Chap 010 - Taxation of Individuals and Business Entities

Chapter 10 - Property: Dispositions
Chapter 10 Property: Dispositions SOLUTIONS MANUAL Discussion Questions

1. [LO 1] Compare and contrast different ways in which a taxpayer triggers a rea i!ation e"ent #y disposing of an asset. A realization event for tax purposes is created in many ways. Virtually any disposal will result in a sale or other disposition. These include a sale, trade, gift to charity, disposal to the landfill, or destruction in a natural disaster. In a sale or trade (exchange), the taxpayer receives something of value in return for the asset. In contrast, a charita le contri ution, disposal, or destruction from a natural disaster generally results in a loss of any remaining asis in the asset without compensation (unless reim ursed y insurance). $. [LO 1] Potomac Corporation wants to se a wareho%se that it has %sed in its #%siness for 10 years. Potomac is as&ing '()0*000 for the property. +he wareho%se is s%#,ect to a mortgage of '1$)*000. -f Potomac accepts .yden -nc./s offer to gi"e Potomac '0$)*000 in cash and ass%me f% responsi#i ity for the mortgage on the property* what amo%nt does Potomac rea i!e on the sa e1 !hen the property disposed of is su "ect to a lia ility and the uyer assumes the lia ility, the relief of de t increases the amount realized. Thus, #otomac$s amount realized consists of %&'(,(((, which is cash of %)*',((( plus %+*',((( relief of de t. This assumes that the uyer hypothetically transfers cash to the seller in order to pay off the mortgage. 0. [LO 1] 2ontana 2ax se s a $*)00-acre ranch for '1*000*000 in cash* a note recei"a# e of '1*000*000* and de#t re ief of '$*(00*000. 3e a so pays se ing commissions of '40*000. -n addition* 2ax agrees to #%i d a new #arn on the property 5cost '$)0*0006 and spend '100*000 %pgrading the fence on the property #efore the sa e. .hat is 2ax/s amo%nt rea i!ed on the sa e1 Anything received y the seller during a sale or exchange is included in the amount realized. ,ost dispositions result in cash to the seller. -owever, amount realized includes, ut is not limited to, cash, the fair mar.et value of any other property received (e.g. mar.eta le securities or a similar asset), or relief of de t. In addition, selling expenses reduce the amount realized. Therefore, ,ax$s amount realized includes the %+,(((,((( of cash, %+,(((,((( note receiva le, relief of de t of %*,&((,(((, and is reduced y selling commissions of %/(,((( (selling expenses reduce the amount realized, 0.1.
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1hapin, 1A23, '(2+ 40T1 56+7+). Anything the seller gives up in the transaction is added to
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the asis of the property given up and is not considered part of the amount realized. Therefore, the arn and fence improvements are not considered part of ,ax$s amount realized. 8ote, however, that ma.ing these improvements decreases his realized gain y increasing ,ontana ,ax$s ad"usted asis in the property due to the improvements. (. [LO 1] 3aw&eye so d farming e7%ipment for '))*000. -t #o%ght the e7%ipment fo%r years ago for '8)*000* and it has since c aimed a tota of '($*000 in depreciation ded%ctions against the asset. 9xp ain how to ca c% ate 3aw&eye/s ad,%sted #asis in the farming e7%ipment. -aw.eye will calculate its ad"usted asis in the farming e9uipment y reducing the historical cost y any cost recovery deductions ta.en:namely, depreciation. Therefore, -aw.eye$s ad"usted asis is %)),((( (%7',((( less %&*,(((). The tax ad"usted asis is usually different than the oo. ad"usted asis. This is ecause most assets use a different recovery period, cost recovery method (e.g. dou le declining alance), and convention (e.g. half2year) for tax than for oo. purposes. 0ee 1hapter 6 for how these differences arise. ;ue to the difference in cost recovery deductions, the ad"usted asis is li.ely different unless the asset is fully depreciated for oth oo. and tax purposes. ). [LO 1] .hen a taxpayer se s an asset* what is the difference #etween rea i!ed and recogni!ed gain or oss on the sa e1 The realized gain or loss is simply the amount realized less the ad"usted asis of the asset sold. <very sale or disposition results in a realized gain or loss (unless, of course, the amount realized is e9ual to the ad"usted asis). ,ost realized gains or losses ecome recognized gains or losses and are included on the taxpayer$s tax return and increases (or decreases in the case of a loss) the taxpayer$s taxa le income and su se9uent tax. -owever, there are some realized gains or losses that are excluded from income or deferred to a later time period. 4. [LO $] .hat does it mean to characteri!e a gain or oss1 .hy is characteri!ing a gain or oss important1 =nce a gain or loss is recognized, a taxpayer must determine how the recognized gain or loss affects the taxpayer$s tax lia ility. The character depends on a com ination of two factors> purpose or use of the asset and holding period. The purpose or use of the asset is important ecause the law does not treat all assets e9ually. The general use categories are> (+) trade or usiness, (*) for the production of income (rental activities), ()) investment, and (&) personal. ?ased on these criteria, we can categorize an asset into one of three groups> (+) ordinary, (*) capital, or ()) section +*)+. 1haracterizing the gain or loss is important ecause all gains and losses are not e9ual. =rdinary gains and losses are taxed at ordinary income rates, regardless of the holding
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period. 1apital gains on assets held for more than a year receive preferential rates while capital gains on assets held for one year or less do not. 0ection +*)+ gains and losses receive the est of oth worlds:the gains ecome long2 term capital gains and the losses ecome ordinary. -owever, to 9ualify as a +*)+ asset, the asset must e used in a trade or usiness for more than a year. 8. [LO $] 9xp ain the difference #etween ordinary* capita * and :1$01 assets. An ordinary asset is an asset that is held for sale in the ordinary course of a taxpayer$s usiness (e.g. inventory) or arises from sales in the ordinary course of usiness (e.g. accounts receiva le). 1apital assets are held for investment (expecting appreciation) or are personal2use assets (e.g. a taxpayer$s personal elongings). A @+*)+ assets is used in a trade or usiness or for the production of income and is held for more than one year. An asset that is used in a trade or usiness or for the production of income and is held for one year or less is an ordinary asset. Aains on personal use property are capital gains while losses are non2deducti le. ;. [LO $] Disc%ss the reasons why indi"id%a s genera y prefer capita gains o"er ordinary gains. 9xp ain why corporate taxpayers might prefer capita gains o"er ordinary gains. Individual taxpayers prefer capital gains ecause they can e taxed at preferential rates. Bong2term capital gains are taxed at preferential rates (' or +'C). 0hort2term capital gains are simply taxed at ordinary rates. 1apital gains can offset capital losses, while ordinary gains cannot. Additionally, individual taxpayers can offset %),((( of net capital losses against ordinary income and carry the remaining capital loss forward indefinitely. <ven though corporate taxpayers are taxed at the same rate on ordinary income and capital gains, they prefer capital gains ecause capital gains can offset capital losses. 1apital losses cannot e used to offset ordinary income. 1orporate taxpayers can carry capital losses ac. three years and forward five years. -owever, after the carry ac. and carry forward periods expire, capital losses expire and are worthless. <. [LO $] Da&ota Conrad owns a parce of and he wo% d i&e to se . Descri#e the circ%mstances in which the sa e of the and wo% d generate :1$01 gain or oss* ordinary gain or oss* or capita gain or oss. = so descri#e the circ%mstances where Da&ota wo% d not #e a owed to ded%ct a oss on the sa e. The parcel of land could 9ualify as a capital asset if it is held y ;a.ota as an investment (e.g. the purpose for holding the land is for expected appreciation in value). The land could 9ualify as a @+*)+ asset if ;a.ota uses it in a trade or usiness such as a sole2proprietorship or for the production of income (a rental property) and he uses it for these purposes for more than one year. The land
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could e ordinary income property to ;a.ota if it is held in a trade or usiness or for the production of income for one year or less or if it is considered to e inventory (for example a real2estate dealer). The loss would e non2deducti le to ;a.ota if he held the land for personal2use purposes. 10. [LO $] Linco n has %sed a piece of and in her #%siness for the past fi"e years. +he and 7%a ifies as :1$01 property. -t is %nc ear whether Linco n wi ha"e to recogni!e a gain or oss when she e"ent%a y se s the asset. >he as&s her acco%ntant how the gain or oss wo% d #e characteri!ed if she decides to se . 3er acco%ntant said that se ing :1$01 assets gi"es se ers ?the #est of #oth wor ds.@ 9xp ain what her acco%ntant means #y ?the #est of #oth wor ds.@ An asset 9ualifies as a @+*)+ asset if used in a trade or usiness or held for the production of income for more than one year. The tax treatment is sometimes descri ed as receiving Dthe est of oth worldsE ecause if they result in gains, the gain will receive capital gain treatment and if they result in losses the loss will receive ordinary loss treatment. 1apital gains are prefera le ecause they are taxed at a preferential rate (for non2corporate taxpayers) and can offset capital losses which cannot always e offset against ordinary income. =rdinary losses are preferred to capital losses ecause they offset ordinary income in the current year rather than eing accumulated to offset future capital gains. 11. [LO 0] 9xp ain Congress/s rationa e for depreciation recapt%re. The purpose of depreciation recapture is to treat the gain on the sale of deprecia le assets as ordinary income to the extent the gain is attri uta le to depreciation (or other cost recovery deductions). This is ecause the ,A1F0 system li erally allows accelerated deductions which often decrease the asis of an asset faster than the real economic decline in value. Thus, depreciation deductions may give rise to artificial gain on the disposition of deprecia le assets. It is important to note that depreciation recapture does not affect the amount of the gainG rather it affects only the character of the gain. Additionally, depreciation recapture only applies to sales or dispositions resulting in gains (e.g. it does not apply to losses). 1$. [LO 0] Compare and contrast :1$() depreciation recapt%re and :1$)0 depreciation recapt%re. @+*&', sometimes referred to as full recapture, generally applies only to tangi le personal property. @+*&' recaptures the lesser of the realized gain or the depreciation ta.en on the asset as ordinary income:thus the full amount of the gain may e recaptured. @+*'(, sometimes referred to as partial recapture, applies only to real property depreciated under accelerated depreciation methods:the term partial recapture indicates that only the depreciation in
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excess of straight2line method is recaptured. @+*'( recapture no longer applies. This is ecause real property has een depreciated under the straight2
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line method since +637. #roperty placed in service efore +637 is now fully depreciated, regardless of whether accelerated or straight2line methods were usedG as a result, there is no excess depreciation to recapture. -owever, section *6+ and unrecaptured section +*'( applies to gains on real property for corporations and non2corporate taxpayers, respectively. 10. [LO 0] .hy is depreciation recapt%re not re7%ired when assets are so d at a oss1 !hen an asset is sold for less than the ad"usted asis ( asis less cost recovery), there is no depreciation recapture. This is ecause the real economic value of the asset declined faster than it was depreciated for tax purposes. Therefore, the loss is simply the recovery of the remaining asis in the asset. ;epreciation recapture is intended to classify any gain due to prior depreciation as ordinary in character. 1(. [LO 0] .hat are the simi arities and differences #etween the tax #enefit r% e and depreciation recapt%re1 1onceptually, oth depreciation recapture and the tax enefit doctrine re9uire a taxpayer to ta.e into income an amount deducted in a prior year. -owever, depreciation recapture only recharacterizes the already existing gain from @+*)+ to ordinary ecause the taxpayer received an ordinary deduction in the past and re9uires the amount to e included into ordinary income in the year of sale. ;epreciation recapture does not change the amount of the gain. In contrast, the tax enefit doctrine re9uires a taxpayer to ta.e into income an amount received when an expense was ta.en in a prior year. Hor example, if a taxpayer deducts (receives a enefit) state income taxes paid during the year paid, ut receives a tax refund in a su se9uent year, the taxpayer must include the refund into income. 1). [LO 0* (] =re #oth corporations and indi"id%a s s%#,ect to depreciation recapt%re when they se deprecia# e rea property at a gain1 9xp ain. ?oth taxpayers used to e su "ect to @+*'( recapture when selling real property. -owever, ecause there is no longer any accelerated depreciation on real property, there is no longer any @+*'( recapture. -owever, real property sold at a gain is still su "ect to other types of recapture rules. 1orporate taxpayers are su "ect to @*6+ recapture and non2corporate taxpayers are su "ect to unrecaptured @+*'( rules. 0ection *6+ re9uires corporate taxpayers to recapture *(C of the lesser of the gain realized or accumulated depreciation ta.en. The recaptured portion of the gain is taxed as ordinary income. The remaining gain is @+*)+ gain. 8on2corporate taxpayers must recognize the lesser of the gain realized or the accumulated depreciation ta.en as unrecaptured @+*'( gain. 4nrecaptured
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@+*'( gain is still @+*)+ (not ordinary) gain, ut it will e taxed at a maximum rate of *'C gain (taxed at the taxpayer$s marginal rate at a maximum *'C). The remaining gain is @+*)+ gain. 14. [LO (] 3ow is %nrecapt%red :1$)0 gain for indi"id%a s simi ar to depreciation recapt%re1 3ow is it different1 4nrecaptured @+*'( gain is similar to depreciation recapture in that the lesser of accumulated depreciation or the gain realized on the sale is separated from the @+*)+ gain. The difference is that the amount is taxed at a taxpayer$s ordinary rate up to a maximum rate of *' percentG whereas depreciation recapture is taxed at ordinary rates with no maximum rate. 18. [LO (] 9xp ain why gains from deprecia# e property so d to a re ated taxpayer are treated as ordinary income %nder :1$0<. 0ection +*)6 re9uires gains on deprecia le property sold to related taxpayers to e taxed at ordinary rates ecause the asis of these assets will e recovered through ordinary depreciation deductions. This rule effectively is li.e reverse depreciation recapture in that it taxes future depreciation at ordinary rates rather than past depreciation at ordinary rates. The related party definition includes family relationships including si lings, spouses, ancestors, and lineal descendants. It also includes an individual and a corporation if the individual owns more than '(C of the stoc. of the corporation 1;. [LO )] Aingaman Beso%rces so d two deprecia# e :1$01 assets d%ring the year. One asset res% ted in a arge gain 5the asset was so d for more than it was p%rchased for6 and the other res% ted in a sma oss. Descri#e the :1$01 netting process for Aingaman. ?ingaman would first determine the gain or loss on each asset. Hor the gain asset, depreciation recapture would recharacterize the gain as ordinary to the extent of depreciation allowed. The remaining gain (the amount in excess of the original asis) would e a @+*)+ gain that would enter the netting process. The loss from the other asset would enter the netting process as well. The @+*)+ gain and loss would e offset. If the result was a gain, ?ingaman would apply the @+*)+ loo.2 ac. rule. After applying the loo.2 ac. rule, any remaining gain would ecome treated as a long2term capital gain and enter the capital gains netting process. If the result of the initial @+*)+ netting process was a loss, the gains and losses would e treated as ordinary gains and losses. 1<. [LO )] Cera dine #e ie"es that when the :1$01 oo&-#ac& r% e app ies* the taxpayer ded%cts a :1$01 oss in a pre"io%s year against :1$01 gains in the c%rrent year. 9xp ain whether Cera dine/s description is correct.
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Ieraldine$s description is incorrect. The @+*)+ loo.2 ac. rule simply recharacterizes @+*)+ gain into ordinary gain. This is done to the extent that prior @+*)+ losses in the prior ' years received ordinary loss treatment. Ieraldine is correct in that the @+*)+ gains in the current year are offset against prior @+*)+ losses:to the extent they haven$t een recaptured through the @+*)+ loo.2 ac. rule in prior years. $0. [LO )] 9xp ain the p%rpose #ehind the :1$01 oo&-#ac& r% e1 The favora le rules of @+*)+ allow a taxpayer to treat a net @+*)+ loss as an ordinary loss. The @+*)+ loo.2 ac. rule applies when a taxpayer has a net @+*)+ gain for the year which will receive capital gain treatment. The rule recharacterizes the gain to ordinary to the extent the taxpayer received favora le ordinary loss treatment in the prior five years (that have not yet een recaptured). This prevents ar itrage of taxpayers timing their sales of loss assets in one year to receive ordinary treatment and selling their gains in a su se9uent year to o tain capital gain treatment. !ithout the loo.2 ac. rule, taxpayers could separate the years in which it sells its gain and loss assets. Hor example, a taxpayer could sell its loss asset on ;ecem er )+, year + and sell its gain asset on Ianuary +, year *. This would allow the loss asset to receive ordinary treatment and e offset against ordinary income. The gain asset would e treated as a long2term capital gain, which would e taxed at preferential rates y non2corporate taxpayers. $1. [LO )] Does a taxpayer app y the :1$01 oo&-#ac& r% e in a year when the taxpayer recogni!es a net :1$01 oss1 9xp ain. The loo.2 ac. rule exists to prevent game playing (ar itrage) opportunities. It prevents taxpayers from selling their @+*)+ loss assets in one year and receiving ordinary loss treatment and then selling their @+*)+ gain assets in a su se9uent year and receiving capital gain treatment. -owever, if the taxpayer does not have a net @+*)+ gain in the su se9uent years, it can e assumed they are not manipulating the situation and the loo.2 ac. rule does not apply to a year in which there is a net @+*)+ loss. $$. [LO )] 3ow wo% d yo% descri#e the app ication of the :1$01 oo&-#ac& r% e to a friend who &nows itt e a#o%t taxation1 The @+*)+ loo.2 ac. rule affects only the character of the gain. It re9uires that any net @+*)+ gain ecome ordinary rather than capital to the extent that there are prior unrecaptured losses in the prior five years that received the preferential ordinary loss treatment. This is done to offset the enefit of receiving ordinary loss treatment in any of the past five years.
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$0. [LO (* )] Descri#e the circ%mstances in which an indi"id%a taxpayer with a net :1$01 gain wi ha"e different portions of the gain taxed at different rates. 8on2corporate taxpayers can have @+*)+ gains taxed at different capital gains rates. ,ost @+*)+ gains (from tangi le personal property and land) will give rise to regular long2term capital gain which will e taxed at a maximum rate of +'C ('C if the taxpayer has a marginal rate of +'C or less). The @+*)+ gains from real property that are referred to as unrecaptured @+*'( gains will e taxed a maximum rate of *'C (e.g. at the taxpayer$s marginal rate unless his rate exceeds *'C). Thus, non2corporate taxpayer$s can have @+*)+ gains and, thus, long2term capital gains that are taxed at two rates. Additionally, a taxpayer who crosses from the +'C to the *'C marginal tax rate rac.et would see capital gains preferential rates increase from 'C to +'C. $(. [LO 4] Boc&y and A% win& e Partnership so d a parce of and d%ring the c%rrent year and rea i!ed a gain of '$)0*000. Boc&y and A% win& e did not recogni!e gain re ated to the sa e of the and on its tax ret%rn. -s this possi# e1 9xp ain how a taxpayer co% d rea i!e a gain #%t not recogni!e it. A realized gain or loss is usually recognized in the year of disposition. -owever, there are some realized gains or losses that are excluded from taxa le income (e.g. gain from the sale of a principal residence:see chapter +& for a detailed discussion) or deferred (e.g. li.e2.ind exchange or related2party loss), or partially deferred (e.g. an installment sale). $). [LO 4] .hy does Congress a ow taxpayers to defer gains on i&e-&ind exchanges1 3ow do the tax aws ens%re that the gains 5or osses6 are deferred and not permanent y exc %ded from a taxpayer/s income1 In a li.e2.ind exchange, a taxpayer maintains an investment in an asset other than cash and therefore does not have the wherewithal to payJthat is, the taxpayer does not have the means to pay taxes currently. -owever, in a li.e2 .ind exchange where oot (non2li.e .ind property) is received, there is a partial recognition of gain for the transaction. The gains are deferred through receiving a carryover asis in the li.e2.ind property received. This defers the gain until the li.e2.ind property received is disposed of rather than permanently excluding the gain from income. $4. [LO 4] Compare and contrast the i&e-&ind property re7%irements for rea property and for persona property for p%rposes of 7%a ifying for a i&e-&ind exchange. 9xp ain whether a car he d #y a corporation for de i"ering doc%ments wi 7%a ify as i&e-&ind property with a car he d #y an indi"id%a for persona %se.
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Hor real property, any two pieces of property 9ualify as li.e2.ind property for purposes of a li.e2.ind exchange. Hor example, a 8ew Kor. 1ity s.yscraper (relatively little land with relatively su stantial uilding) will 9ualify as li.e2.ind with a ,ontana ranch (relatively su stantial land holding with relatively little uildings). Hor personal property to 9ualify as li.e2.ind, it must have the same general use as defined as the same asset class in Fevenue #rocedure 372'/. The cars held y oth taxpayers elong to the same asset class and would 9ualify as li.e2.ind property for purposes of a li.e2.ind exchange for the corporation. !hile the assets are li.e2.ind, the exchange will not 9ualify as li.e2.ind for the individual ecause the asset was not used in a trade or usiness or for the production of income:a re9uirement of 9ualifying for a li.e2.ind exchange. $8. [LO 4] >a a!ar -nc.* a Co orado company* is re ocating to a near#y town. -t wo% d i&e to trade its rea property for some rea property in the new ocation. .hi e >a a!ar has fo%nd se"era prospecti"e #%yers for its rea property and has a so ocated se"era properties that are accepta# e in the new ocation* it cannot find anyone that is wi ing to trade >a a!ar -nc. for its property in a i&e-&ind exchange. 9xp ain how a third-party intermediary co% d faci itate >a a!ar/s i&e-&ind exchange. If 0alazar completed the transaction y selling its old property to one of the prospective uyers and then used the cash to purchase one of the accepta le new properties, it would not e a le to ta.e advantage of the li.e2.ind exchange provisions. A third2party intermediary can ta.e control of 0alazar$s property, sell the property to one of the prospective uyers, and use the cash proceeds to ac9uire 0alazar$s desired property. As a result, use of a third party intermediary allows 0alazar to accomplish what it cannot do on its own (piece together a transaction that 9ualifies as a li.e2.ind exchange). -owever, 0alazar must identify the property to e received within &' days and actually receive the property within +3( days of transferring their property to the third party. $;. [LO 4] 2in%teman wants to enter into a i&e-&ind exchange #y exchanging its o d Dew 9ng and man%fact%ring faci ity for a ranch in .yoming. 2in%teman is %sing a third-party intermediary to faci itate the exchange. +he p%rchaser of the man%fact%ring faci ity wants to comp ete the transaction immediate y #%t* for "ario%s reasons* the ranch transaction wi not #e comp eted for three to fo%r months. .i this de ay ca%se a pro# em for 2in%teman/s desire to accomp ish this thro%gh a i&e&ind exchange1 9xp ain. ,inuteman can still 9ualify for a 0tar.er (deferred) exchange as long it meets two timing re9uirements applica le to li.e2.ind exchanges. Hirst, within &' days of transferring the property to e given up (8ew <ngland manufacturing facility) in an exchange, the taxpayer must identify li.e2.ind property to e received (!yoming ranch). 0econd, within +3( days of initially transferring the property to e given up in a li.e2.ind exchange, the taxpayer must receive the replacement
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li.e2.ind property. In addition, ,inuteman must use a third party intermediary to hold the proceeds from the manufacturing facility until the ranch can e closed. The exchange will 9ualify as long as the new ranch is ac9uired within the +3( day period following the close of the 8ew <ngland manufacturing facility. $<. [LO 4] O ympia Corporation* of Eittery* 2aine* wants to exchange its man%fact%ring machinery for Aangor Company/s machinery. Aoth parties agree that that O ympia/s machinery is worth '100*000 and that Aangor/s machinery is worth '<)*000. O ympia wo% d i&e the transaction to 7%a ify as a i&e-&ind exchange. .hat co% d the parties do to e7%a i!e the "a %e exchanged #%t sti a ow the exchange to 7%a ify as a i&e-&ind exchange1 3ow wo% d the necessary change affect the tax conse7%ences of the transaction1 =lympia could also receive cash or another asset ( oot), to e9ualize the transaction. The receipt of oot does not "eopardize the li.e2.ind exchange treatment. -owever, =lympia will recognize gain e9ual to the oot received in the transaction. Any remaining gain is still deferred under the li.e2.ind exchange rules. ?oot includes any non2li.e .ind asset> cash, tangi le assets, intangi les, etc. 00. [LO 4] Compare and contrast the simi arities and differences #etween i&e-&ind exchanges and in"o %ntary con"ersions for tax p%rposes1 A li.e2.ind exchange involves a trade for a similar asset within the specified time period. An involuntary conversion is the replacement of property damaged through a natural disaster, theft, etc. The two transaction are similar in that they oth lac. (at least a portion of) the wherewithal to pay the tax and thus result in a deferral or partial deferral. The transactions differ in that the definition of 9ualifying property is narrower for involuntary conversions than for li.e2.ind exchanges. 01. [LO 4] .hat is an insta ment sa e1 3ow do the tax aws ens%re that taxpayers recogni!e a the gain they rea i!e on an insta ment sa e1 3ow is depreciation recapt%re treated in an insta ment sa e1 9xp ain the gross profit ratio and how it re ates to gains recogni!ed %nder insta ment method sa es. Installment sales comprise a sale when any portion of the proceeds is received in a year su se9uent to the disposition. The rules re9uire that the realized gain e recognized rata ly as payments are received22unless the taxpayer elects out of the installment method. Therefore, for each dollar received, a portion is return of capital and a portion is the recognition of previously realized gain. ;epreciation recapture is re9uired to e recognized in the year of disposition. The recaptured amount is excluded from the gross profit ratio to avoid dou le taxation (e.g. the gain realized is reduced y the depreciation recapture recognized). The gross profit ratio reflects the percentage of> (Aain Fealized L Amount Fealized. The
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gross profit ratio is used to determine how much of each of these payments will e recognized as gain in the year that the payment is received. 0$. [LO4] 2r. Ey e owns stoc& in a oca p%# ic y traded company. = tho%gh the stoc& price has dec ined since he p%rchased it two years ago* he i&es the ong-term prospects for the company. -f Ey e se s the stoc& to his sister #eca%se he needs some cash for a down payment on a new home* is the oss ded%cti# e1 -f Ey e is right and the stoc& price increases in the f%t%re* how is his sister/s gain comp%ted if she se s the stoc&1 A related party loss is deferred until the time when the asset is sold y the related purchaser to an unrelated party. 0ince Myle sold the stoc. at a loss to his sister, Myle$s loss is disallowed. !hen the stoc. is sold at a gain, the sister can reduce her gain y the amount of Myle$s disallowed loss. If the stoc. continues to decline in value, the disallowed loss is never recognized for tax purposes.
Prob e!s
00. [LO 1] Bafae so d an asset to Cama . .hat is Bafae /s amo%nt rea i!ed on the sa e in each of the fo owing a ternati"e scenarios1 a. Bafae recei"ed ';0*000 of cash and a "ehic e worth '10*000. Bafae a so pays ')*000 in se ing expenses. #. Bafae recei"ed ';0*000 of cash and was re ie"ed of a '00*000 mortgage on the asset he so d to Cama . Bafae a so paid a commission of ')*000 on the transaction. c. Bafae recei"ed '$0*000 of cash* a parce of and worth ')0*000* and mar&eta# e sec%rities of '10*000. Bafae a so paid a commission of ';*000 on the transaction. a. %3',(((, computed as follows> Property Received (+) 1ash (*) Vehicle ()) 1ommissions Amount Fealized Amount %3(,((( +(,((( (',((() %3',((( Explanation Aiven Aiven Aiven (+) N (*) N ())
. %+(',(((, computed as follows> Property Received (+) 1ash (*) Felief of de t ()) 1ommissions Amount Fealized Amount Explanation %3(,((( )(,((( (',((() %+(',((( (+) N (*) N ())
10-10
c. %7*,(((, computed as follows> Property Received (+) 1ash (*) Band ()) ,ar.eta le securities (&) 1ommissions Amount Fealized Amount Explanation %*(,((( '(,((( +(,((( (3,((() %7*,((( (+) N (*) N ()) N (&)
0(. [LO 1] >hasta Corporation so d a piece of and to Ai for '()*000. >hasta #o%ght the and two years ago for '00*400. .hat gain or oss does >hasta rea i!e on the transaction1 %+&,&((, computed as follows> Description Amount Explanation (+) Amount Fealized %&',((( (*) Ad"usted ?asis )(,/(( Gain (Loss) Realized $14 4!! (+) J (*) 0). [LO 1] Lassen Corporation so d a machine to a machine dea er for '$)*000. Lassen #o%ght the machine for '))*000 and has c aimed '1)*000 of depreciation expense on the machine. .hat gain or oss does Lassen rea i!e on the transaction1 (%+',((() loss, computed as follows> Description Amount Explanation (+) Amount Fealized %*',((( Aiven (*) Ad"usted ?asis &(,((( %'',((( original asis 2 %+',((( accumulated depreciation Gain (Loss) Realized ($1" !!!) (+) J (*) 04. [LO $] -dentify each of .hite Corporation/s fo owing assets as an ordinary* capita * or :1$01 asset. a. +wo years ago* .hite %sed its excess cash to p%rchase a piece of and as an in"estment. #. +wo years ago* .hite p%rchased and and a wareho%se. -t %ses these assets in its #%siness. c. 2an%fact%ring machinery .hite p%rchased ear ier this year. d. -n"entory .hite p%rchased 10 months ago* #%t is ready to #e shipped to a c%stomer. e. Office e7%ipment .hite has %sed in its #%siness for the past three years. f. 1*000 shares of stoc& in A ac& corporation that .hite p%rchased two years ago #eca%se it was a good in"estment. g. =cco%nt recei"a# e from a c%stomer with terms $F10 net 00. h. 2achinery .hite he d for three years and then so d at a oss of '10*000. a. 1apital, ecause it is held for investment.
10-1(
. The land and uilding are oth @+*)+ property ecause !hite uses the assets in its trade or usiness and has held the assets property for more than a year. c. =rdinary, the property is ordinary even though it is used in a trade or usiness ecause it has een held for less than one year. =nce !hite has held the machinery for more than a year, it will ecome @+*)+ property. d. =rdinary, inventory is held in the ordinary course of usiness. e. @+*)+, the property is used in a trade or usiness and held for more than one year. f. 1apital, ecause it is held for investment. g. =rdinary, accounts receiva le are created in the ordinary course of usiness. h. @+*)+, the property is used in a trade or usiness and held for more than one year. 08. [LO 0* (] -n year 0* Canon p%rchased a machine to %se in its #%siness for ')4*000. -n year 0* Canon so d the machine for '($*000. Aetween the date of the p%rchase and the date of the sa e* Canon depreciated the machine #y '0$*000. a. .hat is the amo%nt and character of the gain Canon wi recogni!e on the sa e* ass%ming that it is a partnership1 #. .hat is the amo%nt and character of the gain Canon wi recogni!e on the sa e* ass%ming that it is a corporation1 c. .hat is the amo%nt and character of the gain Canon wi recogni!e on the sa e* ass%ming that it is a corporation and the sa e proceeds were increased to '40*0001 d. .hat is the amo%nt and character of the gain Canon wi recogni!e on the sa e* ass%ming that it is a corporation and the sa e proceeds were decreased to '$0*0001 a. %+3,((( ordinary income, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation Amount %&*,((( '/,((( ()*,((() *&,((( %+3,((( Explanation Aiven Aiven Aiven (*) N ()) (+) J (&)
recapture) $1' !!! Besser of ()) or (') %1&(1 )ain $! (') J (/) ?ecause the entire gain is caused y depreciation deductions, the entire gain is treated as ordinary income under @+*&'.
10-1)
. There is no difference in calculating the amount and character of the gain etween a partnership and a corporation on @+*&' property. c. %)/,((( of income (%)*,((( ordinary and %&,((( @+*)+) computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation Amount %/(,((( '/,((( ()*,((() *&,((( %)/,((( Explanation Aiven Aiven Aiven (*) N ()) (+) J (&)
recapture) $(& !!! Besser of ()) or (') %1&(1 )ain $4 !!! (') J (/) =nly the gain caused y depreciation is treated as ordinary income under @+*&', the remaining gain is @+*)+. d. (%&,((() ordinary loss, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation Amount %*(,((( '/,((( ()*,((() *&,((( (%&,((() Explanation Aiven Aiven Aiven (*) N ()) (+) J (&)
recapture) $! Besser of ()) or (') %1&(1 loss ($4 !!!) (') J (/) =nly gains are treated as ordinary income under @+*&', any loss is @+*)+. 0;. [LO 0* (] -n year 0* Longworth Partnership p%rchased a machine for '(0*000 to %se in its #%siness. -n year 0* Longworth so d the machine for '0)*000. Aetween the date of the p%rchase and the date of the sa e* Longworth depreciated the machine #y '$$*000. a. .hat is the amo%nt and character of the gain Longworth wi recogni!e on the sa e1 #. .hat is the amo%nt and character of the gain Longworth wi recogni!e on the sa e if the sa e proceeds were increased to '()*0001
10-14
c. .hat is the amo%nt and character of the gain Longworth wi recogni!e on the sa e if the sa e proceeds were decreased to '1)*0001 a. %+7,((( ordinary income. Description Amount Explanation (+) Amount Fealized %)',((( Aiven (*) =riginal ?asis &(,((( Aiven ()) Accumulated ;epreciation **,((( Aiven (&) Ad"usted ?asis +3,((( (*) 2 ()) (') AainL(Boss) Fecognized %+7,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $1* !!! Besser of ()) or (') %1&(1 )ain $! (') J (/) ?ecause the entire gain is caused y depreciation deductions, the entire gain is treated as ordinary income under @+*&'. . %*7,((( of income (%**,((( ordinary and %',((( @+*)+) computed as follows> Description Amount Explanation (+) Amount Fealized %&',((( Aiven (*) =riginal ?asis &(,((( Aiven ()) Accumulated ;epreciation **,((( Aiven (&) Ad"usted ?asis +3,((( (*) 2 ()) (') AainL(Boss) Fecognized %*7,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $&& !!! Besser of ()) or (') %1&(1 )ain $" !!! (') J (/) =nly the gain caused y depreciation is treated as ordinary income under @+*&', the remaining gain is @+*)+. c. (%),((() ordinary loss, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis Amount %+',((( &(,((( **,((( +3,((( Explanation Aiven Aiven Aiven (*) 2 ())
10-18
(%),((( (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) ) (+) J (&) $! Besser of ()) or (') ($( !!!
%1&(1 loss ) (') J (/) =nly gains are treated as ordinary income under @+*&', any loss is @+*)+. 0<. [LO 0* (] On =%g%st 1 of year 0* Dir&sen p%rchased a machine for '$0*000 to %se in its #%siness. On Decem#er ( of year 0* Dir&sen so d the machine for '1;*000. a. .hat is the amo%nt and character of the gain Dir&sen wi recogni!e on the sa e1 #. .hat is the amo%nt and character of the gain Dir&sen wi recogni!e on the sa e if the machine was so d on Can%ary 1) of year 1 instead1 a. (%*,((() ordinary loss. Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) Amount %+3,((( *(,((( %( *(,((( (%*,((( Explanation Aiven Aiven O (*) 2 ())
) (+) J (&) $! Besser of ()) or (') ($& !!!
%1&(1 loss ) (') J (/) 8o depreciation is allowed on an asset placed in service and disposed of during the same taxa le year. . %',*(( ordinary income. Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income+ %1&(1 )ain Amount %+3,((( *(,((( %7,*(( +*,3(( %',*(( $" &!! $! Explanation Aiven Aiven 1alculated elow (*) 2 ()) (+) J (&) Besser of ()) or (') (') J (/)
10-1;
OAssets held less than one year are ordinary rather than section +*)+ assets. ;epreciation 1alculations (1) (&) $ri)inal ,ear -asis Rate + %*(,((( *(.((C +/.((C * %*(,((( O (1) x (&) Depreciation %&,((( %),*((
%7,*(( O+/C P )*.((C x .' (half2year in year of disposition) (0. [LO 0* (] Bay#%rn Corporation has a #%i ding that it #o%ght d%ring year 0 for ';)0*000. -t so d the #%i ding in year ). D%ring the time it he d the #%i ding Bay#%rn depreciated it #y '100*000. .hat is the amo%nt and character of the gain or oss Bay#%rn wi recogni!e on the sa e in each of the fo owing a ternati"e sit%ations1 a. Bay#%rn recei"es ';(0*000. #. Bay#%rn recei"es '<00*000. c. Bay#%rn recei"es '800*000. a. %+3,((( ordinary income and %7*,((( @+*)+ gain computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain Amount %3&(,((( 3'(,((( +((,((( 7'(,((( %6(,((( *(C 6(,((( $1' !!! $*& !!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Besser of (') or ()) (/) x (7) (') J (3)
. %*(,((( ordinary income and %+)(,((( @+*)+ gain computed as follows>
10-1<
Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain
Amount %6((,((( 3'(,((( +((,((( 7'(,((( %+'(,((( *(C +((,((( $&! !!! $1(! !!!
Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Besser of (') or ()) (/) x (7) (') J (3)
c. %('(,((() ordinary loss computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 loss Amount %7((,((( 3'(,((( +((,((( 7'(,((( (%'(,((() *(C %( $! ($"! !!!) Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Besser of (') or ()) (/) x (7) (') J (3)
(1. [LO 0* (] 2oran owns a #%i ding he #o%ght d%ring year 0 for '1)0*000. 3e so d the #%i ding in year 4. D%ring the time he he d the #%i ding he depreciated it #y '0$*000. .hat is the amo%nt and character of the gain or oss 2oran wi recogni!e on the sa e in each of the fo owing a ternati"e sit%ations1 a. 2oran recei"ed '1()*000. #. 2oran recei"ed '180*000. c. 2oran recei"ed '110*000.
10-$0
a. %*7,((( unrecaptured section +*'( gain, which is section +*)+ gain taxed at maximum rate of *'C, computed as follows> Amount Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ gain 0otal %1&(1 )ain Explanatio n %+&',((( Aiven +'(,((( Aiven )*,((( Aiven ++3,((( (*) J ()) %*7,((( (+) J (&) Besser of (') $&* !!! or ()) %( (') J (/) $&* !!! (/) N (7)
. @+*)+ gain of %'*,(((. =f the %'*,(((, %)*,((( is unrecaptured @+*'( gain su "ect to a maximum *'C tax rate and the remaining %*(,((( is @+*)+ gain su "ect to a maximum rate of +'C. 0ee the following calculations> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ gain 0otal %1&(1 )ain Amount %+7(,((( +'(,((( )*,((( ++3,((( %'*,((( Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) Besser of (') or ())
$(& !!! *(,((( (') J (/) $"& !!! (/) N (7)
c. @+*)+ loss of (%3,(((), calculated as follows> Description Amount Explanation
10-$1
(+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ loss 0otal %1&(1 loss
%++(,((( +'(,((( )*,((( ++3,((( (%3,((()
Aiven Aiven Aiven (*) J ()) (+) J (&) Besser of (') or ())
$! (%3,((() (') J (/) ($' !!!) (/) N (7)
($. [LO 0* (* )] 3art* an indi"id%a * #o%ght an asset for ')00*000 and has c aimed '100*000 of depreciation ded%ctions against the asset. 3art has a margina tax rate of 00 percent. =nswer the 7%estions presented in the fo owing a ternati"e scenarios 5ass%me 3art had no property transactions other than those descri#ed in the pro# em6: a. .hat is the amo%nt and character of 3art/s recogni!ed gain if the asset is tangi# e persona property so d for '()0*0001 .hat effect does the sa e ha"e on 3art/s tax ia#i ity for the year1 #. .hat is the amo%nt and character of 3art/s recogni!ed gain if the asset is tangi# e persona property so d for '))0*0001 .hat effect does the sa e ha"e on 3art/s tax ia#i ity for the year c. .hat is the amo%nt and character of 3art/s recogni!ed gain if the asset is tangi# e persona property so d for '0)0*0001 .hat effect does the sa e ha"e on 3art/s tax ia#i ity for the year1 d. .hat is the amo%nt and character of 3art/s recogni!ed gain if the asset is a non-residentia #%i ding so d for '()0*0001 .hat effect does the sa e ha"e on 3art/s tax ia#i ity for the year1 e. Dow ass%me that 3art is a corporation. .hat is the amo%nt and character of its recogni!ed gain if the asset is a nonresidentia #%i ding so d for '()0*0001 .hat effect does the sa e ha"e on 3art/s tax ia#i ity for the year 5ass%me the same 00 percent margina tax rate61 f. Dow ass%ming that the asset is rea property* which entity type sho% d #e %sed to minimi!e the taxes paid on rea estate gains1 a. %'(,((( ordinary income and a %+',((( tax lia ility on income, computed as follows> Description (+) Amount Fealized Amount Explanation %&'(,((( Aiven
10-$$
(*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain 12aracter @+*&' recapture @+*)+ gain 0ax Amount (1) %'(,((( %(
'((,((( (+((,(((
Aiven Aiven
) &((,((( (*) N ()) %'(,((( (+) J (&) $"! !!! Besser of ()) or (') $! (') J (/)
Rate (&) 0ax (1) x (&) )(C %+',((( +'C %( $1" !!!
. -art has %+((,((( ordinary income and %'(,((( of @+*)+ gain. -art$s tax lia ility is %)7,'((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain 12aracter @+*&' recapture @+*)+ gain 0ax Amount %+((,(( ( %'(,((( Rate (&) )(C +'C 0ax (1) x (&) %)(,((( %7,'(( $(* "!! Amount Explanation %''(,((( Aiven '((,((( Aiven (+((,((( Aiven ) &((,((( (*)N ()) %+'(,((( (+) J (&) $1!! !!! Besser of ()) or (') $"! !!! (') J (/)
c. -art has a @+*)+ loss of %'(,((( and receives tax savings of %+',((( for the loss> Description (+) Amount Fealized (*) =riginal ?asis Amount Explanation %)'(,((( Aiven '((,((( Aiven
10-$0
()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 loss 12aracter @+*&' recapture @+*)+ loss 0ax 3ene4it Amount %( (%'(,((( ) Rate (&) )(C )(C 0ax (1) x (&) %( (%+',((() (%+',((()
(+((,((() &((,((( (%'(,((() $! ($"! !!!)
Aiven (*) N ()) (+) J (&) Besser of ()) or (') (') J (/)
d. -art has a @+*)+ gain of %'(,((( taxed at a maximum *'C rate. -art$s tax lia ility is %+*,'((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain 12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax Amount %&'(,((( '((,((( (+((,((() &((,((( '(,((( $"! !!! %( $"! !!! Explanation Aiven Aiven Aiven (*)N ()) (+) J (&) Besser of (') or ()) (') J (/) (/) N (7)
Amoun Rat t e 0ax %'(,(( *' %+*,'( ( C ( +' %( C %( %+*,'( (
e. -art recognizes %+(,((( ordinary income and %&(,((( @+*)+ gain. -art$s tax lia ility is %+',(((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis Amount Explanation %&'(,((( Aiven '((,((( Aiven
10-$(
()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain 12aracter %&.1)ain %1&(1 )ain 0ax Amount %+(,((( %&(,(((
(+((,((() &((,((( %'(,((( *(C '(,((( $1! !!! $4! !!!
Aiven (*) N ()) (+) J (&) @*6+ Besser of (') or ()) (/) x (7) (') J (3)
Rate 0ax )(C %),((( )(C %+*,((( %+',(((
f. As can e seen from parts (d) and (e), any noncorporate form will result in a lower tax on sales of real property. This is ecause unrecaptured @+*'( gain is taxed at a maximum rate of *' percent for noncorporate taxpayers while corporate taxpayers recognize ordinary gains. (0. [LO (] L%&e so d a #%i ding and the parce of and the #%i ding is #%i t on to his #rother at fair mar&et "a %e. +he fair mar&et "a %e of the #%i ding was determined to #e '0$)*000G L%&e #%i t the #%i ding se"era years ago at a cost of '$00*000. L%&e had c aimed '()*000 of depreciation expense on the #%i ding. +he fair mar&et "a %e of the and was determined to #e '$10*000G L%&e p%rchased the and many years ago for '100*000. L%&e/s #rother wi %se the #%i ding in his #%siness. a. .hat is the amo%nt and character of L%&e/s recogni!ed gain or oss on the #%i ding1 #. .hat is the amo%nt and character of L%&e/s recogni!ed gain or oss on the and1 a. %+7(,((( ordinary income, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis Amount %)*',((( *((,((( (&',((() +'',((( Explanation Aiven Aiven Aiven (*) N ())
10-$)
$rdinary Gain5(Loss) Reco)nized under %1&(.+ $1*! !!! (+) J (&) OBu.e must recognize ordinary income on the sale of the uilding under @+*)6 ecause (+) he sold it at a gain to a related party (his rother) and (*) the asset is a deprecia le asset in the hands of the related party: ecause his rother will use the property in his usiness, he is entitled to depreciate it. . !hat is the amount and character of Bu.e$s recognized gain or loss on the landQ %3(,((( @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis %1&(1 Gain Reco)nized Amount Explanation %*+(,(( ( +)(,((( ( +)(,((( $'! !!! Aiven Aiven Aiven (*) 2 ()) (+) J (&)
((. [LO )] A%c& ey* an indi"id%a * #egan #%siness two years ago and has ne"er so d a :1$01 asset. A%c& ey owned each of the assets for se"era years. -n the c%rrent year* A%c& ey so d the fo owing #%siness assets: Accumulated 1231 Asset Original Cost Depreciation Gain/Loss '4*000 Comp%ters '$*000 5'0*0006 '10*000 2achinery '(*000 5'$*0006 '$0*000 H%rnit%re '1$*000 '8*000 '100*000 A%i ding '10*000 5'1*0006 =ss%ming A%c& ey/s margina ordinary income tax rate is 0) percent* answer the 7%estions for the fo owing a ternati"e scenarios: a. .hat are A%c& ey/s gains or osses for the c%rrent year1 .hat effect do the gains or osses ha"e on A%c& ey/s tax ia#i ity1 #. =ss%me that the amo%nt rea i!ed increased so that the #%i ding was so d at a '4*000 gain instead. .hat are A%c& ey/s gains or osses for the c%rrent year1 .hat effect do the gains and osses ha"e on A%c& ey/s tax ia#i ity1 c. =ss%me that the amo%nt rea i!ed increased so that the #%i ding was so d at a '1)*000 gain instead. .hat are A%c& ey/s gains or osses for the c%rrent year1 .hat effect do the gains and osses ha"e on A%c& ey/s tax ia#i ity1 a. ?uc.ley$s net @+*&' gain is %7,((( and its net @+*)+ loss is %/,((( and is calculated as follows>
10-$4
Asset Description Amount Comp%ters @+*)+ lossO 5'0*0006 2achinery @+*)+ lossO 5'$*0006 H%rnit%re @+*&' recapture '8*000 A%i ding @+*)+ lossO 5'1*0006 O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. 12aracter @+*&' recapture @+*)+ loss 0ax Amoun t %7,((( (%/,((( ) Rate (&) )'C )'C 0ax (1) x (&) %*,&'( (%*,+(() %)'(
. ?uc.ley$s net @+*&' gain is %7,((( and its net @+*)+ gain is %+,((( and is calculated as follows> Asset Description Amount Comp%ters @+*)+ lossO 5'0*0006 2achinery @+*)+ lossO 5'$*0006 H%rnit%re @+*&' recapture '8*000 A%i ding 4nrecaptured @+*'( gainOO '4*000 O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. OO4nrecaptured @+*'( gain is a @+*)+ gain taxed at a maximum rate of *'C Amoun Rate 0ax (1) x 12aracter t (&) (&) @+*&' recapture %7,((( )'C %*,&'( 8et @+*)+ gainO %+,((( *'C %*'( 0ax %*,7(( OAn unrecaptured @+*'( gain of %/,((( from the uilding is offset against @+*)+ losses of (%',((() ((%),((( from computer N (%*,((() from machinery), for a net @+*)+ gain of %+,(((. c. ?uc.ley$s net @+*&' gain is %7,((( and its net @+*)+ gain is %+(,((( and is calculated as follows> Asset Comp%ters 2achinery H%rnit%re Description @+*)+ lossO @+*)+ lossO @+*&' recapture Amount 5'0*0006 5'$*0006 '8*000
10-$8
A%i ding 4nrecaptured @+*'( gainOO '10*000 A%i ding @+*)+ gain ')*000 O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. OO4nrecaptured @+*'( gain is a @+*)+ gain taxed at a maximum rate of *'C
10-$;
12aracter @+*&' recapture 4nrecap. @+*'(O 0ax
Amoun Rate 0ax (1) x t (&) (&) %7,((( )'C %*,&'( %+(,(( ( *'C %*,'(( %&,6'(
O?uc.ley has an unrecaptured @+*'( gain (a @+*)+ gain taxed at *'C) of %+(,((( from the uilding and a @+*)+ gain (taxed at +'C) of %',(((. The (%',((() of @+*)+ losses ((%),((( from computer N (%*,((() from machinery) is offset against the +'C taxed @+*)+ gain first. Therefore, the unrecaptured @+*'( gain of %+(,(((, reducing it to %',(((. (). [LO )] IP anningJ =r%na* a so e proprietor* wants to se two assets that she no onger needs for her #%siness. Aoth assets 7%a ify as :1$01 assets. +he first is machinery and wi generate a '10*000 :1$01 oss on the sa e. +he second is and that wi generate a '8*000 :1$01 gain on the sa e. =r%na/s ordinary margina tax rate is 00 percent. a. =ss%ming she se s #oth assets in Decem#er of year 1 5the c%rrent year6* what effect wi the sa es ha"e on =r%na/s tax ia#i ity1 #. =ss%ming that =r%na se s the and in Decem#er of year 1 and the machinery in Can%ary of year $* what effect wi the sa es ha"e on =r%na/s tax ia#i ity for each year1 c. 9xp ain why se ing the assets in separate years wi res% t in tax sa"ings for =r%na. a. Aruna$s tax will decrease y (%6((). ?ecause there is a net @+*)+ loss, oth the gain and loss will e characterized as ordinary. 12aracter %1&(1 loss6$rdinary %1&(1 )ain6 $rdinary 0ax Rat Amount e 0ax (%+(,((( )( (%),((( ) C ) )( %7,((( C %*,+(( (%6(()
. Aruna$s tax will decrease y (%+,6'(). ?ecause the @+*)+ gain is recognized in Kear +, the gain will e capital. The @+*)+ loss in Kear * will e ordinary. 12aracter %1&(1 )ain61apital ( ,ear 1) %1&(1 loss6$rdinary ( ,ear Rat Amount e 0ax +' %7,((( C %+,('( (%+(,((( )( (%),(((
10-$<
&) 0ax
) (%+,6'( )
c. The @+*)+ rules can e gamed if you understand them. Hirst gains and losses are netted. -owever, losses may offset ordinary income at the marginal tax rate, while gains can e recognized at preferential rates which are lower than the marginal tax rate. 0econd, the loo.2 ac. rules prevent recognizing losses efore gains within a five2year period. -owever, gains may e recognized efore losses.
10-00
d.
If Aruna recognizes her gain efore her loss, the @+*)+ loo.2 oo. rules do not apply.
(4. [LO )] Ao%rne K%itars* a corporation* reported a '1)8*000 net :1$01 gain for year 4. a. =ss%ming Ao%rne reported ')0*000 of %nrecapt%red :1$01 osses d%ring years 1L)* what amo%nt of Ao%rne/s net :1$01 gain for year 4* if any* is treated as ordinary income1 #. =ss%ming Ao%rne/s %nrecapt%red :1$01 osses from years 1L) were '$00*000* what amo%nt of Ao%rne/s net :1$01 gain for year 4* if any* is treated as ordinary income1 a. %'(,((( of ?ourne$s gain would e ordinary income and the remaining %+(7,((( gain is a @+*)+ gain, computed as follows> (+) 1urrent @+*)+ gain (*) 4nrecaptured @+*)+ losses ()) =rdinary income @+*)+ gain %+'7,(( ( Aiven %'(,((( Aiven Besser of (+) or (*)
%'(,((( %+(7,(( ( (+) 2 ())
. The entire %+'7,((( gain would e ordinary income due to the unrecaptured @+*)+ loss rule. (8. [LO )] IP anningJ +onya Cefferson* a so e proprietor* r%ns a s%ccessf% o##ying #%siness in .ashington* D.C. >he doesn/t se many #%siness assets* #%t she is p anning on retiring and se ing her historic townho%se* which she r%ns her #%siness from* in order to #%y a p ace somewhere s%nny and warm. +onya/s townho%se is worth '1*000*000 and the and is worth another '1*000*000. +he origina #asis in the townho%se was '400*000* and she has c aimed '$)0*000 of depreciation ded%ctions against the asset o"er the years. +he origina #asis in the and was ')00*000. +onya has ocated a #%yer that wo% d i&e to fina i!e the transaction in Decem#er of the c%rrent year. +onya/s margina ordinary income tax rate is 0) percent. a. .hat amo%nt of gain or oss does +onya recogni!e on the sa e1 .hat is the character of the gain or oss1 .hat effect does the gain and oss ha"e on her tax ia#i ity1 #. -n additiona to the origina facts* ass%me that +onya reports the fo owing %nrecapt%red 1$01 oss: Year Mear 1 Mear $ Mear 0 Net 1231 Gains/(Losses) 5'$00*0006 '0 '0
10-01
Mear ( Mear ) Mear 4 5c%rrent year6
'0 '0 1
10-0$
.hat amo%nt of gain or oss does +onya recogni!e on the sa e1 .hat is the character of the gain or oss1 .hat effect does the gain or oss ha"e on her year 4 5the c%rrent year6 tax ia#i ity1 c. =ss%ming the %nrecapt%red 1$01 oss in part 5#6* as +onya/s tax ad"isor co% d yo% ma&e a s%ggestion as to when +onya sho% d se the townho%se in order to red%ce her taxes1 .hat wo% d +onya/s tax ia#i ity #e if she adopts yo%r recommendation1 a. Tonya has a @+*)+ gain of %*'(,((( taxed at a maximum *'C rate. 0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a maximum +'C rate. Tonya$s tax lia ility is %+67,'((, calculated as follows> Description o4 -uildin) 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain Description o4 Land 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') @+*)+ AainL(Boss) Fecognized 12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax Amount Explanation %+,(((,(( Aiven ( /((,((( (*'(,((() )'(,((( /'(,((( $&"! !!! %&((,((( $#"! !!! Aiven Aiven (*)N ()) (+) J (&) Besser of (') or ()) (') J (/) (/) N (7)
Amount Explanation %+,(((,(( Aiven ( '((,((( (() '((,((( '((,((( Aiven Aiven (*)N ()) (+) J (&)
Rat Amount e 0ax %*'(,(( *' ( C %/*,'(( %6((,(( +' %+)',(( ( C ( %+67,'( (
. Tonya has an ordinary gain of %*((,(((, due to the @+*)+ loo.2 ac. rule. Tonya has a @+*)+ gain of %'(,((( taxed at a maximum *'C rate (the other
10-00
%*((,((( was recaptured as ordinary since it was the highest rate @+*)+ gain.
10-0(
0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a maximum +'C rate. Tonya$s tax lia ility is %*+7,'((, calculated as follows> Description o4 -uildin) 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain Description o4 Land 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') @+*)+ AainL(Boss) Fecognized ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / 8et %1&(1 )ain (loss) (%*((,((() %( %( %( %( %*'(,((( (*'C) %6((,((( (+'C) Amount Explanation %+,(((,(( Aiven ( /((,((( (*'(,((() )'(,((( /'(,((( $&"! !!! %&((,((( $#"! !!! Aiven Aiven (*)N ()) (+) J (&) Besser of (') or ()) (') J (/) (/) N (7)
Amount Explanation %+,(((,(( Aiven ( '((,((( (() '((,((( '((,((( Aiven Aiven (*)N ()) (+) J (&)
Recaptured5 /nrecaptured %1&(1 losses %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %*((,((( %( %(
8otes Boss is ordinary 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses %*((,((( =rdinary 4nrecaptured losses
$rdinary (%*((,((()
L01G
%*((,(((
%'(,((( %6((,(( (
10-0)
12aracter
Amoun t
Rat e
0a x %*((,(( ( %'(,((( %6((,(( ( )' C *' C +' C %7(,((( %+*,'(( %+)',(( ( %*+7,'( (
$rdinary /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax
c. Tonya/s unrecaptured @+*)+ loss is a out to expire. If she delays the sale of her townhouse until Ianuary of year 7, there is no longer any recapture ecause unrecaptured @+*)+ losses only carry over for five years. This would leave Tonya with the same result as part a. Tonya has a @+*)+ gain of %*'(,((( taxed at a maximum *'C rate. 0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a maximum +'C rate. Tonya$s tax lia ility is %+67,'((, which is a savings of %*(,((( for waiting a few wee.s to sell the asset. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 %*'(,((( (*'C) %6((,((( (+'C) 8et %1&(1 )ain (loss) (%*((,((() %( %( %( %( Recaptured5 /nrecaptured %1&(1 losses %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %( %(
8otes Boss is ordinary 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses only carry over ' years
$rdinary (%*((,((()
L01G
%*'(,(( ( %6((,(( ( Rat Amount e 0ax %*'(,(( *' ( C %/*,'((
12aracter /nrecaptured %1&"! (%1&(1 )ain)
10-04
$t2er %1&(1 )ain 0ax
%6((,(( (
+' C
%+)',(( ( %+67,'( (
(;. [LO )] 2organ/s .ater .or d 52..6* an LLC* opened se"era years ago and reports the fo owing net :1$01 gains and osses since it #egan #%siness.
10-08
Year Mear 1 Mear $ Mear 0 Mear ( Mear ) Mear 4 Mear 8 5c%rrent year6
Net 1231 Gains/(Losses) 5'11*0006 ')*000 5'$1*0006 5'(*0006 '18*000 5'(0*0006 '110*000
.hat amo%nt* if any* of the year 8 '110*000 net :1$01 gain is treated as ordinary income1 After applying the @+*)+ five2year loo. ac. rule, the result is %'7,((( ordinary income and %'/,((( long2term capital gain. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 8et %1&(1 )ain (loss) (%++,((() %',((( (%*+,((() (%&,((() %+7,((( (%&),((() %++),((( Recaptured5 /nrecaptured %1&(1 losses %( (%++,((() (%',((() (%/,((() %( (%*7,((() %( (%)+,((() %+7,((( (%+&,((() (%&),((() (%'7,((() %'7,((( %(
8otes Boss is ordinary 4nrecaptured losses Aain is ordinary 4nrecaptured losses Boss is ordinary 4nrecaptured losses Boss is ordinary 4nrecaptured losses Aain is ordinary 4nrecaptured losses Boss is ordinary 4nrecaptured losses %'7,((( is ordinary 8o unrecaptured losses
$rdinary (%++,((() %',((( (%*+,((() (%&,((() %+7,((( (%&),((() %'7,(((
L01G
%'/,(((
(<. [LO )] 3an r%ns a so e proprietorship. 3ans reported the fo owing net :1$01 gains and osses since he #egan #%siness: Year Mear 1 Mear $ Mear 0 Mear (
10-0;
Net 1231 Gains/(Losses) 5'110*0006 '1)*000 '0 '0
Mear )
'10*000
10-0<
Mear 4 Mear 8 5c%rrent year6
'0 ')0*000
a. .hat amo%nt* if any* of the year 8 5c%rrent year6 ')0*000 net :1$01 gain is treated as ordinary income1 #. =ss%me* that the ')0*000 net :1$01 gain occ%rs in year 4 instead of year 8. .hat amo%nt of the gain wo% d #e treated as ordinary income in year 41 a. After applying the @+*)+ five2year loo. ac. rule, the entire %'(,((( is long2 term capital gain. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 8et %1&(1 )ain (loss) (%++(,((( ) %+',((( %( %( %+(,((( %( %'(,((( Recaptured5 /nrecaptured %1&(1 losses %( (%++(,((() %+',((( (%6',((() %( (%6',((() %( (%6',((() %+(,((( (%3',((() %( %(
8otes Boss is ordinary 4nrecaptured losses Aain is ordinary 4nrecaptured losses 4nrecaptured losses
$rdinary (%++(,((() %+',(((
L01G
4nrecaptured losses Aain is ordinary 4nrecaptured losses 4nrecaptured losses only carryforward ' years %'(,((( %'(,((( is @+*)+ %(
%+(,(((
%'(,(((
. After applying the @+*)+ five2year loo. ac. rule, the entire %'(,((( is ordinary income. ,ear Kear + Kear * Kear ) Kear & 8et %1&(1 )ain (loss) (%++(,((( ) %+',((( %( %( Recaptured5 /nrecaptured %1&(1 losses %( (%++(,((() %+',((( (%6',((() %( (%6',((() %( (%6',((()
8otes Boss is ordinary 4nrecaptured losses Aain is ordinary 4nrecaptured losses 4nrecaptured losses 4nrecaptured losses
$rdinary (%++(,((() %+',(((
L01G
10-(0
Kear ' Kear /
%+(,((( %'(,(((
%+(,((( (%3',((() %'(,((( %(
Aain is ordinary 4nrecaptured losses Aain is ordinary 4nrecaptured losses only carryforward ' years
%+(,((( %'(,(((
)0. [LO 4] -ndependence Corporation needs to rep ace some of the assets %sed in its trade or #%siness and is contemp ating the fo owing exchanges: !c"ange Asset Gi#en $p %& 'ndependence a Aand saw # 2achinery %sed in texti es c Passenger a%tomo#i e %sed for de i"eries d Large wareho%se on two acres e Office #%i ding in Kreen Aay* .%sed in the #%siness Asset (ecei#ed %& 'ndependence Aand saw 2achinery %sed for wood wor&ing 3ea"y d%ty "an that seats two and has a arge cargo #ox >ma wareho%se on twenty-two acres =partment comp ex in Dewport Aeach* C=* that wi #e he d as an in"estment
Determine whether each exchange 7%a ifies as a i&e-&ind exchange. = so exp ain the rationa e for why each 7%a ifies or does not 7%a ify as a i&e-&ind exchange. Exc2an) e a Asset )iven up 3y 9ndependence Asset received 3y 9ndependence
c d e
The exchange of a and saw for a and saw 9ualifies as a li.e2.ind exchange since they are tangi le personal property having the same use (contained in the same asset class). The exchange of machinery used in textiles for machinery used for wood wor.ing does not 9ualify as a li.e2.ind exchange ecause they are tangi le personal property that does not have the same use (not contained in the same asset class). The exchange of passenger automo ile for a heavy duty van does not 9ualify as a li.e2.ind exchange ecause the tangi le personal property does not have the same use (not contained in the same asset class). The exchange of a large warehouse on two acres for a small warehouse on twenty2two acres 9ualifies as a li.e2.ind exchange since they are oth real property. The exchange of the office uilding in Areen ?ay, !I for an apartment complex in 8ewport ?each, 1A 9ualifies as a li.e2.ind exchange since they are oth real property that are either used in the usiness or held for investment.
10-(1
)1. [LO 4] Ease* an indi"id%a * p%rchased some property in Potomac* 2ary and* for '1)0*000 approximate y 10 years ago. Ease is approached #y a rea estate agent representing a c ient who wo% d i&e to exchange a parce of and in Dorth Caro ina for Ease/s 2ary and property. Ease agrees to the exchange. .hat is Ease/s rea i!ed gain or oss* recogni!ed gain or oss* and #asis in the Dorth Caro ina property in each of the fo owing a ternati"e scenarios1 a. +he transaction 7%a ifies as a i&e-&ind exchange and the fair mar&et "a %e of each property is '48)*000. #. +he transaction 7%a ifies as a i&e-&ind exchange and the fair mar&et "a %e of each property is '100*000. a. <ven though Mase has a realized gain of %'*',(((, the recognized gain is %( ecause the transaction 9ualifies as a li.e2.ind exchange and Mase did not receive any oot. Mase receives a carryover asis of %+'(,((( in the 8orth 1arolina property (the same asis Mase had in the ,aryland property). 0ee the following computation> Description (+) Amount realized from machine (*) Amount realized from oot (non li.e2.ind property) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad:usted 3asis in ne; property Amount %/7',((( %( %/7',((( %+'(,((( $"&" !!! $! %'*',((( $1"! !!! Explanation Aiven Aiven (+) N (*) Aiven ()) J (&) Besser of (*) or (') (') J (/) (+) J (7)
. Mase would have a realized loss of (%'(,(((), ut the recognized loss would e %( ecause the transaction 9ualifies as a li.e2.ind exchange. Mase would receive a carryover asis of %+'(,(((. 0ee the following computation> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis Amount %+((,((( %( %+((,((( %+'(,((( Explanation Aiven Aiven (+) N (*) Aiven
10-($
(') Loss realized (/) Loss reco)nized (7) ;eferred loss Ad:usted 3asis in ne; property
($"! !!!) $! %'(,((( $1"! !!!
()) J (&) Besser of (*) or (') (') J (/) (+) N (7)
)$. [LO 4] IBesearchJ Longha% +r%c&ing traded two sma er tr%c&s 5each had a 10*000po%nd gross weight6 for one arger tr%c& 51;*000-po%nd gross weight6. Do the tr%c&s 7%a ify as i&e-&ind property to Longha% 5-int: #eca%se the tr%c&s are tangi# e persona property they m%st #e the same asset c ass to #e i&e-&ind assets6. Mo% sho% d %se Be". Proc. ;8-)4 to determine the asset c asses for the tr%c&s. The smaller truc.s and the larger truc. are not li.e2.ind assets. The smaller truc.s are asset class ((.*&+ (Bight Aeneral #urpose Truc.s) ecause they weigh less than +),((( pounds. The larger truc. is asset class ((.*&* (-eavy Aeneral #urpose Truc.s) ecause it weighs +),((( pounds or more. )0. [LO 4] IBesearchJ IP anningJ +win#roo& Corporation needed to %pgrade to a arger man%fact%ring faci ity. +win#roo& first ac7%ired a new man%fact%ring faci ity for '$*100*000 cash* and then transferred the faci ity it was %sing 5#%i ding and and6 to .hite H int Corporation for '$*000*000 three months ater. Does the exchange 7%a ify for i&e-&ind exchange treatment 5hint: examine Be"en%e Proced%res $000-08 and $00(-)161 -f not* can yo% propose a change in the transaction that wi a ow it to 7%a ify1 Twin roo.$s exchange will not 9ualify as a par.ing transaction or reverse 0tar.er exchange. Initially, under Fev. #roc. *(((2)7 it would have 9ualified. -owever, Fev. #roc. *((&2'+ modified the re9uirements, so that Twin roo.$s transaction no longer 9ualifies. 4nder Fev. #roc. *((&2'+, the IF0 will allow a taxpayer to place property with an accommodation party until the taxpayer can arrange for an exchange. Therefore, if Twin roo. gives the funds to a 9ualified intermediary who o tains the new property and holds it until Twin roo. can arrange for the transfer of its current property, the exchange will 9ualify as a 0tar.er or deferred li.e2.ind exchange if the two timing re9uirements are met. Hirst, the li.e2.ind property to e received is identified within &' days R@+()+(a)())(A)S. 0econd, the li.e2.ind property is received within +3( days of the transfer of the property given up R@+()+(a)())(?)(i)S. )(. [LO 4] IBesearchJ .ood ey Par& Corporation c%rrent y owns two parce s of and 5parce 1 and parce $6. -t owns a wareho%se faci ity on parce 1. .ood ey needs to ac7%ire a new and arger man%fact%ring faci ity. .ood ey was approached #y A a!ing Hast Constr%ction 5who specia i!es in prefa#ricated wareho%ses6 a#o%t
10-(0
)). ac7%iring .ood ey/s existing wareho%se on parce 1. .ood ey indicated that it prefers to exchange its existing faci ity for a new and arger faci ity in a 7%a ifying i&e-&ind exchange. A a!ing Hast indicated that it co% d constr%ct a new man%fact%ring faci ity on parce $ to .ood ey/s specification within fo%r months. .ood ey and A a!ing Hast agreed to the fo owing arrangement. Hirst* A a!ing Hast wo% d constr%ct the new wareho%se on parce $ and then re in7%ish the property to .ood ey within fo%r months. .ood ey wo% d then transfer the wareho%se faci ity and and parce 1 to A a!ing Hast. = of the property exchanged in the dea was identified immediate y and the constr%ction was comp eted within 1;0 days. Does the exchange of the new #%i ding for the o d #%i ding and parce 1 7%a ify as a i&e-&ind exchange 5see ;e1leene v. 1ommissioner, 11) +C ()861 <ven though !oodley is trading real property (old uilding and #arcel +) for real property (a new uilding constructed on !oodley$s #arcel *), the exchange does not 9ualify as a li.e2.ind exchange. !oodley$s facts are similar to those of two cases:;e1leene v. 1ommissioner and ?loomington 1oca21ola ?ottling 1o. v. 1ommissioner ('+2+ 40T1 56)*(). After applying the step transaction doctrine the effect was !oodley purchasing a new facility, and not an exchange of unimproved property for improved property, inasmuch as the taxpayer already owned the land on which the new plant was constructed. ?lazing Hast could not e a party to an exchange with the taxpayer ecause the contractor was never the owner of the property that the taxpayer received in the so2called exchange. )4. [LO 4] 2etro Corp. traded machine = for machine A. 2etro origina y p%rchased machine = for ')0*000 and machine =/s ad,%sted #asis was '$)*000 at the time of the exchange. .hat is 2etro/s rea i!ed gain or oss* recogni!ed gain or oss* and ad,%sted #asis in machine A in each of the fo owing a ternati"e scenarios1 a. +he fair mar&et "a %e of machine = and of machine A is '(0*000 at the time of the exchange. +he exchange does not 7%a ify as a i&e-&ind exchange. #. +he fair mar&et "a %e of machine = and of machine A is '(0*000. +he exchange 7%a ifies as a i&e-&ind exchange c. +he fair mar&et "a %e of machine = is '0)*000 and machine A is "a %ed at '(0*000. 2etro exchanges machine = and ')*000 cash for machine A. 2achine = and machine A are i&e-&ind property. d. +he fair mar&et "a %e of machine = is '()*000 and 2etro trades machine = for machine A "a %ed at '(0*000 and ')*000 cash. 2achine = and machine A are i&e-&ind property. a. If the transaction does not 9ualify as a li.e .ind exchange, ,etro has a realized and recognized gain of %+',((( (%&(,((( amount realized minus %*',((( ad"usted asis). The asis in machine ? is its %&(,((( fair mar.et value. . <ven though ,etro has a realized gain of %+',((( (%&(,((( 2 %*',(((), the recognized gain is %( ecause the transaction 9ualifies as a li.e2.ind
10-((
exchange. ,etro receives a asis of %*',((( in machine ?. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad:usted 3asis in ne; property Amount %&(,((( %( %&(,((( %*',((( $1" !!! $! %+',((( $&" !!! Explanation (+) N (*) %'(,((( 2 %*',((( ()) J (&) Besser of (*) or (') (') J (/) (+) J (7)
c. The realized gain is %+(,((( and the recognized gain is %(. ,etro$s asis in machine ? is %)(,(((. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad:usted 3asis in ne; property Amount Explanation %&(,((( Aiven in example %( Aiven in example %&(,((( (+) N (*) %*',((( N %',((( %)(,((( $1! !!! $! %+(,((( $(! !!! cash ()) J (&) Besser of (*) or (') (') J (/) (+) J (7)
d. ,etro$s realized gain is %*(,((( and its recognized gain is %',((( (the amount of the oot received) ecause the transaction 9ualifies as a li.e2.ind exchange. ,etro$s asis in machine ? is %*',(((. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized Amount Explanation %&(,((( Aiven in example %',((( Aiven in example %&',((( (+) N (*)
10-()
(&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad:usted 3asis in ne; property
%*',((( $&! !!! $" !!! %+',((( $&" !!!
%'(,((( 2 %*',((( ()) J (&) Besser of (*) or (') (') J (/) (+) J (7)
)8. [LO 4] Prater -nc. enters into an exchange in which it gi"es %p its wareho%se on 10 acres of and and recei"es a tract of and. = s%mmary of the exchange is as fo ows: )rans*erred .areho%se Land 2ortgage on wareho%se Cash Assets (ecei#ed Land +,'000*000 ')0*000 '00*000 '$0*000 +,'0(0*000 Original .asis '$$)*000 ')0*000 Accumulated Depreciation '()*000
'$0*000
.hat is Prater/s rea i!ed and recogni!ed gain on the exchange and its #asis in the assets it recei"ed in the exchange1 Aain realized is %+*(,(((, gain recognized is %+(,(((, and #rater$s ad"usted asis in the land is %*)(,(((. Description (+) Amount realized in li.e2.ind (*) Amount realized from oot ()) Total amount realized (&) Ad"usted asis (') Gain Realized (/) Gain reco)nized Amount Explanation %)&(,((( Aiven %)(,((( ,ortgage relief %)7(,((( (+) N (*)
%**',((( 2 %&',((( N %'(,(((
%*'(,((( N %*(,((( (lia $1&! !!! ()) J (&)
ility assumed)
Besser of R(*) J lia ility
$1! !!! assumedS or (')
10-(4
(7) ;eferred gain Ad:usted 3asis in ne; property
%++(,((( (') J (/) $&(! !!! (+) J (7)
OIn this situation, #rater is relieved of %+(,((( more de t than he assumed (%)(,((( minus *(,((() ecause consideration given in the form of cash or other property is offset against consideration received. 1onse9uently, he is allowed to net the lia ilities against each other and he is treated as receiving only the %+(,((( net lia ilities he$s een relieved of as oot. );. [LO 4] Aa&er Corporation owned a #%i ding ocated in Eansas. Aa&er %sed the #%i ding for its #%siness operations. Last year a tornado hit the property and comp ete y destroyed it. +his year* Aa&er recei"ed an ins%rance sett ement. Aa&er had origina y p%rchased the #%i ding for '0)0*000 and had c aimed a tota of '100*000 of depreciation ded%ctions against the property. .hat is Aa&er/s rea i!ed and recogni!ed gain or 5 oss6 on this transaction and what is its #asis in the new #%i ding in the fo owing a ternati"e scenarios1 a. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '()0*000 re#%i ding the #%i ding d%ring the c%rrent year. #. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent ')00*000 re#%i ding the #%i ding d%ring the c%rrent year. c. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '(00*000 re#%i ding the #%i ding d%ring the c%rrent year. d. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '()0*000 re#%i ding the #%i ding d%ring the next three years. a. ?ecause ?a.er reinvested all of the insurance proceeds, it will not recognize any of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %&'(,((( %( $! %*((,((( Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Besser of ()) or (/) ()) J (7)
10-(8
(6) Value of replacement property -asis o4 replacement property
%&'(,((( %&'(,((( $&"! !!! (6) J (3)
. ?ecause ?a.er reinvested all of the insurance proceeds, it will not recognize any of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %)((,(((. 0ee the following calculations> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain (6) Value of replacement property -asis o4 replacement property Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %'((,((( %( $! %*((,((( %'((,((( $(!! !!! Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Besser of ()) or (/) ()) J (7) %&'(,((( N %'(,((( (6) J (3)
c. ?ecause ?a.er reinvested only a portion of the insurance proceeds, it will recognize %'(,((( of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain (6) Value of replacement property Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %&((,((( %'(,((( $"! !!! %+'(,((( %&((,((( Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Besser of ()) or (/) ()) J (7) %&((,(((
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-asis o4 replacement property
$&"! !!! (6) J (3)
d. ?ecause ?a.er too. three years to replace the property destroyed in the involuntary conversion, ?a.er will recognize all of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations> Description Amount Explanation (+) Amount Fealized %&'(,((( Insurance proceeds (*) Ad"usted ?asis %*'(,((( %)'(,((( J +((,((( depreciation ()) Gain Realized $&!! !!! (+) J (*) (&) Insurance proceeds %&'(,((( (+) (') #roceeds reinvestedO %( Aiven (/) Amount not reinvested %&'(,((( (&) J (') (7) Gain reco)nized $&!! !!! Besser of ()) or (/) (3) ;eferred gain %( ()) J (7) (6) Value of replacement property %&'(,((( %&'(,((( -asis o4 replacement property $4"! !!! (6) J (3) OThe proceeds were not reinvested within the two year time periodG therefore, they are not a 9ualified reinvestment.
)<. [LO 4] B%sse Corporation so d a parce of and "a %ed at '(00*000. -ts #asis in the and was '$8)*000. Hor the and* B%sse recei"ed ')0*000 in cash in year 0 and a note pro"iding that B%sse wi recei"e '18)*000 in year 1 and '18)*000 in year $ from the #%yer. a. .hat is B%sse /s rea i!ed gain on the transaction1 #. .hat is B%sse /s recogni!ed gain in year 0* year 1* and year $1 a. Fussell$s realized gain is %+*',(((. . Its year ( recognized gain is %+',/*', its year + recognized gain is %'&,/33, and its year * recognized gain is also %'&,/33. 0ee the following calculations> Description (+) Amount Fealized Amount Explanation %&((,((( Aiven
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(*) Ad"usted ?asis ()) Gain Realized (&) Aross #rofit #ercentage (') #ayment received in year ( Gain reco)nized in year ! (/) #ayment received in year + Gain reco)nized in year 1 (7) #ayment received in year * Gain reco)nized in year &
%*7',((( $1&" !!! )+.*'C %'(,((( $1" #&" %+7',((( $"4 #'' %+7',((( $"4 #''
Aiven (+) J (*) ()) L (+) Aiven (') x (&) Aiven (/) x (&) Aiven (7) x (&)
8ote that all of the %+*',((( gain realized is recognized over the three year period. 40. [LO 4] -n year 0* Ca"ens* -nc. so d machinery with a fair mar&et "a %e of '(00*000 to Chris. +he machinery/s origina #asis was '018*000 and Ca"ens/s acc%m% ated depreciation on the machinery was ')0*000* so its ad,%sted #asis to Ca"ens was '$48*000. Chris paid Ca"ens '(0*000 immediate y 5in year 06 and pro"ided a note to Ca"ens indicating that Chris wo% d pay Ca"ens '40*000 a year for six years #eginning in year 1. .hat is the amo%nt and character of the gain that Ca"ens wi recogni!e in year 01 .hat amo%nt and character of the gain wi Ca"ens recogni!e in years 1 thro%gh 41 Iavens recognizes %'3,)(( of income in year ( (%'(,((( ordinary income and %3,)(( of @+*)+ gain). It also recognizes %+*,&'( of @+*)+ gain each year from year + through year /, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Fealized AainL(Boss) (#) $rdinary income 4rom %1&4" depreciation recapture (not eli)i3le 4or installment reportin)) (7) Aain eligi le for installment reporting Amount %&((,((( %)+7,((( %'(,((( %*/7,((( %+)),((( $"! !!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) =rdinary income
Besser of ()) and (') %3),((( (') J (/)
10-)0
(3) Aross profit percentage (6) #ayment received in year ( (1!) Gain reco)nized on payment in year ! 0otal )ain reco)nized in year ! (++) #ayment received in years + through / (each year) Gain reco)nized in years 1 t2rou)2 # (;it2 eac2 payment)
*(.7'C %&(,((( $' (!! $"' (!!
(7) L (+) Aiven in example (6) x (3) @+*)+ gain (/) N (+()
%/(,((( Aiven in example $1& 4"! (++) x (3) @+*)+ gain
41. [LO 4] IBesearchJ Een so d a renta property for ')00*000G '100*000 in the c%rrent year and '100*000 per year thereafter. '(00*000 of the sa es price was a ocated to the #%i ding and the remaining '100*000 was a ocated to the and. Een p%rchased the property se"era years ago for '000*000. '$$)*000 of the p%rchase price was a ocated to the #%i ding and '8)*000 was a ocated to the and. Een has c aimed '$)*000 of depreciation ded%ctions o"er the years against the #%i ding. -f Een had no other sa es of :1$01 or capita assets in the c%rrent year* determine what Een/s recogni!ed gain or oss is* the character of Een/s gain* and ca c% ate Een/s tax d%e #eca%se of the sa e 5ass%ming his margina ordinary tax rate is 0) percent6. 5-int> see the examp es in Beg. :1.()0-1$.6 Men has a @+*)+ gain of %*',((( taxed at a maximum *'C rate. -e also has a @+*)+ gain of %**',((( (%*((,((( from the uilding and %*',((( from the land) taxed at a maximum +'C rate. Tonya$s tax lia ility is %&*,'((. The unrecaptured @+*'( gain is recognized efore any of the @+*)+ gain (as indicated y the regulations)> Description o4 -uildin) 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainL(Boss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain Amount %&((,((( **',((( (*',((() *((,((( *((,((( $&" !!! %+7',((( $&!! !!! Explanation Aiven Aiven Aiven (*)N ()) (+) J (&) Besser of (') or ()) (') J (/) (/) N (7)
10-)1
Description o4 Land 7ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') @+*)+ AainL(Boss) Fecognized 12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Aross #rofit #ercentage (') #ayment received in year (
Amount %+((,((( 7',((( (() 7',((( *',((( Amount
Explanation Aiven Aiven Aiven (*)N ()) (+) J (&)
Rat e 0ax )' %*',((( C %3,7'( %**',(( +' ( C )),7'( %&*,'( ( Amount %'((,((( %*7',((( $&&" !!! &'C %+((,((( Explanation Aiven Aiven (+) J (*) ()) L (+) Aiven (') x (&), %*',((( of unrecaptured @+*'( and
Gain reco)nized in year ! (/) #ayment received in year + Gain reco)nized in years 164
$4" !!! %*(,((( @+*)+ gain %+((,((( Aiven $4" !!! (/) x (&), all @+*)+ gain
4$. [LO 4] IP anningJ 3i ary is in the easing #%siness and faces a margina tax rate of 0) percent. >he has eased e7%ipment to .hitewater Corporation for se"era years. 3i ary #o%ght the e7%ipment for ')0*000 and c aimed '$0*000 of depreciation ded%ctions against the asset. +he ease term is a#o%t to expire and .hitewater wo% d i&e to ac7%ire the e7%ipment. 3i ary has #een offered two options to choose from:
10-)$
Option Li&e-&ind exchange -nsta ment sa e
Details .hitewater wo% d pro"ide 3i ary with i&e-&ind e7%ipment. +he i&e-&ind e7%ipment has a fair mar&et "a %e of '0)*000. .hitewater wo% d pro"ide 3i ary with two payments of '1<*000. >he wo% d %se the proceeds to p%rchase e7%ipment that she co% d a so ease.
-gnoring time "a %e of money* which option pro"ides the greatest after-tax "a %e for 3i ary* ass%ming she is indifferent #etween the proposa s #ased on nontax factors1 $ption 1 Description (+) Amount realized in li.e2.ind (*) Amount realized in oot ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad:usted 3asis in ne; property Amount %)',((( %( %)',((( %)(,((( $" !!! $! %',((( $(! !!! Explanation Aiven Aiven
%'(,((( 2 %*(,(((
()) J (&) Besser of (*) or (') (') J (/) (+) J (7) Amount %)3,((( %'(,((( %*(,((( %)(,((( %3,((( $' !!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) =rdinary income
$ption & Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Fealized AainL(Boss) (#) $rdinary income 4rom %1&4" depreciation
recapture (not eli)i3le 4or installment reportin))+ Besser of ()) and (') (7) Aain eligi le for installment reporting %( (') J (/) (3) Aross profit percentage (C (7) L (+) O?ecause all of the gain is su "ect to depreciation recapture, the installment method cannot e used to defer the gain.
10-)0
12aracter 1as2 4rom note $rdinary income 0ax Aain %3,(( ( Fat e )' C
%)3,((( (%*,3(( ) %)',*((
-illary would e etter off with =ption *. This is ecause her after tax value is %*(( higher (%)',*(( 2%)',(((). Additionally, her asis in option * is %',*(( (%)',*(( 2 %)(,((() higher which will allow her higher depreciation deductions in the future. 40. [LO 4] Deirdre so d 100 shares of stoc& to her #rother* Cames* for '$*(00. Deirdre p%rchased the stoc& se"era years ago for '0*000. a. .hat gain or oss does Deirdre recogni!e on the sa e1 #. .hat amo%nt of gain or oss does Cames recogni!e if he se s the stoc& for '0*$001 c. .hat amo%nt of gain or oss does Cames recogni!e if he se s the stoc& for '$*4001 d. .hat amo%nt of gain or oss does Cames recogni!e if he se s the stoc& for '$*0001 a. Though ;eirdre realizes a %/(( loss, she is not allowed to recognize any of the loss ecause she sold the stoc. to a related party (her rother). 0ee the following computation> Description (+) Amount Fealized (*) ?asis ()) Aain (Boss) Fealized (&) ;isallowed Boss Gain5(Loss) Reco)nized Amount %*,&(( %),((( (%/(() (%/(() $! Explanation Aiven Aiven (+) J (*) Ono recognized loss on related party sale ()) J (&)
. %*(( gain (see calculations elow) c. %( (see calculations elow) d. (%&(() loss (see calculations elow) Description (+) Amount Fealized (*) Ad"usted ?asis ()) Fealized Aain (Boss) Part 3 %),*(( %*,&(( %3(( Part c %*,/(( %*,&(( %*(( Part d %*,((( %*,&(( (%&(() Explanation Aiven in pro lem (+) J (*)
10-)(
(&) ?enefit of ;eirdre$s (%/(() disallowed Boss Reco)nized Gain5(Loss) Compre"ensi#e /ro%lems %/(( $&!! %*(( $! %( ($4!!)
Besser of ()) (limited to %() or %/(( (the amount of ;eirdre$s disallowed loss) ()) J (&)
4(. +wo years ago* Aethesda Corporation #o%ght a de i"ery tr%c& for '00*000 5not s%#,ect to the %x%ry a%to depreciation imits6. Aethesda %sed 2=CB> $00 percent dec ining #a ance and the ha f-year con"ention to reco"er the cost of the tr%c&* #%t it did not e ect :18< expensing or e igi# e #on%s depreciation. =nswer the 7%estions for the fo owing a ternati"e scenarios. a. =ss%ming Aethesda %sed the tr%c& %nti 2arch of year 0* what depreciation expense can it c aim on the tr%c& for years 1 thro%gh 01 #. =ss%me that Aethesda c aimed '1;*)00 of depreciation expense on the tr%c& #efore it so d it in year 0. .hat is the amo%nt and character of the gain or oss if Aethesda so d the tr%c& in year 0 for '18*000* and inc%rred '$*000 of se ing expenses on the sa e1 c. =ss%me that Aethesda c aimed '1;*)00 of depreciation expense on the tr%c& #efore it so d it in year 0. .hat is the amo%nt and character of the gain or oss if Aethesda so d the tr%c& in year 0 for '0)*000* and inc%rred '0*000 of se ing expenses on the sa e1 a. Kear + %/,(((, year * %6,/((, year ) %*,33(. The recovery period for the truc. is five years, so using the half2year convention ta le as it applies to five2 year property, the depreciation expense is calculated as follows: (1) (&) (1) x (&) $ri)inal ,ear -asis Rate Depreciation + %)(,((( *(.((C %/,((( * %)(,((( )*.((C %6,/(( ) %)(,((( 6./(CO %*,33( %+3,&3( O6./C P +6.*(C x .' (half2year in year of disposition) . ?ethesda would recognize %),'(( of ordinary income due to the @+*&' depreciation recapture rules, computed as follows>
10-))
Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated depreciation (&) Ad"usted ?asis (') Gain5(Loss) Reco)nized (/) @+*&' depreciation recapture @+*&' gain
Amount %+',((( %)(,((( (+3,'(() %++,'(( $( "!! $( "!! $!
Explanation %+7,((( 2 %*,((( selling expenses Aiven Aiven (*) N ()) (+) J (&) Besser of ()) or (') (') J (/)
c. ?ethesda$s would recognize %+3,'(( of ordinary income due to the @+*&' depreciation recapture rules and %*,((( of @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated depreciation (&) Ad"usted ?asis (') Gain5(Loss) Reco)nized (/) @+*&' depreciation recapture (7) @+*)+ gain Amount %)*,((( %)(,((( (+3,'(() %++,'(( $&! "!! $1' "!! $& !!! Explanation %)',((( 2 %),((( selling expenses Aiven Aiven (*) N ()) (+) J (&) Besser of ()) and (') (') J (/)
4). 3a%swirth Corporation so d 5or exchanged6 some man%fact%ring e7%ipment in year 0. 3a%swirth #o%ght the machinery se"era years ago for '4)*000 and it has c aimed '$0*000 of depreciation expense against the e7%ipment. a. =ss%ming that 3a%swirth recei"es ')0*000 in cash for the e7%ipment* comp%te the amo%nt and character of 3a%swirth/s recogni!ed gain or oss on the sa e. #. =ss%ming that 3a%swirth recei"es i&e-&ind e7%ipment with a fair mar&et "a %e of ')0*000 in exchange for its e7%ipment* comp%te 3a%swirth/s gain rea i!ed* gain recogni!ed* deferred gain* and #asis in the new e7%ipment. c. =ss%ming that 3a%swirth recei"es '$0*000 in cash in year 0 and a ')0*000 note recei"a# e that is paya# e in year 1* comp%te the amo%nt and character of 3a%swirth/s gain in year 0 and in year 1.
10-)4
a. -auswirth$s recognizes an %3,((( gain. The entire gain is ordinary income under the @+*&' depreciation recapture rules, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Aain (Boss) Fecognized (/) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain Amount %'(,((( %/',((( (%*),((( ) %&*,((( %3,((( $' !!! $! Explanation Aiven Aiven Aiven (*) N ()) (+) J (&) Besser of ()) or (') (') J (/)
. ?ecause this transaction 9ualifies as a @+()+ li.e2.ind exchange, -auswirth will not recognize any of its %3,((( realized gain (its deferred gain is %3,(((). -auswirth$s asis in its new e9uipment is %&*,(((. 0ee the following computations> Description (+) Amount realized from e9uipment (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) De4erred )ain Ad:usted 3asis in ne; property Amount %'(,((( %( %'(,((( %&*,((( $' !!! $! $' !!! $4& !!! Explanation Aiven Aiven (+) N (*) %/',((( 2 %*),((( ()) J (&) Besser of (*) or (') (') J (/) (+) J (7)
c. In year (, -auswirth recognizes %*),((( of ordinary income and %+,&*6 of @+*)+ gain. In year +, it recognizes %),'7+ of @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation Amount %7(,((( %/',((( (%*),((() Explanation Aiven Aiven Aiven
10-)8
(&) Ad"usted ?asis (') Fealized Aain(Boss) (/) $rdinary income 4rom %1&4" depreciation recapture (not eli)i3le 4or installment reportin)) (7) Aain eligi le for installment reporting (3) Aross profit percentage (6) #ayment received in year ( %1&(1 )ain reco)nized in year ! (+() #ayment received in year + %1&(1 )ain reco)nized in year 1
%&*,((( (*) N ()) %*3,((( (+) J (&) =rdinary income $&( !!! %',((( 7.+&C %*(,((( $1 4&. %'(,((( $( "*1 Besser of ()) and (') (') J (/) (7) L (+) Aiven (6) x (3) @+*)+ gain Aiven in example (+() x (3) @+*)+ gain
44. IBesearchJ Hontenot Corporation so d some machinery to its ma,ority owner Kray 5an indi"id%a who owns 40 percent of Hontenot6. Hontenot p%rchased the machinery for '100*000 and has c aimed a tota of '(0*000 of depreciation expense ded%ctions against the property. Kray wi pro"ide Hontenot with '10*000 of cash today and pro"ide a '100*000 note that wi pay Hontenot ')0*000 one year from now and ')0*000 two years from now. a. .hat gain does Hontenot/s rea i!e on the sa e1 #. .hat is the amo%nt and character of the gain that Hontenot m%st recogni!e in the year of sa e 5if any6 and each of the two s%#se7%ent years1 5-int: %se the -nterna Be"en%e Code and start with :()0* p ease gi"e appropriate citations.6 a. Hontenot$s gain realized is %'(,(((. Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Fealized Aain(Boss) Amount %++(,((( %+((,((( (%&(,((() %/(,((( %'(,((( Explanation Aiven Aiven Aiven (*) N ()) (+) J (&)
. Hontenot must recognize the entire %'(,((( gain. The character of the entire gain is ordinary. ;epreciation recapture is not eligi le for deferral under the installment method under section &')(i), as a result %&(,((( of @+*&' gain (the lesser of gain realized or depreciation ta.en) must e recognized as ordinary income during the year of sale. 0ection &')(g) generally prohi its use of the installment method when deprecia le property is sold to a related
10-);
c. party. 0ection &')(g)()) defines related party with respect to section +*)6( ), which in turn uses the related party definitions contained in section */7. 0ince Aray owns more than '(C of Hontenot 1orporation, they are considered related parties. As a result, the remaining gain is ordinary income under section +*)6 ecause the deprecia le asset was sold to a related entity. A sent these rules, the remaining %+(,((( of gain would have een eligi le for the installment method. 48. 2oa#* -nc. man%fact%res and distri#%tes high-tech #i&ing gadgets. -t has decided to stream ine some of its operations so that it wi #e a# e to #e more prod%cti"e and efficient. Aeca%se of this decision it has entered into se"era transactions d%ring the year. Part 516 Determine the gainF oss rea i!ed and recogni!ed in the c%rrent year for each of these e"ents. = so determine whether the gainF oss recogni!ed is :1$01* capita * or ordinary. a. 2oa# -nc. so d a machine that it %sed to ma&e comp%teri!ed gadgets for '$8*000 cash. -t origina y #o%ght the machine for '1<*$00 three years ago and has ta&en ';*000 depreciation. #. 2oa# -nc. he d stoc& in =AC Corp. which had a "a %e of '1$*000 at the #eginning of the year. +hat same stoc& had a "a %e of '1)*$00 at the end of the year. c. 2oa# -nc. so d some of its in"entory for '8*000 cash. +his in"entory had a #asis of ')*000. d. 2oa# -nc. disposed of an office #%i ding with a fair mar&et "a %e of '8)*000 for another office #%i ding with a fair mar&et "a %e of '))*000 and '$0*000 in cash. -t origina y #o%ght the office #%i ding se"en years ago for '4$*000 and has ta&en '1)*000 in depreciation. e. 2oa# -nc. so d and it he d for in"estment for '$;*000. -t origina y #o%ght the and for '0$*000. f. 2oa# -nc. so d another machine for a note recei"a# e in fo%r ann%a insta ments of '1$*000. +he first payment was recei"ed in the c%rrent year. -t origina y #o%ght the machine two years ago for '0$*000 and had c aimed '<*000 in depreciation expense against the machine. g. 2oa# -nc. so d stoc& it he d for eight years for '$*8)0. -t origina y p%rchased the stoc& for '$*100. h. 2oa# -nc. so d another machine for '8*000. -t origina y p%rchased this machine six months ago for '<*000 and has c aimed ';00 in depreciation expense against the asset. Part 5$6 Hrom the recogni!ed gainsF osses determined in part 1* determine the net :1$01 gainF oss and the net ordinary gainF oss 2oa# wi recogni!e on its tax ret%rn. 2oa#* -nc. a so has '$*000 of %nrecapt%red :1$01 osses from pre"io%s years
10-)<
Part 1 Asse t Amount Realized +a + +c +d +e +f +g +h % % % % % % % % *7,)((.(( 2 7,(((.(( 7',(((.(( *3,(((.(( &3,(((.(( *,7'(.(( 7,)((.((
$ri)inal -asis % % % % % % % +6,*((.(( ',(((.(( /*,(((.(( )*,(((.(( )*,(((.(( *,+((.(( 6,(((.((
Depreciation 0a<en % % % % % % % 3,(((.(( 2 +',(((.(( 2 6,(((.(( 2 3)(.((
Ad:usted -asis % % % % % % % ++,*((.(( ',(((.(( &7,(((.(( )*,(((.(( *),(((.(( *,+((.(( 3,+7(.((
Gain5Loss Realized % % +/,+((.(( *,(((.((
1&4" )ain % 3,(((.(( % % 2 2
1&"! )ain % % 2 2
Gain5Loss % % 3,+((.(( *,(((.((
8o gainLloss ecause there wasnTt a transaction to realize any gain. Appreciation alone will not cause realization.
% *3,(((.(( % (&,(((.(() % % % (37(.(() *',(((.(( /'(.((
%),(((.( ( % % % % 2 2 2 2
% 2 % 6,(((.(( % % 2 2
% +7,(((.(( % (&,(((.(() % &,(((.((
% /'(.(( % (37(.(()
Part 1 continued Asset +a + +c +d +e +f +g +h =rdinary +*)+ 1apital +*)+ 1apital =rdinary ?ecause it wasnTt held over a year not +*)+ property. (Aross profit percentage of )).))C (%+/,((( gain realizedL%&3,((( amount realized) ?ecause oot of %*(,((( received. Kou first recognize recapture. In this case 0ection *6+ applies so *(C of depreciation is recpatured as ordinary. 12aracter o4 Remainin) Gain5Loss +*)+
Part & +a + +c +d +e +f +g +h
Asset % % % % % % % % %
1&(1 3,+((.(( 2 2 +7,(((.(( 2 &,(((.(( 2 2 *6,+((.(( % % % % % % % % %
1apital 2 2 2 2 (&,(((.(() 2 /'(.(( 2 (),)'(.(() % % % % % % % % %
$rdinary 3,(((.(( 2 *,(((.(( ),(((.(( 2 6,(((.(( 2 (37(.(() *+,+)(.((
8et Amounts
Part &
1apital $rdinary
*),7'( net capital gain *),+)( net ordinary income
(net *7,+(( +*)+ gain with (),)'() capital loss) (*,((( unrecpatured +*)+ losses ecome ordinary)
4;. IBesearchJ Nerto"ec -nc.* a arge oca cons% ting firm in Otah* hired se"era new cons% tants from o%t of state ast year to he p ser"ice their expanding ist of c ients. +o aide in re ocating the cons% tants* Nerto"ec -nc. p%rchased the cons% tants/ homes in their prior ocation if the cons% tants were %na# e to se their homes within 00 days
10-40
of isting them for sa e. Nerto"ec -nc. #o%ght the homes from the cons% tants for ) percent ess than the ist price and then contin%ed to ist the homes for sa e. 9ach
10-41
home Nerto"ec -nc. p%rchased was so d at a oss. Ay the end of ast year* Nerto"ec had s%ffered a oss tota ing '$)0*000 from the homes. 3ow sho% d Nerto"ec treat the oss for tax p%rposes1 .rite a memo to Nerto"ec -nc. exp aining yo%r findings and any p anning s%ggestions that yo% may ha"e if Nerto"ec -nc. contin%es to offer this type of re ocation #enefit to new y hired cons% tants. =acts> As an inducement to relocate, Vertovec purchased several consultants$ homes if they were una le to sell them within )( days of listing them for sale. The homes were purchased for 'C less than the list price, and su se9uently sold y real estate firm. Vertovec suffered a loss totaling %*'(,((( from the homes. 9ssue> Aut2orities> -ow should Vertovec treat the loss for tax purposesQ 0ection 3*. 0ection +)*(a)(/). 0ection +/*. 0ection +((+(a). 0ection +(++. 0ection +**+. Fev. Ful. *(('27&, *(('2'+ IF?, ++'). Fev. Ful. 3*2*(&, +63*2* 1.?. +6*. 1orn #roducts Fefining 1o. v. 1omr., )'( 4.0. &/ (+6''). 1onclusion> The transaction is treated as two sales. The first is a sale from the employee to the employer. The second is a sale from the employer to the purchaser. ?ecause the homes are not purchased in the ordinary course of Vertovec$s trade or usiness the losses are capital in nature.
Analysis>
The primary 9uestion for Vertovec is whether it ecomes the owner of the residential property or is simply a facilitator of the sale for the employee. Fev. Ful. 3*2*(& held that homes purchased under a home2 uying plan y the employer , to assist its relocating employees were purchases and su se9uent sales. The decision also notes that the residence was not held in the taxpayer$s ordinary course and did not meet the scope of exceptions contained in section +**+ as indicated in 1orn #roducts and should e
10-4$
classified as a capital asset. As a result, the capital gain or loss is amount realized under section +((+ reduced y the taxpayer$s asis (section +(++). Fev. Ful. *(('27& clarified the situations in which the transfer of the residence was considered a sale etween the employee and employer and when the employer$s expenses were deducti le. Aiven the similarity etween Vertovec$s facts and 0cenario + of Fev. Ful. *(('27&, Vertovec$s losses will e capital in nature. 8otwithstanding this recommendation, if the arrangement could e modified similar to 0cenario ) Fev. Ful. *(('27& so that the enefits and urdens of ownership did not pass to the employer the expenses could e deducted as ordinary expenses under section +/*. 0ection +/* allows employers to deduct moving expense reim ursements as an ordinary, necessary, and reasona le usiness expense. <mployees must include in income amounts received as moving expense reim ursements under section 3* unless the amounts are specifically excluded from income under section +)*(a)(/).
10-40

Chap 010 - Taxation of Individuals and Business Entities

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Chap 010 - Taxation of Individuals and Business Entities

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Chapter 10 - Property: Dispositions

Chapter 10 Property: Dispositions SOLUTIONS MANUAL Discussion Questions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

) (+) J (&) $! Besser of ()) or (') ($& !!!

Chapter 10 - Property: Dispositions

. %*(,((( ordinary income and %+)(,((( @+*)+ gain computed as follows>

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

$(& !!! *(,((( (') J (/) $"& !!! (/) N (7)

c. @+*)+ loss of (%3,(((), calculated as follows> Description Amount Explanation

Chapter 10 - Property: Dispositions

%++(,((( +'(,((( )*,((( ++3,((( (%3,((()

$! (%3,((() (') J (/) ($' !!!) (/) N (7)

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

(+((,((() &((,((( (%'(,((() $! ($"! !!!)

Amoun Rat t e 0ax %'(,(( *' %+*,'( ( C ( +' %( C %( %+*,'( (

Chapter 10 - Property: Dispositions

(+((,((() &((,((( %'(,((( *(C '(,((( $1! !!! $4! !!!

Rate 0ax )(C %),((( )(C %+*,((( %+',(((

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

12aracter @+*&' recapture 4nrecap. @+*'(O 0ax

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

%'(,((( %+(7,(( ( (+) 2 ())

Chapter 10 - Property: Dispositions

Mear ( Mear ) Mear 4 5c%rrent year6

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

$rdinary /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax

%*'(,(( ( %6((,(( ( Rat Amount e 0ax %*'(,(( *' ( C %/*,'((

12aracter /nrecaptured %1&"! (%1&(1 )ain)

Chapter 10 - Property: Dispositions

$t2er %1&(1 )ain 0ax

Chapter 10 - Property: Dispositions

$rdinary (%++,((() %',((( (%*+,((() (%&,((() %+7,((( (%&),((() %'7,(((

Net 1231 Gains/(Losses) 5'110*0006 '1)*000 '0 '0

Chapter 10 - Property: Dispositions

Chapter 10 - Property: Dispositions

Mear 4 Mear 8 5c%rrent year6

$rdinary (%++(,((() %+',(((

$rdinary (%++(,((() %+',(((

. %(,((( ordinary income and %+)(,((( @+)+ gain computed as follows>

Amoun Rat t e 0ax %'(,(( ' %+,'( ( C ( +' %( C %( %+*,'( (

12aracter @+&' recapture 4nrecap. @+'(O 0ax

%'(,(( ( %6((,(( ( Rat Amount e 0ax %'(,(( ' ( C %/,'((

Net 1231 Gains/(Losses) 5'1100006 '1)000 '0 '0

%'(,((( N %(,((( (lia $1&! !!! ()) J (&)

%)3,((( (%,3(( ) %)',((

$ri)inal -asis % % % % % % % +6,((.(( ',(((.(( /,(((.(( ),(((.(( ),(((.(( *,+((.(( 6,(((.((

Ad:usted -asis % % % % % % % ++,((.(( ',(((.(( &7,(((.(( ),(((.(( ),(((.(( ,+((.(( 3,+7(.((

% 3,(((.(( % (&,(((.(() % % % (37(.(() ',(((.(( /'(.((

$rdinary 3,(((.(( 2 ,(((.(( ),(((.(( 2 6,(((.(( 2 (37(.(() +,+)(.((

),7'( net capital gain ),+)( net ordinary income