- In 2025, a calendar-year sole proprietor sold a delivery truck for $45,000. The truck had been held for more than one year; it had an adjusted basis of $20,000, and $30,000 of depreciation had been claimed. The sole proprietor also sold land used in the business for $50,000. The land had also been held for more than one year and had an adjusted basis of $30,000. In 2023, the business had a $10,000 section 1231 loss that has not yet been recaptured. There were no other section 1231 transactions in 2025. What amount of the combined gain is ordinary income?
Answer: $35,000
IRC §§ 1245(a), 1231(b), 1231(c). The truck, held for more than one year and depreciated, is §1245 property. Its gain is $25,000 ($45,000 − $20,000), and because that gain does not exceed the $30,000 of depreciation claimed, the entire $25,000 is ordinary income. The land, held for more than one year and used in the business, produced a $20,000 §1231 gain ($50,000 − $30,000). Under §1231(c), current net §1231 gain is treated as ordinary income to the extent of nonrecaptured §1231 losses from the preceding five years; the 2023 $10,000 loss is within that period. Thus $10,000 of the land gain is ordinary income, and the remaining $10,000 is treated as long-term capital gain. Total ordinary income is $25,000 + $10,000 = $35,000. Choice A ($25,000) omits the §1231(c) recapture of the prior loss. Choice C ($45,000) treats the land gain as ordinary as well. Choice D ($55,000) adds the prior §1231 loss to the current gains as if it were an additional ordinary-income item, rather than using it to recharacterize only $10,000 of current §1231 gain.
- How is the remaining $100,000 of the purchase price allocated and taxed?
Answer: The buyer allocates it to goodwill, amortizable over 15 years; the seller reports long-term capital gain.
IRC § 1060 and Treas. Reg. § 1.1060-1 (residual method); IRC § 197(a). Under the residual method, consideration is allocated to each class of transferred assets up to fair market value, and any excess is allocated to Class VII goodwill and going-concern value. Here the equipment, inventory, building, and covenant have a total fair market value of $900,000, so the remaining $100,000 is allocated to goodwill. The buyer amortizes it ratably over 15 years as a §197 intangible, and the seller's gain on goodwill is long-term capital gain reported on Schedule D. Both parties report the allocation consistently on Form 8594. Choice A would ratably allocate the residual among tangible assets and inventory, a method §1060 does not permit. Choice B would assign the residual to the covenant, but the covenant was separately priced at its $50,000 fair market value; the residual is not allocated to a specifically priced Class VI intangible. Choice C is wrong because §197 goodwill is amortizable over 15 years and the seller's gain is capital, not ordinary.
- What amount of gain does the taxpayer recognize on the exchange?
Answer: $200,000
IRC § 1031(b) requires gain to be recognized in a like-kind exchange to the extent of boot received, but not in excess of realized gain. The realized gain is $200,000 ($800,000 amount realized minus $600,000 adjusted basis). Boot is $300,000: $200,000 cash plus $100,000 net mortgage relief ($200,000 mortgage assumed by the transferee less the $100,000 mortgage the taxpayer assumes). Because boot exceeds the realized gain, the recognized gain is capped at $200,000. Choice A ignores the boot entirely. Choice B nets the cash against the mortgage assumed but omits the $200,000 mortgage relief. Choice D treats the full $300,000 boot as recognized without limiting it to the realized gain.
- How should the taxpayer report the two sales on her 2025 return?
Answer: $58,000 of ordinary income and $10,000 of long-term capital gain.
IRC §§ 1245(a) and 1231(a). The drill press sale produced $78,000 of gain ($120,000 − $42,000). Its $100,000 cost minus its $42,000 adjusted basis reflects $58,000 of depreciation, so $58,000 is recaptured as ordinary income under §1245, and the remaining $20,000 is §1231 gain. The land sale produced a $10,000 §1231 loss. Because the §1231 gains exceed the §1231 losses and no prior-year unrecaptured §1231 losses exist, the $20,000 gain and $10,000 loss are netted, and the resulting $10,000 net gain is treated as long-term capital gain. Choice A is therefore correct. Choice B fails to reduce the §1231 gain by the land loss. Choice C treats the land loss as an ordinary loss against the §1245 recapture, but a §1231 loss must first be netted against §1231 gains and is absorbed in that netting here. Choice D treats the entire drill press gain as long-term capital gain, ignoring §1245 recapture, and also ignores the land loss.
- What amount of gain must she recognize in 2025, and what is her basis in the replacement warehouse?
Answer: $50,000 recognized gain; $300,000 basis
IRC § 1033(a)(2) allows a taxpayer to elect nonrecognition when property is involuntarily converted into money and replacement property is purchased. Gain is recognized only to the extent the insurance proceeds are not reinvested, limited by the realized gain. The realized gain is $200,000 ($500,000 proceeds minus $300,000 adjusted basis). The unreinvested proceeds are $50,000 ($500,000 received minus $450,000 spent), so the recognized gain is $50,000. The basis of the replacement property is its $450,000 cost reduced by the $150,000 deferred gain, or $300,000. Choice B states the correct gain but fails to reduce the replacement basis by the deferred gain. Choice C recognizes the full realized gain even though nonrecognition applies to the reinvested portion. Choice D ignores the $50,000 of proceeds not reinvested and uses an incorrect basis.
- What amount of gain is recognized on the exchange, and what is the basis of the replacement warehouse?
Answer: $150,000 of recognized gain; $400,000 basis in the replacement warehouse.
IRC §§ 1031(a), (b), and (d). The realized gain is $400,000 ($800,000 − $400,000). Boot received equals the $50,000 cash plus the $100,000 net mortgage relief ($200,000 relieved less the $100,000 assumed), so $150,000 of gain is recognized. The replacement basis is the old basis reduced by boot received and increased by gain recognized: $400,000 − $50,000 − $200,000 + $100,000 + $150,000 = $400,000. Choice A treats the full $200,000 of mortgage relief as boot and ignores the $100,000 mortgage assumed, overstating both gain and basis. Choice B treats only the $50,000 cash as boot, understating the recognized gain and basis. Choice C treats only the net mortgage relief as boot and omits the cash.
- How should the $34,000 gain on the sale be reported?
Answer: The entire $34,000 gain is ordinary income under section 1245, with no section 1231 gain.
IRC § 1245(a)(1) provides that gain on the disposition of depreciable personal property is ordinary income to the extent of depreciation previously allowed, limited by the gain realized. The machine's adjusted basis is $18,000 ($80,000 cost minus $62,000 depreciation), and the realized gain is $34,000. Because the recapture amount of $62,000 exceeds the gain, the entire gain is ordinary income; no gain remains for section 1231 treatment. Choice B ignores the recapture and relies only on the holding period. Choice C incorrectly compares the sale price to the original cost instead of the adjusted basis. Choice A misclassifies the asset; a machine used in a trade or business is not a capital asset.
- Which of the following statements is correct regarding the acquisition?
Answer: Both the buyer and the seller must allocate the consideration under the residual method and attach Form 8594 to their income tax returns for the year of sale.
IRC § 1060(a) requires the residual method of allocation in an applicable asset acquisition, and the instructions to Form 8594 require both the transferor and the transferee to file the form with their income tax returns for the year of sale. The residual method assigns consideration among asset classes in a fixed order, with inventory and receivables assigned before tangible personal property and real property. A covenant not to compete is a class VI intangible assigned its fair market value before the residual amount is assigned to class VII goodwill and going concern value. Choice A misstates the class order. Choice C misstates the residual destination. Choice D misstates the effect of a buyer-seller allocation agreement; such an agreement is generally binding on the parties, but it is not binding on the IRS.
- A sole proprietor owns a commercial rental property with an adjusted basis of $500,000 and a fair market value of $800,000. The property is subject to a $100,000 mortgage. In a qualifying like-kind exchange in 2025, she transfers this property and receives a replacement commercial rental property with a fair market value of $800,000, subject to an $80,000 mortgage. She also pays $20,000 cash in the exchange and receives no cash or other property. What is her basis in the replacement property?
Answer: $500,000
IRC §§ 1031(b), 1031(d). The exchange of commercial rental property qualifies for nonrecognition. Boot received is the $100,000 debt relief less the $80,000 debt assumed less the $20,000 cash paid, or $0, so no gain is recognized. The basis of the replacement property is the old adjusted basis ($500,000) plus gain recognized ($0) plus cash paid ($20,000) plus debt assumed ($80,000) minus debt relief ($100,000), or $500,000. Choice B ($700,000) uses the equity in the old property ($800,000 − $100,000). Choice C ($720,000) uses the equity in the replacement property ($800,000 − $80,000). Choice D ($800,000) uses the replacement property's fair market value and ignores the carryover basis rules.
- Which of the following correctly states the tax consequences of these sales?
Answer: The father's $12,000 loss is disallowed, and the son recognizes no gain on his sale.
IRC § 267(a)(1), (b)(1), (c)(4) and (d). A father and son are related parties, so the father's $18,000 - $30,000 = $12,000 loss on the sale to his son is disallowed. The son takes an $18,000 cost basis and realizes $25,000 - $18,000 = $7,000 of gain on the resale. Under § 267(d), the son recognizes that gain only to the extent it exceeds the father's disallowed loss; § 267(d) has no exception for property the transferee uses in a business. The $12,000 disallowed loss fully offsets the $7,000 gain, so the son recognizes no gain, and the remaining $5,000 of the father's loss is lost. Choice C is correct. Choice A ignores the related-party loss disallowance. Choice B ignores the § 267(d) offset by inventing a depreciable-property exception. Choice D gives the son the father's basis instead of his $18,000 cost.
- What amount of gain is recognized on the sale in 2025, and what is its character?
Answer: $96,000, consisting of $90,000 of ordinary income and $6,000 of long-term capital gain.
IRC §§ 453(i), 453(c), and 1245(a). The total gain is $120,000 ($150,000 − $30,000). Under §453(i), §1245 recapture is not deferred on an installment sale: $90,000 of ordinary income is recognized in the year of sale because the recapture equals the lesser of the $90,000 of depreciation or the gain. The remaining $30,000 of §1231 gain is deferred under the installment method; the gross profit percentage is 20% ($30,000 ÷ $150,000), so the $30,000 cash received in 2025 produces $6,000 of gain. Total 2025 gain is $96,000. Choice B accelerates the entire remaining §1231 gain, ignoring the installment method. Choice C applies the 80% gross-profit percentage to the entire gain, improperly deferring the recapture. Choice D mischaracterizes the deferred §1231 gain as ordinary income; for an individual, net §1231 gain is long-term capital gain.
- On July 1, 2025, a sole proprietor sold an apartment building, including the land, for $1,250,000. The sales contract allocated $1,000,000 of the sales price to the building and $250,000 to the land, and the $50,000 of selling expenses was allocated $40,000 to the building and $10,000 to the land. She had bought the property on January 1, 2015, for $1,000,000, allocated $800,000 to the building and $200,000 to the land. She claimed $290,000 of straight-line depreciation on the building. There were no unrecaptured section 1231 losses from prior years. What amount of the gain is subject to the 25% maximum rate on unrecaptured section 1250 gain?
Answer: $290,000
IRC § 1250(b) and IRC § 1(h)(6). The building amount realized is $1,000,000 − $40,000 = $960,000. The building's adjusted basis is $800,000 − $290,000 = $510,000, so the gain on the building is $450,000. Because the building was depreciated using straight-line, none of the gain is ordinary income under §1250. Unrecaptured §1250 gain is the depreciation allowed, $290,000, but not more than the gain on the building ($450,000); therefore Choice C ($290,000) is correct. Choice A ($0) is the amount of ordinary §1250 recapture, not unrecaptured §1250 gain. Choice B ($200,000) is the portion of the total gain remaining after the depreciation portion ($490,000 − $290,000), i.e., the appreciation and land gain, not the depreciation recapture portion. Choice D ($490,000) treats the entire gain as unrecaptured §1250 gain, ignoring that only the depreciation portion carries the 25% rate. The land gain is $250,000 − $10,000 − $200,000 = $40,000, confirming total gain of $450,000 + $40,000 = $490,000.
- What is the correct treatment of the $300,000 gain on the sale?
Answer: $150,000 is ordinary income under section 1250, and the remaining $150,000 is section 1231 gain.
IRC § 1250(a) recaptures as ordinary income the lesser of the gain realized or the additional depreciation on depreciable real property, which is the excess of accelerated depreciation over straight-line depreciation. Here, the additional depreciation is $150,000 and the gain is $300,000, so $150,000 is ordinary income. The remaining $150,000 is section 1231 gain and, because there are no other section 1231 transactions, it is treated as long-term capital gain. Choice B applies the section 1245 rule, recapturing all depreciation, to real property. Choice C ignores the section 1250 recapture and also misstates the scope of the statute. Choice D ignores the ordinary-income recapture portion of the gain.
- Which of the following correctly describes the tax result of the 2025 sale?
Answer: The taxpayer realizes a $1,000 loss, which is not deductible because the machine was personal-use property when sold.
IRC §§ 1001, 1011 and 165(c). Converting business property to personal use does not change its basis: the machine keeps its $40,000 - $18,000 = $22,000 adjusted basis. The $21,000 sale therefore realizes a $1,000 loss. Because the machine was held for personal use when sold, § 165(c) allows no deduction for the loss. Choice B is correct. Choice A measures gain from the $20,000 conversion-date value. Choice C applies the lower-of-basis-or-value rule, which governs property converted from personal use to business or rental use, not the reverse. Choice D treats the machine as § 1231 property, but it was personal-use property at the time of sale.
