Accounting 405 Practice 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, 2002? ___________________________________? 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 property. 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 permitted. _______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 assumed. _______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 asset. _______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) AMOUNT FOR OR FROM __________ __________ 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 business. __________ __________ 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 land. 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.