Chap 010 - Taxation of individuals and business entities

8/13/2019 Chap 010 - Taxation of individuals and business entities

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Chapter 10 - Property: Dispositions

Chapter 10Property: Dispositions

SOLUTIONS MANUAL

Discussion Questions

1. [LO 1] Compare and contrast different ways in which a taxpayer triggers a reai!atione"ent #y disposing of an asset.

A realization event for tax purposes is created in many ways. Virtually anydisposal 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 asale or trade (exchange), the taxpayer receives something of value in return forthe asset. In contrast, a charitale contriution, disposal, or destruction from a

natural disaster generally results in a loss of any remaining asis in the assetwithout compensation (unless reimursed y insurance).

$. [LO 1] Potomac Corporation wants to se a wareho%se that it has %sed in its #%sinessfor 10 years. Potomac is as&ing '()0*000 for the property. +he wareho%se is s%#,ectto a mortgage of '1$)*000. f Potomac accepts yden nc./s offer to gi"e Potomac'$)*000 in cash and ass%me f% responsi#iity for the mortgage on the property*what amo%nt does Potomac reai!e on the sae

!hen the property disposed of is su"ect to a liaility and the uyer assumesthe liaility, the relief of det increases the amount realized. Thus, #otomac$s

amount realized consists of %&',, which is cash of %*', plus %+*',relief of det. This assumes that the uyer hypothetically transfers cash to theseller in order to pay off the mortgage.

. [LO 1] 2ontana 2ax ses a $*)00-acre ranch for '1*000*000 in cash* a noterecei"a#e of '1*000*000* and de#t reief of '$*(00*000. 3e aso pays seingcommissions of '40*000. n addition* 2ax agrees to #%id a new #arn on the property5cost '$)0*0006 and spend '100*000 %pgrading the fence on the property #efore thesae. hat is 2ax/s amo%nt reai!ed on the sae

Anything received y the seller during a sale or exchange is included in theamount realized. ost dispositions result in cash to the seller. -owever,amount realized includes, ut is not limited to, cash, the fair maret value ofany other property received (e.g. maretale securities or a similar asset), orrelief of det. In addition, selling expenses reduce the amount realized.Therefore, ax$s amount realized includes the %+,, of cash, %+,,note receivale, relief of det of %*,&,, and is reduced y sellingcommissions 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 thetransaction is added to

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the asis of the property given up and is not considered part of the amountrealized. Therefore, the arn and fence improvements are not considered partof ax$s amount realized. 8ote, however, that maing these improvementsdecreases his realized gain y increasing ontana ax$s ad"usted asis in theproperty due to the improvements.

(. [LO 1] 3aw&eye sod farming e7%ipment for '))*000. t #o%ght the e7%ipment fo%ryears ago for '8)*000* and it has since caimed a tota of '($*000 in depreciationded%ctions against the asset. 9xpain how to cac%ate 3aw&eye/s ad,%sted #asis inthe farming e7%ipment.

-aweye will calculate its ad"usted asis in the farming e9uipment y reducingthe historical cost y any cost recovery deductions taen:namely,depreciation. Therefore, -aweye$s ad"usted asis is %, (%7', less%&*,). The tax ad"usted asis is usually different than the oo ad"ustedasis. This is ecause most assets use a different recovery period, cost recovery

method (e.g. doule declining alance), and convention (e.g. half2year) for taxthan for oo purposes. 0ee 1hapter 6 for how these differences arise. ;ue tothe difference in cost recovery deductions, the ad"usted asis is liely differentunless the asset is fully depreciated for oth oo and tax purposes.

). [LO 1] hen a taxpayer ses an asset* what is the difference #etween reai!ed andrecogni!ed gain or oss on the sae

The realized gain or loss is simply the amount realized less the ad"usted asis ofthe asset sold.


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period. 1apital gains on assets held for more than a year receive preferentialrates 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 long2term 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 $] 9xpain the difference #etween ordinary* capita* and 1$1 assets.

An ordinary asset is an asset that is held for sale in the ordinary course of ataxpayer$s usiness (e.g. inventory) or arises from sales in the ordinary courseof usiness (e.g. accounts receivale). 1apital assets are held for investment(expecting appreciation) or are personal2use assets (e.g. a taxpayer$s personalelongings). A @+*+ assets is used in a trade or usiness or for the productionof income and is held for more than one year. An asset that is used in a tradeor usiness or for the production of income and is held for one year or less isan ordinary asset. ains on personal use property are capital gains while

losses are non2deductile.

;. [LO $] Disc%ss the reasons why indi"id%as generay prefer capita gains o"erordinary gains. 9xpain why corporate taxpayers might prefer capita gains o"erordinary gains.

Individual taxpayers prefer capital gains ecause they can e taxed atpreferential rates. Bong2term capital gains are taxed at preferential rates (' or+'C). 0hort2term capital gains are simply taxed at ordinary rates. 1apitalgains can offset capital losses, while ordinary gains cannot. Additionally,individual taxpayers can offset %, of net capital losses against ordinaryincome and carry the remaining capital loss forward indefinitely.


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could e ordinary income property to ;aota if it is held in a trade or usinessor for the production of income for one year or less or if it is considered to einventory (for example a real2estate dealer). The loss would e non2deductileto ;aota if he held the land for personal2use purposes.

10. [LO $] Lincon has %sed a piece of and in her #%siness for the past fi"e years. +heand 7%aifies as 1$1 property. t is %ncear whether Lincon wi ha"e to recogni!ea gain or oss when she e"ent%ay ses the asset. >he as&s her acco%ntant how thegain or oss wo%d #e characteri!ed if she decides to se. 3er acco%ntant said thatseing 1$1 assets gi"es seers ?the #est of #oth words.@ 9xpain what heracco%ntant means #y ?the #est of #oth words.@

An asset 9ualifies as a @+*+ asset if used in a trade or usiness or held for theproduction of income for more than one year. The tax treatment is sometimesdescried 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 preferale ecause theyare taxed at a preferential rate (for non2corporate taxpayers) and can offsetcapital losses which cannot always e offset against ordinary income.=rdinary losses are preferred to capital losses ecause they offset ordinaryincome in the current year rather than eing accumulated to offset futurecapital gains.

11. [LO ] 9xpain Congress/s rationae for depreciation recapt%re.

The purpose of depreciation recapture is to treat the gain on the sale ofdepreciale assets as ordinary income to the extent the gain is attriutale todepreciation (or other cost recovery deductions). This is ecause the A1F0system lierally allows accelerated deductions which often decrease the asisof an asset faster than the real economic decline in value. Thus, depreciationdeductions may give rise to artificial gain on the disposition of deprecialeassets. It is important to note that depreciation recapture does not affect theamount of the gainG rather it affects only the character of the gain.Additionally, depreciation recapture only applies to sales or dispositionsresulting in gains (e.g. it does not apply to losses).

1$. [LO ] Compare and contrast 1$() depreciation recapt%re and 1$)0 depreciationrecapt%re.

@+*&', sometimes referred to as full recapture, generally applies only totangile personal property. @+*&' recaptures the lesser of the realized gain orthe depreciation taen on the asset as ordinary income:thus the full amount ofthe gain may e recaptured. @+*', sometimes referred to as partial recapture,applies only to real property depreciated under accelerated depreciationmethods:the term partial recapture indicates that only the depreciation in

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excess of straight2line method is recaptured. @+*' recapture no longerapplies. 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 fullydepreciated, regardless of whether accelerated or straight2line methods wereusedG as a result, there is no excess depreciation to recapture. -owever,section *6+ and unrecaptured section +*' applies to gains on real property forcorporations and non2corporate taxpayers, respectively.

1. [LO ] hy is depreciation recapt%re not re7%ired when assets are sod at a oss

!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 ofthe asset declined faster than it was depreciated for tax purposes. Therefore,the loss is simply the recovery of the remaining asis in the asset. ;epreciationrecapture is intended to classify any gain due to prior depreciation as ordinaryin character.

1(. [LO ] hat are the simiarities and differences #etween the tax #enefit r%e and

depreciation recapt%re

1onceptually, oth depreciation recapture and the tax enefit doctrine re9uirea taxpayer to tae 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 thepast and re9uires the amount to e included into ordinary income in the year ofsale. ;epreciation recapture does not change the amount of the gain. Incontrast, the tax enefit doctrine re9uires a taxpayer to tae into income anamount received when an expense was taen in a prior year. Hor example, if ataxpayer deducts (receives a enefit) state income taxes paid during the yearpaid, ut receives a tax refund in a suse9uent year, the taxpayer must includethe refund into income.

1). [LO * (] =re #oth corporations and indi"id%as s%#,ect to depreciation recapt%rewhen they se deprecia#e rea property at a gain 9xpain.

?oth taxpayers used to e su"ect to @+*' recapture when selling realproperty. -owever, ecause there is no longer any accelerated depreciation onreal property, there is no longer any @+*' recapture. -owever, real propertysold at a gain is still su"ect to other types of recapture rules. 1orporatetaxpayers are su"ect to @*6+ recapture and non2corporate taxpayers aresu"ect to unrecaptured @+*' rules.

0ection *6+ re9uires corporate taxpayers to recapture *C of the lesser of thegain realized or accumulated depreciation taen. The recaptured portion of thegain is taxed as ordinary income. The remaining gain is @+*+ gain.

8on2corporate taxpayers must recognize the lesser of the gain realized or theaccumulated depreciation taen as unrecaptured @+*' gain. 4nrecaptured

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@+*' gain is still @+*+ (not ordinary) gain, ut it will e taxed at a maximumrate 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%as simiar to depreciationrecapt%re 3ow is it different

4nrecaptured @+*' gain is similar to depreciation recapture in that the lesser ofaccumulated 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 ordinaryrate up to a maximum rate of *' percentG whereas depreciation recapture is taxedat ordinary rates with no maximum rate.

18. [LO (] 9xpain why gains from deprecia#e property sod to a reated taxpayer aretreated as ordinary income %nder 1$


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eraldine$s description is incorrect. The @+*+ loo2ac rule simplyrecharacterizes @+*+ gain into ordinary gain. This is done to the extent thatprior @+*+ losses in the prior ' years received ordinary loss treatment.eraldine is correct in that the @+*+ gains in the current year are offsetagainst prior @+*+ losses:to the extent they haven$t een recaptured through

the @+*+ loo2ac rule in prior years.

$0. [LO )] 9xpain the p%rpose #ehind the 1$1 oo&-#ac& r%e

The favorale rules of @+*+ allow a taxpayer to treat a net @+*+ loss as anordinary loss. The @+*+ loo2ac rule applies when a taxpayer has a net@+*+ gain for the year which will receive capital gain treatment. The rulerecharacterizes the gain to ordinary to the extent the taxpayer receivedfavorale ordinary loss treatment in the prior five years (that have not yet eenrecaptured). This prevents aritrage of taxpayers timing their sales of lossassets in one year to receive ordinary treatment and selling their gains in a

suse9uent year to otain capital gain treatment.

!ithout the loo2ac rule, taxpayers could separate the years in which it sellsits gain and loss assets. Hor example, a taxpayer could sell its loss asset on;ecemer +, year + and sell its gain asset on anuary +, year *. This wouldallow the loss asset to receive ordinary treatment and e offset against ordinaryincome. The gain asset would e treated as a long2term capital gain, whichwould e taxed at preferential rates y non2corporate taxpayers.

$1. [LO )] Does a taxpayer appy the 1$1 oo&-#ac& r%e in a year when the taxpayerrecogni!es a net 1$1 oss 9xpain.

The loo2ac rule exists to prevent game playing (aritrage) opportunities. Itprevents taxpayers from selling their @+*+ loss assets in one year and receivingordinary loss treatment and then selling their @+*+ gain assets in a suse9uentyear and receiving capital gain treatment. -owever, if the taxpayer does nothave a net @+*+ gain in the suse9uent years, it can e assumed they are notmanipulating the situation and the loo2ac rule does not apply to a year inwhich there is a net @+*+ loss.

$$. [LO )] 3ow wo%d yo% descri#e the appication of the 1$1 oo&-#ac& r%e to afriend who &nows itte a#o%t taxation

The @+*+ loo2ac rule affects only the character of the gain. It re9uires thatany net @+*+ gain ecome ordinary rather than capital to the extent that thereare prior unrecaptured losses in the prior five years that received thepreferential ordinary loss treatment. This is done to offset the enefit ofreceiving ordinary loss treatment in any of the past five years.

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$. [LO (* )] Descri#e the circ%mstances in which an indi"id%a taxpayer with a net1$1 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 tangile personal property and land) will giverise 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 @+*+ gainsfrom real property that are referred to as unrecaptured @+*' gains will etaxed a maximum rate of *'C (e.g. at the taxpayer$s marginal rate unless hisrate exceeds *'C). Thus, non2corporate taxpayer$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 taxrate racet would see capital gains preferential rates increase from 'C to+'C.

$(. [LO 4] Boc&y and A%win&e Partnership sod a parce of and d%ring the c%rrentyear and reai!ed a gain of '$)0*000. Boc&y and A%win&e did not recogni!e gainreated to the sae of the and on its tax ret%rn. s this possi#e 9xpain how ataxpayer co%d reai!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 fromtaxale income (e.g. gain from the sale of a principal residence:see chapter +&for a detailed discussion) or deferred (e.g. lie2ind exchange or related2partyloss), or partially deferred (e.g. an installment sale).

$). [LO 4] hy does Congress aow taxpayers to defer gains on i&e-&ind exchanges3ow do the tax aws ens%re that the gains 5or osses6 are deferred and notpermanenty exc%ded from a taxpayer/s income

In a lie2ind exchange, a taxpayer maintains an investment in an asset otherthan cash and therefore does not have the wherewithal to payJthat is, thetaxpayer does not have the means to pay taxes currently. -owever, in a lie2ind exchange where oot (non2lie ind property) is received, there is a partialrecognition of gain for the transaction.

The gains are deferred through receiving a carryover asis in the lie2indproperty received. This defers the gain until the lie2ind property received isdisposed of rather than permanently excluding the gain from income.

$4. [LO 4] Compare and contrast the i&e-&ind property re7%irements for rea propertyand for persona property for p%rposes of 7%aifying for a i&e-&ind exchange.9xpain whether a car hed #y a corporation for dei"ering doc%ments wi 7%aify asi&e-&ind property with a car hed #y an indi"id%a for persona %se.

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Hor real property, any two pieces of property 9ualify as lie2ind property forpurposes of a lie2ind exchange. Hor example, a 8ew Kor 1ity syscraper(relatively little land with relatively sustantial uilding) will 9ualify as lie2indwith a ontana ranch (relatively sustantial land holding with relatively little

uildings). Hor personal property to 9ualify as lie2ind, it must have the samegeneral 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 9ualifyas lie2ind property for purposes of a lie2ind exchange for the corporation.!hile the assets are lie2ind, the exchange will not 9ualify as lie2ind for theindividual ecause the asset was not used in a trade or usiness or for theproduction of income:a re9uirement of 9ualifying for a lie2ind exchange.

$8. [LO 4] >aa!ar nc.* a Coorado company* is reocating to a near#y town. t wo%di&e to trade its rea property for some rea property in the new ocation. hie

>aa!ar has fo%nd se"era prospecti"e #%yers for its rea property and has aso ocatedse"era properties that are accepta#e in the new ocation* it cannot find anyone that iswiing to trade >aa!ar nc. for its property in a i&e-&ind exchange. 9xpain how athird-party intermediary co%d faciitate >aa!ar/s i&e-&ind exchange.

If 0alazar completed the transaction y selling its old property to one of theprospective uyers and then used the cash to purchase one of the acceptale newproperties, it would not e ale to tae advantage of the lie2ind exchangeprovisions. A third2party intermediary can tae control of 0alazar$s property,sell the property to one of the prospective uyers, and use the cash proceeds toac9uire 0alazar$s desired property. As a result, use of a third party intermediaryallows 0alazar to accomplish what it cannot do on its own (piece together atransaction that 9ualifies as a lie2ind exchange). -owever, 0alazar mustidentify the property to e received within &' days and actually receive theproperty 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 odew 9ngand man%fact%ring faciity for a ranch in yoming. 2in%teman is %sing athird-party intermediary to faciitate the exchange. +he p%rchaser of theman%fact%ring faciity wants to compete the transaction immediatey #%t* for "ario%sreasons* the ranch transaction wi not #e competed for three to fo%r months. ithis deay ca%se a pro#em for 2in%teman/s desire to accompish this thro%gh a i&e-&ind exchange 9xpain.

inuteman can still 9ualify for a 0tarer (deferred) exchange as long it meetstwo timing re9uirements applicale to lie2ind exchanges. Hirst, within &' daysof transferring the property to e given up (8ew


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lie2ind property. In addition, inuteman must use a third party intermediary tohold 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 +3day period following the close of the 8ew cash, tangile assets, intangiles,etc.

0. [LO 4] Compare and contrast the simiarities and differences #etween i&e-&indexchanges and in"o%ntary con"ersions for tax p%rposes

A lie2ind exchange involves a trade for a similar asset within the specified timeperiod. An involuntary conversion is the replacement of property damagedthrough a natural disaster, theft, etc. The two transaction are similar in that theyoth lac (at least a portion of) the wherewithal to pay the tax and thus result in adeferral or partial deferral. The transactions differ in that the definition of9ualifying property is narrower for involuntary conversions than for lie2indexchanges.

1. [LO 4] hat is an instament sae 3ow do the tax aws ens%re that taxpayersrecogni!e a the gain they reai!e on an instament sae 3ow is depreciationrecapt%re treated in an instament sae 9xpain the gross profit ratio and how itreates to gains recogni!ed %nder instament method saes.

Installment sales comprise a sale when any portion of the proceeds is received ina year suse9uent to the disposition. The rules re9uire that the realized gain erecognized rataly as payments are received22unless the taxpayer elects out of theinstallment method. Therefore, for each dollar received, a portion is return ofcapital and a portion is the recognition of previously realized gain. ;epreciationrecapture is re9uired to e recognized in the year of disposition. The recapturedamount is excluded from the gross profit ratio to avoid doule taxation (e.g. thegain realized is reduced y the depreciation recapture recognized). The grossprofit ratio reflects the percentage of> (ain Fealized L Amount Fealized. The

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gross profit ratio is used to determine how much of each of these payments will erecognized as gain in the year that the payment is received.

$. [LO4] 2r. Eye owns stoc& in a oca p%#icy traded company. =tho%gh the stoc&price has decined since he p%rchased it two years ago* he i&es the ong-term

prospects for the company. f Eye ses the stoc& to his sister #eca%se he needs somecash for a down payment on a new home* is the oss ded%cti#e f Eye is right andthe stoc& price increases in the f%t%re* how is his sister/s gain comp%ted if she sesthe stoc&

A related party loss is deferred until the time when the asset is sold y therelated purchaser to an unrelated party. 0ince Myle sold the stoc at a loss tohis sister, Myle$s loss is disallowed. !hen the stoc is sold at a gain, thesister can reduce her gain y the amount of Myle$s disallowed loss. If thestoc continues to decline in value, the disallowed loss is never recognized fortax purposes.

Probe!s

. [LO 1] Bafae sod an asset to ama. hat is Bafae/s amo%nt reai!ed on the sae ineach of the foowing aternati"e scenarios

a. Bafae recei"ed ';0*000 of cash and a "ehice worth '10*000. Bafae aso pays')*000 in seing expenses.

#. Bafae recei"ed ';0*000 of cash and was reie"ed of a '0*000 mortgage on theasset he sod to ama. Bafae aso paid a commission of ')*000 on thetransaction.

c. Bafae recei"ed '$0*000 of cash* a parce of and worth ')0*000* and mar&eta#esec%rities of '10*000. Bafae aso paid a commission of ';*000 on the transaction.

a. %3',, computed as follows>

Property Received Amount Explanation(+) 1ash %3, iven(*) Vehicle +, iven() 1ommissions (',) ivenAmount Fealized %3', (+) N (*) N ()

. %+',, computed as follows>

Property Received Amount Explanation(+) 1ash %3,(*) Felief of det ,() 1ommissions (',)Amount Fealized %+', (+) N (*) N ()

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c. %7*,, computed as follows>

Property Received Amount Explanation(+) 1ash %*,(*) Band ',

() aretale securities +,(&) 1ommissions (3,)Amount Fealized %7*, (+) N (*) N () N (&)

(. [LO 1] >hasta Corporation sod a piece of and to Ai for '()*000. >hasta #o%ght theand two years ago for '0*400. hat gain or oss does >hasta reai!e on thetransaction

%+&,&, computed as follows>Description Amount Explanation(+) Amount Fealized %&',

(*) Ad"usted ?asis ,/Gain (Loss) Realized $144!! (+) J (*)

). [LO 1] Lassen Corporation sod a machine to a machine deaer for '$)*000. Lassen#o%ght the machine for '))*000 and has caimed '1)*000 of depreciation expense onthe machine. hat gain or oss does Lassen reai!e on the transaction

(%+',) loss, computed as follows>Description Amount Explanation(+) Amount Fealized %*', iven(*) Ad"usted ?asis &, %'', original asis 2 %+',

accumulated depreciationGain (Loss) Realized ($1"!!!) (+) J (*)

4. [LO $] dentify each of hite Corporation/s foowing assets as an ordinary* capita*or 1$1 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 earier this year.d. n"entory hite p%rchased 1 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 Aac& 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 0.h. 2achinery hite hed for three years and then sod at a oss of '10*000.

a. 1apital, ecause it is held for investment.

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. There is no difference in calculating the amount and character of the gainetween a partnership and a corporation on @+*&' property.

c. %/, of income (%*, ordinary and %&, @+*+) computed as follows>

Description Amount Explanation(+) Amount Fealized %/, iven(*) =riginal ?asis '/, iven() Accumulated ;epreciation (*,) iven(&) Ad"usted ?asis *&, (*) N ()(') ainL(Boss) Fecognized %/, (+) J (&)(#) rdinary income (%1&4" depreciation

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 Explanation(+) Amount Fealized %*, iven(*) =riginal ?asis '/, iven() Accumulated ;epreciation (*,) iven(&) Ad"usted ?asis *&, (*) N ()(') ainL(Boss) Fecognized (%&,) (+) J (&)(#) rdinary income (%1&4" depreciation

recapture) $! Besser of () or (')%1&1 loss ($4!!!) (') J (/)=nly gains are treated as ordinary income under @+*&', any loss is @+*+.

;. [LO * (] n year 0* Longworth Partnership p%rchased a machine for '(0*000 to %se inits #%siness. n year * Longworth sod the machine for ')*000. Aetween the date ofthe p%rchase and the date of the sae* Longworth depreciated the machine #y '$$*000.

a. hat is the amo%nt and character of the gain Longworth wi recogni!e on thesae

#. hat is the amo%nt and character of the gain Longworth wi recogni!e on thesae if the sae proceeds were increased to '()*000

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c. hat is the amo%nt and character of the gain Longworth wi recogni!e on thesae if the sae proceeds were decreased to '1)*000

a. %+7, ordinary income.

Description Amount Explanation(+) Amount Fealized %', iven(*) =riginal ?asis &, iven() Accumulated ;epreciation **, iven(&) Ad"usted ?asis +3, (*) 2 ()(') ainL(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 asordinary income under @+*&'.

. %*7, of income (%**, ordinary and %', @+*+) computed as follows>

Description Amount Explanation(+) Amount Fealized %&', iven(*) =riginal ?asis &, iven() Accumulated ;epreciation **, iven(&) Ad"usted ?asis +3, (*) 2 ()(') ainL(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 @+*&', theremaining gain is @+*+.

c. (%,) ordinary loss, computed as follows>

Description Amount Explanation(+) Amount Fealized %+', iven(*) =riginal ?asis &, iven() Accumulated ;epreciation **, iven(&) Ad"usted ?asis +3, (*) 2 ()

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(') ainL(Boss) Fecognized

(%,

) (+) J (&)(#) rdinary income (%1&4" depreciation recapture) $! Besser of () or (')

%1&1 loss

($!!!

) (') J (/)=nly gains are treated as ordinary income under @+*&', any loss is @+*+.


19/63


OAssets held less than one year are ordinary rather than section +*+ assets.

;epreciation 1alculations

,ear

(1)

riinal-asis

(&)

Rate

(1) x (&)

Depreciation+ %*, *.C %&,

* %*,+/.C

O%,*

%7,*O+/C P *.C x .' (half2year in year ofdisposition)

(0. [LO * (] Bay#%rn Corporation has a #%iding that it #o%ght d%ring year 0 for

';)0*000. t sod the #%iding in year ). D%ring the time it hed the #%iding Bay#%rndepreciated it #y '100*000. hat is the amo%nt and character of the gain or ossBay#%rn wi recogni!e on the sae in each of the foowing aternati"e sit%ations

a. Bay#%rn recei"es ';(0*000.#. Bay#%rn recei"es '


20/63


Description Amount Explanation(+) Amount Fealized %6, iven(*) =riginal ?asis 3', iven

() Accumulated ;epreciation +, iven(&) Ad"usted ?asis 7', (*) J ()(') ainL(Boss) Fecognized %+', (+) J (&)(/) @*6+ recapture percentage *C @*6+(7) @*6+ recapture ase +, Besser of (') or ()(3)%&.1 recapture (ordinary income) $&!!!! (/) x (7)%1&1 ain $1!!!! (') J (3)

c. %(',) ordinary loss computed as follows>

Description Amount Explanation(+) Amount Fealized %7, iven(*) =riginal ?asis 3', iven() Accumulated ;epreciation +, iven(&) Ad"usted ?asis 7', (*) J ()(') ainL(Boss) Fecognized (%',) (+) J (&)(/) @*6+ recapture percentage *C @*6+(7) @*6+ recapture ase % Besser of (') or ()(3)%&.1 recapture (ordinary income) $! (/) x (7)%1&1 loss ($"!!!!) (') J (3)

(1. [LO * (] 2oran owns a #%iding he #o%ght d%ring year 0 for '1)0*000. 3e sod the#%iding in year 4. D%ring the time he hed the #%iding he depreciated it #y '$*000.hat is the amo%nt and character of the gain or oss 2oran wi recogni!e on the saein each of the foowing aternati"e sit%ations

a. 2oran recei"ed '1()*000.#. 2oran recei"ed '180*000.c. 2oran recei"ed '110*000.

10-$0


21/63


a. %*7, unrecaptured section +*' gain, which is section +*+ gain taxed atmaximum rate of *'C, computed as follows>

Description Amount Explanation(+) Amount Fealized %+&', iven(*) =riginal ?asis +', iven() Accumulated ;epreciation *, iven(&) Ad"usted ?asis ++3, (*) J ()(') ainL(Boss) Fecognized %*7, (+) J (&)(/) /nrecaptured %1&"! ain (and

%1&1 ain) $&*!!!

Besser of (')

or ()(7) Femaining @+*+ gain % (') J (/)0otal %1&1 ain $&*!!! (/) N (7)

. @+*+ gain of %'*,. =f the %'*,, %*, is unrecaptured @+*' gainsu"ect to a maximum *'C tax rate and the remaining %*, is @+*+ gainsu"ect to a maximum rate of +'C. 0ee the following calculations>

Description Amount Explanation(+) Amount Fealized %+7, iven(*) =riginal ?asis +', iven() Accumulated ;epreciation *, iven(&) Ad"usted ?asis ++3, (*) J ()(') ainL(Boss) Fecognized %'*, (+) J (&)

(/) /nrecaptured %1&"! ain

(and %1&1 ain) $&!!!

Besser of (') or ()

(7) Femaining @+*+ gain *, (') J (/)0otal %1&1 ain $"&!!! (/) N (7)

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

Description Amount Explanation

10-$1


22/63


(+) Amount Fealized %++, iven(*) =riginal ?asis +', iven() Accumulated ;epreciation *, iven(&) Ad"usted ?asis ++3, (*) J ()

(') ainL(Boss) Fecognized (%3,) (+) J (&)(/) /nrecaptured %1&"! ain

(and %1&1 ain) $!

Besser of (') or ()

(7) Femaining @+*+ loss (%3,) (') J (/)0otal %1&1 loss ($'!!!) (/) N (7)

($. [LO * (* )] 3art* an indi"id%a* #o%ght an asset for ')00*000 and has caimed'100*000 of depreciation ded%ctions against the asset. 3art has a margina tax rate of0 percent. =nswer the 7%estions presented in the foowing aternati"e scenarios5ass%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 sod for '()0*000 hat effect does the sae ha"eon 3art/s tax ia#iity for the year

#. hat is the amo%nt and character of 3art/s recogni!ed gain if the asset istangi#e persona property sod for '))0*000 hat effect does the sae ha"eon 3art/s tax ia#iity for the year

c. hat is the amo%nt and character of 3art/s recogni!ed gain if the asset istangi#e persona property sod for ')0*000 hat effect does the sae ha"eon 3art/s tax ia#iity for the year

d. hat is the amo%nt and character of 3art/s recogni!ed gain if the asset is anon-residentia #%iding sod for '()0*000 hat effect does the sae ha"e on3art/s tax ia#iity for the year

e. ow ass%me that 3art is a corporation. hat is the amo%nt and character ofits recogni!ed gain if the asset is a nonresidentia #%iding sod for '()0*000hat effect does the sae ha"e on 3art/s tax ia#iity for the year 5ass%me thesame 0 percent margina tax rate6

f. ow ass%ming that the asset is rea property* which entity type sho%d #e %sedto minimi!e the taxes paid on rea estate gains

a. %', ordinary income and a %+', tax liaility on income, computed asfollows>


(+) Amount Fealized %&', iven

10-$$


23/63


(*) =riginal ?asis ', iven

() Accumulated ;epreciation

(+,

)

iven

(&) Ad"usted ?asis &, (*) N ()

(') ainL(Boss) Fecognized %', (+) J (&)(#) rdinary income (%1&4" depreciation

recapture) $"!!!! Besser of () or (')%1&1 ain $! (') J (/)

2aracter Amount (1) Rate (&) 0ax (1) x (&)@+*&' recapture %', C %+',@+*+ gain % +'C %0ax $1"!!!

. -art has %+, ordinary income and %', of @+*+ gain. -art$s taxliaility is %7,', calculated as follows>

Description Amount Explanation(+) Amount Fealized %'', iven(*) =riginal ?asis ', iven


(+,

)

iven

(&) Ad"usted ?asis &, (*)N ()(') ainL(Boss) Fecognized %+', (+) J (&)(#) rdinary income (%1&4" depreciation

recapture) $1!!!!! Besser of () or (')%1&1 ain $"!!!! (') J (/)

2aracter AmountRate(&)

0ax (1) x(&)

@+*&'recapture

%+, C %,

@+*+ gain %', +'C %7,'

0ax $*"!!

c. -art has a @+*+ loss of %', and receives tax savings of %+', for theloss>

Description Amount Explanation(+) Amount Fealized %', iven(*) =riginal ?asis ', iven

10-$


24/63


() Accumulated ;epreciation (+,) iven(&) Ad"usted ?asis &, (*) N ()(') ainL(Boss) Fecognized (%',) (+) J (&)(#) rdinary income (%1&4" depreciation recapture) $! Besser of () or (')

%1&1 loss ($"!!!!) (') J (/)

2aracter AmountRate(&)

0ax (1) x(&)

@+*&'recapture % C %

@+*+ loss(%',

) C (%+',)

0ax 3eneit (%+',)

d. -art has a @+*+ gain of %', taxed at a maximum *'C rate. -art$s tax

liaility is %+*,', calculated as follows>

Description Amount Explanation(+) Amount Fealized %&', iven(*) =riginal ?asis ', iven() Accumulated ;epreciation (+,) iven(&) Ad"usted ?asis &, (*)N ()(') ainL(Boss) Fecognized ', (+) J (&)(/) /nrecaptured %1&"! ain $"!!!! Besser of (') or ()(7) Femaining @+*+ gain % (') J (/)0otal %1&1 ain $"!!!! (/) N (7)

2aracterAmount

Rate 0ax

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

%',

*'C

%+*,'

t2er %1&1 ain %+'C %

0ax%+*,'

e. -art recognizes %+, ordinary income and %&, @+*+ gain. -art$s tax

liaility is %+',, calculated as follows>

Description Amount Explanation(+) Amount Fealized %&', iven(*) =riginal ?asis ', iven

10-$(


25/63


() Accumulated ;epreciation (+,) iven(&) Ad"usted ?asis &, (*) N ()(') ainL(Boss) Fecognized %', (+) J (&)(/) @*6+ recapture percentage *C @*6+

(7) @*6+ recapture ase ', Besser of (') or ()(3)%&.1 recapture (ordinary income) $1!!!! (/) x (7)%1&1 ain $4!!!! (') J (3)

2aracter Amount Rate 0ax%&.1ain %+, C %,%1&1 ain %&, C %+*,0ax %+',

f. As can e seen from parts (d) and (e), any noncorporate form will result in alower tax on sales of real property. This is ecause unrecaptured @+*' gain is

taxed at a maximum rate of *' percent for noncorporate taxpayers whilecorporate taxpayers recognize ordinary gains.

(. [LO (] L%&e sod a #%iding and the parce of and the #%iding is #%it on to his#rother at fair mar&et "a%e. +he fair mar&et "a%e of the #%iding was determined to#e '$)*000G L%&e #%it the #%iding se"era years ago at a cost of '$00*000. L%&ehad caimed '()*000 of depreciation expense on the #%iding. +he fair mar&et "a%eof the and was determined to #e '$10*000G L%&e p%rchased the and many years agofor '10*000. L%&e/s #rother wi %se the #%iding in his #%siness.

a. hat is the amo%nt and character of L%&e/s recogni!ed gain or oss on the#%iding#. hat is the amo%nt and character of L%&e/s recogni!ed gain or oss on the and

a.%+7, ordinary income, computed as follows>

Description Amount Explanation(+) Amount Fealized %*', iven(*) =riginal ?asis *, iven() Accumulated ;epreciation (&',) iven(&) Ad"usted ?asis +'', (*) N ()

10-$)


26/63


rdinary Gain5(Loss) Reconized under %1&.+ $1*!!!! (+) J (&)OBue 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 deprecialeasset 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 Bue$s recognized gain or loss on the landQ

%3, @+*+ gain, computed as follows>


(+) Amount Fealized

%*+,

iven(*) =riginal ?asis +, iven() Accumulated ;epreciation iven

(&) Ad"usted ?asis +, (*) 2 ()%1&1 Gain Reconized $'!!!! (+) J (&)

((. [LO )] A%c&ey* an indi"id%a* #egan #%siness two years ago and has ne"er sod a1$1 asset. A%c&ey owned each of the assets for se"era years. n the c%rrent year*A%c&ey sod the foowing #%siness assets:

Asset Original Cost

Accumulated

Depreciation

1231

Gain/Loss

Comp%ters '4*000 '$*000 5'*0006

2achinery '10*000 '(*000 5'$*0006

H%rnit%re '$0*000 '1$*000 '8*000

A%iding '100*000 '10*000 5'1*0006

=ss%ming A%c&ey/s margina ordinary income tax rate is ) percent* answer the7%estions for the foowing aternati"e scenarios:

a. hat are A%c&ey/s gains or osses for the c%rrent year hat effect do thegains or osses ha"e on A%c&ey/s tax ia#iity

#. =ss%me that the amo%nt reai!ed increased so that the #%iding was sod at a'4*000 gain instead. hat are A%c&ey/s gains or osses for the c%rrent yearhat effect do the gains and osses ha"e on A%c&ey/s tax ia#iity

c. =ss%me that the amo%nt reai!ed increased so that the #%iding was sod at a'1)*000 gain instead. hat are A%c&ey/s gains or osses for the c%rrent yearhat effect do the gains and osses ha"e on A%c&ey/s tax ia#iity

a. ?ucley$s net @+*&' gain is %7, and its net @+*+ loss is %/, and iscalculated as follows>

10-$4


27/63


Asset Description Amount

Comp%ters @+*+ lossO 5'*0006

2achinery @+*+ lossO 5'$*0006H%rnit%re @+*&' recapture '8*000

A%iding @+*+ lossO 5'1*0006O?ecause ?ucley has only@+*+ losses they ecome ordinary losses.

2aracterAmount

Rate(&)

0ax (1) x(&)

@+*&'recapture %7, 'C %*,&'

@+*+ loss(%/,

) 'C (%*,+)

0ax %'

. ?ucley$s net @+*&' gain is %7, and its net @+*+ gain is %+, and iscalculated as follows>



2achinery @+*+ lossO 5'$*0006H%rnit%re @+*&' recapture '8*000A%iding 4nrecaptured @+*' gainOO '4*000

O?ecause ?ucley has only@+*+ losses they ecome ordinary losses.OO4nrecaptured @+*' gain is a @+*+ gain taxed at a maximum rate of *'C

2aracterAmount

Rate(&)

0ax (1) x(&)

@+*&'recapture %7, 'C %*,&'8et @+*+gainO %+, *'C %*'

0ax %*,7OAn unrecaptured@+*' gain of %/, from the uilding is offset against @+*+ lossesof (%',) ((%, from computer N (%*,) from machinery), for a net @+*+ gain of%+,.

c. ?ucley$s net @+*&' gain is %7, and its net @+*+ gain is %+, and iscalculated as follows>



2achinery @+*+ lossO 5'$*0006H%rnit%re @+*&' recapture '8*000

10-$8


28/63


A%iding 4nrecaptured @+*' gainOO '10*000A%iding @+*+ gain ')*000

O?ecause ?ucley has only@+*+ losses they ecome ordinary losses.OO4nrecaptured @+*' gain is a @+*+ gain taxed at a maximum rate of *'C

10-$;


29/63


2aracterAmount

Rate(&)

0ax (1) x(&)

@+*&' recapture %7, 'C %*,&'4nrecap.

@+*'O

%+,

*'C %*,'0ax %&,6'

O?ucley has an unrecaptured @+*' gain (a @+*+ gain taxed at *'C) of %+, fromthe 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 )] IPanningJ =r%na* a soe proprietor* wants to se two assets that she noonger needs for her #%siness. Aoth assets 7%aify as 1$1 assets. +he first is

machinery and wi generate a '10*000 1$1 oss on the sae. +he second is andthat wi generate a '8*000 1$1 gain on the sae. =r%na/s ordinary margina taxrate is 0 percent.

a. =ss%ming she ses #oth assets in Decem#er of year 1 5the c%rrent year6* whateffect wi the saes ha"e on =r%na/s tax ia#iity

#. =ss%ming that =r%na ses the and in Decem#er of year 1 and the machineryin an%ary of year $* what effect wi the saes ha"e on =r%na/s tax ia#iity foreach year

c. 9xpain why seing 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 thegain and loss will e characterized as ordinary.

2aracter AmountRate 0ax

%1&1 loss6rdinary(%+,

)C

(%,)

%1&1 ain6rdinary %7,

C %*,+

0ax (%6)

. Aruna$s tax will decrease y (%+,6'). ?ecause the @+*+ gain is recognized inKear +, the gain will e capital. The @+*+ loss in Kear * will e ordinary.


%1&1 ain6apital ( ,ear 1) %7,+'C %+,'

%1&1 loss6rdinary ( ,ear (%+, (%,

10-$


30/63


&) ) C )

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 themarginal tax rate. 0econd, the loo2ac rules prevent recognizing losses eforegains within a five2year period. -owever, gains may e recognized efore losses.

10-0


31/63


d. If Aruna recognizes her gain efore her loss, the @+*+ loo2oo rules do notapply.

(4. [LO )] Ao%rne K%itars* a corporation* reported a '1)8*000 net 1$1 gain for year 4.a. =ss%ming Ao%rne reported ')0*000 of %nrecapt%red 1$1 osses d%ring years

1)* what amo%nt of Ao%rne/s net 1$1 gain for year 4* if any* is treated asordinary income#. =ss%ming Ao%rne/s %nrecapt%red 1$1 osses from years 1) were'$00*000* what amo%nt of Ao%rne/s net 1$1 gain for year 4* if any* is treated asordinary income

a. %', of ?ourne$s gain would e ordinary income and the remaining%+7, gain is a @+*+ gain, computed as follows>

(+) 1urrent @+*+ gain%+'7,

iven

(*) 4nrecaptured @+*+losses %', iven

() =rdinary income %',Besser of (+) or(*)

@+*+ gain%+7,

(+) 2 ()

. The entire %+'7, gain would e ordinary income due to the unrecaptured@+*+ loss rule.

(8. [LO )] IPanningJ +onya efferson* a soe proprietor* r%ns a s%ccessf% o##ying#%siness in ashington* D.C. >he doesn/t se many #%siness assets* #%t she ispanning on retiring and seing her historic townho%se* which she r%ns her #%sinessfrom* in order to #%y a pace somewhere s%nny and warm. +onya/s townho%se isworth '1*000*000 and the and is worth another '1*000*000. +he origina #asis in thetownho%se was '400*000* and she has caimed '$)0*000 of depreciation ded%ctionsagainst the asset o"er the years. +he origina #asis in the and was ')00*000. +onyahas ocated a #%yer that wo%d i&e to finai!e the transaction in Decem#er of thec%rrent year. +onya/s margina ordinary income tax rate is ) percent.

a. hat amo%nt of gain or oss does +onya recogni!e on the sae hat is thecharacter of the gain or oss hat effect does the gain and oss ha"e on hertax ia#iity

#. n additiona to the origina facts* ass%me that +onya reports the foowing%nrecapt%red 1$1 oss:

Year Net 1231 Gains/(Losses)

Mear 1 5'$00*0006

Mear $ '0

Mear '0

10-1


32/63


Mear ( '0

Mear ) '0

Mear 4 5c%rrent year6

10-$


33/63


hat amo%nt of gain or oss does +onya recogni!e on the sae hat is thecharacter of the gain or oss hat effect does the gain or oss ha"e on her year 45the c%rrent year6 tax ia#iity

c. =ss%ming the %nrecapt%red 1$1 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 tored%ce her taxes hat wo%d +onya/s tax ia#iity #e if she adopts yo%rrecommendation

a.Tonya has a @+*+ gain of %*', taxed at a maximum *'C rate. 0healso has a @+*+ gain of %6, (%&, from the uilding and %',from the land) taxed at a maximum +'C rate. Tonya$s tax liaility is%+67,', calculated as follows>

Description o -uildin 7ale Amount Explanation

(+) Amount Fealized

%+,,

iven

(*) =riginal ?asis /, iven() Accumulated ;epreciation (*',) iven(&) Ad"usted ?asis ', (*)N ()(') ainL(Boss) Fecognized /', (+) J (&)(/) /nrecaptured %1&"! ain $&"!!!! Besser of (') or ()(7) Femaining @+*+ gain %&, (') J (/)0otal %1&1 ain $#"!!!! (/) N (7)

Description o Land 7ale Amount Explanation

(+) Amount Fealized

%+,,

iven

(*) =riginal ?asis ', iven() Accumulated ;epreciation () iven(&) Ad"usted ?asis ', (*)N ()(') @+*+ ainL(Boss) Fecognized ', (+) J (&)



%*',

*'C %/*,'

t2er %1&1 ain%6,

+'C

%+',

0ax%+67,'

.Tonyahas an ordinary gain of %*,, due to the @+*+ loo2ac rule. Tonya has a @+*+ gain of %', taxed at a maximum *'C rate (the other

10-


34/63


%*, was recaptured as ordinary since it was the highest rate @+*+gain.

10-(


35/63


0he also has a @+*+ gain of %6, (%&, from the uilding and%', from the land) taxed at a maximum +'C rate. Tonya$s tax liailityis %*+7,', calculated as follows>

Description o -uildin 7ale Amount Explanation

(+) Amount Fealized%+,,

iven

(*) =riginal ?asis /, iven() Accumulated ;epreciation (*',) iven(&) Ad"usted ?asis ', (*)N ()(') ainL(Boss) Fecognized /', (+) J (&)(/) /nrecaptured %1&"! ain $&"!!!! Besser of (') or ()(7) Femaining @+*+ gain %&, (') J (/)0otal %1&1 ain $#"!!!! (/) N (7)

Description o Land 7ale Amount Explanation

(+) Amount Fealized

%+,,

iven

(*) =riginal ?asis ', iven() Accumulated ;epreciation () iven(&) Ad"usted ?asis ', (*)N ()(') @+*+ ainL(Boss) Fecognized ', (+) J (&)

,ear 8et %1&1 ain

(loss)

Recaptured5/nrecaptured%1&1 losses 8otes rdinary L0G

Kear + (%*,) %(%*,) Boss is ordinary4nrecaptured losses (%*,)

Kear * % %(%*,) 4nrecaptured losses

Kear % %(%*,) 4nrecaptured losses

Kear & % %(%*,) 4nrecaptured losses

Kear ' % %(%*,) 4nrecaptured losses

Kear / %*', (*'C)

%6, (+'C)

%*,

%%

%*, =rdinary

4nrecaptured losses

%*, %',

%6,

10-)


36/63


2aracterAmount

Rate

0ax

rdinary%*,

'C %7,

/nrecaptured %1&"! (%1&1ain) %', *'C %+*,'

t2er %1&1 ain%6,

+'C

%+',

0ax%*+7,'

c.Tonya/s unrecaptured @+*+ loss is aout to expire. If she delays the saleof her townhouse until anuary of year 7, there is no longer any recaptureecause unrecaptured @+*+ losses only carry over for five years. This wouldleave 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 amaximum +'C rate. Tonya$s tax liaility is %+67,', which is a savings of%*, for waiting a few wees to sell the asset.

,ear 8et %1&1 ain

(loss)


Kear + (%*,) %(%*,)

Boss is ordinary4nrecaptured losses

(%*,)

Kear * % %

(%*,) 4nrecaptured lossesKear % %(%*,) 4nrecaptured losses

Kear & % %(%*,) 4nrecaptured losses

Kear ' % %(%*,) 4nrecaptured losses

Kear / %%

4nrecaptured lossesonly carry over ' years

Kear 7 %*', (*'C)%6, (+'C)

%*',

%6,



%*',

*'C %/*,'

10-4


37/63


t2er %1&1 ain%6,

+'C

%+',

0ax%+67,'

(;. [LO )] 2organ/s ater ord 526* an LLC* opened se"era years ago andreports the foowing net 1$1 gains and osses since it #egan #%siness.

10-8


38/63


Year Net 1231 Gains/(Losses)

Mear 1 5'11*0006

Mear $ ')*000

Mear 5'$1*0006

Mear ( 5'(*0006Mear ) '18*000

Mear 4 5'(*0006

Mear 8 5c%rrent year6 '11*000

hat amo%nt* if any* of the year 8 '11*000 net 1$1 gain is treated as ordinaryincome

After applying the @+*+ five2year loo ac rule, the result is %'7, ordinary incomeand %'/, long2term capital gain.

,ear8et

%1&1ain(loss)


Kear + (%++,) %(%++,)


(%++,)

Kear * %', (%',)(%/,)

ain is ordinary4nrecaptured losses

%',

Kear (%*+,) %(%*7,)


(%*+,)

Kear & (%&,) %

(%+,)

Boss is ordinary

4nrecaptured losses

(%&,)

Kear ' %+7, %+7,

(%+&,)ain is ordinary4nrecaptured losses

%+7,

Kear / (%&,) (%&,)(%'7,)


(%&,)

Kear 7 %++, %'7,%

%'7, is ordinary8o unrecapturedlosses

%'7, %'/,

(


39/63


40/63


Mear 4 '0

Mear 8 5c%rrent year6 ')0*000

a. hat amo%nt* if any* of the year 8 5c%rrent year6 ')0*000 net 1$1 gain is

treated as ordinary income#. =ss%me* that the ')0*000 net 1$1 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 4

a. After applying the @+*+ five2year loo ac rule, the entire %', is long2term capital gain.

,ear 8et %1&1

ain (loss)


Kear + (%++,

)

%

(%++,)

Boss is ordinary

4nrecaptured losses

(%++,)

Kear * %+', %+',(%6',)


%+',

Kear % %(%6',) 4nrecaptured losses

Kear & % %(%6',) 4nrecaptured losses

Kear ' %+, %+,(%3',)


%+,

Kear / % %%

4nrecaptured lossesonly carryforward '

years

Kear 7 %', %',%

%', is @+*+ %',

. After applying the @+*+ five2year loo ac rule, the entire %', isordinary income.

,ear 8et %1&1

ain (loss)


Kear + (%++,)

%(%++,)


(%++,)

Kear * %+', %+',(%6',)


%+',

Kear % %(%6',) 4nrecaptured losses

Kear & % %(%6',) 4nrecaptured losses

10-(0


41/63


Kear ' %+, %+,(%3',)


%+,

Kear / %', %',%


only carryforward 'years

%',

)0. [LO 4] ndependence Corporation needs to repace some of the assets %sed in its tradeor #%siness and is contempating the foowing exchanges:

!c"ange Asset Gi#en $p %&

'ndependence

Asset ecei#ed %& 'ndependence

a Aand saw Aand saw

# 2achinery %sed in texties 2achinery %sed for wood wor&ingc Passenger a%tomo#ie %sed for

dei"eries3ea"y d%ty "an that seats two and has aarge cargo #ox

d Large wareho%se on two acres >ma wareho%se on twenty-two acres

e Office #%iding in Kreen Aay* %sed in the #%siness

=partment compex in ewport Aeach*C=* that wi #e hed as an in"estment

Determine whether each exchange 7%aifies as a i&e-&ind exchange. =so expain therationae for why each 7%aifies or does not 7%aify as a i&e-&ind exchange.

Exc2an

e

Asset iven up 3y 9ndependence Asset received 3y 9ndependence

a The exchange of a and saw for a and saw 9ualifies as a lie2indexchange since they are tangile personal property having the same use(contained in the same asset class).

The exchange of machinery used in textiles for machinery used for woodworing does not 9ualify as a lie2ind exchange ecause they are tangilepersonal property that does not have the same use (not contained in thesame asset class).

c The exchange of passenger automoile for a heavy duty van does not 9ualifyas a lie2ind exchange ecause the tangile personal property does nothave the same use (not contained in the same asset class).

d The exchange of a large warehouse on two acres for a small warehouse ontwenty2two acres 9ualifies as a lie2ind exchange since they are oth realproperty.

e The exchange of the office uilding in reen ?ay, !I for an apartmentcomplex in 8ewport ?each, 1A 9ualifies as a lie2ind exchange since theyare oth real property that are either used in the usiness or held forinvestment.

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)1. [LO 4] Ease* an indi"id%a* p%rchased some property in Potomac* 2aryand* for'1)0*000 approximatey 10 years ago. Ease is approached #y a rea estate agentrepresenting a cient who wo%d i&e to exchange a parce of and in orth Caroinafor Ease/s 2aryand property. Ease agrees to the exchange. hat is Ease/s reai!ed

gain or oss* recogni!ed gain or oss* and #asis in the orth Caroina property in eachof the foowing aternati"e scenariosa. +he transaction 7%aifies as a i&e-&ind exchange and the fair mar&et "a%e ofeach property is '48)*000.#. +he transaction 7%aifies as a i&e-&ind exchange and the fair mar&et "a%e ofeach property is '100*000.

a.


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(')Loss realized ($"!!!!) () J (&)

(/)Loss reconized $! Besser of (*) or (')

(7) ;eferred loss %', (') J (/)

Ad:usted 3asis in ne; property $1"!!!! (+) N (7)

)$. [LO 4] IBesearchJ Longha% +r%c&ing traded two smaer tr%c&s 5each had a 10*000-po%nd gross weight6 for one arger tr%c& 51;*000-po%nd gross weight6. Do the tr%c&s7%aify as i&e-&ind property to Longha% 5-int: #eca%se the tr%c&s are tangi#epersona property they m%st #e the same asset cass to #e i&e-&ind assets6. Mo%sho%d %se Be". Proc. ;8-)4 to determine the asset casses for the tr%c&s.

The smaller trucs and the larger truc are not lie2ind assets. The smallertrucs are asset class .*&+ (Bight eneral #urpose Trucs) ecause they weighless than +, pounds. The larger truc is asset class .*&* (-eavy eneral#urpose Trucs) ecause it weighs +, pounds or more.

). [LO 4] IBesearchJ IPanningJ +win#roo& Corporation needed to %pgrade to a argerman%fact%ring faciity. +win#roo& first ac7%ired a new man%fact%ring faciity for'$*100*000 cash* and then transferred the faciity it was %sing 5#%iding and and6 tohite Hint Corporation for '$*000*000 three months ater. Does the exchange7%aify for i&e-&ind exchange treatment 5hint: examine Be"en%e Proced%res $000-8and $00(-)16 f not* can yo% propose a change in the transaction that wi aow it to7%aify

Twinroo$s exchange will not 9ualify as a paring transaction or reverse0tarer exchange. Initially, under Fev. #roc. *27 it would have 9ualified.

-owever, Fev. #roc. *&2'+ modified the re9uirements, so that Twinroo$stransaction no longer 9ualifies.

4nder Fev. #roc. *&2'+, the IF0 will allow a taxpayer to place property withan accommodation party until the taxpayer can arrange for an exchange.Therefore, if Twinroo gives the funds to a 9ualified intermediary who otainsthe new property and holds it until Twinroo can arrange for the transfer of itscurrent property, the exchange will 9ualify as a 0tarer or deferred lie2indexchange if the two timing re9uirements are met. Hirst, the lie2ind property toe received is identified within &' days R@++(a)()(A)S. 0econd, the lie2indproperty is received within +3 days of the transfer of the property given up

R@++(a)()(?)(i)S.

)(. [LO 4] IBesearchJ oodey Par& Corporation c%rrenty owns two parces of and5parce 1 and parce $6. t owns a wareho%se faciity on parce 1. oodey needs toac7%ire a new and arger man%fact%ring faciity. oodey was approached #yAa!ing Hast Constr%ction 5who speciai!es in prefa#ricated wareho%ses6 a#o%t

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)). ac7%iring oodey/s existing wareho%se on parce 1. oodey indicated that itprefers to exchange its existing faciity for a new and arger faciity in a 7%aifyingi&e-&ind exchange. Aa!ing Hast indicated that it co%d constr%ct a newman%fact%ring faciity on parce $ to oodey/s specification within fo%r months.oodey and Aa!ing Hast agreed to the foowing arrangement. Hirst* Aa!ing Hast

wo%d constr%ct the new wareho%se on parce $ and then rein7%ish the property tooodey within fo%r months. oodey wo%d then transfer the wareho%se faciityand and parce 1 to Aa!ing Hast. = of the property exchanged in the dea wasidentified immediatey and the constr%ction was competed within 1;0 days. Does theexchange of the new #%iding for the od #%iding and parce 1 7%aify as a i&e-&indexchange 5see;e1leene v. 1ommissioner, 11) +C ()86


45/63


exchange. etro receives a asis of %*', in machine ?. 0ee thefollowing computations>


(+) Amount realized from machine %&,

(*) Amount realized from oot (cash) %() Total amount realized %&, (+) N (*)

(&) Ad"usted asis %*', %', 2 %*',

(')Gain realized $1"!!! () J (&)

(/)Gain reconized $! Besser of (*) or (')

(7) ;eferred gain %+', (') J (/)

Ad:usted 3asis in ne; property $&"!!! (+) J (7)

c. The realized gain is %+, and the recognized gain is %. etro$s asisin machine ? is %,. 0ee the following computations>

Description Amount Explanation(+) Amount realized from machine %&, iven in example

(*) Amount realized from oot (cash) % iven in example

() Total amount realized %&, (+) N (*)

(&) Ad"usted asis %,

%*', N %',

cash

(')Gain realized $1!!!! () J (&)

(/)Gain reconized $! Besser of (*) or (')

(7) ;eferred gain %+, (') J (/)

Ad:usted 3asis in ne; property $!!!! (+) J (7)

d. etro$s realized gain is %*, and its recognized gain is %', (theamount of the oot received) ecause the transaction 9ualifies as a lie2indexchange. etro$s asis in machine ? is %*',. 0ee the followingcomputations>


(+) Amount realized from machine %&, iven in example

(*) Amount realized from oot (cash) %', iven in example

() Total amount realized %&', (+) N (*)

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(&) Ad"usted asis %*', %', 2 %*',

(')Gain realized $&!!!! () J (&)

(/)Gain reconized $"!!! Besser of (*) or (')

(7) ;eferred gain %+', (') J (/)

Ad:usted 3asis in ne; property $&"!!! (+) J (7)

)8. [LO 4] Prater nc. enters into an exchange in which it gi"es %p its wareho%se on 10acres of and and recei"es a tract of and. = s%mmary of the exchange is as foows:

rans*erred +,-

Original

.asis

Accumulated

Depreciation

areho%se '00*000 '$$)*000 '()*000

Land ')0*000 ')0*000

2ortgage on

wareho%se

'0*000

Cash '$0*000 '$0*000

Assets ecei#ed +,-

Land '(0*000

hat is Prater/s reai!ed and recogni!ed gain on the exchange and its #asis inthe assets it recei"ed in the exchange

ain realized is %+*,, gain recognized is %+,, and #rater$s ad"usted asis in theland is %*,.


(+) Amount realized in lie2ind %&, iven

(*) Amount realized from oot %, ortgage relief

() Total amount realized %7, (+) N (*)

(&) Ad"usted asis %*',

%**', 2 %&', N %',

N %*, (liaility assumed)

(')Gain Realized $1&!!!! () J (&)

(/)Gain reconized $1!!!!

Besser of R(*) J liaility

assumedS or (')

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(7) ;eferred gain %++, (') J (/)

Ad:usted 3asis in ne; property $&!!!! (+) J (7)

OIn this situation, #rater is relieved of %+, more det than he assumed (%,

minus *,) ecause consideration given in the form of cash or other property is offsetagainst consideration received. 1onse9uently, he is allowed to net the liailities againsteach other and he is treated as receiving only the %+, net liailities he$s eenrelieved of as oot.

);. [LO 4] Aa&er Corporation owned a #%iding ocated in Eansas. Aa&er %sed the#%iding for its #%siness operations. Last year a tornado hit the property andcompetey destroyed it. +his year* Aa&er recei"ed an ins%rance settement. Aa&erhad originay p%rchased the #%iding for ')0*000 and had caimed a tota of'100*000 of depreciation ded%ctions against the property. hat is Aa&er/s reai!edand recogni!ed gain or 5oss6 on this transaction and what is its #asis in the new

#%iding in the foowing aternati"e scenarios

a. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '()0*000 re#%idingthe #%iding d%ring the c%rrent year.

#. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent ')00*000 re#%idingthe #%iding d%ring the c%rrent year.

c. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '(00*000 re#%idingthe #%iding d%ring the c%rrent year.

d. Aa&er recei"ed '()0*000 in ins%rance proceeds and spent '()0*000 re#%idingthe #%iding d%ring the next three years.

a. ?ecause ?aer reinvested all of the insurance proceeds, it will not recognizeany of its %*, realized gain. ?aer$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 reinvested %&', iven(/) Amount not reinvested % (&) J (')

(7) Gain reconized $! Besser of () or (/)(3) ;eferred gain %*, () J (7)

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(6) Value of replacement property %&', %&',-asis o replacement property $&"!!!! (6) J (3)

. ?ecause ?aer reinvested all of the insurance proceeds, it will not recognize

any of its %*, realized gain. ?aer$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 reinvested %', iven(/) Amount not reinvested % (&) J (')(7) Gain reconized $! Besser of () or (/)

(3) ;eferred gain %*, () J (7)(6) Value of replacement property %', %&', N %',-asis o replacement property $!!!!! (6) J (3)

c. ?ecause ?aer reinvested only a portion of the insurance proceeds, it willrecognize %', of its %*, realized gain. ?aer$s asis in the newuilding is %*',. 0ee the following calculations>

Description Amount Explanation(+) Amount Fealized %&', Insurance proceeds(*) Ad"usted ?asis %*', %', J +, depreciation() Gain Realized $&!!!!! (+) J (*)(&) Insurance proceeds %&', (+)(') #roceeds reinvested %&, iven(/) Amount not reinvested %', (&) J (')(7) Gain reconized $"!!!! Besser of () or (/)(3) ;eferred gain %+', () J (7)(6) Value of replacement property %&, %&,

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-asis o replacement property $&"!!!! (6) J (3)

d. ?ecause ?aer too three years to replace the property destroyed in theinvoluntary conversion, ?aer will recognize all of its %*, realized gain.

?aer$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 % iven(/) Amount not reinvested %&', (&) J (')(7) Gain reconized $&!!!!! Besser of () or (/)(3) ;eferred gain % () J (7)

(6) Value of replacement property %&', %&',-asis o replacement property $4"!!!! (6) J (3)OThe proceeds were not reinvested within the two year time periodG therefore, they are

not a 9ualified reinvestment.

)

Description Amount Explanation(+) Amount Fealized %&, iven

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(*) Ad"usted ?asis %*7', iven() Gain Realized $1&"!!! (+) J (*)(&) ross #rofit #ercentage +.*'C () L (+)(') #ayment received in year %', iven

Gain reconized in year ! $1"#&" (') x (&)(/) #ayment received in year + %+7', ivenGain reconized in year 1 $"4#'' (/) x (&)(7) #ayment received in year * %+7', ivenGain reconized in year & $"4#'' (7) x (&)

8ote that all of the %+*', gain realized is recognized over the three year period.

40. [LO 4] n year 0* a"ens* nc. sod machinery with a fair mar&et "a%e of '(00*000 toChris. +he machinery/s origina #asis was '18*000 and a"ens/s acc%m%ated

depreciation on the machinery was ')0*000* so its ad,%sted #asis to a"ens was'$48*000. Chris paid a"ens '(0*000 immediatey 5in year 06 and pro"ided a note toa"ens indicating that Chris wo%d pay a"ens '40*000 a year for six years #eginningin year 1. hat is the amo%nt and character of the gain that a"ens wi recogni!e inyear 0 hat amo%nt and character of the gain wi a"ens recogni!e in years 1thro%gh 4

avens recognizes %'3, of income in year (%', ordinary income and %3, of@+*+ gain). It also recognizes %+*,&' of @+*+ gain each year from year + throughyear /, computed as follows>

Description Amount Explanation(+) Amount Fealized %&, iven(*) =riginal ?asis %+7, iven() Accumulated ;epreciation %', iven(&) Ad"usted ?asis %*/7, (*) J ()(') Fealized ainL(Boss) %+, (+) J (&)(#) rdinary income rom %1&4" depreciation

recapture (not elii3le or installment reportin)

$"!!!! =rdinary income

Besser of () and (')(7) ain eligile for installment reporting %3, (') J (/)

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(3) ross profit percentage *.7'C (7) L (+)(6) #ayment received in year %&, iven in example(1!) Gain reconized on payment in year ! $'!! (6) x (3) @+*+ gain0otal ain reconized in year ! $"'!! (/) N (+)

(++) #ayment received in years + through / (eachyear) %/, iven in exampleGain reconized in years 1 t2rou2 # (;it2 eac2

payment) $1&4"! (++) x (3) @+*+ gain

41. [LO 4] IBesearchJ Een sod a renta property for ')00*000G '100*000 in the c%rrentyear and '100*000 per year thereafter. '(00*000 of the saes price was aocated to the#%iding and the remaining '100*000 was aocated to the and. Een p%rchased theproperty se"era years ago for '00*000. '$$)*000 of the p%rchase price was aocatedto the #%iding and '8)*000 was aocated to the and. Een has caimed '$)*000 of

depreciation ded%ctions o"er the years against the #%iding. f Een had no other saesof 1$1 or capita assets in the c%rrent year* determine what Een/s recogni!ed gainor oss is* the character of Een/s gain* and cac%ate Een/s tax d%e #eca%se of the sae5ass%ming his margina ordinary tax rate is ) percent6. 5-int>see the exampes inBeg. 1.()-1$.6

Men has a @+*+ gain of %*', taxed at a maximum *'C rate. -e also hasa @+*+ gain of %**', (%*, from the uilding and %*', from theland) taxed at a maximum +'C rate. Tonya$s tax liaility is %&*,'. Theunrecaptured @+*' gain is recognized efore any of the @+*+ gain (asindicated y the regulations)>

Description o -uildin 7ale Amount Explanation(+) Amount Fealized %&, iven(*) =riginal ?asis **', iven() Accumulated ;epreciation (*',) iven(&) Ad"usted ?asis *, (*)N ()(') ainL(Boss) Fecognized *, (+) J (&)(/) /nrecaptured %1&"! ain $&"!!! Besser of (') or ()(7) Femaining @+*+ gain %+7', (') J (/)0otal %1&1 ain $&!!!!! (/) N (7)

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Description o Land 7ale Amount Explanation(+) Amount Fealized %+, iven(*) =riginal ?asis 7', iven() Accumulated ;epreciation () iven

(&) Ad"usted ?asis 7', (*)N ()(') @+*+ ainL(Boss) Fecognized *', (+) J (&)


/nrecaptured %1&"! (%1&1ain) %*',

'C %3,7'

t2er %1&1 ain%**',

+'C ,7'

0ax%&*,'

Description Amount Explanation(+) Amount Fealized %', iven(*) Ad"usted ?asis %*7', iven() Gain Realized $&&"!!! (+) J (*)(&) ross #rofit #ercentage &'C () L (+)(') #ayment received in year %+, iven

Gain reconized in year ! $4"!!!

(') x (&), %*', of

unrecaptured @+*' and

%*, @+*+ gain(/) #ayment received in year + %+, ivenGain reconized in years 164 $4"!!! (/) x (&), all @+*+ gain

4$. [LO 4] IPanningJ 3iary is in the easing #%siness and faces a margina tax rate of) percent. >he has eased e7%ipment to hitewater Corporation for se"era years.3iary #o%ght the e7%ipment for ')0*000 and caimed '$0*000 of depreciationded%ctions against the asset. +he ease term is a#o%t to expire and hitewater wo%di&e to ac7%ire the e7%ipment. 3iary has #een offered two options to choose from:

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Option Details

Li&e-&indexchange

hitewater wo%d pro"ide 3iary with i&e-&ind e7%ipment. +hei&e-&ind e7%ipment has a fair mar&et "a%e of ')*000.

nstament sae hitewater wo%d pro"ide 3iary with two payments of '1he wo%d %se the proceeds to p%rchase e7%ipment that she co%d asoease.

gnoring time "a%e of money* which option pro"ides the greatest after-tax "a%e for3iary* ass%ming she is indifferent #etween the proposas #ased on nontax factors

ption 1 Description Amount Explanation

(+) Amount realized in lie2ind %', iven

(*) Amount realized in oot % iven

() Total amount realized %',

(&) Ad"usted asis %, %', 2 %*,

(')Gain realized $"!!! () J (&)(/)Gain reconized $! Besser of (*) or (')

(7) ;eferred gain %', (') J (/)

Ad:usted 3asis in ne; property $!!!! (+) J (7)

ption & Description Amount Explanation(+) Amount Fealized %3, iven(*) =riginal ?asis %', iven() Accumulated ;epreciation %*, iven(&) Ad"usted ?asis %, (*) J ()

(') Fealized ainL(Boss) %3, (+) J (&)(#) rdinary income rom %1&4" depreciation

recapture (not elii3le or installment reportin)+

$'!!! =rdinary income

Besser of () and (')(7) ain eligile for installment reporting % (') J (/)(3) ross 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.

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2aracteras2 rom note %3,

ainFat

e

rdinaryincome %3, 'C (%*,3)0ax %',*

-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.

4. [LO 4] Deirdre sod 100 shares of stoc& to her #rother* ames* for '$*(00. Deirdrep%rchased the stoc& se"era years ago for '*000.

a. hat gain or oss does Deirdre recogni!e on the sae

#. hat amo%nt of gain or oss does ames recogni!e if he ses the stoc& for'*$00c. hat amo%nt of gain or oss does ames recogni!e if he ses the stoc& for

'$*400d. hat amo%nt of gain or oss does ames recogni!e if he ses the stoc& for

'$*000

a. Though ;eirdre realizes a %/ loss, she is not allowed to recognize any ofthe loss ecause she sold the stoc to a related party (her rother). 0ee thefollowing computation>

Description Amount Explanation(+) Amount Fealized %*,& iven(*) ?asis %, iven() ain (Boss) Fealized (%/) (+) J (*)(&) ;isallowed Boss (%/) Ono recognized loss on related party saleGain5(Loss) Reconized $! () J (&)

. %* gain (see calculations elow)c. % (see calculations elow)d. (%&) loss (see calculations elow)

Description Part3

Partc

Partd

Explanation

(+) Amount Fealized %,* %*,/ %*,(*) Ad"usted ?asis %*,& %*,& %*,& iven in prolem() Fealized ain (Boss) %3 %* (%&) (+) J (*)

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(&) ?enefit of ;eirdre$s(%/) disallowed Boss

%/ %* %

Besser of () (limited to%) or %/ (the amountof ;eirdre$s disallowedloss)

Reconized Gain5(Loss) $&!! $! ($4!!) () J (&)

Compre"ensi#e ro%lems

4(. +wo years ago* Aethesda Corporation #o%ght a dei"ery tr%c& for '0*000 5nots%#,ect to the %x%ry a%to depreciation imits6. Aethesda %sed 2=CB> $00 percentdecining #aance and the haf-year con"ention to reco"er the cost of the tr%c&* #%t itdid not eect 18< expensing or eigi#e #on%s depreciation. =nswer the 7%estions forthe foowing aternati"e scenarios.

a. =ss%ming Aethesda %sed the tr%c& %nti 2arch of year * what depreciationexpense can it caim on the tr%c& for years 1 thro%gh

#. =ss%me that Aethesda caimed '1;*)00 of depreciation expense on the tr%cefore it sod it in year . hat is the amo%nt and character of the gain or ossif Aethesda sod the tr%c& in year for '18*000* and inc%rred '$*000 of seingexpenses on the sae

c. =ss%me that Aethesda caimed '1;*)00 of depreciation expense on the tr%cefore it sod it in year . hat is the amo%nt and character of the gain or ossif Aethesda sod the tr%c& in year for ')*000* and inc%rred '*000 of seingexpenses on the sae

a. Kear + %/,, year * %6,/, year %*,33. The recovery period for thetruc is five years, so using the half2year convention tale as it applies to five2year property, the depreciation expense is calculated as follows:

,ear

(1)riinal-asis

(&)

Rate

(1) x (&)

Depreciation+ %, *.C %/,* %, *.C %6,/ %, 6./CO %*,33

%+3,&3O6./C P +6.*C x .' (half2year in year ofdisposition)

. ?ethesda would recognize %,' of ordinary income due to the @+*&'depreciation recapture rules, computed as follows>

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a. -auswirth$s recognizes an %3, gain. The entire gain is ordinary incomeunder the @+*&' depreciation recapture rules, computed as follows>

Description Amount Explanation(+) Amount Fealized %', iven

(*) =riginal ?asis %/', iven


(%*,

)

iven

(&) Ad"usted ?asis %&*, (*) N ()(') ain (Boss) Fecognized %3, (+) J (&)(/)rdinary income (%1&4" depreciation recapture) $'!!! Besser of () or (')%1&1 ain $! (') J (/)

. ?ecause this transaction 9ualifies as a @++ lie2ind exchange, -auswirthwill 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>


(+) Amount realized from e9uipment %', iven

(*) Amount realized from oot (cash) % iven

() Total amount realized %', (+) N (*)

(&) Ad"usted asis %&*, %/', 2 %*,

(') Gain realized $'!!! () J (&)

(/) Gain reconized $! Besser of (*) or (')

(7)Deerred ain $'!!! (') J (/)

Ad:usted 3asis in ne; property $4&!!! (+) J (7)

c. In year , -auswirth recognizes %*, of ordinary income and %+,&*6 of@+*+ gain. In year +, it recognizes %,'7+ of @+*+ gain, computed asfollows>

Description Amount Explanation(+) Amount Fealized %7, iven(*) =riginal ?asis %/', iven() Accumulated ;epreciation (%*,) iven

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(&) Ad"usted ?asis %&*, (*) N ()(') Fealized ain(Boss) %*3, (+) J (&)(/)rdinary income rom %1&4" depreciation

recapture (not elii3le or installment reportin) $&!!!

=rdinary income

Besser of () and (')

(7) ain eligile for installment reporting %', (') J (/)(3) ross profit percentage 7.+&C (7) L (+)(6) #ayment received in year %*, iven%1&1 ain reconized in year ! $14&. (6) x (3) @+*+ gain(+) #ayment received in year + %', iven in example%1&1 ain reconized in year 1 $"*1 (+) x (3) @+*+ gain

44. IBesearchJ Hontenot Corporation sod some machinery to its ma,ority owner Kray5an indi"id%a who owns 40 percent of Hontenot6. Hontenot p%rchased the machineryfor '100*000 and has caimed a tota of '(0*000 of depreciation expense ded%ctionsagainst 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 reai!e on the sae#. hat is the amo%nt and character of the gain that Hontenot m%st recogni!e in

the year of sae 5if any6 and each of the two s%#se7%ent years 5-int: %se thenterna Be"en%e Code and start with ()* pease gi"e appropriate citations.6

a. Hontenot$s gain realized is %',.

Description Amount Explanation(+) Amount Fealized %++, iven

(*) =riginal ?asis %+, iven() Accumulated ;epreciation (%&,) iven(&) Ad"usted ?asis %/, (*) N ()(') Fealized ain(Boss) %', (+) J (&)

. Hontenot must recognize the entire %', gain. The character of the entiregain is ordinary. ;epreciation recapture is not eligile for deferral under theinstallment method under section &'(i), as a result %&, of @+*&' gain(the lesser of gain realized or depreciation taen) must e recognized asordinary income during the year of sale. 0ection &'(g) generally prohiitsuse of the installment method when depreciale property is sold to a related

10-);


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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 ray owns more than 'C of Hontenot 1orporation, they areconsidered related parties. As a result, the remaining gain is ordinaryincome under section +*6 ecause the depreciale asset was sold to a

related entity. Asent these rules, the remaining %+, of gain would haveeen eligile for the installment method.

48. 2oa#* nc. man%fact%res and distri#%tes high-tech #i&ing gadgets. t has decided tostreamine some of its operations so that it wi #e a#e to #e more prod%cti"e andefficient. Aeca%se of this decision it has entered into se"era transactions d%ring theyear.

Part 516 Determine the gainFoss reai!ed and recogni!ed in the c%rrent year for eachof these e"ents. =s

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Chap 010 - Taxation of individuals and business entities

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