A) $ -0-.

B) $15,000.

C) $20,000.

D) $25,000.

Answer:  C

Explanation:  C)

Insurance proceeds$200,000
Minus: Adjusted basis of old building( 175,000)
Equals: Gain realized$  25,000
Insurance proceeds$200,000
Minus: Proceeds reinvested(  180,000)
Equals: Proceeds not reinvested$  20,000
Gain recognized:      Lesser of:  1. Gain realized                         2. Proceeds not reinvested$  25,000 20,000
Gain recognized$  20,000

Page Ref.:  I:12-10; Example I:12-32

Objective:  2

59) Stephanie’s building, which was used in her business, was destroyed in a fire. Stephanie’s adjusted basis in the building was $175,000, and its FMV was $210,000. Stephanie filed an insurance claim and was reimbursed $200,000. In that same year, Stephanie invested $180,000 of the insurance proceeds in another business building. Assuming the proper election is made to defer gain, Stephanie’s basis in the new building will be

A) $175,000.

B) $180,000.

C) $200,000.

D) $210,000.

Answer:  A

Explanation:  A)

Insurance proceeds$200,000
Minus: Adjusted basis of old building( 175,000)
Equals: Gain realized$  25,000
Insurance proceeds$200,000
Minus: Proceeds reinvested(  180,000)
Equals: Proceeds not reinvested$  20,000
Gain recognized:      Lesser of:  1. Gain realized                         2. Proceeds not reinvested$  25,000 20,000
Gain recognized$  20,000
Cost of new building$180,000
Less deferred gain ($25,000 – 20,000)-5,000
Basis of replacement building$175,000

Page Ref.:  I:12-10; Example I:12-32

Objective:  2

60) Ron’s building, which was used in his business, was destroyed in a fire. Ron’s adjusted basis in the building was $210,000, and its FMV was $330,000. Ron filed an insurance claim and was reimbursed $300,000. In that same year, Ron invested $240,000 of the insurance proceeds in another business building.  Ron will recognize gain of

A) $-0-.

B) $30,000.

C) $60,000.

D) $90,000.

Answer:  C

Explanation:  C)

Insurance proceeds$300,000
Minus: Adjusted basis of old building( 210,000)
Equals: Gain realized$ 90,000
Insurance proceeds$300,000
Minus: Proceeds reinvested( 240,000)
Equals: Proceeds not reinvested$  60,000
Gain recognized:      Lesser of:  1. Gain realized                         2. Proceeds not reinvested$ 90,000 60,000
Gain recognized$  60,000

Page Ref.:  I:12-10; Example I:12-32

Objective:  2

61) Ron’s building, which was used in his business, was destroyed in a fire. Ron’s adjusted basis in the building was $210,000, and its FMV was $330,000. Ron filed an insurance claim and was reimbursed $300,000. In that same year, Ron invested $240,000 of the insurance proceeds in another business building. Ron’s basis in the new building is

A) $180,000.

B) $210,000.

C) $240,000.

D) $330,000.

Answer:  B

Explanation:  B)

Insurance proceeds$300,000
Minus: Adjusted basis of old building( 210,000)
Equals: Gain realized$ 90,000
Insurance proceeds$300,000
Minus: Proceeds reinvested( 240,000)
Equals: Proceeds not reinvested$  60,000
Gain recognized:      Lesser of:  1. Gain realized                         2. Proceeds not reinvested$ 90,000 60,000
Gain recognized$  60,000
Cost of new building$240,000
Minus: Deferred gain ($90,000 gain realized      minus $60,000 gain recognized)(  30,000)
Basis of new building$  210,000

Page Ref.:  I:12-10; Example I:12-32

Objective:  2

62) Which of the following statements is false regarding involuntary conversions?

A) A taxpayer must replace the destroyed property within the same tax year in which the gain is realized.

B) A taxpayer cannot elect to defer recognition of a loss resulting from an involuntary conversion.

C) If deferral of gain is elected, the holding period of the converted property carries over to the replacement property.

D) Gain may be deferred if the property is involuntarily converted into property that is similar or related in service or use to the converted property.

Answer:  A

Explanation:  A) The replacement period extends to the end of the second tax year following the tax year in which gain is realized.

Page Ref.:  I:12-11 through I:12-15; Topic Review I:12-2

Objective:  2

63) The building used in Tim’s business was condemned by the city of Lafayette. Tim received a condemnation award of $125,000. He paid $1,200 in lawyer’s fees and $800 for an appraisal of the property. Tim’s adjusted basis in the building was $60,000. Tim reinvests in similar property costing $110,000, and Tim makes the proper election regarding the property. What is the amount of Tim’s realized (not recognized) gain on the condemnation?

A) $ -0-

B) $50,000

C) $63,000

D) $65,000

Answer:  C

Explanation:  C)

Condemnation award$125,000
Minus: Attorney’s fees and appraisal fee  – 2,000
Amount realized$123,000
Minus: Adjusted basis of old building(  60,000)
Equals: Gain realized$  63,000

Page Ref.:  I:12-12; Example I:12-36

Objective:  2

64) The building used in Terry’s business was condemned by the city of St. Louis. Terry received a condemnation award of $125,000. He paid $1,200 in lawyer’s fees and $800 for an appraisal of the property. Terry’s adjusted basis in the building was $60,000. Terry reinvests in similar property costing $110,000, and Terry makes the proper election regarding the property. What is the amount of Terry’s recognized gain on the condemnation?

A) $15,000

B) $13,000

C) $50,000

D) $63,000

Answer:  B

Explanation:  B)

Condemnation award$125,000
Minus: Attorney’s fees and appraisal fee  – 2,000
Amount realized$123,000
Minus: Adjusted basis of old building(  60,000)
Equals: Gain realized$  63,000
Amount realized$123,000
Minus: Proceeds reinvested(110,000)
Equals: Proceeds not reinvested$  13,000
Gain recognized:        Lesser of:  1. Gain realized                         2. Proceeds not reinvested$  63,000 13,000
Gain recognized$  13,000

Page Ref.:  I:12-12; Example I:12-37

Objective:  2

65) Ed owns a racehorse with a $600,000 basis used for breeding purposes. The racehorse is killed in a tornado, and Ed collects $1,000,000 from the insurance company. He purchases another horse for $550,000. What is the amount of gain recognized on the transaction?

A) $0

B) $50,000

C) $350,000

D) $400,000

Answer:  D

Explanation:  D) The gain realized is $400,000 ($1,000,000 – $600,000). The amount realized from the involuntary conversion exceeds the cost of replacement property by $450,000 ($1,000,000 – $550,000 = $450,000). Therefore, the entire $400,000 realized gain is recognized.

Page Ref.:  I:12-12; Example I:12-38

Objective:  2

66) The building used in Manuel’s business was condemned by the city of Mobile. Manuel received a condemnation award of $220,000. He paid $800 in lawyer’s fees and $600 for an appraisal of the property. Manuel’s adjusted basis in the building was $120,000. Manuel reinvests in similar property costing $200,000, and Manuel makes the proper election regarding the property.  Manuel’s basis in the new building is

A) $102,400.

B) $121,400.

C) $120,000.

D) $200,000.

Answer:  B

Explanation:  B)

Cost of new building$200,000
Minus: Deferred gain (Gain realized = $220,000 – $120,000 – $800 – $600 = $98,600; $98,600 realized minus $20,000 gain recognized)( 78,600)
Basis of new building$ 121,400

Page Ref.:  I:12-12 and I:12-13; Example I:12-39

Objective:  2

67) Which of the following statements regarding involuntary conversions is incorrect?

A) With some exceptions, the replacement property must be similar or related in service or use to the property converted.

B) The functional-use test is more restrictive than the like-kind test.

C) The taxpayer-use test applies to the involuntary conversion of rental property owned by an investor.

D) Real property used in a trade or business that is condemned must be replaced with property which has the same functional use as the converted property.

Answer:  D

Explanation:  D) Condemned real property may be replaced with like-kind property.

Page Ref.:  I:12-13 and I:12-14

Objective:  2

68) Each of the following is true of deferral of gain attributable to the involuntary conversion of personal property with the exception of

A) gain deferral is elective, except for direct conversions.

B) the replacement property may be acquired by gift, inheritance, or purchase.

C) qualifying replacement property must be acquired within a specified time period.

D) replacement property must be similar or related in service or use to the converted property.

Answer:  B

Explanation:  B) The general rule is that the taxpayer must purchase replacement property.

Page Ref.:  I:12-13 through I:12-15; Topic Review I:12-2

Objective:  2

69) Alex owns an office building which the state condemns on January 15, 2013. Alex receives the condemnation award on April 1, 2013.  In order to qualify for nonrecognition of gain on this involuntary conversion, what is the last date for Alex to acquire qualified replacement property?

A) January 15, 2015

B) January 15, 2016

C) December 31, 2015

D) December 31, 2016

Answer:  D

Explanation:  D) If real property used in a business is condemned, the replacement period ends three years after the close of the first tax year in which any part of the gain is realized.

Page Ref.:  I:12-15; Example I:12-48

Objective:  2

70) According to Sec. 121, individuals who sell or exchange their personal residence may exclude part or all of the gain if the house was owned and occupied as a principal residence for

A) at least five years immediately before the sale date.

B) at least one year of the three-year period before the sale date.

C) at least two years of the five-year period before the sale date.

D) at least five years of the ten-year period before the sale date.

Answer:  C

Explanation:  C) The residence had to be owned and occupied as a principal residence for at least two years in a five year period before the sale or exchange.

Page Ref.:  I:12-16

Objective:  3

71) Mitchell and Debbie, both 55 years old and married, sell their personal residence to Sophie.  Sophie pays $225,000 and assumes their $70,000 mortgage. To make the sale they pay $4,000 in commissions and $1,000 in legal costs. They have owned and lived in the house for seven years and their tax basis is $125,000. What is the amount of gain recognized on the sale?

A) $-0-

B) $100,000

C) $165,000

D) $170,000

Answer:  A

Explanation:  A) Their realized gain of $165,000 is not recognized because they meet the requirements of Section 121.

Amount realized ($225,000 + $70,000 – $4,000 – $1,000$290,000
Adjusted basis125,000
Gain realized$165,000

Page Ref.:  I:12-16; Example I:12-52

Objective:  3

72) Bob and Elizabeth, both 55 years old and married, sell their personal residence to Wolfgang. Wolfgang pays $660,000 and assumes their $90,000 mortgage. To make the sale they pay $20,000 in commissions and $10,000 in legal costs. They have owned and lived in the house for seven years and their tax basis is $200,000. What is the amount of gain recognized on the sale?

A) $-0-

B) $20,000

C) $50,000

D) $520,000

Answer:  B

Explanation:  B)

Amount realized ($660,000 + $90,000 – $20,000 – $10,000)$720,000
Basis( 200,000)
Realized Gain$520,000
Maximum amount to be excluded  500,000
Recognized Gain$  20,000

Page Ref.:  I:12-16; Example I:12-52

Objective:  3

73) Frank, a single person age 52, sold his home this year.  He had lived in the house for 10 years.

He signed a contract on March 4 to sell his home and closed the sale on May 3.

Sales price$202,000
Selling expenses12,000
Replaced and paid for a broken window on March 2200
Basis of old home before repairs and improvements150,000

Based on these facts, what is the amount of his recognized gain?

A) $-0-

B) $39,800

C) $40,000

D) $52,000

Answer:  A

Explanation:  A) He meets the requirements under Sec. 121.

Sales proceeds$202,000
Minus: Selling expenses( 12,000)
Amount realized$190,000
Minus: Basis of old home( 150,000)
Gain realized$ 40,000
Section 121 exclusion     40,000
Gain recognized$          0

Page Ref.:  I:12-16 and I:12-17

Objective:  3

74) Pierce, a single person age 60, sold his home this year. He had lived in the house for 10 years. He signed a contract on March 4 to sell his home.

Sales price$600,000
Selling expenses15,000
Replaced and paid for a broken window on March 2800
Basis of old home before repairs and improvements310,000

Based on these facts, what is the amount of his recognized gain?

A) $-0-

B) $25,000

C) $40,000

D) $275,000

Answer:  B

Explanation:  B) He meets the requirements under Sec. 121.

Sales proceeds$600,000
Minus: Selling expenses( 15,000)
Amount realized$585,000
Minus: Basis of old home(310,000)
Gain realized$275,000
Section 121 exclusion  250,000
Gain recognized$  25,000

Page Ref.:  I:12-16 and I:12-17

Objective:  3

75) On May 1 of this year, Ingrid sold her personal residence for $250,000. Commissions on the sale were $20,000.  Ingrid also incurred $10,000 of costs for painting and repairs, which were all completed and paid for two weeks prior to the sale of her home. Ingrid’s basis in her old home was $180,000.  Ingrid’s realizedgain upon the sale of her first home is

A) $ -0-.

B) $40,000.

C) $50,000.

D) $70,000.

Answer:  C

Explanation:  C)

Sales proceeds$250,000
Minus: Commissions( 20,000)
Amount realized$230,000
Minus: Basis of old home( 180,000)
Gain realized$ 50,000

Page Ref.:  I:12-16 and I:12-17

Objective:  3

76) William and Kate married in 2013 and purchased a new home together. Each had owned and lived in separate residences for the past 5 years. William’s adjusted basis in his old residence was $200,000; Kate’s adjusted basis in her old residence was $120,000. In late 2013, William sells his residence for $500,000 while Kate sells her residence for $190,000. What is the total gain to be excluded from these transactions in 2013?

A) $-0-

B) $250,000

C) $320,000

D) $370,000

Answer:  C

Explanation:  C) William:

Amount realized$500,000 
Basis(200,000)
Realized Gain300,000 
Maximum amount to be excluded  250,000 
Recognized Gain$  50,000 

Kate:

Amount realized$190,000 
Basis(120,000)
Realized Gain$   70,000 
Maximum amount to be excluded    70,000 
Recognized Gain$            0

Page Ref.:  I:12-17; Example I:12-54

Objective:  3

77) All of the following statements are true with regard to personal residences except:

A) Temporarily renting property that was formerly the taxpayer’s principal residence does not automatically preclude the use of Sec. 121.

B) To qualify for favorable tax treatment under Sec. 121, the residence must be either the taxpayer’s principal residence or a secondary residence.

C) In the case of married taxpayers, an individual may claim the exclusion even if the individual’s spouse used the exclusion within the past two years.

D) Houseboats, house trailers, and condominium apartments may qualify as a principal residence.

Answer:  B

Explanation:  B) Only the principal residence qualifies for the exclusion.

Page Ref.:  I:12-17 and I:12-18

Objective:  3

78) Generally, a full exclusion of gain under Sec. 121 upon the sale of a personal residence applies to only one sale or exchange every

A) six months.

B) year.

C) two years.

D) five years.

Answer:  C

Explanation:  C) The full exclusion provided by Sec. 121 applies to only one sale or exchange every two years.

Page Ref.:  I:12-18

Objective:  3

79) Jenna, who is single, sold her principal residence on December 1, 2012, and excluded the $150,000 gain because she met the ownership and usage requirements under Sec. 121. Jenna purchased another residence in Pensacola on January 1, 2013 that she occupied until July 1, 2013 when she receives a new job offer from an employer in Miami. She sells the Pensacola residence on October 1, 2013 and realizes a gain of $40,000. Jenna may exclude what amount of the gain from the sale on October 1, 2013?

A) $-0-

B) $10,000

C) $20,000

D) $40,000

Answer:  D

Explanation:  D) Since she has not met the two-year ownership and usage requirement on the Pensacola house the exclusion must be prorated. Months of usage in the Pensacola house are 6 months. The exclusion is 6/24, or 1/4 of $250,000 ($62,500). Therefore, none of the gain is taxable.

Page Ref.:  I:12-18; Example I:12-57

Objective:  3

80) Which of the following statements is false with regard to the ownership and use tests under Sec. 121?

A) The taxpayer must be occupying the residence at the time of the sale in order for Sec. 121 to apply.

B) If a principal residence is sold before satisfying the ownership and use tests, part of the gain may be excluded if the sale is due to a change in employment, health, or unforeseen circumstances.

C) For purposes of the two-year ownership rule, a taxpayer’s period of ownership includes the period during which the taxpayer’s deceased spouse owned the residence.

D) When a taxpayer receives a residence from a spouse or an ex-spouse incident to a divorce, the taxpayer’s period of owning the property includes the time the residence was owned by the spouse or ex-spouse.

Answer:  A

Explanation:  A) The property does not have to be one’s principal residence at time of the sale to qualify for the exclusion.

Page Ref.:  I:12-18

Objective:  3

81) Under what circumstances can a taxpayer obtain a partial exclusion if a home is sold before the use and ownership tests are satisfied?

A) change in employment that meets the requirement for a moving expense deduction

B) increased traffic due to widening of a road

C) birth of one child

D) death of a child

Answer:  A

Page Ref.:  I:12-19

Objective:  3

82) Which of the following is not an unforeseen circumstance for purposes of obtaining a partial exclusion of a gain on the sale of a home?

A) loss of employment by the qualified individual if the individual is eligible for unemployment compensation

B) natural or man-made disaster resulting in a casualty to the residence

C) birth of one child

D) divorce or legal separation

Answer:  C

Page Ref.:  I:12-19

Objective:  3

83) Indicate with a “yes” or a “no” which of the following are like-kind exchanges.

a.     Computer used in trade or business for office furniture used in trade or business.

b.     Apartment building held as an investment for an office building used in trade or business.

c.     Land used in trade or business for equipment used in trade or business.

d.    Printer used in trade or business for printer used for personal purposes.

e.     Exchange of improved real estate held for investment for unimproved real estate held for investment

Answer: 
a. No;  b.Yes;  c. No;  d. No;  e. Yes

Page Ref.:  I:12-3 through I:12-5

Objective:  1

84) Indicate with a “yes” or a “no” which of the following are like-kind exchanges (assume all assets are held for business or investment purposes).

a.     Exchange of common stock held as an investment for land held as an investment.

b.     Exchange of farmland for an apartment building.

c.     Exchange of office furniture used in trade or business for computer used in a trade or business

d.    Exchange of unimproved real estate for improved real estate.

e.     Exchange of automobile used in trade or business for office building used in trade or business

Answer: 
a. No;  b. Yes  c. No;  d. Yes;  e. No

Page Ref.:  I:12-3 through I:12-5

Objective:  1

85) Amelia exchanges an office building with a $350,000 adjusted basis for an airplane with a $560,000 fair market value to be used in business.

a.    What is the amount of gain or loss realized by Amelia?

b.    What is the amount of gain or loss recognized by Amelia?

Answer: 
a.     $560,000 – $350,000 = $210,000 gain realized

b.     All $210,000 gain realized is also recognized as the property does not qualify as like kind.

Page Ref.:  I:12-3; Example I:12-5

Objective:  1

86) Cheryl owns 200 shares of Cornerstone Corporation common stock which has an adjusted basis of $60,000 and a fair market value of $75,000. John owns 200 shares of Cable Corporation with a $75,000 fair market value.

a.     If Cheryl and John exchange their stock, what is the amount of Cheryl’s realized gain?

b.     If Cheryl and John exchange their stock, what is the amount of Cheryl’s recognized gain?

Answer: 
a.     $75,000 – $60,000 = $15,000 realized gain.

b.     All $15,000 of the gain is recognized because the exchange is neither a like-kind exchange nor an exchange of stock for stock of the same corporation.

Page Ref.:  I:12-5; Example I:12-12

Objective:  1

87) Kevin exchanges an office building used in his business for another office building worth $200,000 plus $30,000 cash. The FMV of Kevin’s old building is $280,000 (basis $150,000) and it is subject to a mortgage of $50,000.  The mortgage is assumed by the other party.

a.     What is the amount of gain realized by Kevin?

b.     What is the amount of gain recognized by Kevin?

c.     What is the basis of the new building to Kevin?

Answer: 
a.     Property received:

        Office building (FMV)                                                                            $200,000

        Cash                                                                                                                 30,000

        Debt assumed by Charlene                                                                       50,000

        Total                                                                                                            $280,000

        Minus: Basis of office building given up:                                        (150,000)

        Gain realized                                                                                            $130,000

b.     Gain recognized to the extent of boot received—$30,000 cash + $50,000 debt assumed = $80,000.

c.     $150,000 determined as follows:

(1) FMV of property received ($200,000) less unrecognized gain ($50,000), or

(2)$150,000 basis of property exchanged – $80,000 boot received + $80,000 gain recognized.

Page Ref.:  I:12-7; Examples I:12-21 and I:12-23

Objective:  1

88) Summer exchanges an office building used in her business for another office building. Summer’s office building has a FMV of $250,000 (basis of $180,000).  The FMV of the new building is $300,000, and it is subject to a mortgage of $60,000, which is assumed by Summer. Summer also pays the other party $40,000 cash.

a.     What is the amount of gain realized by Summer?

b.     What is the amount of gain recognized by Summer?

c.     What is the basis of the new building to Summer?

Answer: 
a.     FMV office building received                                               $300,000

        Minus:      Basis given up:

        Office building                                                                         (180,000)

        Cash                                                                                             (  40,000)

        Debt assumed                                                                           (  60,000)

        Gain realized by Summer                                                    $   20,000

b.     Summer recognizes no gain since this is a nontaxable exchange and she received no boot.

c.     Basis of property received:

        Office building exchanged                                                    $180,000

        Cash paid                                                                                       40,000

        Debt assumed                                                                                60,000

        Basis of office building received:                                         $280,000

Or FMV of property received ($300,000) less unrecognized gain ($20,000).

Page Ref.:  I:12-7; Examples I:12-22 and I:12-23

Objective:  1

89) Trent, who is in the business of racing horses, exchanges a racehorse with a basis of $80,000 for $40,000 cash and a trotter (another racehorse) with a $150,000 fair market value.

a.     What is the amount of gain realized by Trent?

b.     What is the amount of gain recognized by Trent?

c.     What is the adjusted basis of the trotter?

Answer: 
a.     The gain realized is $110,000 [($150,000 + 40,000) – $80,000].

b.     The amount of gain recognized is $40,000, the amount of boot received.

c.     The basis for the replacement property is $80,000 ($80,000 basis of property exchanged – $40,000 boot received + $40,000 gain recognized) or $80,000 ($150,000 FMV of property received less $70,000 gain not recognized).

Page Ref.:  I:12-7; Example I:12-23

Objective:  1

90) Patricia exchanges office equipment with an adjusted basis of $20,000 for $5,000 cash and office equipment with a fair market value of $12,000.

a.     What is the gain or loss recognized?

b.     What is the adjusted basis of the new office equipment?

Answer: 
a.     There is no loss recognized as it is a like-kind exchange. The realized loss is $3,000 [($5,000 + $12,000) amount realized less $20,000 adjusted basis]. The loss is not recognized as the receipt of boot does not cause loss to be recognized.

b.     The basis of the new equipment is $20,000 basis of property exchanged less $5,000 boot received or $15,000.  Alternatively, the basis can be determined as FMV of the new property ($12,000) plus deferred loss ($3,000) or $15,000.

Page Ref.:  I:12-7; Example I:1:2-24

Objective:  1

91) Eric exchanges a printing press with an adjusted basis of $64,000 for a smaller model with a $100,000 fair market value.  In addition, he receives $20,000 of marketable securities.

a.     What is the amount of gain realized by Eric?

b.     What is the amount of gain recognized by Eric?

c.     What is Eric’s basis in the new printing press?

d.    What is Eric’s basis in the marketable securities?

Answer: 
a.     The realized gain is $56,000 [($100,000 + $20,000) – $64,000].

b.     $20,000.  The recognized gain is the lesser of the boot ($20,000) or the realized gain ($56,000).

c.     The basis for the printing press is $64,000 ($64,000 basis of property exchanged less $20,000 boot received plus $20,000 gain recognized).

d.    The basis for the marketable securities is the FMV of $20,000.

Page Ref.:  I:12-8; Example I:12-26

Objective:  1

92) Olivia exchanges land with a $50,000 basis plus marketable securities with a $20,000 basis for a larger parcel of land worth $110,000 in a transaction that otherwise qualifies as a like-kind exchange. The FMV of the land and marketable securities exchanged by Olivia is $75,000 and $35,000 respectively.

a.     What is the amount of gain realized and recognized by Olivia on each asset?

b.     What is the amount of Olivia’s basis in the new land?

Answer: 
a.   

 Land (L-K asset)Securities (boot)
Amount realized ($110,000 total)$75,000$35,000
Less adjusted basis50,00020,000
Realized gain$25,000$15,000
Recognized gain$-0-$15,000
 No boot is received 

b.    Olivia’s basis in the new land is: $85,000:

 $50,000 basis of old land + $20,000 of marketable securities + 15,000 gain recognized, or

$110,000 FMV new land – $25,000 unrecognized gain

Page Ref.:  I:12-9; Example I:12-28

Objective:  1

93) Whitney exchanges timberland held as an investment for undeveloped land with a $300,000 FMV. Whitney’s basis for the timberland is $150,000. Her tractor with a $15,000 basis and a $10,000 FMV is also transferred as part of the exchange.

a.     What is the amount, if any, of gain or loss recognized on the transaction?

b.     What is the basis of the undeveloped land?

Answer: 
a.    

 Timberland (L-K asset)Tractor (boot)
Amount realized ($300,000 total)$290,000$10,000
Less adjusted basis150,00015,000
Realized gain (loss)$140,000($5,000)
Recognized gain (loss)$-0-($5,000)
 No boot is received 

The tractor is non-like-kind property. Therefore, Whitney must recognize the loss on the transfer of $5,000 ($10,000 FMV – $15,000 basis).

b.     Whitney’s basis for the undeveloped land is $160,000:

$150,000 basis of timberland + $15,000 basis of tractor – $5,000 loss recognized, or

$300,000 FMV undeveloped land – $140,000 unrecognized gain.

Page Ref.:  I:12-9; Example I:12-29

Objective:  1

94) Marinda exchanges an office building worth $800,000 (basis is $820,000) for a warehouse worth $850,000.  A part of the exchange she also transfers $50,000 worth of securities which she purchased for $40,000. 

a.    What are Marinda’s realized and recognized gains (losses) on the two assets exchanged?

b.    What is Marinda’s basis in the warehouse acquired?

Answer: 
a.

 Office (L-K asset)Securities (boot)
Amount realized ($850,000 total)$800,000$50,000
Less adjusted basis820,00040,000
Realized gain (loss)($20,000)$10,000
Recognized gain (loss)$-0-$10,000

Loss cannot be recognized on like-kind property.

b.             Marinda’s basis in the warehouse is: $870,000:

$820,000 basis of office + $40,000 of marketable securities + 10,000 gain recognized, or

$850,000 FMV warehouse + $20,000 unrecognized loss

Page Ref.:  I:12-9; Example I:12-30

Objective:  1

95) Luke’s offshore drilling rig with a $700,000 adjusted basis is destroyed by a hurricane. He collects $620,000 from the insurance company and purchases a new drilling rig for $600,000.

a.     What are the tax consequences of these transactions?

b.     What is the basis of the new rig?

Answer: 
a.     A taxpayer may not defer recognition of loss from an involuntary conversion. Therefore the $80,000 loss ($620,000 – $700,000) is recognized as a casualty loss.

b.     The basis of the new rig is $600,000.

Page Ref.:  I:12-11; Example I:12-33

Objective:  2

96) An office building owned by Abby and used in her business was destroyed in a fire. Abby’s adjusted basis in the building was $145,000 and its FMV was $180,000. Abby filed an insurance claim and she was reimbursed $160,000. In that same year, Abby invested $150,000 of the insurance proceeds in another business building.

a.    Assume Abby made the proper election with regard to the involuntary conversion. What is the amount of gain to be recognized by Abby?

b.    What is Abby’s basis in the new building?

Answer: 
a.     Insurance proceeds                                                                 $160,000 

        Minus: Adjusted basis of old building                             ( 145,000)

        Equals: Gain realized                                                              $  15,000

        Insurance proceeds                                                                 $160,000

        Minus: Proceeds reinvested                                                 ( 150,000)

        Equals: Proceeds not reinvested                                         $   10,000

        Gain recognized:

        Lesser of:          1. Gain realized                                             $ 15,000

                                    2. Proceeds not reinvested                             10,000

        Gain recognized                                                                       $  10,000

b.     Cost of new building                                                               $150,000

        Minus: Deferred gain ($15,000 gain

        realized minus $10,000 gain recognized)                          (   5,000)

        Basis of new building                                                             $145,000

Page Ref.:  I:12-12; Example I:12-37

Objective:  2

97) Mick owns a racehorse with a $500,000 basis used for breeding purposes. The racehorse is killed in an accident and Mick receives $750,000 from the insurance company. Mick purchases another racehorse for $400,000.

a.     What is the amount of Mick’s realized gain?

b.     What is the amount of Mick’s recognized gain?

Answer: 
a.     Amount realized                                                                             $750,000

        Less: Adjusted basis                                                                         500,000

        Gain realized                                                                                   $250,000

b.     Amount realized from the involuntary conversion             $750,000

        Investment in new property                                                          400,000

        Amount in excess of reinvestment                                            $350,000

        Gain recognized is $250,000 because the realized gain is less than the unreinvested proceeds.

Page Ref.:  I:12-12; Example I:12-38

Objective:  2

98) Theresa owns a yacht that is held for personal use and has a $100,000 basis. The yacht is destroyed by a storm and Theresa collects $120,000 from the insurance company. She purchases a new $150,000 yacht for personal use and elects to defer any gain on the transaction. What is the basis of the new yacht?

Answer:  Theresa’s realized gain is $20,000 ($120,000 – $100,000). The deferred gain reduces the basis of the new yacht. The new yacht’s basis is $130,000 ($150,000 – $20,000).

Page Ref.:  I:12-12 and I:12-13; Example I:12-39

Objective:  2

99) Kareem’s office building is destroyed by fire on April 11, 2013.  Settlement is reached with the insurance company on November 1, 2013 when he receives a check for $900,000.  The property had recently been appraised for $920,000.  Kareem’s adjusted basis in the building was $800,000. 

a.     What is Kareem’s realized gain or loss?

b.     Assume Kareem wishes to defer the maximum amount of gain.  Indicate:

        (1) the minimum amount that must be spent on a new property.

        (2) any restrictions on the new property in order for it to qualify.

        (3) the deadline for placing the new property in service.

c.     Assume that instead of a fire, the state forces Kareem to sell the property.  Indicate how your responses to part b would differ.

Answer: 
a.    Realized gain = $100,000 ($900,000 insurance proceeds less $800,000 adjusted basis).

b.

        1.  To avoid any gain recognition, Kareem must re-invest the full $900,00 proceeds in qualifying property.

        2.   The replacement property must also be an office building.

        3.  The replacement deadline will be December 31, 2015.

c.

        1.  To avoid any gain recognition, Kareem must re-invest the full $900,00 proceeds in qualifying property (same as in the case of a casualty).

        2.   The replacement property must satisfy the like-kind requirements so he must re-invest in real property used for business or investment purposes.

        3.  The replacement deadline will be December 31, 2016.

Page Ref.:  I:12-12 through I:12-15

Objective:  2

100) Nicki is single and 46 years old. She sells her principal residence (adjusted basis $200,000) that she purchased ten years ago for $435,000.

a.     What is the amount of Nicki’s recognizedgain on the sale?

b.     Assume instead that Nicki sells the residence for $485,000. What is the amount of Nicki’s recognized gain on the sale?

c.     Assume instead that Nicki has been married to Mike for the entire time they have owned and lived in the home. If they sell the home for $485,000, what is the amount of their recognized gain on the sale?

Answer: 
a.     While Nicki’s realized gain is $235,000 ($435,000 – $200,000), none of the gain is recognized since she has owned and lived in the home for at least two of five years and, as a single person, she may exclude up to $250,000 gain.

b.     Nicki’s realized gain is $285,000 ($485,000 – $200,000). She may exclude the first $250,000 of the gain. The remaining $35,000 gain is recognized.

c.     Nicki and Mike’s realized gain is $285,000 ($485,000 – $200,000). A married filing jointly couple may exclude up to $500,000 of the gain if they have owned and lived in the home for two of five years.

Page Ref.:  I:12-16; Example I:12-49, I:12-50, and I:12-51

Objective:  3

101) In 1997, Paige paid $200,000 to purchase a new residence. She paid a realtor $5,000 to help locate the house and paid legal fees of $3,000 to make certain that the seller had legal title to the property. Under the provisions of tax law in effect at the time of the purchase, she deferred a gain of $30,000 from the sale of a former residence in 1996. In 1999, she added a new porch to the house at a cost of $15,000 and installed central air conditioning at a cost of $12,000. Since purchasing the house, she has paid $2,000 in repairs. What is the adjusted basis of the home?

Answer:  The adjusted basis of the house is $205,000:

Purchase price                                          $200,000

Closing costs ($5,000 + 3,000)                     8,000

Deferred gain                                               -30,000

Improvements ($15,000 + 12,000)           27,000

Adjusted basis                                          $205,000

Repairs do not affect the basis.

Page Ref.:  I:12-17; Example I:12-53

Objective:  3

102) James and Ellen Connors, who are both 50 years old and married, sell their personal residence on July 25, 2013 for $950,000. They have lived in the home for 20 years. The basis of the home is $350,000. They purchased a new home for $1,000,000 in August 2013. After living in that home for 219 days, the Connors were forced to sell their new home in 2014 for $1,300,000 and move to another climate due to Ellen’s severe health problems.

a.     What is the amount of gain recognized on the home sale in 2013?

b.     What is the amount of the gain recognized on the home sale in 2014?

Answer: 
a.     Sales proceeds                                                       $  950,000

        Minus: Basis of old home                                   ( 350,000)

        Gain realized                                                         $  600,000

        Section 121 exclusion                                           ( 500,000)

        Gain recognized                                                    $  100,000

b.     Sales proceeds                                                      $1,300,000

        Minus: Basis of old home                                 (1,000,000)

        Gain realized                                                        $   300,000

        Section 121 exclusion                                          (  150,000)

        Gain recognized                                                   $   150,000

Amount excludable: 219/730 = 30% (rounded) × $500,000 = $150,000 excludable

Page Ref.:  I:12-18; Example I:12-57

Objective:  3

103) Amber receives a residence ($750,000 FMV, $500,000 adjusted basis) owned for eight years by Jonathan, her former spouse, as part of a divorce settlement. Amber and Jonathan had lived in the home for the four years before the divorce. Seven months after the transfer of the residence, Amber sells it for $790,000. What is the amount of Amber’s recognized gain on the sale of the home?

Answer:  Amber’s realized gain is ($790,000 – $500,000) = $290,000. Because her period of ownership includes the four years Jonathan owned the residence, she qualifies under Section 121. The first $250,000 of the gain is excluded; the remaining $40,000 is LTCG.

Page Ref.:  I:12-18; Example I:12-59

Objective:  3

104) The Smiths owned and used their principal residence, with an adjusted basis of $250,000, for ten years. The house is destroyed by a tornado and the Smiths receive insurance proceeds of $800,000. Six months later, they purchase another residence for $850,000.

a.     What is the amount of gain the Smiths must recognize?

b.     What is the basis of the new residence?

Answer: 
a.     Insurance proceeds                                                                 $800,000

        Minus: Basis of old home                                                    ( 250,000)

        Gain realized                                                                            $550,000

        Section 121 exclusion                                                            ( 500,000)

        Remaining gain to be deferred                                            $   50,000

        No gain is currently recognized.

b.     Basis of new home is $850,000 less deferred gain $50,000 = $800,000.

Page Ref.:  I:12-21; Example I:12-66

Objective:  3

105) Discuss the basis rules of property received in a nontaxable like-kind exchange.

Answer:  The basis of property received in a nontaxable exchange is equal to the adjusted basis of the property given in exchange (including boot property given) increased by gain recognized and reduced by any boot received or loss that is recognized on the exchange.  An alternative approach is to start with the FMV of the like-kind property received and either increase it by deferred loss or increase it by deferred gain. The basis of non-like-kind property received is an amount equivalent to its FMV at the date of the exchange.

Page Ref.:  I:12-7 and I:12-8

Objective:  1

106) Discuss the rules regarding the holding period for like-kind property received in a nontaxable exchange.

Answer:  The holding period of like-kind property received in a nontaxable exchange includes the holding period of the property exchanged. As a practical matter, the holding period of the property exchanged carries over to the holding period of the like-kind property received. This carryover holding period rule only applies if the like-kind property surrendered is a capital asset or an asset that is Sec. 1231 property.

Page Ref.:  I:12-9

Objective:  1

107) May a taxpayer elect under Sec. 1033 to defer recognition of loss resulting from an involuntary conversion?

Answer:  Sec. 1033 does not apply to losses realized from an involuntary conversion. A taxpayer may not elect to defer recognition of a loss resulting from an involuntary conversion.

Page Ref.:  I:12-11

Objective:  2

108) Ike and Tina married and moved into their new home (purchase price $800,000) 18 months ago. They are thinking of selling the home which is now worth $1,300,000. They plan to reinvest in a smaller home costing approximately $600,000. What should they consider before selling their home?

Answer:  Under Section 121, if Ike and Tina own and live in the home (their principal residence) for at least two years (in a five year period), up to $500,000 of the gain on the sale will be excluded from income. No reinvestment is required. It would also be necessary to know the reason that Ike and Tina are considering the sale. If the sale is due to a change in employment, health reason, or unforeseen circumstances, at least partial gain exclusion is available even though they have not lived in the residence for the entire two years.

Page Ref.:  I:12-16 through I:12-19

Objective:  3

109) Discuss why a taxpayer would want to avoid like-kind exchange provisions.

Answer:  If the sale of the property results in a gain, a taxpayer may want to recognize the gain because due to business operating losses or losses realized on other assets, there may be no taxes due on the gain or a low level of tax. Recognition of the gain would increase the basis of the property received, thus permitting higher depreciation if depreciation is allowable.  In addition, the taxpayer should weigh marginal tax rates today against anticipated marginal tax rates in the future, taking time value of money into account.

If sale of the property would produce a loss, the taxpayer would likely want to sell in order to recognize the loss. A loss realized on a non-taxable exchange is not recognized.

Page Ref.:  I:12-21 and I:12-22

Objective:  4

Chapter I13 

1) Mark owns an unincorporated business and has $20,000 of Section 1231 gains and $22,000 of Section 1231 losses. He must report a capital loss of $2,000 on his tax return.

Answer:  FALSE

Explanation:  If the netting of Sec. 1231 gains and losses at the end of the year results in a net loss, the Sec. 1231 gains and losses are treated as ordinary gains and losses.

Page Ref.:  I:13-3; Example I:13-3

Objective:  1

2) A net Sec. 1231 gain is treated as ordinary income to the extent of any nonrecaptured net Sec. 1231 losses for the preceding five years.

Answer:  TRUE

Explanation:  Net Sec. 1231 losses are deducted as ordinary losses when incurred, but they cause future net Sec. 1231 gains within the following five years to be recaptured as ordinary income rather than LTCG.

Page Ref.:  I:13-3

Objective:  1

3) In 2013, Thomas, who has a marginal tax rate of 15%, sells land that is Sec. 1231 property at a gain of $4,000. If he has no other 1231 transactions or capital asset transactions and has no nonrecaptured 1231 gain, the $4,000 will not be taxed.

Answer:  TRUE

Explanation:  The Sec. 1231 gain will be treated as a LTCG.  The LTCG rate for taxpayers with a marginal tax rate of 15% is zero.

Page Ref.:  I:13-4; Example I:13-8

Objective:  1

4) Sec. 1231 property must satisfy a holding period of more than one year.

Answer:  TRUE

Explanation:  A holding period of more than one year is required of property that otherwise meets the criteria of Sec. 1231.

Page Ref.:  I:13-5

Objective:  2

5) Depreciable property used in a trade or business for one year or less is considered Sec. 1231 property.

Answer:  FALSE

Explanation:  The property must be held more than one year.

Page Ref.:  I:13-5

Objective:  2

6) Any gain or loss resulting from the sale or disposition of depreciable property used in trade or business and held one year or less is considered ordinary.

Answer:  TRUE

Explanation:  Unless the holding period is satisfied, the gain or loss on otherwise qualifying property will be ordinary.

Page Ref.:  I:13-5

Objective:  2

7) The sale of inventory results in ordinary gain or loss.

Answer:  TRUE

Explanation:  Inventory does not qualify as Sec. 1231 property.

Page Ref.:  I:13-5

Objective:  2

8) Gains and losses from involuntary conversions of property used in a trade or business generally are classified as capital gains and losses.

Answer:  FALSE

Explanation:  They are classified as Sec. 1231 gains and losses.

Page Ref.:  I:13-6

Objective:  2

9) Gains and losses resulting from condemnations of Sec. 1231 property and capital assets held more than one year are classified as ordinary gains and losses.

Answer:  FALSE

Explanation:  Such gains and losses are classified as Sec. 1231 gains and losses.

Page Ref.:  I:13-6

Objective:  2

10) If the recognized losses resulting from involuntary conversions arising from casualty or theft exceed the recognized gains from such events (i.e. a net loss from the casualty), all of the involuntary conversions are treated as ordinary gains and losses.

Answer:  TRUE

Explanation:  There is a special carveout of the normal Sec. 1231 netting process for gains and losses resulting from involuntary conversions due to casualty or theft.

Page Ref.:  I:13-7

Objective:  2

11) If realized gain from disposition of business equipment exceeds total depreciation or cost recovery, a portion of the gain will receive Sec. 1231 treatment if the equipment’s holding period is more than one year.

Answer:  TRUE

Explanation:  Gain on equipment up to the level of accumulated depreciation is recaptured as ordinary; excess gain is Sec. 1231 gain.

Page Ref.:  I:13-9

Objective:  3

12) The purpose of Sec. 1245 is to eliminate the advantage taxpayers would have if they were able to reduce ordinary income by depreciation deductions and also receive favorable Sec. 1231 treatment when the asset was sold.

Answer:  TRUE

Explanation:  During the years of the asset’s usage, tax savings on depreciation deductions is at the ordinary income tax rates.  Net Sec. 1231 gains are taxed at the lower capital gain rates.  Recapture avoids the rate disparity.

Page Ref.:  I:13-9

Objective:  3

13) Sec. 1245 applies to gains on the sale of depreciable personal property, but it generally does not apply to depreciable real property.

Answer:  TRUE

Explanation:  Sec. 1250 recapture provisions apply to most real estate, and Sec. 1245 applies to most other depreciable assets.

Page Ref.:  I:13-9

Objective:  3

14) If a taxpayer has gains on Sec. 1231 assets, Secs. 1245 and 1250 must be applied first to determine any amounts recaptured as ordinary income, and any excess gain may then be netted with Sec. 1231 losses for possible long-term capital gain treatment.

Answer:  TRUE

Explanation:  This is a correct summary of the Sec. 1231 process.

Page Ref.:  I:13-9 and I:13-11

Objective:  4

15) Sec. 1245 ordinary income recapture can apply to buildings placed in service prior to 1987.

Answer:  TRUE

Explanation:  Sec. 1245 can apply to non-residential buildings placed in service between 1981 and 1986.

Page Ref.:  I:13-9

Objective:  4

16) Sec. 1245 can increase the amount of gain recognized on an asset.

Answer:  FALSE

Explanation:  Sec. 1245 only affects the character of the gain.  Total gain recognized is limited to the realized gain.

Page Ref.:  I:13-11; Topic Review I:13-1

Objective:  4

17) Section 1250 could convert a portion of Sec. 1231 gain into ordinary income if the real property was placed in service prior to 1987 and accelerated depreciation was used.

Answer:  TRUE

Explanation:  Sec. 1250 requires recapture of “additional” depreciation.  Buildings placed in service prior to 1987 are allowed to use accelerated depreciation.

Page Ref.:  I:13-11

Objective:  5

18) For noncorporate taxpayers, depreciation recapture is not required on real property placed in service after 1986.

Answer:  TRUE

Explanation:  Taxpayers are required to use straight-line depreciation under MACRS for property placed in service after 1986 so there is no “additional” depreciation under Sec. 1250.

Page Ref.:  I:13-11

Objective:  5

19) When corporate and noncorporate taxpayers sell real property placed in service after 1986, all depreciation taken will be taxed at 25%.

Answer:  FALSE

Explanation:  Corporations do not have a preferential long-term capital gains rate.

Page Ref.:  I:13-12

Objective:  5

20) Unrecaptured 1250 gain is the amount of long-term capital gain which would be taxed as ordinary income if Sec. 1250 provided for the recapture of all depreciation and not just additional depreciation.

Answer:  TRUE

Explanation:  Sec. 1250 requires recapture of only “additional” depreciation, the excess of accumulated depreciation using an accelerated method over recalculated accumulated depreciation using straight-line depreciation.

Page Ref.:  I:13-12

Objective:  5

21) The amount recaptured as ordinary income under either Sec. 1245 or Sec. 1250 can never exceed the realized gain.

Answer:  TRUE

Explanation:  See Topic Reviews I:13-1 and I:13-2.

Page Ref.:  I:13-11 and I:13-16

Objective:  5

22) Section 1250 does not apply to assets sold or exchanged at a loss.

Answer:  TRUE

Explanation:  See Topic Review I13-2.

Page Ref.:  I:13-16

Objective:  5

23) In addition to the normal recapture rules of Sec. 1250, corporations which sell depreciable real estate are subject to additional recapture rules of Sec. 291.

Answer:  TRUE

Explanation:  There is an extra layer of depreciation recapture for buildings that is provided by Sec. 291.

Page Ref.:  I:13-16

Objective:  6

24) The additional recapture under Sec. 291 is 25% of the difference between the amount that would have been recaptured if the property was Sec. 1245 property and the actual recapture under Sec. 1250.

Answer:  FALSE

Explanation:  The correct rate is 20%.

Page Ref.:  I:13-16

Objective:  6

25) Frisco Inc., a C corporation, placed a building in service in 2002 and deducted straight-line depreciation under the MACRS system in the normal manner.  It sold the building this year for a substantial gain.  Because straight-line depreciation was used, Frisco will not need to recognize any ordinary gain.

Answer:  FALSE

Explanation:  Sec. 1250 will not require any depreciation recapture, but Sec. 291 requires recapture for C corporations.

Page Ref.:  I:13-16

Objective:  6

26) Gifts of appreciated depreciable property may trigger recapture of depreciation or cost-recovery deductions to the donor.

Answer:  FALSE

Explanation:  The depreciation recapture will apply when the donee recognizes the gain at the later disposition.

Page Ref.:  I:13-18; Example I:13-38

Objective:  7

27) When a donee disposes of appreciated gift property, the recapture amount for the donee is computed by including the recapture amount attributable to the donor.

Answer:  TRUE

Explanation:  A donor cannot escape depreciation recapture by gifting the property.  The depreciation recapture requirement attaches to the donee.

Page Ref.:  I:13-18; Example I:13-39

Objective:  7

28) When appreciated property is transferred at death, the recapture potential carries over to the person who receives the property from the decedent.

Answer:  FALSE

Explanation:  Inherited assets get a “fresh start.”

Page Ref.:  I:13-18

Objective:  7

29) If no gain is recognized in a nontaxable like-kind exchange involving Sec. 1245 or Sec. 1250 property, the recapture potential carries over to the replacement property.

Answer:  TRUE

Explanation:  A taxpayer cannot escape depreciation recapture by disposing of the property in a like-kind exchange.  The depreciation recapture requirement attaches to the replacement asset.

Page Ref.:  I:13-19

Objective:  7

30) When gain is recognized on an involuntary conversion, gain is subject to recapture under Sec. 1245 or Sec.1250.

Answer:  TRUE

Explanation:  All the regular tax law provisions determining character of gain apply to gain recognized due to an involuntary conversion.

Page Ref.:  I:13-19

Objective:  7

31) Installment sales of depreciable property which result in recaptured income under Secs. 1245 or 1250 require that the recaptured income be recognized in the year of sale.

Answer:  TRUE

Explanation:  The recapture income component of the total gain cannot be spread over the installment period.  It must be recognized in the year of disposition.

Page Ref.:  I:13-19

Objective:  7

32) Costs of tangible personal business property which are expensed under Sec. 179 are subject to recapture if the property is converted to nonbusiness use before the end of the MACRS recovery period.

Answer:  TRUE

Explanation:  Sec. 179 (i.e. immediate) expensing must be recaptured if the property is converted to nonbusiness use.

Page Ref.:  I:13-20

Objective:  7

33) Gain recognized on the sale or exchange of property between related parties is capital if the property is subject to depreciation in the hands of the transferee.

Answer:  FALSE

Explanation:  The gain is ordinary.

Page Ref.:  I:13-22

Objective:  7

34) Why did Congress establish favorable treatment for 1231 assets?

A) to encourage the mobility of capital

B) to allow a larger deduction for losses

C) to help business owners replace assets which had declined in value

D) All of the above

Answer:  D

Page Ref.:  I:13-2

Objective:  1

35) Jeremy has $18,000 of Section 1231 gains and $23,000 of Section 1231 losses. The gains and losses are characterized as

A)

Capital GainCapital LossOrdinary IncomeOrdinary Loss
  $18,000 $23,000

B)

Capital GainCapital LossOrdinary IncomeOrdinary Loss
$18,000   $23,000

C)

Capital GainCapital LossOrdinary IncomeOrdinary Loss
$18,000 $23,000  

D)

Capital GainCapital LossOrdinary IncomeOrdinary Loss
$18,000$3,000 $20,000

Answer:  A

Explanation:  A) If, when netted, Sec. 1231 losses exceed Sec. 1231 gains, both are treated as ordinary.

Page Ref.:  I:13-3; Example I:13-3

Objective:  1

36) Pierce has a $16,000 Section 1231 loss, a $12,000 Section 1231 gain, and a salary of $50,000. What is the treatment of these items in Pierce’s AGI?

A) Pierce has a LTCG of $12,000 and a net ordinary income of $34,000.

B) The 1231 gains and losses are treated as ordinary gains and losses making Pierce’s AGI for the year $46,000.

C) Pierce has a $3,000 LTCL which is deductible for AGI making AGI $47,000. He also has a $1,000 LTCL carryover.

D) Pierce has net LTCG of $9,000 and $37,000 of net ordinary income.

Answer:  B

Explanation:  B) If, when netted, Sec. 1231 losses exceed Sec. 1231 gains, both are treated as ordinary. Therefore, AGI is $50,000 + ($12,000 – $16,000) = $46,000.

Page Ref.:  I:13-3; Example I:13-4

Objective:  1

37) Daniel recognizes $35,000 of Sec. 1231 gains and $25,000 of Sec. 1231 losses during the current year. The only other Sec. 1231 item was a $4,000 loss three years ago. This year, Daniel must report

A)

NLTCGOrdinary Income
$10,000$ 0

B)

NLTCGOrdinary Income
$ 6,000$ 4,000

C)

NLTCGOrdinary Income
$ 4,000$ 6,000

D)

NLTCGOrdinary Income
$ 4,000$10,000

Answer:  B

Explanation:  B) The $4,000 is considered a nonrecaptured net Sec. 1231 loss. Thus, of the net Sec. 1231 gain of $10,000 ($35,000 – $25,000), $4,000 is ordinary income.

Page Ref.:  I:13-3; Example I:13-5

Objective:  1

38) During the current year, Danika recognizes a $30,000 Section 1231 gain and a $22,000 Section 1231 loss. Prior to this, Danika’s only Section 1231 item was a $15,000 loss two years ago. Danika must report a(n)

A) $8,000 net LTCG.

B) $8,000 ordinary income.

C) $15,000 ordinary income.

D) $8,000 ordinary income and $7,000 net LTCG.

Answer:  B

Explanation:  B) $8,000 (from the total $15,000) of the non-recaptured Sec. 1231 loss is recaptured as ordinary income.

Page Ref.:  I:13-3; Example I:13-5

Objective:  1

39) During the current year, George recognizes a $30,000 Section 1231 gain on sale of land and a $18,000 Section 1231 loss on the sale of land. Prior to this, George’s only Section 1231 item was a $14,000 loss six years ago. George must report a

A) $12,000 net LTCG.

B) $12,000 ordinary income.

C) $14,000 ordinary income.

D) $10,000 ordinary income and $2,000 net LTCG.

Answer:  A

Explanation:  A) The lookback rule does not apply because the last 1231 loss was six years ago. Thus, the net Section 1231 gain is $12,000 ($30,000 – $18,000) to be treated as long-term capital gain.

Page Ref.:  I:13-4

Objective:  1

40) During the current year, Kayla recognizes a $40,000 Section 1231 gain on sale of land and a $22,000 Section 1231 loss on the sale of land. Prior to this, Kayla’s only Section 1231 item was a $10,000 loss six years ago. Kayla is in the 28% marginal tax bracket. The amount of tax resulting from these transactions is

A) $2,700.

B) $3,600.

C) $4,000.

D) $5,040.

Answer:  A

Explanation:  A) The lookback rule does not apply because the last 1231 loss was six years ago. Therefore, the entire amount is LTCG and is taxed at 15%. 15% × $18,000 = $2,700.

Page Ref.:  I:13-4; Example I:13-6

Objective:  1

41) Blair, whose tax rate is 28%, sells one tract of land at a gain of $29,000 and another tract of land at a gain of $11,000. Both tracts of land are Sec. 1231 property. She has never had any other Sec. 1231 transactions. How are the gains taxed?

A) ordinary income of $40,000 taxed at 28%

B) a net capital gain of $40,000 which is not taxed

C) a net capital gain of $40,000 taxed at 15%

D) ordinary income of $40,000 taxed at 25%

Answer:  C

Explanation:  C) The 1231 gains are treated as LTCG taxed at a maximum of 15%. ($29,000 + $11,000 = $40,000).

Page Ref.:  I:13-4; Example I:13-6

Objective:  1

42) For a business, Sec. 1231 property does not include

A) timber, coal, or domestic iron ore.

B) inventory purchased 24 months ago.

C) an office building purchased five years ago.

D) land used in the business that was purchased two years ago.

Answer:  B

Explanation:  B) Inventory is not considered Sec. 1231 property.

Page Ref.:  I:13-5

Objective:  2

43) Which of the following assets is 1231 property?

A) a machine used in the company’s manufacturing operations

B) an investment in corporate stock

C) land held for investment

D) items held for resale by a retailer

Answer:  A

Explanation:  A) Corporate stock and land held for investment are capital assets, while inventory is an ordinary asset.  Only machinery used in a business will qualify under Sec. 1231.

Page Ref.:  I:13-5

Objective:  2

44) Section 1231 property will generally have all the following characteristics except

A) real or depreciable property.

B) used in trade or business.

C) held for sale to customers.

D) held for more than one year.

Answer:  C

Explanation:  C) Inventory is not considered Sec. 1231 property.

Page Ref.:  I:13-5

Objective:  2

45) A corporation owns many acres of timber, which it acquired three years ago, and which has a $120,000 basis. The timber was cut last year for use in the corporation’s business. The FMV of the timber on the first day of last year was $270,000. The corporation made the appropriate election to treat the cutting as a sale or exchange. The timber is sold for $300,000 this year. The tax result this year is

A) recognition of capital gain of $30,000.

B) recognition of Sec. 1231 gain of $30,000.

C) recognition of ordinary income of $30,000.

D) no income recognized since all recognition occurs in the year of the cutting of the timber.

Answer:  C

Explanation:  C) $270,000 – $120,000 = $150,000 section 1231 gain recognized last year under the timber election provided by Sec 631. This year recognize the difference between the selling price of $300,000 and $270,000 = $30,000 as ordinary income.

Page Ref.:  I:13-5 and I:13-6; Example I:13-13

Objective:  2

46) A corporation owns many acres of timber, which it acquired three years ago, and which has a $150,000 basis for depletion. The timber is cut during the current year for use in the corporation’s business. The FMV of the timber on the first day of the current year is $280,000. If the corporation makes the appropriate election, the tax result is

A) recognition of a Sec. 1231 gain of $130,000.

B) no recognition of gain or loss since the timber is used in the business.

C) recognition of a gain at the time of sale if the timber is later sold with the gain equal to the sales price less the basis in the timber.

D) recognition of a gain if the timber is later sold with the gain equal to the sales price less $280,000 (FMV on the first day of the year of the cutting).

Answer:  A

Explanation:  A) Sec. 631 provides an election to recognize the Sec. 1231 gain when the timber is cut.  $280,000 – $150,000 = $130,000

Page Ref.:  I:13-5 and I:13-6; Example I:13-13

Objective:  2

47) In order to be considered Sec. 1231 property, all of the following livestock must be held for 12 months or more from date of acquisition except

A) goats.

B) hogs.

C) sheep.

D) cattle.

Answer:  D

Explanation:  D) Cattle must be held for 24 months or more from date of acquisition.

Page Ref.:  I:13-6

Objective:  2

48) For livestock to be considered Section 1231 property,

A) the livestock must be held for draft, breeding or dairy purposes, but not for sport.

B) cattle and horses must be held for at least 12 months from the date of acquisition.

C) cattle and horses must be held for at least 24 months from the date of acquisition.

D) livestock other than cattle and horses must be held for at least 24 months from the date of acquisition.

Answer:  C

Explanation:  C) The first answer choice is incorrect because the livestock may be held for sport. The second answer choice is incorrect and the third answer choice is correct because cattle and horses must be held for at least 24 months. The fourth answer choice is incorrect because other livestock must be held for at least 12 months.

Page Ref.:  I:13-6

Objective:  2

49) If Section 1231 applies to the sale or exchange of an unharvested crop sold with land, the costs of producing the crop are

A) capitalized.

B) deducted as an expense of operations when incurred and also deducted from the sales price at the time of the sale.

C) deducted when incurred if the land is sold but capitalized if the land is exchanged.

D) deducted as an expense of operations when incurred.

Answer:  A

Explanation:  A) Costs of producing the crop must be capitalized.

Page Ref.:  I:13-6

Objective:  2

50) Dinah owned land with a FMV of $130,000 (adjusted basis $120,000) which is investment property (a capital asset). Dinah owned a second tract of land, a 1231 asset, with a FMV of $46,000 (adjusted basis $50,000). Both tracts were acquired in 2001 and condemned by the state this year. The state paid an amount equal to FMV. If there are no other transactions involving capital assets or 1231 assets, Dinah must report on her current year return

A) $6,000 net ordinary income.

B) $6,000 net section 1231 gain treated as a net capital gain.

C) a LTCG of $10,000 and a 1231 loss of $4,000.

D) a LTCG of $10,000 and a nondeductible loss of $4,000.

Answer:  B

Explanation:  B) The $10,000 gain on the condemnation of the land held for investment is considered a Sec. 1231 gain and the $4,000 loss due to the condemnation of the business land is a Sec. 1231 loss. Since the 1231 gains exceed the 1231 losses, both are treated as capital gains and losses.

Page Ref.:  I:13-6 and I:13-7; Example I:13-14

Objective:  2

51) Emma owns a small building ($120,000 basis and $123,000 FMV) and equipment ($35,000 basis and $22,000 FMV). Both assets were acquired three years ago, are used in Emma’s business, and are depreciated using straight-line depreciation. Both are destroyed by fire. Insurance proceeds were equal to their FMVs. Only one other transfer of an asset occurs during the year, and a $3,000 LTCL is recognized. After considering all transactions, the tax result to Emma is a

A) $13,000 NLTCL.

B) $13,000 ordinary loss.

C) $3,000 LTCG; $3,000 LTCL; and $13,000 ordinary loss.

D) $10,000 net ordinary loss and a $3,000 NLTCL.

Answer:  D

Explanation:  D) If the losses from involuntary conversion arising from fire exceed the gains, the gains and losses are treated as ordinary gains and losses which is the case in this problem. $123,000 – $120,000 = $3,000 gain; $22,000 – $35,000 = $13,000 loss. The condemnations result in an ordinary net loss of $10,000.

Page Ref.:  I:13-7; Example I:13-15

Objective:  2

52) Cassie owns equipment ($45,000 basis and $30,000 FMV) and a building ($152,000 basis and $158,000 FMV), which are used in Cassie’s business. Cassie has used straight-line depreciation for both assets, which were acquired two years ago. Both the equipment and the building are destroyed in a fire, and Cassie collects insurance proceeds equal to the assets’ FMV. The tax result to Cassie for this transaction is a

A) $15,000 Sec. 1231 loss and a $6,000 ordinary gain.

B) $15,000 ordinary loss and a $6,000 ordinary gain.

C) $15,000 ordinary loss and a $6,000 Sec. 1231 gain.

D) $15,000 Sec. 1231 loss and a $6,000 Sec. 1231 gain.

Answer:  B

Explanation:  B) If the losses from involuntary conversion arising from fire exceed the gains, the gains and losses are treated as ordinary gains and losses which is the case in this problem. $30,000 – $45,000 = $15,000 loss; $158,000 – $152,000 = $6,000 gain.

Page Ref.:  I:13-7; Example I:13-15

Objective:  2

53) Harry owns equipment ($50,000 basis and $38,000 FMV) and a building ($140,000 basis and $156,000 FMV), which are used in his business. Harry uses straight-line depreciation for both assets, which were acquired several years ago. Both the equipment and the building are destroyed in a fire, and Harry collects insurance proceeds equal to the assets’ FMV. The tax result to Harry for this transaction is

A) the involuntary conversions are treated as ordinary gains and losses.

B) the involuntary conversions are treated as Sec. 1231 gains and losses.

C) the loss on involuntary conversion is treated as a Sec. 1231 loss while the gain is treated as an ordinary gain.

D) the loss on involuntary conversion is treated as an ordinary loss while the gain is treated as a Sec. 1231 gain.

Answer:  B

Explanation:  B) If the gains from involuntary conversions resulting from fire (and other casualties) exceed the losses, which are the case here, all are classified as Sec. 1231 gains and losses. $38,000 – $50,000 = $12,000 loss; $156,000 – $140,000 = $16,000 gain.

Page Ref.:  I:13-6 and I:13-7; Example I:13-16

Objective:  3

54) Terry has sold equipment used in her business.  She acquired three years ago for $50,000 and has recognized $30,000 of depreciation across the years in use.  In order to recognize any Sec. 1231 gain, she must sell the equipment for more than

A) $-0-.

B) $20,000.

C) $30,000.

D) $50,000.

Answer:  D

Explanation:  D) Any sales price of $50,000 or less will result in the full gain being recaptured as ordinary income under the depreciation recapture provisions of Sec. 1245.

Page Ref.:  I:13-9

Objective:  4

55) During the current year, Hugo sells equipment for $150,000. The equipment cost $175,000 when placed in service two years ago, and $55,000 of depreciation deductions were allowed. The results of the sale are

A) LTCG of $30,000.

B) Sec. 1231 gain of $30,000.

C) Sec. 1245 ordinary income $30,000.

D) Sec. 1250 ordinary income of $30,000.

Answer:  C

Explanation:  C)

Amount realized$150,000
Adjusted basis ($175,000 – $55,000)120,000
1231 gain realized$ 30,000
1245 ordinary income recapture to extent of depreciation$ 30,000

Page Ref.:  I:13-8 and I:13-9; Example I:13-19

Objective:  4

56) During the current year, a corporation sells equipment for $300,000. The equipment cost $270,000 when purchased and placed in service two years ago and $60,000 of depreciation deductions were allowed. The results of the sale are

A) ordinary income of $90,000.

B) Sec. 1231 gain of $90,000.

C) ordinary income of $60,000 and LTCG of $30,000.

D) ordinary income of $60,000 and Sec. 1231 gain of $30,000.

Answer:  D

Explanation:  D)

Amount realized$300,000
Adjusted basis ($270,000 – $60,000210,000
1231 gain realized$ 90,000
1245 ordinary income recapture to extent of depreciation$ 60,000
Remaining gain is 1231 gain$ 30,000

Page Ref.:  I:13-9; Example I:13-20

Objective:  4

57) Section 1245 recapture applies to all the following except

A) depreciable personal property.

B) assets sold or exchanged at a loss.

C) total depreciation or amortization allowed or allowable.

D) amortizable intangible personal property.

Answer:  B

Explanation:  B) Section 1245 does not apply to losses.

Page Ref.:  I:13-9

Objective:  4

58) All of the following statements are true regarding Sec. 1245 are true except

A) Sec. 1245 does not apply to any buildings placed in service after 1986.

B) Sec. 1245 applies to assets sold or exchanged at a gain or at a loss.

C) Sec. 1245 property includes nonresidential real estate that qualified as recovery property under the ACRS rules unless the taxpayer elected to use the straight-line method of cost recovery.

D) Sec. 1245 ordinary applies to total depreciation or amortization allowed or allowable but not more than the realized gain.

Answer:  B

Explanation:  B) Sec. 1245 does not apply to assets sold at a loss.

Page Ref.:  I:13-11; Topic Review I:13-1

Objective:  4

59) An unincorporated business sold two warehouses during the current year. The straight-line depreciation method was used for the first building and the accelerated method (ACRS) was used for the second building. Information about those buildings is presented below.

 Building No. 1Building No. 2
Date acquired19861986
Cost$800,000$900,000
Accum. Depreciation      Straight-line800,000 
     ACRS depreciation 900,000
Selling Price80,000400,000

How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture by the owner of the business?

A)

Section 1231 GainOrdinary Income
$480,000$-0-

B)

Section 1231 GainOrdinary Income
$ 80,000$400,000

C)

Section 1231 GainOrdinary Income
$ -0-$480,000

D)

Section 1231 GainOrdinary Income
$400,000$ 80,000

Answer:  B

Explanation:  B) Building No. 2 is considered Sec. 1245 property because ACRS was used.

 Building No. 1Building No. 2
Date acquired19861986
Cost$800,000$900,000
Accum. Depreciation  800,000900,000
Adjusted Basis-0--0-
Selling Price 80,000400,000
Gain   80,000$400,000
Sec. 1231 Gain$ 80,000 
Sec. 1245 Ordinary Income $400,000

Page Ref.:  I:13-10; Example I:13-24

Objective:  4

60) A building used in a business for more than a year is sold.  Sec. 1250 will not cause depreciation recapture if

A) the building is fully depreciated.

B) the building was placed in service after 1986.

C) straight-line depreciation was used.

D) all of the above.

Answer:  D

Explanation:  D) All three conditions will result in -0- depreciation recapture under Sec. 1250.

Page Ref.:  I:13-11

Objective:  5

61) With respect to residential rental property

A) 80% or more of the gross rental income from the building or structure must be rental income from dwelling units in order for it to be classified as residential rental property.

B) hotels are not included in this category if less than half of the units are used on a transient basis.

C) 80% or more of the net rental income from the building or structure must be rental income from dwelling units in order for it to be classified as residential rental property.

D) gain is not subject to the depreciation recapture provisions if the property is held more than one year.

Answer:  A

Explanation:  A) For a building or structure to qualify as residential rental property, 80% or more of the gross rental income from the property must be rental income from dwelling units.

Page Ref.:  I:13-13

Objective:  5

62) Marta purchased residential rental property for $600,000 on January 1, 1985.  Total ACRS deductions for 1985 through the date of sale amounted to $600,000. If the straight-line method of depreciation had been used, depreciation would have been $600,000. The property is sold for $750,000 on January 1 of the current year. The amount and character of the gain is

A) $750,000 Sec. 1231 gain.

B) $150,000 Sec. 1231 gain and $600,000 ordinary income.

C) $750,000 ordinary gain due to Sec 1245.

D) $750,000 ordinary gain due to Sec. 1250.

Answer:  A

Explanation:  A)

Sales price $750,000
Cost$600,000 
Depreciation– 600,000– 0
Realized Gain $750,000
Actual depreciation $600,000
Straight-line depreciation – 600,000
Excess depreciation (Sec. 1250) $ 0
Sec. 1231 $ 750,000

Note that Sec. 1245 does not apply to this ACRS building because it is a residential rental building.

Page Ref.:  I:13-14; Example I:13-33

Objective:  5

63) Emily, whose tax rate is 28%, owns an office building which she purchased for $900,000 on March 18 of last year. The building is sold for $950,000 on February 20 of this year when the adjusted basis of the building was $876,000. The tax results to Emily are

A) $74,000 1231 gain taxed at 15%.

B) $74,000 ordinary income taxed at 28%.

C) $24,000 1250 unrecaptured gain taxed at 25% and $50,000 1231 gain taxed at 15%.

D) $24,000 1231 gain taxed at 15% and $50,000 ordinary income taxed at 28%.

Answer:  B

Explanation:  B) The gain realized is $950,000 – $876,000 = $74,000. The gain is neither Sec. 1231 gain or Sec. 1250 gain because the holding period is not more than one year. Thus, the gain is taxed at ordinary income rates, in this case, 28%.

Page Ref.:  I:13-13; Example I:13-29

Objective:  5

64) In 1980, Mr. Lyle purchased a factory building to use in business for $480,000. When Mr. Lyle sells

the building for $580,000, he has taken depreciation of $470,000. Straight-line depreciation would have been $400,000.  Mr. Lyle must report

A) $570,000 of ordinary gain.

B) $570,000 of Sec. 1231 gain.

C) $70,000 of ordinary income and $500,000 of Sec. 1231 gain.

D) $470,000 of ordinary gain and $100,000 of Sec. 1231 gain.

Answer:  C

Explanation:  C)

Sale price $580,000
Minus: Cost$480,000 
     Minus: Cost-recovery(470,000) 
     Adjusted basis (  10,000)
Gain realized $570,000
Sec. 1250 recapture for property–smaller of:        Gain realized, or $570,000
     Additional depreciation ($470,000 – 400,000) $ 70,000

Remainder of gain ($570,000 – $70,000 = $500,000) is Sec. 1231 gain.

Page Ref.:  I:13-14; Example I:13-31

Objective:  5

65) Ross purchased a building in 1985, which he uses in his manufacturing business. Ross uses the ACRS statutory rates to determine the cost-recovery deduction for the building. Ross’s original cost for the building is $500,000 and cost-recovery deductions allowed are $500,000. If the building is sold for $340,000, the tax results to Ross are

A) $340,000 LTCG.

B) $340,000 Sec. 1231 gain.

C) $340,000 Sec. 1245 ordinary income.

D) $340,000 Sec. 1250 ordinary income.

Answer:  C

Explanation:  C)

Amount realized$340,000
Adjusted basis ($500,000 – $500,000)      -0-
Gain realized$340,000

Section 1245 ordinary income recapture applies to non-residential real estate placed in service after December 31, 1980, and before January 1, 1987. This property qualifies as such. Gain realized is considered 1245 ordinary income to the extent of all depreciation taken—$500,000 in this case. Because the gain was a lesser amount, all of the gain realized is 1245 ordinary income.

Page Ref.:  I:13-14; Example I:13-33

Objective:  5

66) Eric purchased a building in 2003 that he uses in his business. Eric uses the straight-line method for the building. Eric’s original cost for the building is $420,000 and cost-recovery deductions are $120,000. Eric is in the top tax bracket and has never sold any other business assets.  If the building is sold for $560,000, the tax results are

A) $260,000 Sec. 1231 gain, all taxable at 20%.

B) $260,000 unrecaptured Sec. 1250 gain, all taxable at 25%.

C) $260,000 Sec. 1231 gain, of which $120,000 is unrecaptured Sec. 1250 gain taxable at 25% and the $140,000 balance is taxable at 20%.

D) $120,000 Sec. 1245 ordinary income, $140,000 Sec. 1231 gain taxable at 20%.

Answer:  C

Explanation:  C)

Amount realized$560,000
Adjusted basis ($420,000 – $120,000)300,000
Sec 1231 gain realized To be taxed as follows:$260,000
Unrecaptured 1250 income at 25%$120,000
Long-term capital gain at 20%$140,000

Page Ref.:  I:13-14; Example I:13-35

Objective:  5

67) With regard to noncorporate taxpayers, all of the following statements are true regarding Sec. 1250 recapture except

A) Sec. 1250 affects the character of the gain, not the amount of the gain.

B) Sec. 1250 applies to assets sold or exchanged at either a gain or a loss.

C) Sec. 1250 ordinary income does not exist if the straight-line method of depreciation is used.

D) Sec. 1250 ordinary income is never more than the additional depreciation allowed.

Answer:  B

Explanation:  B) Sec. 1250 does not apply to assets sold or exchanged at a loss.

Page Ref.:  I:13-16; Topic Review I:13-2

Objective:  5

68) In 1980, Artima Corporation purchased an office building for $400,000 for use in its business. The

building is sold during the current year for $550,000. Total depreciation allowed for the building was $350,000; straight-line would have been $320,000. As result of the sale, how much section 1231 gain will Artima Corporation report?

A) $350,000

B) $406,000

C) $320,000

D) $500,000

Answer:  B

Explanation:  B)

Date acquired1980
Cost$400,000
Accumulated Depreciation350,000
Adjusted Basis50,000
Selling Price550,000
Gain$500,000
Tentative section 1231 gain500,000
Recapture under 1250 ($350,000 – $320,000)30,000
Recapture, if under 1245350,000
Section 291 recapture 20% of 1245 not recaptured ($350,000 – 30,000)$ 64,000

1231 gain: $500,000 gain – $30,000 (1250 recapture) – $64,000 (291) = $406,000

Page Ref.:  I:13-16; Example I:13-36

Objective:  6

69) A corporation sold a warehouse during the current year. The straight-line depreciation method was used. Information about the building is presented below:

Date acquired1984
Cost$800,000
Accumulated Depreciation – Straight-line620,000
Selling Price890,000

How much gain should the corporation report as section 1231 gain?

A) $124,000

B) $620,000

C) $586,000

D) $710,000

Answer:  C

Explanation:  C)

Date acquired1984
Cost$800,000
Accumulated Depreciation620,000
Adjusted Basis180,000
Selling Price890,000
Gain710,000
Tentative section 1231 gain$710,000
Recapture under 12500
Recapture, if under 1245620,000
Section 291 recapture 20% of 1245 recap.$124,000

$710,000 total gain – $124,000 Sec. 291 recapture = $586,000 Sec. 1231 gain

Page Ref.:  I:13-16; Example I:13-37

Objective:  6

70) Octet Corporation placed a small storage building in service in 1993. Octet’s original cost for the building is $800,000 and the cost recovery deductions are $300,000. This year the building is sold for $1,100,000.  The amount and character of the gain are

A) Ordinary gain of $60,000 and Sec. 1231 gain of $540,000.

B) Ordinary gain of $300,000 and Sec. 1231 gain of $300,000.

C) Ordinary gain of $600,000.

D) Sec. 1231 gain of $600,000.

Answer:  A

Explanation:  A)

Amount realized  $1,100,000
Minus: Adjusted basis ($800,000 – $300,000)  ( 500,000)
Gain realized  $600,000
Recapture under Sec. 12500 
Recapture under Sec. 291 20% × $300,000$60,000 
Sec. 1231 gain    $540,000 

The Sec. 291 recapture equals 20% of the recapture that would have been required if Sec. 1245 had applied less the amount recaptured under Sec. 1250 [20% of (300,000 – 0)].

Page Ref.:  I:13-16; Example I:13-37

Objective:  6

71) Millicent makes a gift of an organ to a church. Millicent uses the organ in her trade or business. The organ has a FMV of $6,500; a cost of $11,000; and $7,000 depreciation claimed. What is the amount of Millicent’s charitable contribution deduction?

A) $2,500

B) $4,000

C) $6,500

D) 11,000

Answer:  B

Explanation:  B) If the organ had been sold for $6,500, the realized and recognized gain would be $2,500 and all of the gain would be ordinary income due to the recapture of depreciation under Sec. 1245. The charitable contribution deduction is limited to $4,000 ($6,500 – $2,500) because none of the $2,500 gain would be taxed as a LTCG if the organ was sold.

Page Ref.:  I:13-18; Example I:13-41

Objective:  7

72) A taxpayer purchased a factory building in 1985 for $800,000. After claiming ACRS-accelerated depreciation of $800,000, she sells the asset for $1,000,000 during the current year. No payment is received during the current year, and the $1,000,000 balance to be paid with interest at the interest rate in four annual payments beginning one year from date of sale. The installment sales method is adopted. How much ordinary income is recognized in the current year?

A) $ -0-

B) $200,000

C) $800,000

D) $1,000,000

Answer:  C

Explanation:  C) $800,000 of the $1,000,000 ($1,000,000 amount realized – $-0- adjusted basis) gain is Sec. 1245 ordinary income and must be recognized in the year of sale.

Page Ref.:  I:13-19; Example I:13-45

Objective:  7

73) Douglas bought office furniture two years and four months ago for $25,000 to use in his business and elected to expense all of it under Sec. 179. Depreciation of $3,500 would have been taken under the MACRS rules. If Douglas converts the furniture to nonbusiness use today, Douglas must

A) amend the prior two years tax returns.

B) include $3,500 in gross income in year of conversion.

C) include $21,500 in gross income in year of conversion.

D) include $25,000 in gross income in year of conversion.

Answer:  C

Explanation:  C) $25,000 depreciation taken – $3,500 depreciation that would have been taken = $21,500 must be recaptured.

Page Ref.:  I:13-20; Example I:13-47

Objective:  7

74) Clarise bought a building three years ago for $180,000 to use in her business. The straight-line method of depreciation was used and $15,000 of depreciation deductions were allowed. During the current year, Clarise sells the building to her wholly-owned corporation for $235,000. The tax results to Clarise are

A) $70,000 ordinary income.

B) $70,000 of Sec. 1231 gain.

C) $55,000 ordinary income and $15,000 Sec. 1231 gain.

D) $15,000 of ordinary income and $55,000 Sec. 1231 gain.

Answer:  A

Explanation:  A)

Amount realized$235,000
Adjusted basis ($180,000 – 15,000)165,000
Gain realized$ 70,000

All gain recognized on the sale or exchange of property between related parties is ordinary income if the property is subject to depreciation in the hands of the transferee.

Page Ref.:  I:13-22; Example I:13-51

Objective:  7

75) All of the following are considered related parties for purposes of Sec. 1239 recapture with the exception of

A) an individual and a partnership where the individual has a one-fourth interest in the partnership.

B) an individual and a corporation where the individual owns more than 50% of the value of the outstanding stock of the corporation.

C) an individual and a corporation where the individual’s spouse owns more than 50% of the value of the outstanding stock of the corporation.

D) an individual and a partnership where the individual owns more than 50% of the capital of the partnership.

Answer:  A

Explanation:  A) With regard to individuals and partnerships, they are considered related if the individual owns more than 50% (not more than 25% as listed in the first answer choice) of the partnership.

Page Ref.:  I:13-22

Objective:  7

76) Lucy, a noncorporate taxpayer, experienced the following Section 1231 gains and losses during the years 2008 through 2013. Her first disposition of a Sec. 1231 asset occurred in 2008.  Assuming Lucy had no capital gains and losses during that time period, what is the tax treatment in each of the years listed?

                        Section 1231 Gains                  Section 1231 Losses

2008                       $10,000                                      $  8,000

2009                       $18,000                                      $23,000

2010                        $  9,000                                      $13,000

2011                       $22,000                                      $16,000

2012                       $25,000                                      $17,000

2013                       $11,000                                      $18,000

Answer: 

2008    $2,000 LTCG

2009    $5,000 Ordinary losses

2010    $4,000 Ordinary losses

2011    $6,000 ordinary income due to Sec. 1231 recapture; leaves $3,000 available for later recapture

2012    $8,000 net gain—recapture $3,000 as ordinary income; $5,000 balance will be LTCG

2013    $7,000 Ordinary losses

Page Ref.:  I:13-3

Objective:  1

77) Jillian, whose tax rate is 39.6%, had the following sales of Section 1231 property this year:

Sale of land at a gain of $15,000

Sale of land at a gain of $12,000

Sale of land at a loss of $8,000

a.    What is the amount of her resulting tax liability?

b.    Assume instead that Jillian has a 15% marginal tax rate. What is the amount of her resulting tax liability?

c.     Assume instead that Jillian has a 28% marginal tax rate.  What is the amount of her resulting tax liability?

Answer: 
a.     The net 1231 gain is $15,000 + $12,000 – $8,000 = $19,000. Because Jillian is in the 39.6% tax bracket, it is taxed at 20%. Thus, the tax is $19,000 × .20 = $3,800.

b.     There is no tax on capital gains for taxpayers with a 15% marginal tax rate or lower.

c.     Because Jillian is in the 28% tax bracket, it is taxed at 15%. Thus, the tax is $19,000 × .15 = $2,850.

Page Ref.:  I:13-4; Example I:13-7 and I:13-8

Objective:  1

78) Hilton, a single taxpayer in the 28% marginal tax bracket, has $16,000 of nonrecaptured net Sec. 1231 losses, at the beginning of a year in which he had the following transactions:

-Sale of Asset A at a $10,000 1231 gain, all of which is unrecaptured Sec. 1250 gain

-Sale of Asset B at a $13,000 1231 gain

How are the items reported this year and at which rate(s) are the amounts taxed?

Answer: 

Asset A- The entire gain from the sale of Asset A is ordinary income due to the five-year lookback.  The full $10,000 gain will be taxed at 28%.

Asset B- As a result of the five-year lookback rule, $6,000 of the gain on the sale of Asset B is ordinary income ($16,000 nonrecaptured losses less $10,000 ordinary income on sale of asset A) taxed at 28%; the remaining $7,000 1231 gain is taxed at 15%

Page Ref.:  I:13-4; Example I:13-9

Objective:  1

79) Indicate whether each of the following assets are capital assets, Sec. 1231 assets, or ordinary income property (property which, if sold, results in ordinary income). Assume that all of the property is held for more than one year.

a.     XYZ Corporation owns land used as an employee parking lot. How is the parking lot classified for tax purposes?

b.     Montana Corporation owns land held as an investment. How is the land classified for tax purposes?

c.     John, a self-employed electrician, owns an automobile he uses strictly for personal use. How is the automobile classified for tax purposes?

d.    Jan, a self-employed contractor, owns a truck she uses exclusively in her trade or business. How is the truck classified for tax purposes?

e.     Leslie owns an office building where her accounting practice is located. What is the classification of the building?

f.      Yvonne purchases a computer for use in her job as a sales representative. She does not use the computer for personal purposes. How is the computer classified for tax purposes?

Answer: 
a.     Sec. 1231 property

b.     Capital asset

c.     Capital asset (although a loss cannot be recognized)

d.     Sec. 1231 property

e.     Sec. 1231 property

f.      Sec. 1231 property

Page Ref.:  I:13-5; Example I:13-10 and I:13-11

Objective:  2

80) Sarah owned land with a FMV of $150,000 (adjusted basis $135,000) which is investment property (a capital asset). Sarah owned a second tract of land, a 1231 asset, with a FMV of $38,000 (adjusted basis $55,000). Both tracts were acquired in 2000 and condemned by the state this year. The state paid an amount equal to FMV. If there are no other transactions involving capital assets or 1231 assets, what is the amount that Sarah must report on her current year return?

Answer:  The $15,000 gain ($150,000 – $135,000) on the condemnation of the land held for investment is treated as a Sec. 1231 gain and the $17,000 ($38,000 – $55,000) loss due to the condemnation of the business land is a Sec. 1231 loss. Since the 1231 losses exceed the 1231 gains, both are treated as ordinary gains and losses.

Page Ref.:  I:13-6 and I:13-7; Example I:13-14

Objective:  2

81) Elaine owns equipment ($23,000 basis and $15,000 FMV) and a building ($136,000 basis and $148,000 FMV), which are used in her business. Elaine uses straight-line depreciation for both assets, which were acquired several years ago. Both the equipment and the building are destroyed in a fire, and Elaine collects insurance proceeds equal to the assets’ FMV.

a.     What is the tax treatment of these two transactions?

b.     Assume that Elaine is only able to collect $3,000 from the insurance company for the equipment loss.  What is the tax treatment of the two transactions (assume the basis and insurance reimbursement remain the same for the building).

Answer: 
a.    Since they are destroyed in a casualty and since the gain of $12,000 ($48,000 FMV – $36,000) exceeds the loss of $8,000 ($15,000 FMV – $23,000), both items are treated as Sec. 1231 gains and losses.

b.    The $20,000 loss on the equipment exceeds the $12,000 gain on the building.  The net $8,000 loss will be treated as an ordinary loss.

Page Ref.:  I:13-7; Example I:13-15

Objective:  2

82)  The following gains and losses pertain to Jimmy’s business assets that qualify as Sec. 1231 property. Jimmy does not have any nonrecaptured net Sec. 1231 losses from previous years, and the portion of gain recaptured as ordinary income due to the depreciation recapture provisions has been eliminated.

Gain due to insurance reimbursement for hurricane damage             $24,000

Loss due to condemnation                                                                              $21,000

Gain due to the sale of Sec. 1231 property                                                  $18,000

Describe the specific tax treatment of each of these transactions.

Answer:  The $24,000 casualty gain is treated as a 1231 gain since casualty gains exceed casualty losses. Thus, the total 1231 gain is $42,000 ($24,000 + $18,000). The condemnation loss is a Sec. 1231 loss of $21,000. Since 1231 gains exceed 1231 losses, each is treated as a capital gain or loss. Thus, the net capital gain is $21,000 (LTCG $42,000 – LTCL $21,000).

Page Ref.:  I:13-6 and I:13-7; Example I:13-16

Objective:  2 and 3

83) The following gains and losses pertain to Arnold’s business assets that qualify as Sec. 1231 property. Arnold does not have any nonrecaptured net Sec. 1231 losses from previous years, and the portion of gain recaptured as ordinary income due to the depreciation recapture provisions has been eliminated.

Loss from hurricane damage                                                                         $25,000

Loss due to condemnation                                                                             $20,000

Gain due to the sale of Sec. 1231 property                                                 $16,000

Describe the specific tax treatment of each of these transactions.

Answer:  The $25,000 casualty loss is an ordinary loss deductible for AGI since casualty losses exceed casualty gains. The condemnation loss is a Sec. 1231 loss of $20,000; the $16,000 gain is a Sec. 1231 gain. Because Sec. 1231 losses exceed Sec. 1231 gains, each is treated as ordinary resulting in a net $4,000 ordinary loss to be added to the $25,000 casualty ordinary loss for a total loss of $29,000.

Page Ref.:  I:13-7 and I:13-8; Example I:13-17

Objective:  3

84) The following are gains and losses recognized in 2013 on Ann’s business assets that were held for more than one year. The assets qualify as Sec. 1231 property.

Gain due to insurance reimbursement for casualty                                $20,000

Gain due to a condemnation                                                                            30,000

Loss due to the sale of Sec. 1231 property                                                     17,000

A summary of Ann’s net Sec. 1231 gains and losses for the previous five-year period is as follows:

                                                                                          Cumulative Nonrecaptured

Year         Sec. 1231 Gain         Sec. 1231 Loss                Net 1231 Losses

2008                 $5,000                                                                              $-0-

2009                                                        $3,000                                  $3,000

2010                                                     $17,000                               $20,000

2011              $12,000                                                                         $8,000

2012                                                     $10,000                               $18,000

Describe the specific tax treatment of each of the current year transactions.

Answer:  The $20,000 gain from the casualty is treated as Sec. 1231 gain since casualty gains exceed casualty losses. The $30,000 gain due to the condemnation is also Sec. 1231 gain. Thus, the net Sec. 1231 gain is $33,000 [($20,000 + $30,000) – $17,000). However, $18,000 of the gain must be recaptured as ordinary income as a result of the $18,000 cumulative nonrecaptured net 1231 losses from 2009 and 2011. The remaining $15,000 is treated as LTCG.

Page Ref.:  I:13-7 and I:13-8; Example I:13-18

Objective:  3

85) Network Corporation purchased $200,000 of five-year equipment on March 24, 2011. They elected to expense $60,000 of the cost under Sec. 179. After depreciating the equipment $28,000 in 2011 and $22,400 in 2012, the equipment was sold for $190,000.

a.     What is the amount of the realized gain (or loss) on the sale?

b.     How is the gain or loss taxed?

Answer: 
a.     The realized gain is $100,400 {$190,000 amount realized less $89,600 ($200,000 – $60,000 – $28,000 – $22,400)}.

b.     All of the gain is Sec. 1245 ordinary income.

Page Ref.:  I:13-9; Example I:13-23

Objective:  4

86) On June 1, 2010, Buffalo Corporation purchased and placed in service 7-year MACRS tangible property costing $100,000. On November 10, 2013, Buffalo sold the property for $102,000 after having taken MACRS $47,525 in depreciation deductions. What is the amount and character of Buffalo’s gain?

Answer: 

        Amount realized                                                                                      $102,000

        Cost                                                                               100,000

        Less: Accumulated depreciation                         (47,525)

Adjusted basis                                                                                                    (52,475)

Gain realized                                                                                                         49,525

Sec. 1245 ordinary gain                                                                                      47,525

Sec. 1231 gain                                                                                                           2,000

Total gain realized                                                                                               49,525

Page Ref.:  I:13-9; Example I:13-23

Objective:  4

87) An unincorporated business sold two warehouses during the current year. The straight-line depreciation method was used for Building No. 1 and the accelerated method (ACRS) was used for Building No. 2. Information about those buildings is presented below.

                                                                     Building No. 1                                   Building No. 2

Date acquired                                                    1984                                                        1984

Cost                                                                  $510,000                                               $650,000

Accum. Depreciation

        Straight-line                                             510,000

        ACRS depreciation                                                                                                650,000

Selling Price                                                     750,000                                                 825,000

How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture?

Answer:  Building No. 2 is considered Sec. 1245 property because ACRS was used.

                                                                     Building No. 1                                   Building No. 2

Date acquired                                                    1984                                                       1984

Cost                                                                  $510,000                                               $650,000

Accum. Depreciation                                    510,000                                                 650,000

Adjusted Basis                                                          -0-                                                           -0-

Selling Price                                                     750,000                                                 825,000

Gain                                                                   750,000                                                 825,000

Sec. 1245 Ordinary Income                               N/A                                               $650,000

Sec. 1231 Gain                                              $750,000                                               $175,000

Page Ref.:  I:13-8 through I:13-10; Example I:13-24

Objective:  4

88) Jed sells an office building during the current year for $800,000. The building was purchased in 1980 for $350,000.  Jed had depreciated the building under an accelerated method, but it is now fully depreciated. Jed has never had any other Sec. 1231 transactions. 

a.     What is the recognized gain or loss on the sale of the building and the character of the gain?

b.     How will the gain be taxed?

Answer:  
a.     Amount realized                                                                     $800,000

        Less: Adjusted basis ($350,000 – 350,000)                                    -0-

        Gain realized                                                                            $800,000

        1250 ordinary income (fully depreciated)                                $ -0-

        1231 gain—treated as 1250 unrecaptured                      $ 350,000

        1231 gain—treated as LTCG                                               $ 450,000

b.     The $300,000 1250 unrecaptured gain is taxed at 25%; the remaining 1231 gain is taxed as LTCG at 15% or 20% depending on the level of the taxpayer’s other taxable income.

Page Ref.:  I:13-10 and I:13-11; Example I:13-26

Objective:  5

89) Pam owns a building used in her trade or business that was placed into service in 2001. The building cost $450,000 and depreciation to date amounts to $200,000. Pam sells the building for $380,000. It is the only asset she sells this year, and she has no nonrecaptured Sec. 1231 losses. What is the amount of recognized gain and the nature of the gain? How will the gain be taxed?

Answer:  Amount realized                                                           $380,000

Less: Adjusted basis ($450,000 – $200,000)                                250,000

Gain realized                                                                                    $130,000

The entire gain is Sec. 1231 gain taxed as Sec. 1250 unrecaptured gain at 25% (the lesser of the gain or the depreciation allowable). There is no Sec. 1250 recapture taxed as ordinary income because all of the depreciation is straight-line.

Page Ref.:  I:13-12; Example I:13-27

Objective:  5

90) Julie sells her manufacturing plant and land originally purchased in 1980. Accelerated depreciation had been taken on the building, but the building is now fully depreciated. Julie is in the 39.6% marginal tax bracket. Other information is as follows:

Property            Original cost           Total depreciation           Adjusted basis           Selling price

Plant                    $2,800,000                      $2,800,000                          $0                              $3,000,000

Land                    $   500,000                                                                   $500,000                   $800,000

She has not sold any other assets this year.  A review of her file indicates that the only asset dispositions in the past five years was a truck sold for a $10,000 loss last year.  What are the tax consequences of the sale (type of gain; rates at which taxed)?

Answer: 

Building realized gain ($3,000,000 – $0)$3,000,000
Sec. 1250 realized gain (fully depreciated)-0-
Tentative Sec. 1231 gain3,000,000
Ordinary income recapture due to lookback (39.6% tax rate)$10,000
Sec. 1231 gain, taxed as follows:$2,990,000
a. Unrecaptured Sec. 1250- 25% tax rate      $2,800,000 – 10,000 lookback recapture$2,790,000
b.  Balance at 20%$200,000
  
Land Sec. 1231 gain taxed at 20% ($800,000 – 500,000)$300,000

Page Ref.:  I:13-12 through I:13-14

Objective:  5

91) Connors Corporation sold a warehouse during the current year for $980,000. The building had been acquired in 1980 at a cost of $830,000. The building is fully depreciated.

What is the amount and nature of the gain or loss on the sale of the warehouse?

Answer:  Selling Price                                                   $980,000

Adjusted Basis                                                                             -0-

Gain                                                                                    $980,000

Tentative section 1231 gain                                            980,000

Recapture under 1250 (fully depreciated)                            -0-

Recapture, if under 1245                                                 830,000

Sec. 291 recapture 20% of ($830,000 – 0)                   $166,000

Sec. 1231 gain ($980,000 – 166,000)                            $814,000

Page Ref.:  I:13-16; Example I:13-36

Objective:  6

92) WAM Corporation sold a warehouse during the current year for $830,000. The building had been acquired in 1989 at a cost of $730,000 and had total straight-line depreciation of $510,000.

What is the amount and nature of the gain or loss on the sale of the warehouse?

Answer:  Cost                                                                                    $730,000

Accumulated Depreciation                                                            510,000

Adjusted Basis                                                                                    220,000

Selling Price                                                                                        530,000

Gain                                                                                                    $310,000

Recapture under 1250                                                                                   0

Recapture, if under 1245                                                                  310,000

Sec. 291 recapture 20% of 1245 recap.                                       $  62,000

Sec. 1231 gain ($310,000 – 62,000)                                              $248,000

Page Ref.:  I:13-16; Example I:13-36

Objective:  6

93) Describe the tax treatment for a noncorporate taxpayer in the 39.6% marginal tax bracket who sells each of the first two assets for $500,000 and each of the second two assets for $750,000. Each asset was purchased in 2009 and is used in a trade or business. There are no other gains and losses and no nonrecaptured Section 1231 losses.

                                       Original Basis            Adjusted Basis

Land                                   $350,000                       $350,000

Equipment                       $600,000                       $450,000

Equipment                       $600,000                       $500,000

Building                            $550,000                       $450,000

Answer: 

•     Land: $150,000 Section 1231 gain taxed at 20%.

•     Equipment: $50,000 Section 1245 ordinary income taxed at 39.6%. All gain is due to depreciation.

•     Equipment: $100,000 Section 1245 ordinary income taxed at 39.6% and $150,000 Section 1231 gain taxed at 20%.

•     Building: $300,000 Section 1231 gain with $200,000 taxed at 20% and $100,000 unrecaptured Section 1250 gain taxed at 25%.

Page Ref.:  I:13-17; Topic Review I:13-3

Objective:  6

94) Jacqueline dies while owning a building with a $1,000,000 FMV. The building is classified as Sec. 1245 property acquired in 1985 for $850,000. Cost-recovery deductions of $850,000 have been claimed. Pam inherits the property.

a.     What is the amount of Pam’s basis in the property?

b.     What is the amount of cost-recovery deductions that Pam must recover if she immediately sells the building?

Answer: 
a.     The basis of the property is the FMV of $1,000,000.

b.     There is no depreciation recapture. The transfer of appreciated property at death does not carry over to the person who receives the property from the decedent.

Page Ref.:  I:13-18; Example I:13-40

Objective:  7

95) Melissa acquired oil and gas properties for $600,000. During 2012 she elected to expense the $180,000 of IDC. Total depletion allowed was $50,000. During the current year, Melissa sells the property for $700,000.

a.     What is the amount of and nature of her gain using the facts above?

b.     What is the amount of and nature of her gain assuming that she sold the property for $850,000?

Answer: 
a.     Melissa has realized gain of $150,000 [$700,000 selling price – $550,000 ($600,000 – $50,000) adjusted basis]. All of her gain is ordinary income due to the recapture of $180,000 IDC and $50,000 depletion.

b.     Melissa has realized gain of $300,000 [$850,000 selling price – $550,000 ($600,000 – $50,000) adjusted basis]. Her gain is ordinary income to the extent of recapture of $230,000 ($180,000 IDC and $50,000 depletion). The remaining gain of $70,000 is 1231 gain.

Page Ref.:  I:13-21; Example I:13-49

Objective:  7

96) Pete sells equipment for $15,000 to Marcel, his son. The equipment cost $20,000 and has accumulated depreciation of $12,000.  Marcel will use the equipment in his business.

a.     What is the amount and character of Pete’s gain on the sale?

b.     How does your answer change if the sales price is $22,000?

Answer: 
a.     Cost of equipment                                      $20,000

        Accumulated depreciation                       12,000

        Adjusted basis                                               $8,000

        Sales price                                                     $15,000

        Gain                                                                 $ 7,000

The gain is less than the $12,000 depreciation taken, so it will consist entirely of ordinary income under Sec. 1245.

b.     Cost of equipment                                      $20,000

        Accumulated depreciation                       12,000

        Adjusted basis                                               $8,000

        Sales price                                                     $22,000

        Gain                                                                $14,000

        Depreciation recapture                               12,000

        Sec. 1239 gain                                                   2,000

The gain is ordinary income according to Sec. 1239 since it involves a sale between related parties.

Page Ref.:  I:13-22; Example I:13-51

Objective:  7

97) What is the purpose of Sec. 1245 and what is its significance?

Answer:  The purpose of Sec. 1245 is to eliminate the advantage a taxpayer might receive if the taxpayer were permitted to reduce ordinary income by deducting depreciation and subsequently receive Sec. 1231 treatment when the asset was sold.

Sec. 1231 is particularly advantageous since an overall net 1231 gain reduces the maximum tax rate on long-term capital gains to the 15% or 20% capital gains rate, depending on the level of other taxable income.  In the case of buildings, part of the Sec. 1231 gain will be taxed at 25% due to unrecaptured Sec. 1250 gain.  These rates compare favorably to the tax rate on ordinary income which can be as high as 39.6%. The effect of converting Sec. 1231 gains to Sec. 1245 ordinary income prevents taxpayers from offsetting Sec. 1231 gains against net capital losses in situations where capital gains do not exist.

Page Ref.:  I:13-9

Objective:  4

98) Jesse installed solar panels in front of his office building in 2011.  The panels are not attached to the building.  After using the solar panels for 13 months, Jesse decided to replace them with a newer model to obtain a greater savings on electricity costs.  Jesse sold the old solar panels for an amount greater than his original purchase price.  What tax issues should be considered with purchase, use and sale of the original solar panels?

Answer:  Are the solar panels 1245 or 1250 property?  Did Jesse take a tax credit on the purchase of the solar panels?  Did Jesse depreciate the panels?  If so, how much?  Did Jesse take a Sec. 179 deduction on the panels?  Will Jesse have any depreciation or credit recapture on the sale? 

Page Ref.:  I:13-8 through I:13-11

Objective:  4 and 5

99) Brian purchased some equipment in 2013 which he intends to use in his trade or business. He approaches you to assist him in planning for the ultimate disposal of the asset—whether it be by sale, charitable contribution to the local university, gift to his sister for use in her business, or some other means. Discuss the tax considerations.

Answer:  Upon disposal, in general, Brian would pay the least amount of tax if the gain is classified as 1231 gain which could ultimately be taxed at a maximum of 15% or 20%, depending on the level of the rest of his taxable income. However, to the extent the gain is due to the accumulated depreciation, it will be ordinary gain recaptured under Sec. 1245.  Sec. 1231 gain on equipment would only result if he sold it at a price greater than the original cost.  The only instance in which recapture is avoided is at Brian’s death. Recapture provisions do not carry over to the beneficiary. On the other hand, recapture can not be avoided by transferring property by gift as the recapture potential carries over to the donee (Brian’s sister). Also, if Brian makes a charitable contribution of the property during his life, his charitable contribution would be reduced by the amount of the potential recapture.

Page Ref.:  I:13-18, I:13-24, and I:13-25

Objective:  7

Chapter I14 

1) The present AMT applies to individuals, corporations, estates, and trusts.

Answer:  TRUE

Page Ref.:  I:14-2

Objective:  1

2) The alternative minimum tax applies to individuals only if it exceeds the taxpayer’s regular income tax liability.

Answer:  TRUE

Page Ref.:  I:14-2

Objective:  1

3) For purposes of the AMT, the standard deduction, but not the personal and dependency exemptions, is allowed.

Answer:  FALSE

Explanation:  Neither is allowed.

Page Ref.:  I:14-4 Key Point

Objective:  1

4) An example of an AMT tax preference is a portion of the excluded gain on qualified small business corporation stock (Sec. 1202 stock).

Answer:  TRUE

Explanation:  Seven percent of the excluded gain on Sec. 1202 stock is a preference.

Page Ref.:  I:14-4

Objective:  1

5) All tax-exempt bond interest income is classified as a tax preference.

Answer:  FALSE

Explanation:  Interest on private activity municipal bond interest is a tax preference item, but interest income from general purpose bonds is not a preference item.

Page Ref.:  I:14-4

Objective:  1

6) Casualty and theft losses in excess of 10% of AGI are deductible for AMT purposes.

Answer:  TRUE

Explanation:  The AMT provisions do not require an adjustment for casualty and theft losses.

Page Ref.:  I:14-4 and I:14-5

Objective:  1

7) Medical expenses in excess of 10% of AGI are deductible when computing AMT.

Answer:  TRUE

Explanation:  Medical expenses in excess of 10% of AGI are deductible for both regular tax and AMT starting in 2013.

Page Ref.:  I:14-4 and I:14-5

Objective:  1

8) For purposes of the AMT, only the foreign tax credit and refundable personal credits are allowed to reduce the tentative minimum tax.

Answer:  FALSE

Explanation:  The foreign tax credit and nonrefundable personal credits reduce the tentative minimum tax.

Page Ref.:  I:14-6

Objective:  1

9) A taxpayer who paid AMT in prior years, but is not subject to the AMT in the current year, may be entitled to an AMT credit against his regular tax liability in the current year.

Answer:  TRUE

Page Ref.:  I:14-7

Objective:  1

10) If an individual is classified as an employee, the employer is required to withhold the employee’s share of the FICA tax and to provide a matching amount.

Answer:  TRUE

Page Ref.:  I:14-8

Objective:  2

11) Self-employed individuals are subject to the self-employment tax if their net earnings are more than the personal exemption amount.

Answer:  FALSE

Explanation:  Individuals are subject to self-employment tax if their net earnings are more than $400.

Page Ref.:  I:14-8

Objective:  2

12) One-half of the self-employment tax imposed is allowed as a for AGI deduction.

Answer:  TRUE

Page Ref.:  I:14-8

Objective:  2

13) If an individual is an employee and also has self-employment income, the maximum tax base for computing self-employment tax is reduced by the wages that are subject to the FICA tax.

Answer:  TRUE

Page Ref.:  I:14-8 and I:14-9

Objective:  2

14) A self-employed individual has earnings from his business of $300,000.  For the earnings in excess of the $113,700, he will only have to pay the 2.9% Medicare tax.

Answer:  FALSE

Explanation:  Because his earned income exceeds $200,000 ($250,000 if married filing a joint return), earned income in excess of the threshold will also be subject to the .9% Additional Medicare tax.

Page Ref.:  I:14-9

Objective:  2

15) When a husband and wife file a joint return and both have self-employment income, the self-employment tax must be computed separately.

Answer:  TRUE

Page Ref.:  I:14-9

Objective:  2

16) Nonrefundable credits may offset tax liability but may not result in additional payments to the taxpayer.

Answer:  TRUE

Page Ref.:  I:14-10

Objective:  3

17) The child and dependent care credit provides relief for working taxpayers who pay for care for younger children or an incapacitated dependent or spouse.

Answer:  TRUE

Page Ref.:  I:14-11

Objective:  3

18) For purposes of the child and dependent care credit, qualifying employment-related expenses cannot include payments to a relative.

Answer:  FALSE

Explanation:  Payments to a relative qualify unless the relative is a dependent or a child (under age 19) of the taxpayer.

Page Ref.:  I:14-11

Objective:  3

19) For purposes of the limitation on qualifying expenses for the child and dependent care credit, a spouse who is either a full-time student or is incapacitated is deemed to have earned income of $250 per month, or $500 per month if there are two or more qualifying individuals in the household.

Answer:  TRUE

Page Ref.:  I:14-11

Objective:  3

20) The adoption credit based on qualified adoption expenses is generally allowed in the year the adoption is finalized.

Answer:  TRUE

Page Ref.:  I:14-13

Objective:  3

21)  Taxpayers with income below phase-out amounts are allowed a child credit of $1,000 for each qualifying child under age 17.

Answer:  TRUE

Page Ref.:  I:14-14

Objective:  3

22) Qualified tuition and related expenses eligible for the American Opportunity Tax Credit are limited to those incurred the first two years of postsecondary education.

Answer:  FALSE

Explanation:  Qualifying expenses for the AOTC are limited to the first four years of postsecondary

education.

Page Ref.:  I:14-14

Objective:  3

23) Brad and Shelly’s daughter is starting her freshman year of college.  Brad and Shelly will be able to claim the American Opportunity Tax Credit for a percentage of the cost of tuition and room and board.

Answer:  FALSE

Explanation:  Room and board is not included in the qualified expenses for AOTC.

Page Ref.:  I:14-14

Objective:  3

24) To claim the Lifetime Learning Credit, a student must take at least one-half of a full-time course load during the year.

Answer:  FALSE

Explanation:  There is no minimum enrollment requirement for the Lifetime Learning Credit.

Page Ref.:  I:14-15

Objective:  3

25) The qualified retirement savings contributions credit is based on a maximum contribution of $2,000.

Answer:  TRUE

Page Ref.:  I:14-17

Objective:  3

26) In lieu of a foreign tax credit, a taxpayer may elect to take a deduction for foreign taxes paid or accrued.

Answer:  TRUE

Page Ref.:  I:14-18

Objective:  3

27) The foreign tax credit is equal to the smaller of foreign taxes paid or accrued in the tax year or the portion of the U.S. income tax liability attributable to the income earned in all foreign countries.

Answer:  TRUE

Page Ref.:  I:14-18

Objective:  3

28) The general business credit is a refundable credit.

Answer:  FALSE

Explanation:  The general business credits are nonrefundable.

Page Ref.:  I:14-19

Objective:  3

29) A credit for rehabilitation expenditures is available to a business for the purchase price of a building originally placed in service before 1936.

Answer:  FALSE

Explanation:  The credit is available for renovation and restoration costs after purchase, not for the purchase price.

Page Ref.:  I:14-19

Objective:  3

30) The nonrefundable disabled access credit is available to eligible small businesses for expenditures incurred to make existing business facilities accessible to disabled individuals.

Answer:  TRUE

Page Ref.:  I:14-22

Objective:  3

31) Research expenses eligible for the research credit include costs that are incident to the development or improvement of a product or component.

Answer:  TRUE

Page Ref.:  I:14-23

Objective:  3

32) The earned income credit is refundable only if a tax has been withheld.

Answer:  FALSE

Explanation:  The EITC is a refundable credit.

Page Ref.:  I:14-25

Objective:  3

33) The earned income credit is available only to taxpayers with qualifying children.

Answer:  FALSE

Explanation:  The EITC is available to individuals without children who meet specific requirements.

Page Ref.:  I:14-25

Objective:  3

34) If an employee has more than one employer during the year, all employers must withhold federal income taxes but only one employer must withhold FICA tax.

Answer:  FALSE

Explanation:  All employers must withhold FICA.

Page Ref.:  I:14-27

Objective:  4

35) If estimated tax payments equal or exceed 100% of the actual tax liability for the prior year, there is generally (assuming AGI less than or equal to $150,000) no penalty for underpayment of estimated taxes.

Answer:  TRUE

Page Ref.:  I:14-29

Objective:  4

36) Nonrefundable personal tax credits are allowed against the taxpayer’s tax liability before other credits are claimed.

Answer:  TRUE

Page Ref.:  I:14-33

Objective:  6

37) Jake and Christina are married and file a joint return for 2013 with taxable income of $100,000 and tax preferences and adjustments of $20,000 for AMT purposes. Their regular tax liability is $16,858. What is the amount of their total tax liability?

A) $6,666

B) $10,192

C) $16,858

D) $27,050

Answer:  C

Explanation:  C) The amount of AMTI is $120,000. Their AMT base $120,000 – $80,800 or $39,200. Their TMT is $39,200 × .26 = $10,192. Their tax liability is the greater of the TMT or regular tax, in this case, $16,858.

Page Ref.:  I:14-2; Example I:14-2

Objective:  1

38) In computing the alternative minimum taxable income, no deduction is allowed for

A) alimony.

B) moving expenses.

C) personal exemptions.

D) individual retirement account contributions.

Answer:  C

Explanation:  C) Personal and dependency exemptions are added back to taxable income to get alternative minimum taxable income.

Page Ref.:  I:14-4 Key Point

Objective:  1

39) Harley’s tentative minimum tax is computed by multiplying the AMT tax rates by her

A) taxable income.

B) alternative minimum tax base.

C) alternative minimum taxable income.

D) tentative alternative taxable income.

Answer:  B

Explanation:  B) The tentative minimum tax is computed by multiplying the alternative minimum tax base (AMTI less the exemption) times the tax rate.

Page Ref.:  I:14-3

Objective:  1

40) In 2013 Charlton and Cindy have alternative minimum taxable income of $130,000 and file a joint return. For purposes of computing the alternative minimum tax, their exemption is

A) $0.

B) $7,800.

C) $48,250.

D) $80,800.

Answer:  D

Explanation:  D) The exemption for a married couple filing a joint return with AMTI of $153,900 or less is $80,800 in 2013.

Page Ref.:  I:14-3

Objective:  1

41) Reva and Josh Lewis had alternative minimum taxable income of $350,000 in 2013 and file a joint return. For purposes of computing the alternative minimum tax, their exemption is

A) $31,775.

B) $51,900.

C) $49,025.

D) $80,800.

Answer:  A

Explanation:  A)

Alternative minimum taxable income$350,000
Threshold 153,900
Excess196,100
Rate of reduction         25%
Reduction$ 49,025
Exemption before reduction   80,800
Allowable exemption$  31,775

Page Ref.:  I:14-3; Example I:14-3

Objective:  1

42) In computing AMTI, tax preference items are

A) excluded.

B) added only.

C) subtracted only.

D) either added or subtracted.

Answer:  B

Explanation:  B) All tax preferences are added to compute the tax base for AMT.

Page Ref.:  I:14-4

Objective:  1

43) In computing AMTI, adjustments are

A) limited.

B) added only.

C) subtracted only.

D) either added or subtracted.

Answer:  D

Explanation:  D) While most adjustments increase the AMT tax base, the AMT tax base may be reduced when the timing differences reverse.

Page Ref.:  I:14-4 and I:14-5

Objective:  1

44) All of the following are allowable deductions under the alternative minimum tax except

A) charitable contributions.

B) gambling losses.

C) qualified housing interest.

D) personal property taxes.

Answer:  D

Explanation:  D) Charitable contributions, qualified housing interest, and gambling losses are all itemized deductions that are allowed for AMT purposes. Personal property taxes are not.

Page Ref.:  I:14-4 and I:14-5

Objective:  1

45) Suzanne, a single taxpayer, has the following tax information for the current year.

•    Charitable contribution of real property with a FMV of $25,000 (adjusted basis $20,000) for which a $25,000 deduction was taken.

•    Research and experimental expenses of $40,000 deducted in full for regular tax.

Suzanne’s total tax preferences and adjustments equals

A) $5,000.

B) $36,000.

C) $41,000.

D) $45,000.

Answer:  B

Explanation:  B) $36,000 (the difference between expensing R and E and amortizing the expenditure over a 10 year period).

Page Ref.:  I:14-3 through I:14-6

Objective:  1

46) Rex has the following AMT adjustments:

-Depreciation of real property acquired in 1996 using MACRS is $22,000 while depreciation for AMT purposes is $15,000.

-R&E expenditures amounting to $60,000 are expensed.

The net adjustment is

A) $7,000.

B) $54,000.

C) $61,000.

D) $67,000.

Answer:  C

Explanation:  C) $7,000 depreciation difference + $54,000 R&E adjustment (60,000 – 60,000/10) = $61,000. The R&E expenditures for AMT purposes are amortized over 10 years.

Page Ref.:  I:14-6; Example I:14-6

Objective:  1

47) Shawn has a regular tax liability of $13,429, taxable income of $70,000, tax preferences of $25,000, and positive adjustments attributable to limitations on itemized deductions of $15,000 this year. Shawn is single and takes a $3,900 personal exemption for herself only.  Shawn’s alternative minimum tax for 2013 is

A) $0.

B) $2,691.

C) $16,185.

D) None of the above.

Answer:  B

Explanation:  B)

Taxable Income$ 70,000
Add: Preferences25,000
Add: Adjustments15,000
Add: Personal exemption      3,900
AMTI$113,900
Exemption( 51,900)
Minimum Tax Base62,000
Tax Rate      26%
Tentative Minimum tax$16,120
Minus Regular Tax( 13,429)
Alternative Minimum Tax$ 2,691

Page Ref.:  I:14-7; Example I:14-7

Objective:  1

48) Self-employment taxes include components for

A) Medicare hospital insurance and SUTA.

B) OASDI and FUTA.

C) FICA and FUTA.

D) OASDI and Medicare hospital insurance.

Answer:  D

Explanation:  D) The SE tax rate replaces the employer and employee portions of the old-age, survivors, and disability insurance (OASDI) and Medicare hospital insurance.

Page Ref.:  I:14-8

Objective:  2

49) A wage cap does not exist for which of the following self-employment taxes?

A) OASDI

B) FICA

C) FUTA

D) Medicare hospital insurance

Answer:  D

Explanation:  D) There is a ceiling on the OASDI portion but not on the HI portion.

Page Ref.:  I:14-8

Objective:  2

50) If an individual is liable for self-employment tax, a portion of the self-employment tax is

A) a for AGI deduction.

B) fromAGIas an itemized deduction.

C) a Schedule C business expense.

D) nondeductible.

Answer:  A

Explanation:  A) One-half of the self-employment tax is a for AGI deduction for 2013.

Page Ref.:  I:14-8

Objective:  2

51) John has $55,000 net earnings from a sole proprietorship. John is also employed by a major corporation and is paid $25,000. John’s self-employment tax (rounded) for 2013 is

A) $3,886.

B) $4,208.

C) $7,771.

D) $8,415.

Answer:  C

Explanation:  C)

Self Employment income$55,000 ×    .9235
Amount subject to tax50,793
Tax rate      15.3%
Self-employment tax$  7,771

Page Ref.:  I:14-8; Example I:14-8

Objective:  2

52) Joe has $130,000 net earnings from a sole proprietorship. Joe’s self-employment tax (rounded) for 2013 is

A) $17,581.

B) $18,368.

C) $19,890.

D) None of the above.

Answer:  A

Explanation:  A)

Self Employment income$130,000          .9235
Amount subject to tax$    120,055
OASDI ($113,700 × 12.4%)$  14,099
HI ($120,055 × 2.9%)       3,482
Total$    17,581

Page Ref.:  I:14-8; Example I:14-9

Objective:  2

53) Hong earns $127,300 in her job as a physician’s assistant. She also has her own business selling cosmetics. This business generated $10,000 of earnings. What is Hong’s self-employment tax for 2013?

A) $268

B) $290

C) $1,412

D) $1,530

Answer:  A

Explanation:  A) 10,000 × .9235 = 9,235 × .029 =      $268       HI

(113,700 – 127,300) × .123 =              0  OASDI

                                                          $268

Page Ref.:  I:14-8 and I:14-9; Example I:14-11

Objective:  2

54) Ava has net earnings from self-employment of $125,000.  She also earned salary of $170,000 from a job held earlier in the year.  How much Additional Medicare Tax will be owed on the self-employment income?

A) $0

B) $855

C) $1,125

D) $3,625

Answer:  B

Explanation:  B) Earned income in excess of $200,000 is subject to the tax.  $200,000 – 170,000 salary = $30,000 remaining threshold.  $125,000 – 30,000 = $95,000 × .009 = $855

Page Ref.:  I:14-9; Example I:14-12

Objective:  2

55) All of the following statements regarding self-employment income/tax are true except:

A) The self-employment tax is imposed on net earnings from self-employment over $400.

B) Self-employment tax is computed separately for married individuals filing joint returns.

C) Independent contractors are subject to self-employment tax on the amount of net earnings from the self-employment activity.

D) Employees who have a business in addition to their regular employment are not subject to the self-employment tax since FICA is withheld on their wages.

Answer:  D

Explanation:  D) If an individual is an employee and also has income from self-employment, the maximum tax base for computing the self-employment tax is reduced by the wages that are subject to the FICA tax.

Page Ref.:  I:14-8 and I:14-9

Objective:  2

56) All of the following are self-employment income except

A) net income of a sole proprietorship.

B) dividends received by a corporate shareholder.

C) fees received for serving as a director of a corporation.

D) distributive share of partnership income from a partnership operating a business.

Answer:  B

Explanation:  B) Dividends are investment income.

Page Ref.:  I:14-9

Objective:  2

57) Nonrefundable tax credits

A) only offset a taxpayer’s tax liability.

B) may only be used if the taxpayer is receiving a refund.

C) can be carried back two years and carried forward 15 years if they exceed tax liability in the current year.

D) allow the excess over the taxpayer’s tax liability to be paid to the taxpayer.

Answer:  A

Explanation:  A) Nonrefundable tax credits may offset the tax liability only.

Page Ref.:  I:14-10

Objective:  3

58) Refundable tax credits

A) only offset a taxpayer’s tax liability.

B) may only be used if the taxpayer is receiving a refund.

C) have all expired but may be reinstated with new tax legislation.

D) allow the excess over the taxpayer’s tax liability to be paid to the taxpayer.

Answer:  D

Explanation:  D) Refundable credits not only offset a taxpayer’s tax liability but if the credits exceed the tax liability, the excess will be paid (refunded) directly to the taxpayer.

Page Ref.:  I:14-10

Objective:  3

59) Which statement is correct?

A) Tax credits reduce tax liability on a dollar-for-dollar basis.

B) Tax deductions reduce tax liability on a dollar-for-dollar basis.

C) The benefit of a tax credit depends on the taxpayer’s marginal tax rate.

D) Tax deductions are less valuable for high-income taxpayers than for low-income taxpayers.

Answer:  A

Explanation:  A) Only tax credits reduce the tax liability dollar-for-dollar; tax deductions generate savings based on the taxpayer’s marginal tax rate.

Page Ref.:  I:14-10

Objective:  3

60) Max and Alexandra are married and incur $5,500 of qualifying expenses to care for their two children, ages 2 and 5. Max’s earned income is $35,000 and Alexandra’s earnings from a part-time job are $5,000. What is the amount of the qualifying expenses for purposes of computing the child and dependent care credit?

A) $3,000

B) $5,000

C) $5,500

D) $6,000

Answer:  B

Explanation:  B) Although the limit for two qualifying children is the lesser of $6,000 or the actual expenses, the earned income limitation applies. The amount of qualifying expenses can not exceed the earned income of the spouse with the lesser earned income, in this case, $5,000.

Page Ref.:  I:14-11; Example I:14-17

Objective:  3

61) Marvin and Pamela are married, file a joint return, and have two children, ages 9 and 11. Their combined AGI is $65,000. Marvin’s earned income is $40,000; Pamela’s is $25,000. They incur $6,500 of child-care expenses to enable them to be employed during the current year. Their child and dependent care credit is

A) $1,200.

B) $1,300.

C) $1,800.

D) $6,000.

Answer:  A

Explanation:  A) $6,000 (limit for two or more children) × .20 = $1,200. Their AGI is above the amount at which the 20% rate applies.

Page Ref.:  I:14-11 and I:14-12

Objective:  3

62) Bud and Stella are married, file a joint return, and have one child, age 3. Their combined AGI is $35,000. Bud and Stella incur $3,500 of child-care expenses during the current year. The child and dependent care credit is

A) $600.

B) $700.

C) $750.

D) $875.

Answer:  C

Explanation:  C) ($35,000 AGI – $15,000)/$2,000 = 10 percentage point reduction. $3,000 (limit for one child) × 25% (rate from table on page I:14-12) = $750

Page Ref.:  I:14-11 and I:14-12

Objective:  3

63) Mark and Stacy are married, file a joint return, and have one child, age 3. Their combined AGI is $55,000. Mark and Stacy incur $3,500 of child-care expenses during the current year. Mark’s employer reimburses him $1,500 under a qualified dependent care assistance plan. The child and dependent care credit is

A) $300.

B) $600.

C) $700.

D) $1,200.

Answer:  A

Explanation:  A) Qualifying expenses of $3,000 are reduced by the amount reimbursed by the employer.  3,000 – 1,500 = 1,500 expenses eligible for credit. 1500 × .20 = 300

Page Ref.:  I:14-12

Objective:  3

64) Evan and Barbara incurred qualified adoption expenses in 2012 of $6,000, and then incurred $7,500 more in 2013 when the adoption of their child became final. Their 2012 AGI was $110,000 and their 2013 AGI was $100,000. The allowable adoption credit is

A) $12,970 in 2013.

B) $13,500 in 2013.

C) $6,000 in 2012 and $6,970 in 2013.

D) $6,000 in 2012 and $7,500 in 2013.

Answer:  A

Explanation:  A) Nothing is creditable in 2012 because the adoption is not final. In 2013, $6,000 + $7,500 = $13,500 is creditable but limited to the maximum credit of $12,970.

Page Ref.:  I:14-13; Example I:14-21

Objective:  3

65)  Lee and Whitney incurred qualified adoption expenses in 2012 of $2,000, and then incurred $7,000 more in 2013 when the adoption of their special needs child became final. Their 2012 AGI was $120,000 and their 2013 AGI was $140,000. The allowable adoption credit is

A) $ 7,000 in 2012.

B) $ 9,000 in 2013.

C) $12,970 in 2013.

D) $2,000 in 2012 and $7,000 in 2013.

Answer:  C

Explanation:  C) Maximum credit in year of adoption, 2013, is $12,970. For a special needs child, this is allowed regardless of whether or not the expenses are actually incurred.

Page Ref.:  I:14-13; Example I:14-21

Objective:  3

66) Marguerite and Josephus have two children, ages 13 and 10. Their modified AGI is $120,500.What is their child tax credit?

A) $900

B) $1,000

C) $2,000

D) None of the above.

Answer:  A

Explanation:  A) $120,500 – $110,000 = 10,500. 10,500/1,000 = 10.5, rounded to 11.  11 × 50 = 550 reduction. $1,000 – 550 = 450 credit. The two credits total $900.

Page Ref.:  I:14-14

Objective:  3

67) The maximum amount of the American Opportunity Tax Credit for each qualified student is

A) $1,500.

B) $2,000.

C) $2,500.

D) $3,000.

Answer:  C

Explanation:  C) The maximum credit amount is $2,500 per student.

Page Ref.:  I:14-14

Objective:  3

68) Jeffery and Cassie, who are married with modified AGI of $90,000, are sending their son to his first year of college. Their total tuition and related payments during 2013 amounted to $5,500. They have not taken advantage of any other type of tax benefit related to educational expenses. Their American Opportunity Tax Credit for 2013 is

A) $1,500.

B) $2,000.

C) $2,500.

D) $5,000.

Answer:  C

Explanation:  C) The credit is 100% of the first $2,000 and 25% of the next $2,000 of educational expenses totaling $2,500.

Page Ref.:  I:14-14 and I:14-15

Objective:  3

69) Timothy and Alice, who are married with modified AGI of $90,000, are sending their daughter to her first year of college. Their total tuition and related payments during the year amounted to $13,000. In addition, their daughter received a $10,000 scholarship to cover tuition. They have not taken advantage of any other type of tax benefit related to educational expenses. Their American Opportunity Tax Credit is

A) $2,000.

B) $2,250.

C) $2,500.

D) $3,000.

Answer:  B

Explanation:  B) The credit is 100% of the first $2,000 and 25% of the next $2,000 of educational expenses. The scholarship reduces the amount deemed paid by Timothy and Alice to $3,000. [($2,000 × 100%) + ($1,000 × 25%) = $2,250].

Page Ref.:  I:14-14 and I:14-15

Objective:  3

70) Joe, who is single with modified AGI of $84,000, is sending his son to his first year of college. The total tuition and related payments during the year amounted to $18,000.  Joe has not taken advantage of any other type of tax benefit related to educational expenses. His American Opportunity Tax Credit is

A) $ 0.

B) $1,000.

C) $1,500.

D) $2,500.

Answer:  C

Explanation:  C) The credit is 100% of the first $2,000 and 25% of the next $2,000 of educational expenses. [($2,000 × 100%) + ($2,000 × 25%) = $2,500]. However, the credit must be phased out based on Joe’s AGI. ($84,000 – $80,000)/10,000 × $2,500 = $1,000. $2,500 – 1,000 = 1,500 allowable credit.

Page Ref.:  I:14-14 and I:14-15

Objective:  3

71) In the fall of 2013, James went back to school to earn a master of accountancy degree. He incurred $7,000 of qualified educational expenses and his modified AGI for the year was $40,000. His Lifetime Learning Credit is

A) $1,000.

B) $1,400.

C) $1,800.

D) $2,000.

Answer:  B

Explanation:  B) The lifetime learning credit applies to qualified tuition and related expenses incurred beyond the first four years of college and is computed as 20% of expenses up to $10,000. ($7,000 × 20% = $1,400)

Page Ref.:  I:14-15

Objective:  3

72) All of the following statements are true regarding the Lifetime Learning Credit except which one?

A) In order to qualify for the Lifetime Learning Credit, a student must be enrolled 1/2 time.

B) Qualifying expenses include those for tuition and related fees but not for room and board.

C) The Lifetime Learning credit may be claimed for any degree or nondegree course at a college or university that helps an individual acquire or improve their job skills.

D) The Lifetime Learning credit and the American Opportunity Tax credit may not be taken in the same tax year with respect to the same student’s tuition and related fees.

Answer:  A

Explanation:  A) Unlike the American Opportunity Tax Credit, there is no requirement that the student be enrolled 1/2 time.

Page Ref.:  I:14-15

Objective:  3

73) Which of the following is not a qualifying property for the residential energy efficient property (REEP) credit?

A) geothermal heat pumps

B) residential wind property

C) metal or asphalt roofs with special coatings

D) solar hot water heaters

Answer:  C

Explanation:  C) Of the properties listed, all qualify for the REEP credit except the specialized roofs.

Page Ref.:  I:14-16

Objective:  3

74) Kerry is single and has AGI of $25,000 in 2013. During the year he contributes $5,000 to his Roth IRA. What is the amount of qualified retirement savings contributions credit to which he is entitled?

A) $200

B) $400

C) $800

D) $1,000

Answer:  A

Explanation:  A) For a single person with AGI over $19,250 but not over $29,500, the applicable percentage credit is 10%. The maximum amount on which to compute the credit is $2,000. Therefore, Kerry’s credit is .10 × $2,000 = $200.

Page Ref.:  I:14-17

Objective:  3

75) A corporation has $100,000 of U.S. source taxable income and $300,000 of foreign source taxable income from countries X and Y for a total worldwide taxable income of $400,000. Countries X and Y levy a total of $60,000 in foreign taxes upon the foreign source taxable income. U.S. taxes before credits are $140,000. The foreign tax credit limitation is

A) $35,000.

B) $60,000.

C) $80,000.

D) $105,000.

Answer:  B

Explanation:  B) Foreign tax credit equals the lesser of foreign taxes paid or accrued ($60,000) or the portion of the U.S. income tax liability attributable to income earned in all foreign countries ($300,000/$400,000 × $140,000 = $105,000).

Page Ref.:  I:14-18; Example I:14-24

Objective:  3

76) Carlotta, Inc. has $50,000 foreign-source income and $150,000 worldwide income. Its U.S. tax on its worldwide income is $42,000 and it paid foreign taxes of $16,000. What is the corporation’s foreign tax credit?

A) $2,000

B) $14,000

C) $16,000

D) $42,000

Answer:  B

Explanation:  B) (50,000/150,000) × 42,000 = 14,000 FTC limit

Page Ref.:  I:14-18; Example I:14-24

Objective:  3

77) Carlotta, Inc. has $50,000 foreign-source income and $150,000 worldwide income. Its U.S. tax on its worldwide income is $42,000 and it paid foreign taxes of $12,000. What is the corporation’s foreign tax credit?

A) $4,000

B) $12,000

C) $14,000

D) $42,000

Answer:  B

Explanation:  B) The foreign taxes paid of $12,000 are lower than the limitation of $14,000. [(50,000/150,000) × 42,000] =$14,000

Page Ref.:  I:14-18; Example I:14-24

Objective:  3

78) Unused foreign tax credits are carried back and forward how many years when the limitation is not exceeded?

A) back one and forward five

B) back one and forward ten

C) back three and forward five

D) back three and forward ten

Answer:  B

Explanation:  B) Unused foreign tax credits are carried back one year and then forward ten years.

Page Ref.:  I:14-19

Objective:  3

79) The general business credit includes all of the following with the exception of

A) research credit.

B) disabled access credit.

C) foreign tax credit.

D) credit for rehabilitation expenditure.

Answer:  C

Explanation:  C) The foreign tax credit is not part of the general business credit.

Page Ref.:  I:14-19 through I:14-23

Objective:  3

80) Which of the following statements regarding the Work Opportunity Tax Credit (WOTC) for hiring veterans is not correct?

A) The amount of qualifying wages varies based on length of unemployment after leaving active duty.

B) The amount of qualifying wages varies based on whether the veteran has a service-related disability.

C) Eligibility for the credit is based on whether the veteran served in a combat zone.

D) All of the above statements are correct.

Answer:  C

Explanation:  C) Service in a combat zone is not a criteria of the WOTC.

Page Ref.:  I:14-21

Objective:  3

81) Runway Corporation has $2 million of gross receipts in the preceding year. For purposes of the disabled access credit, what is the maximum number of full-time employees the corporation can have in the preceding year?

A) 10

B) 15

C) 20

D) 30

Answer:  D

Explanation:  D) An eligible small business is any business that either (1) had gross receipts of $1 million or less in the preceding year or, (2) in the case of a business failing the first test, had no more than 30 full-time employees in the preceding year and makes a timely election to claim the credit.

Page Ref.:  I:14-22

Objective:  3

82) Kors Corporation has 30 employees and $5 million of gross receipts. Kors spends $15,000 for qualified structural improvements for access for the disabled. The disabled access credit is

A) $5,000.

B) $5,125.

C) $-0-.

D) $7,500.

Answer:  A

Explanation:  A) ($10,250 – $250) × .50 =$5,000; the corporation is at the 30 employee maximum for credit eligibility.

Page Ref.:  I:14-22; Example I:14-29

Objective:  3

83) Which of the following expenditures will qualify as a research expenditure for purposes of the research credit?

A) An ice cream producer develops a new type of packaging that will keep ice cream frozen while driving home from the grocery store.

B) An ice cream producer develops a new design on the package that will be more pleasing to the culture of a new market it is entering.

C) An ice cream producer develops a new marketing campaign to introduce its brand to a new region of the country it is entering.

D) All of the above qualify as research expenditures for the research credit.

Answer:  A

Explanation:  A) Only the new type of packaging that prevents melting qualifies as a development or improvement of a product or component.

Page Ref.:  I:14-23

Objective:  3

84) The general business credit may not exceed the net income tax minus the greater of the tentative minimum tax or

A) 20% of the net regular tax liability above $20,000.

B) 25% of the net regular tax liability above $20,000.

C) 20% of the net regular tax liability above $25,000.

D) 25% of the net regular tax liability above $25,000.

Answer:  D

Explanation:  D) The general business credit may not exceed the net income tax minus the greater of the tentative minimum tax or 25% of the net regular tax liability above $25,000.

Page Ref.:  I:14-24

Objective:  3

85) Dwayne has general business credits totaling $30,000 before limitation. His regular tax liability is $83,000 and his tentative minimum tax is $79,000. What amount of general business credit can Dwayne take this year?

A) $4,000

B) $14,500

C) $25,000

D) $30,000

Answer:  A

Explanation:  A) The general business credit may not exceed the smaller of (1) net income tax – tentative minimum tax ($83,000 – $79,000 = $4,000) or (2) net income tax – 0.25) net regular tax – $25,000 [0.25 ($83,000 – $25,000) = $14,500].

Page Ref.:  I:14-24; Example I:14-32

Objective:  3

86) Layla earned $20,000 of general business credits from her sole proprietorship.  Her regular tax liability is $45,000, and her tentative minimum tax is $49,000.  During the current year Layla will apply general business credits of

A) $-0-.

B) $4,000.

C) $20,000.

D) $45,000.

Answer:  A

Explanation:  A) Layla cannot use any of the general business credits this year.  Her tentative minimum tax exceeds her regular tax.

Page Ref.:  I:14-24

Objective:  3

87) Individuals without children are eligible for the earned income credit if they meet all the following conditions except

A) file married filing separately.

B) at tax year end are at least age 25 but not more than age 64.

C) for the tax year are not a dependent of another taxpayer.

D) the United States is their principal place of residence for more than one-half of the tax year.

Answer:  A

Explanation:  A) Married individuals must file jointly to be eligible.

Page Ref.:  I:14-25

Objective:  3

88) A taxpayer will be ineligible for the earned income credit if he or she has disqualified investment income of more than $3,300. Disqualified income includes all the following except

A) net capital gains.

B) tax-exempt interest.

C) net rental income.

D) self-employment income.

Answer:  D

Explanation:  D) Self-employment income is classified as earned income rather than investment income.

Page Ref.:  I:14-25

Objective:  3

89) Which one of the following is a refundable credit?

A) earned income credit

B) child and dependent care credit

C) lifetime learning credit

D) credit for the elderly and disabled

Answer:  A

Explanation:  A) The earned income credit is refundable.

Page Ref.:  I:14-26; Topic Review I:14-2

Objective:  3

90) An individual with AGI equal to or less than $150,000 in the prior year may generally avoid penalties for underpayment of estimated tax in each of the following cases with the exception of

A) estimated tax is less than $1,500.

B) 90% of the tax due for the current year is paid.

C) 90% of the tax due for the current year is paid when computed on an annualized basis.

D) 100% of the actual tax liability for the prior year is paid.

Answer:  A

Explanation:  A) A penalty is not imposed if the estimated tax for the current year is less than $1,000.

Page Ref.:  I:14-29

Objective:  4

91) With respect to estimated tax payments for a taxpayer with AGI of $150,000 or lower in the prior year, all of the following are generally true with the exception of

A) no penalty is imposed if the estimated tax is less than $1,000.

B) no penalty is imposed if the individual has no tax liability for the prior year.

C) no underpayment penalty is imposed if the estimated payments total at least 90% of the tax due for the current year.

D) no underpayment penalty is imposed if the estimated payments total at least 90% of the actual tax liability for the prior year.

Answer:  D

Explanation:  D) No underpayment penalty is imposed if the estimated payments total at least 100% of the actual tax liability for the prior year.

Page Ref.:  I:14-29

Objective:  4

92) If a taxpayer’s AGI is greater than $150,000, no penalty will be imposed if the taxpayer pays estimated tax payments in 2013 equal to what percentage of 2012’s income tax liability?

A) 100%

B) 90%

C) 110%

D) 120%

Answer:  C

Explanation:  C) If the taxpayer’s AGI is greater than $150,000, no penalty will be imposed if the taxpayer pays estimated tax payments in the current year equal to 110% of the preceding year’s income tax liability.

Page Ref.:  I:14-29

Objective:  4

93) Annie has taxable income of $100,000, a regular tax liability of $21,293, a positive AMT adjustment due to limitations on itemized deductions of $20,000, and tax preferences of $25,000 in 2013. Annie is single and takes a $3,900 personal exemption for herself only.  What is Annie’s AMT for 2013?

Answer: 

Taxable income                                                                                                $100,000

Plus: Tax preferences                                                                                          25,000

Plus: Adjustments related to itemized deductions                                    20,000

Plus: Personal exemption                                                                                    3,900

Alternative minimum taxable income                                                     $148,900

Minus: Exemption*                                                                                             43,525

Alternative minimum tax base                                                                   $105,375

Tentative Minimum Tax: $105,375 × .26 =                                                $ 27,398

Minus: Regular tax                                                                                         (  21,293)

AMT                                                                                                                         $6,105

*$51,900 – [.25 × ($148,900 – 115,400)]

Page Ref.:  I:14-3; Example I:14-3

Objective:  1

94) George and Meredith who are married, have a regular tax liability of $23,108, taxable income of $125,000, tax preferences of $25,000, and positive adjustments attributable to limitations on itemized deductions of $18,700 this year.  They claim $11,700 of personal and dependency exemptions for themselves and their 20-year old dependent daughter.  What is George and Meredith’s alternative minimum tax for 2013?

Answer: 

Taxable Income                                                                                                $125,000

Plus: Tax Preferences                                                                                          25,000

Plus: Adjustments                                                                                                18,700

Plus: Personal/dependency exemptions ($3,900 × 3)                                11,700

AMTI                                                                                                                   $180,400

Exemption*                                                                                                         ( 74,175)

Minimum Tax Base                                                                                       $106,225

Tax Rate                                                                                                                       26%

Tentative Minimum Tax                                                                                  $27,619

Minus Regular Tax                                                                                         (  23,108)

Alternative Minimum Tax                                                                                $4,511

*$80,800 – [.25 × ($180,400 – 153,900)] = $74,175

Page Ref.:  I:14-3; Example I:14-3

Objective:  1

95) Sonya started a self-employed consulting business in the last part of the year and earned $40,000.  She had been employed as manager in a consulting firm prior to starting her own business and had earned $125,000. 

(a)   What is Sonya’s self employment tax for 2013?

(b)   What is Sonya’s deduction for AGI for the SE tax?

Answer: 

(a)    Net earnings from self-employment$40,000× .9235$36,940
OASDI: .124 × lesser of–  
(1) net earnings from self-employment, or$36,940 
(2) maximum base – taxed wages  
      $113,700 – $125,000-0-$-0-
Medicare tax:  
  .029 × $36,940 1,071
Self-employment tax $1,071

Her employee wages from her prior job exceeded the maximum wage base for OASDI so no additional OASDI is included in the self employment tax.

(b)   The deduction for AGI will be $536 (.5 × $1,071)

Page Ref.:  I:14-8 and I:14-9; Example I:14-11

Objective:  2

96) Lara started a self-employed consulting business in the last part of the year and earned $60,000 of net self- employment income.  She had been employed as manager in a consulting firm prior to starting her own business and had earned $175,000. 

(a)   What is Lara’s Additional Medicare Tax for 2013, if any?

(b)   What is Lara’s deduction for AGI for the Additional Medicare Tax?

Answer: 

Threshold$200,000
Less wages-175,000
Remaining threshold$  25,000
Net self-employment income$  60,000
Less remaining threshold-25,000
SE income subject to tax$  35,000
 x 0.9%
(a)  Additional Medicare Tax$      315

(b)           There is no deduction for the Additional Medicare Tax.

Page Ref.:  I:14-9; Example I:14-12

Objective:  2

97) Sam and Megan are married with two dependent children.  Both Sam and Megan work, earning $50,000 and $55,000, respectively.  Their AGI totals $110,000.  They incur $6,500 of qualifying child care expenses of which $2,500 is reimbursed by Megan’s dependent care program at work.

What is the amount of their child and dependent care credit?

Answer: 

$6,500 cost limited to ceiling$6,000
Reimbursement by dependent care program-2,500
Expenses eligible for credit$3,500
Credit rate (AGI exceeds $43,000)× .20
Child and dependent care credit$700

Page Ref.:  I:14-11 and I:14-12; Example I:14-19

Objective:  3

98) Nick and Nicole are both 68 years old and file a joint return. They have AGI of $15,000 and receive nontaxable Social Security payments of $4,200 during the current year. What is the amount of the tax credit for the elderly?

Answer:  Initial ceiling amount                                                                       $7,500

Minus: Nontaxable social security benefits                 $4,200

 of AGI in excess of $10,000

($15,000 – $10,000) × .50 =                                                   2,500                    (6,700)

Total credit base                                                                                                      $ 800

Times: credit percentage                                                                                           .15

Tax credit                                                                                                                 $  120

The credit is nonrefundable, that is, it is allowed only to the extent of their tax liability.

Page Ref.:  I:14-12 and I:14-13; Example I:14-20

Objective:  3

99) Tyler and Molly, who are married filing jointly with $200,000 of AGI in 2013, incurred the following expenses in their efforts to adopt a child:

2012:     Attorney’s fees                                                                       $4,500

2013:     Attorney’s fees                                                                       $4,500

                Court costs                                                                              $1,000

                Adoption fees                                                                         $5,500

The adoption was finalized in 2013. What is the amount of the allowable adoption credit in 2013?

Answer: 

Qualifying expense:

$15,500, limited to 2013 maximum of                        $12,970

Less upper income phaseout:

$12,970 × ($200,000 AGI – $194,580)/40,000               –  1,757

Allowable adoption credit                                            $  11,213

2012 expenses of $4,500 plus 2013 expenses of $11,000 = $15,500 are eligible for the credit in the year in which the adoption is finalized. The maximum allowable credit for 2013 is $12,970. The taxpayers’ AGI will cause a phase-out of the credit because AGI exceeds $194,580.

Page Ref.:  I:14-13; Example I:14-21

Objective:  3

100) Tom and Anita are married, file a joint return with an AGI of $165,000, and have one dependent child, Tim, who is a first-time freshman in college. The following expenses are incurred and paid in 2013:

Tuition, fees and textbooks                                             $11,000

Room and Board                                                                  $5,000

What is the maximum education credit allowed to Tom and Anita?

Answer:  Tim is eligible for the American Opportunity Tax credit. The maximum amount of the credit is (100% of the first $2,000 + 25% of the next $2,000 of tuition and fees) = $2,500.

$2,500 × $165,000 – $160,000 = $625 is phased-out leaving $1,875.

                             $20,000

Page Ref.:  I:14-14 and I:14-15

Objective:  3

101) Tyne is single and has AGI of $25,000 in 2013. During the year, she contributes $3,000 to her Roth IRA. What is the amount of Tyne’s qualified retirement savings contributions credit?

Answer:  The credit is computed on a maximum contribution of $2,000. The credit percentage based on Tyne’s AGI is 10%. Thus, the credit is $2,000 × .10 = $200.

Page Ref.:  I:14-17; Example I:14-23

Objective:  3

102) Bonjour Corp. is a U.S.-based corporation with operations in France.  The operations in France generated $200,000 of taxable income whereas worldwide operations generated total taxable income of $2,000,000.  Its U.S. tax liability before credits is $680,000.  Determine the allowable foreign tax credit assuming taxes paid to France as follows:

a.    $40,000.

b.    $80,000.

Answer:  Ceiling on application of foreign tax credits:

$680,000 × 200,000/2,000,000 = $68,000.

a.    The full $40,000 of taxes paid to France can be applied to reduce the U.S. tax liability.

b.    The FTC applied this year will be limited to $68,000.  The excess $12,000 can be carried back one year and forward 10 years.

Page Ref.:  I:14-18; Example I:14-24

Objective:  3

103) During the year, Jim incurs $50,000 of rehabilitation expenditures in connection with a certified historic structure used in his business. The adjusted basis of the structure was $40,000 at the time the rehabilitation began.

a.     What is the amount, if any, of his rehabilitation credit for the year?

b.     What is the depreciable basis of the rehabilitation expenditures?

Answer: 
a.     The property qualifies for the credit. The amount of the credit is 20% × $50,000 = $10,000.

b.     The basis of the rehabilitation expenditures is $50,000 – $10,000 or $40,000.

Page Ref.:  I:14-19; Example I:14-26

Objective:  3

104) Hawaii, Inc., began a child care facility for its employees during the year. The corporation incurred the following expenses:

Rent of facility                                                                                                     $30,000

Leasehold improvements                                                                                  50,000

Equipment, toys, etc.                                                                                           15,000

Salaries of child care employees                                                                      25,000

Other operating expenses of facility                                                               18,000

        Subtotal                                                                                                       $138,000

Qualified child care referral fees                                                                      10,000

        Total expenses                                                                                          $148,000

What is the amount of Hawaii’s credit for employer-provided child care?

Answer:  The credit is ($138,000 × .25) + ($10,000 × .10) = ($34,500) + ($1,000) = $35,500. The credit will reduce the deductible expenses.

Page Ref.:  I:14-21 and I:14-22; Example I:14-28

Objective:  3

105) Ivan has generated the following taxes and credits this year:

Regular tax                                                      $38,000

Tentative minimum tax                                 28,000

Dependent care credit                                       1,200

American Opportunity credit                            800

Research credit                                                 20,000

Rehabilitation credit                                       15,000

How much general business credit will he apply to the current year tax liability?

Answer: 

Regular tax before credits$38,000
Less personal credits-2,000
Regular tax before GBC$36,000
GBC of $35,000, limited to-8,000
Tax liability$28,000

The general business credit generated by the research credit and the rehabilitation credit is applied to regular tax after application of the nonrefundable personal credits.  However, the GBC cannot reduce regular tax below the tentative minimum tax so it is limited to $8,000.  The remaining $27,000 can be carried back on year and carried forward 20 years.

Page Ref.:  I:14-24; Example I:14-32

Objective:  3

106) Beth and Jay project the following taxes for the current year:

        Regular tax                                                  $50,000

        AMT                                                                10,000

        Self employment tax                                  12,000

In order to avoid underpayment penalties, between withholding from wages and quarterly estimated payments, Beth and Jay should pay in at least (assume the following prior year amounts):

a.    AGI of $140,000 and total taxes of $36,000.

b.    AGI of $155,000 and total taxes of $50,000.

Answer: 

Total expected liability$50,000 + 10,000 + 12,000$72,000
Safe harbor 190% × $72,000$64,800
Safe harbor 2-100 or 110% of prior year  
a. AGI < $150,000100% of prior year$36,000
b. AGI > $150,000110% of prior year$55,000

a.     The taxpayers should pay in at least $36,000 to avoid penalties.

b.     The taxpayers should pay in at least $55,000 to avoid penalties.

Page Ref.:  I:14-29 and I:14-30

Objective:  4

107) Discuss tax-planning options available for expenses incurred for child and dependent care.

Answer:  Certain employers may offer up to $5,000 of child-care benefits tax free, and some employers will allow employees to fund child-care expenses through flexible spending accounts which result in paying for childcare in pre-tax dollars.  Costs paid through either of these tax-advantaged employer benefits will not qualify for the child care credit, but they do require reduction in the ceiling on the qualifying expenses. Certain child and dependent care expenses may qualify as a medical expense, such as nursing care. The taxpayer should compute the marginal tax benefit from the child and dependent care credit with the marginal tax benefit from the additional medical expense deduction to determine if the credit is worth more than the deduction. Those expenditures in excess of the child and dependent care ceiling amounts may also qualify as medical expenses.

Page Ref.:  I:14-12

Objective:  3

108) Describe the differences between the American Opportunity Tax credit and the Lifetime Learning credit.

Answer:  The American Opportunity Tax Credit (AOTC) is available for the first four years of college.  It is calculated as 100% of the first $2,000 of tuition, fees and textbooks and 25% of the next $2,000, for a maximum of $2,500.  Student activity fees, room and board are not eligible expenses.  An eligible student must carry at least one-half of the normal full-time courseload.  The AOTC is not available for any student who has been convicted of a federal or state offense for possession or distribution of a controlled substance.  The phaseout range for taxpayers married filing joint returns is from $160,000 to $180,000; for other taxpayers, it is from $80,000 to $90,000.  It is available for each eligible child.

The Lifetime Learning credit is 20% of eligible tuition and fees up to $10,000.  The definition of qualifying expenses is the same as for the AOTC.  It does not require that a student be enrolled on at least a half-time basis and is available for an unlimited number of years. The Lifetime Learning Credit is available for continuing education that is not part of a degree program. The Lifetime Learning Credit limitation for eligible expenses is on a per taxpayer basis, whereas the AOTC limitations are on a per student basis.  The phaseout range for married taxpayers filing joint returns is from $107,000 to $127,000; for other taxpayers it is from $53,000 to $63,000.

Page Ref.:  I:14-14 and I:14-15

Objective:  3

109) Discuss the tax planning techniques available to a U.S. citizen who is on a foreign job assignment.

Answer:  U.S. citizens who are on foreign job assignments can avoid double taxation by electing to take either a foreign tax credit or a foreign-earned income exclusion of $97,600 with respect to income earned while on extended non-U.S. assignments. Generally, the exclusion is chosen if the effective foreign tax rate is less than the effective U.S. tax rate because the foreign tax credit that can be claimed does not equal the gross U.S. tax that is owed on the income. If the foreign tax rate on the earned income exceeds the U.S. tax rate, the exclusion would generally not be elected. Rather, the excess foreign tax credits on earned income are used to offset the U.S. tax owed on other types of foreign income.

Page Ref.:  I:14-32

Objective:  5

110) Discuss when Form 6251, Alternative Minimum Tax, must be filed.

Answer:  File Form 6251 when:

1.     An AMT tax liability actually exists.

2.     The taxpayer has tax credits that are limited by the tentative minimum tax.

3.     The AMT base exceeds the exemption amounts and an individual has AMT adjustments or tax preference items.

Page Ref.:  I:14-33

Objective:  6