Fundamentals of Taxation 2017 Edition 10th Edition Cruz Solutions Manual Download

Solutions Manual
Fundamentals of Taxation 2017 Edition

10th Edition by Cruz ISBN 1259575543
9781259575549
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CHAPTER 7 – SOLUTIONS
END OF CHAPTER MATERIAL
Discussion Questions
1. How are the terms basis, adjusted basis, and fair market value defined as they apply
to the calculation of gains and losses?
Answer:
a. Basis is defined as the cost of the property bought in cash, debt obligations, or
other property or services. Property can also be acquired other than through
purchase such as by gift, inheritance, divorce, or other exchange.
b. Adjusted basis is the cost, including any increases to the property such as
additions, or commission fees incurred on stock transactions, and decreases such as
depreciation on property and nontaxable stock dividends or splits.
c. Fair market value is the price at which the property would change hands between
a buyer and a seller, neither being forced to buy or sell and both having reasonable
knowledge of all the relevant facts. Sales of similar property, around the same date,
are typically used in figuring fair market value.
© 2017 by McGraw-Hill Global Education Holdings, LLC. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part.
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Learning Objective: 07-01

Topic: Terms
Difficulty: 1 Easy
EA: Yes
2. What is meant by the terms realized gain (loss) and recognized gain (loss) as they
apply to the sale of assets by a taxpayer?
Answer:
The term “realized” is everything the taxpayer receives in the transaction and is
sometimes called the proceeds from the sale. This includes cash received plus the
FMV of any property or services also received in the transaction plus any debt
obligations assumed by the purchaser. The term “recognized” is the amount that
will be recorded on the tax return as a gain or loss. Assets sold are considered
depending on the type of transaction.

Topic: Terms
Difficulty: 1 Easy
EA: Yes
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3. How can the gain from the sale of property be characterized? Why is it important to
correctly characterize the gain on the sale of property?
Answer:
The type of gain is dependent on the character (use) of the asset. Assets are
classified as ordinary income property, §1221 capital property (capital assets), or
§1231 trade or business property. It is important to correctly characterize the gain
on the sale of property because different types of gains are reflected differently on
the tax return. Depending on the nature of the asset, the gains can be taxed at
different rates.

Topic: Classification of Assets
Difficulty: 1 Easy
EA: Yes
4. What is a capital asset? What factors affect the determination of whether an asset is
classified as a capital asset?
Answer:
A capital asset includes assets that are not classified as other types of property, and
usually includes assets used for personal or investment purposes. The most obvious
example of a capital asset is stocks or bonds. Examples of other capital assets
include the taxpayer’s primary residence, timber grown on home property,
household furnishings, personal automobile, coin and stamp collections, and
jewelry. Capital assets do not include stock in trade of the taxpayer (inventory),
copyrights, accounts or notes receivables, and property subject to depreciation.

Topic: Capital Assets
Difficulty: 2 Medium
EA: Yes
5. What determines whether land is a capital asset? How else can land be classified?
Answer:
Land held for investment is a capital asset. However, if the land is used in a trade or
business, it is not a capital asset but a §1231 asset. If the land is held for resale by a
real estate developer, it is treated as inventory (an ordinary asset).

EA: Yes
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6. What is a §1231 asset? How are gains and losses from the sale of §1231 assets
treated? On what tax form are gains and losses from the sale of §1231 assets reported?
Answer:
IRC §1231 property is depreciable and nondepreciable property (including real
property) used in a trade or business and held for more than 1 year. Timber, coal,
domestic iron ore and certain livestock held for breeding, dairy, or sporting
purposes are also considered §1231 property. The most typical examples of §1231
assets are machinery and equipment, buildings, and land used in a business. When
a §1231 asset is sold, the gain may be either ordinary or capital. These gains (and/or
losses) on the sale are initially reported on Form 4797.

Topic: Trade or Business Property
EA: Yes
7. When we determine whether an asset is a §1231 asset, does the length of time the
asset is held affect the classification? Explain.
Answer:
By definition, IRC §1231 property is property, depreciable or nondepreciable, used
in a trade or business and held for more than 1 year.

Difficulty: 1 Easy
EA: Yes
8. What are the different classifications of capital assets? List each classification and the
rate at which the gains are taxed.
Answer:
Collectibles 28% rate
IRC §1202 Gain 28% rate
Unrecaptured §1250 Gain 25% rate
Other Capital Gains 0%, 15%, or 20% rate

Difficulty: 1 Easy
EA: Yes
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9. Discuss the concept of ordinary income property and give some examples.
Answer:
Ordinary income property can be defined as any asset that is not a capital asset.
The two most common ordinary assets are inventory and accounts receivable.

Topic: Sales of Ordinary Assets
Difficulty: 1 Easy
EA: Yes
10. What factors affect the taxability of capital gains and losses?
Answer:
Capital gains are taxed at preferential rates and capital losses are limited as to their
deductibility. The tax treatment of a capital gain or loss varies depending on several
factors, including the holding period of the capital asset, whether the sale of the
asset produced a gain or loss, the combination of capital gains and losses (a net
capital gain or a net capital loss), the type of capital asset sold, and the taxpayer’s
tax bracket.

Topic: Sales of Capital Assets
EA: Yes
11. Does the length of time a capital asset is held affect the gain or loss on the sale of the
asset? Explain.
Answer:
The length of time held does not affect the amount of the gain or loss but it does
affect the tax rate on the gain. Only long-term capital gains receive preferential tax
treatment.

Topic: Holding Period of Capital Assets
Difficulty: 1 Easy
EA: Yes
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12. How is a net capital loss treated? Include in your answer a discussion of how a net
capital loss is treated in relation to other income.
Answer:
Long-term capital losses must be netted with long-term capital gains. Short-term
capital losses must be netted with short-term capital gains. Then the two figures
must be netted together. Any remaining capital loss reduces ordinary income by a
maximum of $3,000 per year for individual taxpayers. Any excess may be carried
forward indefinitely to offset gains.

Topic: Netting Capital Gains and Capital Losses
Difficulty: 1 Easy
EA: Yes
13. In what ways can a capital asset be acquired, and how is the holding period
determined for each method of acquisition?
Answer:
Assets can be acquired by purchase, by gift, or through inheritance. For stocks,
bonds, other property, and other nontaxable exchanges, the holding period starts
the day after the taxpayer acquired the property. For a gift, if the taxpayer’s basis
is the donor’s basis, the holding period includes the donor’s period. If the
taxpayer’s basis is the FMV, the holding period starts the day after the date of the
gift. Property acquired through inheritance is always considered to have been held
longer than one year.

Difficulty: 3 Hard
EA: Yes
14. Capital gains can be taxed at several different rates. What determines the rate?
Answer:
Net long-term capital gains can be taxed at a 0%, 15%, 20%, 25%, or 28% rate.
Except for “unrecaptured” §1250 gains and “collectibles gains” (see below), long-
term capital gains are taxed at either 0%, 15% or 20%. The determination of the
percentage is based on the taxpayer’s taxable income and corresponding tax
bracket. The 25% rate relates to “unrecaptured” capital gains from depreciable
real property (buildings) used in a trade or business. The 28% capital gain rate
applies to “collectibles gains” and §1202 gains.

Topic: Capital Gain Rates
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EA: Yes
15. What is a §1202 gain, and how is it taxed?
Answer:
IRC §1202 provides a provision to limit the taxation on a gain from the sale of
“qualified small business stock.” In the case of a taxpayer other than a corporation,
gross income shall not include 75% of any gain from the sale or exchange of
qualified small business stock held for more than 5 years if the stock was purchased
after February 17, 2009 and before September 27, 2010 and 100% for stock
purchased after September 27, 2010 and before January 02, 2012. This 100%
exclusion has been extended to stock acquired before January 01, 2014 and held for
5 years.
For qualified small business stock that was purchased before February 17, 2009,
and held for longer than five years, 50% of any gain may be excluded from taxable
income. The remaining §1202 gain is taxed at the 28% capital gains rate.

Difficulty: 3 Hard
EA: Yes
16. Discuss the netting process of capital gains and losses. What are the possible
outcomes of the netting process, and how would each situation be taxed?
Answer:
In order to determine net capital gains and losses, the taxpayer must combine short-
term capital losses and short-term capital gains to obtain a net short-term capital
gain or loss. The long-term capital gains and losses must also be combined resulting
in a net long-term capital gain or loss. The net short-term gain or loss is then netted
with the long-term gain or loss unless the results of the initial netting created a net
short-term capital gain and a net long-term capital gain or a net short-term capital
loss and a net long-term capital loss.
The taxpayer must then separate the gains that are taxed at 28% (collectibles and
§1202 gains). If an overall net loss results, the individual taxpayer is allowed to
deduct up to a maximum of $3,000 against other income. Any net loss exceeding the
$3,000 is carried over indefinitely to offset other capital gains.
The netting process can result in several different outcomes.
• If the result is a net short-term gain and a net long-term gain, the tax is
paid at the regular tax rates for short-term gain and the net long-term
gain is taxed at the appropriate capital gains rate.
• If the result is a net short-term gain and a net long-term loss, the long-
term loss is offset against the short-term gain.
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o If the short-term gain exceeds the long-term loss, the short-term gain
is taxed at the regular tax rates.
o If a long-term loss results, the loss is allowed up to $3,000 against
other income and any excess is carried forward indefinitely.
• If the result is a net short-term loss and a net long-term gain, the long-
term gains need to be separated into the 28%, 25%, and 20%, 15% or
0% groups. The net short-term loss is first offset against the 28% group,
then the 25% group and if any loss remains, the 20%, 15% or 0% group
gains are reduced.
• If the result is a net short-term loss and a net long-term loss, only $3,000
of the losses can be deducted against other income. The short-term losses
are deducted first against other income and if any of the $3,000 limit
remains, the long-term loss is allowed (up to the $3,000 limit). Any excess
is carried forward indefinitely.

Topic: Netting of Capital Gains and Capital Losses
Difficulty: 3 Hard
EA: Yes
17. What is a §1245 asset? How is it related to a §1231 asset?
Answer:
A §1245 asset is personal trade or business property subject to depreciation. It does
not include land, buildings, and building structural components. A gain on the sale
of a §1245 asset is ordinary to the extent of depreciation taken. Any gain in excess
of depreciation taken is considered to be a §1231 gain and would potentially receive
long-term capital gain treatment. This type of gain is unusual because equipment
rarely appreciates, and any gain is usually caused by accelerated depreciation.

Topic: Sales of Business Property
EA: Yes
18. What is a §1250 asset? How is it related to a §1231 asset?
Answer:
A §1250 asset is depreciable real property used in a trade of business that has never
been considered §1245 asset property. It includes all buildings, residential and non-
residential, used in a business or for the production of income. Since an ordinary
expense deduction was allowed for depreciation on the asset, some or all of the gain
from the sale should be treated as ordinary. Any gain in excess of this gain is
considered a §1231 gain and may be taxed at the preferential rate. If there is a loss,
the loss is always treated as an ordinary loss.
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EA: Yes
19. Explain the terms recapture and unrecaptured provisions as they apply to §1250
assets.
Answer:
There are not many situations in which a sale of §1250 property is subject to
recapture, mostly because any depreciable real property purchased after 1986 must
be depreciated using the straight-line method. If the required depreciation is
straight-line, there cannot be any depreciation in excess of straight-line. Most real
property placed in service between 1981 and 1986 used accelerated methods over
periods of 15, 18, or 19 years.
Although it is likely the same taxpayers still own many of these buildings, most of
these properties are considered §1245 property. Most other buildings placed in
service prior to 1981 are likely to be fully depreciated under either straight-line or
some other method. Therefore, there would be no difference between methods in
the depreciation taken.
However, the gain representing straight-line depreciation deductions claimed by the

taxpayer is unrecaptured §1250 gain and is taxed at a rate of 25% up to
depreciation taken. The remaining gain is §1231 gain.

Topic: Recapture Provisions
Difficulty: 3 Hard
EA: Yes
20. What is a capital gain distribution, and how is it taxed?
Answer:
A capital gain distribution is a distribution of gains and losses to individual
shareholders accumulated from mutual funds. The taxpayer reports the capital
gain distribution (considered long-term) on Schedule D (any 28% gain will be
shown on the mutual fund statement and is separately reported on Schedule D).

Topic: Mutual Fund Capital Gain Distributions
Difficulty: 1 Easy
EA: Yes
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21. How can a taxpayer determine the basis of units from a mutual fund?
Answer:
The gain or loss from the sale of mutual fund stock is calculated by subtracting the
total cost basis from the sale proceeds. If the units were purchased at different
times for different prices, there are several rules that must be followed. The first-in
first-out method requires that the first shares purchased be deemed the first sold.
Using the specific identification method, the taxpayer specifies which units are to be
sold. Using the average basis method, the taxpayer takes the total cost basis and
divides by the total units to get an average cost per unit (single category method).
For sales after March 31, 2011, the “double-category method,” where an average is
calculated for the short-term basis and short-term units and an average is calculated
for the long-term basis and long-term units is not allowed.

Topic: Sales of Shares from a Mutual Fund
EA: Yes
22. How are gains (losses) from the sale of property acquired from a decedent taxed?
Answer:
The beneficiary can choose one of two valuation dates to determine FMV. They are
the date of death or six months after death (only if a federal estate return is filed),
which is termed the “alternate valuation” date. The holding period is always
considered long- term.

Topic: Sales of Inherited Property
Difficulty: 1 Easy
EA: Yes
23. Explain how gains (losses) from the sale of property acquired as a gift are taxed.
Answer:
If the FMV at the date of the gift is more than the basis, use the basis to the donor to
calculate the gain or loss on the sale.
If the FMV at the date of the gift is less than the basis, use the basis to the donor to
calculate the gain on the sale. Use the FMV to calculate the loss on the sale. If the
sales price is between the FMV and the basis to the donor, there is no gain or loss.
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Topic: Sales of Property Received as a Gift
Difficulty: 3 Hard
EA: Yes
Multiple Choice
24. Jim sells a parcel of land for $70,000 cash and the buyer assumes Jim’s liability of
$10,000 on the land. Jim’s basis is $62,000. What is the gain or loss on the sale?
a. $2,000 loss.
b. $2,000 gain.
c. $8,000 gain.
d. $18,000 gain.
Answer: d
Feedback: If the buyer assumes a liability, this is added to the amount realized from
the sale of the asset. In this case, the amount realized includes cash of $70,000 and
the assumed liability of $10,000 are added together as the proceeds. The gain is
calculated as $80,000 - $62,000.

Topic: Terms
Difficulty: 1 Easy
EA: Yes
25. All of the following statements regarding the definition of basis other than cost are
true except
a. The basis for assets received as a gift depends on whether the FMV is greater than,
equal to, or less than the donor’s basis at the time of the gift.
b. The basis of property transferred to a taxpayer from a former spouse pursuant to a
divorce decree is valued at the FMV at the date of the decree.
c. The basis of inherited property is the FMV at the date of death or alternate valuation
date that the personal representative is allowed by law to choose.
d. The basis for property received in exchange for services rendered is the FMV of the
property if the FMV of the services is not known beforehand.
Answer: b
Feedback: The basis of property transferred to a taxpayer from a former spouse

pursuant to a divorce decree is the same as the former spouse’s adjusted basis
before the transfer.

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Topic: Terms
EA: Yes
26. All of the following expenses increase the basis of stock held for investment except
a. Commission fees on the purchase of the stock.
b. Stock splits.
c. Stock dividends from a dividend reinvestment plan.
d. All of the above increase the basis of stock held for investment.
Answer: b
Feedback: In a stock split, the basis per share is decreased by the number of
additional shares given. In a two-for-one split, there will be twice as many shares;
however, the basis per share is reduced by half.

Topic: Terms
Difficulty: 1 Easy
EA: Yes
27. In 2005, Grant purchased land for $100,000 for use in his business. He sold it in
2016 for $106,000. What are the amount and type of gain on this sale, before netting of
any other gains and/or losses?
a. $6,000 short-term capital gain.
b. $6,000 long-term capital gain.
c. $6,000 ordinary income.
d. $6,000 §1231 gain.
Answer: d
Feedback: The land was used in his business and is considered a §1231 asset.

EA: Yes
28. On May 20, 2015, Jessica purchased land for $105,647 to use in her business. She
sold it on May 21, 2016 for $102,595. What are the amount and type of loss on this sale
if Jessica does not have any other sales from a trade or business?
a. $3,052 deferred loss.
b. $3,052 long-term capital loss.
c. $3,052 ordinary loss.
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d. $3,052 § 1231 loss.
Answer: c
Feedback: $105,647 basis - $102,595 sales price = $3,052 loss. Since this was land
used in her business the loss is considered ordinary.

Topic: Recognized Gains (Losses) from Ordinary Assets
Difficulty: 1 Easy
EA: Yes
29. Medhat and Neveen, married filing jointly, have $375,000 in MAGI and $80,000 of
net investment income (NII). They will pay a surtax of:
a. $0.
b. $1,710.
c. $2,850.
d. $3,040.
Answer: d
Feedback: The taxpayers met the threshold of $250,000. The rule is the lesser of the
net investment income or the difference in MAGI and the threshold. In this case,
$375,000 - $250,000 = $125,000 and the net investment income is $80,000; therefore
the surtax is calculated on $80,000.

EA: Yes
30. In 2005, Duncan purchased 2,000 shares of stock for $50,000 in a midsize local
company with gross assets of $15,000,000. In 2016, Duncan sold the stock for $68,000.
How is the gain treated for tax purposes?
a. $18,000 capital gain and taxed at preferential rates.
b. $9,000 excluded from gross income under §1202 and $9,000 taxed at regular rates.
c. $9,000 excluded from gross income under §1202 and $9,000 taxed at 28%.
d. $13,500 excluded from gross income under §1202 and $4,500 taxed at preferential
rates.
Answer: c
Feedback: There are special rules that apply to Qualified Small Business Stock. In
this problem, all the requirements have been met to qualify for this special tax
treatment. The amount of exclusion is 50% because the stock was purchased in
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2005. The 75% exclusion applies to stock purchased after February 17, 2009 and
before January 1, 2011 and held for more than five years.

EA: Yes
31. Blair sold the following stocks in 2016: 200 shares of Dearborn Investments
purchased May 15, 2015, for $3,050 and sold on January 9, 2016 for $4,135; and 40
shares of State Street Investments, purchased November 7, 2013, for $11,875 and sold on
March 29, 2016, for $8,675. What are the pre-net amount and nature of the gain (loss) on
the sale of these transactions on Blair’s 1040 return for 2016?
a. $1,085 short-term gain and $3,000 long-term loss.
b. $1,085 short-term gain and $3,200 long-term loss.
c. $1,915 net long-term loss.
d. $2,115 net long-term loss.
Answer: b
Feedback: Dearborn shares : $4,135 (sales price) - $3,050 (basis) = $1,085 short-
term gain. State Street Investments: $8,675 (sales price) - $11,875 (basis) = ($3,200)
long-term loss.

EA: Yes
32. Which statement is true regarding short-term capital gains?

a. If there are a net short-term gain and a net long-term gain, both gains are taxed at
regular rates.
b. A long-term loss offsets a short-term gain, and if a gain results, the gain is taxed at
regular rates.
c. A long-term loss offsets a short-term gain, and if a gain results, the gain is taxed at
preferential rates.
d. If there are a net short-term gain and a net long-term gain, both gains are taxed at
preferential rates.
Answer: b
Feedback: After netting capital gains and losses for long-term and short-term assets,
a resulting short-term gain is taxed at regular rates.

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Difficulty: 1 Easy
EA: Yes
33. Which is true regarding long-term capital gains?

a. A net long-term gain can offset a short-term gain but not a short-term loss.
b. A net long-term gain can be taxed at 28%, 25%, 20%, 15% or 0%, depending on the
type of gain generated.
c. A net long-term loss can be offset against a long-term gain, and if there is a resulting
long-term gain, it is taxed at regular rates.
d. A long-term loss can offset a long-term gain only if the netting result produces a loss
of more than $3,000.
Answer: b
Feedback: Depending on the tax bracket of the taxpayer, long-term gains can be
taxed at a preferential rate of 0%, 15%, or 20%. The tax rate of 25% is for
unrecaptured §1250 assets and the 28% is for §1202 assets and collectibles.

Difficulty: 1 Easy
EA: Yes
34. When there are a net short-term loss and a net long-term loss, which of the following
is true?
a. The entire short-term loss is used to reduce other income before the long-term loss can
be used to offset other income.
b. A long-term loss is used to reduce other income before the short-term loss.
c. Regardless of the amount of a short-term or long-term loss, the maximum amount of
loss that can be taken in any one year is $3,000. Any remaining loss amounts can be
carried forward for three years for individual taxpayers.
d. Regardless of the amount of a short-term or long-term loss, the maximum amount of
loss that can be taken in any one year is $3,000. Any remaining loss amounts can be
carried forward indefinitely for individual taxpayers.
Answer: d
Feedback: The maximum amount of a loss that can be taken in any one year is
$3,000 regardless of holding period status. Any remaining loss amounts can be
carried forward indefinitely to offset future year gains.
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Difficulty: 1 Easy
EA: Yes
35. Alton received a Form 1099-B that shows a net sales price of $2,500 on the sale of
600 shares of FNP Company. He bought the stock on October 21, 2015, and sold it on
October 22, 2016. His basis in the stock is $1,875, of which $25 is a commission fee.
What is the amount and nature of Alton’s gain?
a. $625 short-term gain.
b. $650 short-term gain.
c. $625 long-term gain.
d. $650 long-term gain.
Answer: c
Feedback: $2,500 (sales price) - $1,875 (basis) = $625 gain. The $25 commission fee
is included in the basis. The holding period is more than one year; therefore, it is a
long-term gain.

Difficulty: 1 Easy
EA: Yes
36. Amal received a Form 1099-DIV with a capital gain distribution of $210. She also
received a Form 1099-B from the sale of 240 shares of AMS stock she purchased for
$2,900 plus a $28 commission fee on February 22, 2015. The net proceeds of the stock
sale were $2,700 (the commission fee was $14) and the trade date was February 22, 2016.
What are the amount and nature of Amal’s gain (loss) on these transactions?
a. $214 short-term loss and $210 long-term gain.
b. $214 long-term loss and $210 short-term gain.
c. $228 long-term loss and $210 short-term gain.
d. $228 short-term loss and $210 long-term gain.
Answer: d
Feedback: Capital gain distributions are considered long-term.

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EA: Yes
37. Shannon bought an apartment building in July 2010 for $360,000 and sold it for
$480,000 in 2016. There was $77,994 of accumulated depreciation allowed on the
apartment building. Assuming that Shannon is in the 33% tax bracket, how much of her
gain is taxed at 25%?
a. $0.
b. $42,006.
c. $77,994.
d. $120,000.
Answer: c
Feedback: The amount of gain up to the accumulated depreciation taken is subject

to a rate of 25%. Any gain over that amount is taxed at preferential rates. This
rarely occurs.

Difficulty: 1 Easy
EA: Yes
38. Francisco, a single taxpayer, has income from his W-2 of $93,250. He also has a
short-term capital loss of $7,311 a short-term capital gain of $2,100, and a long-term
capital gain of $4,680. What is Francisco’s AGI for 2016?
a. $92,719.
b. $93,250.
c. $95,350.
d. $100,030.
Answer: a
Feedback: The short-term capital loss of $7,311 and short-term capital gain of
$2,100 are netted together to result in a net short-term capital loss of $5,211. This
net short-term capital loss can be used to completely offset the long-term capital
gain of $4,680, leaving a $531 short-term capital loss. AGI is $72,719 (wages of
$93,250 less short-term capital loss of $531).

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Difficulty: 1 Easy
EA: Yes
39. In 2016 Ann received 1,000 shares of stock as a gift from her husband Tim, who
purchased them in 2007. At the time of the gift, the FMV of the stock was $29,300 and
Tim’s basis was $31,000. If Ann sells the stock for $32,834 in 2016, what are the nature
and amount of the gain from the sale?
a. $1,834 long-term gain.
b. $3,534 long-term gain.
c. $1,834 short-term gain and $1,700 long-term gain.
d. $1,834 term gain and $1,700 short-term gain.
Answer: a
Feedback: If the FMV at time of gift was less than basis and the stock was sold for
more than basis, Ann would use Tim’s basis for calculating a gain. The holding
period (see Table 7-3) is the same as the donor’s.

EA: Yes
40. In 2016 Ann received 1,000 shares of stock as a gift from her husband Tim, who
purchased them in 2007. At the time of the gift, the FMV of the stock was $29,300 and
Tim’s basis was $31,000. If Ann sells the stock for $26,834 in 2016, what is the nature
and amount of the loss from the sale?
a. $2,466 short-term loss.
b. $1,700 long-term loss.
c. $4,166 long-term loss.
d. $2,466 short-term loss and $1,700 long-term loss.
Answer: a
Feedback: If the FMV at the time of the gift was less than basis and the stock was
sold for less than the FMV, Ann uses the FMV of the stock. The holding period (see
Table 7-3) when there is a loss starts the day after the date of the gift. In this case,
the loss is short-term.

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EA: Yes
Problems
41. Umair sold some equipment he used in his business on August 29, 2016, that was
originally purchased for $70,000 on November 21, 2015. The equipment was
depreciated using the 7-year MACRS method for a total of $18,574. Assume there is no
additional netting of gains and losses for this taxpayer.
a. Assume Umair sold the equipment for $50,000:

(1) What is the amount of realized gain or loss on the sale of the equipment?
(2) Is the nature of the gain or loss considered ordinary or long-term?
Answer:
a (1) ($1,426) loss
a (2) Ordinary
Feedback:
a (1) $50,000- $51,426 = ($1,426) loss
a (2) This is an ordinary loss and initially is recorded on Form 4797; if there is no
other netting, this amount will go on the front of Form 1040 as a loss.
b. Assume Umair sold the equipment for $60,000:

(1) What is the amount of realized gain or loss on the sale of the equipment?
(2) Is the nature of the gain or loss considered ordinary or long-term?
Answer:
b. (1) $8,574 gain
b. (2) Ordinary
Feedback:
b. (1) $60,000 - $51,426 = $8,574 gain
b. (2) This is §1245 property, and will be initially recorded on Form 4797. The gain
of $8,574 is taxed at regular rates up to the amount of depreciation taken.

Topic: Recognized Gain or Loss from Ordinary Assets
EA: Yes
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42. Alice owns undeveloped land with an adjusted basis of $160,000. She sells the
property to George for $205,000.
a. What is Alice’s realized and recognized gain?

b. To what IRC section does the gain on the property apply?
c. If the land is used in a trade or business, to what IRC section does the gain on the
property apply?
Answer:
a. $45,000
b. Section 1221
c. Section 1231
Feedback:
a. $205,000 - $160,000 = $45,000 realized and recognized gain.
b. This is a Capital Asset under Section 1221 Capital Property.
c. This is a Trade or Business Property Asset.

Difficulty: 1 Easy
EA: Yes
43. Haneen has taxable income of $115,000 without consideration of capital gain or loss
transactions. She has a short-term capital gain of $15,000, a long-term capital loss of
$7,000, and a short-term capital gain of $4,000. Assume none of the gains or losses are
from collectibles or unrecaptured §1250 property, and Haneen is in the 25% tax bracket.
a. What is the total short-term gain or loss?

b. What is the total long-term gain or loss?
c. What is the carryover amount?
d. Is the gain or loss after netting taxed at the ordinary or capital rate?
Answer:
a. $19,000 Gain
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b. $7,000 Loss
c. $0
d. Ordinary
Feedback:
a. Short-term Capital Gains $15,000 + $4,000 = $19,000
b. Long-term Capital Loss of $7,000
c. The $19,000 short-term gain offsets the $7,000 long-term loss leaving a $12,000
short-term gain.
d. After netting the result is a short-term gain of $12,000 that is taxed at ordinary
rates with no preferential tax treatment.

EA: Yes
44. Respond to the following independent situations:
a. Jacob is a single taxpayer who has net investment income consisting of $10,000
interest on a certificate of deposit, $5,000 from dividends from a mutual fund, $5,000
from capital gain distributions from mutual funds, and $40,000 in long-term capital gains
from selling some stocks, and his MAGI is $190,000.
(1). How much in surtax will Jacob be assessed on his Form 1040 for 2016?
b. Jacob is a single taxpayer who has net investment income consisting of $10,000
from selling stocks and his MAGI is $250,000.
c. Jacob is a single taxpayer who has net investment income consisting of $30,000 in
from selling some stocks and his MAGI is $300,000.
Answer:
a. (1) $0
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b. (1) $1,900
c. (1) $3,800
Feedback:
a. (1) The threshold for the surtax is $200,000 for a single taxpayer. The $60,000 in
net investment income is included in MAGI.
b. (1) The $200,000 threshold is met for a single taxpayer. The surtax is assessed on
the lesser of the net investment income of $60,000 or the amount over the threshold,
which in this situation is $50,000. $50,000 x 3.8% = $1,900.
c. (1) The $200,000 threshold is met for a single taxpayer. The surtax is assessed on
the lesser of the net investment income of $100,000 or the amount over the
threshold, which in this situation is $100,000. $100,000 x 3.8% = $3,800.

EA: Yes
45. Respond to the following independent situations:
a. Masa and Haiming, husband and wife, filing jointly, earn $275,000 in salaries and do
not have any net investment income.
(1). How much in surtax will Masa and Haiming be assessed on their Form 1040
for 2016?
b. Masa and Haiming, husband and wife, filing jointly, earn $200,000 in salaries and
$50,000 in capital gains, $50,000 in dividends, and $25,000 in savings interest for a total
MAGI of $325,000.
for 2016?
c. Masa and Haiming, husband and wife, filing jointly, earn $320,000 in salaries and
$50,000 in capital gains for a total MAGI of $370,000.
for 2016?
Answer:
a. (1) $0
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b. (1) $2,850
c. (1) $1,900
Feedback:
a. (1) The taxpayers do not have any net investment income.
b. (1) The taxpayers met the threshold of $250,000. The surtax is assessed on the
lesser of the net investment income of $125,000 or the amount by which they are
over the threshold, which is $75,000.
c. (1) The taxpayers met the threshold of $250,000. The surtax is assessed on the
lesser of the net investment income of $50,000 or the amount by which they are over
the threshold, which is $120,000.

EA: Yes
46. Jake purchased a $225,000 crane for his construction business. He sold the crane for
$170,000 after taking $115,000 of depreciation. Assume Jake is in the 33% tax rate
bracket.
a. On what form would the gain or loss originally be reported?
b. What is the amount of gain or loss on the sale?
c. What amount of the gain or loss is subject to ordinary tax rates?
Answer:
a. Form 4797
b. $60,000 Gain
c. $60,000
Feedback:
a. Sales of assets used in a trade or business are first recorded on Form 4797.
b. Sale Proceeds $170,000
Adjusted Basis 110,000
§1245 Gain $ 60,000
======
c. Since the property is §1245 property, the gain is ordinary to the extent of
depreciation taken. Thus, all the gain would be ordinary and reported on page 2 of
Form 4797.
Topic: Sales of Trade or Business Property
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EA: Yes
47. Brantley owns an automobile for personal use. The adjusted basis is $19,500, and the
FMV is $16,000. Assume Brantley has owned the automobile for two years.
a. Respond to the following if Brantley sells the vehicle for $16,000.

(1). What is the amount of realized gain or loss on the sale?
(2). What is the amount Brantley will recognize on his Form 1040?
b. Respond to the following if Brantley sells the vehicle for $20,000.

(1). What is the amount of realized gain or loss on the sale?
(2). What is the amount Brantley will recognize on his Form 1040?
Answer:
a. (1) $3,500 Realized Loss
a. (2) $0
b. (1) $5000 Realized Gain
b. (2) $500
Feedback:
a. (1) Sales Price $16,000
Basis 19,500
Realized Loss ($3,500)
a. (2) Since this is a personal asset, the loss on the sale would not be deductible.
b. (1) Sales Price $20,000
Basis 19,500
Realized Gain $ 500
b. (2) Since the automobile is a capital asset, the gain should be treated as a long-
term capital gain. The $500 realized gain would also be recognized.

EA: Yes
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48. Antoine sold the following stock in 2016. ABC, Inc., is a §1202 qualified small
business (QSB).
Asset Cost Acquired Sale Price Sale Date

ABC, Inc. 200 shares $148,000 1/10/08 $200,000 4/30/16
DEF, Inc. 100 shares 21,000 11/15/11 14,000 2/28/16
GHI, Inc. 50 shares 18,000 3/31/15 17,000 8/30/16
a. Complete the chart:
Asset Amount of Amount of Recognized IRC Section
Realized Gain Gain (Loss)
(Loss)
ABC
DEF
GHI
b. After netting, what is the total gain or loss?
c. If Antoine is in the 33% tax rate bracket, at what rate is the net gain or loss taxed?
Answer:
a.
Asset Amount of Realized Amount of Recognized IRC Section
Gain (Loss) Gain (Loss)
ABC $52,000 $26,000 1202
DEF ($7,000) ($7,000) 1221
GHI ($1,000) ($1,000) 1221
b. $18,000 gain
c. 28% tax rate
Feedback:
a. Realized and Recognized Gain
ABC $200,000 - $148,000 = $52,000 initial §1202 gain subject to 50%
exclusion with the remaining $26,000 taxed at 28%
DEF $ 14,000 - $ 21,000 = ($7,000) LTCL
GHI $ 17,000 - $ 18,000 = ($1,000) LTCL
b. The long-term gain from the sale of ABC (§1202 stock) and the long-term losses
from DEF and GHI stock are netted. The result is a net long-term capital gain of
$18,000, which is taxed at the 28% rate per the special rules that govern the sale of
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§1202 stock.
c. The maximum rate for a taxpayer in the 33% tax bracket is 15%; however, the
gain was from § 1202 stock that is taxed at the 28% rate.

Difficulty: 3 Hard
EA: Yes
49. Ricardo acquired a warehouse for business purposes on August 30, 1997. The
building cost $400,000. He took $226,900 of depreciation on the building, and then sold
it for $500,000 on July 1, 2016. What are the amount and nature of Ricardo’s gain or
loss on the sale of the warehouse?
a. What is the adjusted basis for the warehouse?

b. What amount of the gain or loss is realized on the sale of the warehouse?
c. What amount of the gain or loss is unrecaptured?
d. At what rate is the unrecaptured gain or loss taxed?
e. What amount of the gain or loss qualifies as a § 1231 gain or loss?
Answer:
a. $173,100
b. $326,900 Gain
c. $226,900
d. 25%
e. $100,000
Feedback:
Sales Price $500,000
Basis $400,000
Less Depreciation -$226,900
Adjusted basis (a) ($173,100)
Realized gain (b) $326,900 gain
Unrecaptured gain (c) $226,900 depreciation taken
Rate taxed (d) 25%
Gain qualified as § 1231 (e) $100,000

EA: Yes
50. Davidson Industries, a sole proprietorship, sold the following assets in 2016:
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Asset Cost Acquired Depreciation Sale Price Sale Date

Warehouse $150,000 10/10/09 $25,801 $175,000 3/15/16
Truck 18,000 1/15/15 6,480 16,000 1/14/16
Computer 25,000 7/31/15 6,634 17,000 8/31/16
a. The following questions relate to the sale of the warehouse:

(1). What is the adjusted basis of the warehouse?
(2). What is the realized gain on the warehouse?
(3). What amount of the gain is taxed according to § 1250 rules?
(4). What amount is considered a § 1231 gain before netting?
b. The following questions relate to the sale of the truck:

(1). What is the adjusted basis of the truck?
(2). What is the realized gain on the truck?
(3). What amount of the gain is taxed according to § 1245 rules?
(4). What amount of the gain is taxed as ordinary income?
c. The following questions relate to the sale of the computer:

(1). What is the adjusted basis of the computer?
(2). What is the realized gain or loss on the sale?
(3). Which IRC section code applies to this asset?
Answer:
a.(1) $124,199
a.(2) $50,801 Gain
a.(3) $25,801
a.(4) $25,000
b.(1) $11,520
b.(2) $4,480 Gain
b.(3) $0
b.(4)$4,480
c.(1) $18,366
c.(2)($1,366) loss
c.(3) 1231
Feedback:
Warehouse Truck Computer
Sales Price $175,000 $16,000 $17,000

Adj. Basis $124,199 $11,520 $18,366
Gain (Loss) $ 50,801 $ 4,480 ($1,366)
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The warehouse is a §1250 asset. The gain from the sale is treated as a long-
term capital gain ($25,801 of the gain would be an unrecaptured §1250 gain
subject to the 25% tax rate, the remaining gain of $25,000 is netted with
other §1231 gains and losses).
The truck is a §1245 asset subject to recapture to the extent of depreciation

taken, but because the asset was held for less than one year it is considered
an ordinary income asset and the $4,480 gain is treated as ordinary income.
The computer is a §1231 loss and therefore is netted with §1231 gains.
Difficulty: 3 Hard
EA: Yes
51. In 2016, Rosalva sold stock considered short-term for a gain of $875 and stock
considered long-term for a loss of $3,400. She also had a $3,000 short-term loss
carryover from 2015 and a $1,240 long-term loss carryover from 2014.
a. What amount will be shown as a short-term gain (loss) for 2016?

b. What amount will be shown as a long-term gain (loss) for 2016?
c. How much of the loss is deductible in 2016?
d. What is the amount of long-term carryover to 2017?
Answer:
a. ($2,125)
b. ($4,640)
c. $3,000
d. ($3,765)
Feedback:
a. $3,000 short-term loss carryover - $875 gain for 2016 = $2,125 short-term loss for
2016.
b. $1,240 long-term loss carryover + $3,400 loss for 2016 = $4,640 long-term loss for
2016.
c. The maximum amount of loss to be deducted in any one year is $3,000.
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d. The $2,125 short-term loss will be allowed in 2016 as well as $875 of the long-term
loss of $4,640. The remaining long-term loss of $3,765 will be a carryover long-term
loss to 2017.

EA: Yes
52. Lois purchased the following blocks of Westgate Stock:
Date Shares Price

June 12, 2013 1,000 $4.225
October 21, 2013 2,000 $4.775
December 18, 2015 1,500 $5.500
Lois sold 1,600 shares of the stock on November 20, 2016 for $5.00 per share for a total
of $8,000. Using the first-in, first-out method, what is the gain or loss on the sale of the
Westgate stock?
Answer:
$910 gain
Feedback:
Purchased:
1,000 sh x $4.225 = $4,225
600 sh x $4.775 = 2,865
$7,090
Sales price: 1,600 x $5.000 $8,000

Gain on Sale: $ 910 (Long-term)
What if 750 of the shares sold were identified as being from the October 21, 2013,
purchase and the remaining 850 shares from the December 18, 2015 purchase? Using the
specific identification method, what is the gain or loss on the sale of the Westgate stock?
Answer:
$168.75 gain (long-term)
($425) loss (short-term)
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Feedback:
Purchased: 750 sh x $4.775 = $3,581.25
Sell price: 750 sh x $5.000= $ 3,750.00

Gain on Sale: $ 168.75 (Long-term)
Purchased: 850 sh x $5.500 = $ 4,675.00
Sell price: 850 sh x $5.000= $ 4,250.00

Loss on Sale: ($ 425.00) (Short-term)

Topic: Sales of Stock
Difficulty: 3 Hard
EA: Yes
53. During 2016, Roberto sold 830 shares of Casual Investor Mutual fund for $8.875 per
share. The shares were purchased on the following dates:
Date Shares Price

May 31, 2012 400 $9.375
September 18, 2013 225 $8.500
October 21, 2013 425 $10.000
January 12, 2015 276 $7.125
Calculate the gain (loss) on the sale under the following assumptions (carry your
calculations to three places):
a. Basis is calculated using the first-in, first-out method.

b. Basis is calculated using the average cost method (assume all shares are long-term).
Answer:
a. ($346.250) loss
b. ($69.72) loss
Feedback:
a. FIFO method
Purchased:
400 shares @ $9.375 = $3,750.000
225 shares @ $8.500 = $1,912.500
205 shares @$10.00 = $2,050.000
Total basis: $7,712.500
Sale Proceed: $7,366.250
Loss: ($ 346.250)
b. Average Cost Method
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Average Cost: $11,879.00/1,326 shares = $8.959

Total basis: 830 shares x $8.959 = $7,435.97
Sales Proceed: $7,366.25
Loss: ($ 69.72)

Topic: Sales of Mutual Funds
Difficulty: 3 Hard
EA: Yes
54. Suzette inherited property from her father on April 19, 2016. The FMV at the date of
death was $40,000. The property was worth $35,000 six months later and had a basis to
her father of $25,000.
a. What is the basis of the inherited property to Suzette

(1). If the alternate valuation date was not elected?
(2). If this property qualifies for using the alternate valuation date?
b. Assuming that Suzette sold the property on November 1, 2016 for $47,500, what are
the amount and nature of the gain
(1). If the alternate valuation date was not elected?
(2). If this property qualifies for using the alternate valuation date?
Answer:
a (1) $40,000
a (2) $35,000
b (1) $7,500 Long-term gain

b (2) $12,500 Long-term gain
Feedback:
a. (1) Basis is FMV at death.
a. (2) Basis using alternate valuation date is value of property six months later.
b. (1) $47,500 - $40,000 = $7,500 inherited is always considered long-term.

b. (2) $47,500 - $35,000 = $12,500 inherited is always considered long-term

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Topic: Sales of Inherited Property

EA: Yes
55. Using the following independent situations, answer the following questions:
Situation # 1
Clara received from her Aunt Sona property with a FMV at the date of the gift of
$40,000. Aunt Sona purchased the property five years ago for $35,000. Clara sold the
property for $43,000. Assume Aunt Sona does not have MAGI over $200,000.
a. What is the basis to Clara?
b. What is Clara’s gain on the sale?
c. If Clara is in the 33% tax bracket, what is the tax on the gain (assuming she has
no other gains/losses to be netted)?
d. If Clara is in the 15% tax bracket, what is the tax on the gain (assuming she has
no other gains/losses to be netted)?
Situation #2
Clara received from her Aunt Sona property with a FMV at the date of the gift of
$30,000. Aunt Sona purchased the property five years ago for $35,000.
a. If Clara sold the property for $43,000, what is her gain or loss on the sale?
b. If Clara sold the property for $33,000, what is her gain or loss on the sale?
c. If Clara sold the property for $28,000, what is her gain or loss on the sale?
Answer:
Situation # 1
a. $35,000
b. $8,000
c. $1,200
d. $0
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Situation # 2
a. $8,000
b. $0
c. ($2,000) loss
Feedback:
Situation #1
a. Basis to Clara is $35,000 since it is less than FMV at date of gift and the property
is sold for more than the basis.
b. $43,000 - $35,000 = $8,000
c. $8,000 x 15% = $1,200
d. rule applies where taxpayer is in <=25% tax bracket, no tax on gain
Situation # 2
a. ($43,000 - $35,000). The basis is used to calculate a gain when FMV is lower than
basis at the date of the gift.
b. no gain or loss. When the FMV is lower than the basis at the date of the gift, any
sales between the FMV and basis generate no gain or loss.
c. ($28,000 - $30,000). The FMV is used to calculate a loss when the FMV is lower
than the basis at the date of the gift.

Difficulty: 3 Hard
EA: Yes
56. Ramon received a gift of stock from his uncle. The basis of the stock to his uncle
was $20,000, and it had a FMV of $13,000 at the date of the gift. The donor held the
property for more than one year. Complete the following chart under the independent
situations shown:
Situation 1 Situation 2 Situation 3

Donor’s Basis $20,000 $20,000 $20,000
FMV at Gift Date $13,000 $13,000 $13,000
Ramon’s Selling Price $25,000 $10,000 $15,000
Basis to Ramon ______ ______ ______
Taxable Gain (if any) ______ ______ ______
Deductible Loss (if any) _______ ______ ______
Answer:
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Situation 1 Situation 2 Situation 3

Donor’s Basis $20,000 $20,000 $20,000
FMV at Gift Date $13,000 $13,000 $13,000
Ramon’s Selling Price $25,000 $10,000 $15,000
Basis to Ramon $20,000 $13,000 N/A
Taxable Gain (if any) $ 5,000 N/A no gain
Deductible Loss (if any) N/A $ 3,000 no loss
Feedback:
Situation 1
Basis to Ramon is the donor’s basis. If the FMV is less than the donor’s adjusted
basis at the time of the gift, the basis for figuring a gain is the donor’s basis.
Taxable Gain is $5,000. Calculated as Selling Price $25,000 – Basis $20,000 = $5,000
Situation 2
Basis to Ramon is FMV at date of the gift. If the FMV is less than the donor’s
adjusted basis at the time of the gift, the basis for figuring a loss is the FMV of the
asset.
Deductible Loss is $3,000. Calculated as Selling Price $10,000 – Basis $13,000 =
($3,000).
Situation 3
There is no gain or loss. There is a special provision when the sale price is in
between the basis and the FMV. The sale price was $15,000, which is in between the
donor basis of $20,000 and the FMV at gift date of $13,000.

Difficulty: 3 Hard
EA: Yes
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Learning Objective: 07-01

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15. What is a §1202 gain, and how is it taxed?

Learning Objective: 07-04

Learning Objective: 07-04

17. What is a §1245 asset? How is it related to a §1231 asset?

Learning Objective: 07-05

18. What is a §1250 asset? How is it related to a §1231 asset?

Learning Objective: 07-05

However, the gain representing straight-line depreciation deductions claimed by the

Learning Objective: 07-05

20. What is a capital gain distribution, and how is it taxed?

Learning Objective: 07-06

Learning Objective: 07-06

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Learning Objective: 07-06

Learning Objective: 07-01

Feedback: The basis of property transferred to a taxpayer from a former spouse

Learning Objective: 07-01

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Learning Objective: 07-02

d. $3,052 § 1231 loss.

Learning Objective: 07-03

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Learning Objective: 07-04

Learning Objective: 07-04

32. Which statement is true regarding short-term capital gains?

Learning Objective: 07-04

33. Which is true regarding long-term capital gains?

Learning Objective: 07-04

Learning Objective: 07-04

Learning Objective: 07-04

Feedback: Capital gain distributions are considered long-term.

Learning Objective: 07-04

Feedback: The amount of gain up to the accumulated depreciation taken is subject

Learning Objective: 07-05

Learning Objective: 07-04

Learning Objective: 07-06

Learning Objective: 07-06

a. Assume Umair sold the equipment for $50,000:

b. Assume Umair sold the equipment for $60,000:

Learning Objective: 07-03

a. What is Alice’s realized and recognized gain?

Learning Objective: 07-01

a. What is the total short-term gain or loss?

Learning Objective: 07-04

44. Respond to the following independent situations:

Learning Objective: 07-04

45. Respond to the following independent situations: