Chapter I5

Property Transactions - Capital Gains and Losses

Discussion Questions
I5-1 It may be difficult to determine the fair market value (FMV) of the used building received
by the investor. The problem is likely to be resolved by using the FMV of the property given (the
publicly-traded stock) to measure the amount realized. p. I5-3.
I5-2

cost of the house

cost of the room added to the house
cost of built-in bookshelves
basis for the house p. I5-4.

$60,000
10,000
800
$70,800

I5-3 Yes, sales tax paid or accrued in connection with the acquisition of property is included as
part of the property's cost. p. I5-5.
I5-4

Amount realized
Minus: basis (50 shares x $90)*
LTCG

$8,000
(4,500)
$3,500

*FIFO method is used. pp. I5-5 and I5-6.

I5-5 a.
David's holding period starts on August 5 of the current year (the date of the gift)
if David uses the FMV at the date of the gift to determine his basis.
b.
His holding period starts on January 15, 1987, if he uses his grandfather's basis.
pp. I5-27 and I5-28.
I5-6 a.
The value of the taxable estate would be $80,000 less and the estate tax is reduced
by electing to use the alternate valuation date.
b.
Jim's basis for the property would be $80,000 higher, and he might have a smaller
gain or larger loss when he sells or exchanges the land.
c.
The savings in estate tax is $29,600 (37% x $80,000). If the property is
subsequently sold at a gain, the tax savings will be $22,400 (28% x $80,000), thus the alternate
valuation date should be elected. Another factor to consider is whether Jim plans to sell the
property in the near future since the income tax savings would not occur until Jim sells or
exchanges the property while the estate tax savings are realized currently. p. I5-8.
I5-7

$150 ($82,500/550 shares). pp. I5-10 and I5-11.

I5-1

I5-8

Basis of stock
Total number of
owned before
shares owned after
stock dividend stock dividend

Basis for each

=
share owned
after dividend

$38,880 divided by X = $18

X = 2,160 shares
Total number of shares after stock dividend
Total number of shares before stock dividend
Increase in shares due to stock dividend
Percentage dividend distributed
(160 divided by 2,000) =

2,160
2,000
160
8%

pp. I5-10 and I5-11.

I5-9

The interest must be capitalized. p. I5-5.

I5-10 For Andy, the refrigerator is inventory and not a capital asset. Roger's refrigerator is a
capital asset since it is not included in the list of properties that are not capital assets. pp. I5-12
and I5-13.
I5-11 The purchase and sale of future contracts was an integral part of the company's business.
p. I5-13.
I5-12 The dealer must clearly identify that the security is held for investment. This act of
identification must occur before the close of the day on which the security is acquired and the
security must not be held primarily for sale to customers in the ordinary course of the dealer's
trade or business at any time after the day of purchase. p. I5-14.
I5-13 a.
The gain is LTCG since the requirements of Sec. 1237 are satisfied.
b.
The cost of the 30 acres would be allocated among the lots on the basis of their
relative FMVs. pp. I5-14 and I5-15.
I5-14 The NSTCL is first offset against LTCG that is taxed at 28%, the highest rate for LTCG,
then against LTCG taxed at 25%, and finally against the LTCG that is ANCG taxed at 20%. The
NSTCL is used first to reduce gains taxed at the higher rates. p. I5-17.
I5-15 The debt is a nonbusiness bad debt. The loss is treated as a STCL. p. I5-15.
I5-16 The motive for purchasing the stock is not relevant in determining whether or not the
stock is a capital asset. The stock is not within one of the classes of property excluded from
capital-asset status. p. I5-13.

I5-2

I5-17 Since the stock of the First Corporation is acquired to obtain a potential customer, the Top
Corporation might use the Corn Products case to argue that the asset is not a capital asset since
the stock is acquired as an integral part of Top's business. However, the stock is not likely to be a
capital asset since the Supreme Court in Arkansas Best stated that the motive for purchasing the
stock is not relevant, and the stock is not within one of the classes of property excluded from
capital-asset status. The Arkansas Best case is thought to be controlling because the application
of Corn Products is limited to hedging transactions. Note, however, that this issue continues to
be litigated and the Circle K Corporation case might also be used to support the taxpayer's
position. pp. I5-13 and I5-14.
I5-18 Capital gain. Gain on the sale of stock purchased with a substantial investment motive is
capital gain. pp. I5-13 and I5-14.
I5-19 Nancy held the bonds of the East Corporation as an investment. For Minor Corporation,
the securities of the East Corporation are securities of an affiliated corporation. Thus, Minor's
loss due to the worthless securities is an ordinary loss. p. I5-21.
I5-20 There is no original issue discount since the discount of $20,000 is less than $25,000
(.0025 x $500,000 x 20). pp. I5-22 and I5-23.
I5-21 Juanita purchased a market discount bond (i.e., her purchase price was less than the
maturity value) and the accrued market discount must be recognized as ordinary income when she
has a disposition of the bond unless the de minimus rule applies (i.e., market discount is zero if the
discount is less than 1/4 of 1% of the stated redemption price of the bond at maturity multiplied
by the number of years to maturity). If the bonds are sold after two years, up to 2/11 of the
market discount may be treated as ordinary income if the realized gain is equal to or greater than
this amount. p. I5-24.
I5-22 She should transfer all substantial rights to the patent. p. I5-25.
I5-23 The transferor of a franchise may not treat the transfer as a sale or an exchange of a capital
asset if the transferor retains any significant power, right or continuing interest with respect to the
subject matter of the franchise. pp. I5-26 and I5-27.
I5-24 The lessor treats the payments as ordinary income. p. I5-27.
I5-25 October 1, 1999. p. I5-29.
I5-26 The gain on the sale of A is a LTCG of $12,000, the loss on the sale of B is a STCL of
$3,000, and the gain on the sale of C is a LTCG of $7,400. Phil's NLTCG is $19,400 and his
NSTCL is $3,000. The net capital gain is $16,400 ($19,400 - $3,000). Because both of the assets
sold at a gain had a holding period of more than 18 months, all of the NCG is ANCG. p. I5-27.

I5-3

I5-27 If the individual taxpayer does not have capital gains, only $3,000 of capital losses may be
deducted annually. It may take many years before an investor with a large capital loss is allowed
to deduct all of the losses. Possibly, a taxpayer could die with unused capital losses. The
unfavorable treatment of capital losses may cause the investor to be less willing to take the risks
associated with purchasing stock of a high-risk, start-up company. The instructor may want to
refer to Sec. 1244 which is mentioned in Chapter I5 and discussed in Chapter I8. p. I5-18.
I5-28 The taxpayer may not care if the loss is an ordinary loss or a STCL if the taxpayer has
STCGs or has NLTCG that is mid-term gain but his marginal tax rate is 28% or less. The STCL
could be used to offset STCG or NLTCG. p. I5-18.
I5-29 The amount realized is increased by the amount of the liability assumed by Fred. Fred's
basis is increased by the amount of the assumed liability. pp. I5-3 and I5-4.
I5-30 When Calvin collects the first $10,000 interest payment on December 31, 19Y1, he must
pay taxes of $4,000 and will have $6,000 to reinvest at a 6% after-tax rate of interest for four
years. The after-tax payment received on December 31, 19Y2, will be reinvested at a 6% aftertax rate for three years, etc. At the end of the five years, he will have cash of $133,823 as shown
below:
$ 6,000
6,000
6,000
6,000
6,000
100,000
Total Cash Available

x
x
x
x

1.2625 =
1.1910 =
1.1236 =
1.06 =
=
=

$ 7,575
7,146
6,742
6,360
6,000
100,000
$133,823

The value of the stock increases as follows:

End of year one
End of year two
End of year three
End of year four
End of year five

$108,000
116,640
125,971
136,049
146,933

Amount realized on sale

Less taxes
Cash Available

$146,933
9,387
$137,546

(20% x $46,933)

Despite the different before-tax returns (10% and 8%), Calvin should purchase the stock
since $137,546 exceeds $133,823 by $3,723.

I5-4

Note to Instructor: This problem illustrates the value of deferring the tax and the implications of
preferential tax treatment for net capital gains.
To further illustrate the value of the deferral, ask the students what alternative should be selected
if the time period was six years instead of five years. Without computing the numbers, students
should be able to respond that the stock would be the better investment by a larger margin,
$5,097.
With the bond, Calvin would have another $8,030 ($6,000 x 1.3383), thus increasing the total to
$141,853. The value of the stock at the end of the sixth year would be $158,688 (1.08 x
$146,933). After paying taxes of $11,738, he would have cash of $146,950 ($158,688 $11,738).

Issue Identification Questions

I5-31 The primary tax issue is whether the gain or loss on the sale of the seed is ordinary income
or capital gain or loss. If the gain or loss is capital, secondary issues deal with the netting of other
capital gain and losses, whether the gain or loss is long or short-term, capital loss limitations etc.
In this situation it appears that the gain or loss should be capital because Acorn is in the business
of selling barley and not in the business of buying and selling seed. The facts in this question are
similar to Hufford v. U.S., 17 AFTR 2d 760, 66-1 USTC 9357 (D.C. Wash., 1966). p. I5-13.
I5-32 1.
Are the breeding beavers capital assets for Lisa and John?
depreciable property used in a trade or business.

No, they are

2.
What is the basis of the beavers? The contract is unusual in that the taxpayers may
pay the debt with beavers instead of cash. There may be an issue of whether or not the $30,000
paid for the beavers is an inflated cost which could be used to increase depreciation deductions.
Is this an arm's length transaction? If the cash price for a pair of breeding beavers is significantly
less than $30,000, the basis should not be $30,000.
In Bryant v. Comm [86-1 USTC 9456 (9th Cir., 1986)] beavers were sold under similar contracts
as above to investors for $1,750 when others could purchase beavers for $250. There were tax
related reasons for inflating the cost, and the court reduced the basis to FMV.
3.
When John and Lisa pay the debt with the beavers, will a gain or loss be
recognized? Yes, the gain or loss is ordinary. The payment of the debt by delivering the beavers
is equal to a sale of the beavers. The sales price is the amount of the debt which is satisfied. Gain
or loss is measured by the difference between the sales price and the adjusted basis (cost).
p. I5-13.

I5-5

I5-33 The primary tax issue is whether the gain or loss on the sale of the farm is capital or
ordinary. To determine the amount of gain or loss, the basis rules for inherited property need to
be addressed. If the gain or loss is capital, the holding period rules for inherited property need to
be applied. The basis of the property is $500,000 and the $20,000 gain should be LTCG because
Mike is holding the property for investment (assuming that he keeps the inherited property
separate from his real estate business). pp. I5-8 and I5-9.
I5-34 The primary tax issue is whether the $75,000 gain on the sale of the house is capital or
ordinary. A secondary issue is whether the gain (if capital) is LTCG or STCG. It appears that the
gain is capital because Sylvia is not in the business of home construction. Since she started
construction of the house more than one year ago, she may be deemed to have a split holding
period whereby the portion of the gain attributable to construction on or before July 29, 1997
would be LTCG. Any LTCG is mid-term gain taxed at a maximum rate of 28%. pp. I5-12
through I5-14.

Problems
I5-35 Amount realized
Minus: Adjusted basis
LTCG

$159,000*
(150,000)
$ 9,000

*($74,000 + $40,000 + $45,000)

p. I5-3.
I5-36 a.
b.
c.
7.

$30,000
[($40,000/$120,000) x $90,000]
$60,000
[($80,000/$120,000) x $90,000]
Yes, since the FMV on the date of the gift is greater than the donor's basis. p. I5-

I5-37 a.

Amount realized
$ 784,000
Minus: Basis*
( 118,000)
Gain Realized
($666,000)
*$110,000 + ($200,000/$300,000 x $12,000)
b.

Amount realized
Minus: Basis
Gain realized

$784,000
(110,000)
$674,000

pp. I5-6 and I5-7.

I5-6

($800,000 - $16,000)

I5-38 Adjusted gross income: a. $42,500; b. $22,500; c. $36,500.

a.

Selling price
Minus: Basis
LTCG
Increase in AGI

$48,000
(30,500) ($30,000 + $15,000/$45,000 x $1,500)
$17,500
$17,500

b.

Selling price
Minus: Basis
STCL
Reduction in AGI

$28,000
(30,500)
$(2,500)
$(2,500)

c.

Selling price
Minus: Basis
LTCG
Increase in AGI

$42,000
(30,500)
$11,500
$11,500

Holding period starts on April 12, 1992.

pp. I5-6 and I5-7.
I5-39 a.
b.

$9,600
$600 realized loss [$5,000 - ($9,600 - $4,000)].

pp. I5-9 and I5-10.

I5-40 a.
b.

The basis allocated to the rights is $500 [($1,000/$8,000) x $4,000].

Amount realized
Minus: Basis
LTCG

$1,080
(500)
$ 580

The holding period for the stock rights starts on July 25, 1986.
c.
The basis of the 100 shares purchased by exercising the stock rights is $7,300
($6,800 + $500). The holding period starts on May 14 of the current year.
d.
$1,080 LTCG. pp. I5-11 and I5-12.
I5-41 Since Sec. 1237 applies and less than five lots have been sold, none of the gain recognized
last year will be ordinary income. A LTCG of $7,520 is recognized.
Selling price
$12,000
Minus: Selling expenses
( 480)
Amount realized
$11,520

I5-7

Minus: Basis
Gain (LTCG)

( 4,000)
$ 7,520

This year, ordinary income of $3,000 (0.05 x $60,000) is recognized, and a deduction for selling
expenses of $1,900 is allowed. A LTCG of $37,000 is recognized
Amount realized
Minus: Basis
Gain

$58,100 ($60,000 - $1,900)

(20,000)
$38,100

Ordinary income
LTCG

$ 1,100 ([0.05 x $60,000] - $1,900)

$37,000

pp. I5-14 and I5-15.

I5-42 CASE A - 28% - gain is STCG
CASE B - 28% - collectibles gain
CASE C - 20% - gain is ANCG
CASE D - 28% - mid-term gain
pp. I5-17 and I5-18.
I5-43 a.
b.
class.
c.

$1,960
$1,960

[($2,000 x 28%) + ($7,000 x 20%)].

same as (a) because the NSTCL is first offset against 28% rate

$1,800

All of the $9,000 NCG is ANCG taxed at 20%.

pp. I5-17 and I5-18.

I5-44 a.
b.

Tax on $70,000 + 20% ($20,000) = $19,187.

$20,142.50 + 31% ($90,000 - $87,700) = $20,856.

p. I5-19.
I5-45 a.
b.

$21,058.
$23,444

[$13,896.50 + 31% x ($84,500 - $61,400)]

[$13,896.50 + 31% x ($85,100* - $61,400) + (20% x $11,000)]

p. I5-19.
*The $11,000 addition to his AGI results in a $330 (3% x $11,000) reduction of itemized
deductions and a $270 (2% x 5 x $2,700) reduction in the personal exemption deduction, thus his
taxable income is increased by $11,600 [$11,000 + ($330 + $270)] and his tax liability is increased
by $2,386. Note to instructor: This problem illustrates how adjusted net capital gain may be
subject to a tax rate greater than 20%. The marginal tax rate on the $11,000 net capital gain
amounts to 21.69% ($2,386 $11,000).
I5-8

I5-46 Find the selling price (SP) such that the selling price less the tax on the LTCG is $90,000.
SP - [.2 x (SP - $60,000)] = $90,000
SP - .2SP + $12,000 = $90,000
.8SP = $78,000
SP = $97,500
p. I5-19.
I5-47
Situation 1
AGI after considering
capital gains and losses
NSTCG (NSTCL)
NLTCG (NLTCL)

Situation 2

Situation 3

Situation 4

$45,000
4,000
1,000

$58,000
( 3,000)
11,000

$59,000
1,000
( 2,000)

$67,000*
( 9,000)
5,000

1995

1996

1997

1998

*$1,000 STCL is a carryforward.

pp. I5-16 through I5-18.
I5-48

AGI
STCL to be carried
forward
LTCL to be carried
forward

$37,000

$47,000

1,000

--

--

7,000

pp. I5-16 through I5-18.

I5-9

$57,000

$67,000

800

3,300

I5-49 The loss due to Wolverine stock at one time would have been an ordinary loss since the
security probably would not have been a capital asset due to the Corn Products doctrine.
However, the Supreme Court's decision in 1988 in the Arkansas Best Corporation case severely
limits the use of the ordinary loss exception in the case of stock or other assets that fall within the
definition of a capital assets. As a result, the loss on the Wolverine stock is probably a capital loss.
The loss due to the Spartan stock is a LTCL. The loss due to the Huron stock is ordinary since
the stock is that of an affiliated corporation. p. I5-21.
I5-50 a.
b.

$3,432 ($20,000 - $16,568)

$94
Cash
Received

12-31-96
6-30-97
12-31-97
6-30-98
12-31-98
6-30-99

Amortization
of Discount

$900
900
900
900
900

Interest
Income

$ 94
100
106
112
119

$ 994
1,000
1,006
1,012
1,019

Basis
of Bond
$16,568
16,662
16,762
16,868
16,980
17,099

For the first semiannual period, Phil must recognize $94 of original issue discount as ordinary
income.
c.
d.

$1,994 ($994 + $1,000)

$16,762 ($16,568 + $94 + $100). p. I5-23.

I5-51
(a.)
Amount Realized
Adjusted Basis
Realized and Recognized
Gain or (Loss)
Ordinary Gain
Capital Gain or (Loss)

(b.)

(c.)

$191,000
(184,000)

$185,750
(184,000)

$183,000
(184,000)

$ 7,000
2,000*
$ 5,000

$ 1,750
1,750
$ 0

$ 1,000
($ 1,000)

*The market discount of $16,000 accrued for the two years that Swen held the bond is $2,000
($16,000 x 2 years/16 years). pp. I5-23 and I5-24.
I5-52 The $3,800 loss on the sale of the automobile is not deductible. Gary has a $11,700
STCG that is offset by $2,000 ($5,000 - $3,000 deduction in 1997) STCL carried forward from
1997. Thus, Gary has a $9,700 NSTCG. Gary's AGI is $59,700 ($50,000 + $9,700). pp. I5-16
and I5-17.

I5-53 a.

Amount realized
Minus: Basis
STCG

b.

$5,000 (20 X $250) STCL

c.

$11,000 LTCG
Amount realized
Minus: Basis
LTCG

$ 6,200
( 5,000)
$ 1,200

(20 x $310)

$100,000
( 89,000)
$ 11,000

(2,000 x $50)
[(2,000 x $42) + $5,000]

pp. I5-24 and I5-25.

I5-54 a.

b.

$23,550 LTCG
Amount realized
Minus: Basis
LTCG

$38,550
(15,000)
$23,550

($37,500 + $1,050)
(500 x $30)

$1,050 STCG is recognized in 1999. pp. I5-24 and I5-25.

I5-55 The painting is not a capital asset. She has ordinary income of $1,950. The basis for the
stock is $30,000, thus a LTCL of $1,500 ($28,500 - $30,000) is recognized. The holding period
for inherited property is always considered to be more than one year (i.e., long-term).
Since the land is sold at a loss, her basis is $30,000. Since her basis is the property's FMV on the
date of the gift, the holding period starts on the date of the gift, April 8, 1997. She has a STCL of
$5,000.
a.
NSTCL of $5,000
b.
NLTCL of $1,500
c.
Betty's AGI is reduced by $3,000.
d.
Betty has a STCL carryforward of $2,000 ($5,000 - $3,000) and a LTCL
carryforward of $1,500. pp. I5-6 through I5-9, I5-16 and I5-18.
I5-56 Case A: taxable income is $184,000.
Case B: taxable income is $115,000.
Case C: taxable income is $80,000. Net corporate capital losses are not deductible.
Case D: taxable income is $90,000. Net corporate capital losses are not deductible.
pp. I5-20 and I5-21.
I5-57 a.
b.
c.

$9,259 ($4,614 + $4,645)

$4,677
$1,736 [$95,949 - ($92,277 + $614 + $645 + $677)]. p. I5-22.

I5-58 a.
If Dale sells the stock, his LTCG is $5,500 and the tax is $1,100 ($5,500 x 0.2).
He will have $5,400 ($6,500 - $1,100) to give to Tammy.
b.
If Dale gives the stock to Tammy and she sells it, her LTCG is $5,500 since her
basis for the stock is $1,000. Her tax is $550 ($5,500 x 10%). Tammy will have $5,950 ($6,500
- $550) available for college. pp. I5-6 and I5-7.
I5-59 a.

$40,000
( 3,000)
14,000
$51,000

AGI without considering the gains and losses

Capital loss
Ordinary gain
AGI

b.

$40,000
4,000
$44,000

AGI without considering the gains and losses

Net capital gain ($14,000 - $10,000)
AGI

c.
The answer in part (a) is the same. The AGI in part (b) is reduced by $2,500 to
$41,500 since the net capital gain is $1,500 ($14,000 - $12,500). pp. I5-16 through I5-18.
I5-60 a.
NSTCG is $13,000 since the capital loss incurred in 1992 is carried forward as a
$40,000 STCL.
b.
$263,000 ($250,000 + $13,000).
c.
$303,000 ($250,000 + $53,000). The $40,000 capital loss may not be carried
forward to 1997 since the carryforward period is only five years. pp. I5-20 and I5-21.

Tax Form/Return Preparation Problems

I5-61 (See Instructor's Guide)
I5-62 (See Instructor's Guide)

Case Study Problems

I5-63 (See Instructor's Guide)
I5-64 (See Instructor's Guide)

Tax Research Problems

I5-65 (See Instructor's Guide)
I5-66 (See Instructor's Guide)
I5-67 (See Instructor's Guide)
I5-68 (See Instructor's Guide)