Exam Prep Investments Chapter 7

Taxation of Individuals, 11e (Spilker)

Chapter 7 Investments

1) Generally, interest income is taxed at preferential capital gains rates and dividend income is taxed at ordinary rates.

2) Interest earned on U.S. savings bonds is interest received at sale or maturity but must be taxed annually.

3) When a taxable bond is issued at a premium, the taxpayer may elect to calculate and apply the yearly amortization amount to reduce a portion of the actual interest payments that taxpayers include in gross income.

4) Qualified dividends are always taxed at a 15 percent preferential rate.

5) The capital gains (losses) netting process for taxpayers without 25 or 28 percent capital gains requires them to (1) net short-term and long-term gains, (2) net short-term and long-term losses, and (3) net the outcome to yield a final gain or loss to place on the tax return.

6) Two advantages of investing in capital assets are (1) gains are generally deferred and (2) gains are generally taxed at preferential rates.

7) Dave and Jane file a joint return. They sell a capital asset at a $150,000 loss. Even though they have no capital gains, $6,000 of the loss can still be deducted in the current year.

8) Unrecaptured §1250 gain is taxed at the 28 percent preferential capital gains rate.

9) Losses associated with personal-use assets, sales to related parties, and wash sales are not currently deductible.

10) Capital loss carryovers for individuals are carried forward indefinitely.

11) Investment expenses (other than investment interest expenses) are deductible.

12) Taxpayers may make an election to include preferentially taxed capital gains and qualified dividends in investment income and deduct more investment interest expense currently if they are willing to subject this income to ordinary tax rates.

13) Investment interest expense is a for AGI deduction.

14) When electing to include preferentially taxed capital gains and qualified dividends in net investment income, taxpayers must include all preferentially taxed capital gains and qualified dividends recognized for that year.

15) The investment interest expense deduction is limited to the amount of investment income for the year.

16) Net investment income is always less than gross investment income.

17) Generally, losses from rental activities are considered to be active losses.

18) Passive losses that exceed passive income are deferred until the taxpayer generates passive income to offset these passive losses or until the taxpayer disposes of that activity.

19) A loss from a passive activity is fully deductible as long as the taxpayer has sufficient tax basis in the activity.

20) A passive activity is any activity that involves a trade or business in which the taxpayer does not materially participate or any rental activity (unless the taxpayer is engaged in a real property trade or business).

21) To qualify under the passive activity rental real estate exception, the taxpayer must (1) own at least 15 percent of the property and (2) participate in the process of making management decisions.

22) Which of the following types of interest income is not taxed as it is earned?

A) Interest from savings accounts.

B) Original issue discounts on corporate bonds.

C) Accrued market discount on bonds.

D) Interest from money market accounts.

E) All of the choices are correct.

23) Nontax factor(s) investors should consider when choosing among investments include:

A) before-tax rates of return.

B) after-tax rates of return.

C) liquidity needs.

D) before-tax rates of return and after-tax rates of return.

E) before-tax rates of return and liquidity needs.

24) One primary difference between corporate and U.S. Treasury bonds is:

A) Treasury bonds always pay interest periodically.

B) Corporate bonds always pay interest periodically.

C) Interest from Treasury bonds is exempt from federal taxation.

D) Interest from corporate bonds is exempt from state taxation.

E) None of the choices are correct.

25) The amount of interest income a taxpayer recognizes when he redeems a U.S. savings bond is:

A) the excess of the taxpayer's basis in the bonds over the bond proceeds.

B) the bond proceeds.

C) the excess of the bond proceeds over the taxpayer's basis in the bonds.

D) the taxpayer's basis in the bonds.

E) None of the choices are correct.

26) Which of the following is not a tax advantage of a Series EE savings bond?

A) Taxes are paid as the original issue discount on the bond is amortized.

B) Interest earned is exempt from state taxation.

C) Taxes are deferred until the bond is cashed in at maturity.

D) Interest is exempt from federal taxation when used for qualifying educational expenses.

E) None of the choices are correct.

27) When a bond is purchased in the secondary bond market at a discount, the amount of discount treated as interest income when the bond is sold prior to maturity is the:

A) market premium.

B) market discount.

C) accrued market premium.

D) accrued market discount.

E) None of the choices are correct.

28) When selling stocks, which method of calculating basis provides the greatest opportunity for minimizing gains or increasing losses?

A) LIFO.

B) FIFO.

C) Weighted average.

D) Specific identification.

E) None of the choices are correct.

29) Long-term capital gains (depending on type) for individual taxpayers can be taxed at a maximum rate of:

A) 20 percent.

B) 25 percent.

C) 28 percent.

D) Both 20 percent and 28 percent.

E) All of the choices are correct.

30) Cory recently sold his qualified small business stock for $90,000 after holding it for 10 years. His basis in the stock is $40,000. Applying the rules as if the stock were acquired in 2019 and assuming his marginal tax rate is 32 percent, how much tax will he owe on the sale?

A) $3,750.

B) $7,000.

C) $7,500.

D) $14,000.

E) None of the choices are correct.

31) In X8, Erin had the following capital gains (losses) from the sale of her investments: $2,000 LTCG, $25,000 STCG, ($9,000) LTCL, and ($15,000) STCL. What is the amount and nature of Erin's capital gains and losses?

A) $3,000 net short-term capital gain.

B) $3,000 net long-term capital loss.

C) $4,000 net short-term capital gain.

D) $4,000 net long-term capital loss.

E) None of the choices are correct.

32) The netting process for capital gains (losses) with 0/15/20 percent, 25 percent, and 28 percent capital assets helps maximize the tax benefit of:

A) current-year net loss in the 25-percent rate group.

B) net short-term capital losses.

C) long-term capital loss carryovers.

D) current-year net loss in the 25-percent rate group and long-term capital loss carryovers.

E) net short-term capital losses and long-term capital loss carryovers.

33) When the wash sale rules apply, the realized loss is:

A) recognized at time of sale.

B) not recognized at time of sale and does not affect basis of newly acquired stock.

C) recognized at time of sale and added to basis of the newly acquired stock.

D) not recognized at time of sale and added to basis of the newly acquired stock.

E) not recognized at time of sale and subtracted from the basis of the newly acquired stock.

34) The maximum amount of net capital losses individual taxpayers may deduct against their ordinary income per year is:

A) $3,000.

B) $5,000.

C) $0, losses are not deductible.

D) There is no maximum. All losses are allowed to be deducted.

E) None of the choices are correct.

35) In the current year, Norris, an individual, has $50,000 of ordinary income, a net short-term capital loss (NSTCL) of $10,000, and a net long-term capital gain (NLTCG) of $2,800. From his capital gains and losses, Norris reports:

A) an offset against ordinary income of $10,000.

B) an offset against ordinary income of $3,000 and an NSTCL carryforward of $7,000.

C) an offset against ordinary income of $2,800 and an NSTCL carryforward of $7,200.

D) an offset against ordinary income of $3,000 and an NSTCL carryforward of $7,200.

E) an offset against ordinary income of $3,000 and an NSTCL carryforward of $4,200.

36) Ms. Fresh bought 1,000 shares of Ibis Corporation stock for $5,000 on January 15, 2017. On December 31, 2019, she sold all 1,000 shares of her Ibis stock for $4,500. Based on a hot tip from her friend, she bought 1,000 shares of Ibis stock on January 23, 2020, for $3,000. What is Ms. Fresh's recognized loss on her 2019 sale, and what is her basis in her 1,000 shares purchased in 2020?

A) $-0- LTCL and $3,500 basis.

B) $200 LTCL and $3,300 basis.

C) $300 LTCL and $3,200 basis.

D) $400 LTCL and $3,100 basis.

E) $500 LTCL and $3,000 basis.

37) Kevin bought 200 shares of Intel stock on January 1, 2019, for $50 per share, with a brokerage fee of $100. Then, Kevin sells all 200 shares for $75 per share on December 12, 2019. The brokerage fee on the sale was $150. What is the amount of the gain/loss Kevin must report on his 2019 tax return?

A) $4,500.

B) $4,750.

C) $5,000.

D) $5,250.

E) None of the choices are correct.

38) If an individual taxpayer's marginal tax rate is 35 percent and he holds the following assets for more than one year, which gain will be taxed at the highest rate at the time of sale?

A) Gain from investment land.

B) Gain from personal-use property.

C) Gain from a coin collection.

D) Gain from the sale of qualified small business stock held for three years.

E) Gain attributable to tax depreciation taken on real property.

39) John holds a taxable bond and a municipal bond. Which are considered part of John's deductible investment interest expense?

A) Attorney and accounting fees on municipal bond.

B) Safe deposit box rental fees on taxable bond.

C) Interest expense on taxable bond.

D) Interest expense on municipal bond.

E) Interest expense on municipal bond and interest expense on taxable bond.

40) Investment income includes:

A) interest income.

B) net short-term capital gains.

C) nonqualified dividends.

D) royalty income.

E) All of the choices are correct.

41) Unused investment interest expense:

A) expires after the current year.

B) is carried back two years.

C) is carried forward 20 years.

D) is carried forward indefinitely.

E) None of the choices are correct.

42) Brandon and Jane Forte file a joint tax return and decide to itemize their deductions. The Fortes' income for the year consists of $120,000 in salary, $1,000 interest income, $1,500 nonqualifying dividends, and $1,100 long-term capital gains. The Fortes' expenses for the year consist of $3,000 in investment interest expense and $900 in tax preparation fees. Assuming that the Fortes' marginal tax rate is 32 percent and they make no special elections, what is the amount of investment interest expense deduction for the year?

A) $0.

B) $1,000.

C) $2,500.

D) $3,000.

E) None of the choices are correct.

43) Investment interest expense does not include:

A) interest expense from loans to purchase municipal bonds.

B) interest expense from loans to purchase corporate bonds.

C) interest expense from loans to purchase stocks.

D) interest expense from loans to purchase U.S. savings bonds and interest expense from loans to purchase corporate bonds.

E) interest expense from loans to purchase corporate bonds and interest expense from loans to purchase stocks.

44) Assume that Joe (single) has a marginal tax rate of 37 percent and decides to make the election to include preferentially taxed capital gains and qualified dividends as investment income. What rate must Joe use when calculating the tax on these two items?

A) 20 percent.

B) 25 percent.

C) 28 percent.

D) 37 percent.

E) None of the choices are correct.

45) Doug and Sue Click file a joint tax return and decide to itemize their deductions. The Clicks' income for the year consists of $90,000 in salary, $2,000 interest income, and $800 long-term capital loss. The Clicks' expenses for the year consist of $1,500 investment interest expense. Assuming that the Clicks' marginal tax rate is 35 percent, what is the amount of their investment interest expense deduction for the year?

A) $1,200.

B) $1,500.

C) $2,000.

D) $2,300.

E) None of the choices are correct.

46) Bob Brain files a single tax return and decides to itemize his deductions. Bob's income for the year consists of $75,000 of salary, $3,000 long-term capital gain, and $1,500 interest income. Bob's expenses for the year consist of $800 in investment advice fees and $250 in tax return preparation fees. What is Bob's investment expense deduction?

A) $0.

B) $800.

C) $250.

D) $1,050.

E) None of the choices are correct.

47) Alain Mire files a single tax return and has adjusted gross income of $304,000. His net investment income is $53,000. What is the additional tax that Alain will pay on his net investment income for the year?

A) $0.

B) $2,014.

C) $3,952.

D) $1,938.

E) None of the choices are correct.

48) What is the correct order of the loss-limitation rules?

A) Tax basis, at-risk amount, passive loss limits.

B) At-risk amount, tax basis, passive loss limits.

C) Passive loss limits, at-risk amount, tax basis.

D) Tax basis, passive loss limits, at-risk amount.

E) Passive loss limits, tax basis, at-risk amount.

49) Sue invested $5,000 in the ABC Limited Partnership and received a 10 percent interest in the partnership. The partnership had $20,000 of qualified nonrecourse debt and $20,000 of debt Sue is not responsible to repay because she is a limited partner. Sue is allocated a 10 percent share of both types of debt, resulting in a tax basis of $9,000 and an at-risk amount of $7,000. During the year, ABC LP generated a ($90,000) loss. How much of Sue's loss is disallowed due to her tax basis or at-risk amount?

A) $0; all of her loss is allowed to be deducted.

B) $2,000 disallowed because of her at-risk amount.

C) $2,000 disallowed because of her tax basis.

D) $4,000 disallowed because of her tax basis.

E) $4,000 disallowed because of her at-risk amount.

50) Which taxpayer would not be considered a material participant of an activity?

A) Taxpayer materially participated in the activity for any five of the preceding ten years.

B) Taxpayer participated on a regular, continuous, and substantial basis last year.

C) Taxpayer participated 95 hours last year and participation is not less than any other participants for the year.

D) Taxpayer participated in the activity for 995 hours last year.

E) None of the choices are correct.

51) Generally, which of the following does not correctly categorize the type of income?

A) Rental real estate — passive income/loss.

B) Salary — active income/loss.

C) Dividends — portfolio income/loss.

D) Capital losses — passive income/loss.

E) All of the choices are correct.

52) Michelle is an active participant in the rental condominium property she owns. During the year, the property generates a ($15,000) loss; however, Michelle has sufficient tax basis and at-risk amounts to absorb the loss. If Michelle has $115,000 of salary, $10,000 of long-term capital gains, $3,000 of dividends, and no additional sources of income or deductions, how much loss can Michelle deduct?

A) $0; losses from rental property are passive losses and can only be offset by passive income.

B) $4,000.

C) $11,000.

D) $15,000.

E) None of the choices are correct.

53) The rental real estate exception favors:

A) lower-income taxpayers (AGI less than $80,000).

B) middle-income taxpayers (AGI greater than $80,000 and less than $150,000).

C) upper-income taxpayers (AGI greater than $150,000).

D) lower-income taxpayers (AGI less than $80,000) and middle-income taxpayers (AGI greater than $80,000 and less than $150,000).

E) middle-income taxpayers (AGI greater than $80,000 and less than $150,000) and upper-income taxpayers (AGI greater than $150,000).

54) On the sale of a passive activity, any suspended losses cannot be used to offset income from:

A) active business income.

B) capital gains.

C) interest income.

D) wages and tips.

E) None of the choices are correct.

55) A taxpayer's at-risk amount in an activity is increased by:

A) a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying.

B) cash contributions to the activity.

C) cash distributions from the activity.

D) a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying and cash contributions to the activity.

E) a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying and cash distributions from the activity.

56) Compare and contrast how interest income is reported for the following types of bonds: (a) bond originally issued at a discount, (b) bond originally issued at a premium, (c) bond purchased at a discount in a secondary market, and (d) bond purchased at a premium in a secondary market.

57) What requirements must be satisfied before an investor may receive preferential tax treatment on dividend income, and what preferential treatment will result?

58) On January 1, 20X1, Fred purchased a corporate bond with a face value of $50,000 from the secondary market at a premium. The bond has a coupon rate of 8 percent and matures in five years. The market rate of the bond is a 6 percent annual before-tax return compounded semiannually. If Fred is trying to minimize interest income, what is the least amount of interest income Fred may report on his 20X1 tax return? Present value of $1, Present value of Annuity $1 (Do not round intermediate calculations. Round your final answer to two decimal places.)

59) On December 1, 20X7, George Jimenez needed a little extra cash for the upcoming holiday season, and sold 250 shares of Microsoft stock for $50 per share less a broker's fee of $200 for the entire sale transaction. Prior to the sale, George held the following blocks of Microsoft stock (associated broker's fee paid at the time of purchase). (Do not round intermediate calculations.)

If his goal is to minimize his current capital gain, how much capital gain will George report from the sale?

60) What are the rules limiting the amount of capital losses a taxpayer may deduct in a given year? Name at least three.

61) Henry, a single taxpayer with a marginal tax rate of 35 percent (taxable income is $300,000 before considering any of the items below), sold the following assets during the year:

*$25,000 of the gain is a 25 percent gain. The remaining gain is 0/15/20 percent gain.

What tax rate(s) will apply to Henry's capital gains or losses?

62) Scott Bean is a computer programmer and incurred the following transactions last year.

*Purchased when originally issued by Provo City.

What is the net short-term capital gain/loss reported on the 2019 Schedule D? What is the net long-term capital gain/loss reported on the 2019 Schedule D? What amount of capital gain is subject to the preferential capital gains rate?

63) Mr. and Mrs. Smith purchased 100 shares of stock for $45 per share on June 30, 20X6. On March 30, 20X8, the Smith family decides to sell these shares for $30, generating a loss of $15 per share. On April 15, 20X8, the Smith family realized they made a mistake and repurchased 100 shares for $35 per share. When will the Smith family receive a tax benefit for the loss on the March 30, 20X8, sale?

64) What is the tax treatment for qualified small business stock acquired in 2019 and held for more than five years, and what is the tax treatment if it is held for less than five years? 

65) How are individual taxpayers' investment expenses and investment interest expense treated for tax purposes?

66) Sarantuya, a college student, feels that now is a good time to buy stocks. However, because she doesn't have any savings, she decides to borrow $15,000 at an annual interest rate of 8 percent. She must make an interest-only payment each year for five years, plus repay the entire principal in Year Five. On August 1, 20X8, when Sarantuya obtained the loan, Sarantuya invested $10,000 in several individual stocks and used the remaining $5,000 to pay her tuition for the year. Assuming Sarantuya's investment income this year is greater than her investment interest expense this year, how much investment interest expense can she deduct in 20X8? (Round your intermediate calculations to the nearest whole percent.)  

67) How can electing to include preferentially taxed capital gains and qualifying dividends in the computation of net investment income be beneficial to taxpayers?

68) Kerri, a single taxpayer who itemizes deductions on Schedule A, incurs $15,000 of interest expense on funds borrowed to acquire taxable bonds. Kerri also has $20,000 of taxable interest income for the year. Assume Kerri is in a 32 percent marginal tax bracket. How much of the interest expense can she deduct? Assuming the same facts except that the $20,000 of investment income is a qualifying dividend rather than taxable interest income, what should Kerry do if she wants to minimize her current-year tax liability?

69) The Crane family recognized the following types of investment income during 20X6: (1) $1,500 qualified dividends, (2) $3,000 long-term capital gains, and (3) $850 taxable interest. Additionally, the Crane family has $500 in investment expenses for the year. The Crane family paid $3,333 in investment interest expense during 20X6. Calculate the different possibilities to determine the maximum deduction for investment interest expense for the Crane family in 20X6. From these possibilities, which provides the maximum deduction?

70) Describe the three main loss limitations that taxpayers must overcome before deducting losses allocated to them from a specific activity.

71) Given that losses from passive activities can only offset income from passive activities unless the passive activity is sold, what types of activities are not considered to be passive? Name at least three ways (tests) a taxpayer may be treated as an active participant in an activity.

72) Roy, a resident of Michigan, owns 25 percent of a fourplex in the nearby college town of Ann Arbor with three other friends. The fourplex is rented to students who attend the University of Michigan. Roy's responsibility is to approve new tenants each year and take care of any maintenance issues. During the year, the rental property generated a $25,000 loss, which was split equally among Roy and his three friends. Assuming Roy's only source of income was $145,000 of salary, how much of the rental loss can Roy deduct this year and what amount must be carried forward?

73) Judy, a single individual, reports the following items of income and loss:

Judy owns 100 percent of the rental property and actively participates in the rental of the property. Calculate Judy's AGI.

74) On January 1, 20X8, Jill contributed $18,000 of cash to the XYZ limited partnership for a 25 percent limited partnership interest. On April 6, 20X8, XYZ limited partnership distributed $2,000 to Jill. For the year ended December 31, 20X8, Jill received the following income/loss allocations from her partnership investments: (1) XYZ limited partnership allocated a $5,000 loss to Jill and (2) ABC limited partnership allocated $2,300 of income to Jill. How much of the $5,000 loss from XYZ limited partnership can Jill deduct in 20X8?