FTax IRGTB ch16 p001-022

FTax IRGTB ch16 p001-022 - 16 Property Transactions:...

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Unformatted text preview: 16 Property Transactions: Capital Gains and Losses Solutions to Tax Research Problems 16-57 5The controlling question is whether a geographical limitation on the exploitation of a patent is a substantial right. According to the cases cited, it is. Therefore, if such a limit is imposed capital gain treatment that might be available under 1235 cannot be preserved. One way of handling this problem has been to transfer all rights to the patent, giving the transferee the right to sublease the patent in certain geographic areas, the transferor having the right to refuse any potential sublessee (e.g., giving the transferee exclusive rights east of the Rockies and the right to sublease west of the Rockies, with sublessees subject to G's approval). This retained right has not been considered substantial. Kueneman v. Comm., 628 F.2d 1196 (CA-9, 1980), involved a situation similar to that stated in the problem, and capital gain treatment was denied. A similar result was reached in Klein Estate v. Comm., 507 F.2d 617 (CA-7, 1974). In Rouverol, 42 T.C. 186 (1964) (N.Acq., 1965-2 CB 7), an inventor transferred all substantial rights to a U.S. patent. Later, under the agreement, some of the rights were sublet to another company with Rouverol's approval. The ability to approve the transfer was not considered "substantial." For an earlier case with a similar result, see Rogers, 51 T.C. 927. Where a transfer limited the transferee to use of the patent within a single industry, even though it could be applied in another industry, all substantial rights were not transferred. [See Fawick v. Comm., 71-1 USTC {9147, 27 AFTR2d 71-381, 436 F.2d 655 (CA-6, 1971).] A determination must be made as to whether gain is ordinary income or capital gain on the sale of real property. This determination depends on the taxpayer's primary motivation and takes into account such factors as the frequency and continuity of sales, the holding period, the taxpayer's intent, the subdivision of the property and improvement activities. This question focuses on subdivision and improvement. [Malat v. Riddell, 66-1 USTC {9317, 17 AFTR 2d 604, 383 US 569 (USSC, 1966)]. a. This is the sale of a capital asset and would qualify for long-term capital gain treatment since there was a long holding period, primarily for appreciation, and a single sale. b. Subdividing and improving real estate is one of the many factors in determining whether the property is held for sale to customers in the ordinary course of a trade or business. Subdividing and making physical changes in the form of roads and improvements would probably be sufficient to convert this to an ordinary asset [Houston Endowment, Inc. v. U.S., 79.2 USTC {9690, 44 AFTR 2d 79-6074, 606 F.2d 77 (CA-S, 1979) and Biedenharn Realty Co., Inc. v. U.S. 76-1 USTC {9194.37 AFTR 2d 76-679, 526 F.2d 409 (CA-5, 1976)]. c. It is possible that the mere recording of the subdivision plan without making physical changes would not change the character of the property. If so, the gain would be long-term capital gain. 55- 5- 16-58 16-1 16-2 Chapter 16 Property Transactions: Capital Gains and Losses d. If recording the subdivision does not change the character, D would recognize capital gain on the sale to the partnership. The partnership would have ordinary income when the individual lots are sold, 40 percent of which would pass through to D. (See 701-704.) 16 Property Transactions: Capital Gains and Losses Test Bank True or False 1. A personal automobile (i.e., one that is owned by the taxpayer and driven for personal purposes) is an example of a capital asset. 2. Undeveloped vacant real estate held exclusively for speculation is treated as business property and does not qualify as a capital asset. 3. In order for real property to be considered ordinary income property (i.e., inventory rather than a capital asset), the taxpayer's livelihood must be derived primarily from buying and selling real estate. 4. The gain or loss on the disposition of a sole proprietorship is capital gain or loss. 5. Casualties and thefts involving personal-use property are treated as capital gains and losses if the gains exceed the losses from such events for a particular year. 6. For a capital gain or loss to be considered long-term, the asset must generally be held more than one year. 7. Both the date of acquisition and the date of sale are included in determining the holding period for a capital asset. 8. The holding period of like-kind property acquired in a qualifying exchange begins on the date of the exchange. 9. The holding period of property acquired by gift that is sold at a gain is always treated as having a long-term holding period. 10. The holding period of stock purchased and sold on a stock exchange begins and ends with the dates of settlement with the broker. The first step in the capital gain and loss netting process is to combine all capital gains and all capital losses. 11. 16-3 16-4 Chapter 16 Property Transactions: Capital Gains and Losses 12. A net 15 percent capital gain results when a noncorporate taxpayer has a 15 percent capital gain with no capital loss or a net 15 percent capital gain to the extent it exceeds net short-term capital losses. A net 15 percent capital gain of a noncorporate taxpayer that would otherwise fall into the 10 percent bracket for a lower-income individual will be taxed at 10 percent. A net short-term capital gain (NSTCG) with no further netting, or the excess of a net short-term capital gain over a net long-term capital loss (NSTCG NLTCL) is treated just like ordinary income for tax computation purposes. Capital losses in excess of the annual limitation for individuals are carried forward only. The deduction for excess capital losses for individual taxpayers is limited to the lower of an absolute amount of (a) $3,000 or (b) the taxable income for the year, before the deduction. A long-term capital loss carryforward is treated as a short-term capital loss in the carryover year by an individual taxpayer. An employer of the creator of a patent cannot be a "holder" of the patent, and therefore cannot qualify for long-term capital gain treatment. Gain or loss resulting from lease cancellation payments is treated as ordinary income. Section 1244 applies to losses, but not gains, resulting from the sale or exchange of 1244 stock; therefore, any gain on the disposition of such stock held for investment is subject to capital gain treatment. When stock becomes worthless, the loss is ordinary because there is no "sale or exchange" as required for capital loss treatment. In order for a corporation's stock to qualify as a qualified small business stock under 1202, the corporation must be a C corporation and the gross assets at incorporation must be $20 million or less. The stock of a corporation involved in food processing cannot be qualified small business stock. A taxpayer can defer gain on the sale of stock traded on a stock exchange if the proceeds are invested in a specialized small business investment company within 60 days. FGH, Inc. issued stock to individuals for $800,000 cash in 1980 and $400,000 in 1987. None of the stock currently qualifies as 1244 stock since the paid-in capital of the corporation exceeds $1,000,000. J purchased stock in X Corporation from C, one of the original shareholders. In C's hands, the shares were 1244 stock. The stock will also be 1244 stock to J. Both J and C are individuals. Dealers in securities hold stocks and bonds as inventory, not as any other class of asset. Options to purchase property are always treated as capital assets. Original-issue discount on corporate bonds issued during the current year must be amortized over the life of the bond using the straight-line method. Market discount only occurs when there is a purchase of a bond after issue, not at original issue. The market discount is the excess of the discount in price over any unamortized original-issue discount. The purchase of an investment from a seller who agrees to buy the investment back at a speculative market price at the option of the buyer for three years is a conversion transaction. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. Test Bank 16-5 Multiple Choice 32. Which of the following assets is not generally considered a capital asset? a. b. c. d. A personal residence A computer used in a trade or business Chrysler Corporation stock held for investment U.S. Government securities held for investment 33. Which of the following is not an important factor used to determine whether or not real estate is held primarily for sale? a. b. c. d. Subdivision and improvement Amount of gain or loss on sale Purpose and manner of acquisition Reason for and method of sale 34. Which of the following dispositions of property is not treated as a sale or exchange? a. b. c. d. Securities becoming worthless Transfer of property in satisfaction of debt Abandonment of unencumbered property Gain or loss from personal casualty or theft, if any gains exceed any losses 35. M had three separate casualties involving personal use property during the current year: Fair Market Value Before After Casualty Casualty $70,000 $60,000 9,000 8,000 7,000 0 Casualty Fire Accident Theft Property Residence Personal car Silverware Adjusted Basis $50,000 10,000 2,000 M received insurance reimbursement as follows: $8,000 for damages to home; $700 for repair of car; and $5,000 for theft of silverware. What is M's deductible gain (or loss) on each casualty, respectively, before any percentage limit? a. b. c. d. 36. $1,900 loss, $200 loss, $3,000 gain $2,000 loss, $300 loss, $3,000 gain $10,000 loss, $1,000 loss, $7,000 loss $10,000 gain, $2,000 loss, $2,000 loss M had three separate casualties involving personal use property during the current year: Fair Market Value Before After Casualty Casualty $70,000 $60,000 9,000 8,000 7,000 ,000 Casualty Fire Accident Theft Property Residence Personal car Silverware Adjusted Basis $50,000 10,000 2,000 M received insurance reimbursement as follows: $8,000 for damages to home; $700 for repair of car; and $5,000 for theft of silverware. Which of the following is not necessarily true concerning M's gains and losses? a. b. c. d. M must report each separate gain or loss as a gain or loss from the sale or exchange of a capital asset. M's personal casualty gain exceeds her personal casualty losses by $900. If M's personal casualty losses had exceeded her gain, then only so much of the net loss as exceeds 10 percent of A.G.I. could have been taken as an itemized deduction. M's personal casualty gains and/or losses are long-term. 16-6 Chapter 16 Property Transactions: Capital Gains and Losses 37. K sold the following investments during the current year: Date Sold 2/3/X2 2/5/X2 4/5/X2 Date Acquired 1/2/X1 2/5/X1 5/4/X1 Sales Price $3,200 1,200 4,200 Adjusted Basis $1,300 1,400 3,400 Property X Co. stock Y bond Land How much are K's net long-term capital gain or loss and net short-term capital gain or loss, respectively, if any? a. b. c. d. 38. $0 and $2,500 $1,700 and $800 $1,900 and $600 $2,500 and $0 Which of the following is not always true in determining the holding period of capital assets acquired during the current year? a. b. c. d. The holding period is short-term if property is purchased March 15 and is sold March 15 next year (except for inherited property and certain property acquired in tax deferral transactions). The holding period begins and ends when title passes, rather than when settlement is made. The holding period for property acquired from a decedent, may be long-term even if the property is sold less than one year after it was acquired by the decedent. The holding period of the donor of a gift is included in the holding period of the donee. 39. Which of the following is not true of the netting process for capital gains and losses? a. b. c. d. Short-term capital gains and losses are combined and result in either a net short-term capital gain (NSTCG) or a net short-term capital loss (NSTCL). Long-term capital gains and losses are combined and result in either a net long-term capital gain (NLTCG) or a net long-term capital loss (NLTCL). If a taxpayer has both a NSTCG and a NLTCG or both a NSTCL and a NLTCL, the results are netted in the second stage of the netting process. If a taxpayer has either a NSTCG and a NLTCL or NSTCL and a NLTCG, the results are netted in the second stage of the netting process. 40. For the current year, a taxpayer had a short-term capital gain (STCG) of $5,000 and a short-term capital loss (STCL) of $1,000. The taxpayer also had a long-term capital gain (LTCG) of $3,000 and a long-term capital loss (LTCL) of $6,000. Based upon that information, which of the following is not true? a. b. c. d. The taxpayer has a NSTCG of $4,000. The taxpayer has a NLTCL of $3,000. The taxpayer treats the net gain of $1,000 just like ordinary income. The taxpayer cannot combine the NSTCG and NLTCL; therefore, the NSTCG is treated like ordinary income and the NLTCL is deductible as a net capital loss (NCL). 41. Which of the following netting processes does not result in a net capital loss (NCL)? (Assume that all results are positive numbers.) a. b. c. d. NLTCG > NSTCL NSTCL and NLTCL NSTCL > NLTCG NLTCL > NSTCG Test Bank 16-7 42. K had short-term capital losses of $2,000 and long-term capital gains of $5,000 during the current year. By what amount is K's A.G.I. increased as a result of these transactions? a. b. c. d. $2,000 $2,500 $3,000 $5,000 43. During the current year, J had long-term capital gains of $3,600 and short-term capital gains of $3,200. By what amount is J's A.G.I. increased? a. b. c. d. $0 $3,200 $6,800 The increase in J's A.G.I. cannot be determined from the facts given. 44. G is a single, calendar year, individual taxpayer. She has taxable income for the year 2011 of $65,000, including a net short-term capital gain of $5,000 and a net long-term (15 percent) capital gain of $10,000. The 2011 tax schedules for single taxpayers are as follows: Taxable Income But not Over Over $ 0 $ 8,500 8,500 34,500 34,500 83,600 83,600 -- G's federal gross income tax for 2011 is a. b. c. d. $11,375 $9,875 $18,200 $12,375 Tax Liability 10% $850.00 15% 4,750.00 25% 17,025.00 28% Of the Amount Over $ 0 8,500 34,500 83,600 45. H is a single, calendar year, individual taxpayer. She has taxable income for the year 2011 of $70,000, including a net short-term capital gain of $5,000 and a net long-term (15 percent) capital gain of $30,000. The 2011 tax schedules for single taxpayers are as follows: Taxable Income But not Over Over $ 0 $ 8,500 8,500 34,500 34,500 83,600 83,600 -- H's federal gross income tax for 2011 is a. b. c. d. $14,000 $10,625 $18,125 $13,625 Tax Liability 10% $850.00 15% 4,750.00 25% 17,025.00 28% Of the Amount Over $ 0 8,500 34,500 83,600 16-8 Chapter 16 Property Transactions: Capital Gains and Losses 46. J is a single, calendar year, individual taxpayer. She has taxable income for the year 2011 of $65,000, including a net short-term capital loss of $5,000 and a net long-term (15 percent) capital gain of $10,000. The 2011 tax schedules for single taxpayers are as follows: Taxable Income But not Over Over $ 0 $ 8,500 8,500 34,500 34,500 83,600 83,600 -- J's federal gross income tax for 2011 is a. b. c. d. $16,875 $13,000 $11,875 $11,375 Tax Liability 10% $850.00 15% 4,750.00 25% 17,025.00 28% Of the Amount Over $ 0 8,500 34,500 83,600 47. K is a single, calendar year, individual taxpayer. A net long-term (15 percent) capital gain of $10,000 is included in K's taxable income. The 2011 tax schedules for single taxpayers are as follows: Taxable Income But not Over Over $ 0 $ 8,500 8,500 34,500 34,500 83,600 83,600 -- Tax Liability 10% $850.00 15% 4,750.00 25% 17,025.00 28% Of the Amount Over $ 0 8,500 34,500 83,600 Which of the following is not true regarding the taxation of K's federal gross income tax for 2011? a. b. c. d. If K's taxable income is $70,000, all of the net capital gain is taxed at 15 percent. If K's taxable income is $20,000, all of the net capital gain is taxed at 0 percent. If K's taxable income is $40,000, the net capital gain is taxed at the same rate as it would have been had it been ordinary income. If K's taxable income is $37,000, the net capital gain is taxed partly at 15 percent and partly at 0 percent. 48. Dr. T recently called her tax adviser and indicated that one of her investments had turned sour and now was worthless. Assuming T has no other property transactions during the year, the best possible tax treatment could result from a $30,000 loss from holding which of the following? a. b. c. d. A worthless bond A worthless nonbusiness debt A worthless share of 1244 stock Some combination of the above, because the treatment would be the same in both or all cases 49. Q, who is single, acquired 1244 stock of XYZ Corporation several years ago for $150,000. During the current year, Q sold the XYZ stock for $20,000. Q also realized a $10,000 long-term capital gain during the year from a separate transaction. Q's taxable income, excluding both of these transactions, is $70,000 (after personal and dependency exemptions). Q's taxable income including these transactions is how much? a. b. c. d. e. $0 $17,000 $20,000 $67,000 None of the above Test Bank 16-9 50. The importance of stock being designated 1244 stock is which of the following? a. b. c. d. e. Any loss on the stock is deductible as an ordinary loss. It can be sold by the shareholder at a premium because of the availability of the ordinary loss deduction to the new owner. The first $50,000 of each year's loss ($100,000 on a joint return) on the stock may be deducted as an ordinary loss. More than one but less than all of the above are true. All of the above are true. 51. E always had eyes for a deal. When B approached her about his idea of having his chain of pizza parlors deliver video tapes along with pizzas, E saw dollar signs. B needed financing, and E gave the corporation $10,000 in exchange for stock. A summary of the corporation's balance sheet after the exchange revealed the following: Assets Liabilities Retained earnings Capital stock $3,000,000 500,000 1,200,000 800,000 Despite some initial growth based on the idea, the pizza business fell on hard times due to heavy competition. This year E sold her stock at a $9,000 loss, her only property transaction (i.e., sales during the year). This year, E may deduct how much? a. b. c. d. e. 52. $0 $3,000 $9,000 $10,000 None of the above During the current year, F, an individual, had long-term capital losses of $2,000 and short-term capital losses of $1,500. If this is the first year F has experienced capital gains or losses, what amount of these losses may F deduct this year? a. b. c. d. $1,750 $2,500 $3,000 $3,500 53. C had a long-term capital loss carryover to the current year of $4,000. For the current year, she had a short-term capital loss of $2,000 and a long-term capital gain of $1,000. What is C's capital loss deduction for the current year and her carryover to the next year? a. b. c. d. $3,000 and no carryover $2,500 and no carryover $3,000 and $2,000 short-term loss carryover $3,000 and $2,000 long-term loss carryover 54. Which of the following is not required for a patent to qualify for long-term capital gain treatment? a. b. c. d. The transferor must be a holder; holders include the creator of the patentable technology and certain transferees. All substantial rights to the patent must be sold. The price must be a fixed price. All of the above listed conditions are required. 16-10 Chapter 16 Property Transactions: Capital Gains and Losses 55. J and K, who file jointly, started a small business in 1985 by investing $225,000 cash. Their basis in their corporate stock remained at $225,000 until it became worthless during the current year. They have no other gains and losses for the year. How much may they deduct and what is the character of their loss? a. b. c. d. $50,000 ordinary loss, $3,000 capital loss deduction, $172,000 long-term capital loss carryover $100,000 ordinary loss and no capital loss deduction or carryover $100,000 ordinary loss, $3,000 capital loss deduction, and $122,000 long-term capital loss carryover $225,000 ordinary loss 56. W and Y are married and file a joint return each year. They owned 50 percent of the stock in a small business corporation with total paid-in capital of $550,000. During the current year, they sold their stock, which had a basis of $275,000, for $190,000. How is this sale treated on their return? a. b. c. d. Ordinary deduction of $50,000 and long-term capital loss of $35,000 Ordinary deduction of $85,000 Short-term capital loss of $85,000 Long-term capital loss of $85,000 57. Which one of the following is not true of securities held by dealers in securities? a. b. c. d. Securities are generally held as inventory, with any gains or losses on their disposition being ordinary in nature. A dealer may designate a particular lot as held for investment, but the designation must be made on the day the lot is acquired. Once a lot is designated as an investment, losses on its disposition cannot be treated as ordinary. A dealer can receive capital gain treatment on lots of stock held as inventory if they are held for more than two years. 58. The sale of subdivided real estate by a non-corporate taxpayer shall not qualify for 1237 capital gain treatment if a. b. c. d. The taxpayer made substantial improvements to the property. The taxpayer has held the property for more than five years. The taxpayer held other real property primarily for sale during the same tax year. Both a. and c. are true. 59. Which of the following statements is true? a. b. c. d. The transfer of a trademark will result in a capital gain or loss, even if the original owner retains the right to disapprove any assignment of the trademark. A nonbusiness debt is deductible in installments over the years that the debtor displays a diminishing ability to repay it. A loss from the failure to exercise an option to buy or sell an investment is treated as a capital loss. Both a. and b. are true. 60. The de minimis amount of discount for a 10-year bond with a face value of $10,000 is how much? a. b. c. d. $0 $200 $250 $2,000 Test Bank 16-11 61. On July 1, 19X7, T, an investor, purchased a newly issued corporate bond with a face value of $10,000 bearing 10 percent interest for a term of 30 years for $9,500. The bond pays interest semiannually on December 31 and June 30. During 19X7 T received an interest payment of $1,000. Assume the bond's semi-annual yield to maturity is 10.6 percent. The original issue discount will increase T's interest income of $500 by how much in 19X7? a. b. c. d. $0 $3.50 $5 $8.33 62. Which of the following debt instruments are not excluded from original issue discount (OID) rules? a. b. c. d. U.S. Savings Bonds Issues not in security (bond) form Bonds with maturity dates no more than one year after their dates of issue (unless held by accrual basis taxpayers) Nonbusiness loans between individuals of $10,000 or less 63. On September 10, 20X1 (before 2009), C purchased qualified small business stock for $40,000. Which of the following is true? a. b. c. d. If the stock is sold for $100,000 on September 11, 20X6, the maximum tax on the gain is $8,400. If the stock is sold for $35,000 on September 11, 20X8, C may deduct an ordinary loss of $5,000. If the stock is sold after September 10, 20X8, C can qualify for a 50 percent exclusion and a maximum tax of 28 percent on the remaining gain for an effective maximum tax of 14 percent on the gain. More than one of the above is true. 64. D purchased an option to acquire 3 acres of real estate for investment for $15,000 on or before March 15, 20X4. The option cost $2,000. Which of the following is NOT true? a. b. c. d. If D allows the option to lapse, she has a long-term capital loss of $2,000 in the year 20X4. If D exercises the option on March 15, 20X1, the real estate has a basis of $17,000. If D sells the option for $1,500, she may not deduct the loss. The option is a capital asset to D since the land would be a capital asset if it were held. 16 Property Transactions: Capital Gains and Losses Solutions to Test Bank True or False 1. 2. True. Personal use assets are examples of capital assets. (See pp. 16-4 through 16-5.) False. Assets held strictly as investments, such as much unused undeveloped real estate, are capital assets. Land used in a trade or business is 1231 property rather than a capital asset. (See pp. 16-4 through 16-5.) False. A taxpayer who merely improves or subdivides real estate before selling it or who makes frequent or continuous sales can easily end up reporting ordinary income or loss rather than capital gain or loss. (See p. 16-5.) False. The gain or loss on the disposition of a business is determined with respect to each asset of the business. The character of the gain or loss depends on the character of each individual asset. Typically, the seller has both ordinary and capital gains and losses. (See p. 16-6.) True. If there is a net loss for a year, then that amount is deductible as an ordinary loss, but only to the extent it exceeds 10 percent of A.G.I. and is an itemized deduction. A net gain results in each gain or loss being treated as a capital gain or loss. [See Example 5, pp. 16-9 and 16-10, and 165(c) and (h).] True. A holding period of exactly one year is short-term. (See Examples 7 through 8, p. 16-10 and 1222.) False. The date of sale is included in the holding period, but the date of acquisition is not. (See Examples 7 through 8, p. 16-10, and 1222.) False. Section 1223(1) provides a carryover holding period if there is a substituted basis (i.e., the basis of property is found with reference to the basis of other property given up by the taxpayer). (See p. 16-11.) False. This is true of inherited property. For gifted property that is sold at a gain, the holding period of the donee includes the holding period of the donor. Thus, the total holding period may be less than one year. [See Examples 11 through 12, p. 16-12 and 1223(2).] False. The actual trade dates on the exchange are the buy and sale dates. (See Example 9 and p. 16-11.) False. The first step is to separately combine all short-term gains and losses and all long-term gains and losses. (See p. 16-13.) 16-13 3. 4. 5. 6. 7. 8. 9. 10. 11. 16-14 Chapter 16 Property Transactions: Capital Gains and Losses 12. 13. True. Netting first occurs within groups, then between groups. (See p. 16-14). False. The net capital gain is taxed at the 0 (20112012) percent rate if the 10 or 15 percent rate is otherwise applicable. The preferential treatment of capital gains provides this reduced rate. (See p. 16-15.) True. Ordinary income treatment results if there is either a NSTCG with no further netting allowed, or there is an excess of a NSTCG over a net long-term capital loss (NSTCG NLTCL), not a net short-term capital loss (NSTCL). [See p. 16-14 and 1222(9).] True. Excess capital losses of individuals are carried forward indefinitely, but no provision is made for a carryback. (See Examples 15 through 17, pp. 16-16 and 16-17, and 1212.) True. The capital loss deduction is limited to $3,000 or taxable income, whichever is less. (See p. 16-16.) False. Although this is true for corporate taxpayers, a long-term capital loss carryover by an individual taxpayer retains its character as long-term. As a result, it is first combined with long-term gains and losses in the carryover year. (See pp. 16-16 and 16-20.) True. The employer would not qualify for the special treatment accorded patents since the employer is specifically precluded from being a "holder." (See p. 16-26 and 1235.) False. Payments received in cancellation of a lease or in cancellation of a distributorship agreement are considered as having been received in a sale or exchange. Any gain or loss will be treated as a capital gain or loss if the underlying assets are capital assets. (See p. 16-26 and 1241.) True. Section 1244 allows the taxpayer to treat a loss on 1244 stock as an ordinary loss deduction (up to a maximum of $50,000 for single taxpayers, or $100,000 for married taxpayers filing jointly). Gains, however, are subject to capital gain treatment. (See Examples 27, pp. 16-26 and 16-27, and 1244.) False. Sale-or-exchange treatment is mandated under 165(g) as of the last day of the taxable year of worthlessness. [See Example 3, p. 16-8, and 1654(g).] False. The statement is true, except that the gross assets at incorporation may be as much as $50 million. (See p. 16-28.) False. Certain businesses such as the professions, farming, financial, and hotels, motels and restaurants are excluded. However, food processing is not on the list. (See p. 16-29.) True. These are some of the requirements. (See p. 16-30.) False. The original issue retains its character as 1244 stock, even though the portion of the subsequent issue in excess of $1,000,000 does not qualify. (See Example 28 and 16-27.) False. Section 1244 only applies to the original owner of the stock. (See p. 16-27.) False. The exception provided by 1236 allows designation by the dealer of those securities to be held as investments at the time of purchase. (See p. 16-31.) False. The character of the gain or loss on an option is determined with reference to the way in which the optioned property would be held. [See p. 16-36 and 1234(a).] False. Amortization may not be required if the discount is considered de minimis. Further, amortization is based on the effective interest method, using the yield to maturity. (See p. 16-39.) True. Market discount occurs because of market swings after issue. (See p. 16-41.) False. Not necessarily unless the redemption price is guaranteed. (See p. 16-42.) 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. Solutions to Test Bank 16-15 Multiple Choice 32. b. One of the exclusions from the definition of capital assets is depreciable business property. Such property generally is 1231 property if held for more than one year. (See p. 16-4 and 1221.) The amount of gain or loss from the sale of real estate is unimportant in determining whether or not it is property held primarily for sale. (See p. 16-5.) Abandonment of property does not generally constitute a sale or exchange. Therefore, any loss from such a disposition will be an ordinary loss, if deductible. [See p. 16-9, 165(g) and (h).] The computation of gain and loss for each casualty is as follows: Residence: $10,000 (the lesser of adjusted basis or decline in value $8,000 (insurance recovery) $100 (floor) $1,900 loss. $1,000 (lesser of adjusted basis or decline in value $700 (insurance recovery) $100 (floor) $200 loss. $5,000 (insurance recovery) $2,000 (adjusted basis) $3,000 gain. 33. 34. 35. b. c. a. Car: Silverware: (See Example 5 and pp. 16-9 and 16-10.) 36. d. Whether the casualty gain and losses are short-term or long-term is determined from the taxpayer's holding period for the property. Such a determination cannot be made from the information given in the problem. Because the personal casualty gain exceeded the losses (by $900: $1,900 $200 $2,100 loss; $3,000 gain $2,100 loss $900 gain), the taxpayer must report each separate gain or loss as a gain or loss from the sale or exchange of a capital asset. Had the personal casualty losses exceeded the gain, then the net loss would have been treated as an itemized deduction, deductible only to the extent it exceeded 10 percent of A.G.I. [See Example 5, pp. 16-9 and 16-10, and 165(h).] Long-term capital gains and losses are only incurred on the sale of property held longer than one year. Only the stock meets that requirement. The bond was held exactly 12 months and is therefore short-term. (See pp. 16-13 and 16-14.) Choice d. is not always true. In certain instances the basis to the donee is not found with reference to the basis of the donor. For Example, if the property is sold at a loss and the basis in the property for determining loss is FMV on the date of the gift, then the holding period begins on the date of the gift. (See Examples 9 through 13 and pp. 16-10 through 16-12.) If a taxpayer has both a NSTCG and a NLTCG, or a NSTCL and a NLTCL, no further netting is appropriate, since amounts of like signs ( or ) are not "netted." (See Examples 15 through 17, pp. 16-14 through 16-16 and 1222.) The NSTCG of $4,000 and the NLTCL of $3,000 are combined, resulting in an overall short-term gain of $1,000. [See Examples 15 through 17, pp. 16-14 through 16-16 and 1222(9).] NLTCG > NSTCL results in a net capital gain (NCG). [See p. 16-14 and 1222(10).] K has long-term capital gains in excess of short-term capital losses in the amount of $3,000. Therefore, her A.G.I. includes net capital gains of $3,000 in addition to ordinary income. (See Example 17 and pp. 16-14 through 16-16.) Both capital gain net income and net capital gains are fully included as gross income, effective since 1988. (See Example 15 and pp. 16-14 through 16-15.) 37. c. 38. d. 39. c. 40. c. 41. 42. a. c. 43. c. 16-16 Chapter 16 Property Transactions: Capital Gains and Losses 44. a. G's taxable income is $65,000, $55,000 of which is treated as ordinary income. The tax is determined as follows: Tax using normal rates on the larger of (1) the maximum amount taxed at 15 percent or less ($34,500) or (2) the taxpayer's ordinary income ($55,000). Tax on $34,500 Add: ($55,000 $34,500) 25% Tax on $55,000 Add: Capital gains tax ($10,000 15%) Total tax $ 4,750 5,125 $ 9,875 1,500 $11,375 (See Exhibit 16.1, Example 23 and pp. 16-20 through 16-22.) 45. b. H's taxable income is $70,000, $40,000 of which is treated as ordinary income. The tax is determined as follows: Tax using normal rates on the larger of (1) the maximum amount taxed at 15 percent or less ($34,500) or (2) the taxpayer's ordinary income ($40,000). Tax on $34,500 Add: ($40,000 $34,500) 25% Add: Capital gains tax ($30,000 15%) Total tax (See Exhibit 16.1, Example 23 and pp. 16-20 through 16-22.) 46. c. J's taxable income is $65,000, $60,000 of which is treated as ordinary income. The tax is determined as follows: Tax using normal rates on the larger of (1) the maximum amount taxed at 15 percent or less ($34,000) or (2) the taxpayer's ordinary income ($60,000). Tax on $34,500 Add: ($60,000 $34,500) 25% Tax on $60,000 Add: Capital gains tax ($5,000 15%) Total tax (See Exhibit 16.1, Example 23 and pp. 16-20 through 16-22.) 47. c. A preferential rate always applies to a net 15 percent gain. (See pp. 16-14 through 16-15 and 16-20 through 16-24.) Section 165(g) provides that worthless securities are treated as having been sold on the last day of the taxable year in which they became worthless. (See p. 16-8.) security is defined as stock or bonds that are capital assets in the hands of the holder. If the bond becomes worthless, a capital loss will result. Similarly, a nonbusiness bad debt is treated as a short-term capital loss. Because this is the only property transaction during the year, the maximum deduction for a capital loss is $3,000. However, if a share of 1244 stock becomes worthless, the loss is treated as an ordinary loss and is deductible up to $50,000 ($100,000 on a joint return). (See pp. 16-26 and 16-27.) $ 4,750 6,375 $11,125 750 $11,875 $ 4,750 1,375 4,500 $10,625 48. c. Solutions to Test Bank 16-17 49. b. Q's taxable income is determined as follows: Taxable income Loss on 1244 stock: Amount realized Adjusted basis Total loss Limitation Long-term capital loss: Remaining loss on 1244 stock: Total loss Less: Limit (above) Capital loss Offset against long-term capital gain Limited to maximum capital loss deduction Taxable income $ 70,000 $ 20,000 (150,000) $(130,000) (50,000) $ 130,000 (50,000) $ 80,000 (10,000) $ 70,000 (3,000) $ 17,000 This assumes there is no effect due to the various limitations on medical, casualty and thefts. (See Example 27 and pp. 16-26 and 16-27.) 50. c. A loss on 1244 stock can be deducted as an ordinary loss, rather than a capital loss, by the original owner only, to a limit of $50,000 a year or $100,000 on a joint return. Answer (a) is incorrect because any loss over the $50,000 or $100,000 threshold is treated as a capital loss. Answer (b) is incorrect because 1244 treatment is available only to the original owner of the stock, and, therefore, the stock loses its 1244 character when sold. (See pp. 16-26 and 16-27.) The stock qualifies as 1244 stock because E was the initial owner and the corporation's capitalization at the time of the exchange did not exceed $1 million. (See pp. 16-26 and 16-27.) F has $3,500 of allowable losses but is restricted to a $3,000 annual deduction for capital losses in the current year. F will have a carryover of $500 in net long-term capital losses. (See Exhibit 4-1, Examples 15 through 17, pp. 16-14 through 16-16, and 1011.) The excess of net short-term capital loss over net long-term capital gain equals $1,000 ($2,000 $1,000). Subjected to the $3,000 limit, C will deduct the current excess $1,000 short-term capital loss and then $2,000 of the $4,000 carryover long-term capital loss. C will carry the remaining $2,000 loss forward. (See Examples 18 through 20, pp. 16-16 through 16-18, and 1211.) It is not necessary that the price be fixed. The amount may be contingent on the productivity or use of the patent. (See Example 26, p. 16-26, and 1235.) Section 1244 converts up to $100,000 of what would have been a capital loss on the disposition of 1244 stock to an ordinary deduction for a married couple. Any loss in excess of the $100,000 is subject to the rules governing capital losses. (See Example 27, p. 16-27, and 1244.) This loss is covered by 1244 of the Code. The annual limit on the deduction for married persons filing jointly is $100,000, and therefore, the loss is all ordinary, rather than capital, in nature. [See Example 27 and, pp. 16-26 and 16-27, and 1244(b).] The first three statements are true. The fourth statement is false; gains and losses on securities held as inventory are always treated as ordinary, not as capital gains and losses. [See p. 16-31 and 1236(b).] To qualify for 1237 treatment, subdivided property must have been held primarily for sale to customers, no substantial improvements can have been made, and the property must have been held at least five years unless inherited, and the taxpayer must not have held any other real property primarily for sale during the same tax year. [See p. 16-32 and 1237(a).] 51. c. 52. c. 53. d. 54. c. 55. c. 56. b. 57. d. 58. d. 16-18 Chapter 16 Property Transactions: Capital Gains and Losses 59. c. Transfers of trademarks, trade names, and franchise agreements are not treated as capital gains or losses if the transferor retains a "significant power, right, or interest" in the property. (See Example 35 and pp. 16-33 and 16-34.) Nonbusiness bad debts are only deductible in the year the debt is declared worthless. (See p. 16-33.) Both the sale of an option to buy or sell a capital asset and the failure to exercise such an option result in capital gain or loss. [See Example 41, and p. 16-36, and 166(d), 1234(a), and 1253.] The de minimis amount is calculated as follows: redemption price of bond at maturity multiplied by 0.25 percent multiplied by number of years to complete maturity. In this case, the de minimis amount would be $10,000 multiplied by 0.25 percent multiplied by 10 $250. [See Example 46, p. 16-39 and 1273(a)(3).] The bond's original issue discount was $500 ($10,000 $9,500). Because the discount is less than the de minimis amount of $750 ($10,000 0.25% 30 years), the OID provisions do not require amortization of the bond. (See Example 46, pp. 16-38 through 16-39, and 1271-1275.) The obligation need not be in security form. [See p. 16-40 and 1272(a)(2), 1274(c)(2) and 1281(b).] Although statement b. may be true, only c is true in all instances. (See pp. 16-28 through 16-29.) The loss of $500 is deductible as a capital loss, the same as if the land were sold. (See p. 16-36.) 60. c. 61. a. 62. 63. 64. b. c. c. 16 Property Transactions: Capital Gains and Losses Comprehensive Problems 1. Elsie Elston is 67 years of age, retired, single, with no dependents, and had the following income and expenses for her calendar year 2011: Fully taxable pension Federal income tax withheld Social Security benefits Dividend income (qualifying) Excludable municipal bond interest Personal exemptions In addition, Elsie sold the following assets during the year: Adjusted Basis $12,960 $2,800 15,000 5,540 1,600 1 Asset Description Holding Period Sales Price 300 sh. Major Co. Vacant land Personal jewelry three months eight years four years $ 4,000 32,000 3,400 $ 5,200 12,500 5,200 a. b. Calculate adjusted gross income and taxable income for Elsie. Explain how Elsie's tax will be calculated. Present your answers in good form. 2. Gail Haile is a single, calendar year, individual taxpayer, age-54. She has the following income and expenses for 2011: Salaries and wages $111,350 Dividend income 5,000 Long-term capital gain (corporate stock held four years) 15,000 Short-term capital gain (gold bullion) 5,000 Itemized deductions (all subject to phase-out) 16,000 Personal exemptions 1 16-19 16-20 Chapter 16 Property Transactions: Capital Gains and Losses 11- he 2011 tax schedules for single taxpayers are as follows: T Taxable Income Over But not Over Tax Liability Of the Amount Over $ 0 8,500 34,500 83,600 $ 8,500 34,500 83,600 -- 10% $850.00 15% 4,750.00 25% 17,025.00 28% $ 0 8,500 34,500 83,600 11- alculate Gail's adjusted gross income, taxable income and federal gross income tax for 2011. C Solutions to Comprehensive Problems 16-21 Solutions to Comprehensive Problems 1. a. First, calculate Elsie Elston's adjusted gross income excluding Social Security; then, her A.G.I.; and finally, her taxable income. Fully taxable pension Dividend income Short-term capital loss $ (1,200) Long-term capital gain* 19,500 Subtotal Taxable Social Security** Adjusted gross income Standard deduction ($5,800 $1,450 for age) Personal exemptions Taxable income $12,960 5,540 18,300 $36,800 12,750 $49,550 (7,250) (3,700) $38,600 11- *The loss on the sale of the personal use asset is disallowed **$4,500 85% ($45,900 modified AGI $34,000), not to exceed 85 percent of the benefit, or $12,750 ($15,000 85%). b. Any part of Elsie's net capital gain and qualifying dividends that would be taxed at a rate exceeding 15 percent (i.e., 25 percent or higher) will be taxed at 15 percent. In this case, ordinary income is $14,760 ($38,600 $23,840). It is taxed at 10 and 15 percent. The capital gain and dividends of $23,840 ($5,540 $18,300) are taxed at two rates--$19,740 ($34,500 $14,760) at 0 percent and the remainder at 15 percent. 2. Gail Haile's taxable income is determined as follows: Salaries and wages Dividend income Long-term capital gain Short-term capital gain Adjusted gross income Itemized deductions Personal exemption Taxable income $111,350 5,000 15,000 5,000 $136,350 (16,000) (3,700) $116,650 In calculating Gail's taxable income, $96,650 is treated as ordinary income and $20,000 is long-term capital gain. Her tax is calculated as follows: Tax using normal rates on the larger of (1) the maximum amount taxed at 10 or 15 percent ($34,500) or (2) the taxpayer's ordinary income ($96,650) Tax on $83,600 Add: ($96,650 $83,600) 28% Tax on $96,650 Add: Capital gains tax ($20,000 15%) Total tax $ 17,025 3,654 $ 20,679 3,000 $ 23,679 ...
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This note was uploaded on 02/05/2012 for the course ACCT 112 taught by Professor Smith during the Spring '11 term at Adrian College.

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