3.0 Federal Taxation of Property Transactions REG Practice Quiz

• A. Basis = $85,000 (FMV at date of death, §1014 stepped-up basis); gain = $5,000 long-term capital gain (inherited property is always long-term)
• B. Basis = $10,000 (carryover basis from decedent); gain = $80,000 short-term capital gain (held 9 months)
• C. Basis = $47,500 (average of purchase price and FMV at death); gain = $42,500 long-term capital gain
• D. Basis = $85,000; gain = $5,000 short-term capital gain (held only 9 months after inheritance)

Section §1014, inherited property basis: (1) Basis = FMV at date of death = $85,000 (regardless of the decedent's original $10,000 cost, the basis is 'stepped up' to FMV); (2) Gain on sale = $90,000 − $85,000 = $5,000; (3) Character: ALL inherited property, regardless of how long the heir actually holds it, is classified as LONG-TERM capital gain when sold. The holding period rule for inherited property: the property is deemed to have been held for MORE THAN ONE YEAR, even if the heir holds it for only one day. This special long-term treatment means the taxpayer pays the preferential LTCG rate (0/15/20%) on the $5,000 gain, not the short-term ordinary rate. The step-up in basis eliminates the $75,000 of built-in gain the decedent never paid tax on, a significant estate planning benefit.

• A. $10,000, the full 20% applies to the $50,000 cost because the asset was placed in service on July 1
• B. $5,000, under the half-year convention, only 50% of the annual depreciation is allowed in the first year regardless of the actual placement date
• C. $4,167, depreciation is calculated from the actual date of service (July 1 = 6 months remaining) at 20% × 6/12
• D. $10,000, 20% × $50,000 = $10,000; the half-year convention is applied in the SECOND year, not the first

Under the MACRS half-year convention, ALL personal property placed in service at ANY point during the tax year is treated as if it were placed in service at the midpoint of the year (July 1 for a calendar-year taxpayer). This means the PUBLISHED MACRS RATE already incorporates the half-year convention, the first-year rate of 20% is already the HALF-YEAR-ADJUSTED rate. Applying it to the full cost: 20% × $50,000 = $10,000. The taxpayer does NOT further reduce this by another 50%, doing so would double-apply the convention. The MACRS percentage tables for 5-year property (20%, 32%, 19.2%, 11.52%, 11.52%, 5.76% for years 1-6) already reflect the half-year convention built into each year's rate.

• A. Gain basis: $22,000; Loss basis: $22,000, the donor's carryover basis always applies to gifts
• B. Gain basis: $22,000 (donor's carryover basis); Loss basis: $15,000 (FMV at gift date), the dual-basis rule applies because FMV at gift was less than the donor's basis
• C. Gain basis: $15,000 (FMV at gift date); Loss basis: $15,000, FMV at gift date always determines the donee's basis
• D. Gain basis: $22,000; Loss basis: $22,000, gift basis always equals the donor's original purchase price

Gift basis rules under §1015, the DUAL BASIS rule: When FMV at gift date < Donor's adjusted basis (a 'loss' gift): (1) For purposes of computing GAIN: the donee's basis = DONOR'S ADJUSTED BASIS ($22,000). If Maria sells for MORE than $22,000, she computes gain on $22,000 basis. (2) For purposes of computing LOSS: the donee's basis = FMV AT DATE OF GIFT ($15,000). If Maria sells for LESS than $15,000, she computes loss on $15,000 basis. (3) No gain or loss zone: if Maria sells for between $15,000 and $22,000 (e.g., $18,000), she neither recognizes gain (sale price $18,000 < gain basis $22,000) nor loss (sale price $18,000 > loss basis $15,000). This creates a 'built-in loss preservation' rule, it prevents the donee from recognizing a loss that existed when the property was transferred as a gift.

• A. §179 deduction: $1,220,000; remaining basis: $580,000; bonus depreciation: 60% × $580,000 = $348,000; regular MACRS on remaining: $580,000 − $348,000 = $232,000 × 14.29% = $33,153; total: $1,220,000 + $348,000 + $33,153 = $1,601,153
• B. §179 deduction: $1,220,000 (no phase-out since $1,800,000 < $3,050,000); remaining basis: $580,000; bonus depreciation: 60% × $580,000 = $348,000; regular MACRS on remaining: ($580,000 − $348,000) × 14.29% = $33,153; total first-year: $1,601,153, but limited to not create NOL? §179 is limited to taxable income but bonus and regular MACRS can create a loss
• C. §179 deduction: $900,000 (limited to business taxable income before depreciation); remaining basis: $900,000; bonus: 60% × $900,000 = $540,000; total limited by taxable income
• D. Total deduction = $1,080,000 (60% × $1,800,000 bonus only), §179 is not combined with bonus depreciation

Full calculation using §179 up to $1,220,000 (no phase-out) then bonus on remainder: §179 = $1,220,000; remaining basis = $580,000; bonus = 60% × $580,000 = $348,000; regular MACRS on $232,000 remaining × 14.29% = $33,153; total = $1,601,153. §179 income limitation: §179 cannot exceed business taxable income before §179 ($900,000). So §179 is capped at $900,000. But bonus depreciation has no income limitation and can create/increase an NOL. This makes the total deduction complex to compute without more information about applying the $900,000 §179 cap. The key insight: §179 limited by income; bonus depreciation not limited by income.

• A. Total gain: $420,000, all ordinary income under §1250 because depreciation was taken on the building
• B. Total gain: $420,000; §1250 ordinary recapture: $0 (straight-line MACRS, no additional depreciation above straight-line); unrecaptured §1250 gain: $120,000 (taxed at max 25%); §1231 gain: $300,000 (taxed at preferential LTCG rates 0/15/20%)
• C. Total gain: $420,000; §1245 ordinary income: $120,000 (all depreciation recaptured as ordinary); §1231 gain: $300,000
• D. Total gain: $420,000; all §1231 capital gain, real property depreciation is never recaptured as ordinary income

Gain characterization for non-residential real property sold at a gain: Total gain = $800,000 − $380,000 = $420,000. §1250 ordinary income recapture: For real property using MACRS straight-line (as required for post-1986 real property), §1250 ordinary income = 0 (no acceleration above straight-line). Unrecaptured §1250 gain (§1(h)(1)(D)): = accumulated straight-line depreciation = $120,000. This is CAPITAL gain, not ordinary income, but taxed at a MAXIMUM RATE OF 25% (higher than the 0/15/20% LTCG rates). §1231 gain: Total gain ($420,000) − Unrecaptured §1250 ($120,000) = $300,000, eligible for preferential 0/15/20% LTCG rates. Tax impact: the $120,000 unrecaptured §1250 gain is taxed at up to 25%, while the $300,000 §1231 gain is taxed at the lower preferential LTCG rates.

• A. The $3,000 loss is fully deductible in the current year, the wash sale rule only applies if the replacement shares are purchased BEFORE the original shares are sold
• B. The $3,000 loss is disallowed and permanently lost, the wash sale rule eliminates the loss with no basis adjustment to the replacement shares
• C. The $3,000 loss is disallowed under §1091 because substantially identical shares were purchased within 30 days after the sale; the disallowed $3,000 loss is added to the basis of the replacement shares, making their adjusted basis $12,000
• D. The wash sale rule applies only to losses on stocks held for less than one year; since no holding period is specified, the loss is deductible

Wash sale rule (§1091): A loss from the sale of stock or securities is DISALLOWED if the taxpayer acquires substantially identical securities within the 61-day wash sale period (30 days before to 30 days after the sale date). Analysis: March 1 sale creates $3,000 loss. March 20 purchase (19 days after sale) = within 30-day post-sale window → WASH SALE. The $3,000 loss is DISALLOWED for the current year. However, the disallowed loss is NOT permanently lost, it is ADDED TO THE BASIS of the replacement shares: New basis of replacement shares = $9,000 (purchase price) + $3,000 (disallowed loss) = $12,000. The holding period of the replacement shares also includes the holding period of the sold shares. Effect: when the replacement shares are later sold, the increased $12,000 basis will reduce the recognized gain (or increase the recognized loss), the $3,000 loss deduction is deferred, not eliminated.

• A. Goodwill and trade name: not amortizable (indefinite life); customer list: amortized over 5 years; covenant: amortized over its 5-year contractual term
• B. Goodwill is not deductible; other intangibles are amortized over their useful lives as determined by accounting standards
• C. All four intangibles are §197 intangibles and are amortized ratably over 15 years (180 months) on a straight-line basis, beginning with the month of acquisition
• D. All intangibles are immediately expensed under §195 as start-up costs in the year of acquisition

IRC §197, amortization of acquired intangible assets: For intangibles ACQUIRED as part of a trade or business (or the acquisition of assets constituting a trade or business), §197 requires 15-year straight-line amortization beginning with the month of acquisition. §197 intangibles include: goodwill, going-concern value, workforce in place, business books and records/systems, patents, copyrights (if acquired as part of a business), customer lists, trade names, franchises, licenses, and covenants not to compete. Annual amortization: $2,000,000 / 180 months × 12 = $133,333/year. Key feature: EVEN COVENANT NOT TO COMPETE with a 5-year term must be amortized over 15 YEARS under §197 (not over the contractual 5-year term) when acquired as part of a business acquisition. This can be unfavorable for buyers who prefer faster deductions.

• A. All $29,800 of pre-opening costs must be capitalized and have no deduction until the corporation is sold or liquidated
• B. All $29,800 are immediately deductible in the year they are incurred as ordinary and necessary business expenses under §162
• C. Organization costs ($4,800) are permanent capital expenditures with no deduction; start-up costs ($25,000) are immediately expensed under §195
• D. Organization costs (§248): $4,800; Start-up costs (§195): $25,000; Each category gets $5,000 immediate deduction (reduced if costs exceed $50,000) with the remainder amortized over 180 months beginning with the month the active trade or business begins

Classification and treatment: ORGANIZATION COSTS (§248), costs of creating the corporation itself: Legal fees for incorporation: $4,000; State filing fees: $800. Total organization costs: $4,800. TREATMENT: elect to deduct up to $5,000 immediately (reduced dollar-for-dollar by organization costs exceeding $50,000); remainder amortized over 180 months. Since $4,800 < $5,000, the full $4,800 is immediately deductible. START-UP COSTS (§195), costs incurred before the active trade or business begins that would be deductible if incurred after opening: Market research: $12,000; Employee training: $8,000; Pre-opening advertising: $5,000. Total start-up costs: $25,000. TREATMENT: elect to deduct up to $5,000 immediately (reduced dollar-for-dollar when total costs exceed $50,000); remainder amortized over 180 months. Since $25,000 < $50,000, the full $5,000 can be deducted immediately; $20,000 is amortized over 180 months (≈$111/month). Total year 1 deductions: $4,800 (org costs) + $5,000 immediate + partial month's amortization (≈$67 if opened Jan 1).