Federal Taxation Chapter 7 Review Questions with Verified Answers (100% Correct)
How are the terms basis, adjusted basis, and fair market value defined as they apply to the calculation of
gains and losses? - Answers a. Basis is defined as the cost of the property bought in cash, debt
obligations, or other property or services. Property can also be acquired other than through purchase
such as by gift, inheritance, divorce, or other exchange.
b. Adjusted basis is the cost, including any increases to the property such as additions, or commission
fees incurred on stock transactions, and decreases such as depreciation on property and nontaxable
stock dividends or splits.
c. Fair market value is the price at which the property would change hands between a buyer and a seller,
neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts. Sales
of similar property, around the same date, are typically used in figuring fair market value.
What is meant by the terms realized gain (loss) and recognized gain (loss) as they apply to the sale of
assets by a taxpayer? - Answers The term "realized" is everything the taxpayer receives in the
transaction and is sometimes called the proceeds from the sale. This includes cash received plus the
FMV of any property or services also received in the transaction plus any debt obligations assumed by
the purchaser. The term "recognized" is the amount that will be recorded on the tax return as a gain or
loss. Assets sold are considered depending on the type of transaction.
How can the gain from the sale of property be characterized? Why is it important to correctly
characterize the gain on the sale of property? - Answers The type of gain is dependent on the character
(use) of the asset. Assets are classified as ordinary income property, §1221 capital property (capital
assets), or §1231 trade or business property. It is important to correctly characterize the gain on the sale
of property because different types of gains are reflected differently on the tax return. Depending on the
nature of the asset, the gains can be taxed at different rates.
What is a capital asset? What factors affect the determination of whether an asset is classified as a
capital asset? - Answers A capital asset includes assets that are not classified as other types of property,
and usually includes assets used for personal or investment purposes. The most obvious example of a
capital asset is stocks or bonds. Examples of other capital assets include the taxpayer's primary
residence, timber grown on home property, household furnishings, personal automobile, coin and
stamp collections, and jewelry. Capital assets do not include stock in trade of the taxpayer (inventory),
copyrights, accounts or notes receivables, and property subject to depreciation.
What determines whether land is a capital asset? How else can land be classified? - Answers Land held
for investment is a capital asset. However, if the land is used in a trade or business, it is not a capital
asset but a §1231 asset. If the land is held for resale by a real estate developer, it is treated as inventory
(an ordinary asset).
, What is a §1231 asset? How are gains and losses from the sale of §1231 assets treated? On what tax
form are gains and losses from the sale of §1231 assets reported? - Answers IRC §1231 property is
depreciable and nondepreciable property (including real property) used in a trade or business and held
for more than 1 year. Timber, coal, domestic iron ore and certain livestock held for breeding, dairy, or
sporting purposes are also considered §1231 property. The most typical examples of §1231 assets are
machinery and equipment, buildings, and land used in a business. When a §1231 asset is sold, the gain
may be either ordinary or capital. These gains (and/or losses) on the sale are initially reported on Form
4797.
When we determine whether an asset is a §1231 asset, does the length of time the asset is held affect
the classification? Explain. - Answers By definition, IRC §1231 property is property, depreciable or
nondepreciable, used in a trade or business and held for more than 1 year.
What are the different classifications of capital assets? List each classification and the rate at which the
gains are taxed. - Answers Collectibles: 28% rate
IRC §1202 Gain: 28% rate
Unrecaptured §1250 Gain: 25% rate
Other Capital Gains: 0%, 15%, or 20% rate
Discuss the concept of ordinary income property and give some examples. - Answers Ordinary income
property can be defined as any asset that is not a capital asset. The two most common ordinary assets
are inventory and accounts receivable.
What factors affect the taxability of capital gains and losses? - Answers Capital gains are taxed at
preferential rates and capital losses are limited as to their deductibility. The tax treatment of a capital
gain or loss varies depending on several factors, including the holding period of the capital asset,
whether the sale of the asset produced a gain or loss, the combination of capital gains and losses (a net
capital gain or a net capital loss), the type of capital asset sold, and the taxpayer's tax bracket.
Does the length of time a capital asset is held affect the gain or loss on the sale of the asset? Explain. -
Answers The length of time held does not affect the amount of the gain or loss but it does affect the tax
rate on the gain. Only long-term capital gains receive preferential tax treatment.
How is a net capital loss treated? Include in your answer a discussion of how a net capital loss is treated
in relation to other income. - Answers Long-term capital losses must be netted with long-term capital
gains. Short-term capital losses must be netted with short-term capital gains. Then the two figures must
be netted together. Any remaining capital loss reduces ordinary income by a maximum of $3,000 per
year for individual taxpayers. Any excess may be carried forward indefinitely to offset gains.
In what ways can a capital asset be acquired, and how is the holding period determined for each method
of acquisition? - Answers Assets can be acquired by purchase, by gift, or through inheritance. For stocks,
bonds, other property, and other nontaxable exchanges, the holding period starts the day after the
How are the terms basis, adjusted basis, and fair market value defined as they apply to the calculation of
gains and losses? - Answers a. Basis is defined as the cost of the property bought in cash, debt
obligations, or other property or services. Property can also be acquired other than through purchase
such as by gift, inheritance, divorce, or other exchange.
b. Adjusted basis is the cost, including any increases to the property such as additions, or commission
fees incurred on stock transactions, and decreases such as depreciation on property and nontaxable
stock dividends or splits.
c. Fair market value is the price at which the property would change hands between a buyer and a seller,
neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts. Sales
of similar property, around the same date, are typically used in figuring fair market value.
What is meant by the terms realized gain (loss) and recognized gain (loss) as they apply to the sale of
assets by a taxpayer? - Answers The term "realized" is everything the taxpayer receives in the
transaction and is sometimes called the proceeds from the sale. This includes cash received plus the
FMV of any property or services also received in the transaction plus any debt obligations assumed by
the purchaser. The term "recognized" is the amount that will be recorded on the tax return as a gain or
loss. Assets sold are considered depending on the type of transaction.
How can the gain from the sale of property be characterized? Why is it important to correctly
characterize the gain on the sale of property? - Answers The type of gain is dependent on the character
(use) of the asset. Assets are classified as ordinary income property, §1221 capital property (capital
assets), or §1231 trade or business property. It is important to correctly characterize the gain on the sale
of property because different types of gains are reflected differently on the tax return. Depending on the
nature of the asset, the gains can be taxed at different rates.
What is a capital asset? What factors affect the determination of whether an asset is classified as a
capital asset? - Answers A capital asset includes assets that are not classified as other types of property,
and usually includes assets used for personal or investment purposes. The most obvious example of a
capital asset is stocks or bonds. Examples of other capital assets include the taxpayer's primary
residence, timber grown on home property, household furnishings, personal automobile, coin and
stamp collections, and jewelry. Capital assets do not include stock in trade of the taxpayer (inventory),
copyrights, accounts or notes receivables, and property subject to depreciation.
What determines whether land is a capital asset? How else can land be classified? - Answers Land held
for investment is a capital asset. However, if the land is used in a trade or business, it is not a capital
asset but a §1231 asset. If the land is held for resale by a real estate developer, it is treated as inventory
(an ordinary asset).
, What is a §1231 asset? How are gains and losses from the sale of §1231 assets treated? On what tax
form are gains and losses from the sale of §1231 assets reported? - Answers IRC §1231 property is
depreciable and nondepreciable property (including real property) used in a trade or business and held
for more than 1 year. Timber, coal, domestic iron ore and certain livestock held for breeding, dairy, or
sporting purposes are also considered §1231 property. The most typical examples of §1231 assets are
machinery and equipment, buildings, and land used in a business. When a §1231 asset is sold, the gain
may be either ordinary or capital. These gains (and/or losses) on the sale are initially reported on Form
4797.
When we determine whether an asset is a §1231 asset, does the length of time the asset is held affect
the classification? Explain. - Answers By definition, IRC §1231 property is property, depreciable or
nondepreciable, used in a trade or business and held for more than 1 year.
What are the different classifications of capital assets? List each classification and the rate at which the
gains are taxed. - Answers Collectibles: 28% rate
IRC §1202 Gain: 28% rate
Unrecaptured §1250 Gain: 25% rate
Other Capital Gains: 0%, 15%, or 20% rate
Discuss the concept of ordinary income property and give some examples. - Answers Ordinary income
property can be defined as any asset that is not a capital asset. The two most common ordinary assets
are inventory and accounts receivable.
What factors affect the taxability of capital gains and losses? - Answers Capital gains are taxed at
preferential rates and capital losses are limited as to their deductibility. The tax treatment of a capital
gain or loss varies depending on several factors, including the holding period of the capital asset,
whether the sale of the asset produced a gain or loss, the combination of capital gains and losses (a net
capital gain or a net capital loss), the type of capital asset sold, and the taxpayer's tax bracket.
Does the length of time a capital asset is held affect the gain or loss on the sale of the asset? Explain. -
Answers The length of time held does not affect the amount of the gain or loss but it does affect the tax
rate on the gain. Only long-term capital gains receive preferential tax treatment.
How is a net capital loss treated? Include in your answer a discussion of how a net capital loss is treated
in relation to other income. - Answers Long-term capital losses must be netted with long-term capital
gains. Short-term capital losses must be netted with short-term capital gains. Then the two figures must
be netted together. Any remaining capital loss reduces ordinary income by a maximum of $3,000 per
year for individual taxpayers. Any excess may be carried forward indefinitely to offset gains.
In what ways can a capital asset be acquired, and how is the holding period determined for each method
of acquisition? - Answers Assets can be acquired by purchase, by gift, or through inheritance. For stocks,
bonds, other property, and other nontaxable exchanges, the holding period starts the day after the
