Chapter 3 Property Dispositions SOLUTIONS MANUAL Discussion Questions

1. [LO 1] Compare and contrast different ways in which a taxpayer triggers a realization event by disposing of an asset. A realization event for tax purposes is created in many ways. Virtually any disposal will result in a sale or other disposition. These include a sale, trade, gift to charity, disposal to the landfill, or destruction in a natural disaster. In a sale or trade (exchange), the taxpayer receives something of value in return for the asset. In contrast, a charita le contri ution, disposal, or destruction from a natural disaster generally results in a loss of any remaining asis in the asset without compensation (unless reim ursed y insurance). 2. [LO 1] otomac Corporation wants to sell a wareho!se that it has !sed in its b!siness for 1" years. otomac is as#ing $%&"'""" for the property. (he wareho!se is s!b)ect to a mortgage of $12&'""". *f otomac accepts +yden *nc.,s offer to give otomac $-2&'""" in cash and ass!me f!ll responsibility for the mortgage on the property' what amo!nt does otomac realize on the sale. !hen the property disposed of is su "ect to a lia ility and the uyer assumes the lia ility, the relief of de t increases the amount realized. Thus, #otomac$s amount realized consists of %&'(,(((, which is cash of %)*',((( plus %+*',((( relief of de t. This assumes that the uyer hypothetically transfers cash to the seller in order to pay off the mortgage. -. [LO 1] /ontana /ax sells a 2'&""0acre ranch for $1'"""'""" in cash' a note receivable of $1'"""'"""' and debt relief of $2'%""'""". 1e also pays selling commissions of $2"'""". *n addition' /ax agrees to b!ild a new barn on the property 3cost $2&"'"""4 and spend $1""'""" !pgrading the fence on the property before the sale. +hat is /ax,s amo!nt realized on the sale. %&,)&(,(((. Anything received y the seller during a sale or exchange is included in the amount realized. ,ost dispositions result in cash to the seller. -owever, amount realized includes, ut is not limited to, cash, the fair mar.et value of any other property received (e.g. mar.eta le securities or a similar asset), or relief of de t. In addition, selling expenses reduce the amount realized. Therefore, ,ax$s amount realized includes the %+,(((,((( of cash, %+,(((,((( note receiva le, relief of de t of %*,&((,(((, and is reduced y selling commissions of %/(,((( (selling expenses reduce the amount realized, 0.1. 1hapin, 1A23, '(2+ 40T1 56+7+). Anything the seller gives up in the transaction is added to the asis of the property

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given up and is not considered part of the amount realized. Therefore, the arn and fence improvements are not considered part of ,ax$s amount realized. 8ote, however, that ma.ing these improvements decreases his realized gain y increasing ,ontana ,ax$s ad"usted asis in the property due to the improvements. %. [LO 1] 1aw#eye sold farming e5!ipment for $&&'""". *t bo!ght the e5!ipment fo!r years ago for $6&'"""' and it has since claimed a total of $%2'""" in depreciation ded!ctions against the asset. 7xplain how to calc!late 1aw#eye,s ad)!sted basis in the farming e5!ipment. -aw.eye will calculate its ad"usted asis in the farming e9uipment y reducing the historical cost y any cost recovery deductions ta.en:namely, depreciation. Therefore, -aw.eye$s ad"usted asis is %)),((( (%7',((( less %&*,(((). The tax ad"usted asis is usually different than the oo. ad"usted asis. This is ecause most assets use a different recovery period, cost recovery method (e.g. dou le declining alance), and convention (e.g. half2year) for tax than for oo. purposes. 0ee 1hapter 6 for how these differences arise. ;ue to the difference in cost recovery deductions, the ad"usted asis is li.ely different unless the asset is fully depreciated for oth oo. and tax purposes. &. [LO 1] +hen a taxpayer sells an asset' what is the difference between realized and recognized gain or loss on the sale. The realized gain or loss is simply the amount realized less the ad"usted asis of the asset sold. <very sale or disposition results in a realized gain or loss (unless, of course, the amount realized is e9ual to the ad"usted asis). ,ost realized gains or losses ecome recognized gains or losses and are included on the taxpayer$s tax return and increases (or decreases in the case of a loss) the taxpayer$s taxa le income and su se9uent tax. -owever, there are some realized gains or losses that are excluded from income or deferred to a later time period. 2. [LO 2] +hat does it mean to characterize a gain or loss. +hy is characterizing a gain or loss important. =nce a gain or loss is recognized, a taxpayer must determine how the recognized gain or loss affects the taxpayer$s tax lia ility. The character depends on a com ination of two factors> purpose or use of the asset and holding period. The purpose or use of the asset is important ecause the law does not treat all assets e9ually. The general use categories are> (+) trade or usiness, (*) for the production of income (rental activities), ()) investment, and (&) personal. ?ased on these criteria, we can categorize an asset into one of three groups> (+) ordinary, (*) capital, or ()) section +*)+. 1haracterizing the gain or loss is important ecause the tax treatment for gains and losses vary depending on the character. =rdinary gains and losses are taxed at ordinary income rates, regardless of the holding period. 1apital gains on assets held for more than a year have preferential tax rates for non2corporate taxpayers while capital gains on assets held for one year or

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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. 6. [LO 2] 7xplain the difference between ordinary' capital' and 812-1 assets. An ordinary asset is an asset that is held for sale in the ordinary course of a taxpayer$s usiness (e.g. inventory) or arises from sales in the ordinary course of usiness (e.g. accounts receiva le). 1apital assets are held for investment (expecting appreciation) or are personal2use assets (e.g. a taxpayer$s personal elongings). @+*)+ assets are used in a trade or usiness or for the production of income and are held for more than one year. An asset that is used in a trade or usiness or for the production of income and is held for one year or less is an ordinary asset. Aains on personal use property are capital gains while losses are non2deducti le. 9. [LO 2] :isc!ss the reasons why individ!als generally prefer capital gains over ordinary gains. 7xplain why corporate taxpayers might prefer capital gains over ordinary gains. Individual taxpayers prefer capital gains ecause they may e taxed at preferential rates. 8et long2term capital gains are taxed at preferential rates ((B, +'B., or *(B). 0hort2term capital gains are simply taxed at ordinary rates. 1apital gains can offset capital losses, while ordinary gains cannot. Additionally, individual taxpayers can offset %),((( of net capital losses against ordinary income and carry the remaining capital loss forward indefinitely. <ven though corporate taxpayers are taxed at the same rate on ordinary income and capital gains, they prefer capital gains ecause capital gains can offset capital losses. 1apital losses cannot e used to offset ordinary incomeC therefore, capital gains allow corporate taxpayers to enefit from their capital losses. 1orporate taxpayers can carry capital losses ac. three years and forward five years. -owever, after the carry ac. and carry forward periods expire, capital losses expire and are worthless. ;. [LO 2] :a#ota Conrad owns a parcel of land he wo!ld li#e to sell. :escribe the circ!mstances in which the sale of the land wo!ld generate 812-1 gain or loss' ordinary gain or loss' or capital gain or loss. <lso describe the circ!mstances where :a#ota wo!ld not be allowed to ded!ct a loss on the sale. The parcel of land could 9ualify as a capital asset if it is held y ;a.ota as an investment (e.g. the purpose for holding the land is for expected appreciation in value). The land could 9ualify as a @+*)+ asset if ;a.ota uses it in a trade or usiness such as a sole2proprietorship or for the production of income (a rental property) and he uses it for these purposes for more than one year. The land could e ordinary income property to ;a.ota if it is held in a trade or usiness or for the

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production of income for one year or less or if it is considered to e inventory (for example a real2estate dealer). The loss would e non2deducti le to ;a.ota if he held the land for personal2use purposes. 1". [LO 2] Lincoln has !sed a piece of land in her b!siness for the past five years. (he land 5!alifies as 812-1 property. *t is !nclear whether Lincoln will have to recognize a gain or loss when she event!ally sells the asset. =he as#s her acco!ntant how the gain or loss wo!ld be characterized if she decides to sell. 1er acco!ntant said that selling 812-1 assets gives sellers >the best of both worlds.? 7xplain what her acco!ntant means by >the best of both worlds.? An asset 9ualifies as a @+*)+ asset if used in a trade or usiness or held for the production of income for more than one year. The tax treatment is sometimes descri ed as receiving Dthe est of oth worldsE ecause net gains receive capital gain treatment and net losses receive ordinary loss treatment. 1apital gains are prefera le ecause they are taxed at a preferential rate (for non2corporate taxpayers) and can offset capital losses, which cannot always e offset against ordinary income. =rdinary losses are preferred to capital losses ecause they offset ordinary income in the current year rather than eing accumulated to offset future capital gains. 11. [LO -] 7xplain Congress,s rationale for depreciation recapt!re. The purpose of depreciation recapture is to treat the gain on the sale of deprecia le assets as ordinary income to the extent the gain is attri uta le to depreciation (or other cost recovery deductions). The ,A1F0 system allows accelerated deductions that often reduce the asis of an asset faster than the real economic decline in value. Thus, depreciation deductions generate an artificial gain on the disposition of deprecia le assets. The recapture rules ensure that some or all of the artificial gain is characterized as ordinary similar to the depreciation deductions that created the artificial gain. It is important to note that depreciation recapture does not affect the amount of the gainC rather it affects only the character of the gain. Additionally, depreciation recapture only applies to sales or dispositions resulting in gains (e.g. it does not apply to losses). 12. [LO -] Compare and contrast 812%& depreciation recapt!re and 812&" depreciation recapt!re. @+*&', sometimes referred to as full recapture, generally applies only to tangi le personal property. @+*&' recaptures the lesser of the realized gain or the depreciation ta.en on the asset as ordinary income:thus the full amount of the gain may e recaptured. @+*'(, sometimes referred to as partial recapture, applies only to real property depreciated under accelerated depreciation methods:the term partial recapture indicates that only the depreciation in excess of straight2line method is recaptured. @+*'( recapture generally no longer applies. This is ecause real property has een depreciated under the straight2line method since

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+637. #roperty placed in service efore +637 is now fully depreciated, regardless of whether accelerated or straight2line methods were usedC as a result, there is no excess depreciation to recapture. -owever, section *6+ and unrecaptured section +*'( applies to gains on real property for corporations and non2corporate taxpayers, respectively. 1-. [LO -] +hy is depreciation recapt!re not re5!ired when assets are sold at a loss. !hen an asset is sold for less than the ad"usted asis ( asis less cost recovery), there is no depreciation recapture. This is ecause the real economic value of the asset declined faster than it was depreciated for tax purposes. Therefore, the loss is simply the recovery of the remaining asis in the asset. ;epreciation recapture is intended to classify any gain due to prior depreciation as ordinary in character. 1%. [LO -] +hat are the similarities and differences between the tax benefit r!le and depreciation recapt!re. 1onceptually, oth depreciation recapture and the tax enefit doctrine re9uire a taxpayer to ta.e into income an amount deducted in a prior year. -owever, depreciation recapture only recharacterizes the already existing gain from @+*)+ to ordinary ecause the taxpayer received an ordinary deduction in the past and re9uires the amount to e included into ordinary income in the year of sale. ;epreciation recapture does not change the amount of the gain. In contrast, the tax enefit doctrine re9uires a taxpayer to ta.e into income an amount received when an expense was ta.en in a prior year. Gor example, if a taxpayer deducts (receives a enefit) state income taxes paid during the year paid, ut receives a tax refund in a su se9uent year, the taxpayer must include the refund into income. 1&. [LO -' %] <re both corporations and individ!als s!b)ect to depreciation recapt!re when they sell depreciable real property at a gain. 7xplain. ?oth taxpayers used to e su "ect to @+*'( recapture when selling real property. -owever, ecause there is no longer any accelerated depreciation on most real property, there is generally no longer any @+*'( recapture. -owever, real property sold at a gain is still su "ect to other types of recapture rules. 1orporate taxpayers are su "ect to @*6+ recapture and non2corporate taxpayers are su "ect to unrecaptured @+*'( rules. 0ection *6+ re9uires corporate taxpayers to recapture *(B of the lesser of the gain realized or accumulated depreciation ta.en. The recaptured portion of the gain is taxed as ordinary income. The remaining gain is @+*)+ gain. 8on2corporate taxpayers must recognize the lesser of the gain realized or the accumulated depreciation ta.en as unrecaptured @+*'( gain. 4nrecaptured @+*'( gain is still @+*)+ (not ordinary) gain, ut it will e taxed at a maximum rate of

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*'B gain (taxed at the taxpayer$s marginal rate at a maximum *'B). The remaining gain is @+*)+ gain. 12. [LO %] 1ow is !nrecapt!red 812&" gain for individ!als similar to depreciation recapt!re. 1ow is it different. 4nrecaptured @+*'( gain is similar to depreciation recapture in that the lesser of accumulated depreciation or the gain realized on the sale is separated from the @+*)+ gain. The difference is that the amount is taxed at a taxpayer$s ordinary rate up to a maximum rate of *' percentC whereas depreciation recapture is taxed at ordinary rates with no maximum rate. 16. [LO %] 7xplain why gains from depreciable property sold to a related taxpayer are treated as ordinary income !nder 812-;. 0ection +*)6 re9uires gains on deprecia le property sold to related taxpayers to e taxed at ordinary rates ecause the asis of these assets will e recovered through ordinary depreciation deductions. This rule is essentially li.e reverse depreciation recapture in that it taxes future depreciation at ordinary rates rather than past depreciation at ordinary rates. The related party definition includes family relationships including si lings, spouses, ancestors, and lineal descendants. It also includes an individual and a corporation if the individual owns more than '(B of the stoc. of the corporation 19. [LO &] @ingaman Aeso!rces sold two depreciable 812-1 assets d!ring the year. One asset res!lted in a large gain 3the asset was sold for more than it was p!rchased for4 and the other res!lted in a small loss. :escribe the 812-1 netting process for @ingaman. ?ingaman would first determine the gain or loss on each asset. Gor the gain asset, ?ingaman would then determine the depreciation recapture and would recharacterize the gain as ordinary to the extent of depreciation allowed. The remaining gain (the amount in excess of the original asis) would e classified as a @+*)+ gain. ?ingaman would com ine the @+*)+ gain and the loss from the other asset in the @+*)+ netting process. If the result from com ining the gain and loss was a gain, ?ingaman would apply the @+*)+ loo.2 ac. rule. After applying the loo.2 ac. rule, any remaining gain would ecome treated as a long2term capital gain and enter the capital gains netting process. If the result of the initial @+*)+ netting process was a loss, the gains and losses would e treated as ordinary gains and losses. 1;. [LO &] Beraldine believes that when the 812-1 loo#0bac# r!le applies' the taxpayer ded!cts a 812-1 loss in a previo!s year against 812-1 gains in the c!rrent year. 7xplain whether Beraldine,s description is correct.

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Heraldine$s description is incorrect. The @+*)+ loo.2 ac. rule simply recharacterizes @+*)+ gain into ordinary gain. This is done to the extent that prior @+*)+ losses in the prior ' years received ordinary loss treatment. Heraldine is correct in that the @+*)+ gains in the current year are offset against prior @+*)+ losses:to the extent they haven$t een recaptured through the @+*)+ loo.2 ac. rule in prior years. 2". [LO &] 7xplain the p!rpose behind the 812-1 loo#0bac# r!le. The favora le rules of @+*)+ allow a taxpayer to treat a net @+*)+ loss as an ordinary loss. The @+*)+ loo.2 ac. rule applies when a taxpayer has a net @+*)+ gain for the year which will receive capital gain treatment. The rule recharacterizes the gain to ordinary to the extent the taxpayer received favora le ordinary loss treatment in the prior five years (that have not yet een recaptured). This prevents taxpayers from timing their sales of loss assets in one year to receive ordinary treatment and selling their gains in a su se9uent year to o tain capital gain treatment. !ithout the loo.2 ac. rule, taxpayers could separate the years in which it sells its gain and loss assets. Gor example, a taxpayer could sell its loss asset on ;ecem er )+, year + and sell its gain asset on Hanuary +, year *. This would allow the loss asset to receive ordinary treatment and e offset against ordinary income. The gain asset would e treated as a long2term capital gain, which would e taxed at preferential rates y non2corporate taxpayers. 21. [LO &] :oes a taxpayer apply the 812-1 loo#0bac# r!le in a year when the taxpayer recognizes a net 812-1 loss. 7xplain. The loo.2 ac. rule exists to prevent game playing (ar itrage) opportunities. It prevents taxpayers from selling their @+*)+ loss assets in one year and receiving ordinary loss treatment and then selling their @+*)+ gain assets in a su se9uent year and receiving capital gain treatment. -owever, if the taxpayer does not have a net @+*)+ gain in the su se9uent years, it can e assumed they are not manipulating the situation, and the loo.2 ac. rule does not apply to a year in which there is a net @+*)+ loss. 22. [LO %' &] :escribe the circ!mstances in which an individ!al taxpayer with a net 812-1 gain will have different portions of the gain taxed at different rates. 8on2corporate taxpayers can have @+*)+ gains taxed at different capital gains rates. ,ost @+*)+ gains (from tangi le personal property and land) will give rise to regular long2term capital gain which will e taxed at a maximum rate of (I+'I*(B ((B if the taxpayer has a marginal rate of +'B or less, *( B if the taxpayer has a marginal rate of )6./B, and +'B otherwise). The @+*)+ gains from real property that are referred to as unrecaptured @+*'( gains will e taxed a

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maximum rate of *'B (e.g. at the taxpayer$s marginal rate unless his rate exceeds *'B). Thus, non2corporate taxpayer$s can have @+*)+ gains and, thus, long2term capital gains that are taxed at two rates. Additionally, a taxpayer who crosses from the +'B to the *'B marginal tax rate rac.et would see capital gains preferential rates increase from (B to +'B. 2-. [LO 2] Aoc#y and @!llwin#le artnership sold a parcel of land d!ring the c!rrent year and realized a gain of $2&"'""". Aoc#y and @!llwin#le did not recognize gain related to the sale of the land on its tax ret!rn. *s this possible. 7xplain how a taxpayer co!ld realize a gain b!t not recognize it. A realized gain or loss is usually recognized in the year of disposition. -owever, there are some realized gains or losses that are excluded from taxa le income (e.g. gain from the sale of a principal residence:see chapter +& for a detailed discussion) or deferred (e.g. li.e2.ind exchange or related2party loss), or partially deferred (e.g. an installment sale). 2%. [LO 2] +hy does the tax code allow taxpayers to defer gains on li#e0#ind exchanges. 1ow do the tax laws ens!re that the gains 3or losses4 are deferred and not permanently excl!ded from a taxpayer,s income. In a li.e2.ind exchange, a taxpayer maintains an investment in an asset other than cash and therefore does not have the wherewithal to payJthat is, the taxpayer does not have the means to pay taxes currently. -owever, in a li.e2.ind exchange where oot (non2li.e .ind property) is received, there is a partial recognition of gain for the transaction. The gains are deferred through receiving a carryover asis in the li.e2.ind property received. This defers the gain until the li.e2.ind property received is disposed of rather than permanently excluding the gain from income. 2&. [LO 2] Compare and contrast the li#e0#ind property re5!irements for real property and for personal property for p!rposes of 5!alifying for a li#e0#ind exchange. 7xplain whether a car held by a corporation for delivering doc!ments will 5!alify as li#e0#ind property with a car held by an individ!al for personal !se. Gor real property, any two pieces of property 9ualify as li.e2.ind property for purposes of a li.e2.ind exchange. Gor example, a 8ew Kor. 1ity s.yscraper (relatively little land with relatively su stantial uilding) will 9ualify as li.e2.ind with a ,ontana ranch (relatively su stantial land holding with relatively little uildings). Gor personal property to 9ualify as li.e2.ind, it must have the same general use as defined as the same asset class in Fevenue #rocedure 372'/.

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The cars held y oth taxpayers elong to the same asset class and would 9ualify as li.e2.ind property for purposes of a li.e2.ind exchange for the corporation. !hile the

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assets are li.e2.ind, the exchange will not 9ualify as li.e2.ind for the individual ecause the asset was not used in a trade or usiness or for the production of income :a re9uirement of 9ualifying for a li.e2.ind exchange. 22. [LO 2] =alazar *nc.' a Colorado company' is relocating to a nearby town. *t wo!ld li#e to trade its real property for some real property in the new location. +hile =alazar has fo!nd several prospective b!yers for its real property and has also located several properties that are acceptable in the new location' it cannot find anyone that is willing to trade =alazar *nc. for its property in a li#e0#ind exchange. 7xplain how a third0party intermediary co!ld facilitate =alazar,s li#e0#ind exchange. If 0alazar completed the transaction y selling its old property to one of the prospective uyers and then used the cash to purchase one of the accepta le new properties, it would not e a le to ta.e advantage of the li.e2.ind exchange provisions. A third2party intermediary can ta.e control of 0alazar$s property, sell the property to one of the prospective uyers, and use the cash proceeds to ac9uire 0alazar$s desired property. As a result, use of a third party intermediary allows 0alazar to accomplish what it cannot do on its own (piece together a transaction that 9ualifies as a li.e2.ind exchange). -owever, 0alazar must identify the property to e received within &' days and actually receive the property within +3( days of transferring their property to the third party. 26. [LO 2] /in!teman wants to enter into a li#e0#ind exchange by exchanging its old Cew 7ngland man!fact!ring facility for a ranch in +yoming. /in!teman is !sing a third0 party intermediary to facilitate the exchange. (he p!rchaser of the man!fact!ring facility wants to complete the transaction immediately b!t' for vario!s reasons' the ranch transaction will not be completed for three to fo!r months. +ill this delay ca!se a problem for /in!teman,s desire to accomplish this thro!gh a li#e0#ind exchange. 7xplain. ,inuteman can still 9ualify for a 0tar.er (deferred) exchange as long it meets two timing re9uirements applica le to li.e2.ind exchanges. Girst, within &' days of transferring the property to e given up (8ew <ngland manufacturing facility) in an exchange, the taxpayer must identify li.e2.ind property to e received (!yoming ranch). 0econd, within +3( days of initially transferring the property to e given up in a li.e2.ind exchange, the taxpayer must receive the replacement li.e2.ind property. In addition, ,inuteman must use a third party intermediary to hold the proceeds from the manufacturing facility until the ranch can e closed. The exchange will 9ualify as long as the new ranch is ac9uired within the +3( day period following the close of the 8ew <ngland manufacturing facility. 29. [LO 2] Olympia Corporation' of Dittery' /aine' wants to exchange its man!fact!ring machinery for @angor Company,s machinery. @oth parties agree that that Olympia,s machinery is worth $1""'""" and that @angor,s machinery is worth $;&'""". Olympia wo!ld li#e the transaction to 5!alify as a li#e0#ind exchange. +hat co!ld the parties do to e5!alize the val!e exchanged b!t still allow the exchange to 5!alify as a li#e0#ind

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exchange. 1ow wo!ld the necessary change affect the tax conse5!ences of the transaction. The parties could agree to have ?angor pay =lympia cash or another asset ( oot), to e9ualize the transaction. The receipt of oot does not "eopardize the li.e2.ind exchange treatment. -owever, =lympia will recognize gain e9ual to the oot received in the transaction. Any remaining gain is still deferred under the li.e2.ind exchange rules. ?oot includes any non2li.e .ind asset> cash, tangi le assets, intangi les, etc. 2;. [LO 2] Compare and contrast the similarities and differences between li#e0#ind exchanges and invol!ntary conversions for tax p!rposes. A li.e2.ind exchange involves a trade for a similar asset within the specified time period. An involuntary conversion is the replacement of property damaged through a natural disaster, theft, etc. The two transaction are similar in that they oth lac. (at least a portion of) the wherewithal to pay the tax and thus result in a deferral or partial deferral. The transactions differ in that the definition of 9ualifying property is narrower for involuntary conversions than for li.e2.ind exchanges. In addition, in a li.e2.ind exchange taxpayers defer gain or lossC whereas, involuntary conversions only apply to gains. -". [LO 2] +hat is an installment sale. 1ow do the tax laws ens!re that taxpayers recognize all the gain they realize on an installment sale. 1ow is depreciation recapt!re treated in an installment sale. 7xplain the gross profit ratio and how it relates to gains recognized !nder installment method sales. Installment sales comprise a sale when any portion of the proceeds is received in a year su se9uent to the disposition. The rules re9uire that the realized gain e recognized rata ly as payments are received22unless the taxpayer elects out of the installment method. Therefore, for each dollar received, a portion is return of capital and a portion is the recognition of previously realized gain. ;epreciation recapture is re9uired to e recognized in the year of disposition. The recaptured amount is excluded from the gross profit ratio to avoid dou le taxation (e.g. the gain realized is reduced y the depreciation recapture recognized). The gross profit ratio reflects the percentage of> Aain Fealized I Amount Fealized. The gross profit ratio is used to determine how much of each of these payments will e recognized as gain in the year that the payment is received. -1. [LO2] /r. Dyle owns stoc# in a local p!blicly traded company. <ltho!gh the stoc# price has declined since he p!rchased it two years ago' he li#es the long0term prospects for the company. *f Dyle sells the stoc# to his sister beca!se he needs some cash for a down payment on a new home' is the loss ded!ctible. *f Dyle is right and the stoc# price increases in the f!t!re' how is his sister,s gain comp!ted if she sells the stoc#.

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

Problems
-2. [LO 1] Aafael sold an asset to Bamal. +hat is Aafael,s amo!nt realized on the sale in each of the following alternative scenarios. a. Aafael received $9"'""" of cash and a vehicle worth $1"'""". Aafael also pays $&'""" in selling expenses. b. Aafael received $9"'""" of cash and was relieved of a $-"'""" mortgage on the asset he sold to Bamal. Aafael also paid a commission of $&'""" on the transaction. c. Aafael received $2"'""" of cash' a parcel of land worth $&"'"""' and mar#etable sec!rities of $1"'""". Aafael also paid a commission of $9'""" on the transaction. a. %3',(((, computed as follows> Property Received (+) 1ash (*) Vehicle ()) 1ommissions Amount Fealized Amount %3(,((( +(,((( (',((() %3',((( Explanation Aiven Aiven Aiven (+) M (*) M ())

. %+(',(((, computed as follows> Property Received (+) 1ash (*) Felief of de t ()) 1ommissions Amount Fealized Amount %3(,((( )(,((( (',((() %+(',((( Explanation

(+) M (*) M ())

c. %7*,(((, computed as follows> Property Received (+) 1ash (*) Nand ()) ,ar.eta le securities (&) 1ommissions Amount Fealized Amount Explanation %*(,((( '(,((( +(,((( (3,((() %7*,((( (+) M (*) M ()) M (&)

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--. [LO 1] =hasta Corporation sold a piece of land to @ill for $%&'""". =hasta bo!ght the land two years ago for $-"'2"". +hat gain or loss does =hasta realize on the transaction. %+&,&((, computed as follows> Description Amount Explanation (+) Amount Fealized %&',((( (*) Ad"usted ?asis )(,/(( Gain (Loss) Realized $14 4!! (+) J (*) -%. [LO 1] Lassen Corporation sold a machine to a machine dealer for $2&'""". Lassen bo!ght the machine for $&&'""" and has claimed $1&'""" of depreciation expense on the machine. +hat gain or loss does Lassen realize on the transaction. (%+',((() loss, computed as follows> Description Amount Explanation (+) Amount Fealized %*',((( Aiven (*) Ad"usted ?asis &(,((( %'',((( original asis 2 %+',((( accumulated depreciation Gain (Loss) Realized ($1" !!!) (+) J (*) -&. [LO 2] *dentify each of +hite Corporation,s following assets as an ordinary' capital' or 812-1 asset. a. (wo years ago' +hite !sed its excess cash to p!rchase a piece of land as an investment. b. (wo years ago' +hite p!rchased land and a wareho!se. *t !ses these assets in its b!siness. c. /an!fact!ring machinery +hite p!rchased earlier this year. d. *nventory +hite p!rchased 1- months ago' b!t is ready to be shipped to a c!stomer. e. Office e5!ipment +hite has !sed in its b!siness for the past three years. f. 1'""" shares of stoc# in @lac# corporation that +hite p!rchased two years ago beca!se it was a good investment. g. <cco!nt receivable from a c!stomer with terms 2E1" net -". h. /achinery +hite held for three years and then sold at a loss of $1"'""". a. 1apital, ecause it is held for investment. . The land and uilding are oth @+*)+ property ecause !hite uses the assets in its trade or usiness and has held the assets property for more than a year. c. =rdinary, the property is ordinary even though it is used in a trade or usiness ecause it has een held for less than one year. =nce !hite has held the machinery for more than a year, it will ecome @+*)+ property. d. =rdinary, inventory is held in the ordinary course of usiness. e. @+*)+, the property is used in a trade or usiness and held for more than one year. f. 1apital, ecause it is held for investment.

-01-

g. =rdinary, accounts receiva le are created in the ordinary course of usiness. h. @+*)+, the property is used in a trade or usiness and held for more than one year. -2. [LO -' %] *n year "' Canon p!rchased a machine to !se in its b!siness for $&2'""". *n year -' Canon sold the machine for $%2'""". @etween the date of the p!rchase and the date of the sale' Canon depreciated the machine by $-2'""". a. +hat is the amo!nt and character of the gain Canon will recognize on the sale' ass!ming that it is a partnership. b. +hat is the amo!nt and character of the gain Canon will recognize on the sale' ass!ming that it is a corporation. c. +hat is the amo!nt and character of the gain Canon will recognize on the sale' ass!ming that it is a corporation and the sale proceeds were increased to $2"'""". d. +hat is the amo!nt and character of the gain Canon will recognize on the sale' ass!ming that it is a corporation and the sale proceeds were decreased to $2"'""". a. %+3,((( ordinary income, computed as follows> Description Amount Explanation (+) Amount Fealized %&*,((( Aiven (*) =riginal ?asis '/,((( Aiven ()) Accumulated ;epreciation ()*,((() Aiven (&) Ad"usted ?asis *&,((( (*) M ()) (') AainI(Noss) Fecognized %+3,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $1' !!! Nesser of ()) or (') %1&(1 )ain $! (') J (/) ?ecause the entire gain is caused y depreciation deductions, the entire gain is treated as ordinary income under @+*&'. . %+3,(((C there is no difference in calculating the amount and character of the gain etween a partnership and a corporation on @+*&' property. c. %)/,((( gain (%)*,((( ordinary and %&,((( @+*)+) computed as follows>

-01%

Description Amount Explanation (+) Amount Fealized %/(,((( Aiven (*) =riginal ?asis '/,((( Aiven ()) Accumulated ;epreciation ()*,((() Aiven (&) Ad"usted ?asis *&,((( (*) M ()) (') AainI(Noss) Fecognized %)/,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $(& !!! Nesser 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 %*(,((( Aiven (*) =riginal ?asis '/,((( Aiven ()) Accumulated ;epreciation ()*,((() Aiven (&) Ad"usted ?asis *&,((( (*) M ()) (') AainI(Noss) Fecognized (%&,((() (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $! Nesser of ()) or (') %1&(1 loss ($4 !!!) (') J (/) =nly gains are treated as ordinary income under @+*&', any loss is @+*)+. -6. [LO -' %] *n year "' Longworth artnership p!rchased a machine for $%"'""" to !se in its b!siness. *n year -' Longworth sold the machine for $-&'""". @etween the date of the p!rchase and the date of the sale' Longworth depreciated the machine by $22'""". a. +hat is the amo!nt and character of the gain Longworth will recognize on the sale. b. +hat is the amo!nt and character of the gain Longworth will recognize on the sale if the sale proceeds were increased to $%&'""". c. +hat is the amo!nt and character of the gain Longworth will recognize on the sale if the sale proceeds were decreased to $1&'""".

-01&

a. %+7,((( ordinary income. Description Amount Explanation (+) Amount Fealized %)',((( Aiven (*) =riginal ?asis &(,((( Aiven ()) Accumulated ;epreciation **,((( Aiven (&) Ad"usted ?asis +3,((( (*) 2 ()) (') AainI(Noss) Fecognized %+7,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $1* !!! Nesser of ()) or (') %1&(1 )ain $! (') J (/) ?ecause the entire gain is caused y depreciation deductions, the entire gain is treated as ordinary income under @+*&'. . %*7,((( gain (%**,((( ordinary and %',((( @+*)+) computed as follows> Description Amount Explanation (+) Amount Fealized %&',((( Aiven (*) =riginal ?asis &(,((( Aiven ()) Accumulated ;epreciation **,((( Aiven (&) Ad"usted ?asis +3,((( (*) 2 ()) (') AainI(Noss) Fecognized %*7,((( (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $&& !!! Nesser of ()) or (') %1&(1 )ain $" !!! (') J (/) =nly the gain caused y depreciation is treated as ordinary income under @+*&', the remaining gain is @+*)+. c. (%),((() ordinary loss, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis Amount Explanation %+',((( Aiven &(,((( Aiven **,((( Aiven +3,((( (*) 2 ()) (%),((( (') AainI(Noss) Fecognized ) (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $! Nesser of ()) or (') ($( !!! %1&(1 loss ) (') J (/) =nly gains are treated as ordinary income under @+*&', any loss is @+*)+.

-012

-9. [LO -' %] On <!g!st 1 of year "' :ir#sen p!rchased a machine for $2"'""" to !se in its b!siness. On :ecember % of year "' :ir#sen sold the machine for $19'""". a. +hat is the amo!nt and character of the gain or loss :ir#sen will recognize on the sale. b. +hat is the amo!nt and character of the gain or loss :ir#sen will recognize on the sale if the machine was sold on Ban!ary 1& of year 1 instead. a. (%*,((() ordinary loss. Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis Amount Explanation %+3,((( Aiven *(,((( Aiven %( O *(,((( (*) 2 ()) (%*,((( (') AainI(Noss) Fecognized ) (+) J (&) (#) $rdinary income (%1&4" depreciation recapture) $! Nesser of ()) or (') ($& !!! $rdinary loss ) (') J (/) 8o depreciation is allowed on an asset placed in service and disposed of during the same taxa le year. Assets held less than one year are ordinary rather than section +*)+ assets. . %),)(7 ordinary income. Description Amount Explanation (+) Amount Fealized %+3,((( Aiven (*) =riginal ?asis *(,((( Aiven ()) Accumulated ;epreciation %',)(7 1alculated elow (&) Ad"usted ?asis +&,/6) (*) 2 ()) (') AainI(Noss) Fecognized %),)(7 (+) J (&) (#) $rdinary income+ $( (!* Nesser of ()) or (') %1&(1 )ain $! (') J (/) OAssets held less than one year are ordinary rather than section +*)+ assets. ;epreciation 1alculation (1) $ri)inal ,ear -asis + %*(,((( * %*(,((( (&) Rate +&.*6B +*.*&'BO (1) x (&)

Depreciation %*,3'3 %*,&&6 %',)(7 O+*.*&'B P *&.&6B x .' (half2year in year of disposition)

-016

-;. [LO -' %] Aayb!rn Corporation has a b!ilding that it bo!ght d!ring year " for $9&"'""". *t sold the b!ilding in year &. :!ring the time it held the b!ilding' Aayb!rn depreciated it by $1""'""". +hat is the amo!nt and character of the gain or loss Aayb!rn will recognize on the sale in each of the following alternative sit!ations.

-019

a. Aayb!rn receives $9%"'""". b. Aayb!rn receives $;""'""". c. Aayb!rn receives $6""'""". a. %+3,((( ordinary income and %7*,((( @+*)+ gain computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain Amount %3&(,((( 3'(,((( +((,((( 7'(,((( %6(,((( *(B 6(,((( $1' !!! $*& !!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Nesser of (') or ()) (/) x (7) (') J (3)

. %*(,((( ordinary income and %+)(,((( @+*)+ gain computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain Amount %6((,((( 3'(,((( +((,((( 7'(,((( %+'(,((( *(B +((,((( $&! !!! $1(! !!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Nesser of (') or ()) (/) x (7) (') J (3)

c. %('(,((() ordinary loss computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 loss Amount %7((,((( 3'(,((( +((,((( 7'(,((( (%'(,((() *(B %( $! ($"! !!!) Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) @*6+ Nesser of (') or ()) (/) x (7) (') J (3)

-01;

%". [LO -' %] /oran owns a b!ilding he bo!ght d!ring year " for $1&"'""". 1e sold the b!ilding in year 2. :!ring the time he held the b!ilding he depreciated it by $-2'""". +hat is the amo!nt and character of the gain or loss /oran will recognize on the sale in each of the following alternative sit!ations. a. /oran received $1%&'""". b. /oran received $16"'""". c. /oran received $11"'""". a. %*7,((( unrecaptured @+*'( gain, which is @+*)+ gain taxed at maximum rate of *'B, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ gain 0otal %1&(1 )ain Amount %+&',((( +'(,((( )*,((( ++3,((( %*7,((( Explanation Aiven Aiven Aiven (*) J ()) (+) J (&)

$&* !!! Nesser of (') or ()) %( (') J (/) $&* !!! (/) M (7)

. @+*)+ gain of %'*,(((. =f the %'*,(((, %)*,((( is unrecaptured @+*'( gain su "ect to a maximum *'B tax rate and the remaining %*(,((( is @+*)+ gain su "ect to a maximum rate of (I+'I*(B. 0ee the following calculations> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ gain 0otal %1&(1 )ain Amount %+7(,((( +'(,((( )*,((( ++3,((( %'*,((( Explanation Aiven Aiven Aiven (*) J ()) (+) J (&)

$(& !!! Nesser of (') or ()) *(,((( (') J (/) $"& !!! (/) M (7)

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

-02"

Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (and %1&(1 )ain) (7) Femaining @+*)+ loss 0otal %1&(1 loss

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

Explanation Aiven Aiven Aiven (*) J ()) (+) J (&)

$! Nesser of (') or ()) (%3,((() (') J (/) ($' !!!) (/) M (7)

%1. [LO -' %' &] 1art' an individ!al' bo!ght an asset for $&""'""" and has claimed $1""'""" of depreciation ded!ctions against the asset. 1art has a marginal tax rate of -" percent. <nswer the 5!estions presented in the following alternative scenarios 3ass!me 1art had no property transactions other than those described in the problem4F a. +hat is the amo!nt and character of 1art,s recognized gain if the asset is tangible personal property sold for $%&"'""". +hat effect does the sale have on 1art,s tax liability for the year. b. +hat is the amo!nt and character of 1art,s recognized gain if the asset is tangible personal property sold for $&&"'""". +hat effect does the sale have on 1art,s tax liability for the year c. +hat is the amo!nt and character of 1art,s recognized gain if the asset is tangible personal property sold for $-&"'""". +hat effect does the sale have on 1art,s tax liability for the year. d. +hat is the amo!nt and character of 1art,s recognized gain if the asset is a non0 residential b!ilding sold for $%&"'""". +hat effect does the sale have on 1art,s tax liability for the year. e. Cow ass!me that 1art is a corporation. +hat is the amo!nt and character of its recognized gain if the asset is a nonresidential b!ilding sold for $%&"'""". +hat effect does the sale have on 1art,s tax liability for the year 3ass!me the same -" percent marginal tax rate4. f. Cow ass!ming that the asset is real property' which entity type sho!ld be !sed to minimize the taxes paid on real estate gains. a. %'(,((( ordinary income and a %+',((( tax lia ility on income, computed as follows>

-021

Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain 12aracter @+*&' recapture @+*)+ gain 0ax Amount (1) %'(,((( %(

Amount %&'(,((( '((,((( (+((,((( ) &((,((( %'(,(((

Explanation Aiven Aiven Aiven (*) M ()) (+) J (&)

$"! !!! Nesser of ()) or (') $! (') J (/)

Rate (&) 0ax (1) x (&) )(B %+',((( +'B %( $1" !!!

. -art has %+((,((( ordinary income and %'(,((( of @+*)+ gain. -art$s tax lia ility is %)7,'((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain 12aracter @+*&' recapture @+*)+ gain 0ax Rate 0ax (1) x Amount (&) (&) %+((,(( ( )(B %)(,((( %'(,((( +'B %7,'(( $(* "!! Amount %''(,((( '((,((( (+((,((( ) &((,((( %+'(,((( Explanation Aiven Aiven Aiven (*)M ()) (+) J (&)

$1!! !!! Nesser of ()) or (') $"! !!! (') J (/)

c. -art has a @+*)+ loss of %'(,((( and receives tax savings of %+',((( for the loss> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation Amount Explanation %)'(,((( Aiven '((,((( Aiven (+((,((() Aiven

-022

(&) Ad"usted ?asis (') AainI(Noss) Fecognized (#) $rdinary income (%1&4" depreciation recapture) %1&(1 loss

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

(*) M ()) (+) J (&) Nesser of ()) or (') (') J (/)

-02-

12aracter @+*&' recapture @+*)+ loss 0ax 3ene4it

Amount %( (%'(,((( )

Rate (&) )(B )(B

0ax (1) x (&) %( (%+',((() (%+',((()

d. -art has a @+*)+ gain of %'(,((( taxed at a maximum *'B rate. -art$s tax lia ility is %+*,'((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain 12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax Amount %&'(,((( '((,((( (+((,((() &((,((( '(,((( $"! !!! %( $"! !!! Explanation Aiven Aiven Aiven (*)M ()) (+) J (&) Nesser of (') or ()) (') J (/) (/) M (7)

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

e. -art recognizes %+(,((( ordinary income and %&(,((( @+*)+ gain. -art$s tax lia ility is %+',(((, calculated as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) @*6+ recapture percentage (7) @*6+ recapture ase (3) %&.1 recapture (ordinary income) %1&(1 )ain 12aracter Amount Rate Amount %&'(,((( '((,((( (+((,((() &((,((( %'(,((( *(B '(,((( $1! !!! $4! !!! 0ax
-02%

Explanation Aiven Aiven Aiven (*) M ()) (+) J (&) @*6+ Nesser of (') or ()) (/) x (7) (') J (3)

%&.1 )ain %1&(1 )ain 0ax

%+(,((( %&(,(((

)(B )(B

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

-02&

f. As can e seen from parts (d) and (e), any noncorporate form will result in a lower tax on sales of real property. This is ecause unrecaptured @+*'( gain is taxed at a maximum rate of *' percent for noncorporate taxpayers while corporate taxpayers recognize ordinary gains. %2. [LO %] L!#e sold a b!ilding and the land on which the b!ilding sits to his brother at fair mar#et val!e. (he fair mar#et val!e of the b!ilding was determined to be $-2&'"""G L!#e b!ilt the b!ilding several years ago at a cost of $2""'""". L!#e had claimed $%&'""" of depreciation expense on the b!ilding. (he fair mar#et val!e of the land was determined to be $21"'""" at the time of the saleG L!#e p!rchased the land many years ago for $1-"'""". L!#e,s brother will !se the b!ilding in his b!siness. a. +hat is the amo!nt and character of L!#e,s recognized gain or loss on the b!ilding. b. +hat is the amo!nt and character of L!#e,s recognized gain or loss on the land. a. %+7(,((( ordinary income, computed as follows> Description Amount Explanation (+) Amount Fealized %)*',((( Aiven (*) =riginal ?asis *((,((( Aiven ()) Accumulated ;epreciation (&',((() Aiven (&) Ad"usted ?asis +'',((( (*) M ()) $rdinary Gain5(Loss) Reco)nized under %1&(.+ $1*! !!! (+) J (&) ONu.e must recognize ordinary income on the sale of the uilding under @+*)6 ecause (+) he sold it at a gain to a related party (his rother) and (*) the asset is a deprecia le asset in the hands of the related party: ecause his rother will use the property in his usiness, he is entitled to depreciate it. . %3(,((( @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis %1&(1 Gain Reco)nized Amount %*+(,(( ( +)(,((( ( +)(,((( $'! !!! Explanation Aiven Aiven Aiven (*) 2 ()) (+) J (&)

@12-; is not applicable for the land beca!se it is not depreciable to the b!yer.

-022

%-. [LO &] @!c#ley' an individ!al' began a b!siness two years ago and has never sold a 812-1 asset. @!c#ley owned each of the assets since he began the b!siness. *n the c!rrent year' @!c#ley sold the following b!siness assetsF Accumulated Asset Original Cost Depreciation Gain/Loss $2'""" Comp!ters $2'""" 3$-'"""4 1"'""" /achinery %'""" 32'"""4 2"'""" H!rnit!re 12'""" 6'""" 1""'""" @!ilding 1"'""" 31'"""4 <ss!ming @!c#ley,s marginal ordinary income tax rate is -& percent' answer the 5!estions for the following alternative scenariosF a. +hat is the character of @!c#ley,s gains or losses for the c!rrent year. +hat effect do the gains or losses have on @!c#ley,s tax liability. b. <ss!me that the amo!nt realized increased so that the b!ilding was sold at a $2'""" gain instead. +hat is the character of @!c#ley,s gains or losses for the c!rrent year. +hat effect do the gains and losses have on @!c#ley,s tax liability. c. <ss!me that the amo!nt realized increased so that the b!ilding was sold at a $1&'""" gain instead. +hat is the character of @!c#ley,s gains or losses for the c!rrent year. +hat effect do the gains and losses have on @!c#ley,s tax liability. a. ?uc.ley$s net @+*&' gain is %7,((( and his net @+*)+ loss is %/,((( and is calculated as follows> Asset Description Amount Comp!ters @+*)+ lossO 3$-'"""4 /achinery @+*)+ lossO 3$2'"""4 H!rnit!re @+*&' recapture $6'""" @!ilding @+*)+ lossO 3$1'"""4 O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. 12aracter @+*&' recapture @+*)+ loss 0ax Amoun t %7,((( (%/,((( ) Rate (&) )'B )'B 0ax (1) x (&) %*,&'( (%*,+(() %)'(

. ?uc.ley$s net @+*&' gain is %7,((( and its net @+*)+ gain is %+,((( and is calculated as follows>

-026

Asset Description Amount Comp!ters @+*)+ lossO 3$-'"""4 /achinery @+*)+ lossO 3$2'"""4 H!rnit!re @+*&' recapture $6'""" @!ilding 4nrecaptured @+*'( gainOO $2'""" O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. OO4nrecaptured @+*'( gain is a @+*)+ gain taxed at a maximum rate of *'B 12aracter @+*&' recapture %7,((( )'B %*,&'( 8et @+*)+ gainO %+,((( *'B %*'( 0ax %*,7(( OAn unrecaptured @+*'( gain of %/,((( from the uilding is offset against @+*)+ losses of (%',((() ((%),((( from computer M (%*,((() from machinery), for a net @+*)+ gain of %+,(((. c. ?uc.ley$s net @+*&' gain is %7,((( and its net @+*)+ gain is %+(,((( and is calculated as follows> Asset Description Amount Comp!ters @+*)+ lossO 3$-'"""4 /achinery @+*)+ lossO 3$2'"""4 H!rnit!re @+*&' recapture $6'""" @!ilding 4nrecaptured @+*'( gainOO $1"'""" @!ilding @+*)+ gain $&'""" O?ecause ?uc.ley has only @+*)+ losses they ecome ordinary losses. OO4nrecaptured @+*'( gain is a @+*)+ gain taxed at a maximum rate of *'B 12aracter @+*&' recapture 4nrecap. @+*'(O 0ax Amoun Rate 0ax (1) x t (&) (&) %7,((( )'B %*,&'( %+(,(( ( *'B %*,'(( %&,6'( Amoun t Rate (&) 0ax (1) x (&)

O?uc.ley has an unrecaptured @+*'( gain (a @+*)+ gain taxed at *'B) of %+(,((( from the uilding and a @+*)+ gain (taxed at +'B) of %',(((. The (%',((() of @+*)+ losses ((%),((( from computer M (%*,((() from machinery) are offset against the +'B taxed @+*)+ gain first. Therefore, the unrecaptured @+*'( gain of %+(,((( remains. %%. 3LO-' LO%' LO&4 Lily (!c#er 3single4 owns and operates a bi#e shop as a sole
-029

proprietorship. (his year' she sells the following long0term assets !sed in her b!sinessF

-02;

Asset @!ilding 75!ipment

Sales Price $ 2-"'""" 9"'"""

Cost $2""'""" 1%9'"""

Accumulated Depreciation $&2'""" 2-'"""

Lily,s taxable income before these transactions is $12"'&"". +hat is Lily,s taxable income and tax liability for the year. Nily$s taxa le income is %+67,'(( and her tax lia ility is %&7,&3). 0ee the following calculations> Asset ?uilding <9uipmen t 6ales Price % *)(,((( 3(,((( Ad7usted 3asis %+&3,((( +*',((( Gain5 (Loss) %3*,((( 12aracter

%'*,((( is 4nrecaptured @+*'( %)(,((( is @+*)+ (&',((() %(&',((() @+*)+

8etting> The %)(,((( @+*)+ gain is offset y the %&',((( @+*)+ loss. The remaining %+',((( loss then reduces the unrecaptured @+*'( gain of %'*,((( to %)7,(((. This gain will e taxed at *' percent. Taxa le income efore transactions 4nrecaptured @+*'( gain 0axa3le income 0ax lia3ility =rdinary Income> (+67,'(( J )7,((() P %+/(,'(( (%+/(,'(( J37,3'() Q *3B M%+7,36+.*' 1apital gain> %)7,((( Q *'B 0otal tax lia3ility % +/(,'(( )7,((( $1.* "!!

P%)3,*)) 6,*'( $4* #"14'(

%&. 3LO-' LO%' LO&4 =himmer *nc. is a calendar0year end' accr!al0method corporation. (his year' it sells the following long0term assetsF Asset @!ilding =par#le Corporation stoc# Sales Price $ 2&"'""" 1-"'""" Cost $2%2'""" 19"'""" Accumulated Depreciation $-6'""" nEa

=himmer does not sell any other assets d!ring the year and its taxable income before these transactions is $9""'""". +hat is =himmer,s taxable income and tax liability for the year.

-0-"

0himmer$s taxa le income is %3(7,&(( and its tax lia ility is %*7&,'+/. 0ee the following calculations> Asset ?uilding 0par.le stoc. 6ales Price % /'(,((( +)(,((( Ad7usted 3asis %/(',((( +3(,((( Gain5 (Loss) %&',((( ('(,((() 12aracter %7,&(( is @*6+ ordinary income %)7,/(( is @+*)+ %('(,((() NT1N

The %)7,/(( @+*)+ gain on the uilding is treated as a long2term capital gain, which can e offset y the long2term capital loss from the sale of the stoc.. -owever, ecause 0himmer is a corporation, it can only use its capital losses to the extent of its capital gains. The excess loss of %+*,&(( (%)7,/(( 2 %'(,((() can e carried ac. ) years or carried forward ' years. Taxa le income efore transactions =rdinary income from sale 0axa3le income a4ter transactions 0ax lia3ility ($'!* 4!! 8 (49) %3((,((( 7,&(( $'!* 4!! $&*4 "1#

%2. [LO &] I lanningJ <r!na' a sole proprietor' wants to sell two assets that she no longer needs for her b!siness. @oth assets 5!alify as 812-1 assets. (he first is machinery and will generate a $1"'""" 812-1 loss on the sale. (he second is land that will generate a $6'""" 812-1 gain on the sale. <r!na,s ordinary marginal tax rate is -" percent. a. <ss!ming she sells both assets in :ecember of year 1 3the c!rrent year4' what effect will the sales have on <r!na,s tax liability. b. <ss!ming that <r!na sells the land in :ecember of year 1 and the machinery in Ban!ary of year 2' what effect will the sales have on <r!na,s tax liability for each year. c. 7xplain why selling the assets in separate years will res!lt in greater tax savings for <r!na. a. Aruna$s tax will decrease y (%6((). ?ecause there is a net @+*)+ loss of %),(((, oth the gain and loss will e characterized as ordinary. 12aracter %1&(1 loss:$rdinary %1&(1 )ain: $rdinary 0ax Rat Amount e 0ax (%+(,((( )( (%),((( ) B ) )( %7,((( B %*,+(( (%6(()

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

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12aracter %1&(1 )ain:1apital ( ,ear 1) %1&(1 loss:$rdinary ( ,ear &) 0ax

Amount

Rat e 0ax +' %7,((( B %+,('( (%+(,((( )( (%),((( ) B ) (%+,6'( )

c. The @+*)+ rules can e gamed if you understand them. Girst gains and losses are netted. -owever, losses may offset ordinary income at the marginal tax rate, while gains can e recognized at preferential rates which are lower than the marginal tax rate. 0econd, the loo.2 ac. rules prevent recognizing losses efore gains within a five2year period. -owever, gains may e recognized efore losses. If Aruna recognizes her gain efore her loss, the @+*)+ loo.2 oo. rules do not apply. =ne additional factor to consider is that the tax savings from the loss is delayed y one year. Thus, if the taxpayer is sensitive to the time value of money, the delay should e considered as well. %6. [LO &] @o!rne K!itars' a corporation' reported a $1&6'""" net 812-1 gain for year 2. a. <ss!ming @o!rne reported $&"'""" of nonrecapt!red 812-1 losses d!ring years 1L&' what amo!nt of @o!rne,s net 812-1 gain for year 2' if any' is treated as ordinary income. b. <ss!ming @o!rne,s nonrecapt!red 812-1 losses from years 1L& were $2""'"""' what amo!nt of @o!rne,s net 812-1 gain for year 2' if any' is treated as ordinary income. a. %'(,((( of ?ourne$s gain would e ordinary income and the remaining %+(7,((( gain is a @+*)+ gain, computed as follows> Description (+) 1urrent @+*)+ gain (*) 8onrecaptured @+*)+ losses ()) =rdinary income @+*)+ gain Amount Explanation %+'7,(( ( Aiven %'(,((( Aiven Nesser of (+) or %'(,((( (*) %+(7,(( ( (+) 2 ())

. The entire %+'7,((( gain would e ordinary income due to the @+*)+ loo.2 ac. rule. %9. [LO &] I lanningJ (onya Befferson' a sole proprietor' r!ns a s!ccessf!l lobbying b!siness in +ashington' :.C. =he doesn,t sell many b!siness assets' b!t she is planning on retiring and selling her historic townho!se' from which she r!ns her b!siness' in order

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to b!y a place somewhere s!nny and warm. (onya,s townho!se is worth $1'"""'""" and the land is worth another $1'"""'""". (he original basis in the townho!se was $2""'"""' and she has claimed $2&"'""" of depreciation ded!ctions against the asset over the years. (he original basis in the land was $&""'""". (onya has located a b!yer that wo!ld li#e to finalize the transaction in :ecember of the c!rrent year. (onya,s marginal ordinary income tax rate is -& percent.

-0--

a. +hat amo!nt of gain or loss does (onya recognize on the sale. +hat is the character of the gain or loss. +hat effect does the gain and loss have on her tax liability. b. *n addition to the original facts' ass!me that (onya reports the following nonrecapt!red 12-1 lossF Year Mear 1 Mear 2 Mear Mear % Mear & Mear 2 3c!rrent year4 Net 1231 Gains/ Losses! 3$2""'"""4 " " " " .

+hat amo!nt of gain or loss does (onya recognize on the sale. +hat is the character of the gain or loss. +hat effect does the gain or loss have on her year 2 3the c!rrent year4 tax liability. c. <s (onya,s tax advisor yo! s!ggest that (onya sell the townho!se in year 6 in order to red!ce her taxes. +hat amo!nt of gain or loss does (onya recognize on the sale in year 6. a. Tonya has a @+*)+ gain of %*'(,((( taxed at a maximum *'B rate. 0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a +'B rate since she has a )'B marginal ordinary income tax rate. Tonya$s tax lia ility is %+67,'((, calculated as follows> Description o4 -uildin) 6ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain Description o4 Land 6ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis Amount %+,(((,(( ( /((,((( (*'(,((() )'(,((( /'(,((( Explanation Aiven

Aiven Aiven (*)M ()) (+) J (&) Nesser of (') or $&"! !!! ()) %&((,((( (') J (/) $#"! !!! (/) M (7) Explanation Aiven Aiven Aiven (*)M ())

Amount %+,(((,(( ( '((,((( (() '((,(((

-0-%

(') @+*)+ AainI(Noss) Fecognized

'((,(((

(+) J (&)

-0-&

12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax

Rat Amount e 0ax %*'(,(( *' ( B %/*,'(( %6((,(( +' %+)',(( ( B ( %+67,'( (

. Tonya has an ordinary gain of %*((,(((, due to the @+*)+ loo.2 ac. rule. Tonya has a @+*)+ gain of %'(,((( taxed at a maximum *'B rate (the other %*((,((( was recaptured as ordinary since it was the highest rate @+*)+ gain. 0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a +'B rate since her marginal ordinary income tax rate is )'B. Tonya$s tax lia ility is %*+7,'((, calculated as follows> Description o4 -uildin) 6ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') AainI(Noss) Fecognized (/) /nrecaptured %1&"! )ain (7) Femaining @+*)+ gain 0otal %1&(1 )ain Description o4 Land 6ale (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') @+*)+ AainI(Noss) Fecognized ,ear Kear + Kear * Kear ) ;et %1&(1 )ain (loss) (%*((,((() %( %( Amount %+,(((,(( ( /((,((( (*'(,((() )'(,((( /'(,((( Explanation Aiven

Aiven Aiven (*)M ()) (+) J (&) Nesser of (') or $&"! !!! ()) %&((,((( (') J (/) $#"! !!! (/) M (7) Explanation Aiven Aiven Aiven (*)M ()) (+) J (&)

Amount %+,(((,(( ( '((,((( (() '((,((( '((,(((

Recaptured5 ;onrecaptured %1&(1 losses %( (%*((,((() %( (%*((,((() %( (%*((,((()

;otes Noss is ordinary 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses

$rdinary (%*((,((()

L01G

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Kear & Kear ' Kear /

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

%( (%*((,((() %( (%*((,((() %*((,((( %( %(

8onrecaptured losses 8onrecaptured losses %*((,((( =rdinary 8onrecaptured losses %*((,((( %'(,((( %6((,(( (

12aracter $rdinary /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax

Rat Amount e 0ax %*((,(( )' ( B %7(,((( *' %'(,((( B %+*,'(( %6((,(( +' %+)',(( ( B ( %*+7,'( (

c. Tonya,s nonrecaptured @+*)+ loss is a out to expire. If she delays the sale of her townhouse until Hanuary of year 7, there is no longer any recapture ecause nonrecaptured @+*)+ losses only carry over for five years. This would leave Tonya with the same result as part a. Tonya has a @+*)+ gain of %*'(,((( taxed at a maximum *'B rate. 0he also has a @+*)+ gain of %6((,((( (%&((,((( from the uilding and %'((,((( from the land) taxed at a +'B rate. Tonya$s tax lia ility is %+67,'((, which is a savings of %*(,((( for waiting a few wee.s to sell the asset. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 %*'(,((( (*'B) %6((,((( (+'B) ;et %1&(1 )ain (loss) (%*((,((() %( %( %( %( Recaptured5 ;onrecaptured %1&(1 losses %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %( (%*((,((() %( %(

;otes Noss is ordinary 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses only carry over ' years

$rdinary (%*((,((()

L01G

%*'(,(( (

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%6((,(( ( 12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax Rat Amount e 0ax %*'(,(( *' ( B %/*,'(( %6((,(( +' %+)',(( ( B ( %+67,'( (

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%;. [LO &] /organ,s +ater +orld 3/++4' an LLC' opened several years ago and reports the following net 812-1 gains and losses since it began b!siness. Year Mear 1 Mear 2 Mear Mear % Mear & Mear 2 Mear 6 3c!rrent year4 Net 1231 Gains/ Losses! 3$11'"""4 &'""" 321'"""4 3%'"""4 16'""" 3%-'"""4 11-'"""

+hat amo!nt' if any' of the year 6 $11-'""" net 812-1 gain is treated as ordinary income. After applying the @+*)+ five2year loo. ac. rule, the result is %'7,((( ordinary income and %'/,((( long2term capital gain. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 ;et %1&(1 )ain (loss) (%++,((() %',((( (%*+,((() (%&,((() %+7,((( (%&),((() %++),((( Recaptured5 ;onrecapture d %1&(1 losses %( (%++,((() (%',((() (%/,((() %( (%*7,((() %( (%)+,((() %+7,((( (%+&,((() (%&),((() (%'7,((() %'7,((( %(

;otes Noss is ordinary 8onrecaptured losses Aain is ordinary 8onrecaptured losses Noss is ordinary 8onrecaptured losses Noss is ordinary 8onrecaptured losses Aain is ordinary 8onrecaptured losses Noss is ordinary 8onrecaptured losses %'7,((( is ordinary 8o nonrecaptured losses

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

L01G

%'/,(((

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&". [LO &] 1an r!ns a sole proprietorship. 1ans reported the following net 812-1 gains and losses since he began b!sinessF Year Mear 1 Mear 2 Mear Mear % Mear & Mear 2 Mear 6 3c!rrent year4 Net 1231 Gains/ Losses! 3$2&'"""4 1&'""" " " 1"'""" " &"'"""

a. +hat amo!nt' if any' of the year 6 3c!rrent year4 $&"'""" net 812-1 gain is treated as ordinary income. b. <ss!me that the $&"'""" net 812-1 gain occ!rs in year 2 instead of year 6. +hat amo!nt of the gain wo!ld be treated as ordinary income in year 2. a. After applying the @+*)+ five2year loo. ac. rule, the entire %'(,((( is long2term capital gain. ,ear Kear + Kear * Kear ) Kear & Kear ' Kear / Kear 7 ;et %1&(1 )ain (loss) (%/',((() %+',((( %( %( %+(,((( %( %'(,((( Recaptured5 ;onrecapture d %1&(1 losses %( (%++(,((() %+',((( (%'(,((() %( (%'(,((() %( (%'(,((() %+(,((( (%&(,((() %( %(

;otes Noss is ordinary 8onrecaptured losses Aain is ordinary 8onrecaptured losses 8onrecaptured losses

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

L01G

8onrecaptured losses Aain is ordinary 8onrecaptured losses 8onrecaptured losses only carryforward ' years %'(,((( %'(,((( is @+*)+ %(

%+(,(((

%'(,(((

. After applying the @+*)+ five2year loo. ac. rule, %&(,((( is ordinary income and %+(,((( is long2term capital gain.

-0%"

,ear Kear + Kear * Kear ) Kear & Kear ' Kear /

;et %1&(1 )ain (loss) (%/',((() %+',((( %( %( %+(,((( %'(,(((

Recaptured5 ;onrecapture d %1&(1 losses %( (%/',((() %+',((( (%'(,((() %( (%'(,((() %( (%'(,((() %+(,((( (%&(,((() %&(,((( %+(,((( %(

;otes Noss is ordinary 8onrecaptured losses Aain is ordinary 8onrecaptured losses 8onrecaptured losses 8onrecaptured losses Aain is ordinary 8onrecaptured losses Aain is ordinary @+*)+ 8onrecaptured losses only carryforward ' years

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

L01G

%+(,((( %&(,((( %+(,(((

&1. [LO 2] *ndependence Corporation needs to replace some of the assets !sed in its trade or b!siness and is contemplating the following exchangesF "#c$ange Asset Gi%en &p '( )ndependence a @and saw b /achinery !sed in textiles c assenger a!tomobile !sed for deliveries d Large wareho!se on two acres e Office b!ilding in Kreen @ay' +* !sed in the b!siness Asset *ecei%ed '( )ndependence @and saw /achinery !sed for wood wor#ing 1eavy d!ty van that seats two and has a large cargo box =mall wareho!se on twenty0two acres <partment complex in Cewport @each' C<' that will be held as an investment

:etermine whether each exchange 5!alifies as a li#e0#ind exchange. <lso explain the rationale for why each 5!alifies or does not 5!alify as a li#e0#ind exchange. Exc2an) e a

The exchange of a and saw for a and saw 9ualifies as a li.e2.ind exchange since they are tangi le personal property having the same use (contained in the same asset class). The exchange of machinery used in textiles for machinery used for wood wor.ing does not 9ualify as a li.e2.ind exchange ecause they are tangi le personal property that does not have the same use (not contained in the
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c d e

same asset class). The exchange of passenger automo ile for a heavy duty van does not 9ualify as a li.e2.ind exchange ecause the tangi le personal property does not have the same use (not contained in the same asset class). The exchange of a large warehouse on two acres for a small warehouse on twenty2two acres 9ualifies as a li.e2.ind exchange since they are oth real property. The exchange of the office uilding in Areen ?ay, !I for an apartment complex in 8ewport ?each, 1A 9ualifies as a li.e2.ind exchange since they are oth real property that are either used in the usiness or held for investment.

&2. [LO 2] Dase' an individ!al' p!rchased some property in otomac' /aryland' for $1&"'""" approximately 1" years ago. Dase is approached by a real estate agent representing a client who wo!ld li#e to exchange a parcel of land in Corth Carolina for Dase,s /aryland property. Dase agrees to the exchange. +hat is Dase,s realized gain or loss' recognized gain or loss' and basis in the Corth Carolina property in each of the following alternative scenarios. a. (he transaction 5!alifies as a li#e0#ind exchange and the fair mar#et val!e of each property is $26&'""". b. (he transaction 5!alifies as a li#e0#ind exchange and the fair mar#et val!e of each property is $1""'""". a. <ven though Lase has a realized gain of %'*',(((, the recognized gain is %( ecause the transaction 9ualifies as a li.e2.ind exchange and Lase did not receive any oot. Lase receives a carryover asis of %+'(,((( in the 8orth 1arolina property (the same asis Lase had in the ,aryland property). 0ee the following computation> Description (+) Amount realized from machine (*) Amount realized from oot (non li.e2.ind property) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount %/7',((( %( %/7',((( %+'(,((( $"&" !!! $! %'*',((( $1"! !!! Explanation Aiven Aiven (+) M (*) Aiven ()) J (&) Nesser of (*) or (') (') J (/) (+) J (7)

. Lase has a realized loss of (%'(,(((), ut the recognized loss is %( ecause the transaction 9ualifies as a li.e2.ind exchange. Lase would have a carryover asis of %+'(,(((. 0ee the following computation>

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Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Loss realized (/) Loss reco)nized (7) ;eferred loss Ad7usted 3asis in ne< property

Amount %+((,((( %( %+((,((( %+'(,((( ($"! !!!) $! %'(,((( $1"! !!!

Explanation Aiven Aiven (+) M (*) Aiven ()) J (&) Nesser of (*) or (') (') J (/) (+) M (7)

&-. [LO 2] IAesearchJ Longha!l (r!c#ing traded two small tr!c#s 3each had a 1"'"""0po!nd gross weight4 for one large tr!c# 319'"""0po!nd gross weight4. :o the tr!c#s 5!alify as li#e0#ind property to Longha!l 3-intF beca!se the tr!c#s are tangible personal property they m!st be the same asset class to be li#e0#ind assets. Nse Aev. roc. 960&2 to determine the asset classes for the tr!c#s.4 The smaller truc.s and the larger truc. are not li.e2.ind assets. The smaller truc.s are asset class ((.*&+ (Night Aeneral #urpose Truc.s) ecause they weigh less than +),((( pounds. The larger truc. is asset class ((.*&* (-eavy Aeneral #urpose Truc.s) ecause it weighs +),((( pounds or more. &%. [LO 2] IAesearchJ I lanningJ (winbroo# Corporation needed to !pgrade to a larger man!fact!ring facility. (winbroo# first ac5!ired a new man!fact!ring facility for $2'1""'""" cash' and then transferred the facility it was !sing 3b!ilding and land4 to +hite Hlint Corporation for $2'"""'""" three months later. :oes the exchange 5!alify for li#e0#ind exchange treatment 3-intF examine Aeven!e roced!res 2"""0-6 and 2""%0 &14. *f not' can yo! propose a change in the transaction that will allow it to 5!alify. Twin roo.$s exchange will not 9ualify as a par.ing transaction or reverse 0tar.er exchange. Initially, under Fev. #roc. *(((2)7 it would have 9ualified. -owever, Fev. #roc. *((&2'+ modified the re9uirements, so that Twin roo.$s transaction no longer 9ualifies. 4nder Fev. #roc. *((&2'+, a taxpayer may place property with an accommodation party until the taxpayer can arrange for an exchange. Therefore, if Twin roo. gives the funds to a 9ualified intermediary who o tains the new property and holds it until Twin roo. can arrange for the transfer of its current property, the exchange will 9ualify as a 0tar.er or deferred li.e2.ind exchange if the two timing re9uirements are met. Girst, the li.e2.ind property to e received is identified within &' days R@+()+(a)())(A)S. 0econd, the li.e2.ind property is received within +3( days of the transfer of the property given up R@+()+(a)())(?)(i)S.

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&&. [LO 2] IAesearchJ +oodley ar# Corporation c!rrently owns two parcels of land 3parcel 1 and parcel 24. *t owns a wareho!se facility on parcel 1. +oodley needs to ac5!ire a new and larger man!fact!ring facility. +oodley was approached by @lazing Hast Constr!ction 3who specializes in prefabricated wareho!ses4 abo!t ac5!iring +oodley,s existing wareho!se on parcel 1. +oodley indicated that it prefers to exchange its existing facility for a new and larger facility in a 5!alifying li#e0#ind exchange. @lazing Hast indicated that it co!ld constr!ct a new man!fact!ring facility on parcel 2 to +oodley,s specification within fo!r months. +oodley and @lazing Hast agreed to the following arrangement. Hirst' @lazing Hast wo!ld constr!ct the new wareho!se on parcel 2 and then relin5!ish the property to +oodley within fo!r months. +oodley wo!ld then transfer the wareho!se facility and land parcel 1 to @lazing Hast. <ll of the property exchanged in the deal was identified immediately and the constr!ction was completed within 19" days. :oes the exchange of the new b!ilding for the old b!ilding and parcel 1 5!alify as a li#e0#ind exchange 3see ;e1leene v. 1ommissioner, 11& (C %&64. <ven though !oodley is trading real property (old uilding and #arcel +) for real property (a new uilding constructed on !oodley$s #arcel *), the exchange does not 9ualify as a li.e2.ind exchange. !oodley$s facts are similar to those of two cases: ;e1leene v. 1ommissioner and ?loomington 1oca21ola ?ottling 1o. v. 1ommissioner ('+2+ 40T1 56)*(). After applying the step transaction doctrine the effect was !oodley purchasing a new facility, and not an exchange of unimproved property for improved property, inasmuch as the taxpayer already owned the land on which the new plant was constructed. ?lazing Gast could not e a party to an exchange with the taxpayer ecause the contractor was never the owner of the property that the taxpayer received in the so2called exchange. &2. [LO 2] /etro Corp. traded machine < for machine @. /etro originally p!rchased machine < for $&"'""" and machine <,s ad)!sted basis was $2&'""" at the time of the exchange. +hat is /etro,s realized gain or loss' recognized gain or loss' and ad)!sted basis in machine @ in each of the following alternative scenarios. a. (he fair mar#et val!e of machine < and of machine @ is $%"'""" at the time of the exchange. (he exchange does not 5!alify as a li#e0#ind exchange. b. (he fair mar#et val!e of machine < and of machine @ is $%"'""". (he exchange 5!alifies as a li#e0#ind exchange c. (he fair mar#et val!e of machine < is $-&'""" and machine @ is val!ed at $%"'""". /etro exchanges machine < and $&'""" cash for machine @. /achine < and machine @ are li#e0#ind property. d. (he fair mar#et val!e of machine < is $%&'""" and /etro trades machine < for machine @ val!ed at $%"'""" and $&'""" cash. /achine < and machine @ are li#e0#ind property. a. If the transaction does not 9ualify as a li.e .ind exchange, ,etro has a realized and recognized gain of %+',((( (%&(,((( amount realized minus %*',((( ad"usted asis). The asis in machine ? is its %&(,((( fair mar.et value.

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. <ven though ,etro has a realized gain of %+',((( (%&(,((( 2 %*',(((), the recognized gain is %( ecause the transaction 9ualifies as a li.e2.ind exchange. ,etro receives a asis of %*',((( in machine ?. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount %&(,((( %( %&(,((( %*',((( $1" !!! $! %+',((( $&" !!! Explanation (+) M (*) %'(,((( 2 %*',((( ()) J (&) Nesser of (*) or (') (') J (/) (+) J (7)

c. The realized gain is %+(,((( and the recognized gain is %(. ,etro$s asis in machine ? is %)(,(((. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount Explanation %&(,((( Aiven in example %( Aiven in example %&(,((( (+) M (*) %*',((( M %',((( %)(,((( cash $1! !!! ()) J (&) $! Nesser of (*) or (') %+(,((( (') J (/) $(! !!! (+) J (7)

d. ,etro$s realized gain is %*(,((( and its recognized gain is %',((( (the amount of the oot received) ecause the transaction 9ualifies as a li.e2.ind exchange. ,etro$s asis in machine ? is %*',(((. 0ee the following computations> Description (+) Amount realized from machine (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount %&(,((( %',((( %&',((( %*',((( $&! !!! $" !!! %+',((( $&" !!! Explanation Aiven in example Aiven in example (+) M (*) %'(,((( 2 %*',((( ()) J (&) Nesser of (*) or (') (') J (/) (+) J (7)

-0%&

&6. [LO 2] rater *nc. enters into an exchange in which it gives !p its wareho!se on 1" acres of land and receives a tract of land. < s!mmary of the exchange is as followsF +rans,erred +areho!se Land /ortgage on wareho!se Cash Assets *ecei%ed Land -./ $-""'""" &"'""" -"'""" 2"'""" -./ $-%"'""" Original 0asis $22&'""" &"'""" 2"'""" Accumulated Depreciation $%&'"""

+hat is rater,s realized and recognized gain on the exchange and its basis in the assets it received in the exchange. Aain realized is %+*(,(((, gain recognized is %+(,(((, and #rater$s ad"usted asis in the land is %*)(,(((. Description (+) Amount realized in li.e2.ind (*) Amount realized from oot ()) Total amount realized (&) Ad"usted asis (') Gain Realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount Explanation %)&(,((( Aiven. G,V of land )(,((( ,ortgage relief %)7(,((( (+) M (*) *'(,((( (land) M %*(,((( (cash) $1&! !!! ()) J (&)
%**',((( 2 %&',((( M %'(,(((

$1! !!! or lia ility assumedS or (') %++(,((( (') J (/) $&(! !!! (+) J (7)

Nesser of R(*) J cash paid

O#rater has de t relief of %)(,((( and can offset this oot with cash paid of %*(,(((. The offset rules allow a taxpayer to offset de t relief with cash paid or with other lia ilities assumed. 1onse9uently, #rater is allowed to net the de t relief against cash paid and he is treated as receiving only the %+(,((( net lia ilities he$s een relieved of as oot. &9. [LO 2] @a#er Corporation owned a b!ilding located in Dansas. @a#er !sed the b!ilding for its b!siness operations. Last year a tornado hit the property and completely destroyed it. (his year' @a#er received an ins!rance settlement. @a#er had originally p!rchased the b!ilding for $-&"'""" and had claimed a total of $1""'""" of depreciation ded!ctions against the property. +hat is @a#er,s realized and recognized gain or 3loss4 on this transaction and what is its basis in the new b!ilding in the following alternative scenarios.

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a. @a#er received $%&"'""" in ins!rance proceeds and spent $%&"'""" reb!ilding the b!ilding d!ring the c!rrent year. b. @a#er received $%&"'""" in ins!rance proceeds and spent $&""'""" reb!ilding the b!ilding d!ring the c!rrent year. c. @a#er received $%&"'""" in ins!rance proceeds and spent $%""'""" reb!ilding the b!ilding d!ring the c!rrent year. d. @a#er received $%&"'""" in ins!rance proceeds and spent $%&"'""" reb!ilding the b!ilding d!ring the next three years. a. ?ecause ?a.er reinvested all of the insurance proceeds, it will not recognize any of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain (6) Value of replacement property -asis o4 replacement property Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %&'(,((( %( $! %*((,((( %&'(,((( $&"! !!! Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Nesser of ()) or (/) ()) J (7) Aiven (6) J (3)

. ?ecause ?a.er reinvested all of the insurance proceeds, it will not recognize any of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %)((,(((. 0ee the following calculations> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain (6) Value of replacement property -asis o4 replacement property Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %'((,((( %( $! %*((,((( %'((,((( $(!! !!! Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Nesser of ()) or (/) ()) J (7) %&'(,((( M %'(,((( (6) J (3)

c. ?ecause ?a.er reinvested only a portion of the insurance proceeds, it will recognize %'(,((( of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations>

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Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Insurance proceeds (') #roceeds reinvested (/) Amount not reinvested (7) Gain reco)nized (3) ;eferred gain (6) Value of replacement property -asis o4 replacement property

Amount %&'(,((( %*'(,((( $&!! !!! %&'(,((( %&((,((( %'(,((( $"! !!! %+'(,((( %&((,((( $&"! !!!

Explanation Insurance proceeds %)'(,((( J +((,((( depreciation (+) J (*) (+) Aiven (&) J (') Nesser of ()) or (/) ()) J (7) Aiven (6) J (3)

d. ?ecause ?a.er too. three years to replace the property destroyed in the involuntary conversion, ?a.er will recognize all of its %*((,((( realized gain. ?a.er$s asis in the new uilding is %*'(,(((. 0ee the following calculations> Description Amount Explanation (+) Amount Fealized %&'(,((( Insurance proceeds (*) Ad"usted ?asis %*'(,((( %)'(,((( J +((,((( depreciation ()) Gain Realized $&!! !!! (+) J (*) (&) Insurance proceeds %&'(,((( (+) (') #roceeds reinvestedO %( Aiven (/) Amount not reinvested %&'(,((( (&) J (') (7) Gain reco)nized $&!! !!! Nesser of ()) or (/) (3) ;eferred gain %( ()) J (7) (6) Value of replacement property %&'(,((( Aiven -asis o4 replacement property $4"! !!! (6) J (3) OThe proceeds were not reinvested within the two year time periodC therefore, they are not a 9ualified reinvestment. &;. [LO 2] A!ssell Corporation sold a parcel of land val!ed at $%""'""". *ts basis in the land was $26&'""". Hor the land' A!ssell received $&"'""" in cash in year " and a note providing that A!ssell will receive $16&'""" in year 1 and $16&'""" in year 2 from the b!yer. a. +hat is A!ssell,s realized gain on the transaction. b. +hat is A!ssell,s recognized gain in year "' year 1' and year 2. a. Fussell$s realized gain is %+*',((( (see calculation elow). . Fussell recognizes %+',/*' in year (, %'&,/33 in year +, and %'&,/33 in year *. 0ee the following calculations>

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Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Aross #rofit #ercentage (') #ayment received in year ( Gain reco)nized in year ! (/) #ayment received in year + Gain reco)nized in year 1 (7) #ayment received in year * Gain reco)nized in year &

Amount %&((,((( %*7',((( $1&" !!! )+.*'B %'(,((( $1" #&" %+7',((( $"4 #'' %+7',((( $"4 #''

Explanation Aiven Aiven (+) J (*) ()) I (+) Aiven (') x (&) Aiven (/) x (&) Aiven (7) x (&)

8ote that all of the %+*',((( gain realized is recognized over the three year period. 2". [LO 2] *n year "' Bavens' *nc. sold machinery with a fair mar#et val!e of $%""'""" to Chris. (he machinery,s original basis was $-16'""" and Bavens,s acc!m!lated depreciation on the machinery was $&"'"""' so its ad)!sted basis to Bavens was $226'""". Chris paid Bavens $%"'""" immediately 3in year "4 and provided a note to Bavens indicating that Chris wo!ld pay Bavens $2"'""" a year for six years beginning in year 1. +hat is the amo!nt and character of the gain that Bavens will recognize in year ". +hat amo!nt and character of the gain will Bavens recognize in years 1 thro!gh 2. Havens recognizes %'3,)(( of income in year ( (%'(,((( ordinary income and %3,)(( of @+*)+ gain). It also recognizes %+*,&'( of @+*)+ gain each year from year + through year /, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Fealized AainI(Noss) (#) $rdinary income 4rom %1&4" depreciation recapture (not eli)i3le 4or installment reportin)) (7) Aain eligi le for installment reporting (3) Aross profit percentage (6) #ayment received in year ( (1!) Gain reco)nized on payment in year ! 0otal )ain reco)nized in year ! (++) #ayment received in years + through / (each year) Gain reco)nized in years 1 t2rou)2 # (<it2 eac2 Amount %&((,((( %)+7,((( %'(,((( %*/7,((( %+)),((( $"! !!! %3),((( *(.7'B %&(,((( $' (!! $"' (!! Explanation Aiven Aiven Aiven (*) J ()) (+) J (&) =rdinary income Nesser of ()) and (') (') J (/) (7) I (+) Aiven in example (6) x (3) @+*)+ gain (/) M (+()

%/(,((( Aiven in example $1& 4"! (++) x (3) @+*)+ gain

-0%;

payment) 21. [LO 2] IAesearchJ Den sold a rental property for $&""'""". 1e received $1""'""" in the c!rrent year and $1""'""" each year for the next fo!r years. $%""'""" of the sales price was allocated to the b!ilding and the remaining $1""'""" was allocated to the land. Den p!rchased the property several years ago for $-""'""". +hen he initially p!rchased the property' he allocated $22&'""" of the p!rchase price to the b!ilding and $6&'""" to the land. Den has claimed $2&'""" of depreciation ded!ctions over the years against the b!ilding. Den had no other sales of 812-1 or capital assets in the c!rrent year. Hor the year of the sale' determine Den,s recognized gain or loss' the character of Den,s gain' and calc!late Den,s tax d!e beca!se of the sale 3ass!ming his marginal ordinary tax rate is -& percent4. 3-int> see the examples in Aeg. 81.%&-012.4 The sale 9ualifies as an installment sale. As a result, in the year of the sale Len has a @+*)+ gain of %*',((( taxed at a maximum *'B rate. -e also has a @+*)+ gain of %*(,((( taxed at a maximum +'B rate. In the year of the sale, Len$s tax lia ility is %6,*'(. The unrecaptured @+*'( gain is recognized efore any of the @+*)+ gain (as indicated y the regulations). The remaining gain is taxed in su se9uent years. The computation for the current year is as follows> Description (+) Amount Fealized (*) Ad"usted ?asis ()) Gain Realized (&) Aross #rofit #ercentage (') #ayment received in year ( Gain reco)nized in year ! Amount %'((,((( %*7',((( $&&" !!! &'B %+((,((( $4" !!! Explanation Aiven Aiven (+) J (*) ()) I (+) Aiven. (') Q (&), %*',((( of unrecaptured @+*'( and %*(,((( @+*)+ gain

12aracter /nrecaptured %1&"! (%1&(1 )ain) $t2er %1&(1 )ain 0ax

Amoun Rat t e 0ax %*',(( *' %/,*' ( B ( %*(,(( +' ( B ),((( %6,*' (

22. [LO 2] I lanningJ 1illary is in the leasing b!siness and faces a marginal tax rate of -& percent. =he has leased e5!ipment to +hitewater Corporation for several years. 1illary bo!ght the e5!ipment for $&"'""" and claimed $2"'""" of depreciation ded!ctions against the asset. (he lease term is abo!t to expire and +hitewater wo!ld li#e to ac5!ire the e5!ipment. 1illary has been offered two options to choose fromF

-0&"

Option Li#e0#ind exchange *nstallment sale

Details +hitewater wo!ld provide 1illary with li#e0#ind e5!ipment. (he li#e0#ind e5!ipment has a fair mar#et val!e of $-&'""". +hitewater wo!ld provide 1illary with two payments of $1;'""". =he wo!ld !se the proceeds to p!rchase e5!ipment that she co!ld also lease.

*gnoring time val!e of money' which option provides the greatest after0tax val!e for 1illary' ass!ming she is indifferent between the proposals based on nontax factors. $ption 1 Description (+) Amount realized in li.e2.ind (*) Amount realized in oot ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) ;eferred gain Ad7usted 3asis in ne< property Amount %)',((( %( %)',((( %)(,((( $" !!! $! %',((( $(! !!! Explanation Aiven Aiven %'(,((( 2 %*(,((( ()) J (&) Nesser of (*) or (') (') J (/) (+) J (7)

$ption & Description Amount Explanation (+) Amount Fealized %)3,((( Aiven (*) =riginal ?asis %'(,((( Aiven ()) Accumulated ;epreciation %*(,((( Aiven (&) Ad"usted ?asis %)(,((( (*) J ()) (') Fealized AainI(Noss) %3,((( (+) J (&) (#) $rdinary income 4rom %1&4" depreciation $' !!! =rdinary income recapture (not eli)i3le 4or installment reportin))+ Nesser of ()) and (') (7) Aain eligi le for installment reporting %( (') J (/) (3) Aross profit percentage (B (7) I (+) O?ecause all of the gain is su "ect to depreciation recapture, the installment method cannot e used to defer the gain. Description (+) Amount realized (*) Tax After Tax Value Amount %)3,((( (*,3(() %)',*(( Explanation 1ash from note %3,((( gain Q )'B tax rate (+) J (*)

-illary would e etter off with =ption *. This option gives her a higher after tax value y %*(( (%)',*(( versus %)',(((). Additionally, if she invests her after2tax proceeds from the installment sale in new e9uipment, her asis in option * is %',*(( (%)',*(( 2 %)(,((() higher, which allows her higher depreciation deductions in the future.

-0&1

2-. [LO 2] :eirdre sold 1"" shares of stoc# to her brother' Bames' for $2'%"". :eirdre p!rchased the stoc# several years ago for $-'""". a. +hat gain or loss does :eirdre recognize on the sale. b. +hat amo!nt of gain or loss does Bames recognize if he sells the stoc# for $-'2"". c. +hat amo!nt of gain or loss does Bames recognize if he sells the stoc# for $2'2"". d. +hat amo!nt of gain or loss does Bames recognize if he sells the stoc# for $2'""". a. Though ;eirdre realizes a %/(( loss, she is not allowed to recognize any of the loss ecause she sold the stoc. to a related party (her rother). 0ee the following computation> Description Amount Explanation (+) Amount Fealized %*,&(( Aiven (*) ?asis ),((( Aiven ()) Aain (Noss) Fealized (%/(() (+) J (*) (&) ;isallowed Noss (/(() Ono recognized loss on related party sale Gain5(Loss) Reco)nized $! ()) J (&) . %*(( gain (see calculations elow) c. %( (see calculations elow) d. (%&(() loss (see calculations elow) Description (+) Amount Fealized (*) Ad"usted ?asis ()) Fealized Aain (Noss) (&) ?enefit of ;eirdre$s (%/(() disallowed Noss Reco)nized Gain5(Loss) Compre$ensi%e Pro'lems 2%. (wo years ago' @ethesda Corporation bo!ght a delivery tr!c# for $-"'""" 3not s!b)ect to the l!x!ry a!to depreciation limits4. @ethesda !sed /<CA= 2"" percent declining balance and the half0year convention to recover the cost of the tr!c#' b!t it did not elect 816; expensing or eligible bon!s depreciation. <nswer the 5!estions for the following alternative scenarios. a. <ss!ming @ethesda !sed the tr!c# !ntil /arch of year -' what depreciation expense can it claim on the tr!c# for years 1 thro!gh -. b. <ss!me that @ethesda claimed $19'&"" of depreciation expense on the tr!c# before it sold it in year -. +hat is the amo!nt and character of the gain or loss if Part 3 %),*(( *,&(( %3(( %/(( Part c %*,/(( *,&(( %*(( %*(( Part d %*,((( *,&(( (%&(() %( Explanation Aiven in pro lem (+) J (*) Nesser of ()) (if a loss, then %() or %/(( (the amount of ;eirdre$s disallowed loss) ()) J (&)

$&!!

$!

($4!!)

-0&2

@ethesda sold the tr!c# in year - for $16'"""' and inc!rred $2'""" of selling expenses on the sale. c. <ss!me that @ethesda claimed $19'&"" of depreciation expense on the tr!c# before it sold it in year -. +hat is the amo!nt and character of the gain or loss if @ethesda sold the tr!c# in year - for $-&'"""' and inc!rred $-'""" of selling expenses on the sale. a. ;epreciation expense for years + through ) is %/,(((, %6,/((, %*,33(, respectively. This is calculated under ,A1F0 with a five2year recovery period, half2year convention, and *(( percent declining alance method. ?ecause the truc. was disposed of during year ), the depreciation rate in the ta le is reduced y '(B. The depreciation expense for each year is calculated as followsF ,ear + * ) (1) $ri)inal -asis %)(,((( )(,((( )(,((( (&) Rate *(.((B )*.((B 6./(BO (1) x (&) Depreciation %/,((( 6,/(( *,33( %+3,&3(

O6./B P +6.*(B Q .' (half2year in year of disposition) . ?ethesda would recognize %),'(( of ordinary income due to the @+*&' depreciation recapture rules, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated depreciation (&) Ad"usted ?asis (') Gain5(Loss) Reco)nized (/) @+*&' depreciation recapture (7) @+*)+ gain Amount %+',((( %)(,((( (+3,'(() %++,'(( $( "!! $( "!! $! Explanation %+7,((( 2 %*,((( selling expenses Aiven Aiven (*) M ()) (+) J (&) Nesser of ()) or (') (') J (/)

c. ?ethesda$s would recognize %*(,'(( of gain. =f that amount, %+3,'(( will e ordinary income due to the @+*&' depreciation recapture rules and the remaining %*,((( will e @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated depreciation (&) Ad"usted ?asis Amount %)*,((( %)(,((( (+3,'(() %++,'((
-0&-

Explanation %)',((( 2 %),((( selling expenses Aiven Aiven (*) M ())

(') Gain5(Loss) Reco)nized (/) @+*&' depreciation recapture (7) @+*)+ gain

$&! "!! $1' "!! $& !!!

(+) J (&) Nesser of ()) and (') (') J (/)

2&. 1a!swirth Corporation sold 3or exchanged4 some man!fact!ring e5!ipment in year ". 1a!swirth bo!ght the machinery several years ago for $2&'""" and it has claimed $2-'""" of depreciation expense against the e5!ipment. a. <ss!ming that 1a!swirth receives $&"'""" in cash for the e5!ipment' comp!te the amo!nt and character of 1a!swirth,s recognized gain or loss on the sale. b. <ss!ming that 1a!swirth receives li#e0#ind e5!ipment with a fair mar#et val!e of $&"'""" in exchange for its e5!ipment' comp!te 1a!swirth,s gain realized' gain recognized' deferred gain' and basis in the new e5!ipment. c. <ss!ming that 1a!swirth receives $2"'""" in cash in year " and a $&"'""" note receivable that is payable in year 1' comp!te the amo!nt and character of 1a!swirth,s gain in year " and in year 1. a. -auswirth$s recognizes an %3,((( gain. The entire gain is ordinary income under the @+*&' depreciation recapture rules, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Aain (Noss) Fecognized (/) $rdinary income (%1&4" depreciation recapture) %1&(1 )ain Amount %'(,((( /',((( (*),((() %&*,((( %3,((( $' !!! $! Explanation Aiven Aiven Aiven (*) M ()) (+) J (&) Nesser of ()) or (') (') J (/)

. ?ecause this transaction 9ualifies as a @+()+ li.e2.ind exchange, -auswirth will not recognize any of its %3,((( realized gain (its deferred gain is %3,(((). -auswirth$s asis in its new e9uipment is %&*,(((. 0ee the following computations> Description (+) Amount realized from e9uipment (*) Amount realized from oot (cash) ()) Total amount realized (&) Ad"usted asis (') Gain realized (/) Gain reco)nized (7) De4erred )ain Ad7usted 3asis in ne< property Amount %'(,((( ( %'(,((( &*,((( $' !!! $! $' !!! $4& !!! Explanation Aiven Aiven (+) M (*) %/',((( 2 %*),((( ()) J (&) Nesser of (*) or (') (') J (/) (+) J (7)

-0&%

c. In year (, -auswirth recognizes %*),((( of ordinary income and %+,&*3 of @+*)+ gain. In year +, it recognizes %),'7+ of @+*)+ gain, computed as follows> Description (+) Amount Fealized (*) =riginal ?asis ()) Accumulated ;epreciation (&) Ad"usted ?asis (') Fealized Aain(Noss) (/) $rdinary income 4rom %1&4" depreciation recapture (not eli)i3le 4or installment reportin)) (7) Aain eligi le for installment reporting (3) Aross profit percentage (6) #ayment received in year ( %1&(1 )ain reco)nized in year ! (+() #ayment received in year + %1&(1 )ain reco)nized in year 1 Amount %7(,((( /',((( (*),((() %&*,((( %*3,((( $&( !!! %',((( 7.+&B %*(,((( $1 4&' %'(,((( $( "*1 Explanation Aiven Aiven Aiven (*) M ()) (+) J (&) =rdinary income Nesser of ()) and (') (') J (/) (7) I (+) Aiven (6) x (3) @+*)+ gain Aiven in example (+() Q (3) @+*)+ gain

26. /oab' *nc. man!fact!res and distrib!tes high0tech bi#ing gadgets. *t has decided to streamline some of its operations so that it will be able to be more prod!ctive and efficient. @eca!se of this decision it has entered into several transactions d!ring the year. art 314 :etermine the gainEloss realized and recognized in the c!rrent year for each of these events. <lso determine whether the gainEloss recognized is 812-1' capital' or ordinary.

-0&&

a. /oab *nc. sold a machine that it !sed to ma#e comp!terized gadgets for $26'-"" cash. *t originally bo!ght the machine for $1;'2"" three years ago and has ta#en $9'""" depreciation. b. /oab *nc. held stoc# in <@C Corp. which had a val!e of $12'""" at the beginning of the year. (hat same stoc# had a val!e of $1&'2-" at the end of the year. c. /oab *nc. sold some of its inventory for $6'""" cash. (his inventory had a basis of $&'""". d. /oab *nc. disposed of an office b!ilding with a fair mar#et val!e of $6&'""" for another office b!ilding with a fair mar#et val!e of $&&'""" and $2"'""" in cash. *t originally bo!ght the office b!ilding seven years ago for $22'""" and has ta#en $1&'""" in depreciation. e. /oab *nc. sold land it held for investment for $29'""". *t originally bo!ght the land for $-2'""" two years ago. f. /oab *nc. sold another machine for a note receivable in fo!r ann!al installments of $12'""". (he first payment was received in the c!rrent year. *t originally bo!ght the machine two years ago for $-2'""" and had claimed $;'""" in depreciation expense against the machine. g. /oab *nc. sold stoc# it held for eight years for $2'6&". *t originally p!rchased the stoc# for $2'1"". h. /oab *nc. sold another machine for $6'-"". *t originally p!rchased this machine six months ago for $;'""" and has claimed $9-" in depreciation expense against the asset. art 324 Hrom the recognized gainsElosses determined in part 1' determine the net 812-1 gainEloss and the net ordinary gainEloss /oab will recognize on its tax ret!rn. /oab' *nc. also has $2'""" of nonrecapt!red 812-1 losses from previo!s years. art 3-4 3Horms4 Complete /oab' *nc.,s Horm %6;6 for the year. Part (1) Realized Reco)nized Asset Gain5Loss Gain5Loss 12aracter +a %+/,+(( %+/,+(( %3,((( @+*&' recaptureC %3,+(( @+*)+ gain + 2(2 2(2 8o realization +c *,((( *,((( =rdinary income +d *3,((( *(,(((O %),((( @*6+ recaptureC %+7,((( @+*)+ gain +e (&,((() (&,((() Nong term capital loss +f *',((( +),(((OO %6,((( @+*&' recaptureC %&,((( @+*)+ gain +g /'( /'( Nong term capital gain +h (37() (37() =rdinary lossC not held more than +* months O ,oa recognizes %*(,((( gain due to the oot received in the li.e2.ind exchange. The remaining gain is deferred.

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OO%+),((( recognized gain consists of %6,((( depreciation recapture (re9uired to e recognized in year of sale and not eligi le for installment sale treatment) and %&,((( R(%+/,((( remaining gainI%&3,((( amount realized) x %+*,((( cash received in year of saleS. Part (&) ,oa will realize %*),7'( in net capital gains and %*),+)( in ordinary income. This is computed as follows> @+*)+ 8etting #rocess Description (+) @+*)+ gain (*) @+*)+ loss ()) 8et @+*)+ gain (&) 8onrecaptured @+*)+ losses ;et %1&(1 )ain =rdinary Income> Description (+) @+*&' recapture (*) @*6+ recapture ()) =rdinary income (&) =rdinary loss (') =rdinary income from @+*)+ netting 0otal 1apital Aains and Nosses> Description (+) 1apital gain (*) 1apital loss ;et capital )ain Part (() ,oa $s Gorm &767 appears as follows> Amount %*6,+(( 2(2 %*6,+(( %*,((( $&* 1!! Amount %+7,((( ),((( *,((( (37() *,((( $&( 1(! Amount %*7,7'( (&,((() $&( *"! Explanation %3,+(( from +a M+7,((( from +d M&,((( from +f (+) M (*) =rdinary ()) J (&)C treated as NT1A Explanation %3,((( from +a M 6,((( from +f Grom +d Grom +c Grom +h Noo. ac. rule (+) M(*) M ()) M(&) Explanation %/'( from +g M *7,+(( from @+*)+ netting Grom +e (+) M(*)

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29. IAesearchJ Oertovec *nc.' a large local cons!lting firm in Ntah' hired several new cons!ltants from o!t of state last year to help service their expanding list of clients. (o aide in relocating the cons!ltants' Oertovec *nc. p!rchased the cons!ltants, homes in their prior location if the cons!ltants were !nable to sell their homes within -" days of listing them for sale. Oertovec *nc. bo!ght the homes from the cons!ltants for & percent less than the list price and then contin!ed to list the homes for sale. 7ach home Oertovec *nc. p!rchased was sold at a loss. @y the end of last year' Oertovec had s!ffered a loss totaling $2&"'""" from the homes. 1ow sho!ld Oertovec treat the loss for tax p!rposes. +rite a memo to Oertovec *nc. explaining yo!r findings and any planning s!ggestions that yo! may have if Oertovec *nc. contin!es to offer this type of relocation benefit to newly hired cons!ltants. =acts> As an inducement to relocate, Vertovec purchased several consultants$ homes if they were una le to sell them within )( days of listing them for sale. The homes were purchased for 'B less than the list price, and su se9uently sold y real estate firm. Vertovec suffered a loss totaling %*'(,((( from the homes. -ow should Vertovec treat the loss for tax purposesT @3*. @+)*(a)(/). @+/*. @+((+(a). @+(++. @+**+. Fev. Ful. *(('27&, *(('2'+ IF?, ++'). Fev. Ful. 3*2*(&, +63*2* 1.?. +6*. 1orn #roducts Fefining 1o. v. 1omr., )'( 4.0. &/ (+6'').

>ssue? Aut2orities?

1onclusion? The transaction is treated as two sales. The first is a sale from the employee to the employer. The second is a sale from the employer to the purchaser. ?ecause the homes are not purchased in the ordinary course of Vertovec$s trade or usiness the losses are capital in nature. Analysis? The primary 9uestion for Vertovec is whether it ecomes the owner of the residential property or is simply a facilitator of the sale for the employee. Fev. Ful. 3*2*(& held that homes purchased under a home2 uying plan y the employer , to assist its relocating employees were purchases and su se9uent sales. The decision also notes that the residence was not held in the taxpayer$s ordinary course and did not meet the scope of exceptions contained in @+**+ as indicated in 1orn #roducts and should e classified as a capital asset. As a result, the capital gain or loss is amount realized under @+((+ reduced y the taxpayer$s asis (@+(++).

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Fev. Ful. *(('27& clarified the situations in which the transfer of the residence was considered a sale etween the employee and employer and when the employer$s expenses were deducti le. Aiven the similarity etween Vertovec$s facts and 0cenario + of Fev. Ful. *(('27&, Vertovec$s losses will e capital in nature. 8otwithstanding this recommendation, if the arrangement could e modified similar to 0cenario ) Fev. Ful. *(('27& so that the enefits and urdens of ownership did not pass to the employer the expenses could e deducted as ordinary expenses under @+/*. @+/* allows employers to deduct moving expense reim ursements as an ordinary, necessary, and reasona le usiness expense. <mployees must include in income amounts received as moving expense reim ursements under @3* unless the amounts are specifically excluded from income under @+)*(a)(/).

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