Test Prep Test Prep Certifications CPA-REGULATION Questions & Answers

• Question 31:

  Which of the following statements is the best definition of real property?

  A. Real property is only land.

  B. Real property is all tangible property including land.

  C. Real property is land and intangible property in realized form.

  D. Real property is land and everything permanently attached to it.

  Correct Answer: D

  Choice "d" is correct. Real property includes land and all items permanently affixed to the land (e.g.,

  buildings, paving, etc.) Choice "a" is incorrect. Real property includes more than just the land (as per the

  explanation above); it includes all items permanently affixed to land.

  Choice "b" is incorrect. "All" tangible property could include moveable personal property and is therefore,

  incorrect.

  Choice "c" is incorrect. "Intangible property in realized form" is a distracter and a contradiction in terms.

• Question 32:

  Starr, a self-employed individual, purchased a piece of equipment for use in Starr's business. The costs associated with the acquisition of the equipment were:

  

  What is the depreciable basis of the equipment?

  A. $55,000

  B. $58,400

  C. $59,125

  D. $59,425

  Correct Answer: D

  Choice "d" is correct. The rules for depreciable basis in tax are generally the same as the GAAP rules for capitalizing an asset. The depreciable basis is the cost associated with the purchase of the asset and with getting the asset ready for its intended use. Further improvements are also capitalized, and the basis is reduced for any accumulated depreciation. In this case, the cost of obtaining the equipment and getting the equipment ready for its intended use includes all the items shown above, as follows: Choice "a" is incorrect. The costs of delivery charges, installation, and sales tax are all part of the cost of obtaining the asset and getting the asset ready for its intended use. All of these charges are included in the depreciable basis of the equipment. Choice "b" is incorrect. The costs of delivery charges and installation are both part of the cost of obtaining the asset and getting the asset ready for its intended use. These charges are included in the depreciable basis of the equipment. Choice "c" is incorrect. The cost of installation is part of the cost getting the asset ready for its intended use. This charge is included in the depreciable basis of the equipment.

  

• Question 33:

  Which of the following sales should be reported as a capital gain?

  A. Sale of equipment.

  B. Real property subdivided and sold by a dealer.

  C. Sale of inventory.

  D. Government bonds sold by an individual investor.

  Correct Answer: D

  Choice "d" is correct. Government bonds held by an individual investor are considered capital assets in the hands of the investor. When these types of security investments are sold, the resulting gain or loss is reported as capital. Choice "a" is incorrect. In this case, we must assume that the BEST answer is option "d" (as that option would ALWAYS result in capital gain or loss treatment) and that the examiners are assuming that the equipment is depreciable equipment that has been used in a business for over one year. [If the equipment had been considered a personal asset by the examiners and had sold for a gain, it would also be a capital asset that sold for a capital gain, and there would be two correct answers. Remember that the correct answer is the option that best answers the question.] Depreciable equipment used in a business and held for over one year falls under the category of Section 1245 property. When Section 1245 assets are sold at a gain, all the accumulated depreciation on the asset is recaptured as ordinary income (the same category as the depreciation expense was deducted against), and any remaining gain (typically, in practice, this is not the case, though, as the asset would have had to sell for an amount greater than its purchase price) is capital gain under Code Section 1231. [Note that Section 1245 applies only to gains. If the asset had sold for a loss, the loss would have been ordinary under Section 1231.] Choice "b" is incorrect. Real property sold by a dealer is considered inventory and results in ordinary income or ordinary losses upon sale. Inventory is not a capital asset and is not afforded the capital gain benefits. Choice "c" is incorrect. Inventory is not a capital asset and is not afforded the capital gain benefits. The sale of inventory results in ordinary income or loss (e.g., gross profit on sales) being reported on the tax return, as inventory is an asset held for sale in the ordinary course of business.

• Question 34:

  Wallace purchased 500 shares of Kingpin, Inc. 15 years ago for $25,000. Wallace has worked as an owner/employee and owned 40% of the company throughout this time. This year, Kingpin, which is not an S corporation, redeemed 100% of Wallace's stock for $200,000. What is the treatment and amount of income or gain that Wallace should report?

  A. $0

  B. $175,000 long-term capital gain.

  C. $175,000 ordinary income.

  D. $200,000 long-term capital gain.

  Correct Answer: B

  Choice "b" is correct. An investment in a capital asset (e.g., stock) results in the income being capital (either a capital loss or a capital gain). Ownership percentage is not a factor in the calculation, and, in this question, nor is the fact that the corporation is not an S corporation. The calculation is simple: Wallace invested $25,000 in the stock and received $200,000 for 100% of his investment 15 years later. The capital gain is $175,000 ($200,000 - $25,000), and it is considered long-term because the stock was held for greater than one year. Choice "a" is incorrect. There is $175,000 of gain on the transaction ($200,000 - $25,000). This type of transaction is not a transaction that is excluded from tax in the tax code. Choice "c" is incorrect. An investment in a capital asset (e.g., stock) results in the income being capital (either a capital loss or a capital gain). Although the calculation of the income is correct (i.e., $175,000), ordinary income is not the proper treatment for this transaction. Choice "d" is incorrect. Although this transaction does result in a long-term capital gain, Wallace has basis in the stock ($25,000), and the gain is calculated as the proceeds from the sale ($200,000) less the basis in the stock.

• Question 35:

  Allen owns 100 shares of Prime Corp., a publicly-traded company, which Allen purchased on January 1, 2001, for $10,000. On January 1, 2003, Prime declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Prime stock was $62 per share. On February 1, 2003, Allen had his broker specifically sell the 100 shares of Prime stock received in the split when the FMV of the stock was $65 per share. What amount should Allen recognize as long-term capital gain income on his Form 1040, U.S. Individual Income Tax Return, for 2003?

  A. $300

  B. $750

  C. $1,500 D. $2,000

  Correct Answer: C

  Choice "c" is correct. The receipt of a nontaxable stock dividend will require the shareholder to spread the basis of his original shares over both the original shares and the new shares received, resulting in the same total basis but a lower basis per share of stock helD. Therefore, Allen's total basis remains the same, $10,000, but is now split between 200 shares (a 2-for-1 split and he originally owned 100 shares). Therefore, his basis per share goes from $100/share ($10,000/100) to $50/share ($10,000/200). Consequently, his basis in the 100 shares sold is 100 x $50 = $5,000. Calculate his gain as follows:

  

  Choices "a", "b", and "d" are incorrect.

• Question 36:

  Farr made a gift of stock to her child, Pat. At the date of gift, Farr's stock basis was $10,000 and the stock's fair market value was $15,000. No gift taxes were paid. What is Pat's basis in the stock for computing gain?

  A. $0

  B. $5,000

  C. $10,000

  D. $15,000

  Correct Answer: C

  Choice "c" is correct. Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift. Basis is increased by any gift tax paid that is attributable to the net appreciation in the value of the gift. Since there were no gift taxes paid, Pat's basis for computing a gain is the rollover cost (basis), $10,000. Choices "a", "b", and "d" are incorrect, per the explanation above.

• Question 37:

  Greller owns 100 shares of Arden Corp., a publicly-traded company, which Greller purchased on January 1, 2001, for $10,000. On January 1, 2003, Arden declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Arden stock was $62 per share. On February 1, 2003, Greller had his broker specifically sell the 100 shares of Arden stock received in the split when the FMV of the stock was $65 per share. What is the basis of the 100 shares of Arden sold?

  A. $5,000

  B. $6,000

  C. $6,200

  D. $6,500

  Correct Answer: A

  Choice "a" is correct. The receipt of a nontaxable stock dividend will require the shareholder to spread the

  basis of his original share over both the original shares and the new shares received resulting in the same

  total basis, but a lower basis per share of stock held. Therefore, Greller total basis remains the same,

  $10,000, but is now split between 200 shares (a 2-for-1 split and he originally owned 100 shares).

  Therefore, his basis per share goes from $100/share ($10,000/100) to $50/share ($10,000/200).

  Consequently, his basis in 100 share is 100 x $50 = $5,000.

  Choices "b", "c", and "d" are incorrect per the above explanation.

• Question 38:

  Smith, an individual calendar-year taxpayer, purchased 100 shares of Core Co. common stock for $15,000 on December 15, 1992, and an additional 100 shares for $13,000 on December 30, 1992. On January 3, 1993, Smith sold the shares purchased on December 15, 1992, for $13,000. What amount of loss from the sale of Core's stock is deductible on Smith's 1992 and 1993 income tax returns?

  

  A. Option A

  B. Option B

  C. Option C

  D. Option D

  Correct Answer: A

  Choice "a" is correct. In 1992, no sale of stock occurred so there would be no loss. In 1993, there is a $2,000 loss realized ($15,000 basis less $13,000 received), but it is not deductible because it is a wash sale. A wash sale occurs when a taxpayer sells stock at a loss and invests in substantially identical stock within 30 days before or after the sale. In this case, Smith reinvested in an additional 100 shares four days prior to selling 100 shares of the same stock at a loss. The $2,000 disallowed loss would, however, increase the basis of the new shares by $2,000.

  Choice "b" is incorrect. The $2,000 loss realized in 1993 is disallowed under the wash sale rules.

  Choice "c" is incorrect. In 1992, there is no loss since no shares were sold. In 1993, the $2,000 loss is

  disallowed under the wash sale rules.

  Choice "d" is incorrect. In 1992, there is no possible loss since no shares were sold.

• Question 39:

  Conner purchased 300 shares of Zinco stock for $30,000 in 1980. On May 23, 1994, Conner sold all the

  stock to his daughter Alice for $20,000, its then fair market value. Conner realized no other gain or loss

  during 1994. On July 26, 1994, Alice sold the 300 shares of Zinco for $25,000.

  What was Alice's recognized gain or loss on her sale?

  A. $0

  B. $5,000 long-term gain.

  C. $5,000 short-term loss.

  D. $5,000 long-term loss.

  Correct Answer: A

  Choice "a" is correct. Alice has a realized gain of $5,000 on the transaction: $25,000 sales price less $20,000 purchase price. However, she can reduce the gain, but not below zero, by the amount of loss her father could not deduct on the sale to her. Thus, Alice can reduce her gain by up to $10,000, but not below zero. Here, the gain is $5,000, so it is reduced to zero. Conner should have sold the stock in the open market so that he could deduct the entire loss. Alice could then have purchased the stock in the open market. Choice "b" is incorrect. $5,000 is Alice's realized long-term gain on the sale. However, she can reduce the gain, but not below zero, by the amount of loss her father could not deduct on the sale to her. Choice "c" is incorrect. Alice has a realized gain of $5,000 on the sale. However, since she is related to Conner, her holding period includes his holding period. Therefore, her realized gain is long-term. In addition, she can reduce the gain, but not below zero, by the amount of loss her father could not deduct on the sale to her. Choice "d" is incorrect. Alice can reduce the gain by the amount of loss her father could not deduct on the sale to her. However, she cannot reduce the gain below zero.

• Question 40:

  Conner purchased 300 shares of Zinco stock for $30,000 in 1980. On May 23, 1994, Conner sold all the

  stock to his daughter Alice for $20,000, its then fair market value. Conner realized no other gain or loss

  during 1994. On July 26, 1994, Alice sold the 300 shares of Zinco for $25,000.

  What amount of the loss from the sale of Zinco stock can Conner deduct in 1994?

  A. $0

  B. $3,000

  C. $5,000

  D. $10,000

  Correct Answer: A

  Choice "a" is correct. Even though Conner has a realized loss of $10,000 on this transaction he cannot deduct the loss since it was incurred in a transaction with his daughter, a related party. Choice "b" is incorrect. $3,000 is the limit on deductible net capital losses. However, Conner cannot deduct this loss, since it was incurred in a transaction with his daughter, a related party. Choice "c" is incorrect. Conner's realized loss on the sale is $10,000 ($20,000 proceeds less $30,000 basis). However, Conner cannot deduct this loss, since it was incurred in a transaction with his daughter, a related party. Choice "d" is incorrect. $10,000 is Conner's realized loss on the sale. However, Conner cannot deduct this loss, since it was incurred in a transaction with his daughter, a related party.