CHAPTER 12 END OF CHAPTER PROBLEMS
Discussion Questions
1. Can the exchange of personal use property qualify as a like-kind exchange? Why?
Answer: If a taxpayer trades a personal use asset for another asset, the exchange does not qualify as a like-kind exchange. The property must be held for productive use or investment in order to qualify.
2. What types of properties do not qualify for like-kind exchange treatment?
Answer: Exchanges of inventory, stocks, bonds, notes, other securities or evidence of indebtedness or interest, interests in a partnership, and certificates of trust or beneficial interests do not qualify for like-kind treatment.
3. Discuss the characteristics of what is considered a like-kind asset. Must the asset received in a like-kind exchange be an exact duplicate of the asset given? Explain.
Answer: In order to qualify as “like-kind,” the property must be of the same nature or character. The grade or quality of the exchanged assets does not matter. The asset does not have to be an exact duplicate of the property exchanged.
4. What is boot? How does the receipt of boot affect a like-kind exchange?
Answer: Boot is defined as property given or received in a like-kind exchange that is not like-kind property. The receipt of boot property often triggers the recognition of gain. (Cash)
5. What is the difference between a deferred gain and an excluded gain?
Answer: The gain is deferred because the unrecognized gain reduces the basis in new asset received, so the gain is deferred until new asset is sold or disposed of. The reduced basis also causes less depreciation allowed on the new asset. 6. How is the basis calculated in a like-kind exchange? How does the receipt of boot affect the basis of the asset received? How does the giving of boot affect the basis of the asset received?
Answer: The basis of property received in a like-kind exchange is the adjusted basis of the property given up plus the adjusted basis of the boot given plus gain recognized minus FMV of boot received minus loss recognized.
7. Often, when assets are exchanged, liabilities are assumed in the exchange. How does the assumption of liabilities in a like-kind exchange affect the gain or loss recognized? How does it affect the basis of an asset received in a like-kind exchange?
Answer: When a taxpayer is released of a liability in an exchange, the release of a liability is considered boot received. The taxpayer who assumes the debt is treated as having paid cash and the taxpayer released of the debt is treated as having received cash. Since liabilities assumed are treated as boot, the presence of a liability can trigger gain to the lesser of boot received or gain realized.
8. What are the special provisions for like-kind exchanges between related-parties? Why are these special provisions included in the IRC?
Answer: Exchanges between related parties are not considered like-kind exchanges if either party disposes of the property within two years of the exchange. Related parties could exchange gain property and have the party that was in the lower tax bracket pay tax at a lower tax rate.
9. Must both parties in a potential like-kind exchange agree to the exchange? If not, how can the transaction be structured to defer any gain?
Answer: If a like-kind exchange is properly executed, the exchange can be non-taxable even if a seller of a property is unwilling to exchange properties. A like-kind exchange does not need to be simultaneous to be tax-free. The most common way to create a deferred exchange occurs when the title to the property to be exchanged is placed in an escrow account with a custodian. The custodian then sells the property and the cash is placed in an escrow account. The taxpayer then has 45 days to identify like-kind property, and then the custodian purchases the new asset and distributes the title to the taxpayer. The taxpayer cannot have actual or constructive receipt of the proceeds from the sale of old property at any time.
10. What is an involuntary conversion?
Answer: An involuntary conversion occurs when property is destroyed, stolen, condemned, or disposed of under the threat of condemnation, and the taxpayer receives other property or payment (such as insurance).
11. When an involuntary conversion occurs and the taxpayer receives insurance proceeds, what must the taxpayer do to guarantee that no gain is recognized?
Answer: If the taxpayer receives property of similar or related use for the converted property, no gain is recognized.
12. When faced with an involuntary conversion, does the taxpayer have an unlimited amount of time to replace the converted property? Explain.
Answer: There is a time limit to purchase replacement property. The replacement period ends 2 years after the close of the first taxable year in which any part of the gain is realized. For condemned real property held for use in a trade or business or investment the replacement period is 3 years.
13. How are the basis and holding period of the replacement property in an involuntary conversion determined? Explain.
Answer: The adjusted basis of converted property minus any money received not used to replace the property plus the amount of gain recognized by the taxpayer on the conversion minus the amount of loss recognized by the taxpayer on the conversion equals the adjusted basis of replacement property. The holding period for the replacement property includes the holding period of the converted property.
14. What information must be reported to the IRS concerning an involuntary conversion? Answer: There is no form to elect deferral of gain on an involuntary conversion. The taxpayer must attach a schedule or statement to the end of the tax return noting the election. If the replacement property is purchased in a subsequent tax year, another statement is attached to the subsequent return detailing the replacement property. There are two circumstances involving involuntary conversions where taxpayers must to file an amended tax return (From 1040X): if the taxpayer does not buy replacement property within the replacement period or if the replacement property purchased by the taxpayer costs less than the amount realized for the converted property. The gain is reported on either Form 4797 for business property or on Schedule D for personal investment property.
15. How is income reported from an installment sale? What are the components of the payments received in an installment sale and how is the gross profit percentage calculated?
Answer: The interest income is reported separately from the gain on the sale (Form 1040, Schedule B). The return of basis and the gain portion of each payment are determined based on the gross profit percentage of the asset sold. The gross profit percentage is calculated as follows:
Selling Price $xxx Installment Sale Basis Adj. Basis of the Property $xxx Selling Expenses xxx Depreciation Recapture xxx (xxx) Gross Profit xxx
Contract Price $xxx Gross Profit Percentage (Gross Profit divided by Contract Price) x%
16. Discuss the rules concerning the sale of a personal residence. Include in your discussion, the specifics regarding the ownership test and the use test.
Answer: In order to qualify for the exclusion on sale of a personal residence the taxpayer must meet the ownership test and the use test. During the 5-year period ending on the date of the sale, the taxpayer must meet the ownership test (owned the home for at least 2 years) and the use test (lived in the home as your main home for at least 2 years). 17. Is a taxpayer allowed to take the §121 exclusion for a vacation home that was never rented? Explain.
Answer: The IRC §121 exclusion only applies to the taxpayer’s principle residence. In order to qualify for the exclusion, the taxpayer must meet the ownership test and the use test.
18. If a taxpayer moves within two years after moving into a new home and uses the exclusion on his former home, is any gain taxable on the sale of the new home? Under what conditions can some of the exclusion be used?
Answer: The exclusion applies to only one sale every two years. The taxpayer is ineligible for the exclusion if during the 2-year period ending on the date of sale of the present home, the taxpayer sold another home at a gain and excluded all or part of that gain. If the second sale is caused by a change in the place of employment or for health reasons, the taxpayer is still eligible for a partial exclusion. When the second sale is caused by health or employment reasons, (or other unforeseen circumstances), a portion of the gain can be excluded by taking a ratio of the number of days used divided by 730 days.
19. What happens in the following circumstances if a wife, prior to marriage, uses the exclusion on the sale of a residence and subsequently (after marriage) sells a second residence within two years?
a. The new husband sells a residence; b. The new husband dies within two years and the wife sells the residence;
Answer: a. If a wife (prior to marriage) uses the exclusion on the sale of a residence and after marriage sells a second residence within two years, the wife is not eligible for the exclusion. The husband will be allowed to exclude one-half of the gain on sale of the residence.
b. If the husband dies within two years and the wife sells the residence, the surviving spouse is deemed to have owned and lived in the property for any period when the decedent spouse owned and lived in the home.
20. What is a related-party loss and why are they disallowed?
Answer: A related-party loss is any loss that occurs from a sale or exchange between related parties. Related parties could exchange loss property in order for the loss to be deductible for one of the parties.
21. Explain the constructive ownership rules and how they relate to related-party transactions.
Answer: The constructive ownership rules mean that a taxpayer is deemed to also own the stock of anyone or any entity he or she also controls through ownership or family relationships. Losses between related parties are not allowed. Related parties are also determined with reference to the constructive ownership rules.
22. What is a wash sale and why are losses from wash sales disallowed?
Answer: A wash sale occurs when a taxpayer sells stock or securities at a loss and, within a 30 day period before or after the sale, the taxpayer acquires substantially identical stock or securities. Wash sales are disallowed because, in effect, the ownership of the company is not reduced.
Multiple Choice
23. For an exchange to qualify as a nontaxable exchange, what criteria must be present? a. There must be an exchange. b. The property transferred and received must be held for use in a trade or business or for investment. c. The property exchanged must be like-kind. d. All of the must be present.
Answer: d
24. For the asset received in a like-kind exchange, how is the holding period of the new asset determined? a. According to the date the new asset is received. b. According to the date the old asset is given away. c. According to the holding period of the old asset. d. None of the above.
Answer: c 25. Which of the following exchanges qualify as “like-kind” property? a. Partnership interest for partnership interest. b. Inventory for equipment. c. Investment land for an apartment building. d. Business use delivery truck for business use van.
Answer: d
26. Ava exchanges a machine used in her business with Gail for another machine. The basis of Ava’s old machine is $50,000, FMV is $66,000, and she gives Gail cash of $14,000. Gail’s basis in her machine is $70,000 and FMV is $80,000. Which of the following statements is correct? a. Gail must recognize $24,000 gain on the exchange. b. Gail must recognize $10,000 gain on the exchange. c. Because this is a like-kind exchange, neither Ava nor Gail must recognize any gain. d. Ava must recognize gain of $16,000 on the exchange
Answer: b
27. Ava exchanges a machine used in her business with Gail for another machine. The basis of Ava’s old machine is $50,000, FMV is $66,000, and she gives Gail cash of $14,000. Gail’s basis in her machine is $70,000 and FMV is $80,000. What is Ava’s adjusted basis in the new machine she receives? a. $50,000. b. $64,000. c. $66,000. d. $80,000
Answer: d
28. Janel exchanges a building she uses in her rental business for a building owned by Russel that she will use in her rental business. The adjusted basis of Janel’s building is $160,000 and the fair market value is $250,000. The adjusted basis of Russel’s building is $80,000 and the fair market value is $250,000. Which of the following statements is correct? a. Janel’s recognized gain is $0 and her basis for the building received is $160,000. b. Janel’s recognized gain is $90,000 and her basis for the building received is $160,000. c. Janel’s recognized gain is $0 and her basis for the building received is $250,000. d. Janel’s recognized gain is $90,000 and her basis for the building received is $250,000.
Answer: a 29. Caleb exchanges equipment (seven-year property) with an adjusted basis of $18,000 for furniture (seven-year property) worth $12,000. Caleb also receives cash of $10,000. What are the recognized gain or loss and the basis of the new machine? a. $0 and $18,000. b. $0 and $8,000. c. $4,000 and $12,000. d. ($6,000) and $12,000.
Answer: c
30. Gretel exchanges a warehouse with an adjusted basis of $150,000 and fair market value of $160,000 for a mini-storage building with a fair market value of $100,000 and $60,000 cash. What are the recognized gain or loss and the basis of the mini storage building? a. $0 gain and $150,000 basis. b. $10,000 gain and $160,000 basis. c. $10,000 gain and $150,000 basis. d. ($10,000) loss and $160,000 basis.
Answer: b
31. What tax form is completed to report an involuntary conversion? a. No form is required. b. Form 4797. c. Form 4562. d. Form 1040, Schedule D.
Answer: a
32. The City of Smithfield condemned 100 acres of Edna’s land worth $500,000. Her basis in it was $125,000. In payment to Edna, Smithfield awarded Edna 500 acres of similar land. An appraisal indicated that the land Edna received was worth $650,000. What is Edna’s recognized gain or loss on the involuntary conversion and what is her basis in the land received? a. $0 gain and $125,000 basis. b. $0 gain and $525,000 basis. c. $375,000 gain and $500,000 basis. d. $525,000 gain and $650,000 basis.
Answer: a 33. A warehouse with an adjusted basis of $125,000 was destroyed by a tornado on April 15, 2006. On June 15, 2006, the insurance company paid the owner $195,000. The owner reinvested $170,000 in a warehouse. What is the basis of the new warehouse if nonrecognition of gain from an involuntary conversion is elected? a. $100,000. b. $125,000. c. $170,000. d. $195,000.
Answer: b
34. A warehouse with an adjusted basis of $250,000 was destroyed by a tornado on April 15, 2006. On June 15, 2006, the insurance company paid the owner $395,000. The owner reinvested $470,000 in a new warehouse. What is the basis of the new warehouse if nonrecognition of gain from an involuntary conversion is elected? a. $105,000. b. $250,000. c. $325,000. d. $395,000.
Answer: c
35. Kyla owns a convenience store with an adjusted basis of $215,000 that was destroyed by a flood on August 15, 2006. Kyla received a check for $275,000 from her insurance company on January 10, 2007 compensating her for the damage to her store. What is the latest date that Kyla can buy replacement property to avoid recognition of any realized gain? a. August 15, 2008. b. December 31, 2008. c. January 10, 2009. d. December 31, 2009.
Answer: d
36. On June 15, 2006, Allen sold land held for investment to Stan for $50,000 and an installment note of $250,000 payable in five equal annual installments beginning on June 15, 2007 plus interest at 10%. Allen’s basis in the land is $150,000. What amount of gain is recognized in 2006 under the installment method? a. $0. b. $25,000. c. $50,000. d.$150,000. Answer: b
37. On August 15, 2006, Tucker sold land held for investment to Charles. Tucker’s land had a basis of $400,000 and was subject to a mortgage of $100,000. Under the terms of the sale, Charles will pay Tucker $100,000 on the date of the sale, assume the $100,000 mortgage and give Tucker a note for $600,000 (plus interest at the federal rate) due the following year. What are the contract price and gain recognized in the year of sale? Contract Price Gain Recognized a. $700,000 $50,000 b. $700,000 $57,143 c. $800,000 $50,000 d. $800,000 $400,000
Answer: b
38. Which of the following statements is correct with regard to installment sales? a. The contract price is generally the amount of cash the seller will receive. b. Sales by a taxpayer who is a dealer in the item sold are not eligible for installment sale treatment. c. The installment method cannot be used to report gain from the sale of stock or securities that are traded on an established securities market. d. All of the above are correct.
Answer: d
39. A taxpayer who sells her personal residence in 2006 may exclude some or all of the gain on the sale if the residence was owned and lived in for: a. At least four years before the sale date. b. Any of the last two years out of a five year period before the sale. c. Any of the last fours years out of an eight year period before the sale. d. At least one year prior to the sale date.
Answer: b
40. Ashley and David are married and 45 years old. They sell their personal residence to Geoffry for $400,000 cash and Geoffry assumes their $220,000 mortgage. Ashley and David purchased the house ten years ago for $300,000. What is the amount of gain should Ashley and David recognize on the sale? a. $0. b. $100,000. c. $250,000. d. $320,000.
Answer: a
41. Daniel, who is single, purchased a house on May 15, 1985 for $115,000. During the years he owned the house, he installed a swimming pool at a cost of $24,000 and replaced the driveway at a cost of $12,000. On April 28, 2006 Daniel sold the house for $470,000. He paid a realtor commission of $28,000 and legal fees of $1,000 connected with the sale of the house. What is Daniel’s recognized gain on the sale of the house? a. $0. b. $ 40,000. c. $290,000. d. $319,000.
Answer: b
42. All of the following relationships are considered related parties except for: a. A corporation and a taxpayer whose spouse of the taxpayer owns 80% of the corporation’s stock. b. A trust and a taxpayer who is the grantor of the trust. c. A corporation and a taxpayer who owns 20% of the corporation’s stock. d. A partnership and a taxpayer who is a two-thirds partner.
Answer: c
43. On June 1, 2006, Nigel sells land (basis $55,000) to his son Ted for $40,000, the land’s fair market value on the date of the sale. On September 21, 2006, Ted sells the land to an unrelated party. Which of the following statements is correct? a. If Ted sells the land for $35,000 he has a $20,000 recognized loss on the sale. b. If Ted sells the land for $65,000 he has a $25,000 recognized gain on the sale. c. If Ted sells the land for $45,000 he has a $5,000 recognized gain on the sale. d. If Ted sells the land for $57,000 he has a $2,000 recognized gain on the sale.
Answer: d
44. Bryce owns 200 shares of Basic Company stock that he purchased for $8,000 three years ago. On December 28, 2006, Bryce sold 100 shares of the stock for $2,500. On January 3, 2007, Bryce repurchased 50 shares for $1,100. How much of the loss can Bryce deduct in 2006? a. $0. b. $ 750. c. $4,400. c. $5,500.
Answer: b
Problems
45. Carlton holds undeveloped land for investment. His adjusted basis in the land is $200,000 and the FMV is $325,000. On November 1, 2006, he exchanges this land for land owned by his son, who is 31 years old. The appraised value of his son’s land is $320,000 with a basis of $310,000.
a. Calculate Carlton’s realized and recognized gain or loss from the exchange with his son and on Carlton’s subsequent sale of the land to a real estate agent on July 19, 2007, for $375,000. b. Calculate Carlton’s realized and recognized gain or loss from the exchange with his son if Carlton does not sell the land received from his son, but his son sells the land received from Carlton on July 19, 2007. Calculate Carlton’s basis for the land on November 1, 2006 and July 19, 2007. c. What could Carlton do to avoid any recognition of gain associated with the first exchange prior to his sale of the land?
Answer: a. Carlton Son Amount Received $320,000 $325,000 Basis 200,000 310,000 Realized Gain $120,000 $15,000
Since the land was sold within 2 years, the deferred gain would be recognized in the year of the subsequent sale. Thus, not only must Carlton recognize the gain on the sale, but also the gain on the original property exchange ($120,000). The son must also recognize the $15,000 previously deferred gain.
b. If either party disposes of the property within two years, both previously deferred gains are recognized.
Carlton’s Basis $200,000 (on Nov. 1, 2006 when the like-kind exchange was still good)
Since the gain is recognized now, his basis would go up to $320,000 (what he gave up or the basis of the old of $200,000 plus the gain of $120,000). c. Wait two years before any sale is made by either himself or his son.
46. Elaine exchanges a van that is used exclusively for business purposes for another van that also is to be used exclusively for business. The adjusted basis for the old van is $18,000, and its FMV is $14,500.
a. Calculate Elaine’s recognized gain or loss on the exchange. b. Calculate Elaine’s basis for the van he receives.
Answer: a. Since Elaine receives no “boot,” no gain or loss is recognized in the transaction. Gain, but no loss, can be recognized.
b. Basis of the new van is $18,000 (same as the basis of the old van).
47. What is the basis of the new property in each of the following situations? Is any gain recognized in the following transactions?
a. Rental house with an adjusted basis of $100,000 exchanged for personal use river cottage with an FMV of $130,000. b. General Motors common stock with an adjusted basis of $19,000 exchanged for Quaker Oats common stock with a FMV of $14,000. c. Land and building with an adjusted basis of $25,000 used as a furniture repair shop exchanged for land and a building with a FMV of $52,000 used as a car dealership. d. An office building with an adjusted basis of $22,000 exchanged for a heavy- duty truck with a FMV of $28,000. Both properties are held for 100% business purposes. e. A residential rental property held for investment with an adjusted basis of $230,000 exchanged for a warehouse to be held for investment with a FMV of $180,000.
Answer:
a. If the river house is not rented, the transaction does not qualify as a like- kind exchange. Thus, the basis in the new property is $130,000 and a $30,000 gain is recognized.
b. Stock exchanges do not qualify for like-kind treatment. The loss recognized is $5,000, and the basis of the new stock is $14,000.
c. Qualifies as a like-kind exchange. Gain recognized $0 Basis $25,000
d. These are not like-kind assets, so this does not qualify for like-kind treatment. Gain = $28,000 – 22,000 = $6,000 Basis in truck = $28,000 (cost of asset or basis + gain)
e. Qualifies for like-kind treatment Gain $0 Basis $230,000 (same as old)
48. Viktor exchanges stock (adjusted basis $18,000, FMV $25,000) and real estate (adjusted basis $18,000, FMV $44,000) held for investment for other real estate to be held for investment. The real estate acquired in the exchange has a FMV of $67,000.
a. What is Viktor’s realized and recognized gain or loss? b. What is the basis of the acquired real estate?
Answer: a. The stock would be considered “boot.”
$67,000 Basis of old (18,000) Stock 25,000 Realized gain $24,000
$25,000 (18,000) Recognized gain on the stock $ 7,000
No gain is recognized on the real estate exchange. Giving of “boot” does not cause the recognition of gain.
b. Basis of old $18,000 or Price of new $67,000 Basis of boot* 25,000 Deferred gain on real estate (24,000) $43,000 $43,000
*The basis of the stock increases from $18,000 to $25,000 because of the gain recognized on the disposition of the stock.
49. LaRhonda owns an office building that has an adjusted basis of $45,000. The building is subject to a mortgage of $20,000. She transfers the building to Miguel in exchange for $15,000 cash and a warehouse with a FMV of $50,000. Miguel assumes the mortgage on the building.
a. What is LaRhonda’s realized and recognized gain or loss? b. What is her basis in the newly acquired warehouse?
Answer: a. Proceeds $50,000 + 15,000 Cash + 20,000 mortgage = $85,000 Basis (45,000) Realized Gain $40,000
Gain is recognized to the extent of boot received. Cash $15,000 + Release of liabilities $20,000 = $35,000
b. Old Basis $45,000 Boot 15,000 Liabilities 20,000 Basis of new $80,000 or $85,000 Deferred gain (5,000) $80,000
50. Kim owns equipment that is exclusively used in her business. The equipment has an adjusted basis of $8,500 (FMV $5,000). Kim transfers the equipment and $2,000 cash to David for a computer (also used for business purposes) that has a FMV of $7,000.
a. What is Kim’s recognized gain or loss on the exchange? b. What is Kim’s adjusted basis in the computer?
Answer: Equipment – treated as a sale because they are not like-kind assets
a. Sale Price – FMV of computer $ 7,000 Basis: $8,000 + 2,000 Cash 10,500 Loss in the sale ($3,500)
b. Basis is the “cost” of the computer. $5,000 FMV of equipment + $2,000 cash = $7,000
51. Joshua owns undeveloped land that has an adjusted basis of $45,000. He exchanges it for other undeveloped land with a FMV of $70,000.
a. What are his realized and recognized gains or losses on the exchange? b. What is his basis in the acquired land? Answer:
a. $70,000 45,000 $25,000 realized gain; recognized on a like-kind exchange
b. Basis = $70,000 FMV received - $25,000 deferred gain = $45,000 Or old basis $45,000 Boot given 0 Gain recognized (0) Boot Received (0) Loss Recognized (0) $45,000
52. Patti’s garage (used to store business property) is destroyed by a fire. She decides not to replace it and uses the insurance proceeds to invest in her business. The garage had an adjusted basis of $50,000.
a. If the insurance proceeds total $20,000, what is Patti’s recognized gain or loss? b. If the insurance proceeds total $60,000, what is Patti’s recognized gain or loss?
Answer:
a. Proceeds $20,000 Basis 50,000 Gain ($30,000) can be deducted as a business casualty loss
b. Proceeds $60,000 Basis 50,000 Gain $10,000 recognized as the gain on business property
53. Indicate whether the property acquired qualifies as replacement property for each of the following involuntary conversions.
a. The Harts’ personal residence is destroyed by a hurricane. They decide not to acquire a replacement residence but to invest the insurance proceeds in a house that they rent to tenants. b. Faiqa’s personal residence is condemned. She uses the proceeds to invest in another personal residence. c. Tonya owns a storage warehouse used for business purposes. A flood destroys the building and she decides to use the insurance proceeds to rebuild the warehouse in another state. d. Ramona owns an apartment building that is destroyed by a flood. She uses the insurance proceeds to build an apartment building nearby, which is out of the flood zone.
Answer: a. No, the replacement property must be of “similar or related in service or use.” For real property, the test is like-kind, but since one is a residence and one is rental, the involuntary rules would not apply. However, since the destroyed property is a personal residence any gain could be excluded under §121.
b. yes
c. yes – location (state) would not matter
d. yes
54. Jessica’s office building is destroyed by fire on November 15, 2006. The adjusted basis of the building is $410,000. She receives insurance proceeds of $550,000 on December 12, 2006.
a. Calculate her realized and recognized gain or loss for the replacement property if she acquires an office building in December 2006 for $550,000. b. Calculate her realized and recognized gain or loss for the replacement property if she acquires an office building in December 2006 for $495,000. c. What is her basis for the replacement property in (a) and (b)? d. Calculate Jessica’s realized and recognized gain or loss if she does not invest in replacement property.
Answer:
a. Insurance $550,000 Adjusted Basis 410,000 Realized Gain $140,000
$0 gain recognized because of the replacement was for $550,000 or more.
b. Gain is recognized to the lesser of the realized gain or the amount of the proceeds in excess of the replacement cost ($55,000). $55,000 recognized gain
c. For (a), basis remains the same as the old asset: $550,000 – 140,000 gain deferred = $410,000. For (b), $495,000 – 85,000 gain deferred = $410,000 d. $140,000 realized $140,000 recognized
55. Reid’s personal residence is condemned on September 12, 2006 as part of a plan to add two lanes to the existing highway. His adjusted basis is $300,000. He receives condemnation proceeds of $340,000 on September 30, 2006. He purchases another personal residence for $325,000 on October 15, 2006. What is Reid’s realized and recognized gain or loss?
Answer: $340,000 300,000 $ 40,000 realized gain
Replacement for $325,000 would normally result in a $15,000 gain recognized (proceeds in excess of replacement cost). However, since this was a personal residence, the $15,000 gain is not recognized due to the exclusion of gain for personal residences (IRC §121).
56. Pedro sells investment land on September 1, 2006. Information pertaining to the sale follows:
Adjusted basis $25,000 Selling price 90,000 Selling expenses 1,500 Down payment 12,000 4 installment payments 15,000 Mortgage assumed by the buyer 18,000
Each installment payment (including interest) is due on September 1 of 2007, 2008, 2009, and 2010. Assume a 10% interest rate. Determine the tax consequences in 2006, 2007, 2008, 2009, and 2010.
Answer: Sales Price $90,000 Basis 25,000 Selling Expenses 1,500 26,500 Realized Gain 63,500 Gross Profit % 88.19% Gross Profit/Contract Price ($72,000)
September 1, 2006 $12,000 * 88.19% = $10,584 gain recognized September 1, 2007 $15,000 * 88.19% = $13,229 September 1, 2008 $15,000 * 88.19% = $13,229 September 1, 2009 $15,000 * 88.19% = $13,229 September 1, 2010 $15,000 * 88.19% = $13,229 $63,500
57. Virginia is an accountant for a global CPA firm. She is being temporarily transferred from the Raleigh, North Carolina office to Tokyo. She will leave Raleigh on October 7, 2006, and will be out of the country for four years. She sells her personal residence on September 30, 2006 for $250,000 (her adjusted basis is $190,000). Upon her return to the United States in 2010, she purchases a new residence in Los Angeles for $220,000, where she will continue working for the same firm.
a. What is Virginia’s realized and recognized gain or loss? b. What is Virginia’s basis in the new residence?
Answer: a. Realized gain $250,000 – 190,000 = $60,000 Recognized gain $0 §121 exclusion
b. Cost $220,000
58. On February 1, 2006, a 39-year-old widow buys a new residence for $150,000. Three months later she sells her old residence for $310,000 (adjusted basis of $120,000). Selling expenses totaled $21,000.
a. What is the widow’s realized and recognized gain or loss? b. What is her basis in the new residence?
Answer: a. Realized gain ($310,000 - $21,000) - $120,000 = $169,000. However, none of the gain is recognized because of the §121 exclusion.
b. The basis of the new residence is $150,000.
59. Dominique is a manager for a regional bank. He is being relocated several states away to act as a temporary manager while the a new branch is interviewing for a permanent manager. He will leave on May 1, 2006, and will be at the new location for less than one year. He sells his personal residence on April 15, 2006 for $123,000 (adjusted basis $95,000). Upon completion of the assignment, he purchases a new residence for $200,000.
a. What is Dominique’s realized and recognized gain or loss? b. What is Dominique’s basis in the new residence? c. Assume Dominique is transferred out-of-state and sells his new residence for $230,000 two months later (Dominique is single).
Answer:
a. $123,000 95,000 $ 28,000 realized gain; excluded under §121; $0 recognized
b. Basis is the cost of the new home: $200,000
Allowable exclusion: (60/730) * $250,000 = $20,548 allowed exclusion $230,000 – 200,000 = $30,000 gain on sale 20,548 excluded $ 9,452 taxable gain
60. Crystal owns 150 shares of Carson, Inc., stock that has an adjusted basis of $100,000. On December 18, 2006, she sells the 150 shares for FMV ($88,000). On January 7, 2007, she purchases 200 shares of Carson stock for $127,500.
a. What is Crystal’s realized and recognized gain or loss on the sale of the 150 shares sold on December 18, 2006? b. What is Crystal’s adjusted basis for the 200 shares purchased on January 7, 2007? c. How would your answers in (a) and (b) change is she purchased only 100 shares for $98,000 in January?
Answer:
a. $88,000 100,000 $12,000 realized loss – The loss is not recognized because of the wash sale rules.
b. Cost $127,500 Disallowed loss 12,000 New Basis in 200 shares $139,500
c. Since Crystal only repurchased 2/3 of the shares (100 shares versus 150 sold), then 1/3 of the loss on the December sale is allowed. $12,000 * 1/3 = $4,000 allowed; $8,000 disallowed and added to basis.
61. On January 1, 2006, Myron sells stock that has a $50,000 FMV on the date of the sale (basis $75,000) to his son Vernon. On October 21, 2006, Vernon sells the land to an unrelated party. In each of the following, determine the tax consequences of these transactions to Myron and Vernon.
a. Vernon sells the stock for $40,000. b. Vernon sells the stock for $80,000. c. Vernon sells the stock for $65,000.
Answer: a. Myron’s $25,000 loss would be disallowed under the related party rules. Vernon would recognize a $10,000 loss. Myron’s $25,000 loss would not be used and lost forever.
b. Myron’s $25,000 loss would be disallowed under the related party rules. Vernon would recognize a $5,000 gain. The gain is actually $30,000 on the sale but it can be reduced by the $25,000 disallowed loss on the sale by Myron.
c. Myron’s $25,000 loss would be disallowed under the related party rules. Vernon would not recognize any gain on the sale. The $15,000 gain is reduced by Myron’s disallowed loss. Myron’s additional loss of $10,000 would be lost forever.
62. Harold owns 130 shares of stock in Becker Corporation. His adjusted basis for the stock is $210,000. On December 15, 2006 he sells the stock for $180,000. He purchases 200 shares of Becker Corporation stock on January 12, 2007, for $195,000.
a. What is Harold’s realized and recognized gain or loss on the sale? b. What is Harold’s adjusted basis for the 200 shares purchased on January 12, 2007? c. How would your answers in (a) and (b) change if he purchased only 100 shares for $95,000 in January?
Answer: a. $180,000 210,000 ($30,000) realized loss; $0 recognized because of the wash sale rules
b. Basis of new shares $195,000 Disallowed loss 30,000 Basis of new stock $225,000
c. Since he only purchases 100 shares, a portion of the loss is recognized: (100/130) = 76.92% * $30,000 = $23,076 disallowed; $6,924 allowed Basis: $195,000 + 23,076 = $218,076 63. Lewis owns 200 shares of stock in Modlin Corporation. His adjusted basis for the stock is $180,000. On December 15, 2006, he sells the stock for $170,000. He purchases 200 shares of Modlin Corporation stock on January 8, 2007, for $170,000.
a. What is Lewis’ realized and recognized gain or loss on the sale? b. What is Lewis’ adjusted basis for the 200 shares purchased on January 8, 2007? c. How would your answers in (a) and (b) change if he purchased only 100 shares for $105,000 in January? d. What tax treatment is Lewis trying to achieve?
Answer: a. December 15, 2006: Sale $170,000 Basis 180,000 Realized Loss ($10,000)
This is a wash sale. The $10,000 loss would be disallowed. The $10,000 disallowed loss is added to the basis of the second purchase on 1/08/07.
b. $170,000 + 10,000 disallowed loss = $180,000.
c. Since ½ of the shares were repurchased, the same proportion of the loss is allowed. $5,000 of the $10,000 disallowed loss is allowed. Basis in new stock = $105,000 + 5,000 disallowed loss
d. Lewis is trying to generate a tax loss without changing the ownership in Modlin Corp.
Tax Return Problems
Use your tax software to complete the following problems. If you are manually preparing the tax returns, the problem indicates the forms or schedules you will need.
Tax Return Problem #1
During 2006, Wendy O’Neil (SSN 444-44-4444), who is single, worked full-time as the director at a local charity. She resides at 1501 Front Street, Highland, AZ 12345. For the year, she had the following reported on her W-2
W-2 wages $46,200 Federal withholding $ 5,930 Soc. sec. wages $46,200 Soc. sec. withholding $ 2,864 Medicare withholding $ 670 State withholding $ 2,310
Other information follows: 1099-INT New Bank $ 300
1099-DIV Freeze, Inc Ordinary dividends $ 400 Qualified dividends $ 400
Wendy had the following itemized deductions: State income tax withholding (above) $ 2,310 State income tax paid with the 2005 return $ 100 Real estate tax $ 2,600 Mortgage interest $ 8,060
Wendy inherited a beach rental house in North Carolina (Rental Only) on October 4, 2005 from her father. The FMV at the father’s death was $850,000. He had purchased the house twenty years earlier for $100,000.
Summer rental income $45,000 Repairs $2,500 Real estate taxes $6,500 Utilities $2,400 Depreciation (Calculate)
On November 12, 2006, Wendy properly conducted a like-kind exchange for rental real estate located at 128 Lake Blvd., Hot Town, Arizona. She received rental property with a FMV of $950,000 and $20,000 cash in exchange for the NC beach house. The Arizona property did not produce any income until 2007.
Prepare Form 1040 for Wendy for 2006. You will need Form 1040, Schedule A, Schedule B, Schedule D, Schedule E, Form 4562, and Form 8824
------insert Form 1040 - 2 pages Schedule A&B – 2 pages Schedule D – 2 pages Schedule E - 1 page Form 4562 – 1 page Form 8824 – 1 page Tax Return Problem #2
Dave (SSN 555-55-5555) and Alica (SSN 343-43-3434) Stanley are married and retired at age 50. The couples’ income consists of rental property, stock investments, and royalties from an invention. They sold their large house that they had purchased six years ago for $580,000 on October 18, 2006 for $1.2 million. They now live in a condo at 101 Magnolia Lane, Suite 15, High Park, Florida.
The rental property is an apartment complex (building cost $1.5 million and purchased January 5, 2006) with 30 units that rent for $27,000 per month and are at 90% occupancy.
Rental Income $291,600 Salaries $ 115,000 Payroll taxes 8,798 Real estate taxes 18,750 Interest 45,000 Repairs & maintenance 29,000 Depreciation calculate
The following is also for the year: 1099-INT Old Bank $ 22,000
1099-DIV Dell, Inc Ordinary dividends $ 15,250 Qualified dividends $ 15,250
1099-DIV IBM, Inc Ordinary dividends $ 8,650 Qualified dividends $ 8,650
1099-DIV Pepsi, Inc Ordinary dividends $ 18,785 Qualified dividends $ 18,785
1099-MISC Box 2 Royalties $152,300
Purchased Sold Sales Price Basis Gain/Loss Dell (held 9 mo.) 12/01/05 09/01/06 $15,000 $ 9,000 $6,000 Pepsi (held 4 mo.) 09/01/06 12/29/06 $17,000 $25,000 ($8,000) IBM (held 30 mo) 06/05/04 12/05/06 $38,000 $20,000 $18,000
On January 3, 2007, Dave repurchased the exact number of shares he sold on 12/29/06.
The Stanley’s paid $23,000 each quarter (4 payments) in federal estimated income taxes.
Prepare Form 1040 for the Stanleys. You will need Form 1040, Schedule B, Schedule D, Schedule E, and Form 4562. ------insert Form 1040 - 2 pages Schedule B – 1 page Schedule D – 2 pages Schedule E - 1 page Form 4562 – 1 page