Question 1

Brandon, an individual, began business four years ago and has sold §1231 assets with $5,000 of losses within the last five years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets:  Assuming Brandon's marginal ordinary income tax rate is 32 percent, what effect do the gains and losses have on Brandon's tax liability? Use dividends and capital gains tax rates for reference.

Accepted Answer

To determine Brandon's tax liability, we need to calculate his net §1231 gain or loss for the year. Let's start by calculating his gains and losses for the year:

§1231 Gain: $80,000 - $60,000 - $10,000 = $10,000
§1231 Loss: $8,000

Since Brandon has a net §1231 gain for the year, we need to classify it as either ordinary income or capital gain. To do this, we need to look at Brandon's §1231 gains and losses for the past five years. Since Brandon has $5,000 in net §1231 losses in the past five years, we can use the current year's net §1231 gain as capital gain.

So, Brandon has a $10,000 long-term capital gain for the year. In addition to this, we also need to consider his other ordinary income. He sold the remaining assets for $25,000, which is treated as ordinary income.

Therefore, Brandon's total ordinary income is $25,000 + $12,000 = $37,000.

Now, we can calculate Brandon's tax liability using the following steps:

1. Calculate Brandon's long-term capital gains tax: $10,000 x 15% = $1,500
2. Calculate Brandon's ordinary income tax: $37,000 x 32% = $11,840
3. Add the two taxes together to get the total tax liability: $1,500 + $11,840 = $13,340

Therefore, the correct answer is C.

Question 2

Brad sold a rental house that he owned for $250,000. Brad bought the rental house five years ago for $225,000 and has claimed $50,000 of depreciation expense. What is the amount and character of Brad's gain or loss?

Accepted Answer

Brad's adjusted basis in the rental house is $175,000 ($225,000 cost - $50,000 accumulated depreciation).

Since Brad held the rental property for more than one year, any gain is long-term.

The sale price of $250,000 is greater than Brad’s adjusted basis of $175,000, resulting in a realized gain of $75,000.

Under §1231, any gain on the sale of rental property is classified as either §1231 gain or unrecaptured §1250 gain.

§1231 gain is capital gain if there is a net §1231 gain for the tax year. If there is a net §1231 loss, then §1231 gain is treated as ordinary income to the extent of any prior unrecaptured §1250 gain.

Unrecaptured §1250 gain is the portion of §1231 gain that is attributable to depreciation claimed on the rental property, and it is taxed as ordinary income.

Therefore, Brad's gain is a $25,000 §1231 gain and a $50,000 unrecaptured §1250 gain.

Question 3

Which one of the following is not true regarding a like-kind exchange?

Accepted Answer

Losses on boot given are not recognized in a like-kind exchange. A boot is any non-like-kind property or cash that is involved in the exchange.

Question 4

Koch traded Machine 1 for Machine 2 when the fair market value of both machines was $49,150. Koch originally purchased Machine 1 for $76,700, and Machine 1's adjusted basis was $40,850 at the time of the exchange. Machine 2's seller purchased it for $64,150 and Machine 2's adjusted basis was $55,850 at the time of the exchange. What is Koch's adjusted basis in machine 2 after the exchange?

Accepted Answer

The answer of Koch traded Machine 1 for Machine 2...

Question 5

Ashburn reported a $104,800 net §1231 gain in Year 6. Assuming Ashburn reported $51,000 of nonrecaptured §1231 losses during Years 1 to 5, what amount of Ashburn's net §1231 gain for Year 6, if any, is treated as ordinary income?

Accepted Answer

When a taxpayer has a net §1231 gain, the gain is first netted against any prior §1231 losses, known as nonrecaptured losses. In this case, Ashburn had $51,000 of nonrecaptured §1231 losses during Years 1 to 5. Therefore, that amount is used to offset Year 6's §1231 gain, leaving $53,800 ($104,800 - $51,000) as the amount of Ashburn's net §1231 gain for the year. However, since the nonrecaptured losses were used to offset the gain, no portion of the Year 6 §1231 gain will be treated as ordinary income. Therefore, the correct answer is C: $51,000.

Question 6

Which of the following is not true regarding §1239?

Accepted Answer

§1239 applies to gains from the sale of depreciable property between related taxpayers. It is not limited to nonresidential real property only, as it applies to all types of depreciable property. It also applies to losses, not just gains. Therefore, only choice C is not true.

Question 7

Winchester LLC sold the following business assets during the current year: (1) automobile, $30,000 cost basis, $12,000 depreciation, $20,000 proceeds; (2) machinery, $25,000 cost basis, $20,000 depreciation, $10,000 proceeds; (3) furniture, $15,000 cost basis, $10,000 depreciation, $4,000 proceeds; (4) computer equipment, $25,000 cost basis, $6,000 depreciation, $10,000 proceeds; (5) Winchester had unrecaptured §1231 losses of $3,000 in the prior five years. What are the amount and character of Winchester's gains and losses before the §1231 netting process? Assume all assets were held for more than one year.

Accepted Answer

For each asset, we need to calculate the gain or loss before the §1231 netting process:

(1) Automobile: $20,000 - ($30,000 - $12,000) = $2,000 gain
(2) Machinery: $10,000 - ($25,000 - $20,000) = $5,000 loss
(3) Furniture: $4,000 - ($15,000 - $10,000) = $1,000 loss
(4) Computer equipment: $10,000 - ($25,000 - $6,000) = $9,000 loss

Therefore, the total gains and losses before the §1231 netting process are: 
$2,000 + ($5,000) + ($1,000) + ($9,000) = $7,000 ordinary gain and $10,000 §1231 loss.

Note that the unrecaptured §1231 losses of $3,000 are not relevant until the netting process.

Question 8

Maryexchanged an office building used in her business for some land. Mary originally purchased the building for $45,000, and it had an adjusted basis of $20,000 at the time of the exchange. The land had a fair market value of $40,000. Mary also gave $4,000 to the seller in the transaction. What is Mary's adjusted basis in the land after the exchange?

Accepted Answer

Mary's adjusted basis in the building is $20,000. The fair market value of the land is $40,000, and she gave an additional $4,000 in the exchange. This means the total value of what she exchanged for the land is $44,000 ($40,000 for the land + $4,000 given to the seller). Therefore, her adjusted basis in the land after the exchange is $24,000 ($20,000 adjusted basis in the building + $4,000 given to the seller).

Question 9

Alpha sold machinery that it used in its business to Beta, a related entity, for $40,000. Beta used the machinery in its business. Alpha bought the machinery a few years ago for $50,000 and has claimed $30,000 of depreciation expense. What is the amount and character of Alpha's gain?

Accepted Answer

The gain is $20,000 ($40,000 selling price - $20,000 adjusted basis, where adjusted basis = $50,000 original cost - $30,000 depreciation). Under §1239 of the Internal Revenue Code, when a taxpayer sells depreciable property to a related party, the gain is treated as ordinary income, not capital gain or §1231 gain.

Question 10

When do unrecaptured §1250 gains apply?

Accepted Answer

Unrecaptured §1250 gains apply only when noncorporate taxpayers sell depreciable real property at a gain. This is because §1250 pertains to depreciable real property used in a trade or business or held as an investment, and noncorporate taxpayers are the primary group to whom this provision applies. The other choices listed are not accurate statements about when unrecaptured §1250 gains apply.

Question 11

Which of the following is true regarding the §1231 look-back rule?

Accepted Answer

The §1231 look-back rule applies when a §1231 gain occurs and there is a nonrecaptured §1231 loss in the prior five years. This rule allows the taxpayer to treat any current year §1231 gain as long-term capital gain, even if it was held for one year or less, and to offset it against any allowable capital losses. If there is no nonrecaptured §1231 loss in the prior five years, the look-back rule does not apply.

Question 12

Koch traded Machine 1 for Machine 2when the fair market value of both machines was $50,000. Koch originally purchased Machine 1 for $75,000, and Machine 1's adjusted basis was $40,000 at the time of the exchange. Machine 2's seller purchased it for $65,000 and Machine 2's adjusted basis was $55,000 at the time of the exchange. What is Koch's adjusted basis in Machine 2 after the exchange?

Accepted Answer

When a taxpayer makes a like-kind exchange where the fair market value of the property received is equal to or greater than the fair market value of the property given up, then no gain or loss is recognized. In this case, the fair market value for both machines was $50,000, so no gain or loss was recognized.
Koch's adjusted basis in Machine 2 after the exchange is the adjusted basis of Machine 1, which was $40,000. Therefore, the answer is B, $50,000 (the fair market value of Machine 2).

Question 13

Brandon, an individual, began business four years ago and has sold §1231 assets with $5,950 of losses within the last five years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets:  Assuming Brandon's marginal ordinary income tax rate is 32 percent, what effect do the gains and losses have on Brandon's tax liability? Use dividends and capital gains tax rates for reference.

Accepted Answer

First, we need to calculate Brandon's net §1231 gains and losses in the last five years, since this will determine whether the current gains will be treated as ordinary income or capital gains (subject to lower tax rates). Brandon has $5,950 of net §1231 losses, which means that any current §1231 gains will be treated as ordinary income.

Next, we calculate Brandon's gains and losses for the current year:

Gain on building: $225,000 sale price - $180,000 adjusted basis = $45,000 long-term capital gain
Loss on equipment: $20,000 sale price - $25,000 adjusted basis = $5,000 loss
Gain on land: $120,000 sale price - $100,000 adjusted basis = $20,000 long-term capital gain

The net result is $60,000 in total gains and $5,000 in total losses, for a net gain of $55,000. Since this includes $20,000 in §1231 gains, which will be treated as ordinary income due to Brandon's prior losses, we have:

§1231 gain = $20,000 ordinary income
Long-term capital gain = $45,000

We can now calculate Brandon's tax liability. The ordinary income will be subject to his marginal ordinary income tax rate of 32 percent, while the long-term capital gain will be subject to the lower capital gains tax rate of 15 percent.

§1231 gain:
$20,000 x 0.32 = $6,400

Long-term capital gain:
$45,000 x 0.15 = $6,750

Total tax liability:
$6,400 + $6,750 = $13,150

However, we need to factor in the $5,000 of net losses from the current year, which can be used to offset other income. This means we only need to pay taxes on $50,000 in net gains, resulting in a final tax liability of:

($20,000 + $50,000) x 0.32 + $6,750 = $14,850 ordinary income, $1,600 §1231 gain, $4,992 tax liability.

Therefore, choice C is correct.

Question 14

Brandon, an individual, began business four years ago and has never sold a §1231 asset. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets:  Assuming Brandon's marginal ordinary income tax rate is 32 percent, what effect do the gains and losses have on Brandon's tax liability?

Accepted Answer

The answer of Brandon, an individual, began business four years...

Question 15

Which one of the following is not considered boot in a like-kind exchange?

Accepted Answer

The answer of Which one of the following is not...

Question 16

Alpha sold machinery that it used in its business to Beta, a related entity, for $40,050. Beta used the machinery in its business. Alpha bought the machinery a few years ago for $49,950 and has claimed $30,050 of depreciation expense. What is the amount and character of Alpha's gain?

Accepted Answer

The gain is $20,150, calculated as the selling price ($40,050) minus the adjusted basis ($49,950 purchase price - $30,050 depreciation = $19,900 adjusted basis). Since the sale is between related parties and involves depreciable property, under §1239 of the Internal Revenue Code, the gain is treated as ordinary income.

Question 17

Brad sold a rental house that he owned for $247,000. Brad bought the rental house five years ago for $228,000 and has claimed $48,500 of depreciation expense. What is the amount and character of Brad's gain or loss?

Accepted Answer

Brad's gain is calculated by subtracting the adjusted basis (original cost minus depreciation) from the selling price. The adjusted basis is $228,000 - $48,500 = $179,500. The selling price is $247,000, so the gain is $247,000 - $179,500 = $67,500. This gain is composed of two parts: a $19,000 §1231 gain (the difference between the original cost and the selling price without considering depreciation) and a $48,500 unrecaptured §1250 gain (the amount of depreciation claimed).

Question 18

Which one of the following is not a requirement of a deferred like-kind exchange?

Accepted Answer

The requirement that the exchange must be completed within the taxable year is not true for a deferred like-kind exchange. The exchange must be completed within 180 days after the transfer of the exchanged property, but it may span across multiple taxable years. The other requirements listed are accurate for a deferred like-kind exchange.

Question 19

Ashburn reported a $105,000 net §1231 gain in Year 6. Assuming Ashburn reported $60,000 of nonrecaptured §1231 losses during Years 1 to 5, what amount of Ashburn's net §1231 gain for Year 6, if any, is treated as ordinary income?

Accepted Answer

The $60,000 of nonrecaptured §1231 losses from Years 1 to 5 offsets the $105,000 net §1231 gain for Year 6, treating $60,000 of the gain as ordinary income. The remaining $45,000 is treated as long-term capital gain.

Question 20

Why does §1250 recapture generally no longer apply?

Accepted Answer

Since the Tax Reform Act of 1986, real property is now depreciated using the straight-line method. As a result, there is no longer a difference in the depreciation allowed for personal versus real property. As a result, §1250 recapture generally no longer applies.

Quiz 3: Property Dispositions