sol ch 11 - ANSWER TO KEYSTONE PROBLEM—CHAPTER 11(fl 1...

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Unformatted text preview: ANSWER TO KEYSTONE PROBLEM—CHAPTER 11 (fl 1 1 ,3 8 5 .) 1. Taxpayers might prefer to have a sale rather than an exchange if they were in a low tax bracket in the year of sale, which would mean that the tax would be relatively low. In such a case, the basis of the newly purchased asset would be higher than the basis of the new asset would be if the transaction were a like-kind exchange. The high basis might be preferable especially if the taxpayer expected to be in higher tax brackets in future years. If a loss would be realized on disposal of an asset, it might be preferable to recognize it through a sale transaction rather than through a like-kind exchange. This could be especially important if the taxpayer were in a high tax bracket in the year of sale and in loWer tax brackets in future years when the asset would be depreciated. 2. There may be times when it is better not to; make the election for nonrecognition of gain. This could be the case if the taxpayer were in a relatively low tax bracket in the current year or because of an expiring net operating loss carryover which could be offset against the gain. Also, the basis of the new replacement asset would be the cost, which would result in a higher basis than if the gain had not been recognized. Sale of Residence: Law 1. For sales or exchanges of residences, married taxpayers may exclude up to $500,000 of gain upon the sale of ‘ illegroiemdengehand single taxpayers may exclude up to $250,000 of their gain. Taxpayers must have owned cupie t e res1dence for two out of the last five years prior to the sale. The exclusion applies to only one sale or exchange every two years. For married taxpayers, the exclusion is allowed if ( 1) either spouse meets the ownership test, (2) both spouses meet the use test, and (3) neither spouse is ineligible for exclusion because of a sale or exchange of a residence within the last two years. Sale of Residence: Electing Out of the Exclusion 2. Taxpayers may elect out of this exclusion provision for any sale or exchange. Thus, for example, taxpayers who plan to sell within two years two properties that meet the exclusion eligibility requirements and who first sell the property with the lesser gain may choose to elect out of the exclusion to reserve its use for the second sale where the gain is larger. . Sale of Residence: No Deferral of Gain 3. Because this exclusion replaces the deferral of gain provision of Code Sec. 1034 and the one-time $125,000 exclusion for taxpayers age 55 or older, application of the exclusion does not result in a reduction of the basis of a replacement residence as was the case under prior law. Sale of Residence: Pro-ration of Exclusion 4. The $250,000 or $500,000 exclusion can be pro-rated if the sale is due to a change in place of employment, health, or unforeseen circumstances even if a taxpayer does not meet the ownership or usage requirement. The amount of the exclusion is $250,000 or $500,000 multiplied by the portion that is the shorter of (1) the aggregate periods during which the ownership and use requirements were met during the five-year period ending on the date of the sale or (2) the period after the date of the most recent sale, bears to two years. Sale of Residence: Special Rules 5. A widowed taxpayer’s period of ownership of a residence includes the period the deceased spouse owned - and used the property before death. In the case of a residence that is transferred to a taxpayer incident to a divorce, the time during which the taxpayer’s spouse or former spouse owned the residence is added to the taxpayer’s period of ownership. A taxpayer who owns a residence is considered to have used it as a principal residence while the taxpayer’s spouse or former spouse is granted use of the residence under the terms of the divorce or separation instrument. If a taxpayer becomes physically or mentally incapable of self-care, the taxpayer is deemed to use a residence as a principal residence during the time in which the taxpayer owns the residence and resides in a care facility licensed by a state or political subdivision such as in a nursing home. The taxpayer must have owned and used the residence as a principal residence for a period of at least one year during the five years preceding the sale in order to use this provision. Sale of Residence: Tax Planning Pointers 6. The Housing Assistance Tax Act of 2008 provides that gain from the sale of a principal residence that is allocable to periods of “nonqualified use” is not excluded from the taxpayer’s income. Certain usage is not treated as nonqualified, including leaving the home vacant and temporary absences because of a change in employment, health, or unforeseen circumstances. This applies to periods starting in 2009, but pre-2009 periods are grandfathered in and are considered qualified use. Gain is allocated to periods of nonqualified use based on the ratio which the aggregate periods of nonqualified use during the period the property was owned by the taxpayer bears to the total period of time the property was owned by the taxpayer. Thus, if a taxpayer bought a home in January 1, 2011, and rents it out until January 1, 2017 when the taxpayer moves into the home and then sells the home in January 1, 2019, the two-out-of-five year requirement is met, but six years out of the eight-year ownership period is nonqualified use, and six-eights of the gain would not be eligible for exclusion. Like-Kind Exchanges 7. In nontaxable exchanges, property exchanged for like-kind property is not a change in substance or economic position. The new property is viewed as a continuation of the old investment. Like-Kind Exchange v. Sale of Property 8. A taxpayer might want to avoid the nonrecognition of gain provision and have a sale if the taxpayer is in a low tax bracket or if the gain would receive favorable capital gain treatment. Recognition of gain also increases the basis of the new property, which may be important if the property is depreciable property. Like-Kind Exchanges: Basis of New Property 9. First method: Adjusted basis of property given up Boot given Gain recognized Liability assumed by the transferor A Boot received - Loss recognized — Liability assumed by the transferee Basis of the property acquired +++ Second method: Fair market value of the property received - Deferred gain + Deferred loss Basis of the acquired property || Like-Kind Exchanges: Types 1 0. (1) Business for business property. (2) Business for investment property. (3) Investment for business property. (4) Investment for investment property. Like-Kind Exchanges: Boot and Gain or Loss 11. a. Boot is cash or other property that is not like-kind property. b. Postponed gain or loss is deferred gain or loss or gain or loss that is realized but not recognized. In determining the basis of new property acquired in a like-kind exchange, the definition fits in as follows: Fair market value of the property received - Deferred gain + Deferred loss = Basis of the acquired property c. Realized gain or loss is the difference between the fair market value of the property received and the adjusted basis of the property given up. d. In like-kind exchanges, generally there is no gain or loss recognized in a boot given situation. The exception is that if the boot given has a difference between the basis and its fair market value, there is gain or loss recognized to that extent. In a boot received situation, gain is recognized to the extent of boot received but not to exceed the gain realized. Losses realized in a boot received situation are not recognized. Involuntary Conversions: Personal Residence 12. Casualty Condemnation Gain situation Exclude under Code Sec. 121 and election to Exclude under Code Sec. 121 postpone under the involuntary conversion and election to defer under the provisions of Code Sec. 1033 provision of Code Sec. 1033 Loss situation Recognized subject to the personal casualty Notrecognized loss limitations ’ Involuntary Conversions: Types 13. (1) Destruction. (2) Theft. (3) Seizure. (4) Condemnation. Involuntary Conversions: Replacement Property Rules 14. If the amount realized is greater than the amount reinvested in replacement property, then gain is recognized to the extent of the excess of the amount realized over the amount reinvested. If the amount realized is less than or equal to the amount reinvested in replacement property, then no gain is recognized. Involuntary Conversions: Condemnation 15. The taxpayer is required to obtain confirmation that there has been a decision to acquire the property for public use and must have reasonable grounds to believe that the property will be taken. Involuntary Conversions: Condemnation Replacement Period 16. The allowed period for replacement with qualified property begins on the earlier of the date of disposition of the converted property, or the earliest date of the threat or imminence of the condemnation of the converted property. The taxpayer has until two years after the close of the first taxable year in which any part of the gain is realized from the involuntary conversion to replace with qualified property. The taxpayer has three years after the close of the first taxable year in which gain is first realized in the case of condemnations of real property. Involuntary Conversions: Losses 17. Losses realized from involuntary conversions of income-producing or business property are recognized. Casualty and theft losses of personal-use assets are also recognized (subject to limits), but"condemnation losses of personal-use assets are not recognized. Involuntary Conversions: Qualifying Replacement Property Tests 18. The taxpayer-use test means that if the taxpayer is an owner-investor, the replacement property must have the same relationship of service or use to the taxpayer as the converted property had. A rental office building replaced with a rental warehouse would qualify. The functional-use test means that if the taxpayer owned and used the property that was converted, the replacement property must be used in the same way as the converted property. A restaurant owned by the user replaced by another restaurant owned by the user would qualify. Nontaxable Exchanges 19. The following exchanges generally qualify for nonrecognition: (1) An insurance contract for another insurance contract. (2) An insurance contract for an endowment or annuity contract. (3) An endowment contract for an annuity contract. (4) An annuity for an annuity contract. (5) An endowment contract for an endowment contract provided that the contract received does not provide for payments Sooner than the contract given up. Sale of Residence: Adjusted Basis 20. Adjusted basis of a residence is its cost and commissions, plus any capital improvements, less insurance reimbursements and deductible casualty losses. Answers to Problems Sale of Residence: Gain Realization [Exclusion/Recognition 21. a. The Lindsays’ basis of the residence at the time of the sale is $130,000 and their realized gain is $220,000 ($350,000 less $130,000). They may exclude the total $220,000 realized gain and therefore they have no recognized gain. b. The Lindsays have a realized gain of $570,000 ($700,000 less $130,000). They may exclude $500,000 and must recognize $70,000. The fact that they moved into another home is irrelevant and there is no _ opportunity to defer the $70,000 gain through an adjustment in the basis of the new residence as was the case under the old law. 0. The Lindsays have a realized loss of $50,000, but none of it is recognized, since taxpayers are not allowed to deduct losses on the sale of personal-use assets. Sale of Residence: Gain Realization / Exclusion] Recognition 22. a. John has a realized gain of $475,000 ($650,000 less $175,000), but as a single individual, he can only exclude $250,000 and he must recognize $225,000. b. John’s exclusion is still $250,000, and he must still recognize $225,000. The fact that he moved into another home is irrelevant and there is no opportunity to defer the $225,000 gain through an adjustment in the basis of the new residence as was the case under the old law. Sale of Residence: Pro-ration of Exclusion 23. a. The Millers have owned and used the home for less than two years, but because they are selling for a job- related reason, they may pro-rate the exclusion. The pro—rated amount of exclusion is $291,667 ($500,000 X 14 months divided by 24 months = $291,667). Since the realized gain is only $200,000 ($550,000 less $350,000), they can exclude the whole $200,000 and need not recognize any gain. b. The Millers have a realized gain of $400,000, of which $291,667 is excluded and the remaining $108,333 is recognized. $850,000, there is a $300,000 realized gam. However, as a Single taxpayer, 1111a can exuuue .pzwgmu. one can count the time they owned it when they were married. Therefore, she must recognize $50,000 gain. Sale of Residence: Divorced Taxpayers 25. a. Thomas can exclude the $120,000 gain since he can count the time that Tonya owned the residence which makes the ownership and use more than two years. b. Tonya can exclude the $120,000 gain since she can count the time that Thomas used the residence as part of the divorce agreement. Sale of Residence: Incapacitated Taxpayers 26. Arnold can exclude the $85,000 gain ($245,000 less $160,000) because he has used the residence at least one year during the preceding five years. Sale of Residence: Involuntary Conversion 27. a. Oscar does not recognize any of the $230,000 realized gain on the involuntary conversion of his home by the tornado because it is less than the $250,000 exclusion allowed for a single individual. b. Oscar has a realized gain of $355,000 ($525,000 less $170,000). He may exclude $250,000 and would have to recognize $105,000 gain. If, however, he purchased a home for $275,000 or more, he could defer the remaining $105,000 of realized gain. The $525,000 would be reduced by the $250,000 gain excluded leaving $275,000 of proceeds to be used when applying the gain deferral provision under the involuntary conversion rules of Code Sec. 1033. Sale of Residence: Pro-ration of Exclusion 28. a. Carl can exclude $156,250 ($250,000 times 15 months divided by 24 months = $156,250). He must recognize $118,750, the difference between the realized gain of $275,000 ($440,000 less $165,000) and the exclusion of $156,250. b. Carl would still be able to exclude up to $156,250, which is more than the realized gain of $135,000. Therefore, he does not need to recognize any gain. Like-Kind Exchanges: Types 29. (a), (b), and (e) are like-kind exchanges. (c) is not a like-kind exchange because it is personality for realty. (d) is not a like-kind exchange because inventory does not qualify under the like-kind provisions. Sale, Exchange, and Casualty 30. a. If Lewis sells the yacht for $220,000, there is a $90,000 capital loss ($220,000 — $310,000). b. If Lewis exchanges the yacht for another yacht worth $220,000, there is a $90,000 realized loss, but no recognized loss because it is a personal use asset. c. If the yacht burns and is completely destroyed, and he receives $200,000 proceeds, he has a personal casualty loss of $20,000 ($200,000 less $220,000, the lesser of the decline in the fair market value or the - \ TLZ, man Ann :. ..-.I..-,,.J I.-. (‘1 An .wnl l“, 1n0/_ nfnrlinnl-nrl mnoc innnmn a. Sheila’s realized and recognized gain is as follows: Fair market value of property received $40,000 Plus: cash received 10,000 Total fair market value received $50,000 Less: adjusted basis 25,000 Equals: Realized Gain M Recognized Gain m (to the extent of the cash received) The basis in the new property is as follows: Method 1: Basis of old property $25,000 Plus: gain recognized 10,000 Less: cash received 10,000 Basis in new property m Method 2: Fair market value of the like-kind property $40,000 Less: Gain not recognized 15,000 Basis of new Property m b. The realized and recognized gain is as follows: Fair market value of property received $40,000 Plus: cash received 10,000 Total fair market value received $50,000 Less: adjusted basis 45,000 Equals: Realized Gain w Recognized Gain QM (to the extent of the cash received but not to exceed the amount of realized gain) The basis in the new property is as follows: Method 1: Basis of old property $45,000 Plus: gain recognized 5,000 Less: cash received 10,000 Basis in new property M Method 2: Fair market value of the like-kind property $40,000 Less: Gain not recognized 0 Basis of new Property M c. The realized and recognized loss is as follows: Fair market value of property received $40,000 Plus: cash received 10,000 Total fair market value received $50,000 Less: adjusted basis 55,000 Equals: Realized Loss QM Recognized Loss $__Q (no loss recognized in a boot received situation) 1’ lus: 1055 I‘ccugiuzcu v Less: cash received 10,00 Basis in new property M Method 2: Fair market value of the like-kind property $40,000 Plus: Loss not recognized 5,000 Basis of New Property M Like-Kind Exchanges: Basis and Gain or Loss 32. Ben’s realized and recognized gain is $1,300 and the basis of the new machine is $2,000. FMV of property received ($2,000 + $2,500) $4,500 Less: Adjusted basis of property given up 12% Gain realized M Gain recognized m Gain is recognized by Ben to the extent of boot received but not to exceed realized gain. Method 1: Basis of old machine $3,200 Plus: Gain recognized 1,3 00 Less: Boot received M Basis of new machine M Method 11: FMV of property received $2,000 Less: Deferred gain __0 Basis of new machine m Lester has $300 realized gain, no recognized gain, and the basis of his new machine is $4,200. FMV of property received $4,500 Less: Adjusted basis ($1,700 + $2,500) 4,200 Gain realized DE Gain recognized This is a boot given situation for Lester, and therefore no gain is recognized. Method 1: Basis of old machine $1,700 Plus: Boot given _2~,5_0_0 Basis of new machine M Method 11: FMV of property received $4,5 00 Less: Deferred gain __m Basis of new machine M a. Emma’s realized and recognized gain 1s as Iollows: Fair market value of property received $23,000 Plus: cash received 7,000 Total fair market value received $30,000 Less: adjusted basis 25,000 Equals: Realized Gain m Recognized Gain w (to the extent of the cash received but not to exceed the realized gain) The basis in the new property is as follows: Method 1: Basis of old property $25,000 Plus: gain recognized 5,000 Less: cash received 7,000 Basis in new property M Method 2: Fair market value of the like-kind property $23,000 Less: Gain not recognized 0 Basis of new Property m b. Lily’s realized and recognized gain is as follows: Fair market value of property received $30,000 Less: adjusted basis 20,000 Less: cash paid 7,000 Realized Gain w Recognized Gain $___Q (no gain recognized in a boot given situation) The basis in the new property is as follows: Method 1: Basis of old property $20,000 Plus: gain recognized 0 Plus: cash paid 7,000 Basis in new property m Method 2: Fair market value of the like-kind property $30,000 Less: Gain not recognized 3,000 Basis of new Property m Like-Kind Exchanges: Basis and Gain or Loss 34. a. Betsy’s realized and recognized gain is as follows: Fair market value of property received $28,000 Less: adjusted basis 25,000 Less: cash paid 6,000 Hus: ga1n recognlzeo u Plus: cash paid 6 000 Basis in new property m Method 2: Fair market value of the like-kind property $28,000 Plus: Loss not recognized 3,000 Basis of New Property M b. Although there is a loss realized of $3,000, there is no recognized loss since the property is a personal use item. The basis of the new property is the fair market value of $28,000. Like-Kind Exchanges: Basis and Gain or Loss 35. a. Wayne has a realized gain of $300,000, a recognized gain of $100,000, and a basis in the office building of $300,000. FMV of property received ($500,000 + $100,000) $600,000 Less: Adjusted basis 300,000 Gain realiz...
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