Question & Answer

How do business owners create legal entities? Is the process the same for all entities? If not, what are the differences?

What are the most common legal entities used for operating a business? How are these entities treated similarly and differently for state law purposes?

Assume you asked your favorite AI learning tool to do the following: “Describe the §1231 netting process” and the AI tool responded as follows:

Assume you asked your favorite AI learning tool “Would a taxpayer classify a car used for business as a capital asset for tax purposes?” and the AI tool responded as follows:

74. Fizbo Corporation is in the business of breeding and racing horses. Fizbo has taxable income of $5,000,000 other than from these transactions. It has nonrecaptured §1231 losses of $10,000 from 2020 and $13,000 from 2018. 

Consider the following transactions that occur during 2024:

a. A building with an adjusted basis of $300,000 is totally destroyed by fire. Fizbo receives insurance proceeds of $400,000 but does not plan to replace the building. The building was built 12 years ago at a cost of $420,000 and was used to provide lodging for employees. 

b. Fizbo sells four acres of undeveloped farmland (used for grazing) for $50,000. Fizbo purchased the land 15 years ago for $15,000.

c. Fizbo sells a racehorse for $250,000. The racehorse was purchased four years ago for $200,000. Total depreciation taken on the racehorse was $160,000. 

d. Fizbo exchanges equipment that was purchased three years ago for $300,000 for $100,000 of IBM common stock. The adjusted basis of the equipment is $220,000. If straight-line depreciation had been used, the adjusted basis would be $252,000.

e. On November 1, Fizbo sold XCON stock for $50,000. Fizbo had purchased the stock on December 12, 2023, for $112,000.

Part (1): After all netting is complete, what is Fizbo’s total amount of income from these transactions to be treated as ordinary income or loss? What is its capital gain or loss?  

Part (2):  What is Fizbo’s taxable income for the year after including the effects of these transactions?

WAR (We Are Rich) has been in business since 1991. WAR is an accrual-method sole proprietorship that deals in the manufacturing and wholesaling of various types of golf equipment. Hack & Hack CPAs has filed accurate tax returns for WAR’s owner since WAR opened its doors. The managing partner of Hack & Hack (Jack) has gotten along very well with the owner of WAR – Mr. Someday Woods (single). However, in early 2024, Jack Hack and Someday Woods played a round of golf, and Jack, for the first time ever, beat Mr. Woods. Mr. Woods was so upset that he fired Hack & Hack and has hired you to compute his 2024 taxable income. Mr. Woods was able to provide you with the following information from prior tax returns. The taxable income numbers reflect the results from all of Mr. Woods’ activities except for the items separately stated. You will need to consider how to handle the separately stated items for tax purposes. Also, note that the 2019–2023 numbers do not reflect capital loss carryovers.

Vertovec Inc., a large local consulting firm in Utah, hired several new consultants from out of state last year to help service their expanding list of clients. To aid in relocating the consultants, Vertovec Inc. purchased the consultants’ homes in their prior location if the consultants were unable to sell their homes within 30 days of listing them for sale. Vertovec Inc. bought the homes from the consultants for 5 percent less than the list price and then continued to list the homes for sale. Each home Vertovec Inc. purchased was sold at a loss. By the end of last year, Vertovec had suffered a loss totaling $250,000 from the homes. How should Vertovec treat the loss for tax purposes?  Write a memo to Vertovec Inc. explaining your findings and any planning suggestions that you may have if Vertovec Inc. continues to offer this type of relocation benefit to newly hired consultants. 

Moab Inc. manufactures and distributes high-tech biking gadgets. It has decided to streamline some of its operations so that it will be able to be more productive and efficient. Because of this decision, it has entered into several transactions during the year. 

Part (1): Determine the gain/loss realized and recognized in the current year for each of these events. Also determine whether the gain/loss recognized will be §1231, capital, or ordinary.

Fontenot Corporation sold some machinery to its majority owner Gray (an individual who owns 60 percent of Fontenot). Fontenot purchased the machinery for $100,000 and has claimed a total of $40,000 of depreciation expense deductions against the property. Gray will provide Fontenot with $10,000 of cash today and a $100,000 note that will pay Fontenot $50,000 one year from now and $50,000 two years from now. 

a. What gain or loss does Fontenot realize on the sale?

b. What are the amount and character of the gain or loss that Fontenot must recognize in the year of sale (if any) and each of the two subsequent years? (Hint: Use the Internal Revenue Code and start with §453; please give appropriate citations.)

69. Hauswirth Corporation sold (or exchanged) a warehouse in year 0. Hauswirth bought the warehouse several years ago for $65,000, and it has claimed $23,000 of depreciation expense against the building. 

a. Assuming that Hauswirth receives $50,000 in cash for the warehouse, compute the amount and character of Hauswirth’s recognized gain or loss on the sale.

b. Assuming that Hauswirth exchanges the warehouse in a like-kind exchange for some land with a fair market value of $50,000, compute Hauswirth’s realized gain or loss, recognized gain or loss, deferred gain or loss, and basis in the new land.

c. Assuming that Hauswirth receives $20,000 in cash in year 0 and a $50,000 note receivable that is payable in year 1, compute the amount and character of Hauswirth’s gain or loss in year 0 and in year 1.

68. Two years ago, Bethesda Corporation bought a delivery truck for $30,000 (not subject to the luxury auto depreciation limits). Bethesda used MACRS 200 percent declining balance and the half-year convention to recover the cost of the truck, but it did not elect §179 expensing and opted out of bonus depreciation. Answer the questions for the following alternative scenarios.

a. Assuming Bethesda used the truck until it sold it in March of year 3, what depreciation expense can it claim on the truck for years 1 through 3? 

b. Assume that Bethesda claimed $18,480 of depreciation expense on the truck before it sold it in year 3. What are the amount and character of the gain or loss if Bethesda sold the truck in year 3 for $17,000 and incurred $2,000 of selling expenses on the sale?

c. Assume that Bethesda claimed $18,480 of depreciation expense on the truck before it sold it in year 3. What are the amount and character of the gain or loss if Bethesda sold the truck in year 3 for $35,000 and incurred $3,000 of selling expenses on the sale?

Deirdre sold 100 shares of stock to her brother, James, for $2,400. Deirdre purchased the stock several years ago for $3,000. 

a. What gain or loss does Deirdre recognize on the sale?

b. What amount of gain or loss does James recognize if he sells the stock for $3,200?

c. What amount of gain or loss does James recognize if he sells the stock for $2,600?

d. What amount of gain or loss does James recognize if he sells the stock for $2,000?

Hill Corporation is in the leasing business and faces a marginal tax rate of 21 percent. It has leased a building to Whitewater Corporation for several years. Hill bought the building for $150,000 and claimed $20,000 of depreciation deductions against the asset. The lease term is about to expire and Whitewater would like to acquire the building. Hill has been offered two options: 

Ken sold a rental property for $500,000. He received $100,000 in the current year and $100,000 each year for the next four years. Of the sales price, $400,000 was allocated to the building, and the remaining $100,000 was allocated to the land. Ken purchased the property several years ago for $300,000. When he initially purchased the property, he allocated $225,000 of the purchase price to the building and $75,000 to the land. Ken has claimed $25,000 of depreciation deductions over the years against the building. Ken had no other sales of §1231 or capital assets in the current year. For the year of the sale, determine Ken’s recognized gain or loss and the character of Ken’s gain, and calculate Ken’s tax due because of the sale (assuming his marginal ordinary tax rate is 32 percent). (Hint: See the examples in Reg. §1.453-12.)

In year 0, Javens Inc. sold machinery with a fair market value of $400,000 to Chris. The machinery’s original basis was $317,000, and Javens’s accumulated depreciation on the machinery was $50,000, so its adjusted basis to Javens was $267,000. Chris paid Javens $40,000 immediately (in year 0) and provided a note to Javens indicating that Chris would pay Javens $60,000 a year for six years beginning in year 1. What are the amount and character of the gain that Javens will recognize in year 0?  What amount and character of the gain will Javens recognize in years 1 through 6? 

Russell Corporation sold a parcel of land valued at $400,000. Its basis in the land was $275,000. For the land, Russell received $50,000 in cash in year 0 and a note providing that Russell will receive $175,000 in year 1 and $175,000 in year 2 from the buyer. 

a. What is Russell’s realized gain on the transaction?  

b. What is Russell’s recognized gain in year 0, year 1, and year 2?

Baker Corporation owned a building located in Kansas. Baker used the building for its business operations. Last year, a tornado hit the property and completely destroyed it. This year, Baker received an insurance settlement. Baker had originally purchased the building for $350,000 and had claimed a total of $100,000 of depreciation deductions against the property. What are Baker’s realized and recognized gain or (loss) on this transaction and what is its basis in the new building in the following alternative scenarios?

a. Baker received $450,000 in insurance proceeds and spent $450,000 rebuilding the building during the current year.

b. Baker received $450,000 in insurance proceeds and spent $500,000 rebuilding the building during the current year.

c. Baker received $450,000 in insurance proceeds and spent $400,000 rebuilding the building during the current year.

d. Baker received $450,000 in insurance proceeds and spent $450,000 rebuilding the building during the next three years.

Prater Inc. enters into an exchange in which it gives up its warehouse on 10 acres of land and receives a tract of land. A summary of the exchange is as follows:

Transferred           FMV Original       Basis Accumulated Depreciation

Warehouse $300,000 $225,000 $45,000

Land50,00050,000

Mortgage on warehouse30,000

Cash20,00020,000

Assets Received          FMV

Land $340,000

What are Prater’s realized and recognized gain on the exchange and its basis in the assets it received in the exchange?

Metro Corp. traded building A for building B. Metro originally purchased building A for $50,000, and building A’s adjusted basis was $25,000 at the time of the exchange. What is Metro’s realized gain or loss, recognized gain or loss, and adjusted basis in building B in each of the following alternative scenarios? 

a.  The fair market value of building A and of building B is $40,000 at the time of the exchange. The exchange does not qualify as a like-kind exchange.

b.  The fair market value of building A and of building B is $40,000. The exchange qualifies as a like-kind exchange

c. The fair market value of building A is $35,000, and building B is valued at $40,000. Metro exchanges building A and $5,000 cash for building B. building A and building B are like-kind property.

d. The fair market value of building A is $45,000, and Metro trades building A for building B valued at $40,000 and $5,000 cash. Building A and building B are like-kind property.

Woodley Park Corporation currently owns two parcels of land (parcel 1 and parcel 2). It owns a warehouse facility on parcel 1. Woodley needs to acquire a new and larger manufacturing facility. Woodley was approached by Blazing Fast Construction (which specializes in prefabricated warehouses) about acquiring Woodley’s existing warehouse on parcel 1. Woodley indicated that it would prefer to exchange its existing facility for a new and larger facility in a qualifying like-kind exchange. Blazing Fast indicated that it could construct a new manufacturing facility on parcel 2 to Woodley’s specification within four months. Woodley and Blazing Fast agreed to the following arrangement. First, Blazing Fast would construct the new warehouse on parcel 2 and then relinquish the property to Woodley within four months. Woodley would then transfer the warehouse facility and land parcel 1 to Blazing Fast. All of the property exchanged in the deal was identified immediately and the construction was completed within 180 days. Does the exchange of the new building for the old building and parcel 1 qualify as a like-kind exchange? [Hint: See DeCleene v. Comm’r, 115 TC 457 (2000).]

Twinbrook Corporation needed to upgrade to a larger manufacturing facility. Twinbrook first acquired a new manufacturing facility for $2,100,000 cash and then transferred the facility it was using (building and land) to White Flint Corporation for $2,000,000 three months later. Does the exchange qualify for like-kind exchange treatment? (Hint: Examine Revenue Procedures 2000-37 and 2004-51.)  If not, can you propose a change in the transaction that will allow it to qualify?

Longhaul Real Estate exchanged a parcel of land it held for sale in Bryan, Texas, for a warehouse in College Station, Texas. Will the exchange qualify for like-kind treatment?

Kase, an individual, purchased some property in Potomac, Maryland, for $150,000 approximately 10 years ago. Kase is approached by a real estate agent representing a client who would like to exchange a parcel of land in North Carolina for Kase’s Maryland property. Kase agrees to the exchange. What is Kase’s realized gain or loss, recognized gain or loss, and basis in the North Carolina property in each of the following alternative scenarios?  

a. The transaction qualifies as a like-kind exchange, and the fair market value of each property is $675,000.

b. The transaction qualifies as a like-kind exchange, and the fair market value of 

Independence Corporation needs to replace some of the assets used in its trade or business and is contemplating the following exchanges:

Exchange Asset Given Up by Independence Asset Received by Independence

A Office building in Chicago, IL Piece of land in Toronto, Canada

B Large warehouse on 2 acres Small warehouse on 22 acres

C Office building in Green Bay, WI, used in the business Apartment complex in Newport Beach, CA, that will be held as an investment

Hans runs a sole proprietorship. Hans has reported the following net §1231 gains and losses since he began business. Net §1231 gains shown are before the look-back rule.

Year Net §1231 Gains/(Losses)

Year 1 ($65,000)

Year 2 15,000

Year 3 0

Year 4 0

Year 5 10,000

Year 6 0

Year 7 (current year) 50,000

a. What amount, if any, of the year 7 (current year) $50,000 net §1231 gain is treated as ordinary income?

b. Assume that the $50,000 net §1231 gain occurs in year 6 instead of year 7. What amount of the gain would be treated as ordinary income in year 6?