Discussion Questions

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Chapter I:5

Property Transactions: Capital Gains and Losses

Discussion Questions

I:5-1 It may be difficult to determine the fair market value (FMV) of the used building received by the investor. The problem is likely to be resolved by using the FMV of the property

given (the publicly-traded stock) to measure the amount realized. p. I:5-3.

I:5-2 Cost of the house $150,000

Cost of the room added to the house 20,000 Cost of built-in bookshelves 1,200 Basis for the house $171,200

p. I:5-4.

I:5-3 Yes, sales tax paid or accrued in connection with the acquisition of property is included

as part of the property’s cost. p. I:5-5.

I:5-4 Amount realized $8,000

Minus: basis (50 shares x $90)* (4,500)

LTCG $3,500

*FIFO method is used. p. I:5-6. I:5-5 a. David’s holding period starts on October 22 of the current year (the day after the date of the gift) if David uses the FMV at the date of the gift to determine his basis.

• His holding period starts on January 21, 1996 if he uses his grandfather’s basis.

pp. I:5-28 and I:5-29.

I:5-6 a. The value of the taxable estate would be $400,000 less, and the estate tax is reduced by electing to use the alternate valuation date.

• Jim’s basis for the property would be $400,000 higher, and he might have a

smaller gain or larger loss for income taxes when he sells or exchanges the land.

• The potential savings in estate tax is $160,000 (40% x $400,000). If the property

is subsequently sold at a gain, the tax savings will be $60,000* (15% x $400,000); thus the alternate valuation date should be elected. The holding period for an inherited asset is long-term, so the gain is LTCG eligible for a preferential rate (here 15% because Jim’s marginal tax rate is 24% which means his taxable income is associated with a 15% preferential rate). Another factor to consider is whether Jim plans to sell the property in the near future since the income tax savings would not occur until Jim sells or exchanges the property, while the estate tax savings are realized currently.*The income tax savings may be more than $60,000 because the $400,000 gain may cause the tax rate on ANCG to be increased to 20%. Also, the 3.8% Medicare tax on net investment income must be considered, so the savings due to having a higher basis could be as much as $95,500 (23.8% x $400,000), but still less than $160,000. p. I:5-8. 1 / 3

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I:5-7 $150 ($82,500/550 shares). pp. I:5-10 and I:5-11.

I:5-8 Basis of stock Total number of Basis for each

owned before  shares owned after = share owned stock dividend stock dividend after dividend

$38,880 divided by x = $18 x = 2,160 shares

Total number of shares after stock dividend 2,160 Total number of shares before stock dividend 2,000 Increase in shares due to stock dividend 160 Percentage dividend distributed (160 divided by 2,000) = 8% pp. I:5-10 and I:5-11.

I:5-9 The interest must be capitalized. p. I:5-5.

I:5-10 For Andy, the refrigerator is inventory and not a capital asset. Roger’s refrigerator is a capital asset since it is not included in the list of properties that are not capital assets. pp. I:5-12

and I:5-13.

I:5-11 The purchase and sale of future contracts was an integral part of the company’s business.

p. I:5-13.

I:5-12 The dealer must clearly identify that the security is held for investment. This act of identification must occur before the close of the day on which the security is acquired and the security must not be held primarily for sale to customers in the ordinary course of the dealer’s

trade or business at any time after the day of purchase. p. I:5-14.

I:5-13 a. The gain is LTCG since the requirements of Sec. 1237 are satisfied.

• The cost of the 30 acres would be allocated among the lots on the basis of their

relative FMVs. p. I:5-15.

I:5-14 The NSTCL is first offset against LTCG that is taxed at 28%, the highest rate for LTCG, then against LTCG taxed at 25%, and finally against the LTCG that is ANCG taxed at 15% (or 20%). The NSTCL is used first to reduce gains taxed at the higher rates. p. I:5-19.

I:5-15 The debt is a nonbusiness bad debt. The loss is treated as a STCL. p. I:5-15.

I:5-16 The motive for purchasing the stock is not relevant in determining whether or not the stock is a capital asset. The stock is not within one of the classes of property excluded from

capital-asset status. p. I:5-14.

I:5-17 Agree; Because half of the gain is excluded and the remaining half is taxed at a maximum rate of 28%, the effective tax rate is normally 14%. A taxpayer whose tax rate is less than 28% 2 / 3

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might have a lower effective tax rate. Furthermore, the effective tax rate could be zero if the Sec.

1202 stock was purchased after September 27, 2010. p. I:5-17.

I:5-18 Nancy held the bonds of the East Corporation as an investment. For Minor Corporation, the securities of the East Corporation are securities of an affiliated corporation. Thus, Minor’s

loss due to the worthless securities is an ordinary loss. p. I:5-22.

I:5-19 There is no original issue discount since the discount of $20,000 is less than $25,000

(.0025 x $500,000 x 20). p. I:5-22.

I:5-20 Juanita purchased a market discount bond (i.e., her purchase price was less than the maturity value) and the accrued market discount must be recognized as ordinary income when she has a disposition of the bond unless the de minimus rule applies (i.e., market discount is zero if the discount is less than 1/4 of 1% of the stated redemption price of the bond at maturity multiplied by the number of years to maturity). If the bonds are sold after two years, up to 2/11 of the market discount may be treated as ordinary income if the realized gain is equal to or greater than this amount. pp. I:5-23 and I:5-24.

I:5-21 She should transfer all substantial rights to the patent. p. I:5-26.

I:5-22 The transferor of a franchise may not treat the transfer as a sale or an exchange of a capital asset if the transferor retains any significant power, right or continuing interest with respect to the subject matter of the franchise. pp. I:5-26 and I:5-27.

I:5-23 The lessor treats the payments as ordinary income. p. I:5-27.

I:5-24 April 1, 2026. p. I:5-28.

I:5-25 The gain on the sale of A is a LTCG of $12,000; the loss on the sale of B is a STCL of $3,000; and the gain on the sale of C is a LTCG of $7,400. Phil’s NLTCG is $19,400 and his NSTCL is $3,000. The net capital gain is $16,400 ($19,400 - $3,000). Because there is no collectibles gain, Sec. 1202 gain or unrecaptured Sec. 1250 gain, the NCG is ANCG. p. I:5-28.

I:5-26 If the individual taxpayer does not have capital gains, only $3,000 of capital losses may be deducted annually. It may take many years before an investor with a large capital loss is allowed to deduct all of the losses. Possibly, a taxpayer could die with unused capital losses. The unfavorable treatment of capital losses may cause the investor to be less willing to take the risks associated with purchasing stock of a high-risk, start-up company. The instructor may want to refer to Sec. 1244 which is mentioned in Chapter I:5 and discussed in Chapter I:9. p. I:5-18.

I:5-27 The taxpayer may not care if the loss is an ordinary loss or a STCL if the taxpayer has STCGs or has NLTCG that is 28% - rate gain but his marginal tax rate is 28% or less. The STCL

could be used to offset STCG or NLTCG. p. I:5-18.

I:5-28 The amount realized is increased by the amount of the liability assumed by Fred. Fred’s basis is increased by the amount of the assumed liability. p. I:5-3.

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