Chapter 7 Federal Taxation Textbook Solutions

Chapter 07 - Capital Gains and Other Sales of Property

CHAPTER 7 CAPITAL GAINS AND OTHER SALES OF PROPERTY Discussion Questions

1. How are basis, adjusted basis, and fair market value defined as they apply to the calculation of gains and losses? Answer: a. Basis is defined as the cost of the property bought in cash, debt obligations, or other property of services. Property can also be acquired other than through a purchase as by gift, inheritance, divorces, or other exchange. b. Adjusted basis is the cost including any increases made to the property such as additions made to property or commission fees incurred on stock transactions and decreases such as depreciation on property of stock dividends or splits. c. Fair market value is the price at which the property would change hands between a buyer and a seller, neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts. Sales of similar property, around the same date are typically used in figuring fair market value.

2. What is meant by the terms terms realized gain (loss) (loss) and recognized gain (loss) as they apply to the sale of assets by a taxpayer? Answer: The term realized is everything the taxpayer receives in the transaction and is sometimes called the proceeds from the sale. This includes cash received plus the FMV of any property or services also received in the transaction. The term recognized is the amount that will be recorded on the tax return as a gain or loss. Assets sold are considered realized but they may or may not be immediately recognized for tax purposes depending on the type of transaction.

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3. How can the gain from the sale sale of property be characterized? Why is it it important to correctly characterize the gain on the sale of property? Answer: The type of gain or loss is dependent on the character (use) of the asset. Assets are classified as ordinary income property, §1221 capital property (capital assets), or §1231 trade or business property. It is important to correctly characterize the gain on the sale of property because different types of gains are reflected differently on the tax return. Depending on the nature of the asset, the gains can be taxed at different rates, losses can be allowed only to a certain extent, and gains and losses are reported in different places on a tax return.

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

5. What determines whether land is a capital asset? Discuss the the circumstances under which land is considered a capital ca pital asset. How else can land be classified? Answer: Land held for investment is a capital asset. However, if the land is used in a trade or business, it is not a capital asset but but a §1231 asset. If the land was held for resale by a real estate developer, the land is treated as inventory (an ordinary asset).

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6. What is a §1231 asset? How are gains and losses from the sale of §1231 assets treated? On what tax forms are gains and losses from the sale of §1231 assets reported? Answer: IRC §1231 property is property used in a trade or business that is subject to depreciation and held for more than 1 year, which includes real property held for more than 1 year and used in the trade or business even though depreciation is not allowed (e.g., land). Timber, coal, domestic iron ore and certain livestock held for breeding, dairy, or sporting purposes are also considered §1231 property. The most typical examples of §1231 assets are machinery and equipment, buildings, and land used in a business. When a §1231 asset is sold, the gain may be either ordinary or capital. The sale of §1231 assets (both gains and losses) is initially reported on Form 4797.

7. When making the determination of whether an asset is a §1231 asset, does the length of time the asset is held enter into the classification? Explain. Answer: By definition, IRC §1231 property is property used in a trade or business and is subject to depreciation and held for more than 1 year.

8. What are the different classifications of capital assets? Define each classification and explain the difference in the preferential tax treatment (rate at which the gains are taxed). Answer: Collectibles 28% rate IRC §1202 Gain 28% rate Unrecaptured §1250 Gain 25% rate Other Capital Gains (pre 5/06/03 sales) 10% or 20% rate* Other Capital Gains (post 05/05/03 sales) 5% or 15% rate * * The actual rate is dependent on the tax bracket of the taxpayer. Most capital gains will be taxed at 20% for pre 05/06/03 sales and 15% for post 05/05/03 sales

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

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

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

12. How is a net capital loss treated? Include in your answer a discussion of how a net capital loss is treated in relation to other income. Answer: Long-term capital losses must be netted against long-term capital gains. Short-term capital losses must be netted against short-term capital gains. Then the two figures must be netted against each other. Any remaining capital loss reduces ordinary income by a maximum of $3,000 per year. Any excess may be carried forward indefinitely to offset gains.

13. In what ways can a capital asset be acquired, and how is the holding period determined for each method of acquisition? Answer: Long-term capital losses must be netted against long-term capital gains. Short-term capital losses must be netted against short-term capital gains. Then the two figures must be netted against each other. Any remaining capital loss reduces ordinary income by a maximum of $3,000 per year. Any excess may be carried forward indefinitely to offset gains.

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14. Capital gains can be taxed at several different rates. What determines the rate? Answer: Net long-term capital gains can be taxed at a 5%, 10%, 15%, 20%, 25%, or 28% rate. Except for unrecaptured §1250 gains and “collectible gains” (see below), long-term capital gains are taxed at either 5%/15% (post 05/05/03) or 10%/ 20% (pre 05/06/03). The determination of the percentage is based on the taxpayer’s taxable income and corresponding tax bracket. The 25% rate relates to capital gains from depreciable real property (buildings) used in a trade or business. The 28% capital gain rate applies to “collectible gains” and §1202 gains.

15. What is a §1202 gain and how is it taxed? Answer: IRC §1202 provides a provision to limit the taxation on a gain from the sale of a “qualified small business stock.” In the case of a taxpayer other than a corporation, gross income shall not include 50% of any gain from the sale or exchange of qualified small business stock held for more than 5 years. The 28% tax rate applies to §1202 gain

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16. Discuss the netting process of capital gains and losses. What are the possible outcomes of the netting process and how would each situation be taxed? Answer: In order to determine net capital gains and losses, the taxpayer must combine short-term capital losses and short-term capital gains to obtain a net short-term gain or loss. The long-term capital gains and losses must also be combined resulting in a net long-term capital gain or loss. The net shortterm gain or loss is then netted with the long-term gain or loss. Then the taxpayer must separate the gains that are taxed at 28% (collectibles and §1202 gains). If an overall net loss results, the taxpayer is allowed to deduct up to a maximum of $3,000 against other income. Any net loss exceeding the $3,000 is carried over indefinitely to offset other capital gains. The netting process can result in several different outcomes. If the result is a net short-term gain and a net long-term gain the tax is • paid at the regular tax rates for short-term gain and the net long-term gain is taxed as the appropriate capital gain rate. If the result is a net short-term gain and a net long-term loss, the long• term loss is offset against the short-term gain. If a short-term gain exceeds the long-term loss, the short-term gain is • taxed at the regular tax rates. If a long-term loss results, the loss is allowed up to $3,000 against other • income and any excess is carried forward indefinitely. If the result is a net short-term loss and a net long-term gain, the long• term gains need to be separated into the 28%, 25%, and 20%/10% or 5%/15% groups. The net short-term loss is first offset against the 28% group, then the 25% group and if any loss remains, the 20% (15% post 05/05/03) group gains are reduced. If the result is a net short-term loss and a net long-term loss, only $3,000 • of the losses can be deducted against other income. The short-term losses are deducted against other income and if any of the $3,000 limit remains, the long-term loss is allowed (up to the $3,000 limit).

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

18. Discuss the concept of §1245 recapture. Why is the gain on the sale of a §1245 asset treated as ordinary? Is all the gain on the sale of a §1245 asset always treated as ordinary? Answer: The §1245 recapture provisions only apply when a gain occurs on the sale of §1231 property. Any gain on the sale of §1245 property is ordinary to the extent of depreciation taken. Any excess gain is taxed at long-term capital gain rates.

19. What is a §1250 asset? How is it related to a §1231 asset? Answer: A §1250 asset is depreciable real property in a trade of business that has never been considered §1245 asset property. It includes all buildings, residential and non-residential, used in a business or for the production of income. Since an ordinary expense deduction was allowed for depreciation on the asset, some or all of the gain from the sale should be treated as ordinary. Any gain in excess of this gain is considered a §1231 gain and is taxed at the preferential rate. If there is a loss, the loss is always treated as an ordinary loss.

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20. Explain the terms recapture and unrecapture provisions as they apply to §1250 assets. Answer: There are not many situations in which a sale of §1250 property is subject to recapture, mostly because any depreciable real property purchased after 1986 must be depreciated using the straight-line method. If the required depreciation is straight-line, there cannot be any depreciation in excess of straight-line. Most real property placed in service between 1981 and 1986 used accelerated methods over periods of 15, 18, or 19 years. Although it is likely the same taxpayers still own many of these buildings, most of these properties are considered §1245 property. Most other buildings placed in service prior to 1980 are likely to be fully depreciated under either straightline or some other method. Therefore there would be no difference between methods in the depreciation taken. However, the gain representing depreciation deductions claimed by the taxpayer is unrecaptured §1250 gain and taxed at a rate of 25% up to depreciation taken. The remaining gain is §1231 gain.

21. What is a capital gain distribution and how is it taxed? Answer: A capital gain distribution is a distribution of gains and losses to individual shareholders accumulated from mutual funds. The taxpayer reports the capital gain distribution on Schedule D (any 28% gain will be shown on the mutual fund statement and is separately reported on Schedule D).

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22. How can a taxpayer determine the basis of units from a mutual fund? Answer: The gain or loss from the sale of mutual fund stock is calculated by subtracting the total cost basis from the sale proceeds. If the units were purchased at different times for different prices, there are several rules that must be followed. The first-in first-out method requires that the first shares purchased be deemed the first sold. Using the specific identification method the taxpayer specifically specifies which units are to be sold. Using the average basis method, the taxpayer takes the total cost basis and divides by the total units to get an average cost per unit (single category method). The taxpayer can also use a “double-category method,” where an average is calculated for the short-term basis and short-term units and the average is calculated for a long-term basis and long-term units.

23. How are gains (losses) from the sale of property acquired from an inheritance taxed? Answer: The beneficiary can choose one of two valuation dates to determine FMV. They are the date of death or six months after death which is termed the “alternate valuation” date. The holding period is always considered long term.

Multiple Choice

24. Jim sells a parcel of land for $60,000 cash and the buyer assumes Jim’s liability of $8,000 on the land. The basis of Jim’s land is $50,000. What is the gain or loss on the sale? a. $2,000 gain b. $10,000 gain c. $18,000 gain d. $18,000 loss Answer: c

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

26. All of the following expenses increase the basis of stock held for investment except: a. Commission fees on the purchase of stock. b. Stock splits. c. Stock dividends from a dividend reinvestment plan. d. All of the above increase the basis of stock held for investment. Answer: b

27. In 2000, Matthew purchased land for $97,000 for use in his business. He sold it in 2007 for $103,000. What are the amount and type of gain on this sale before netting of any other gains and/or losses? a. $6,000 short-term capital gain b. $6,000 long-term capital gain c. $6,000 ordinary income d. $6,000 §1231 gain Answer: d

28. On May 20, 2006, Jessica purchased land for $92,000 to use in her business. She sold it on May 21, 2007 for $87,000. What are the amount and type of loss on this sale if Jessica does not have any other sales from a trade or business? a. $5,000 deferred loss b. $5,000 long-term capital loss c. $5,000 ordinary loss d. $5,000 § 1231 loss Answer: c

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29. What are the “maximum gain rates? a. 33% and 35% b. 15% and 25% c. 25% and 28% d. 5% and 15% Answer: d

30. In 1998, Sam purchased 2,000 shares of stock for $50,000 in a mid-size local company with gross assets of $15,000,000. In 2007, Sam sold the stock for $88,000. How is the gain treated for tax purposes? a. $38,000 capital gain and taxed at preferential rates. b. $19,000 excluded from gross income under §1202 with the remaining gain recognized and taxed at regular rates. c. $19,000 excluded from gross income under §1202 and $19,000 taxed at 28% d. $19,000 excluded from gross income under §1202 and $19,000 taxed at preferential rates. Answer: c

31. Blair sold the following stocks in 2007: 200 shares of Deaborn Investments purchased May 15, 2006 for $3,050 and sold January 9, 2007 for $4,135 and 40 shares of State Street Investments, purchased November 7, 2004 for $11,875 and sold March 29, 2007 for $8,675. What is the pre-net amount and nature of the gain (loss) on the sale of these transactions on Blair’s 1040 return for 2007? a. $1,085 short-term gain and $2,000 long-term loss. b. $1,085 short-term gain and $3,200 long-term loss. c. $1,915 net long-term loss. d. $2,115 net long-term loss. Answer: b

32. Which statement is true regarding short-term capital gains? a. If there is a net short-term gain and a net long-term gain both gains are taxed at regular rates. b. A long-term loss offsets a short-term gain and if a gain results, the gain is taxed at regular rates. c. A long-term loss offsets a short-term gain and if a gain results, the gain is taxed at preferential rates. d. If there is a net short-term gain and a net long-term gain both gains are taxed at preferential rates. Answer: b

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33. Which is true regarding long-term capital gains? a. A net long-term gain can offset a short-term gain but not a short-term loss. b. A net long-term gain can be taxed at 28%, 25%, 15% or 5% depending on the type of gain generated. c. A net long-term loss can be offset against a long-term gain and if there is a resulting long-term gain, it is taxed at regular rate. d. A long-term loss can only offset a long-term gain if the “netting” result produces a loss of more than $3,000. Answer: b

34. When there is a net short-term loss and a net long-term loss, which of the following is true? a. The entire short-term loss is used to deduct other income before the long-term loss can be used to offset other income. b. A long-term loss is used to deduct other income before the short-term loss. c. Regardless of the amount of a short-term or long-term loss, the maximum amount of loss that can be taken in any one year is $3,000. Any remaining loss amounts can be carried forward for 3 years. d. Regardless of the amount of a short-term or long-term loss, the maximum amount of loss that can be taken in any one year is $3,000. Any remaining loss amounts can be carried forward indefinitely. Answer: d

35. Alton received a Form 1099-B that shows a net sales price of $1,500 on the sale of 600 shares of FNP Company. He bought the stock on October 21, 2006, and sold it on October 22, 2007. His basis in the stock is $1,325, of which $25 is commission fee. What is the amount and nature of Alton’s gain? a. $175 short-term gain. b. $200 short-term gain. c. $175 long-term gain. d.$200 long-term gain. Answer: c

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36. Amal received a Form 1099-DIV with a capital gain distribution of $170. She also received a Form 1099-B from the sale of 240 shares of AMS stock she purchased for $2,400 plus $28 commission fee on February 22, 2006. The net proceeds of the stock sale were $2,200 (commission fee was $14) and the trade date was February 22, 2007. What is the amount and nature of Amal’s gain (loss) on these transactions? a. $214 short-term loss and $170 long-term gain. b. $214 long-term loss and $170 short-term gain. c. $228 long-term loss and $170 short-term gain. d. $228 short-term loss and $170 long-term gain. Answer: d

37. Shannon bought an apartment building in July 2001 for $360,000 and sells it for $480,000 in 2007. There was $95,000 of accumulated straight-line depreciation on the apartment building. Assuming that Shannon is in the 33% tax bracket, how much of her gain is taxed at 25%? a. $0 b. $95,000 c. $120,000 d. $215,000 Answer: b

38. Karen, a single taxpayer, has income from her W-2 of $60,000. She also has a shortterm capital loss of $8,000, a short-term capital gain of $3,000, and a long-term capital gain of $4,000. What is Karen’s AGI for 2007? a. $59,000 b. $61,000 c. $64,000 d. $67,000 Answer: a

39. In 2007, Ann received 1,000 shares of stock as a gift from her husband Tim, who purchased them in 2000. At the time of the gift, the FMV of the stock was $20,000 and Tim’s basis was $25,000. If Ann sells the stock for $28,000, what are the nature and amount of the gain from the sale? a. $3,000 long-term gain. b. $8,000 long-term gain. c. $3,000 short-term gain and $5,000 long-term gain. d. $3,000 long-term gain and $5,000 short-term gain. Answer: a

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40. In 2007, Ann received 1,000 shares of stock as a gift from her husband Tim, who purchased them in 2000. At the time of the gift, the FMV of the stock was $20,000 and Tim’s basis was $25,000. If Ann sells the stock for $18,000, what are the nature and amount of the loss from the sale? a. $2,000 long-term loss. b. $5,000 long-term loss. c. $7,000 long-term loss. d. $2,000 short-term loss and $5,000 long-term loss. Answer: a

Problems

41. On what tax form is gain or loss reported if land is undeveloped? On what tax form is gain or loss reported if land is used in a trade or business? Answer: Undeveloped – report on Schedule D Trade or Business – report on Form 4797, pg. 1 Part I

42. Stanley buys a painting for $500 from a museum for resale in his art gallery. He sold it 18 months later for $1,400. What is the most favorable tax treatment for Stanley? Would the tax treatment be different if Stanley had purchased the painting for personal enjoyment? Answer: Since the painting was purchased for resale, the painting is considered inventory. Thus the $900 gain would be treated as ordinary income. If the painting was held as a personal investment, the gain would be considered a long-term capital gain and taxed at a maximum rate of 28% for a collectible.

43. Alice owns undeveloped land as an investment with an adjusted basis of $140,000. She sells the property to George for $185,000. a. What is Alice’s realized and recognized gain or loss? $185,000 - $140,000 = $45,000 realized and recognized gain

b. What is the character of the gain or loss?

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Section 1221 capital gain

c. If the land is used in a trade or business, is the character of the gain or loss different? Explain. Yes, the gain would be a §1231 gain. However, the gain would still be treated as capital but must first offset §1231 losses.

44. Gaylord has taxable income of $95,000 without consideration of capital gain or loss transactions. He has a short-term capital gain of $10,000, a long-term capital loss of $2,000, and a short-term capital gain of $4,000. What is the effect of these gains and losses on taxable income? What are the amount and nature of any carryforward? Assuming that none of the gains or losses is from collectibles or unrecaptured §1250 property, at what tax rate will the gains or losses be taxed to Gaylord who is in the 25% tax bracket for ordinary income? Answer: Short-term Capital Gain Short-term Capital Gain Net Short-term Capital Gain Long-term Capital Loss

$10,000 $ 4,000 $14,000 $ 2,000

Netted gives the taxpayer a $12,000 net short-term capital gain. The net short-term gain is included in taxable income with no carryovers. A short-term capital gain gets no preferential treatment. The $12,000 would be reported on Schedule D but would be taxed at the ordinary income rate.

45. Jake purchased a $200,000 crane for his construction business. He sold the crane for $145,000 after taking $110,000 of depreciation. What are the nature and the amount of gain or loss on the sale? On what tax form would the gain or loss originally be reported? Answer: Sale Proceeds Adjusted Basis §1245 Gain

$145,000 $ 90,000 $ 55,000 ======

Since the property is §1245 property, the gain is ordinary to the extent of depreciation taken. Thus, the gain would be ordinary and reported on page 2 of Form 4797.

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46. Rufus owns two plots of land for business use. He has a short-term-capital loss of $18,000 from other sources. He has the opportunity to sell one parcel (Plot A) at a gain of $52,000, and the other (Plot B) for a loss of $21,000. What would be the tax effects to Rufus if he sells: a. Plot A only? S/T Capital Loss §1231 (LTCG) Plot A §1231 LTCG

($18,000) $52,000 $34,000

Taxed at a maximum rate of 5% or 15%

b. Plot B only? S/T Capital Loss ($18,000) Plot B §1231 ordinary loss ($21,000) The ordinary loss on Plot B is deductible as an ordinary loss and the S/T capital loss of $15,000 is carried forward indefinitely and $3,000 could be used against ordinary income.

c. Both Plots A and B? S/T Capital Loss carryover

($18,000)

§1231 (LTCG) §1231 Loss Plot B Net §1231 Gain (LTCG)

$52,000 ($21,000) $31,000

The net §1231 gain of $31,000 is netted with the $18,000 loss and results in a $13,000 LTCG. The LTCG is taxed at a maximum rate of 5% or 15%.

d. What would you recommend? Explain your recommendation. From a tax perspective, the best option would be to sell both properties. The $18,000 loss is used to lessen the gain on Plot A and the loss on Plot B would nearly eliminate the excess gain.

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47. Larry owns an automobile for personal use. The adjusted basis is $16,000, and the FMV is $13,500. a. Calculate the realized and recognized gain or loss if Larry sells the vehicle for $13,500. Sell Price $13,500 Basis 16,000 Realized Loss ($2,500) Since this is a personal asset, the loss on the sale would not be deductible.

b. Calculate the realized and recognized gain or loss if Larry sells the vehicle for $17,000. Sell Price Basis

$17,000 16,000 $ 1,000 gain

Since the automobile is a capital asset, the gain should be treated as a longterm capital gain.

48. Antoine sold the following stock in 2007. ABC, Inc. is a Section 1202 qualified small business. Asset

Cost

Acquired

Sales Price

ABC, Inc. 200 shares DEF, Inc. 100 shares GHI, Inc. 50 shares

$148,000 21,000 18,000

1/10/03 11/15/04 3/31/06

$200,000 14,000 17,000

Sale Date 4/30/07 2/28/07 8/30/07

a. Determine the amount and the character of the realized and recognized gain or loss from each sale. Realized and Recognized Gain ABC $200,000 - $148,000 = $52,000 initial gain subject to 50% exclusion with the remaining $26,000 being taxed at 28% DEF $ 14,000 - $ 21,000 = ($7,000) STCL GHI $ 17,000 - $ 18,000 = ($1,000) LTCL

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b. How would the gains and losses be netted? The long-term gain from the sale of ABC (Section 1202 stock) and loss are netted first and then netted with the short-term loss. The result is a net longterm capital gain of $18,000 which is taxed at the 28% per the special rules for the sale of Section 1202 stock.

c. On what form would the gains and losses be reported? Complete page 1 of that form to show the proper reporting of these stock sales. ---------- Insert filled in Schedule D here, one page -------------

49. Ricardo acquired a warehouse for business purposes on August 30, 1990. The building cost $200,000. He took $133,333 of depreciation on the building, and then sold it for $350,000 on July 1, 2007. What are the amount and nature of Ricardo’s gain or loss on the sale of the warehouse? Sales Price Adjusted Basis Less Depreciation

$350,000 $200,000 -$133,333

($ 66,667) $283,333 gain

$133,333 of the gain would be unrecaptured Section 1250 gain which becomes a long-term capital gain taxed at 25%. The remaining $150,000 is a Section 1231 gain.

50. Davidson Industries, a sole proprietorship, sold the following assets in 2007.

Asset

Cost

Acquired

Depreciation

Warehouse Truck Computer

$150,000 18,000 25,000

10/10/03 1/15/06 7/31/06

$28,000 4,500 3,000

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Sales Price $175,000 16,000 21,000

Sale Date 3/15/07 1/15/07 8/31/07


a. Determine the amount and the character of the realized and recognized gain or loss from the sale of each asset. Warehouse $175,000 $122,000 $53,000

Truck $16,000 $13,500 $2,500

Computer $21,000 $22,000 ($1,000)

The warehouse is a §1231 gain – treated as a long-term capital gain ($28,000 of the gain would be a unrecaptured 1250 gain subject to 25% tax rate, the remaining gain is netted with other §1231 gains). The truck is a §1245 gain subject to recapture to the extent of depreciation taken – the $2,500 gain is treated as an ordinary gain. The computer is a §1231 loss and therefore is treated as ordinary loss.

b. Prepare Form 4797 to report the gains and losses.

------------- Insert filled in Form 4797 here, 2 pages ----------------

c. How would your answer change if the computer were a personal computer used at home? The computer would be a personal asset and the corresponding loss would not be deductible.

51. Juan sells depreciable equipment for $65,000, the property’s FMV. His adjusted basis for the equipment was $40,000, and he had originally purchased the equipment for $70,000. What are the tax consequences of this sale to Juan? Sales Price Basis Gain

$65,000 $40,000 $25,000

The gain would be a §1245 propety gain and thus be subject to recapture. The $25,000 gain would be treated as ordinary.

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52. Rowena acquired depreciable real property for $175,000 on January 1, 2001. She sold the asset on January 5, 2007 for $120,000, when its adjusted basis was $95,000. a. Calculate the amount and nature of the gain if the real property were nonresidential. Sales Price Basis Gain

$120,000 $ 95,000 $ 25,000

The $25,000 gain would be classified as a Section 1250 property gain subject to the unrecaptured depreciaton provision which is taxed at a 25% rate.

b. Would the nature of the gain change if the real property were residential? Explain. The gain would change because the deprecation life would change from 39 year S/L to 27 ½ years for residential real property. The character of the gain would remain the same.

53. In 2007, Juanita sold stock considered short-term for a gain of $875 and stock considered long-term for a loss of $2,400. She also had a $2,000 short-term loss carryover from 2006 and a $240 long-term loss carryover from 2006. a. What amount will be shown as a short-term gain (loss) for 2007? $2,000 short-term loss carryover - $875 gain for 2007 = $1,125 short-term loss for 2007.

b. What amount will be shown as a long-term gain (loss) for 2007? $240 long-term loss carryover + $2,400 loss for 2007 = $2,640 long-term loss for 2007.

c. Will there be a carryover for 2008? If so, what is the nature and amount of the carryforward. Yes, the maximum amount of loss to be deducted in any one year is $3,000. Therefore the $1,125 short-term loss will be allowed in 2007 as will $1,875 of the long-term loss of $2,640. The remaining long-term loss of $765 will be a carryover long-term loss to 2008.

d. Prepare a Schedule D. (Detailed stock information has been omitted; use reasonable assumptions to complete the form) ------------- Insert filled in Schedule D here, 2 pages ----------------

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54. Howard, operator of a sole proprietorship, sold the following assets in 2007. Asset

Cost

Forklift

$75,00 0 Truck $31,00 0 Bulldozer $48,00 0

Acquired Depreciation Sales Price 2/15/05 $35,645 $55,00 0 12/15/05 $19,096 $24,00 0 7/31/06 $12,737 $30,00 0

Sale Date 6/30/07 5/01/07 12/31/07

a. Determine the amount and the character of the realized and recognized gain or loss from the sale of each asset. Forklift Sales Price Cost $75,000 Accumulated Depreciation (35,645) §1245 gain, all treated as ordinary income

$55,000 39,355 $15,645

Truck Sales Price Cost $31,000 Accumulated Depreciation (19,096) §1245 gain, all treated as ordinary income Bulldozer Sales Price Cost Accumulated Depreciation §1231 loss, treated as ordinary loss

$24,000 11,904 $12,096

$30,000 $48,000 (12,737)

35,263 ($5,263)

b. Prepare a Form 4797. ------------- Insert filled in Form 4797 here, 2 pages ----------------

55. Jernigan Company, a sole proprietorship, acquired a building for use in the business on April 15, 2005, for $450,000. Straight-line cost recovery was used. Jernigan sold the building for $390,000 on December 31, 2007.

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a. What is the adjusted basis of the property at the time of sale? 39-year S/L 2005: $450,000 * 1.819 2006: $450,000 * 2.564 2007: $450,000 * 2.564 Accumulated Depreciation

x 11.5/12

= $ 8,186 = $11,538 = $11,057 $30,781

Cost Basis $450,000 Accumulated Depreciation (30,781) Adjusted Basis $419,219

b. What are the amount and nature of gain upon sale of the building? Sales Price Basis §1231 ordinary loss

$390,000 419,219 ($29,219)

56. During 2007, Roberto sold 830 shares of Casual Investor Mutual fund for $8.875 per share. The shares were purchased on the following dates: May 31, 2004 400 shares @ $9.375 September 18, 2005 225 shares @ $8.500 October 21, 2005 425 shares @ $10.000 January 12, 2006 276 shares @ $7.125 Required: Calculate the gain (loss) on the sale under the following assumptions: (Carry your calculations to three places) a. Basis is calculated using first in first out method. Proceeds = 830 shares x $8.875 = $7,366.25 FIFO method 400 shares @ $9.375 = $3,750.000 225 shares @ $8.500 = $1,912.500 205 shares @$10.00 = $2,050.000 Total basis: $7,712.500 Less Proceeds: $7,366.250 Loss:

($ 346.250)

b. Basis is calculated using the average cost method (assume all shares are long-term). Proceeds = 830 shares x $8.875 = $7,366.25

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Average Cost Method Average Cost: $11,879.00/1,326 shares = $8.959 Total basis: 830 shares x $8,959 Less Proceeds:

$7,435.573 $7,366.250

Loss:

($ 69.323) = $69.32

Use your tax software to complete the following problems. If you are manually preparing the tax returns, you will need Form 4797, Schedule D, Schedule A, Schedule B, Form 1040, and Schedule D worksheets.

Tax Return Problem #1

Jeffery Norville is a single taxpayer. His SSN is 123-44-7788 and he lives at 5037 Circle Court, Crestview, Illinois. His W-2 for 2007 shows gross wages of $83,000 with $5,146 of Social Security and $1,203.50 of Medicare taxes withheld. He has $17,747 of federal withholding and $2,490 in state withholding. Jeffrey does not itemize. He had the following stock transactions for the year: Stock Shares 5,500 800 2,800

Date Purchased 7/8/06 3/12/07 2/13/01

Date Sold 9/12/07 10/21/07 10/21/07

Sales Price 15,000 54,000 34,000

Cost Basis 18,000 58,000 22,000

He also has interest from a savings account with Local Neighborhood Bank of $167.84 and a dividend from a 1099-DIV in the amount of $1,389 with $1,106 in qualified dividends. Prepare a Form 1040 for Jeffery and all related schedules and forms.

---------------- Insert filled in tax forms here ------------------------Form 1040 – 2 pages Schedule B – one page Schedule D – two pages ------------------------------------------------------------------------------

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Tax Return Problem # 2

Tony and Agnes Miller are married and file a joint return in 2007. They had the following transactions for 2007: Tony W-2

Gross wages Social security tax Medicare tax Federal withholding tax State withholding tax -

$74,000 $ 4,588 $ 1,073 $14,800 $ 2,220

Agnes W-2

Gross wages Social security tax Medicare tax Federal withholding tax State withholding tax -

$98,000 $ 6,045 $ 1,421 $14,500 $ 2,490

Their Schedule A deductions consist of $8,642 in real estate taxes, $15,000 in mortgage interest, and $5,000 in charitable contributions. They have $2,385 in interest from Treasury Bills. During the year they sold the following assets: Equipment on May 15, 2007 for $123,000 that cost $120,000 on May 20, 2005; with $5,000 depreciation had been taken on the equipment; which was used in Tony’s trade or business. Land, held as an investment, was sold on December 19, 2007 for $110,000. It cost $118,500 when it was purchased on February 22, 2000. Prepare a Form 1040 for Tony and Agnes Miller and all related schedules and forms.

---------------- Insert filled in tax forms here ------------------------Form 1040 – 2 pages Schedule A – one page Schedule B – one page Schedule D – two pages Form 4797 – two pages ------------------------------------------------------------------------------

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Tax Return Problem # 3

Janis Blakeley is a single taxpayer who lives at 5411 Melbourne Avenue, Chicago, IL; her SSN is 123-45-9876. She sold the following assets in 2007: Section 1245 (equipment) property was purchased on November 21, 2002 for $86,000 and was sold for $71,250 on October 11, 2007; $24,000 of depreciation had been taken. A two-flat apartment building purchased for $284,600 on June 13, 1999 for $248,900 on February 13, 2007; $53,815 of depreciation had been taken. She also had some investments in a mutual fund and received a substitute 1099 at the end of the year. She received $2,634 in dividends of which $891 was considered qualified dividends. She also had a capital gain distribution of $4,711 from the fund. Janis worked two jobs and had the following W-2’s: ABC Company

Gross compensation Social security tax Medicare tax Federal withholding State withholding

= $ 81,650 = $ 5,062 = $ 1,184 = $ 20,412 =$ 849

QRS Company

Gross compensation Social security Medicare Federal withholding State withholding

= $ 20,000 = $ 1,240 =$ 290 = $ 2,000 =$ 600

Janis’ Schedule A deductions consisted of $7,633 real estate taxes, $10,000 mortgage interest, and $3,000 charitable contributions. Prepare a Form 1040 for Janis Blakeley and all related schedules and forms. ---------------- Insert filled in tax forms here ------------------------Form 1040 – 2 pages Schedule A – one page Schedule B – one page Schedule D – two pages Form 4797 – two pages ------------------------------------------------------------------------------

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Chapter 7 Federal Taxation Textbook Solutions

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