ACCT553

Week 7 Homework
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Chapters 10-11-12
1. Please explain the distinction between a "realized" gain and a "recognized" gain.
(5 pts)
A recognized gain is the amount received on a sale minus the adjusted basis of the
property sold. On the other hand the realized gain is the amount that is part of this
recognized gain which will be treated as income and it is subjected to tax on the
sellers income tax return.
For example, if someone owns a stock with a basis of $35 and sells it for $55, then
he earns a recognized gain of $20 ($55 - $35). He can also deduct brokerage fees
when determining his actual earnings from the sale of the stock. The final earnings
after all cost deductions equal to his realized gain. Here if the brokerage fees are
$3, then the realized gain is $17. IRS typically taxes earnings based on realized
gains.
2. Are there any limits to the deductibility of losses on sales and exchanges
between related parties? What code section defines this limitation? (5 pts.)
No deduction is allowed on loss on sales or exchanges of property between
certain related parties. This was done to prevent transactions between
related taxpayers solely for the purpose of obtaining loss deductions to tax liabilities
when the property still remained in the family.
However, any disallowed loss, may be used to offset the gain realized by
the related purchaser on a later sale of the property. This offset possibility is
available only to the original transferee.
US IR Code Sec. 267 defines this limitation.
For example: Alex owned stock costing $16,000 which he sold to his son Bob for
$13,000. Normans $3,000 loss is disallowed. If Bob later sells the stock for $18,000,
he will have a gain of $2,000. His $5,000 realized gain is reduced by Alexs
disallowed loss of $3,000. If Bob sells the stock for $14,000, he does not recognize
any gain. The $1,000 realized gain is wiped out by Alexs disallowed loss. If Bob sells
the stock for $10,000, he has a $3,000 recognized loss ($10,000 less $13,000).
Alexs disallowed loss does not increase Bob loss, but can only reduce the amount
of gain recognized. If the property sold was a personal use asset (rather than stock)
and sold at $10,000, even the $3,000 loss would not be deductible by Bob.
3. What is the basis of property received (i.e. new property) in a like-kind
exchange? What is the holding period for the new asset? (5 pts.)

There are two ways of figuring the basis of the property received (i.e. new property)
in a like-kind exchange.
1. First method starts with the adjusted basis of the property given up (Code Sec.
1031(d)) as follows:

Adjusted basis of the like-kind property given

+
+
+

Boot given
Gain recognized
Liability assumed by the transferor
Boot received
Loss recognized
Liability assumed by the transferee
Basis of the property acquired

2. The second method starts with the fair market value of the property received as
follows:

Fair market value of the like-kind property received

Deferred gain
+ Deferred loss
= Basis of the acquired property
If the property was a capital asset or property used in a taxpayers trade or
business, then the holding period for property acquired in a nontaxable exchange
includes the holding period of the property given in exchange. However, the holding
period of property received as boot in a like-kind exchange transaction begins on
the day following the date of its receipt.

4. David purchased stock in Zoll Corporation in 1985 for $6,000. On April 16, 2013
he gifted the stock to his daughter Susan; at the time of the gift, the Zoll stock was
valued at $250,000. Susan sold the stock the next month for $ 252,000. What is
Susan's gain or loss and what is the character of the gain or loss? ( 5 pts.)
Answer:
Donor basis $6,000 and the fair value of the stock at the time of sale is $250,000.
Since the donor basis is less that the fair value at the time of the sale, the donor
basis will be used for the tax purpose, According to the IRS publication 550.

Therefore the capital gain = $252,000 - $6,000 = $246,000.

This will be treated as long term capital gain as the stock is held more than a year.