Question 1

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

Accepted Answer

The answer of Mary traded furniture used in her business...

Question 2

Koch traded machine 1 for machine 2. 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

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

Question 3

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

Accepted Answer

(1) Automobile: $12,000 loss, treated as ordinary loss.
(2) Machinery: $5,000 loss (proceeds $10,000 - adjusted basis $20,000), treated as §1231 loss.
(3) Furniture: $6,000 loss, treated as ordinary loss.
(4) Computer equipment: $19,000 gain (proceeds $10,000 - adjusted basis $6,000 - unrecaptured losses $3,000), treated as §1231 gain.
Total gains and losses before the 1231 netting process:
Ordinary loss: $18,000
Ordinary gain: $19,000
§1231 loss: $10,000
§1231 gain: $19,000 - $3,000 = $16,000
Therefore, the best choice is (B) $7,000 ordinary gain, $10,000 §1231 loss.

Question 4

The general rule regarding the exchanged basis in a like-kind exchange is:

Accepted Answer

The general rule for determining the basis of property received in a like-kind exchange is that the basis of the new property is equal to the adjusted basis of the old property. This means that the basis of the new property is carried over from the old property, rather than being reset to fair market value or cost basis.

Question 5

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: $$\begin{array} { | l | r | r | r | } 
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r } 
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Computers } & 10,000 & 6,000 & ( 2,000 ) \
\hline \text { Building } & 90,000 & 20,000 & ( 2,000 ) \
\hline
\end{array}$$ Assuming Brandon's marginal ordinary income tax rate is 35 percent, what effect do the gains and losses have on Brandon's tax liability?

Accepted Answer

Since Brandon has never sold a §1231 asset, all of the assets are treated as ordinary assets. Therefore, the gain on Machinery is treated as ordinary income: $10,000 - ($30,000 - $7,000) = $7,000. The loss on Computers is also treated as ordinary: ($10,000 - $6,000) - $2,000 = $2,000. However, the loss on Building is a §1231 loss: ($90,000 - $20,000) - $2,000 = $68,000, which is treated as a §1231 loss since it is less than the gains. Therefore, the net gain on §1231 assets is $7,000 - $0 + $0 = $7,000. The net gain on ordinary assets is $7,000 - $2,000 = $5,000. Since the marginal tax rate is 35%, the tax liability on the ordinary gain is $5,000 x 0.35 = $1,750. The tax liability on the §1231 gain is $7,000 x 0.28 = $1,960. Therefore, the total tax liability is $1,750 + $1,960 = $3,710, which is closest to $2,100 in choice B.

Question 6

How long does a taxpayer have to identify replacement property in a like-kind exchange?

Accepted Answer

According to the IRS, the taxpayer must identify potential replacement property within 45 days after the transfer of the original property.

Question 7

Alpha sold machinery, which it used in its business, to Beta, a related entity, for $40,000. Beta used the machinery in its business. Alpha bought the equipment 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 sale of property between related parties is governed by §1239, which treats gains as ordinary income to the extent of the depreciation claimed by the selling party. Thus, Alpha's gain is $20,000 ordinary income under §1239 ($40,000 sale price - $30,000 depreciation claimed).

Question 8

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

Accepted Answer

The answer of Ashburn reported a $105,000 net §1231 gain...

Question 9

Brandon, an individual, began business four years ago and has sold §1231 assets with $5,000 of losses within the last 5 years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: $$\begin{array} { | l | r | r | r | } 
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r } 
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Land } & 40,000 & 0 & 20,000 \
\hline \text { Building } & 90,000 & 20,000 & ( 5,000 ) \
\hline
\end{array}$$ Assuming Brandon's marginal ordinary income tax rate is 35 percent, what effect do the gains and losses have on Brandon's tax liability?

Accepted Answer

To determine the effect of gains and losses on Brandon's tax liability, we must first identify the type of gain or loss. The gains and losses on assets sold should be classified as either §1231 gains/losses or ordinary gains/losses.

- Machinery:

The machinery is a §1231 asset because the asset was held for longer than one year and was used in Brandon's trade or business. The gain on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$30,000 - ($30,000 - $7,000) = $10,000 §1231 gain

- Land:

The land is also a §1231 asset because it was held for longer than one year and was used in Brandon's trade or business. The gain on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$20,000 - $40,000 = ($20,000) §1231 loss

The loss on the land is subject to special treatment under the tax code. If a taxpayer has a net §1231 loss for the year (i.e. more losses than gains), the net loss is treated as an ordinary loss. If there is a net §1231 gain for the year (i.e. more gains than losses), the net gain is treated as a capital gain. In this case, since there is only one §1231 gain and one §1231 loss, the net §1231 gain is $10,000 - $20,000 = ($10,000). Therefore, the net loss is treated as an ordinary loss.

- Building:

The building is also a §1231 asset because it was held for longer than one year and was used in Brandon's trade or business. The loss on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$0 - ($90,000 - $20,000) = ($70,000) §1231 loss

Therefore, in total, Brandon has a net §1231 loss of ($10,000) + ($70,000) = ($80,000).

Brandon has an additional $5,000 of §1231 losses carried forward from previous years. Therefore, Brandon's total net §1231 losses for tax purposes is ($85,000). This net loss is treated as an ordinary loss and can be used to offset ordinary income.

Brandon also has $0 of ordinary income in the current year ($25,000 - $25,000). Therefore, his taxable income is the same as his ordinary income, which is $0.

Finally, we need to calculate Brandon's tax liability on his ordinary income. Brandon's marginal ordinary income tax rate is 35 percent. Therefore, his tax liability on $0 of ordinary income is also $0.

Therefore, combining the net loss on §1231 assets with the lack of ordinary income, Brandon's tax liability for this year is $0. The only answer choice that matches this is (C), $13,000 §1231 gain, $12,000 ordinary income, and $6,150 tax liability.

Question 10

Which of the following is not true regarding §1239?

Accepted Answer

§1239 applies to gains on sales of both depreciable property and non-residential real property. Therefore, choice C is not true.

Question 11

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

Accepted Answer

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

Question 12

When does unrecaptured §1250 gains apply?

Accepted Answer

Unrecaptured §1250 gains apply only when non-corporate taxpayers sell depreciable real property at a gain. The amount of gain subject to this tax is equal to the lesser of the gain recognized or the amount of depreciation that was allowed or allowable on the property. The tax rate is capped at 25%. Therefore, option B is the correct choice.

Question 13

Each of the following is true except for:

Accepted Answer

The answer of Each of the following is true except...

Question 14

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

Accepted Answer

A deferred like-kind exchange does not have to be completed within the taxable year. However, the like-kind property to be received must be identified within 45 days and the exchange must be completed within 180 days. A third party intermediary is often used to facilitate the exchange.

Question 15

Arlington LLC traded machinery used in its business to a machinery dealer for some new machinery. Arlington originally purchased the machinery for $60,000 and it had an adjusted basis of $28,000 at the time of the exchange. The new machinery had a fair market value of $35,000. Arlington also received $2,000 of office equipment in the transaction. What is Arlington's gain or loss recognized on the exchange?

Accepted Answer

The answer of Arlington LLC traded machinery used in its...

Question 16

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 17

What is the primary purpose of a third-party intermediary in a deferred like-kind exchange?

Accepted Answer

The answer of What is the primary purpose of a...

Question 18

Which of the following is not an involuntary conversion?

Accepted Answer

A foreclosure is a voluntary conversion, as it is a result of the borrower's inability to repay the loan. The other options are all examples of involuntary conversions.

Question 19

Why does §1250 recapture generally no longer apply?

Accepted Answer

The Tax Reform Act of 1986 changed the depreciation of real property to the straight-line method. This change essentially eliminated the need for recapturing depreciation under §1250, as the straight-line method does not produce as much depreciation in the early years of property ownership as compared to the accelerated methods previously used.

Question 20

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

Accepted Answer

The §1231 look-back rule applies when there is a §1231 gain and a nonrecaptured §1231 loss in the prior five years. So, only choice C is correct. Choices A, B, and D are incorrect because they do not provide the correct conditions for the application of the §1231 look-back rule. Choice E is incorrect because there is a correct option.

Quiz 10: Property Dispositions