Question & Answer

Tonya Jefferson (single), a sole proprietor, runs a successful lobbying business in Washington, D.C. She doesn’t sell many business assets, but she is planning on retiring and selling her historic townhouse, from which she runs her business, to buy a place somewhere sunny and warm. Tonya’s townhouse is worth $1,000,000 and the land is worth another $1,000,000. The original basis in the townhouse was $600,000, and she has claimed $250,000 of depreciation deductions against the asset over the years. The original basis in the land was $500,000. Tonya has located a buyer that would like to finalize the transaction in December of the current year. Tonya’s marginal ordinary income tax rate is 35 percent, and her capital gains tax rate is 20 percent.

a.       What amount of gain or loss does Tonya recognize on the sale?  What is the character of the gain or loss? What effect does the gain or loss have on her tax liability?

b.      In addition to the original facts, assume that Tonya reports the following nonrecaptured net §1231 loss:

What amount of gain or loss does Tonya recognize on the sale?  What is the character of the gain or loss? What effect does the gain or loss have on her year 6 (the current year) tax liability?

Bourne Guitars, a corporation, reported a $157,000 net §1231 gain for year 6.

a. Assuming Bourne reported $50,000 of nonrecaptured net §1231 losses during years 1–5, what amount of Bourne’s net §1231 gain for year 6, if any, is treated as ordinary income?

b. Assuming Bourne’s nonrecaptured net §1231 losses from years 1–5 were $200,000, what amount of Bourne’s net §1231 gain for year 6, if any, is treated as ordinary income? 

Aruna, a sole proprietor, wants to sell two assets that she no longer needs for her business. Both assets qualify as §1231 assets. The first is machinery and will generate a $10,000 §1231 loss on the sale. The second is land that will generate a $7,000 §1231 gain on the sale. Aruna’s ordinary marginal tax rate is 32 percent.

a. Assuming she sells both assets in December of year 1 (the current year), what effect will the sales have on Aruna’s tax liability?

b. Assuming that Aruna sells the land in December of year 1 and the machinery in January of year 2, what effect will the sales have on Aruna’s tax liability for each year?

c. Explain why selling the assets in separate years will result in greater tax savings for Aruna.

Shimmer Inc. is a calendar-year-end, accrual-method corporation. This year, it sells the following long-term assets:

Lily Tucker (single) owns and operates a bike shop as a sole proprietorship. In 2024, she sells the following long-term assets used in her business:

Buckley, an individual, began a business two years ago and has never sold a §1231 asset. Buckley has owned each of the assets since they began the business. In the current year, Buckley sold the following business assets: 

Asset

Original Cost Accumulated

Depreciation Gain/Loss

Computers $6,000 $2,000 ($3,000)

Machinery 10,000 4,000 (2,000)

Furniture 20,000 12,000 7,000 

Building 100,000 10,000 (1,000)

Luke sold a building and the land on which the building sits to his wholly owned corporation, Studemont Corp., at fair market value. The fair market value of the building was determined to be $325,000; Luke built the building several years ago at a cost of $200,000. Luke had claimed $45,000 of depreciation on the building. The fair market value of the land was determined to be $210,000 at the time of the sale; Luke purchased the land many years ago for $130,000.   

a. What are the amount and character of Luke’s recognized gain or loss on the building? 

b. What are the amount and character of Luke’s recognized gain or loss on the land? 

Hart, an individual, bought an asset for $500,000 and has claimed $100,000 of depreciation deductions against the asset. Hart has a marginal tax rate of 32 percent. Answer the questions presented in the following alternative scenarios (assume Hart had no property transactions other than those described in the problem):

a. What are the amount and character of Hart’s recognized gain or loss if the asset is tangible personal property sold for $450,000?  What effect does the sale have on Hart’s tax liability for the year? 

b. What are the amount and character of Hart’s recognized gain or loss if the asset is tangible personal property sold for $550,000?  What effect does the sale have on Hart’s tax liability for the year? 

c. What are the amount and character of Hart’s recognized gain or loss if the asset is tangible personal property sold for $350,000?  What effect does the sale have on Hart’s tax liability for the year? 

d. What are the amount and character of Hart’s recognized gain or loss if the asset is a nonresidential building sold for $450,000?  What effect does the sale have on Hart’s tax liability for the year? 

e. Now assume that Hart is a C corporation. What are the amount and character of its recognized gain or loss if the asset is a nonresidential building sold for $450,000?  What effect does the sale have on Hart’s tax liability for the year (assume a 21 percent tax rate)? 

f. Assuming that the asset is real property, which entity type should be used to minimize the taxes paid on real estate gains? 

Moran owns a building he bought during year 0 for $150,000. He sold the building in year 6. During the time he held the building, he depreciated it by $32,000. What are the amount and character of the gain or loss Moran will recognize on the sale in each of the following alternative situations? 

a. Moran received $145,000. 

b. Moran received $170,000.

c. Moran received $110,000.

Rayburn Corporation has a building that it bought during year 0 for $850,000. It sold the building in year 5. During the time it held the building, Rayburn depreciated it by $100,000. What are the amount and character of the gain or loss Rayburn will recognize on the sale in each of the following alternative situations? 

a. Rayburn receives $840,000. 

b. Rayburn receives $900,000.

c. Rayburn receives $700,000.

On August 1 of year 0, Dirksen purchased a machine for $20,000 to use in its business. On December 4 of year 0, Dirksen sold the machine for $18,000.

a. What are the amount and character of the gain or loss Dirksen will recognize on the sale? 

b. Dirksen depreciated the machinery using MACRS (seven-year recovery period). What are the amount and character of the gain or loss Dirksen will recognize on the sale if the machine was sold on January 15 of year 1 instead? 

In year 0, Longworth Partnership purchased a machine for $40,000 to use in its business. In year 3, Longworth sold the machine for $35,000. Between the date of the purchase and the date of the sale, Longworth depreciated the machine by $22,000. 

a. What are the amount and character of the gain or loss Longworth will recognize on the sale? 

b. What are the amount and character of the gain or loss Longworth will recognize on the sale if the sale proceeds are increased to $45,000? 

c. What are the amount and character of the gain or loss Longworth will recognize on the sale if the sale proceeds are decreased to $15,000? 

In year 0, Canon purchased a machine to use in its business for $56,000. In year 3, Canon sold the machine for $42,000. Between the date of the purchase and the date of the sale, Canon depreciated the machine by $32,000. 

a. What are the amount and character of the gain or loss Canon will recognize on the sale, assuming that it is a partnership? 

b. What are the amount and character of the gain or loss Canon will recognize on the sale, assuming that it is a corporation?

c. What are the amount and character of the gain or loss Canon will recognize on the sale, assuming that it is a corporation and the sale proceeds were increased to $60,000? 

d. What are the amount and character of the gain or loss Canon will recognize on the sale, assuming that it is a corporation and the sale proceeds were decreased to $20,000? 

Franco converted a building from personal to business use in May 2021 when the fair market value was $55,000. He purchased the building in July 2018 for $80,000. On December 15 of this year, Franco sells the building for $40,000. On the date of the sale, the accumulated depreciation on the building is $5,565. What is Franco’s recognized gain or loss on the sale?

On September 30 of last year, Rex received some investment land from Holly as a gift. Holly’s basis was $50,000 and the land was valued at $40,000 at the time of the gift. Holly acquired the land five years ago. What are the amount and character of Rex’s recognized gain (loss) if he sells the land on May 12 this year at the following prices?

a. $32,000

b. $70,000

c. $45,000

a. $8,000 short-term capital loss, computed as follows:

Description Amount Explanation

(1) Amount Realized$32,000

(2) Adjusted Basis 40,000 Rex’s basis is the fair market value of the land at the date of the gift.

Gain (Loss) Recognized ($8,000) (1) – (2)

Hannah Tywin owns 100 shares of MM Inc. stock. She sells the stock on December 11 for $25 per share. She received the stock as a gift from her Aunt Pam on March 20 of this year when the fair market value of the stock was $18 per share. Aunt Pam originally purchased the stock seven years ago at a price of $12 per share. What are the amount and character of Hannah’s recognized gain or loss on the stock?

Alan Meer inherits a hotel from his grandmother, Mary, on February 11 of the current year. Mary bought the hotel for $730,000 three years ago. Mary deducted $27,000 of cost recovery on the hotel before her death. The fair market value of the hotel in February is $725,000. (Assume that the alternative valuation date is not used.)

a. What is Alan’s adjusted basis in the hotel?

b. If the fair market value of the hotel at the time of Mary’s death was $500,000, what is Alan’s basis?

Rafael sold an asset to Jamal. What is Rafael’s amount realized on the sale in each of the following alternative scenarios?

a. Rafael received $80,000 of cash and a vehicle worth $10,000. Rafael also paid $5,000 in selling expenses. 

b. Rafael received $80,000 of cash and was relieved of a $30,000 mortgage on the asset he sold to Jamal. Rafael also paid a commission of $5,000 on the transaction. 

c. Rafael received $20,000 of cash, a parcel of land worth $50,000, and marketable securities of $10,000. Rafael also paid a commission of $8,000 on the transaction.

Mr. Kyle owns stock in a local publicly traded company. Although the stock price has declined since he purchased it two years ago, he likes the long-term prospects for the company. If Kyle sells the stock to his sister because he needs some cash for a down payment on a new home, is the loss deductible? If Kyle is right and the stock price increases in the future, how is his sister’s gain computed if she sells the stock?

What is an installment sale?  How do the tax laws ensure that taxpayers recognize all the gain they realize on an installment sale?  How is depreciation recapture treated in an installment sale?  Explain the gross profit ratio and how it relates to gains recognized under installment method sales.

Compare and contrast the similarities and differences between like-kind exchanges and involuntary conversions for tax purposes.

Olympia Corporation, of Kittery, Maine, wants to exchange its manufacturing facility for Bangor Company’s warehouse. Both parties agree that that Olympia’s building is worth $100,000 and that Bangor’s building is worth $95,000. Olympia would like the transaction to qualify as a like-kind exchange. What could the parties do to equalize the value exchanged but still allow the exchange to qualify as a like-kind exchange?  How would the necessary change affect the tax consequences of the transaction?

Minuteman wants to enter into a like-kind exchange by exchanging its old New England manufacturing facility for a ranch in Wyoming. Minuteman is using a third-party intermediary to facilitate the exchange. The purchaser of the manufacturing facility wants to complete the transaction immediately, but, for various reasons, the ranch transaction will not be completed for three to four months. Will this delay cause a problem for Minuteman’s desire to accomplish this through a like-kind exchange?  Explain. 

Salazar Inc., a Colorado company, is relocating to a nearby town. It would like to trade its real property for some real property in the new location. While Salazar has found several prospective buyers for its real property and has also located several properties that are acceptable in the new location, it cannot find anyone willing to trade Salazar Inc. for its property in a like-kind exchange. Explain how a third-party intermediary could facilitate Salazar’s like-kind exchange. 

Describe the like-kind property requirements for real property for purposes of qualifying for a like-kind exchange. Explain whether land held for investment by a corporation will qualify as like-kind property with land held by an individual for personal use.