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                            MidTerm Test #2

        Name: _______________________________

         Group: ______________________________

Note: This test was based on 2002 tax law, so any questions that require expensing
of assets and/or additional first-year depreciation were based on the 2002 law that
allowed only $24,000 expensing maximum and 30%, rather than 50%, additional
first-year depreciation. In addition, the maximum tax rate on net LTCG’s in 2002
was 20% rather than 15%. These statements are relevant only for the multiple
choice and true-false portion of this mid-term test.
Part I—Multiple Choice. Enter the letter of your choice on the front side of the
scantron sheet. 2.5 points each 60 points.

1.    Rex, a cash basis calendar year taxpayer, runs a bingo operation which is illegal
      under state law. During 2002, a bill designated H.R. 9 is introduced into the state
      legislature which, if enacted, would legitimize bingo games. In 2002, Rex had the
      following expenses:

          Operating expenses in conducting bingo games                               $247,000
          Payoff money to state and local police                                       24,000
          Newspaper ads supporting H.R. 9                                               2,000
          Political contributions to legislators who support H.R. 9                     8,000

      Of these expenditures, Rex may deduct:
      a.     $247,000.
      b.     $249,000.
      c.     $257,000.
      d.     $281,000.
      e.     $2,000

2.    Melvin is engaged in an illegal drug-running operation.         Of the following
      expenses, which will reduce Melvin’s taxable income?
      a.     Rent.
      b.     Bribes paid to border guards.
      c.     Cost of goods sold.
      d.     Interest on business indebtedness.
      e.     None of the expenses are deductible.

3.    In the Groetzinger case, the court ruled that:
      a.      The taxpayer’s gambling activity was not a trade or business.
      b.      The taxpayer’s gambling activity was a trade or business.
      c.      The bank’s stock was a capital asset.
      d.      The taxpayer’s fire loss was not deductible as a casualty loss.
      e.      The replacement building qualified for purposes of Section 1033.

4.    Carlos purchased an apartment building on November 16, 1987, for $1,000,000.
      Determine the cost recovery for 2002 if the building were sold on February 28,

5.   On June 1, 2002, Irene places in service an automobile that cost $21,000. The car
     is used 70% for business and 30% for personal use. (Assume this percentage is
     maintained for the life of the car.) Determine the cost recovery deduction for
     2002. Note: the below numbers are based on 2002 law.
     a.     $9,240.
     b.     $6,468
     c.     $2,940.
     d.     $7,660
     e.     $5,362

6.   Mary is the sole proprietor of Crow Loan Company. On May 1, 2001, Crow
     loaned John $20,000. In 2002, John filed for bankruptcy. At that time, it was
     revealed that John’s creditors could expect to receive 60 cents on the dollar. In
     March 2003, final settlement was made, and Crow received $5,000. Crow’s
     policy is to deduct losses as soon as permitted. How much loss can Crow deduct
     and in which year?
     a.    2001—$15,000.
     b.    2002—zero; 2003—$15,000.
     c.    2002—$12,000; 2003—$3,000.
     d.    2002—$8,000; 2003—$7,000.
     e.    2002--$8,000; 2003--$3,000

7.   Ilene, a single taxpayer, had the following items for 2002:

        Salary of $80,000.
        Gain of $20,000 on sale of § 1244 stock acquired two years ago.
        Loss of $60,000 on the sale of § 1244 stock acquired 17 months ago.
        Stock acquired three years ago for $8,000 became worthless on May 20 of the
         current year.

     Determine Ilene’s AGI for 2002.
     a.   $14,000.
     b.   $17,000.
     c.   $37,000.
     d.   $77,000.
     e.   $27,000
8.   Alma is in the business of dairy farming. During the year, one of her barns was
     completely destroyed by fire. The adjusted basis of the barn was $90,000. The
     fair market value of the barn before the fire was $75,000. The barn was insured
     for 95% of its fair market value, and Alma recovered this amount under the
     insurance policy. Alma has adjusted gross income for the year of $40,000 (before
     considering the casualty). Determine the amount of loss she can deduct on her tax
     return for the current year.
     a.    $3,750.
     b.    $14,650.
     c.    $14,750.
     d.    $18,750.
     e.    None of the above.
9.    Josh has investments in two passive activities. Activity A, acquired three years
      ago, produces income of $30,000 this year. Activity B, acquired two years ago,
      produces a loss of $50,000. What is the amount of Josh’s suspended loss with
      respect to these activities for the year?
      a.      $0.
      b. $18,000.
      c. $20,000.
      d. $50,000.
      e. None of the above.

10.   Josie, an unmarried taxpayer, has $95,000 in salary, $15,000 net income from
      renting one apartment building in which she actively participates and a $42,000
      loss from renting another apartment building in which she actively participates.
      Of that $42,000 loss, she can deduct this year.
      a.    $0
      b.    $42,000
      c.    $25,000
      d.    $15,000.
      e.    $35,000.

11.   Pedro borrowed $5,000 to purchase a machine. He later borrowed $1,000 using
      the machine as collateral. Both notes are nonrecourse. Ten years later, the
      machine has an adjusted basis of zero and two outstanding note balances of
      $1,200 and $500. Pedro sells the machine subject to the two liabilities for $400.
      What is his realized gain or loss?
      a.     $400.
      b.     $900.
      c.     $1,600.
      d.     $2,100.
      e.     None of the above.

12.   Gift property (disregarding any adjustment for gift tax paid by the donor):
      a.      Has no basis to the donee because he or she did not pay anything for the
      b.      Has the same basis to the donee as the donor’s adjusted basis if the donee
              disposes of the property at a gain.
      c.      Has the same basis to the donee as the donor’s adjusted basis if the donee
              disposes of the property at a loss, and the fair market value on the date of
              gift was less than the donor’s adjusted basis.
      d.      Has no basis to the donee if the fair market value on the date of gift is less
              than the donor’s adjusted basis.
      e.      None of the above.

13.   Shontelle received a gift of income-producing property with an adjusted basis of
      $50,000 to the donor and fair market value of $40,000 on the date of gift. Gift tax
      of $1,000 was paid by the donor. Shontelle subsequently sold the property for
      $45,000. What is the recognized gain or loss?
      a.     $5,000.
      b.     $4,000.
      c.     ($6,000).
      d.     ($5,000).
      e.     None of the above.
14.   Taxpayer exchanges a productive use machine, which has an adjusted basis of
      $9,000, for a new machine worth $6,000. In addition, the taxpayer receives cash
      of $5,000. What is the recognized gain or loss and the basis of the new machine?
      a. $0 and $4,000.
      b. $2,000 and $5,000.
      c. $2,000 and $6,000.
      d. $2,000 and $9,000.
      e. $0 and $9,000

15.   Ashley owns 200 acres of farm land is southeastern Virginia. Her adjusted basis
      for the land is $525,000 and there is a $390,000 mortgage on the land. She
      exchanges the land for an office building owned by Chris in Newark, New Jersey.
      The building has a fair market value of $450,000. Chris assumes Ashley's
      mortgage on the land. What is the amount of Ashley's recognized gain or loss on
      the exchange?
      a.     $0.
      b.     $840,000
      c.     $390,000.
      d.     $315,000.
      e.     $60,000

16.   Sam's office building with an adjusted basis of $550,000 and a fair market value
      of $975,000 is condemned on December 30, 2002. Sam is a calendar year
      taxpayer. He receives a condemnation award of $950,000 on March 1, 2003. He
      builds a new office building at a cost of $930,000 which is completed and paid for
      on December 31, 2005. What is Sam’s recognized gain on receipt of the
      condemnation award and basis for the new office building assuming his objective
      is to minimize gain recognition?
      a.      $0; $530,000.
      b.      $0; $930,000.
      c.      $20,000; $550,000.
      d.      $400,000; $930,000.
      e.      $20,000; $575,000

17.   Which of the following is a capital asset?
      a.    The bicycle of a 10-year old child. The child purchased the bicycle with
            money inherited from an aunt.
      b.    The tools used by a self-employed carpenter.
      c.    The lots owned by a company that is in the business of buying and
            reselling residential building lots.
      d.    A “mint” set of 1985 coins owned by a coin dealer and that is for sale on
            his website.
      a.    A painting painted by the taxpayer.
18.   Ophelia had the following capital transactions for the year:

      Acquired                 Item            Sold          Selling Price        Cost
      09-13-1997              Stock        07-13-2002           $3,000           $4,500
      06-20-1993              Stock        09-30-2002           $5,800           $2,000
      07-01-2002              Stock        09-30-2002           $1,000           $1,300

      In addition, Ophelia has a long-term capital loss carryover from 2001 of $1,800.
      As a result, in 2002, Ophelia has a:
      a.     $2,300 net LTCG and $300 net STCL
      b.     $2,000 net LTCG
      c.     $500 net LTCG and $300 net STCL
      d.     $200 net LTCG
      e.     $200 net STCG

19.   White Company is an accrual basis taxpayer that sold $45,000 of accounts
      receivable for $33,000. The $12,000 loss on the sale is an ordinary loss because:
      a.     The asset is a capital asset.
      b.     The asset is a § 1231 asset.
      c.     The asset is an ordinary asset.
      d.     The asset was disposed of for a loss.
      e.     None of the above are correct.

20.   Swan, Inc. has a $28,000 net § 1231 gain for 2002. In 2001, Swan had a $13,000
      net   § 1231 loss. For 2002, Swan's net § 1231 gain is treated as:
      a.     A $28,000 ordinary loss.
      b.     A $15,000 long-term capital gain and a $13,000 ordinary gain.
      c.     A $28,000 ordinary gain.
      d.     A $20,000 long-term capital gain and a $6,000 ordinary gain.
      e.     A $28,000 long-term capital gain.

21.   James sells equipment for $500 which had been purchased for $15,000 and on
      which $13,254 of depreciation had been taken. He had used the equipment in his
      business for several years. James has:
      a.     A $1,246 § 1245 loss.
      b.     A $1,246 § 1231 loss.
      c.     A $1,246 short-term capital loss.
      d.     A $500 § 1231 gain.
      e.     A $1,246 Sec. 1231 gain.

22.   Eighteen-year residential real property owned by an individual has accumulated
      accelerated depreciation of $150,000 at January 1, 2002. If depreciation had been
      computed under the straight-line method, accumulated depreciation would be
      $140,000. The property is sold on January 1, 2002 with a recognized gain of
      $175,000. What is the amount and character of the gain?
      a.     $175,000 Sec 1250G
      b.     $140,000 Sec 1250G; $ 35,000 Sec 1231G
      c.     $150,000 Sec 1250G; $ 25,000 Sec 1231G
      d.     $ 10,000 Sec 1250G; $165,000 Sec 1231G
      e.     None of the above.
23.   Rick transferred the following assets and liabilities to Warbler Corporation.

                                                   Adjusted               Fair Market
                                                     Basis                  Value
      Building                                     $210,000                $225,000
      Equipment                                      45,000                   75,000
      Automobile                                     15,000                   30,000
      Mortgage (held for four                        30,000                   30,000
               years) on building

      In return Rick received $75,000 in cash plus 90% of Warbler Corporation's only
      class of stock outstanding (fair market value of $225,000).
      a.      Rick has a recognized gain of $30,000.
      b.      Rick has a recognized gain of $75,000.
      c.      Rick's basis in the stock of Warbler Corporation is $270,000.
      d.      Warbler Corporation has the same basis in the assets received as Rick does
              in the stock.
      e.      Rick has a recognized gain of $60,000.

24.   Eve transfers property worth $400,000, basis of $120,000, to Green Corporation
      for 80% of its stock, worth $350,000, and a long-term note, executed by Green
      Corporation and made payable to Eve, worth $50,000.
      a.     Eve recognizes no gain on the transfer.
      b.     Eve recognizes a gain of $230,000 on the transfer.
      c.     Eve recognizes a gain of $280,000 on the transfer.
      d.     Eve recognizes a gain of $50,000 on the transfer.
      e.     None of the above.

Part II—True or False. On the back of the scantron sheet, enter A for T or B for F
            for each of the following 16 questions. 1 point each. 16 Points.

_______51.   Ralph, a shareholder-employee of Warbler, Inc., receives a $250,000
             salary. The IRS classifies $80,000 of this amount as unreasonable
             compensation. The effect of this reclassification is to reduce Ralph’s
             gross income by $80,000.
_______52.   Deductions for lobbying expenses incurred in attempting to influence
             Federal legislation are not permitted, but deductions for lobbying expenses
             incurred in attempting to influence local (e.g., a city) legislation are

_______53.   Hollis operates a lawn care service business in southeastern Missouri. He
             incurs $3,000 of expenses determining the feasibility of expanding his
             lawn care service business to southwestern Missouri. If he expands the
             business to southwestern Missouri, the $3,000 is deductible in the current
             tax year. If he does not do so, then he must amortize the $3,000 over a 60-
             month period.
_______54.   Residential rental real estate placed in service after May 12, 1993, has a
             cost recovery period of 39 years.
_______55.   Accrual basis taxpayers can use the reserve (or estimated) method for
             computing deductions for bad debts.

_______56.   If rental property is completely destroyed, the amount of the loss is the
             lesser of the fair market value of the property or the adjusted basis of the
             property at the time of the destruction.

_______57.   In the current year, Rich has a $40,000 loss from a business he owns. His
             at-risk amount at the end of the year, prior to considering the current year
             loss, is $24,000. He will be allowed to deduct $24,000 of that loss this
             year if he is a material participant in the business.

_______58.   Wayne owns a small apartment building that produces a $45,000 loss
             during the year. His AGI before considering the rental loss is $85,000.
             Because Wayne is an active participant with respect to the rental activity,
             he may deduct the $45,000 loss this year.
_______59.   If the buyer assumes the seller's liability on the property acquired, the
             seller's amount realized is decreased by the amount of the liability

_______60.   Expenditures made for ordinary repairs and maintenance of property are
             not added to the original basis in the determination of the property’s
             adjusted basis.

_______61.   The amount of the loss basis of a gift will differ from the amount of the
             gain basis only if at the date of the gift the adjusted basis of the property is
             less than the property’s fair market value.

_______62.   In a like-kind exchange, if boot received exceeds the realized gain, gain is
             recognized only to the extent of the realized gain.

_______63.   Noncorporate taxpayers carry unused capital losses, short-term or long-
             term, back 3 years and forward 5 years.

_______64.   A business taxpayer sells machinery that is included in its inventory. One
             of the machines has been held more than a year. That machine is a § 1231

_______65.   Depreciation recapture generally does not apply to depreciable real estate
             sold by an individual that was placed in service after 1986 because
             straight-line depreciation was used to depreciate the property.

_______66.   When § 1239 (relating to the sale of depreciable property between related
             taxpayers) applies, it results in the entire gain being treated as § 1231 gain.
Part III Problems. Points As Indicated. Answer on sheet. (24 Points)

1.    The following shares of Lanco were purchased by Ted.

      800 shares at $12 on 3/11/00
      900 shares at $16 on 8/22/01
      700 shares at $13 on 9/25/01

      Ted sold 1,200 shares of Lanco for $14 per share on 7/3/02

      a)     If Ted does not identify the stock sold, how much and what kind of gain
             and/or loss does he have? (2 Points)

      b)     Same as A except the Specific Identification method is used and he
             designates that the sale comes from the most recent purchase first, then
             from the second most recent. (2 Points)

2.    For each of the following indicate the amount deductible in 2002 and whether the
      amount is deductible FOR or FROM AGI: (9 points)


__________ __________ A.             A three-year fire insurance policy costing $36,000
                                     was purchased by a sole proprietor on 4/1/2002
                                     (the effective date)

__________ __________ B.             $1,800 for advice received by an investor for
                                     deciding purchases and sales of stocks.

__________ __________ C.             Legal fees of $3,000 incurred in connection with the
                                     purchase of land and $4,000 for defending a sole
                                     proprietor against an injury suit involving his

__________ __________ D.             A $6,000 loan evidenced by a 3-year 6% note owed
                                     to Bob by his friend Fred became uncollectible in
                                     2002. Bob has no capital gains.
__________ __________ E.           $5,000 in maintenance fees and $2,000 of bribes to
                                   police paid by a landlord of an apartment building.

__________ __________ F.           John, a sole proprietor, acquired another related
                                   business in 2001. As part of the acquisition,
                                   $30,000 was paid for goodwill and $15,000 for

3.    Farmer exchanged Land A, adj Basis of $400,000, subject to a $90,000 mortgage
      for Land B worth $378,000 subject to a $75,000 mortgage and cash of $35,000.
      (6 points)

      a)     Determine Farmer’s realized gain.

      b)     Determine Farmer’s recognized gain and tell what kind of gain it is.

      c)     Determine the basis of Land B to Farmer.
4.   Ted owns a sole proprietorship and is an investor in stocks. In 2002 he had the
     following: (6 points)

     - STCG                                      $19,000
     - STCL                                      $21,000
     - Casualty gain on business
            assets held 2 years                  $ 8,000
     - 1245 G                                    $13,000
     - 1231 G                                    $ 9,000
     - LTCL                                      $ 8,000
     - LTCG                                      $13,000
     - 1231 L                                    $11,000
     - Casualty loss on business
            assets held 2 years                  $ 2,000

     A.     Determine Ted’s net Sec 1231 G or L.

     B.     Determine Ted’s net capital gain or loss.