University of Wisconsin Parkside School of Business and Technology

Dr. R. Zameeruddin

I DI!IDU"# T"$"TI% & "''T ()* PR"'TI'+ ,I "# +$"-

ame .......................

-U#TIP#+ '/%I'+
1. Jeanne had an accident while hiking on vacation. She sustained nose injuries that required cosmetic surgery. While having the surgery done to restore her appearance, she had additional surgery done to reshape her chin, which was not injured in the accident. The surgery to restore her appearance cost $1 ,!!! and the surgery to reshape her chin cost $",!!!. #ow much o$ Jeanne%s surgical $ees will quali$y as a deducti&le medical e'pense (&e$ore application o$ the ). * limitation+, a. $!. &. $",!!!. c. $1 ,!!!. d. $1-,!!!. e. .one o$ the a&ove.

/.S0 1 1osmetic surgery is necessary (and there$ore deducti&le+ when it ameliorates (1+ a de$ormity arising $rom a congenital a&normality, (2+ a personal injury, or (3+ a dis$iguring disease. The $1 ,!!! cost incurred in connection with the restorative surgery (required as a result o$ the accident+ is deducti&le &ecause the surgery was necessary. /mounts paid $or the unnecessary cosmetic surgery ($",!!! $or reshaping the chin+ are not deducti&le as a medical e'pense. 4TS0 1 5670 6'ample 2 8 6'ample 3

2.

7red and 9ucy are married and together have /:; o$ $12!,!!! in 2!!). They have $our dependents and $ile a joint return. They pay $ ,!!! $or a high deducti&le health insurance policy and contri&ute $2,<!! to a quali$ied #ealth Savings /ccount. =uring the year, they paid the $ollowing amounts $or medical care0 $-,2!! in doctor and dentist &ills and hospital e'penses, and $3,!!! $or prescri&ed medicine and drugs. ;n >cto&er 2!!), they received an insurance reim&ursement o$ $","!! $or hospitali?ation. They e'pect to receive an additional reim&ursement o$ $1,!!! in January 2!!@. =etermine the ma'imum deduction allowa&le $or medical e'penses in 2!!). a. $1,1!!. &. $3,@!!. c. $-,2!!. d. $12,@!!. e. .one o$ the a&ove.

/.S0 A 7red and 9ucy can claim a medical e'pense deduction $or the current year o$ $3,@!!, determined as $ollows0 4hysician &ills, dentist &ills, and hospital e'penses 9ess0 5eim&ursement Bnreim&ursed e'penses #ealth insurance premiums 4rescri&ed medicines and drugs Total medical e'penses 9ess0 ). * o$ $12!,!!! (/:;+ =educti&le medical e'penses $ -,2!! (","!!+ $ ",@!! ,!!! 3,!!! $12,@!! (-,!!!+ $ 3,@!!

The contri&ution o$ $2,<!! to the #S/ is a deduction for /:;, and is not included in the medical e'pense calculation. 4TS0 1 5670 p. 1!C2 8 p. 1!C3 8 p. 1!C) to 1!C1! 8 6'ample 12 8 6'ample 1

3.

9i?, who is single, travels $requently on &usiness. /rt, 9i?%s @"CyearCold dependent grand$ather, lived with 9i? until this year when he moved to :ranite 7alls .ursing #ome &ecause he needs daily medical and nursing care. =uring the year, 9i? made the $ollowing payments to :ranite 7alls on &ehal$ o$ /rt0 5oom at :ranite 7alls Deals $or /rt =octor and nurse $ees 1a&le TE service $or /rt%s room Total $3<,3!! ),2<! ,<1! <<! $"-,@3!

:ranite 7alls has medical sta$$ in residence. =isregarding the ). * $loor, how much, i$ any, o$ these e'penses quali$ies $or a medical e'pense deduction &y 9i?, a. $ ,<1!. &. $"1,-1!. c. $"-,1)!. d. $"-,@3!. e. .one o$ the a&ove. /.S0 1 The amount that quali$ies $or the medical e'pense deduction is $"-,1)! ($3<,3!! F $),2<! F $ ,<1!+. The room and &oard $or :ranite 7alls quali$ies &ecause the move was motivated &y /rt%s need $or medical care. The ca&le TE $ee is a personal e'pense. 4TS0 1 5670 p. 1!C3 8 6'ample "

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4hillip developed hip pro&lems and was una&le to clim& the stairs to reach his secondC$loor &edroom. #is physician advised him to add a $irstC$loor &edroom to his home. The cost o$ constructing the room was $32,!!!. The increase in the value o$ the residence as a result o$ the room addition was determined to &e $1),!!!. ;n addition, 4hillip paid the contractor $ , !! to construct an entrance ramp to his home and $@, !! to widen the hallways to accommodate his wheelchair. 4hillip%s /:; $or the year was $1!!,!!!. #ow much o$ these e'penditures can 4hillip deduct as a medical e'pense, a. $1",!!!. &. $1 ,!!!. c. $21, !!. d. $2-,!!!. e. .one o$ the a&ove.

/.S0 1 / capital improvement that ordinarily would not have a medical purpose quali$ies as a medical e'pense i$ it is directly related to prescri&ed medical care and is deducti&le to the e'tent that the e'penditure e'ceeds the increase in value o$ the related property. 6'amples o$ such improvements include dust elimination systems, elevators, and a room &uilt to house an iron lung. 4hillip%s medical e'pense related to the room addition is $1 ,!!! ($32,!!! G $1),!!!+. The $ull cost o$ homeCrelated capital e'penditures incurred to ena&le a physically handicapped individual to live independently and productively quali$ies as a medical e'pense. Huali$ying costs include e'penditures $or constructing entrance and e'it ramps to the residence, widening hallways and doorways to accommodate wheelchairs, installing support &ars and railings in &athrooms and other rooms, and adjusting electrical outlets and $i'tures. These e'penditures are su&ject to the ). * $loor only, and the increase in the home%s value is deemed to &e ?ero. 4hillip%s medical e'pense related to the ramp and hallways is $1",!!! ($ , !! F $@, !!+. So 4hillip%s medical e'pense deduction is as $ollows0 Huali$ying medical e'penses ($1 ,!!! F $1",!!!+ 9ess0 ). * $1!!,!!! =educti&le medical e'penses 4TS0 1 5670 p. 1!C" 8 p. 1!C 8 6'ample < $2-,!!! (), !!+ $21, !!

Huinn, who is single and lives alone, is physically handicapped as a result o$ a diving accident. ;n order to live independently, he modi$ies his personal residence at a cost o$ $3!,!!!. The modi$ications included widening halls and doorways $or a wheelchair, installing support &ars in the &athroom and kitchen, installing a stairway li$t, and rewiring so he could reach electrical outlets and appliances. Huinn pays $2!! $or an appraisal that places the value o$ the residence at $12-,!!! &e$ore the improvements and $1"!,!!! a$ter. /s a result o$ the operation o$ the stairway li$t, Huinn e'perienced an increase o$ $<@! in his utility &ills $or the current year. =isregarding percentage limitations, how much o$ the a&ove e'penditures quali$y as medical e'pense deductions, a. $11,<@!. &. $3!,<@!. c. $3!,@@!. d. $3",@@!. e. .one o$ the a&ove.

/.S0 A Huinn, who is physically handicapped, modi$ied his residence so he could live independently. There$ore, the $3!,!!! cost o$ the improvements is not reduced &y the $11,!!! ($1"!,!!! G $12-,!!!+ increase in the value o$ the house. The additional operating e'penses o$ $<@! are deducti&le as a medical e'pense. The $2!! appraisal $ee is not deducti&le as a medical e'pense, &ut rather as a miscellaneous itemi?ed deduction su&ject to the 2* o$ /:; $loor. So $3!,<@! ($3!,!!! F $<@!+ quali$ies as medical e'penses. 4TS0 1 5670 p. 1!C" 8 p. 1!C <. Darilyn, 6d%s daughter who would otherwise quali$y as his dependent, $iled a joint return with her hus&and #enry. 6d, who had /:; o$ $1 !,!!!, incurred the $ollowing e'penses0 9aser surgery to correct Darilyn%s vision pro&lem Darilyn%s prescri&ed medicines 6d%s doctor and dentist &ills 4rescri&ed drugs $or 6d 1ontact lenses $or 6d 1ost o$ program $or 6d to stop smoking Weight reduction program $or 6d (related to o&esity+ Total 6d has a medical e'pense deduction o$0 a. $!. &. $ !. c. $1,2 !. d. $12, !!. e. .one o$ the a&ove. /.S0 1 6d may claim the medical e'penses he paid on &ehal$ o$ Darilyn, even though Darilyn cannot &e claimed as his dependent. This e'ception applies i$ the gross income andIor joint return tests are the only reasons why a person cannot &e otherwise claimed as a dependent. /ll o$ the listed e'penditures quali$y. 6d%s medical e'pense deduction is $1,2 ! J$12, !! G ($1 !,!!! ). *+K. 4TS0 1 5670 p. 1!C" 8 p. 1!C 8 6'hi&it 1!C1 $ 2,-!! !! <,2!! 1,3 ! 3 ! ! < ! $12, !!

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Lour $riend Scotty in$orms you that he received a Mta'C$reeN reim&ursement in 2!!) o$ some medical e'penses he paid in 2!!<. Which o$ the $ollowing statements &est e'plains why Scotty is not required to report the reim&ursement in gross income, a. Scotty itemi?ed deductions in 2!!<. &. Scotty did not itemi?e deductions in 2!!<. c. Scotty itemi?ed deductions in 2!!). d. Scotty did not itemi?e deductions in 2!!). e. Scotty itemi?ed deductions in 2!!) &ut not in 2!!<.

/.S0 A ;$ Scotty did not itemi?e in 2!!<, he can e'clude the reim&ursement $rom gross income in 2!!). ;$ Scotty itemi?ed deductions in 2!!<, he must report the reim&ursement as gross income in 2!!) to the e'tent he received a ta' &ene$it $rom deducting medical e'penses in 2!!<. Whether he itemi?ed in 2!!) will have no impact on the treatment o$ the reim&ursement. 4TS0 1 5670 6'ample 12 @. ;n 2!!), Aoris pays a $",@!! premium $or highCdeducti&le medical insurance $or himsel$ and his $amily. ;n addition, he contri&utes $3,!!! to a #ealth Savings /ccount. Which o$ the $ollowing statements is true, a. ;$ Aoris is sel$Cemployed, he may deduct $),@!! as a deduction for /:;. &. ;$ Aoris is sel$Cemployed, he may deduct $3,!!! as a deduction for /:; and may include the $",@!! premium when calculating his medical e'pense deduction. c. ;$ Aoris is an employee, he may deduct $),@!! as a deduction for /:;. d. ;$ Aoris is an employee, he may include $),@!! when calculating his medical e'pense deduction. e. .one o$ the a&ove.

/.S0 / Aoris, who is sel$Cemployed, may deduct 1!!* o$ the premium ($",@!!+ as a deduction for /:;. #e may also deduct the $3,!!! #S/ contri&ution as a deduction for /:;. 4TS0 1 5670 6'ample 1

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=uring the current year, #ugh, a sel$Cemployed individual, paid the $ollowing amounts0 5eal estate ta' on ;owa residence State income ta' 5eal estate ta'es on land in 4uerto 5ico (held as an investment+ :i$t ta' paid on gi$t to daughter State sales ta'es State occupational license $ee 4roperty ta' on value o$ his automo&ile (used 1!!* $or &usiness+ $3,@!! 1,)!! 1,1!! 1,2!! 1,) ! 3!! ")

What is the ma'imum amount #ugh can claim as ta'es in itemi?ing deductions from /:;, a. $<,<!!. &. $<,< !. c. $),@ !. d. $@,<2 . e. .one o$ the a&ove. /.S0 A State sales ta'es ($1,) !+ are more than the state income ta' ($1,)!!+O so #ugh should choose to deduct the sales ta' rather than the state income ta'. The state occupational license $ee ($3!!+ and the ta' on his &usiness use auto ($") + are deducti&le for /:; as &usiness e'penses. The state sales ta' ($1,) !+ and the real estate ta'es ($3,@!! F $1,1!!+ are deducti&le as itemi?ed deductions. The gi$t ta' is not deducti&le. The total itemi?ed deductions are $<,< ! ($3,@!! F $1,1!! F $1,) !+. 4TS0 1 5670 p. 1!C11 to 1!C13 8 6'hi&it 1!C2 1!. Arad, who uses the cash method o$ accounting, lives in a state that imposes an income ta' (including withholding $rom wages+. >n /pril 1", 2!!), he $iles his state return $or 2!!<, paying an additional $<!! in state income ta'es. =uring 2!!), his withholdings $or state income ta' purposes amount to $3, !. >n /pril 13, 2!!@, he $iles his state return $or 2!!) claiming a re$und o$ $@!!. Arad receives the re$und on /ugust 3, 2!!@. ;$ he itemi?es deductions, how much may Arad claim as a deduction $or state income ta'es on his 7ederal income ta' return $or calendar year 2!!) ($iled in /pril 2!!@+, a. $3,3 !. &. $3, !. c. $",1 !. d. $ ,1 !. e. .one o$ the a&ove. /.S0 1 Arad is a cash &asis ta'payer. #is deduction is limited to the amounts paid in 2!!). The $@!! re$und is reported as income in 2!!@ under the ta' &ene$it rule. Arad%s state income ta' deduction $or 2!!) is determined as $ollows0 4aid /pril 1", 2!!), $or 2!!< Withholdings $or 2!!) Total deduction 4TS0 1 5670 p. 1!C13 $ <!! 3, ! $",1 !

11. Aarry and 9arry, who are &rothers, are equal owners in 1hickadee 1orporation. >n July 1, 2!!), each loans the corporation $1!,!!! at annual interest o$ 1!*. Aoth shareholders are on the cash method o$ accounting, while 1hickadee 1orporation is on the accrual method. /ll parties use the calendar year $or ta' purposes. >n June 3!, 2!!@, 1hickadee repays the loans o$ $2!,!!! together with the speci$ied interest o$ $2,!!!. #ow much o$ the interest can 1hickadee 1orporation deduct in 2!!), a. $!. &. $ !!. c. $1,!!!. d. $2,!!!. e. .one o$ the a&ove. /.S0 / 1hickadee 1orporation can deduct interest e'pense o$ $2,!!! in 2!!@ and $! in 2!!). Bnder P 2<), Aarry and 9arry are regarded as related to the corporation. 1onsequently, the deducti&ility must await actual payment (in 2!!@+. 4TS0 1 5670 p. 1!C1@

12. Tony is married and $iles a joint ta' return $or 2!!). #e has investment interest e'pense o$ $- ,!!! $or a loan made to him in 2!!) to purchase a parcel o$ unimproved land. #is income $rom investments Jdividends (not quali$ied+ and interestK totaled $1@,!!!. /$ter reducing his miscellaneous deductions &y the applica&le 2* $loor, the deducti&le portion amounted to $2,@!!. ;n addition to $1,"!! o$ investment e'penses included in miscellaneous deductions, Tony paid $3,<!! o$ real estate ta'es on the unimproved land. Tony also has a $", !! net longCterm capital gain $rom the sale o$ another parcel o$ unimproved land. 1alculate Tony%s ma'imum investment interest deduction $or 2!!). a. $- ,!!!. &. $1@,!!!. c. $1), !!. d. $13,!!!. e. .one o$ the a&ove. /.S0 1 Tony%s net investment income in 2!!) is computed as $ollows0 ;ncome $rom investments0 ;nterest and dividends 9ongCterm capital gainQ 9ess0 ;nvestment e'pensesQQ .et investment income $1@,!!! ", !! ( ,!!!+ $1), !!

Q.et capital gain generally is not included in investment income. ;n order to ma'imi?e his investment interest deduction, Tony may elect to treat the $", !! net capital gain as investment income, and there&y increase the deduction $or investment interest &y that amount. The &ene$icial alternative ta' on net capital gain will not apply to the $", !! net capital gain, however. QQThe amount o$ investment e'penses is calculated as $ollows0 The smaller o$ (1+ $1,"!!, the amount o$ investment e'penses included in the total o$ miscellaneous itemi?ed deductions su&ject to the 2* o$ /:; $loor, or (2+ $2,@!!, the amount o$ miscellaneous e'penses deducti&le a$ter the 2* o$ /:; $loor is applied. ;nvestment e'penses 4lus0 5eal property ta'es on unimproved land Total investment e'penses $1,"!! 3,<!! $ ,!!!

Tony%s investment interest e'pense deduction $or 2!!) is limited to $1), !!, the amount o$ net investment income, and $)), !! would &e disallowed0 Total investment interest e'pense 9ess0 .et investment income ;nvestment interest disallowed in 2!!) $- ,!!! (1), !!+ $)), !!

The amount o$ investment interest disallowed may &e carried over and &ecomes investment interest e'pense in the su&sequent year su&ject to the net investment income limitation in that later year. 4TS0 1 5670 p. 1!C1" to 1!C1<

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13. Joseph and Sandra, married ta'payers, took out a mortgage on their home $or $3 !,!!! in 1-@-. ;n Day o$ 2!!), when the home had a $air market value o$ $" !,!!! and they owed $2 !,!!! on the mortgage, they took out a home equity loan $or $22!,!!!. They used the $unds to purchase a single engine airplane to &e used $or recreational travel purposes. What is the ma'imum amount o$ de&t on which they can deduct home equity interest, a. $ !,!!!. &. $1!!,!!!. c. $22!,!!!. d. $23!,!!!. e. .one o$ the a&ove. /.S0 A ;nterest is deducti&le only on the portion o$ the $22!,!!! home equity loan that does not e'ceed the lesser o$0 The $air market value o$ the residence, reduced &y the acquisition inde&tedness ($" !,!!! 7DE G $2 !,!!! acquisition inde&tedness R $2!!,!!!+. $1!!,!!! ($ !,!!! $or married persons $iling separate returns+.

>$ the $22!,!!! home equity loan, interest on $1!!,!!! is deducti&le as home equity interest. 4TS0 1 5670 p. 1!C1< 8 6'ample 2 1". 4edro%s child attends a school operated &y the church the $amily attends. 4edro made a donation o$ $1,!!! to the church in lieu o$ the normal registration $ee o$ $2!!. ;n addition, 4edro paid the regular tuition o$ $<,!!! to the school. Aased on this in$ormation, what is 4edro%s charita&le contri&ution, a. $!. &. $@!!. c. $1,!!!. d. $<,@!!. e. $),!!!. /.S0 A The ta'payer%s donation o$ $1,!!! in lieu o$ the normal $2!! registration $ee would &e deducti&le to the e'tent o$ $@!! J$1,!!! G $2!! &ene$it received (the registration $ee+K. The tuition o$ $<,!!! is a personal e'pense that cannot &e deducted as a charita&le contri&ution. 4TS0 1 5670 p. 1!C2!

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1 . 6mily, who lives in ;ndiana, volunteered to travel to 9ouisiana in Darch to work on a homeC &uilding project $or #a&itat $or #umanity (a quali$ied charita&le organi?ation+. She was in 9ouisiana $or three weeks. She normally makes $ !! per week as a carpenter%s assistant and plans to deduct $1, !! as a charita&le contri&ution. ;n addition, she incurred the $ollowing costs in connection with the trip0 $<!! $or transportation, $1,2!! $or lodging, and $"!! $or meals. What is 6mily%s deduction associated with this charita&le activity, a. $<!!. &. $1,2!!. c. $1,@!!. d. $2,2!!. e. $3,)!!. /.S0 = 6mily cannot deduct the estimated value o$ $1, !! o$ her contri&uted services. #owever, she can deduct outCo$Cpocket costs o$ $2,2!! ($<!! $or transportation, $1,2!! $or lodging, and $"!! $or meals+. 4TS0 1 5670 p. 1!C21 1<. ;n 2!!), 5oseann makes the $ollowing donations to quali$ied charita&le organi?ations0 ;nventory held $or resale in 5oseann%s &usiness (a sole proprietorship+ Stock in /A1, ;nc. held as an investment (acquired two years ago+ 1omic &ook collection held as an investment (acquired si' years ago+ Aasis $3,!!! <,!!! 1, !! 7air Darket Ealue $ 2,<!! 1 ,!!! ),!!!

The /A1 stock and the inventory were given to 5oseann%s church, and the comic &ook collection was given to the Bnited Way. Aoth donees promptly sold the property $or the stated $air market value. =isregarding percentage limitations, 5oseann%s charita&le contri&ution deduction $or 2!!) is0 a. $1!, !!. &. $1-,1!!. c. $2",<!!. d. $2 ,!!!. e. .one o$ the a&ove. /.S0 A ;nventory is ordinary income property, &ut the $air market value ($2,<!!+ must &e used i$ lower than the &asis ($3,!!!+. Stock is intangi&le property and is not su&ject to the tangi&le personalty rules. Since a sale o$ the /A1 stock would have yielded a longCterm capital gain, the $ull $air market value quali$ies $or the deduction ($1 ,!!!+. The comic &ook collection comes under the tangi&le personalty e'ception, and the adjusted &asis ($1, !!+ must &e used. Thus, $2,<!! F $1 ,!!! F $1, !! R $1-,1!!. 4TS0 1 5670 p. 1!C23 to 1!C2

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1). 5osie owned stock in /cme 1orporation that she donated to a university (a quali$ied charita&le organi?ation+ on Septem&er <, 2!!). What is the amount o$ 5osie%s charita&le contri&ution deduction assuming that she had purchased the stock $or $2!,1!! on >cto&er 22, 2!!<, and the stock had a value o$ $2@,2!! when she made the donation, a. $@,1!!. &. $2!,1!!. c. $2",1 !. d. $2@,2!!. e. .one o$ the a&ove. /.S0 A ;$ ordinary income property is contri&uted to a quali$ied charita&le organi?ation, the deduction is equal to the $air market value o$ the property less the amount o$ ordinary income that would have &een reported i$ the property were sold. ;n most instances, the deduction is limited to the adjusted &asis o$ the property to the donor. Since she had not held the property long enough to meet the longCterm capital gain requirement (>cto&er 22, 2!!< C Septem&er <, 2!!)+, 5osie would have recogni?ed a shortCterm capital gain o$ $@,1!! i$ she had sold the property. Since shortCterm capital gain property is treated as ordinary income property $or charita&le contri&ution purposes, 5osie%s charita&le contri&ution deduction is limited to the property%s adjusted &asis o$ $2!,1!!. 4TS0 1 5670 6'ample 32 1@. Saren, a calendar year ta'payer, made the $ollowing donations to quali$ied charita&le organi?ations in 2!!)0 1ash donation to ;ndiana State Bniversity Bnimproved land to the city o$ Terre #aute, ;ndiana Aasis $3!,!!! )!,!!! 7air Darket Ealue $ 3!,!!! 21!,!!!

The land had &een held as an investment and was acquired " years ago. Shortly a$ter receipt, the city o$ Terre #aute sold the land $or $21!,!!!. Saren%s /:; is $" !,!!!. The allowa&le charita&le contri&ution deduction is0 a. $@",!!! i$ the reduced deduction election is not made. &. $1!!,!!! i$ the reduced deduction election is not made. c. $1< ,!!! i$ the reduced deduction election is not made. d. $1)!,!!! i$ the reduced deduction election is made. e. .one o$ the a&ove. /.S0 1 $3!,!!! (cash+ F $13 ,!!! (3!* $" !,!!! /:;+ R $1< ,!!!. The longCterm capital gain property is limited to 3!* o$ $" !,!!! /:;, or $13 ,!!!. The carryover to the ne't $ive years is $) ,!!! J$21!,!!! (7DE o$ the land+ G $13 ,!!! (deduction allowed $or 2!!)+K. ;$ the reduced deduction election is made, the deduction &ecomes $1!!,!!! J$3!,!!! (cash+ F $)!,!!! (&asis o$ land+K. 4TS0 1 5670 p. 1!C2" to 1!C2< 8 6'ample 3 8 6'ample 3<

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1-. 4at died in 2!!). Ae$ore she died, 4at gave ,!!! shares o$ stock in 1oyote 1orporation (a pu&licly traded corporation+ to her church (a quali$ied charita&le organi?ation+. The stock was worth $1@!,!!! and she had acquired it as an investment $our years ago at a cost o$ $1 !,!!!. ;n the year o$ her death, 4at had /:; o$ $3!!,!!!. ;n completing her $inal income ta' return, how much o$ the charita&le contri&ution should 4at%s e'ecutor deduct, a. $-!,!!!. &. $1 !,!!!. c. $1@!,!!!. d. $21!,!!!. e. .one o$ the a&ove. /.S0 A Bnder the general rule concerning longCterm capital gain property, 4at%s e'ecutor could deduct $-!,!!! (3!* o$ $3!!,!!! /:;+. The remaining $-!,!!! J$1@!,!!! ($air market value o$ the 1oyote 1orporation stock+ G $-!,!!! (current deduction+K would &e lost &ecause there is no $iveCyear carryover period in 4at%s case. 4at%s e'ecutor can, however, make the reduced deduction election, which moves the longC term capital gain property $rom the 3!* limitation to the !* limitation with no $urther carryover. To do so, the e'ecutor must $orgo a deduction o$ the $3!,!!! appreciation J$1@!,!!! ($air market value+ G $1 !,!!! (cost+K o$ the stock. Thus, the charita&le contri&ution deduction on 4at%s $inal income ta' return &ecomes $1 !,!!! ( !* o$ $3!!,!!! /:;+. Ay making the reduced deduction election, the charita&le deduction on 4at%s $inal return is increased &y $<!,!!! J$1 !,!!! (allowed under the reduced deduction election+ G $-!,!!! (allowed under the general rule+K. 4TS0 1 5670 p. 1!C2< 8 6'ample "< 2!. 5oger is considering making a $3,!!! investment in a venture that its promoter promises will generate immediate ta' &ene$its $or him. 5oger, who does not anticipate itemi?ing his deductions, is in the 3!* marginal income ta' &racket. ;$ the investment is o$ a type that produces a ta' credit o$ "!* o$ the amount o$ the e'penditure, &y how much will 5oger%s ta' lia&ility decline &ecause o$ the investment, a. $!. &. $-!!. c. $1,1!!. d. $1,2!!. e. .one o$ the a&ove. /.S0 = The ta' credit reduces 5oger%s ta' lia&ility &y $1,2!! ($3,!!! "!*+. 4TS0 1 5670 p. 12C" 8 6'ample " 21. 5e$unda&le ta' credits include the0 a. 7oreign ta' credit. &. Ta' credit $or reha&ilitation e'penses. c. 1redit $or certain retirement plan contri&utions. d. 6arned income credit. e. .one o$ the a&ove. /.S0 = 5670 6'hi&it 12C1

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22. Which o$ the $ollowing &est descri&es the treatment applica&le to unused &usiness credits, a. Bnused amounts are carried $orward inde$initely. &. Bnused amounts are $irst carried &ack one year and then $orward $or 2! years. c. Bnused amounts are $irst carried &ack one year and then $orward $or 1 years. d. Bnused amounts are carried $orward $or $ive years. e. .one o$ the a&ove. /.S0 A 5670 p. 12C<

23. Dolly has generated general &usiness credits over the years that have not &een utili?ed. The amounts generated and not utili?ed $ollow0 2!!3 2!!" 2!! 2!!< $ ,!!! 1 ,!!! 1!,!!! @,!!!

;n the current year, 2!!), her &usiness generates an additional $3!,!!! general &usiness credit. ;n 2!!), &ased on her ta' lia&ility &e$ore credits, she can utili?e a general &usiness credit o$ up to $"!,!!!. /$ter utili?ing the carry$orwards and the current year credits, how much o$ the general &usiness credit generated in 2!!) is availa&le $or $uture years, a. $!. &. $2,!!!. c. $23,!!!. d. $2@,!!!. e. .one o$ the a&ove. /.S0 = Total credit allowed in 2!!) (&ased on ta' lia&ility+ Btili?ation o$ carryovers0 2!!3 2!!" 2!! 2!!< 5emaining credit allowed0 Btili?ation o$ current year credit 1arryover o$ unused current year general &usiness credit :eneral &usiness credit generated in 2!!) /pplied against 2!!) general &usiness credit Bnused 2!!) amount availa&le $or carry $orward to 2!!@ 4TS0 1 5670 p. 12C< 8 6'ample @ $"!,!!! $ ,!!! 1 ,!!! 1!,!!! @,!!!

(3@,!!!+ $ 2,!!! $3!,!!! (2,!!!+ $2@,!!!

2". Which o$ the $ollowing correctly descri&es the ta' credit $or reha&ilitation e'penditures, a. The cost o$ enlarging any e'isting &usiness &uilding is a quali$ying e'penditure. &. The cost o$ $acilities related to the &uilding (e.g., a parking lot+ is a quali$ying e'penditure. c. .o recapture provisions apply. d. .o credit is allowed $or the reha&ilitation o$ personal use property. e. .one o$ the a&ove. /.S0 = 5670 p. 12C) 8 p. 12C@

2 . Several years ago, Shirley purchased a structure $or $1 !,!!! that was originally placed in service in 1-2-. Three and oneChal$ years ago she incurred quali$ying reha&ilitation e'penditures o$ $2!!,!!!. ;n the current year, Shirley sold the property in a ta'a&le transaction. 1alculate the amount o$ the recapture o$ the ta' credit $or reha&ilitation e'penditures. a. $!. &. $@,!!!. c. $12,!!!. d. $1<,!!!. e. .one o$ the a&ove. /.S0 A $@,!!! R "!*($2!!,!!! 1!*+. The structure was held $or more than 3 years &ut less than " years. 4TS0 1 5670 Ta&le 12C1 8 6'ample 1! 2<. Alack 1ompany paid wages o$ $1@!,!!!, o$ which $"!,!!! was quali$ied wages $or the work opportunity ta' credit under the general rules. Alack 1ompany%s deduction $or wages $or the year is0 a. $1"!,!!!. &. $1<",!!!. c. $1<<,!!!. d. $1@!,!!!. e. .one o$ the a&ove. /.S0 A $1<",!!! R J$1@!,!!! G ($"!,!!! "!*+K. 4TS0 1 5670 p. 12C- 8 6'ample 11

1<

2). ;n Darch 2!!), :ray 1orporation hired two individuals, &oth o$ whom were certi$ied as longCterm recipients o$ $amily assistance &ene$its. 6ach employee was paid $11,!!! during 2!!). >nly one o$ the individuals continued to work $or :ray 1orporation in 2!!@, earning $-,!!! during the year. .o additional workers were hired in 2!!@. :ray 1orporation%s work opportunity ta' credit amounts $or 2!!) and 2!!@ are0 a. $",!!! in 2!!), $",!!! in 2!!@. &. $@,!!! in 2!!), $", !! in 2!!@. c. $@,!!! in 2!!), $ ,!!! in 2!!@. d. $@,!!! in 2!!), $-,!!! in 2!!@. e. .one o$ the a&ove. /.S0 A The ma'imum work opportunity ta' credit in this case is "!* o$ the $irst $1!,!!! o$ quali$ied wages per employee paid in the $irst year o$ employment, plus !* o$ the $irst $1!,!!! o$ quali$ied wages per employee paid in the second year o$ employment. There$ore, the 2!!) credit amount is $@,!!! ("!* $1!,!!! wages 2 employees+, while the 2!!@ credit amount is $", !! ( !* $-,!!! wages 1 employee+. 4TS0 1 5670 p. 12C1! 8 6'ample 13 2@. Which, i$ any, o$ the $ollowing correctly descri&es the research activities credit, a. The research activities credit is the greater o$ the incremental research credit, the &asic research credit, or the energy research credit. &. ;$ the research activities credit is claimed, no deduction is allowed $or research and e'perimentation e'penditures. c. The credit is not availa&le $or research conducted outside the Bnited States. d. /ll corporations quali$y $or the &asic research credit. e. .one o$ the a&ove. /.S0 1 The research activities credit is the sum o$ the incremental research credit, the &asic research credit, and the energy research credit (option a.+. Huali$ying e'penditures not only are eligi&le $or the credit, they also can &e e'pensed in the year incurred (option &.+. S corporations and personal service corporations do not quali$y $or the &asic research credit (option d.+. 4TS0 1 5670 p. 12C1! to 12C12 2-. :reen 1ompany, in the renovation o$ its &uilding, incurs $@,!!! o$ e'penditures that quali$y $or the disa&led access credit. The disa&led access credit is0 a. $),) !. &. $",!!!. c. $3,@) . d. $3,) !. e. .one o$ the a&ove. /.S0 1 $3,@) R ($@,!!! G $2 !+ !*. 4TS0 1 5670 p. 12C13

1)

3!. 5e' and =ena are married and have two children, Dichelle (age )+ and .ancy (age +. =uring 2!!), 5e' earned a salary o$ $2!,!!!, received interest income o$ $2!!, and $iled a joint income ta' return. =ena had $! gross income. Their earned income credit $or the year is0 a. $!. &. $ -2. c. $",12". d. $",)1<. e. .one o$ the a&ove. /.S0 1 Da'imum earned income credit ($11,)-! "!*+ 9ess0 4haseout J($2!,2!! G $1),3-!+ 21.!<*K /llowa&le earned income credit 4TS0 1 5670 p. 12C1 and 12C1< 8 Ta&le 12C2 $",)1< ( -2+ $",12"

31. 1heryl is single, has one child (age <+, and $iles as head o$ household during 2!!). #er salary $or the year is $1-,!!!. She quali$ies $or an earned income credit o$ the $ollowing amount0 a. $!. &. $ )). c. $2,2)<. d. $2,@ 3. e. .one o$ the a&ove. /.S0 1 Da'imum earned income credit ($@,3-! 3"*+ 9ess0 4haseout J($1-,!!! G $1 ,3-!+ 1 .-@*K /llowa&le earned income credit 4TS0 1 5670 p. 12C1 and 12C1< 8 Ta&le 12C2 $2,@ 3 ( ))+ $2,2)<

32. Aarry and Susan, who are married and $ile a joint return, have one child, :eorge. =uring 2!!), Aarry earned a salary o$ $2<,!!! and they received interest income o$ $2!!. Their earned income credit $or the year is0 a. $!. &. $1,"!@. c. $1,"" . d. $2,@ 3. e. .one o$ the a&ove. /.S0 1 Da'imum earned income credit ($@,3-! 3"*+ 9ess0 4haseout J($2<,2!!Q G $1),3-!+ 1 .-@*K /llowa&le earned income credit Q The greater o$ earned income ($2<,!!!+ or /:; ($2<,2!!+. 4TS0 1 5670 p. 12C1 and 12C1< 8 Ta&le 12C2 $2,@ 3 (1,"!@+ $1,""

1@

33. :eorge and Jill are hus&and and wi$e, ages <) and < respectively. =uring the year, they receive Social Security &ene$its o$ $",!!! and have adjusted gross income o$ $11,!!!. /ssuming they $ile a joint return, their ta' credit $or the elderly, &e$ore considering any possi&le limitation due to their ta' lia&ility, is0 a. $1,12 . &. $) !. c. $" !. d. $3) . e. .one o$ the a&ove. /.S0 1 $), !! (&ase amount+ G $",!!! (Social Security &ene$its+ G $ !! (oneChal$ o$ adjusted gross income in e'cess o$ $1!,!!!+ R $3,!!! 1 * R $" !. 4TS0 1 5670 p. 12C1) 8 p. 12C1@ 8 6'ample 2" 3". =uring the year, 4urple 1orporation (a B.S. 1orporation+ has B.S.Csource income o$ $-!!,!!! and $oreign income o$ $3!!,!!!. The $oreignCsource income generates $oreign income ta'es o$ $1!!,!!!. The B.S. income ta' &e$ore the $oreign ta' credit is $"!@,!!!. 4urple 1orporation%s $oreign ta' credit is0 a. $) ,!!!. &. $1!!,!!!. c. $1!2,!!!. d. $13<,!!!. e. .one o$ the a&ove. /.S0 A The overall limitation is J($3!!,!!!I$1,2!!,!!!+ $"!@,!!!K, or $1!2,!!!. #owever, the $oreign ta' credit cannot e'ceed the amount o$ $oreign ta'es paid ($1!!,!!!+. 4TS0 1 5670 p. 12C1@ 8 p. 12C1- 8 6'ample 2 3 . ;n 2!!<, Juan and Juanita incur $),2!! in legal and adoption $ees directly related to the adoption o$ an in$ant son &orn in a near&y state. >ver the ne't year, they incur another $",3!! o$ adoption e'penses. The adoption &ecomes $inal in 2!!). Which o$ the $ollowing choices properly re$lects the amounts and years in which the adoption e'penses credit is availa&le. 2!!< 2!!) a. $),2!! $ ",3!! &. .one $1!,-<! c. .one $11, !! d. $),!!! $ ",3-! e. .one o$ the a&ove. /.S0 6 7or quali$ying adoption e'penses paid or incurred in a ta' year prior to the year when the adoption is $inali?ed, the adoption e'penses credit must &e claimed in the year $ollowing the year the e'pense is paid. /lso, the total amount o$ the credit cannot e'ceed $11,3-! in 2!!). Thus, the adoption e'penses credit is $11,3-! in 2!!). 4TS0 1 5670 p. 12C2! 8 6'ample 2<

1-

3<. Which o$ the $ollowing statements regarding the adoption e'penses credit is not true, a. The adoption e'penses credit is a nonre$unda&le credit. &. The adoption e'penses credit starts to &e phased out in 2!!) &eginning when a ta'payer%s modi$ied /:; e'ceeds $1)!,@2!. c. .o adoption e'penses credit is a availa&le in 2!!) i$ a ta'payer%s modi$ied /:; e'ceeds $21!,@2!. d. The adoption e'penses credit is limited to no more than $1!,!!! per eligi&le child in 2!!). e. /ll o$ the a&ove statements are true. /.S0 = ;n 2!!), the credit is limited to no more than the inde'ed amount o$ $11,3-!, not $1!,!!!. 4TS0 1 5670 p. 12C2! 3). 1ale& and Toe are married and $ile a joint ta' return claiming their two children, ages 1! and @ as dependents. /ssuming their /:; is $11@,2!!, 1ale& and Toe%s child ta' credit is0 a. $!. &. $" !. c. $1, !. d. $2,!!!. e. .one o$ the a&ove. /.S0 1 The ma'imum child ta' credit is $1,!!! per dependent child under age 1). The ma'imum credit must &e reduced $or higherCincome ta'payers. 7or married ta'payers, the credit reduction is $ ! $or every $1,!!! (or part thereo$+ o$ /:; a&ove the threshold amount $11!,!!!, resulting in a reduction o$ $" ! J($11@,2!! G $11!,!!!+I$1,!!! (rounded to -+ $ !K $or 1ale& and Toe. There$ore, the child ta' credit is $1, ! ($2,!!! ma'imum credit G $" ! reduction+. 4TS0 1 5670 p. 12C21 8 6'ample 2@ 3@. Tom, unmarried, pays #eloise (a housekeeper+ $",-!! to care $or his physically incapacitated mother so that he can &e gain$ully employed. #e has /:; o$ $"!,!!! and claims his mother as a dependent. Tom may claim a credit $or child and dependent care e'penses o$0 a. $!. &. $<<!. c. $1,! !. d. $1,!)@. e. .one o$ the a&ove. /.S0 A $<<! R 22* $3,!!!. 4TS0 1 5670 p. 12C21 8 p. 12C22

2!

3-. Which o$ the $ollowing statements concerning the credit $or child and dependent care e'penses is not correct, a. / ta'payer is not allowed &oth an e'clusion $rom income and the credit $or child and dependent care e'penses on the same amount. &. / ta'payer is not allowed &oth a deduction as a medical e'pense and the credit $or child and dependent care e'penses on the same amount. c. ;$ a ta'payer%s adjusted gross income e'ceeds $"3,!!!, the rate $or the credit $or child and dependent care e'penses is 2!*. d. ;$ a ta'payer%s adjusted gross income e'ceeds $1 ,!!! &ut is less than $1),!!!, the rate $or the credit $or child and dependent care e'penses is 3 *. e. /ll o$ the a&ove are correct. /.S0 = ;$ /:; e'ceeds $1 ,!!!, the credit is less than 3 *. 4TS0 1 5670 p. 12C22 "!. Jermaine and Sesha are married, $ile a joint ta' return, have /:; o$ $) ,!!!, and have two children. =evona is &eginning her $reshman year at State Bniversity during 7all 2!!), and /rethia is &eginning her senior year at .ortheast Bniversity during 7all 2!!) a$ter having completed her junior year during the spring o$ that year. Aoth =evona and /rethia are claimed as dependents on their parents% ta' return. =evona%s quali$ying tuition e'penses and $ees total $3, !! $or the $all semester, while /rethia%s quali$ying tuition e'penses and $ees total $ ,2 ! $or each semester during 2!!). 7ull payment is made $or the tuition and related e'penses $or &oth children during each semester. The #>46 scholarship and li$etime learning credits availa&le to Jermaine and Sesha $or 2!!) are0 #>46 scholarship credit a. $1,< ! &. $1,< ! c. $2,2 ! d. $2,2 ! e. .one o$ the a&ove. 9i$etime learning credit $1,! ! $2,!!! $2,<2 $ ,2 !

/.S0 A The #>46 scholarship credit is availa&le $or =evona since she is in her $irst two years o$ postsecondary education. /rethia%s e'penses are eligi&le $or the li$etime learning credit since she is &eyond the $irst two years o$ postCsecondary education. There$ore, the availa&le credit amounts are $1,< ! J(1!!* $1,1!!+ F ( !* $1,1!!+K $or the #>46 scholarship credit and $2,!!! $or the li$etime learning credit (2!* $1!,!!!+. .o reduction $or income level is required. The credit phaseCout $or higherCincome ta'payers &egins at an /:; level o$ $-",!!! $or married ta'payers $iling joint returns. 4TS0 1 5670 p. 12C23 8 p. 12C2" 8 6'ample 32

21

"1. Ao& and Sally are married, $ile a joint ta' return, have /:; o$ $11!,!!!, and have two children. =el is &eginning her $reshman year at State 1ollege during 7all 2!!), and >wen is &eginning his senior year at Southwest Bniversity during 7all 2!!). >wen completed his junior year during the Spring semester o$ 2!!< (i.e., he took a Mleave o$ a&senceN during the 2!!<C2!!) school year+. Aoth =el and >wen are claimed as dependents on their parents% ta' return. =el%s quali$ying tuition e'penses and $ees total $", !! $or the 7all semester, while >wen%s quali$ying tuition e'penses were $",2!! $or the 7all 2!!) semester. =el%s room and &oard costs were $2,) ! $or the 7all semester. >wen did not incur room and &oard costs since he lived with his aunt and uncle during the year. 7ull payment is made $or the tuition and related e'penses $or &oth children at the &eginning o$ each semester. ;n addition to the children%s college e'penses, Ao& also spent $2, !! on pro$essional education seminars during the year in order to maintain his license as a practicing dentist. Ao& attended the seminars during July and /ugust 2!!). 1ompute the availa&le education ta' credits $or Ao& and Sally $or 2!!). a. $ -@. &. $2,3-2. c. $2,@"!. d. $2,--!. e. .one o$ the a&ove. "2. 5eali?ing that providing $or a com$orta&le retirement is up to them, Jim and Julie commit to making regular contri&utions to their ;5/s, &eginning this year. 1onsequently, they each make a $2,!!! contri&ution to their traditional ;5/. ;$ their /:; is $3 ,!!! on their joint return, what is the amount o$ their credit $or certain retirement plan contri&utions, a. $2,!!!. &. $@!!. c. $"!!. d. $2!!. e. .one o$ the a&ove. /.S0 1 The availa&le credit $or ta'payers reporting /:; o$ $3 ,!!! on a joint return is limited to 1!* times up to $2,!!! $or each eligi&le individual who makes a contri&ution. There$ore, the credit is equal to $"!! J1!* ($2,!!! 2+K. 4TS0 1 5670 6'ample 3" "3. 5ecogni?ed gains and losses must &e properly classi$ied. 4roper classi$ication depends upon three characteristics. Which o$ the $ollowing is not one o$ those three characteristics, a. The ta' status o$ the property. &. The manner o$ the property%s acquisition. c. The manner o$ the property%s disposition. d. The holding period o$ the property. e. /ll o$ the a&ove. /.S0 A The manner o$ the property%s acquisition generally has no impact on classi$ication o$ the recogni?ed gain or loss. 4TS0 1 5670 p. 1"C3

22

"". /n individual ta'payer owns a landscape painting. The painting would not &e a capital asset i$ it was held &y the ta'payer in which o$ the $ollowing circumstances, a. ;t is used in his &usiness and is deprecia&le property. &. ;t is personal use activity property $or the ta'payer and he did not create it or receive it &y gi$t $rom someone who did create it. c. ;t is investment use activity property $or the ta'payer and he did not create it or receive it &y gi$t $rom someone who did create it. d. ;t is held as inventory &y the ta'payer. e. a. and d. /.S0 6 ;$ the property is deprecia&le, it is used in a &usiness and is not a capital asset (option a.+. ;$ the property is inventory, the ta'payer is in the &usiness o$ &uying and selling paintings and the painting is an ordinary asset (option d.+. 4ersonal use activity and investment activity assets are capital assets as long as the ta'payer%s e$$orts did not create the painting or the ta'payer did not receive the painting &y gi$t $rom the creator o$ the painting (options &. and c.+. 4TS0 1 5670 p. 1"C" " . Jeremiah is a dealer in securities. #e would like to acquire and hold stock as a capital asset, then sell it to get a capital gain or loss. Which o$ the statements &elow is correct, a. Since he is a dealer, he cannot hold stock as a capital asset. &. Since he is a dealer, all the stock he acquires is a capital asset. c. 9osses are capital losses i$ at any time the stock has &een clearly identi$ied &y Jeremiah as held $or investment. d. ;$ Jeremiah clearly identi$ies the stock as held $or investment &y the close o$ &usiness on the acquisition date, gain $rom the stock%s sale will &e capital gain. e. c. and d. /.S0 6 :enerally, stock acquired &y a securities dealer is an ordinary asset &ecause the stock is the dealer%s inventory. #owever, i$ the dealer designates the stock &y the end o$ the &usiness day o$ its acquisition as an investment, gain $rom disposition o$ the stock can &e capital gain (option d.+. =esignating the stock as an investment at any time &e$ore selling it is su$$icient to characteri?e the loss as a capital loss (option c.+. 4TS0 1 5670 p. 1"C)

23

"<. 5ea is a songwriter. She wrote a song, copyrighted it, and sold it $or $1!,!!! cash a$ter holding the copyright $or 1" months. The song had a ?ero ta' &asis. The purchaser was a national song &rokerage company. 5ea is not in the &usiness o$ songwriting. The $1!,!!! received &y 5ea is0 a. 9ongCterm capital gain i$ she elects to treat the copyright as a capital asset. &. ShortCterm capital gain no matter what is the holding period. c. >rdinary gain &ecause the song is treated as inventory. d. 9ongCterm capital gain i$ she elects not to treat the copyright as a capital asset. e. .one o$ the a&ove. /.S0 / .ormally, the song creator does not have a capital asset. #owever, under P 1221(&+(3+, the creator o$ a song may elect to have the copyright treated as a capital asset, not elect not to have it treated as a capital asset (options a. and d.+. There is no rule automatically making the gain on the song copyright shortCterm capital gain (option &.+. Since 5ea is not in the &usiness o$ creating songs, the song copyright is not inventory (option c.+. 4TS0 1 5670 p. 1"C" 8 p. 1"C "). Sam operates a variety store as a sole proprietorship. Which o$ the $ollowing items are capital assets in the hands o$ Sam, a. The vacant lot ne't to his store that was purchased $or use as a parking lot $or his customers. &. Si'teen &icycles that have &een in his inventory $or over a year. c. / note receiva&le that was given to him &y a customer in payment o$ the &alance due on the customer%s account at the store. d. / corporate &ond in which Sam invested some o$ the store%s e'cess cash. e. .one o$ the a&ove. /.S0 = Section 1221 e'cludes all o$ the listed items $rom &eing capital assets e'cept the &ond. 4TS0 1 5670 p. 1"C3 8 p. 1"C" "@. Julia purchased vacant land in 2!!< that she su&divided $or resale as lots. /ll 1! o$ the lots were sold during 2!!). The lots had a ta' &asis o$ $3,!!! each and sold $or $" ,!!! each. Julia made no su&stantial improvements to the lots. She acted as her own real estate &rokerO so there were no sales e'penses $or selling the lots. Which o$ the $ollowing statements is correct, a. Julia must hold the lots $or at least $ive years &e$ore she is eligi&le $or the special capital gain treatment o$ P 123). &. Some o$ the gain $rom the sale o$ the ten lots is longCterm capital gain. c. /ll o$ the gain $rom the sale o$ the ten lots is longCterm capital gain. d. To &e eligi&le $or the special capital gain treatment o$ P 123), Julia must &e a real estate dealer. e. .one o$ the a&ove. /.S0 / Julia must hold the land at least $ive years to &e eligi&le $or P 123) treatment and must not &e a dealer in lots. Since Julia does not satis$y this requirement, all o$ the gain is ordinary income. 4TS0 1 5670 p. 1"C)

2"

"-. / worthless security had a holding period o$ 11 months when it &ecame worthless on .ovem&er 1!, 2!!). The investor who had owned the security had a &asis o$ $1!,!!! $or it. Which o$ the $ollowing statements is correct, a. The investor has a longCterm capital loss o$ $1!,!!!. &. The investor has a shortCterm capital loss o$ $1!,!!!. c. The investor has a nondeducti&le loss o$ $1!,!!!. d. The investor has a longCterm capital gain o$ $1!,!!!. e. .one o$ the a&ove. /.S0 / Section 1< (g+(1+ provides that i$ a security &ecomes worthless during the ta' year, the loss is treated as i$ it occurred on the last day o$ the ta' year. >n the last day o$ the ta' year, the security would have &een held $or more than a year. 4TS0 1 5670 p. 1"C!. Sylvia purchased $or $1,<1! a $2,!!! &ond when it was issued two years ago. Sylvia amorti?ed $2!! o$ the original issue discount and then sold the &ond $or $1,@!!. Which o$ the $ollowing statements is correct, a. Sylvia has $1! o$ longCterm capital loss. &. Sylvia has $1-! o$ longCterm capital gain. c. Sylvia has no capital gain or loss. d. Sylvia has $1-! o$ longCterm capital loss. e. .one o$ the a&ove. /.S0 / Sylvia%s original &asis o$ $1,<1! is increased &y the $2!! o$ original issue discount amorti?ation. #er &asis is $1,@1! when she sells the &ond $or $1,@!!O so her loss is $1! and is long term. 4TS0 1 5670 p. 1"C1. >n July 1, 2!!), Arandon purchased an option to &uy 1,!!! shares o$ :eneral, ;nc. at $3! per share. #e purchased the option $or $2,!!!. ;t was to remain in e$$ect $or $ive months. The market e'perienced a decline during the latter part o$ the year, so Arandon decided to let the option lapse as o$ =ecem&er 1, 2!!). >n his 2!!) ta' return, what should Arandon report, a. / $2,!!! longCterm capital loss. &. / $2,!!! shortCterm capital loss. c. / $2,!!! P 1231 loss. d. / $2,!!! ordinary loss. e. .one o$ the a&ove. /.S0 A The lapse o$ the option is treated as a sale or e'change &y P 123"(a+(2+. There$ore, a shortC term capital loss o$ $2,!!! is recogni?ed. 4TS0 1 5670 1oncept Summary 1"C1

2. Which o$ the $ollowing events causes the purchaser o$ an option to add the cost o$ the option to the &asis o$ the property to which the option relates, a. The option is e'ercised. &. The option is sold. c. The option lapses. d. The option is rescinded. e. .one o$ the a&ove. /.S0 / ;$ the option is e'ercised, the cost o$ the option &ecomes part o$ the &asis o$ the property. >therwise, the lapse o$ the option is treated as a sale or e'change. 4TS0 1 5670 p. 1"C1! 3. #arold is a mechanical engineer and, while unemployed, invents a switching device $or computer networks. #e patents the device, &ut does not reduce it to practice. #arold has a ?ero ta' &asis $or the patent. ;n consideration o$ $3!!,!!! plus a $1 royalty per device sold, #arold assigns the patent to a computer manu$acturing company. #arold assigned all su&stantial rights in the patent. Which o$ the $ollowing is correct, a. #arold automatically has longCterm capital gain $rom the lump sum payment, &ut not $rom the royalty payments. &. #arold automatically has longCterm capital gain $rom the royalty payments, &ut not $rom the lump sum payment. c. #arold automatically has longCterm capital gain $rom both the lump sum payment and the royalty payments. d. #arold does not have automatic longCterm capital gain $rom either the lump sum payment or the royalty payments. e. .one o$ the a&ove. /.S0 1 Since #arold meets the de$inition o$ a holder, he receives automatic longCterm capital gain treatment $or &oth the lump sum payment and the royalty payments. 4TS0 1 5670 p. 1"C11 8 p. 1"C12 ". Alue 1ompany signs a 12Cyear $ranchise agreement with 7ast Taco. 7ast Taco retained signi$icant powers, rights, and a continuing interest. Alue (the $ranchisee+ makes noncontingent payments o$ $1 ,!!! per year $or the $irst $ive years o$ the $ranchise. Alue 1ompany also pays a contingent $ee o$ 2* o$ gross sales every month. Which o$ the $ollowing statements is correct, a. Alue 1ompany may deduct the $1 ,!!! per year noncontingent payments in $ull as they are made. &. Alue 1ompany may deduct the monthly contingent $ee as it is paid. c. Alue 1ompany may deduct both the noncontingent annual $ee and the contingent monthly $ees as they are paid. d. Alue 1ompany may not deduct either the noncontingent annual $ee or the contingent monthly $ees as they are paid. e. .one o$ the a&ove. /.S0 A The contingent payments are deducti&le as they are made. The noncontingent payments must &e capitali?ed and amorti?ed over 1 years. 4TS0 1 5670 p. 1"C12 8 p. 1"C13

2<

. Which o$ the statements &elow concerning sports $ranchises (e.g., the =etroit Tigers+ is correct, a. Sports $ranchises are su&ject to the $ranchise rules o$ P 12 3. &. 4layer contracts are usually one o$ the major assets acquired with a sports $ranchise. c. 4layer contracts are amorti?a&le over 1 years. d. /ll o$ the a&ove. e. .one o$ the a&ove. /.S0 = Sports $ranchises are su&ject to the rules o$ P 12 3 that apply to $ranchises generally. Bnder those rules, the $ranchise and other intangi&le assets acquired along with the $ranchise are 1 Cyear P 1-) intangi&les. There$ore, the player contracts are amorti?ed over 1 years even though the contracts may &e $or a shorter period. 4TS0 1 5670 p. 1"C13 8 p. 1"C1" 8 1oncept Summary 1"C2 <. Eirgil was leasing an apartment $rom Dauve, ;nc. Dauve paid Eirgil $1,!!! to cancel his lease and move out so that Dauve could demolish the &uilding. /s a result0 a. Eirgil has a $1,!!! capital gain. &. Eirgil has a $1,!!! capital loss. c. Dauve has a $1,!!! capital loss. d. Dauve has a $1,!!! capital gain. e. .one o$ the a&ove. /.S0 / Since the apartment was Eirgil%s personal residence, the lease on the apartment was a capital asset &ecause all personal use assets are capital assets. Eirgil has a ?ero &asis $or the lease. There$ore, the entire payment is capital gain. Whether the gain is long term or short term depends upon how long Eirgil has held the lease. Dauve has an ordinary deduction o$ $1,!!!. 4TS0 1 5670 p. 1"C1" 8 p. 1"C1 ). Dagenta, ;nc. sold a $orkli$t on 7e&ruary 12, 2!!), $or $3,!!! (its 7DE+ to its 1!!* shareholder, /nise. Dagenta%s adjusted &asis $or the $orkli$t was $),!!!. /nise%s holding period $or the $orkli$t0 a. ;ncludes Dagenta%s holding period $or the $orkli$t. &. Aegins on 7e&ruary 12, 2!!). c. Aegins on 7e&ruary 13, 2!!). d. =oes not &egin until /nise sells the $orkli$t. e. .one o$ the a&ove. /.S0 1 When a loss is disallowed in a related party transaction, there is no carryover o$ holding period. Dagenta has a $",!!! reali?ed loss on the sale o$ the $orkli$t to /nise and the loss is disallowed &ecause /nise is a related ta'payer. /nise%s holding period &egins on the day a$ter the property is acquired. 4TS0 1 5670 p. 1"C1<

2)

@. #arry inherited a residence $rom his mother when she died. The mother had a ta' &asis o$ $ <<,!!! $or the residence when she died and the residence was worth $"33,!!! at the date o$ her death. Which o$ the statements &elow is correct, a. #arry%s holding period $or the residence includes his mother%s holding period $or the residence. &. #arry%s holding period $or the residence does not include his mother%s holding period $or the residence. c. #arry%s holding period $or the residence is automatically long term. d. & and c e. .one o$ the a&ove. /.S0 = #arry has an automatic longCterm holding period &ecause the residence is inherited property. There$ore, his holding period does not include his mother%s holding period $or the residence. 4TS0 1 5670 p. 1"C1< -. Which o$ the $ollowing is correct concerning short sales o$ stock, a. /t the time the short sale is made, the ta'payer does not deliver to the purchaser the shares sold short. &. /t the time the short sale is made, the ta'payer delivers to the purchaser the shares sold short. c. /t the time the short sale is made, the ta'payer may already own the shares sold short. d. /t the time the short sale is made, the ta'payer always already owns the shares sold short. e. .one o$ the a&ove. /.S0 A / short sale occurs when a ta'payer sells borrowed property and repays the lender with su&stantially identical property either held on the date o$ the sale or purchased a$ter the date o$ the sale. 4TS0 1 5670 p. 1"C1< <!. ;n 2!!), Dark has $1",!!! shortCterm capital loss, $<,!!! 2@* gain, and $),!!! *I1 * gain. Which o$ the statements &elow is correct, a. Dark has a $1,!!! capital loss deduction. &. Dark has a $3,!!! capital loss deduction. c. Dark has a $1,!!! net capital gain. d. Dark has a $<,!!! net capital gain. e. Dark has a $1",!!! net capital loss. /.S0 / There is a net shortCterm capital loss o$ $1,!!! ($1",!!! shortCterm capital loss G $<,!!! 2@* gain G $),!!! *I1 * gain+ which is deducti&le $or /:; as a capital loss deduction. 4TS0 1 5670 p. 1"C2!

2@

<1. ;n 2!!<, Jenny had a $1",!!! net shortCterm capital loss and deducted $3,!!! as a capital loss deduction. ;n 2!!), Jenny has a $1@,!!! *I1 * longCterm capital gain and no other capital gain or loss transactions. Which o$ the statements &elow is correct, a. Jenny has a 2!!) $1@,!!! net capital gain. &. Jenny has a 2!!) $),!!! net capital gain. c. Jenny has a 2!!) $),!!! net capital loss. d. Jenny has a 2!!) $3,!!! capital loss deduction. e. Jenny has a 2!!) $),!!! capital loss deduction. /.S0 A The 2!!< capital loss carry$orward is $11,!!! ($1",!!! 2!!< net capital loss G 2!!< $3,!!! capital loss deduction+. The $11,!!! carries $orward as a shortCterm capital loss and is o$$set against the $1@,!!! longCterm capital gain. 4TS0 1 5670 p. 1"C22 <2. ;n 2!!), Satesh has $",!!! shortCterm capital loss, $1",!!! *I1 * longCterm capital gain, and $),!!! quali$ied dividend income. Satesh is single and has other ta'a&le income o$ $1 ,!!!. Which o$ the $ollowing statements is correct, a. .o more than $1",!!! o$ Satesh%s ta'a&le income is ta'ed at *. &. .o more than $),!!! o$ Satesh%s ta'a&le income is ta'ed at *. c. .o more than $1),!!! o$ Satesh%s ta'a&le income is ta'ed at *. d. .one o$ Satesh%s ta'a&le income is ta'ed at *. e. /ll o$ Satesh%s ta'a&le income is ta'ed at *. /.S0 1 The net longCterm capital gain is $1!,!!! ($1",!!! *I1 * longCterm capital gain G $",!!! shortCterm capital loss+. The $),!!! quali$ied dividend income is added to the *I1 * net longCterm capital gain and the $1),!!! total is eligi&le $or the *I1 * alternative ta' rate. 4TS0 1 5670 p. 1"C23 8 p. 1"C2" 8 6'ample 3) <3. 1orrine is $iling as head o$ household and has 2!!) ta'a&le income o$ $3@,!!! which includes $2",!!! o$ *I1 * gain. What is the ta' on her ta'a&le income using the alternative ta' method, a. $1,2!!. &. $2,)"!. c. $3,3!!. d. $ ,)!!. e. .one o$ the a&ove. /.S0 A Since 1orrine%s total ta'a&le income does not take her out o$ the 1 * regular ta' &racket, all o$ the $2",!!! *I1 * gain is ta'ed at *. The total ta' is $2,)"! ($1, "! on $1",!!! regular ta'a&le income F * o$ $2",!!! longCterm capital gain+. 4TS0 1 5670 p. 1"C23 8 p. 1"C2"

2-

<". Sam is $iling as single and has 2!!) ta'a&le income o$ $"@,!!! which includes $23,!!! o$ *I1 * gain. What is the ta' on his ta'a&le income using the alternative ta' method, a. $12,!!!. &. $<,12 . c. $<,@!-. d. $",3@<. e. .one o$ the a&ove. /.S0 A Sam%s ta'a&le income takes him out o$ the 1 * regular ta' &racket, &ut his regular ta'a&le income does not. There$ore, a portion o$ the *I1 * gain is ta'ed at * and a portion is ta'ed at 1 *. #is total ta' is $<,12 U$3,3 - ta' on $2 ,!!! regular ta'a&le income ($"@,!!! G $23,!!!+ F J($31,@ ! end o$ single 1 * &racket G $2 ,!!!+ .! K F J($"@,!!! G $31,@ !+ .1 KV. 4TS0 1 5670 p. 1"C2" < . 7or 2!!), 5yan (a single person+ has $3 ,!!! net capital gain (all *I1 * gain+. #is ta'a&le income is $1@ ,!!!. Which o$ the $ollowing is correct, a. The net capital gain will &e su&ject to special ta' treatment. &. 5yan%s ta'a&le income without the net capital gain will &e ta'ed at greater than 2 *. c. The ta' rate on the net capital gain cannot e'ceed 1 *. d. /ll o$ the a&ove. e. .one o$ the a&ove. /.S0 = The net capital gain is su&ject to special ta' treatment. The ta'a&le income without the net capital gain puts 5yan in the 2@* &racket. The net capital gain is ta'ed at no greater than 1 *. 4TS0 1 5670 p. 1"C2" <<. Which o$ the $ollowing comparisons is correct, a. 1orporations may carry&ack capital lossesO individuals may not. &. Aoth corporation and individual longCterm capital losses carryover as shortCterm capital losses. c. 1orporations may carry$orward capital losses inde$initelyO individuals may only carry$orward capital losses $or $ive years. d. Aoth corporations and individuals may use an alternative ta' rate on net capital gains. e. .one o$ the a&ove. /.S0 / 1orporations may carry&ack capital lossesO individuals may not (a+. ;ndividual longCterm capital losses carryover as longCterm, not shortCterm. 1orporations have a $iveCyear carry$orward limitO individuals may carry$orward capital losses inde$initely. 1orporations% alternative ta' rate on longCterm capital gains is 3 *, not 2!*. 4TS0 1 5670 p. 1"C2< 8 p. 1"C2@

3!

<). Tan, ;nc., has a 2!!) $ !,!!! longCterm capital gain included in its $1@ ,!!! ta'a&le income. Which o$ the $ollowing is correct, a. Tan will &ene$it $rom an alternative ta' on net capital gains computation. &. Tan%s regular ta' on ta'a&le income will &e the same as its ta' using an alternative ta' on net capital gains approach. c. Tan%s $ !,!!! net capital gain is not ta'a&le. d. Tan%s regular ta' on ta'a&le income will &e greater than its ta' using an alternative ta' on net capital gain approach. e. .one o$ the a&ove. /.S0 A /lthough there is an alternative ta' on net capital gains $or corporations, it yields the same ta' result as the regular computation method. This unusual result is caused &y the $act that the alternative ta' rate and the ma'imum regular ta' rate are &oth 3 *. 4TS0 1 5670 p. 1"C2@ <@. :reen 1ompany acquires a new machine $or use in its manu$acturing operations, places it in service, &ut then discovers that it is not suita&le $or :reen%s &usiness. 1onsequently, :reen sells the machine 1! months a$ter it was acquired. There is a $1!,!!! loss on the disposition. When the machine was disposed o$, it was0 a. / capital asset. &. /n ordinary asset. c. /n inventory asset. d. / P 1231 asset. e. .one o$ the a&ove. /.S0 A The machine was deprecia&le property used in a &usiness and held one year or lessO so it was an ordinary asset. 4TS0 1 5670 p. 1"C3! <-. Which o$ the $ollowing assets held &y a manu$acturing &usiness is not a P 1231 asset, a. ;nventory. &. / machine used in the &usiness and held more than one year. c. / $actory &uilding used in the &usiness and held more than one year. d. 9and used in the &usiness and held more than one year. e. /ll o$ the a&ove. /.S0 / ;nventory is an ordinary asset. 4TS0 1 5670 p. 1"C31

31

)!. Which o$ the $ollowing assets held &y a cash &asis law $irm is not a P 1231 asset, a. /n account receiva&le $rom a client. &. / computer used in the &usiness and held more than one year. c. /n o$$ice &uilding used in the &usiness and held more than one year. d. / desk used in the &usiness and held more than one year. e. /ll o$ the a&ove. /.S0 / /n account receiva&le is an ordinary asset. 4TS0 1 5670 p. 1"C31 )1. / machine held more than one year and used in a &usiness is destroyed in a $ire. The machine was not insured. So there is a loss $rom its destruction. Which o$ the statements &elow is correct concerning these $acts, a. The machine was a longCterm nonpersonal use asset. &. The machine was a longCterm personal use asset. c. The loss is not usa&le. d. The loss is su&ject to special netting rules. e. a and d /.S0 6 4roperty used in a &usiness is a nonpersonal use asset and the loss due to casualty is su&ject to a special netting rule $or nonpersonal use property casualty gains and losses. 4TS0 1 5670 p. 1"C31 8 p. 1"C32 )2. Eertigo, ;nc., has a 2!!) net P 1231 loss o$ $" ,!!! and had a $22,!!! net P 1231 gain in 2!!<. 7or 2!!), Eertigo%s net P1231 loss is treated as0 a. >rdinary loss. &. >rdinary gain. c. 1apital loss. d. 1apital gain. e. .one o$ the a&ove. /.S0 / Since there is a 2!!) net P 1231 loss, the loss is treated as an ordinary loss. 4TS0 1 5670 p. 1"C33 )3. Eertical, ;nc., has a 2!!) net P 1231 gain o$ $" ,!!! and had a $22,!!! net P 1231 loss in 2!!<. 7or 2!!), Eertical%s net P 1231 gain is treated as0 a. $23,!!! longCterm capital gain and $22,!!! ordinary loss. &. $" ,!!! ordinary gain. c. $23,!!! longCterm capital gain and $22,!!! ordinary gain. d. $" ,!!! capital gain. e. .one o$ the a&ove. /.S0 1 The 2!!< P 1231 loss is a look&ack loss and converts $22,!!! o$ the 2!!) net P 1231 gain into ordinary gain. The $23,!!! remaining o$ the $" ,!!! 2!!) net P 1231 gain is treated as longCterm capital gain. 4TS0 1 5670 p. 1"C33 8 p. 1"C3"

32

)". Eerway, ;nc, has a 2!!) net P 1231 gain o$ $" ,!!! and had a $ 2,!!! net P 1231 loss in 2!!<. 7or 2!!), Eerway%s net P 1231 gain is treated as0 a. $" ,!!! ordinary loss. &. $" ,!!! ordinary gain. c. $" ,!!! capital loss. d. $" ,!!! capital gain. e. .one o$ the a&ove. /.S0 A Since the 2!!) $" ,!!! net P 1231 gain is less than the $ 2,!!! 2!!< P 1231 look&ack loss, the entire $" ,!!! is treated as ordinary gain. 4TS0 1 5670 p. 1"C33 8 p. 1"C3" ) . The $ollowing assets in Jack%s &usiness were sold in 2!!)0 /sset >$$ice 6quipment /utomo&ile /A1 Stock (capital asset+ #olding 4eriod < years @ months 2 years :ainI(9oss+ $1,1!! ($ @!!+ $1,"!!

The o$$ice equipment had a ?ero adjusted &asis and was purchased $or $@,!!!. The automo&ile was purchased $or $2,!!! and sold $or $1,2!!. The /A1 stock was purchased $or $1,@!! and sold $or $3,2!!. ;n 2!!) (the year o$ sale+, Jack should report what amount o$ net capital gain and net ordinary income, a. $1,)!! 9T1:. &. $<!! 9T1: and $3!! ordinary gain. c. $1,"!! 9T1: and $3!! ordinary gain. d. $2, !! 9T1: and $@!! ordinary loss. e. .one o$ the a&ove. /.S0 1 The sale o$ the o$$ice equipment results in a $1,1!! P 12" gain. The sale o$ the auto results in an ordinary loss o$ $@!! &ecause the auto was not held $or the longCterm holding period. The P 12" gain o$ $1,1!! o$$sets the $@!! ordinary loss $or a net ordinary gain o$ $3!!. The sale o$ the stock results in a $1,"!! 9T1:. 4TS0 1 5670 p. 1"C33 to 1"C3)

33

)<. /n individual had the $ollowing gains and losses during 2!!) on property held $or the longC term holding period0 sale o$ >range common stock ($@,!!! gain+O sale o$ real property used in the ta'payer%s &usiness ($1,@!! loss+O destruction o$ real property used in the ta'payer%s &usiness &y $ire ($1,!!! loss+. Which o$ the $ollowing is correct, a. The $ire loss would reduce the real property sale loss. &. The $ire loss would reduce the stock sale gain. c. The sale o$ real property loss would &e netted against the stock sale gain. d. The sale o$ real property is a P 1231 loss. e. .one o$ the a&ove. /.S0 = The sale o$ the >range stock produces a $@,!!! 9T1:, which is $ully includi&le in gross income. The real property sale results in a net P1231 loss o$ $1,@!!. The real property $1,!!! $ire loss is treated as an ordinary loss &ecause there are no casualty gains against which it can &e netted. 4TS0 1 5670 p. 1"C33 to 1"C3) )). Spencer has an investment in two parcels o$ vacant land. 4arcel 1 is a capital asset and parcel 2 is a P 1231 asset. Spencer already has shortCterm capital loss $or the year he would like to o$$set with capital gain. Spencer has P 1231 look&ack loss that e'ceeds the gain $rom the disposition o$ either land parcel. Spencer only wants to sell one land parcel and each o$ them would yield the same amount o$ gain. The gain that would &e recogni?ed e'ceeds the shortCterm capital loss Spencer already has. Which o$ the statements &elow is correct, a. Spencer will have a net capital loss no matter which land parcel he sells. &. Spencer will have a net capital loss i$ he sells parcel 2. c. Spencer will have a net capital loss i$ he sells parcel 1. d. Spencer will have a net capital gain i$ he sells either parcel 1 or parcel 2. e. .one o$ the a&ove. /.S0 A Since parcel 2 is a P 1231 asset, its gain will &e treated as ordinary income due to the P 1231 look&ack and none o$ the gain will &e treated as longCterm capital gain. Thus, the e'isting shortCterm capital loss will not &e o$$set &y any gain and a net capital loss will result. Selling parcel 1 will yield a capital gain that will more than o$$set the e'isting shortCterm capital loss, resulting in a net capital gain. 4TS0 1 5670 p. 1"C33 to 1"C3<

3"

)@. 1opper 1orporation sold machinery $or $2),!!! on =ecem&er 31, 2!!). The machinery had &een purchased on January 2, 2!!" $or $3!,!!! and had an adjusted &asis o$ $21,!!! at the date o$ the sale. 7or 2!!), what should 1opper 1orporation report, a. >rdinary income o$ $<,!!!. &. / P 1231 gain o$ $3,!!! and $3,!!! o$ ordinary income. c. / P 1231 gain o$ $<,!!!. d. / P 1231 gain o$ $<,!!! and $3,!!! o$ ordinary income. e. .one o$ the a&ove. /.S0 / The recogni?ed gain $rom the disposition o$ the machinery is $<,!!! ($2),!!! sale price G $21,!!! adjusted &asis+. Since the recogni?ed gain is less than the depreciation taken o$ $-,!!! ($3!,!!! cost G $21,!!! adjusted &asis+ and the asset is deprecia&le equipment used in a &usiness, P 12" depreciation recapture applies. 4TS0 1 5670 p. 1"C3) )-. Alue 1ompany sold machinery $or $ ,!!! on =ecem&er 23, 2!!). The machinery had &een acquired on /pril 1, 2!! $or $"-,!!! and its adjusted &asis was $1",2!!. The P 1231 gain, P 12" recapture gain, and P 1231 loss $rom this transaction are0 a. $<,!!! P 1231 gain, $3",@!! P 12" recapture gain, $! P 1231 loss. &. $! P 1231 gain, $"!,"!! P 12" recapture gain, $! P 1231 loss. c. $<,!!! P 1231 gain, $"!,"!! P 12" recapture gain, $! P 1231 loss. d. $! P 1231 gain, $"!,"!! P 12" recapture gain, $1",2!! P 1231 loss. e. .one o$ the a&ove. /.S0 / Since the machine was held more than 12 months and was depreciated, it was a P 1231 asset. Since it was sold at a gain and the selling price e'ceeded the original cost, all o$ the depreciation taken o$ $3",@!! ($"-,!!! cost G $1",2!! adjusted &asis+ is gain recaptured &y P 12" and the remaining $<,!!! gain ($ ,!!! selling price G $"-,!!! original cost+ is P 1231 gain. 4TS0 1 5670 p. 1"C3) @!. 5ed 1ompany had an involuntary conversion on =ecem&er 23, 2!!). The machinery had &een acquired on /pril 1, 2!! $or $"-,!!! and its adjusted &asis was $1",2!!. The machinery was completely destroyed &y $ire and 5ed received $1!,!!! o$ insurance proceeds $or the machine and did not replace it. This was 5ed%s only casualty or the$t event $or the year. /s a result o$ this event, 5ed initially has0 a. $1!,!!! P 1231 loss. &. $1!,!!! P 12" recapture gain. c. $",2!! casualty loss. d. $",2!! P 1231 loss. e. .one o$ the a&ove. /.S0 1 Since the machine was held more than 12 months and was depreciated, it was a P 1231 asset. #owever, since it was disposed o$ at a $",2!! loss ($1!,!!! insurance proceeds G $1",2!! adjusted &asis+, all o$ the loss is initially a casualty loss. 4TS0 1 5670 p. 1"C3-

@1. >range 1ompany had machinery destroyed &y a $ire on =ecem&er 23, 2!!). The machinery had &een acquired on /pril 1, 2!! $or $"-,!!! and its adjusted &asis was $1",2!!. The machinery was completely destroyed and >range received $3!,!!! o$ insurance proceeds $or the machine and did not replace it. This was >range%s only casualty or the$t event $or the year. /s a result o$ this event, >range has0 a. $",2!! ordinary loss. &. $1 ,@!! P 12" recapture gain. c. $1",2!! P 12" recapture gain. d. $3!,!!! P 1231 gain. e. .one o$ the a&ove. /.S0 A Since the machine was held more than 12 months and was depreciated, it was a P 1231 asset. #owever, since it was disposed o$ at a $1 ,@!! gain ($3!,!!! insurance proceeds G $1",2!! adjusted &asis+, all o$ the gain is initially P 12" depreciation recapture gain and not casualty gain. 4TS0 1 5670 p. 1"C3@ 8 p. 1"C3@2. Section 12 ! property is0 a. =eprecia&le real property. &. =eprecia&le intangi&le personal property. c. =eprecia&le tangi&le personal property. d. ;nventory. e. .one o$ the a&ove. /.S0 / Section 12 ! property is deprecia&le real property (principally &uildings and their structural components+. 4TS0 1 5670 p. 1"C3@3. / &usiness &uilding owned &y an individual is destroyed &y $ire. The &uilding was depreciated using straightCline depreciation. The &uilding was insured and the insurance proceeds e'ceeded the &uilding%s adjusted &asis. The &uilding was not replaced. The insurance proceeds did not e'ceed the original cost o$ the &uilding. The gain $rom disposition o$ the &uilding is initially0 a. 1asualty gain. &. 1asualty loss. c. Section 1231 gain. d. Section 12 ! gain. e. .one o$ the a&ove. /.S0 / There is no P 12 ! depreciation recapture &ecause straightCline depreciation was used. Since the disposition o$ the asset was &y casualty and depreciation recapture does not apply, the initial characteri?ation o$ the gain is casualty gain. 4TS0 1 5670 p. 1"C31 8 p. 1"C"!

3<

@". Sari owns deprecia&le residential rental real estate which has accumulated depreciation (all $rom straightCline+ o$ $" ,!!!. ;$ Sari sold the property, she would have a $33,!!! gain. The initial characteri?ation o$ the gain would &e0 a. Section 12" gain. &. Section 1231 gain. c. Section 12 ! gain. d. Section 123- gain. e. .one o$ the a&ove. /.S0 A The gain is P 1231 gain. Since straightCline depreciation was used, there is no P 12 ! recapture. /lso, since Sari is an individual, there is no Mordinary gain adjustmentN under P 2-1. Section 123- would not apply &ecause there is no reason to conclude that the property would &e sold to a related ta'payer. 4TS0 1 5670 p. 1"C"! 8 p. 1"C"1 8 p. 1"C"< @ . / retail &uilding used in the &usiness o$ a sole proprietor is sold on Darch 1!, 2!!), $or $322,!!!. The &uilding was acquired in 1--) $or $"!!,!!! and straightCline depreciation o$ $1!",!!! had &een taken on the &uilding. What is the maximum unrecaptured P 12 ! gain $rom the disposition o$ this &uilding, a. $"!!,!!!. &. $322,!!!. c. $1!",!!!. d. $2<,!!!. e. .one o$ the a&ove. /.S0 1 The ma'imum unrecaptured P 12 ! gain is the $1!",!!! depreciation taken. That ma'imum is reduced to the $2<,!!! gain $rom the disposition J$322,!!! sale price G ($"!!,!!! cost G $1!",!!! depreciation taken+K. 4TS0 1 5670 p.1"C"2 8 p. 1"C"3 @<. Which o$ the $ollowing statements is correct, a. When deprecia&le property is gi$ted to another individual ta'payer, the depreciation recapture potential is e'tinguished. &. When deprecia&le property is inherited &y a ta'payer, the depreciation recapture potential is e'tinguished. c. When corporate deprecia&le property is distri&uted as a dividend, the depreciation recapture potential is generally not recogni?ed. d. When deprecia&le property is contri&uted to charity, the depreciation recapture potential has no e$$ect on the amount o$ the charita&le contri&ution deduction. e. /ll o$ the a&ove are correct. /.S0 A =epreciation recapture potential is e'tinguished when property is received as an inheritance, carries over when the property is received &y gi$t, is recogni?ed &y the corporation when property is distri&uted &y a corporation and a gain would have &een recogni?ed i$ the property had &een sold, and reduces the charita&le contri&ution deduction amount. 4TS0 1 5670 p. 1"C"" to 1"C"<

3)

@). Which o$ the $ollowing would e'tinguish the P 12" recapture potential, a. /n e'change o$ deprecia&le &usiness equipment $or likeCkind &usiness equipment with gain reali?ed, &ut not recogni?ed. &. / nonta'a&le incorporation under P 3 1. c. / nonta'a&le contri&ution to a partnership under P )21. d. / nonta'a&le reorgani?ation. e. .one o$ the a&ove. /.S0 6 /ll o$ the transactions involve a carryover o$ &asis and do not e'tinguish the P 12" depreciation recapture potential. 4TS0 1 5670 p. 1"C" 8 p. 1"C"< @@. Section 123- (relating to the sale o$ certain property &etween related ta'payers+ does not apply unless the property0 a. Was depreciated &y the trans$eror. &. ;s deprecia&le in the hands o$ the trans$eree. c. ;s a capital asset. d. ;s real property. e. .one o$ the a&ove. /.S0 A Section 123- produces the conversion o$ the trans$eror%s capital gain into ordinary income i$ the property is deprecia&le in the hands o$ the related trans$eree. 4TS0 1 5670 p. 1"C"< @-. /n individual has a $1!,!!! P 12" gain, a $1 ,!!! P 1231 gain, a $13,!!! P 1231 loss, a $",!!! P 1231 look&ack loss, and a $1 ,!!! longCterm capital gain. The net longCterm capital gain is0 a. $3!,!!!. &. $"!,!!!. c. $1),!!!. d. $1 ,!!!. e. .one o$ the a&ove. /.S0 = .one o$ the P 1231 gain survives to &e treated as longCterm capital gain. $13,!!! o$ the $1 ,!!! P 1231 gain is a&sor&ed &y the $13,!!! P 1231 loss and the remaining $2,!!! is treated as ordinary gain &ecause o$ the $",!!! P 1231 look&ack loss. The $1!,!!! o$ P 12" gain is ordinary income. 4TS0 1 5670 1oncept Summary 1"C@

3@

-!. Which o$ the $ollowing statements regarding a 2C 3 week ta' year is not correct, a. The yearCend must &e the same day o$ the week in all years. &. Some ta' years will include more than 3<< calendar days. c. Whether the particular ta' year includes 2 weeks or 3 weeks is not elective. d. /ll o$ the a&ove are correct. e. .one o$ the a&ove is correct. /.S0 = The ta' yearCend must &e the same day o$ the week in all years. Thus, a. is correct. With a 2C 3 week year, 3)1 days ( 3 )+ may &e included in a ta' year. Thus, &. is correct. Whether the ta' year is 2 weeks or is 3 weeks is not elective. Thus, c. is correct. 4TS0 1 5670 p. 1<C3 -1. :old 1orporation and Silver 1orporation are equal partners in the :WS 4artnership, which was $ormed on July 1, 2!!). :old uses a calendar ta' year, and Silver%s ta' year ends Septem&er 3!. :WS is not a seasonal &usiness. a. :WS must use a ta' year ending June 3!th. &. :WS must use a ta' year ending =ecem&er 31st. c. :WS must use a ta' year ending Septem&er 3!th. d. :WS may elect its ta' year without regard to the partners% ta' years. e. .one o$ the a&ove. /.S0 1 / ta' year ending Septem&er 3!th will result in the least aggregate de$erral. LearCend Septem&er 3! =ecem&er 31 4TS0 1 5670 p. 1<C" . 3 R 1. . - R ".

-2. ;n regard to choosing a ta' year $or a retail &usiness owned &y individuals, which $orm o$ &usiness provides the greater num&er o$ options in regard to the ta' year, a. The 1 corporation. &. The S corporation. c. The partnership. d. The limited lia&ility company. e. /ll o$ the a&ove have the same options. /.S0 / /nswer &. is incorrect &ecause S corporations generally must use a calendar ta' year. /nswer c. and d. are incorrect &ecause a speci$ic sequence is provided $or determining the ta' year o$ partnerships (i.e., the limited lia&ility company is normally ta'ed as a partnership+0 (1+ majority interest partners, (2+ principal partners, and (3+ least aggregate de$erral method. 4TS0 1 5670 p. 1<C3 to 1<C

3-

-3. ;n the case o$ a partnership whose partners all use a calendar year, a reason that is accepta&le to the ;5S $or using a ta' year ending June 3!th would &e0 a. The accountant is already over&urdened with calendar year ta' returns and could not timely $ile the partnership%s return. &. / =ecem&er 31st inventory would &e required i$ a calendar year was used, and the employees do not want to work on .ew Lear%s 6ve. c. The company%s income does not $luctuate a great deal $rom year to year. d. The &usiness has a natural &usiness year that ends June 3!th. e. .one o$ the a&ove. /.S0 = The ;5S has issued 5evenue 5uling @)C ) to o&jectively determine the entity%s natural &usiness year. 4TS0 1 5670 p. 1<C -". 4urple 1orporation, a personal services corporation, adopted a $iscal year ending Septem&er 3!th. The sole shareholder o$ the corporation is a calendar year ta'payer. =uring the $iscal year ending Septem&er 3!, 2!!), the shareholderCemployee received $12!,!!! salary. The corporation paid the shareholderCemployee a salary o$ $1 ,!!! during the period &eginning >cto&er 1, 2!!) through =ecem&er 31, 2!!). a. The corporation salary e'pense $or the $iscal year ending Septem&er 3!, 2!!@ is limited to $12!,!!!. &. The corporation salary e'pense $or the $iscal year ending Septem&er 3!, 2!!@ is limited to $13 ,!!!. c. The corporation salary e'pense $or the $iscal year ending Septem&er 3!, 2!!@ is limited to $<!,!!!. d. The corporation must switch to a calendar year. e. .one o$ the a&ove. /.S0 1 The corporation can deduct only the annuali?ed amount paid in the period $rom >cto&er 1, 2!!) through =ecem&er 31, 2!!) calculated as $ollows0 $1 ,!!! F $1 ,!!!J(12 G 3+I3K R $<!,!!!. 4TS0 1 5670 p. 1<C< 8 6'ample <

"!

- . ;n 2!!), :od$rey received a $ ,!!! re$und o$ his 2!!< state income ta'. #e included the re$und in his 2!!) gross income in accordance with the ta' &ene$it rule (i.e., &ecause the state income ta' had &een deducted on his 2!!< 7ederal income ta' return+. ;n 2!!@, :od$rey%s 2!!< state income ta' return was audited and he was required to pay an additional $",!!! o$ state income ta'. :od$rey was in the 1 * ta' &racket in 2!!< and 2!!), &ut his marginal ta' &racket in 2!!@ is 3 *. #e will itemi?e his deductions on his 2!!@ return. a. The $",!!! payment in 2!!@ is not deducti&le. &. :od$rey must amend his 2!!) return. c. The $",!!! payment in 2!!@ will reduce his 2!!@ 7ederal income ta' &y $<!! ($",!!! 1 *+. d. :od$rey can reduce his 2!!@ 7ederal income ta' &y $1,"!! ($",!!! 3 *+. e. .one o$ the a&ove. /.S0 = The ta' year in which the $",!!! payment is made (2!!@+ applies $or the deduction even though the deduction is an adjustment to income ta'ed at a lower rate. 4TS0 1 5670 p. 1<C- 8 6'ample 12 -<. Which o$ the $ollowing is permitted to use the cash method o$ accounting, a. / retail &usiness with average annual gross receipts o$ $@!!,!!!. &. / medical doctor with average annual gross receipts o$ $2,!!!,!!!. c. /n insurance agency with average annual gross receipts o$ $2,!!!,!!!. d. /ll o$ the a&ove are permitted to use the cash method. e. .one o$ the a&ove is permitted to use the cash method. /.S0 = :enerally, sales and cost o$ goods sold $or the retail &usiness must &e reported &y the accrual method &ecause inventories are material. #owever, $or a., the small &usiness e'ception applies. There$ore, the retailer in a. can use the cash method. The cash method can &e used in &. and c. &ecause the medical doctor and insurance agency are service entities. 4TS0 1 5670 pp. 1<C1! to 1<C12

"1

-). The accrual method generally must &e used to report income0 ;. ;;. ;;;. a. &. c. d. e. 7rom longCterm construction contracts. 6arned &y a partnership with a corporate partner. 6arned &y an incorporated pu&lic accounting $irm with gross receipts in e'cess o$ $ ,!!!,!!!. /ll o$ the a&ove are true. >nly ;;; is true. >nly ;; and ;;; are true. >nly ;; is true. .one o$ the a&ove is true.

/.S0 = ; is not true &ecause contractors may &e required to use the completed contract method or the percentage o$ completion method. ;;; is not true &ecause a pu&lic accounting $irm is a personal services corporation. 4TS0 1 5670 pp. 1<C12 to 1<C1 -@. Which o$ the $ollowing must use the accrual method o$ accounting, ;. ;;. ;;;. a. &. c. d. e. /n incorporated property management company with average annual gross receipts o$ $ !,!!!,!!!. /n incorporated law $irm with average annual gross receipts o$ $1,2!!,!!!. /n unincorporated grocery store with average annual gross receipts o$ $-!!,!!!. /ll o$ the a&ove must use the accrual method. .one o$ the a&ove must use the accrual method. >nly ; and ;;; must use the accrual method. >nly ; must use the accrual method. >nly ;;; must use the accrual method.

/.S0 = The incorporated property management company must use the accrual method. The incorporated law $irm is not required to use the accrual method under the small &usiness e'emption (average annual gross receipts are $ ,!!!,!!! or less+. The grocery store can use the cash method under the small &usiness e'ception (average annual gross receipts o$ $1,!!!,!!! or less+. 4TS0 1 5670 p. 1<C12

"2

--. ;n the case o$ an accrual &asis ta'payer, an item o$ income0 a. ;s not recogni?ed until cash is received. &. 7rom services is never recogni?ed until the services are per$ormed. c. ;s not recogni?ed i$ the customer can return the goods. d. ;s recogni?ed when all the events have occurred to $i' the ta'payer%s right to receive the income and the amount o$ the income can &e determined with reasona&le accuracy. e. .one o$ the a&ove. /.S0 = /nswer &. is incorrect &ecause prepaid income may &e recogni?ed &e$ore all o$ the services are per$ormed. 4TS0 1 5670 p. 1<C12 1!!. ;vory 7ast =elivery 1ompany, an accrual &asis ta'payer, $requently has claims $or damages to property the company delivered. >$ten the claim is not $iled until a month a$ter the delivery. ;n the past, appro'imately @!* o$ the claims are paid &y ;vory. /t the end o$ 2!!), $1 ,!!! in claims had &een $iled. The company re$used to pay $",!!! o$ the claims, and paid the other $11,!!! o$ claims in January 2!!@. /lso, in January 2!!@, claims $or $12,!!! were $iled $or deliveries made in 2!!), and $1!,!!! was paid on these claims &y Darch 2!!@. ;vory has elected to use the recurring item e'ception to economic per$ormance. Bnder the allCevents test, ;vory can accrue as an e'pense $or 2!!)0 a. $11,!!!. &. $1 ,!!!. c. $23,!!!. d. $2),!!!. e. .one o$ the a&ove. /.S0 / The allCevents test is not satis$ied until the customer makes a claim that ;vory acknowledged as a valid claim that it will pay. #owever, the $11,!!! $or actual claims $iled in 2!!) and paid in January 2!!@ can &e deducted in 2!!) under the recurring item e'ception. The claims $iled in January 2!!@ $or 2!!) services cannot &e deducted in 2!!) &ecause the claims had not &e $iled in 2!!) and there$ore, the allCevents test was not satis$ied &y the end o$ 2!!). 4TS0 1 5670 p. 1<C13 8 p. 1<C1"

"3

1!1. 1olor ;nc., is an accrual &asis ta'payer. ;n =ecem&er 2!!), the company received a &ill o$ $<!! $or o$$ice supplies that had &een purchased and used in .ovem&er. The &ill was not paid until January 2!!@. /lso in =ecem&er 2!!), the company received a claim $rom a customer $or $ !!. The merchandise was de$ective and 1olor paid the customer in January 2!!@. ;n January 2!!@, the company received a claim $or $-!! $or de$ective merchandise purchased in 2!!). 1olor paid the customer the $-!! in 7e&ruary 2!!@. /ssuming 1olor uses the recurring item e'ception to economic per$ormance, the company%s deductions $or 2!!) as a result o$ the a&ove are0 a. $ !!. &. $<!!. c. $1,1!!. d. $2,!!!. e. .one o$ the a&ove. /.S0 1 The allCevents test was not satis$ied in 2!!) $or the $-!! claim $or de$ective merchandise. The economic per$ormance test was satis$ied $or the o$$ice supplies when they were delivered (i.e., the other party provided the property+. The allCevents test was satis$ied in 2!!) $or the $ !! customer claim and the economic per$ormance test was also satis$ied when the payment was made within @ 1I2 months a$ter year end. 4TS0 1 5670 pp. 1<C12 to 1<C1 1!2. 4ink 1orporation is an accrual &asis ta'payer that uses the recurring item e'ception to the economic per$ormance test $or all relevant years. 7or 2!!), the corporation%s income su&ject to state income ta' was $3!!,!!! and the state corporate ta' rate was <*. =uring 2!!), the corporation paid $1 ,!!! on its state income ta' lia&ility $or that year. The remaining $3,!!! o$ 2!!) state income ta' was paid in Darch 2!!@. ;n Darch 2!!), the corporation paid $",!!! on its year 2!!< state income ta' lia&ility. /s a result o$ the a&ove0 a. 4ink should deduct $22,!!! as state income ta'es $or 2!!). &. 4ink should deduct $1-,!!! as state income ta'es $or 2!!). c. 4ink should deduct $1@,!!! as state income ta'es $or 2!!). d. 4ink should deduct $1 ,!!! as state income ta'es $or 2!!). e. .one o$ the a&ove. /.S0 1 4ink can deduct $1@,!!! (<* $3!!,!!!+ under the recurring item e'ception. The ta'es are recurringO allowing the deduction will result in an accurate matching o$ revenues and e'penses, and the ta'es are paid within @ 1I2 months a$ter the close o$ the ta' year. The $",!!! paid in 2!!) on 2!!< ta'es is deducted in 2!!< under the recurring item e'ception. 4TS0 1 5670 p. 1<C13 8 p. 1<C1"

""

1!3. :ray 1ompany, a calendar year ta'payer, allows customers to return de$ective merchandise $or a $ull re$und within 3! days o$ the purchase. ;n 2!!), the company re$unded $"!!,!!! $or claims involving sales. The $"!!,!!! consisted o$ $3 !,!!! in re$unds $rom 2!!) sales and $ !,!!! in re$unds $rom 2!!< sales. /ll o$ the re$unds $rom 2!!< sales were $or claims $iled in 2!!< and were paid in January and 7e&ruary 2!!). /t the end o$ 2!!), the company had $12,!!! in re$und claims $or sales in 2!!) $or which payment had &een approved. These claims were paid in January 2!!@. /lso in January 2!!@, the company received an additional $3!,!!! in claims $or sales in 2!!). This $3!,!!! was paid &y :ray in 7e&ruary 2!!@. With respect to the a&ove, :ray can deduct0 a. $3 !,!!! in 2!!). &. $3<2,!!! in 2!!). c. $3-2,!!! in 2!!). d. $""2,!!! in 2!!). e. .one o$ the a&ove. /.S0 A The $3 !,!!! claims paid in 2!!) $or 2!!) sales are deducti&le in that year. The $ !,!!! in claims $rom 2!!< sales should have &een deducted in 2!!< under the recurring item e'ception. The $12,!!! paid in January 2!!@ $or sales in 2!!) can &e deducted in 2!!) under the recurring item e'ception. The allCevents test was satis$ied in 2!!) when claims $or $12,!!! were approved. 6conomic per$ormance (payment+ occurred within @ 1I2 months a$ter the end o$ 2!!). The allCevents test was not satis$ied $or the $3!,!!! o$ claims $or 2!!) sales that were received in January 2!!@ and paid in 7e&ruary 2!!@. 4TS0 1 5670 p. 1<C13 8 p. 1<C1" 1!". :enerally, deductions $or additions to reserves (e.g., an allowance $or estimated warranty costs+ are not allowed $or income ta' purposes &ecause allowing the deduction would0 a. 5esult in a mismatching o$ revenues and e'penses. &. Eiolate the doctrine o$ constructive receipt. c. 5educe the costs o$ companies selling de$ective products. d. Eiolate the economic per$ormance requirement. e. .one o$ the a&ove. /.S0 = a. is incorrect &ecause the reason $or creating reserves is to match revenues and e'penses &etter. 4TS0 1 5670 p. 1<C1

"

1! . ;n 2!!), Swan 1ompany discovered that it had $or the past 1! years capitali?ed as a production cost certain e'penses that are properly classi$ied as administrative e'penses. This caused the ending inventory $or 2!!< to &e overstated &y $1 !,!!!. a. The company should amend its 2!!< ta' return. &. The company should change its accounting method in 2!!), with a $1 !,!!! negative P "@1 adjustment which reduces 2!!) ta'a&le income. c. The company should change its accounting method in 2!!), with a $3), !! negative P "@1 adjustment which reduces 2!!)C2!1! ta'a&le income. d. The company should change its accounting method in 2!!) and recogni?e a $1 !,!!! positive P "@1 adjustment which increases 2!!) ta'a&le income. e. .one o$ the a&ove. /.S0 A This is a voluntary change in accounting method with a negative P "@1 adjustment. 4TS0 1 5670 p. 1<C1) 8 6'ample 23 1!<. The ta'payer has consistently, &ut incorrectly, used an allowance $or &ad de&ts. /t the &eginning o$ the year, the &alance in the allowance account is $-!,!!!. a. ;$ the ;5S e'amines the ta'payer%s return and requires the ta'payer to change accounting methods, the ta'payer will &e required to recogni?e an additional $-!,!!! o$ income (oneChal$ in the current year and oneChal$ in the $ollowing year+ as the adjustment due to the change in accounting methods. &. ;$ the ta'payer voluntarily changes methods, the $-!,!!! adjustment can &e spread over the current and three $ollowing years. c. ;$ the ta'payer voluntarily changes methods, the $-!,!!! reserve can &e used to a&sor& &ad de&ts until the account &alance is ?ero. d. ;$ the ;5S e'amines the ta'payer%s return, no adjustment to the reserve account will &e required i$ the &alance is consistent with prior &ad de&t e'perience. e. .one o$ the a&ove. /.S0 A 5670 p. 1<C1< to 1<C1@

1!). When the ;5S requires a ta'payer to change accounting methods0 a. The ta'payer may &e su&ject to penalties and interest. &. The ta'payer generally is required to make the change as o$ the &eginning o$ the current ta' year. c. The adjustments due to the change can &e spread over su&sequent years. d. /ll o$ the a&ove are correct. e. .one o$ the a&ove is correct. /.S0 / /nswers &. and c. are incorrect &ecause the ;5S will require that the change &e made as o$ the &eginning o$ the earliest open ta' year. 4TS0 1 5670 p. 1<C1< 8 p. 1<C1@

"<

1!@. The ta'payer voluntarily changed $rom the cash to the accrual method o$ accounting, &ecause inventories were material to the ta'payer%s &usiness. The change resulted in a positive $<!,!!! adjustment to income. a. The ta'payer must add the $<!,!!! to income $or the year o$ the change. &. The ta'payer must amend all prior open years and compute income &y the accrual method and pay the additional ta'. c. The ta'payer must add $1 ,!!! to income $or the year o$ the change and add $1 ,!!! to the incomes $or each o$ the three preceding years. d. The ta'payer may add $1 ,!!! to the income $or the year o$ the change and to the incomes $or each o$ the three $ollowing years. e. .one o$ the a&ove. /.S0 = This is a voluntary change $rom a correct method to another correct method. The adjustment increases income. Bnder these circumstances, the ta'payer may spread the adjustment over " years (the current ta' year and the three $ollowing ta' years+. 4TS0 1 5670 p. 1<C1< 8 p. 1<C1) 1!-. /t the &eginning o$ 2!!), the ta'payer voluntarily changed $rom the cash to the accrual method o$ accounting. The relevant account &alances as o$ January 1, 2!!) were as $ollows0 /ccounts receiva&le ;nventory /ccounts paya&le $or merchandise $ -!,!!! 1! ,!!! ) ,!!!

a. The company has a positive adjustment to income o$ $12!,!!! that must &e recogni?ed in 2!!). &. The company has a negative adjustment to income o$ $12!,!!! that must &e taken in 2!!) income. c. The company has a positive adjustment to income that can &e allocated as $ollows0 $3!,!!! to 2!!) income, and $3!,!!! each to 2!!@C2!1! income. d. The company has a $12!,!!! positive adjustment to income that must &e allocated equally to 2!!)C2!!-. e. .one o$ the a&ove. /.S0 1 The change is voluntary and results in a positive $12!,!!! ($-!,!!! F $1! ,!!! G $) ,!!!+ adjustment to income. Aecause the change is voluntary, the ta'payer can spread the adjustment over the current year and the three $ollowing years. 4TS0 1 5670 p. 1<C1< 8 p. 1<C1)

")

11!. The installment method applies to which o$ the $ollowing sales with payments &eing made in the year $ollowing the year o$ sale, a. /n automo&ile dealer%s sale o$ an SBE. &. / cash &asis individual%s sale o$ :eneral 6lectric common stock. c. / manu$acturer%s sale o$ $ullyCdepreciated equipment. d. /ll o$ the a&ove. e. .one o$ the a&ove. /.S0 6 The inventory in a., the pu&liclyCtraded securities in &., and the P 12" depreciation recapture in c. are not eligi&le $or the installment method. 4TS0 1 5670 p. 1<C1@ 8 p. 1<C1111. The installment method applies where a payment will &e received a$ter the ta' year o$ the sale0 a. Ay an investor who sold real estate at a gain. &. Ay an investor who sold real estate at a loss. c. Ay an appliance dealer who sold inventory. d. Ay an investor who sold ;AD 1orporation common stock. e. .one o$ the a&ove. /.S0 / The installment method does not apply to reali?ed losses (answer &.+ or to inventory (answer c.+. 4u&liclyCtraded securities are ineligi&le $or the installment method (answer d.+. 4TS0 1 5670 p. 1<C1@ 112. ;n 2!!), #elen sold property and reported her gain &y the installment method. #er &asis in the property was $1 !,!!! ($2!!,!!! cost less $ !,!!! o$ depreciation+. #elen sold the property $or $3!!,!!!, with $) ,!!! due on the date o$ the sale and $22 ,!!! (plus interest at the 7ederal rate+ due in 2!!-. #elen%s recogni?ed installment sale gain in 2!!- is0 a. $!. &. $ !,!!!. c. $) ,!!!. d. $1 !,!!!. e. .one o$ the a&ove. /.S0 1 The total gain is $1 !,!!! ($3!!,!!! G $1 !,!!!+. This includes $ !,!!! o$ depreciation recapture that is not eligi&le $or installment reporting. The remaining $1!!,!!! gain will &e spread over the collection o$ the $3!!,!!! (the contract price+. ;n the year o$ sale, $) ,!!! is collected. There$ore, $2 ,!!! J$) ,!!! ($1!!,!!!I$3!!,!!!+K installment sale gain and $ !,!!! depreciation recapture must &e recogni?ed in the year o$ sale. The remaining gain o$ $) ,!!! ($1 !,!!! G $ !,!!! G $2 ,!!!+ must &e recogni?ed when the $22 ,!!! is collected in 2!!-0 $22 ,!!! ($1!!,!!!I$3!!,!!!+. 4TS0 1 5670 pp. 1<C1- to 1<C21

"@

113. #al sold land held as an investment with a $air market value o$ $1!!,!!! $or $3<,!!! cash and a note $or $<",!!! that was due in two years. The note &ore interest o$ 11* when the applica&le 7ederal rate was )*. #al%s cost o$ the land was $"!,!!!. Aecause o$ the &uyer%s good credit record and the high interest rate on the note, #al thought the $air market value o$ the note was at least $)",!!!. a. #al can elect to treat the $3<,!!! as a recovery o$ capital. &. #al must recogni?e $)!,!!! gain in the year o$ sale. c. #al must recogni?e $<!,!!! gain in the year o$ sale. d. Bnless #al elects not to use the installment method, #al must recogni?e $21,<!! gain in the year o$ sale. e. .one o$ the a&ove. /.S0 = Bnder the installment method, #al%s recogni?ed gain in the year o$ sale is as $ollows0 J($1!!,!!! G $"!,!!!+I$1!!,!!!K $3<,!!! R $21,<!! 4TS0 1 5670 pp. 1<C1@ to 1<C21 11". Todd, a 14/, sold land $or $2!!,!!! plus a note $or $"!!,!!!. The interest rate on the note was equal to the 7ederal rate. The $air market value o$ the note was $3<!,!!!. Todd%s &asis in the land was $) ,!!!. a. ;$ Todd uses the accrual &asis to report the income $rom his practice, he cannot use the installment method to report the gain on the sale o$ the land. &. ;$ Todd uses the cash &asis to report the income $rom his practice, he cannot use the installment method to report the gain $rom the sale o$ the land. c. ;$ Todd uses the installment method to report the gain, the contract price is $<!!,!!!. d. ;$ Todd does not use the installment method, his gain in the year o$ sale is $12 ,!!! ($2!!,!!! G $) ,!!!+. e. .one o$ the a&ove. /.S0 1 The contract price is $<!!,!!!, the $2!!,!!! down payment plus the $ace amount o$ the note o$ $"!!,!!!. The installment method can &e used to report the gain on the land regardless o$ the method o$ accounting the ta'payer uses to report the income $rom his trade or &usinessO thus, answers a. and &. are incorrect. /nswer d. is incorrect &ecause the note o$ $"!!,!!! would &e included in the amount reali?ed $or the cash &asis sale. 4TS0 1 5670 p. 1<C2!

"-

11 . Juan, not a dealer in real property, sold land that he owned with an adjusted &asis o$ $"!!,!!! that was encum&ered &y a mortgage $or $2!!,!!!. The terms o$ the sale required the &uyer to pay Juan $1 !,!!! on the date o$ the sale. The &uyer assumed Juan%s mortgage and gave Juan a note $or $" !,!!! (plus interest at the 7ederal rate+ due in the $ollowing year. What is the gross pro$it percentage, a. "!!I@!! R !*. &. "!!I<!! R <<.<)*. c. <!!I@!! R ) *. d. "!!I" ! R @@.@-*. e. .one o$ the a&ove. /.S0 A The gross pro$it percentage is the gain divided &y the contract price. The contract price is the selling price less the seller%s o&ligations assumed &y the &uyer. The selling price is the total consideration received &y the &uyer, e'clusive o$ interest. Juan%s selling price is $@!!,!!! ($2!!,!!! mortgage assumed plus the $1 !,!!! cash received plus the $" !,!!! &uyer%s note+. Juan%s gross pro$it is $"!!,!!! ($@!!,!!! less $"!!,!!! &asis+. The contract price is $<!!,!!! ($@!!,!!! selling price less $2!!,!!! mortgage assumed &y the &uyer+. There$ore, the gross pro$it percentage is $"!!,!!!I$<!!,!!! R <<.<)*. 4TS0 1 5670 p. 1<C1- 8 p. 1<C2! 11<. 4edro, not a dealer, sold real property that he owned with an adjusted &asis o$ $<!,!!! and encum&ered &y a mortgage $or $2@,!!! to 4at in 2!!). The terms o$ the sale required 4at to pay $1",!!! cash, assume the $2@,!!! mortgage, and give 4edro eleven notes $or $<,!!! each (plus interest at the 7ederal rate+. The $irst note was paya&le two years $rom the date o$ sale and each succeeding note &ecame due at twoCyear intervals. 4edro did not Xelect outX o$ the installment method $or reporting the transaction. ;$ 4at pays the 2!!- note as promised, what is the recogni?ed gain to 4edro in 2!!- (e'clusive o$ interest+, a. $<,!!!. &. $3,<!!. c. $2,"!!. d. $!. e. .one o$ the a&ove. /.S0 A The reali?ed gain on the sale is $"@,!!! ($<<,!!! F $1",!!! F $2@,!!! G $<!,!!!+. The contract price is $@!,!!! ($1!@,!!! amount reali?ed G $2@,!!! mortgage assumed+. The recogni?ed gain is calculated as $ollows $or 2!!-0 $"@,!!! $<,!!! R $3,<!! $@!,!!! Since the mortgage assumed o$ $2@,!!! does not e'ceed the adjusted &asis o$ $<!,!!!, there is no deemed payment pro&lem in 2!!). 4TS0 1 5670 p. 1<C1- 8 p. 1<C2!

11). 1harlotte sold her unincorporated &usiness $or $3<!,!!! in 2!!). The sales contract allocated $1 !,!!! to equipment, $11!,!!! to land, and $1!!,!!! to goodwill. 1harlotte had a $! &asis in the goodwill, the land cost $<!,!!!, and the equipment originally cost $2 !,!!! &ut it was $ully depreciated. What is the amount o$ the gain eligi&le $or installment sales treatment, a. $!. &. $1 !,!!!. c. $1" ,!!!. d. $2 ,!!!. e. .one o$ the a&ove. /.S0 A The $1 !,!!! gain on the equipment is all P 12" depreciation recapture and there$ore is ineligi&le $or the installment method. The gain on the land o$ $ !,!!! and the $1!!,!!! gain $rom the sale o$ the goodwill are eligi&le $or the installment method. There$ore, the amount o$ gain eligi&le $or installment sales treatment is $1 !,!!! ($1!!,!!! F $ !,!!!+. 4TS0 1 5670 p. 1<C1- 8 p. 1<C2! 11@. ;n 2!!), .orma sold Tinc, ;nc., common stock $or $1!!,!!! cash and a note receiva&le $or $-!!,!!!. The note was due in 2!!@ with accrued interest at the 7ederal rate. .orma%s &asis in the stock was $2 !,!!!. This was .orma%s only installment sale transaction. Which o$ the $ollowing statements is correct, a. .orma cannot use the installment method to report her gain i$ the stock is listed on the .ew Lork Stock 6'change. &. .orma must recogni?e $) ,!!! gain in 2!!) and she will &e lia&le $or interest on ta'es de$erred under the installment method. c. .orma must recogni?e $) ,!!! gain in 2!!) and she will not &e lia&le $or interest on the ta'es de$erred under the installment method i$ the stock is not pu&licly traded. d. .orma should treat the $1!!,!!! received as a recovery o$ capital. e. .one o$ the a&ove. /.S0 / The sale does not quali$y $or the installment method i$ the stock is listed on the .ew Lork stock e'change. The installment method is denied $or reporting the gains on stocks and securities i$ they are traded on an esta&lished market. 4TS0 1 5670 p. 1<C1@ 8 p. 1<C1-

11-. /l&ert is in the 3 * marginal ta' &racket. #e sold a &uilding in the current year $or $3!!,!!!. /l&ert received $1!!,!!! cash at closing, the &uyer assumed /l&ert%s mortgage $or $12!,!!!, and the &uyer gave /l&ert a <* note $or $@!,!!! due in two years. The 7ederal rate was <*. /l&ert%s &asis in the &uilding was $1@!,!!! ($"!!,!!! cost G $22!,!!! accumulated straightCline depreciation+. /ssuming he did not elect out o$ the installment method, /l&ert%s gain ta'ed as ordinary income and at the 2 * rate in the year o$ sale are what amounts, >rdinary :ain a. $12!,!!! &. $! c. $33,333 d. $! e. $1!!,!!! Bnrecaptured P 12 ! :ain Ta'ed at 2 * $! $1!!,!!! $<<,<<) $<<,<<) $!

/.S0 = The total reali?ed gain is $12!,!!! ($3!!,!!! amount reali?ed G $1@!,!!! adjusted &asis+. The contract price is $1@!,!!! ($3!!,!!! G $12!,!!! seller%s mortgage assumed &y the &uyer+. The entire recogni?ed gain o$ $<<,<)! is unrecaptured P 12 ! gain &ecause it is less than the depreciation (straight line+ that was deducted ($22!,!!!+. $12!,!!! $1@!,!!! R <<.<)* gross pro$it percentage

$1!!,!!! payments <<.<)* R $<<,<)! recogni?ed gain There is no P 12 ! depreciation recapture &ecause the straightCline method was used. This unrecaptured P 12 ! gain is ta'ed at the 2 * alternative ta' rate. 4TS0 1 5670 pp. 1<C1@ to 1<C2" 12!. Jay sold land (a capital asset+ to an unrelated party $or $2!,!!! cash and a -* note $or $1!!,!!! due in two years. #is &asis in the land was $"!,!!!. Which o$ the $ollowing statements is correct, a. ;$ the 7ederal rate is <*, interest will &e imputed at that rate. &. ;$ the 7ederal rate is )*, interest will not &e imputed. c. ;$ the 7ederal rate is -*, interest will &e imputed at 1!*. d. /ll o$ the a&ove. e. .one o$ the a&ove. /.S0 A /lternative &. is correct. ;$ the principal amount is less than $2.@ million (adjusted $or in$lation amount $or 2!!< is $",<3!,3!!+, -* interest can &e charged. ;n &., &ecause the stated rate (-*+ is greater than the 7ederal rate, no interest is imputed. 4TS0 1 5670 p. 1<C2! 8 p. 1<C21 8 1oncept Summary 1<C1

121. Taylor sold a capital asset on the installment &asis and did not charge interest on the de$erred payment due in three years. a. ;nterest will &e imputed, thus increasing the capital gain. &. ;nterest will &e imputed, thus creating ordinary income. c. ;nterest will not &e imputed &ecause the contract is $or less than $ive years. d. ;nterest will &e imputed, thus reducing the seller%s total income $rom the transactions. e. .one o$ the a&ove. /.S0 A When the interest is imputed, the selling price is reduced &y the amount o$ the imputed interest. There$ore, the gain is reduced &y the amount o$ the newly created interest income. The timing o$ the income is a$$ected &ecause the gain without any interest would &e reported in proportion to the payments collected each year. #owever, with interest, the total price is reduced and the interest accrues &ased on the &alance o$ the outstanding receiva&le. The payment is $irst allocated to interest and then to principal. There$ore, the interest payments will decrease as more is paid on principal. 4TS0 1 5670 p. 1<C2! 8 p. 1<C21 122. 5elatedCparty installment sales include all o$ the $ollowing except the $irst seller%s0 a. Arothers and sisters. &. 1ontrolled corporations. c. 9ineal descendants. d. 4artnerships in which the seller has an interest. e. /ll o$ the a&ove would &e considered related parties. /.S0 6 5670 pp. 1<C21 to 1<C23

123. ;n 2!!), 7ather sold land to Son $or $) ,!!! cash and an installment note $or $22 ,!!!. 7ather%s &asis was $12!,!!!. ;n 2!!@, a$ter paying $2",!!! interest &ut nothing on the principal, Son sold the land $or $3!!,!!! cash. /s a result o$ the second disposition, what gain must 7ather recogni?e in 2!!@, a. $1@!,!!!. &. $13 ,!!!. c. $12!,!!!. d. $<!,!!!. e. .one o$ the a&ove. /.S0 A 7ather%s reali?ed gain is $1@!,!!! ($3!!,!!! amount reali?ed G $12!,!!! adjusted &asis+. ;n 2!!), 7ather recogni?ed gain o$ $" ,!!! as $ollows0 $1@!,!!! $) ,!!! R $" ,!!! $3!!,!!! The proceeds o$ the sale &y Son in 2!!@ (to the e'tent o$ $22 ,!!!+ are attri&uted to 7ather. 7ather is deemed to have received payment o$ the $22 ,!!! receiva&le $rom Son when the second sale occurred. This results in the recognition o$ the remaining reali?ed gain o$ $13 ,!!! ($1@!,!!! G $" ,!!!+ o$ gain in 2!!@. 4TS0 1 5670 p. 1<C21 8 p. 1<C22

12". ;n 2!!), Sathy sold an apartment &uilding to her 1!! percent controlled corporation, Sathy, ;nc. The apartment &uilding cost $ !!,!!! and the &alance in the accumulated depreciation account was $"!!,!!!. Sathy, ;nc. paid $1!!,!!! in the year o$ sale and gave Sathy a note $or $-!!,!!! plus adequate interest due in 2!!-. a. Sathy can use the installment method only i$ ta' avoidance was not a principal purpose o$ the transaction. &. Sathy generally cannot report the gain &y the installment method. c. a and & are true. d. a and & are $alse. e. .one o$ the a&ove. /.S0 1 The related party sale o$ deprecia&le property results in a penalty. Section " 3(g+ provides generally that the installment method is not availa&le. #owever, i$ the ta'payer can esta&lish that ta' avoidance was not a principal purpose o$ the transaction, the installment method can &e used. 4TS0 1 5670 p. 1<C23 8 6'ample 212 . Which o$ the $ollowing is (are+ a ta'a&le disposition o$ an installment o&ligation, (1+ Trans$er to a relative as a gi$t. (2+ Trans$er to the trans$eror%s 1!!* owned corporation. (3+ Trans$er to a partnership $or an interest in partnership capital and pro$its. a. &. c. d. e. (1+ only. (1+ and (2+. (1+, (2+, and (3+. (2+ and (3+. .one o$ the a&ove.

/.S0 / :i$ts are treated as ta'a&le dispositions o$ installment o&ligations. 4TS0 1 5670 p. 1<C23

"

12<. :old 1orporation sold its "!* o$ the 5u&y 1orporation common stock. :old received $@,!!!,!!! in the year o$ the sale and a note $or $12,!!!,!!!, paya&le in three years with interest at the 7ederal rate. :old%s &asis in the stock was $2,!!!,!!!. /ssume that :old 1orporation will report the gain &y the installment method where the method is permitted. a. ;$ the 5u&y 1orporation stock is traded on a national e'change, :old must recogni?e $1@,!!!,!!! gain in the year o$ sale. &. ;$ the 5u&y 1orporation stock is not traded on an esta&lished market, :old must recogni?e a $),2!!,!!! gain in the year o$ sale. c. ;$ the 5u&y 1orporation stock is not traded on a national e'change, :old must pay interest on a portion o$ the de$erred ta'es. d. /ll o$ the a&ove are true. e. .one o$ the a&ove is true. /.S0 = /nswer a. is correct &ecause pu&licly traded property is not eligi&le $or installment reporting. /nswer &. is correct &ecause the gain is -!* o$ the selling price and when $@,!!!,!!! was collected, the company was required to recogni?e $),2!!,!!! gain ($@,!!!,!!! -!*+. /nswer c. is correct &ecause outstanding installment o&ligations at the close o$ the ta' year e'ceed $ million. 4TS0 1 5670 pp. 1<C1- to 1<C21 12). ;n the case o$ a small home construction company that &uilds under longCterm contracts, generally0 a. The percentage o$ completion method must &e used. &. The percentage o$ completion method should &e used to de$er income. c. The completed contract method must &e used. d. The completed contract method de$ers income recognition. e. .one o$ the a&ove is true. /.S0 = The major ta' advantage o$ the completed contract method is the a&ility to de$er income. 4TS0 1 5670 p. 1<C2< 8 p. 1<C2)

12@. 5o&in 1onstruction 1ompany &egan a longCterm contract in 2!!). The contract price was $) !,!!!. The estimated cost o$ the contract in 2!!) was $<!!,!!!. The actual cost incurred in 2!!) was $3!!,!!!. The contract was completed in 2!!@ and the cost incurred that year was $"!!,!!!. Bnder the percentage o$ completion method0 a. 5o&in should report $<!,!!! o$ income in 2!!). &. 5o&in should report a $1!,!!! loss in 2!!@. c. 5o&in will receive interest (under the lookC&ack method+ on the overpayment o$ ta'es in 2!!). d. /ll o$ the a&ove are true. e. .one o$ the a&ove is true. /.S0 = The pro$it on the contract recogni?ed in 2!!) was calculated as $ollows0 $1 !,!!! $3!!,!!! R $<!,!!! $) !,!!! The total pro$it on the contract was $ !,!!! ($) !,!!! G $3!!,!!! G $"!!,!!!+. Aecause 5o&in reported pro$it on the contract o$ $<!,!!! in 2!!), 5o&in must report a $1!,!!! loss in 2!!@ and will receive interest on the overpayment o$ ta'es. 4TS0 1 5670 pp. 1<C2 to 1<C2@ 12-. Bnder the percentage o$ completion method, i$ the actual costs are YYYY the estimated costs, the ta'payer must pay interest on the underpayment o$ prior years% ta'es. a. :reater than. &. 9ess than. c. 6qual to or greater than. d. 6qual to. e. .one o$ the a&ove. /.S0 A Bnder the lookback method, the ta'payer is deemed to have underpaid prior years% ta'es, and interest must &e paid. 4TS0 1 5670 p. 1<C2@ 13!. 6ve trans$ers property (&asis o$ $12!,!!! and $air market value o$ $"!!,!!!+ to :reen 1orporation $or @!* o$ its stock (worth $3 !,!!!+ and a longCterm note (worth $ !,!!!+, e'ecuted &y :reen 1orporation and made paya&le to 6ve. /s a result o$ the trans$er0 a. 6ve recogni?es no gain. &. 6ve recogni?es a gain o$ $23!,!!!. c. 6ve recogni?es a gain o$ $2@!,!!!. d. 6ve recogni?es a gain o$ $ !,!!!. e. .one o$ the a&ove. /.S0 = / longCterm note is treated as M&oot.N Thus, 6ve is ta'ed on the value o$ the note received. 4TS0 1 5670 p. 1@C" 8 p. 1@C

<

131. /nn trans$erred land worth $2!!,!!!, with a ta' &asis o$ $"!,!!!, to Arown 1orporation, an e'isting entity, $or 1!! shares o$ its stock. Arown 1orporation has two other shareholders, Aill and Ao&, each o$ whom holds 1!! shares. With respect to the trans$er0 a. /nn has no recogni?ed gain. &. Arown 1orporation has a &asis o$ $1<!,!!! in the land. c. /nn has a &asis o$ $2!!,!!! in her 1!! shares in Arown 1orporation. d. /nn has a &asis o$ $"!,!!! in her 1!! shares in Arown 1orporation. e. .one o$ the a&ove. /.S0 1 The trans$er does not quali$y under P 3 1 as /nn has only a 1I3 interest in Arown 1orporation. The requirements o$ P 3 1 apply to trans$ers to an e'isting corporation, as well as to a newly $ormed corporation. 4TS0 1 5670 6'ample 12 132. Tara incorporates her sole proprietorship, trans$erring it to newly $ormed Alack 1orporation. The assets trans$erred have an adjusted &asis o$ $2"!,!!! and a $air market value o$ $3!!,!!!. /lso trans$erred was $1!,!!! in lia&ilities, $1,!!! o$ which was personal and the &alance o$ $-,!!! &eing &usiness related. ;n return $or these trans$ers, Tara receives all o$ the stock in Alack 1orporation. a. Alack 1orporation has a &asis o$ $2"1,!!! in the property. &. Alack 1orporation has a &asis o$ $2"!,!!! in the property. c. Tara%s &asis in the Alack 1orporation stock is $2"1,!!!. d. Tara%s &asis in the Alack 1orporation stock is $2"-,!!!. e. .one o$ the a&ove. /.S0 6 Tara has a recogni?ed gain o$ $1!,!!! that is the amount o$ the &oot she is treated as having received. Thus, her &asis in the Alack 1orporation stock is $2"!,!!! J$2"!,!!! (&asis o$ the property given up+ G $1!,!!! (&oot received+ F $1!,!!! (gain recogni?ed+K. Alack 1orporation%s &asis in the property is $2 !,!!! J$2"!,!!! (Tara%s &asis in the property+ F $1!,!!! (gain recogni?ed &y Tara+K. ;n terms o$ the $1!,!!! &oot, P 3 )(&+ taints all lia&ilities even though some are supported &y a &ona $ide &usiness purpose. 4TS0 1 5670 p. 1@C- 8 p. 1@C1!

133. Tim, a cash &asis ta'payer, incorporates his sole proprietorship. #e trans$ers the $ollowing items to newly created Wren 1orporation. /djusted Aasis $ 2!,!!! 11!,!!! 13 ,!!! 7air Darket Ealue $ 2!,!!! 1<!,!!! 13 ,!!!

1ash Auilding Dortgage paya&le (secured &y the &uilding and held $or 1 years+ With respect to this transaction0 a. Wren 1orporation%s &asis in the &uilding is $11!,!!!. &. Tim has no recogni?ed gain. c. Tim has a recogni?ed gain o$ $2 ,!!!. d. Tim has a recogni?ed gain o$ $ ,!!!. e. .one o$ the a&ove.

/.S0 = Bnder P 3 )(c+ Tim recogni?es gain to the e'tent lia&ilities (mortgage paya&le o$ $13 ,!!!+ e'ceed the &asis o$ all assets trans$erred J$11!,!!! (&uilding+ F $2!,!!! (cash+K. Wren 1orporation%s &asis in the &uilding is $11 ,!!! J$11!,!!! (Tim%s &asis+ F $ ,!!! (gain recogni?ed &y Tim+K. 4TS0 1 5670 p. 1@C@ to 1@C11 13". Dary trans$ers a &uilding (adjusted &asis o$ $1 ,!!! and $air market value o$ $-!,!!!+ to White 1orporation. ;n return, Dary receives @!* o$ White 1orporation%s stock (worth $< ,!!!+ and an automo&ile ($air market value o$ $ ,!!!+. ;n addition, there is an outstanding mortgage o$ $2!,!!! (taken out 1 years ago+ on the &uilding, which White 1orporation assumes. With respect to this transaction0 a. Dary%s recogni?ed gain is $1!,!!!. &. Dary%s recogni?ed gain is $ ,!!!. c. Dary has no recogni?ed gain. d. White 1orporation%s &asis in the &uilding is $1 ,!!!. e. .one o$ the a&ove. /.S0 / /s a result o$ the trans$er, Dary receives &oot o$ $ ,!!! ($air market value o$ the automo&ile+ and has additional gain o$ $ ,!!! (e'cess o$ the mortgage over the &asis o$ the &uilding+. Since the sum o$ these amounts is less than the reali?ed gain o$ $) ,!!!, $1!,!!! is recogni?ed under P 3 1(&+. White 1orporation%s &asis in the &uilding is $2 ,!!! J$1 ,!!! (Dary%s &asis in the &uilding+ F $1!,!!! (Dary%s recogni?ed gain+K. 4TS0 1 5670 p. 1@C" 8 p. 1@C- to 1@C12

13 . Sim owns 1!!* o$ the stock o$ 1ardinal 1orporation. ;n the current year Sim trans$ers an installment o&ligation, ta' &asis o$ $3!,!!! and $air market value o$ $2!!,!!!, $or additional stock in 1ardinal worth $2!!,!!!. a. Sim recogni?es no ta'a&le gain on the trans$er. &. Sim has a ta'a&le gain o$ $1)!,!!!. c. Sim has a ta'a&le gain o$ $1@!,!!!. d. Sim has a &asis o$ $2!!,!!! in the additional stock she received in 1ardinal 1orporation. e. .one o$ the a&ove. /.S0 / /n installment o&ligation quali$ies as MpropertyN under P 3 1. Thus, Sim recogni?es no gain on the trans$er. 1ardinal has a &asis o$ $3!,!!! in the installment o&ligation. 4TS0 1 5670 p. 1@C" 8 p. 1@C11

13<. 5ick trans$erred the $ollowing assets and lia&ilities to War&ler 1orporation. /djusted Aasis $21!,!!! " ,!!! 1 ,!!! 3!,!!! 7air Darket Ealue $22 ,!!! ) ,!!! 3!,!!! 3!,!!!

Auilding 6quipment /utomo&ile Dortgage (held $or $our years+ on &uilding

;n return 5ick received $) ,!!! in cash plus -!* o$ War&ler 1orporation%s only class o$ stock outstanding ($air market value o$ $22 ,!!!+. a. 5ick has a recogni?ed gain o$ $<!,!!!. &. 5ick has a recogni?ed gain o$ $) ,!!!. c. 5ick%s &asis in the stock o$ War&ler 1orporation is $2)!,!!!. d. War&ler 1orporation has the same &asis in the assets received as 5ick does in the stock. e. .one o$ the a&ove. /.S0 / 5ick has a reali?ed gain o$ $<!,!!! determined as $ollows. /mount reali?edZ 7air market value o$ the stock in War&ler 1orporation 1ash received 9ia&ility trans$erred 9ess0 Aasis o$ property trans$erred 5eali?ed gain $22 ,!!! ) ,!!! 3!,!!!

$33!,!!! (2)!,!!!+ $ <!,!!!

Aecause recogni?ed gain cannot e'ceed the lesser o$ the reali?ed gain ($<!,!!!+ or the &oot received ($) ,!!!+, the recogni?ed gain is $<!,!!!. 5ick%s &asis in the War&ler 1orporation stock is $22 ,!!! J$2)!,!!! (&asis o$ property trans$erred+ G $) ,!!! (&oot received+ G $3!,!!! (lia&ility trans$erred+ F $<!,!!! (gain recogni?ed+K. War&ler 1orporation%s &asis in the property trans$erred is $33!,!!! J$2)!,!!! (&asis in the property trans$erred+ F $<!,!!! (gain recogni?ed+K. 4TS0 1 5670 p. 1@C" 8 p. 1@C11

<!

13). Sarah and Tony (mother and son+ $orm =ove 1orporation with the $ollowing investments0 cash &y Sarah o$ $ ,!!!O land &y Tony (&asis o$ $3 ,!!! and $air market value o$ $" ,!!!+. =ove 1orporation issues 2!! shares o$ stock, 1!! each to Sarah and Tony. Thus, each receives stock in =ove worth $ !,!!!. a. Section 3 1 cannot apply since Sarah should have received 11! shares instead o$ only 1!!. &. /s a result o$ the trans$er, Tony recogni?es a gain o$ $1!,!!!. c. Tony%s &asis in the stock o$ =ove 1orporation is $ !,!!!. d. Section 3 1 may apply &ecause stock need not &e issued to Sarah and Tony in proportion to the value o$ the property trans$erred. e. .one o$ the a&ove. /.S0 = The $act that the stock was not in proportion to the value o$ the property trans$erred (choice a.+ does not prevent P 3 1 $rom applying. Since P 3 1 applies and no &oot was received, Tony does not recogni?e a gain (choice &.+. #is &asis in the stock is $3 ,!!! plus $ ,!!!, the &asis o$ the stock implicitly gi$ted &y Sarah to Tony (not $ !,!!! as in choice c.+. 4TS0 1 5670 p. 1@C" 8 p. 1@C11 8 6'ample < 13@. #unter and Warren $orm Tan 1orporation. #unter trans$ers equipment (&asis o$ $21!,!!! and $air market value o$ $1@!,!!!+ while Warren trans$ers land (&asis o$ $1 ,!!! and $air market value o$ $1 !,!!!+ and $3!,!!! o$ cash. 6ach receives !* o$ Tan%s stock. /s a result o$ these trans$ers0 a. #unter has a recogni?ed loss o$ $3!,!!!, and Warren has a recogni?ed gain o$ $13 ,!!!. &. .either #unter nor Warren has any recogni?ed gain or loss. c. #unter has no recogni?ed loss, &ut Warren has a recogni?ed gain o$ $3!,!!!. d. Tan 1orporation will have a &asis in the land o$ $" ,!!!. e. .one o$ the a&ove. /.S0 A This $act pattern clearly comes within the scope o$ P 3 1. /s such, #unter may not recogni?e the reali?ed loss o$ $3!,!!! (choice a.+. /lthough cash was involved, it was given and not received &y Warren (choice c.+. ;t is not, there$ore, &oot within the meaning o$ the P 3 1. Tan 1orporation will have a &asis o$ $1@!,!!! in the equipment trans$erred &y #unter ($21!,!!! carryover &asis reduced &y the $3!,!!! &uiltCin loss+ and $1 ,!!! in the land (not $" ,!!! as in choice d.+. 4TS0 1 5670 p. 1@C3 8 p. 1@C" 8 p. 1@C12 8 6'ample 21

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13-. =awn, a sole proprietor, was engaged in a service &usiness and reported her income on a cash &asis. 9ater, she incorporates her &usiness and trans$ers the assets o$ the &usiness to the corporation in return $or all the stock in the corporation plus the corporation%s assumption o$ the lia&ilities o$ her proprietorship. /ll the receiva&les and the unpaid trade paya&les are trans$erred to the newly $ormed corporation. The assets o$ the proprietorship had a &asis o$ $1! ,!!! and $air market value o$ $3!!,!!!. The trade accounts paya&le totaled $2 ,!!!. There was a note paya&le to the &ank in the amount o$ $- ,!!! that the corporation assumes. The note was issued $or the purchase o$ computers and other &usiness equipment. a. =awn has a gain on the trans$er o$ $1 ,!!!. &. The &asis o$ the assets to the corporation is $3!!,!!!. c. =awn has a &asis o$ $1!,!!! in the stock she receives. d. =awn has a ?ero &asis in the stock she receives. e. .one o$ the a&ove. /.S0 1 =awn has a &asis o$ $1!,!!! in the stock in the newly $ormed corporation J$1! ,!!! (&asis in the assets trans$erred to the corporation+ G $- ,!!! (lia&ilities assumed &y the corporation+K. Aecause the trade accounts paya&le give rise to a deduction, they are not considered to &e lia&ilities $or purposes o$ P 3 )(c+O thus, lia&ilities do not e'ceed &asis. ;n addition, the cash &asis paya&les are not considered in the computation o$ =awn%s stock &asis. =awn has no gain on the trans$er, and the &asis o$ the assets to the corporation is $1! ,!!!. 4TS0 1 5670 p. 1@C1! 8 p. 1@C11

<2

1"!. 1arl trans$ers land to 1ardinal 1orporation $or -!* o$ the stock in 1ardinal 1orporation worth $2!,!!! plus a note paya&le to 1arl in the amount o$ $"!,!!! and the assumption &y 1ardinal 1orporation o$ a mortgage on the land in the amount o$ $1!!,!!!. The land, which has a &asis to 1arl o$ $)!,!!!, is worth $1<!,!!!. a. 1arl will have a gain on the trans$er o$ $)!,!!!. &. 1arl will have a gain on the trans$er o$ $3!,!!!. c. 1ardinal 1orporation will have a &asis in the land trans$erred &y 1arl o$ $)!,!!!. d. 1ardinal 1orporation will have a &asis in the land trans$erred &y 1arl o$ $1<!,!!!. e. .one o$ the a&ove. /.S0 / The mortgage on the land e'ceeds 1arl%s &asis in the land &y $3!,!!!. This amount would &e gain under P 3 )(c+. ;n addition, the note paya&le to 1arl does not quali$y $or nonrecognition under P 3 1O thus, 1arl would have additional gain o$ $"!,!!!. /mount reali?ed0 Stock .ote 5elease o$ mortgage 9ess0 Aasis o$ land 5eali?ed gain 5ecogni?ed gain ($3!,!!! F $"!,!!!+ $ 2!,!!! "!,!!! 1!!,!!! $1<!,!!! ()!,!!!+ $ -!,!!! $ )!,!!!

1ardinal 1orporation will have a &asis o$ $1"!,!!! in the land J$)!,!!! (1arl%s &asis in the land+ F $)!,!!! (gain recogni?ed &y 1arl with respect to the trans$er o$ the land+K. 4TS0 1 5670 p. 1@C" 8 p. 1@C1! 1"1. Joe and Say $orm :ull 1orporation. Joe trans$ers cash o$ $2 !,!!! $or 2!! shares in :ull 1orporation. Say trans$ers property with a &asis o$ $ !,!!! and $air market value o$ $2"!,!!!. She agrees to accept 2!! shares in :ull 1orporation $or the property and $or providing &ookkeeping services to the corporation in its $irst year o$ operation. The value o$ Say%s services is $1!,!!!. With respect to the trans$er0 a. :ull 1orporation has a &asis o$ $2"!,!!! in the property trans$erred &y Say. &. .either Joe nor Say recogni?e gain on the e'changes. c. :ull 1orporation has a &usiness deduction under P 1<2 o$ $1!,!!!. d. :ull capitali?es $1!,!!! as organi?ational costs. e. .one o$ the a&ove. /.S0 1 :ull 1orporation has a &asis o$ $ !,!!! in the property it received $rom Say. Say has income o$ $1!,!!! on the e'change. :ull 1orporation deducts the $1!,!!! as a &usiness e'pense. 4TS0 1 5670 6'ample 23

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1"2. 6arl and Dary $orm 1row 1orporation. 6arl trans$ers property, &asis o$ $2!!,!!! and value o$ $1,<!!,!!!, $or ! shares in 1row 1orporation. Dary trans$ers property, &asis o$ $@!,!!! and value o$ $1,"@!,!!!, and agrees to serve as manager o$ 1row $or one yearO in return Dary receives ! shares o$ 1row. The value o$ Dary%s services is $12!,!!!. With respect to the trans$ers0 a. Dary will not recogni?e gain. &. 6arl will recogni?e a gain o$ $1,"!!,!!!. c. 1row 1orporation has a &asis o$ $1,"@!,!!! in the property it received $rom Dary. d. 1row will have a &usiness deduction o$ $12!,!!! $or the value o$ the services Dary will render. e. .one o$ the a&ove. /.S0 = 6arl will not recogni?e gain on the trans$er. Dary will have income o$ $12!,!!!, the value o$ the services she will render to 1row. 1row will have a &usiness deduction o$ $12!,!!!. 4TS0 1 5670 6'ample 23 1"3. 7our individuals $orm 1hickadee 1orporation under P 3 1. Two o$ these individuals, Jane and Walt, made the $ollowing contri&utions0 /djusted Aasis 7rom JaneZ 1ash 4atent 7rom WaltZ 6quipment (depreciation claimed o$ $1!!,!!!+ $3<!,!!! C!C 2"!,!!! 7air Darket Ealue $3<!,!!! "!,!!! 3)!,!!!

Aoth Jane and Walt receive stock in 1hickadee 1orporation equal to the value o$ their investments. a. Jane must recogni?e income o$ $"!,!!!O Walt has no income. &. .either Jane nor Walt recogni?e income. c. Walt must recogni?e income o$ $13!,!!!O Jane has no income. d. Walt must recogni?e income o$ $1!!,!!!O Jane has no income. e. .one o$ the a&ove. /.S0 A Aoth Jane and Walt are protected &y P 3 1 and have no income to recogni?e (choices a., c., and d.+. The depreciation recapture rules do not apply to Walt &ecause he does not recogni?e income $rom the transaction. 4TS0 1 5670 p. 1@C1 8 6'ample 2 8 6'ample 3

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1"". 9eonard trans$ers equipment (&asis o$ $"!,!!! and $air market value o$ $1!!,!!!+ $or additional stock in :reen 1orporation. /$ter the trans$er, 9eonard owns -!* o$ the stock. 9eonard had claimed depreciation o$ $ !,!!! on the equipment prior to trans$erring it to :reen 1orporation. With respect to the trans$er0 a. 9eonard has ordinary income o$ $ !,!!!. &. 9eonard has ordinary income o$ $ !,!!! and a P 1231 gain o$ $1!,!!!. c. :reen 1orporation has ordinary income o$ $ !,!!!. d. :reen 1orporation has a &asis o$ $"!,!!! in the equipment and it will have no depreciation recapture i$ it later disposes o$ the equipment in a ta'a&le transaction. e. .one o$ the a&ove. /.S0 6 The trans$er comes under P 3 1O thus, 9eonard has no recogni?ed gain and no depreciation to recapture. #owever, when :reen 1orporation later disposes o$ the equipment in a ta'a&le transaction, it must take into account the P 12" recapture potential originating with 9eonard. The &asis o$ the equipment to :reen is $"!,!!!. 4TS0 1 5670 6'ample 2 1" . :eorge trans$ers cash o$ $1 !,!!! to :rouse 1orporation, a newly $ormed corporation, $or 1!!* o$ the stock in :rouse worth $@!,!!! and de&t in the amount o$ $)!,!!!, paya&le in equal annual installments o$ $),!!! plus interest at the rate o$ -* per annum. ;n the $irst year o$ operation, :rouse has net ta'a&le income o$ $"!,!!!. ;$ :rouse pays :eorge interest o$ $<,3!! and $),!!! principal payment on the note0 a. :eorge has dividend income o$ $13,3!!. &. :rouse 1orporation does not have a ta' deduction with respect to the payment. c. :eorge has dividend income o$ $),!!!. d. :rouse 1orporation has an interest e'pense deduction o$ $<,3!!. e. .one o$ the a&ove. /.S0 = The payment will &e treated as a payment on the de&t. The interest will &e ordinary income to :eorge and produce a deduction to :rouse 1orporation. 4TS0 1 5670 6'ample 2@ 1"<. /dam trans$ers cash o$ $3!!,!!! and land worth $2!!,!!! to 1amel 1orporation $or 1!!* o$ the stock in 1amel. ;n the $irst year o$ operation, 1amel has net ta'a&le income o$ $)!,!!!. ;$ 1amel distri&utes $ !,!!! to /dam0 a. /dam has ta'a&le income o$ $ !,!!!. &. 1amel 1orporation has a ta' deduction o$ $ !,!!!. c. /dam has no ta'a&le income $rom the distri&ution. d. 1amel 1orporation reduces its &asis in the land to $1 !,!!!. e. .one o$ the a&ove. /.S0 / /dam will have a ta'a&le dividend o$ $ !,!!!. 1amel will not &e permitted a deduction $or the $ !,!!! payment &ecause dividends are not deducti&le &y the distri&uting corporation. 4TS0 1 5670 p. 1@C1)

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1"). When 4heasant 1orporation was $ormed under P 3 1, Sristen trans$erred property (&asis o$ $2<,!!! and $air market value o$ $22, !!+ $or P 12"" stock. Sristen%s &asis in the 4heasant stock is $2<,!!!. Three years later, 4heasant 1orporation goes &ankrupt and its stock &ecomes worthless. Sristen, who is single, owned the stock as an investment. Sristen%s loss is0 a. $2<,!!! capital. &. $22, !! ordinary and $3, !! capital. c. $3, !! ordinary and $22, !! capital. d. $2<,!!! ordinary. e. .one o$ the a&ove. /.S0 A 5670 6'ample 31

1"@. Shawn trans$ers property (&asis o$ $"!,!!! and $air market value o$ $3 ,!!!+ to 1ondor 1orporation in e'change $or P 12"" stock. The trans$er quali$ies as a nonta'a&le e'change under P 3 1O there$ore, Shawn%s &asis in the 1ondor stock is $"!,!!!. 7ive years later, Shawn sells the 1ondor stock $or $2 ,!!!. With respect to the sale, Shawn has0 a. /n ordinary loss o$ $1 ,!!!. &. /n ordinary loss o$ $1!,!!! and a capital loss o$ $ ,!!!. c. / capital loss o$ $1 ,!!!. d. / capital loss o$ $1!,!!! and an ordinary loss o$ $ ,!!!. e. .one o$ the a&ove. /.S0 A 7or purposes o$ P 12"" treatment, the &asis in the stock is $3 ,!!!. When the stock is sold $or $2 ,!!!, only $1!,!!! quali$ies as an ordinary lossO the remaining $ ,!!! loss is a capital loss. 4TS0 1 5670 p. 1@C21 8 6'ample 31

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