CPA Regulation (REG) : Involuntary Conversions
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Example Questions
Example Question #1 : Involuntary Conversions
Marshall purchased a computer for $1,500 and a stereo system for $1,300. The computer is used solely for business and the stereo solely for personal entertainment. During the same year, Marshall experienced serious financial difficulty and sold the stereo for $300 and the computer for $1,000. What amount, if any, is Marshall entitled to deduct as a loss relating to the sale of the stereo and computer?
$1,000
$0
$500
$1,500
$500
A taxpayer may only deduct losses relating to business-use assets. Since the stereo was used solely for personal entertainment, loss recognition is not allowed for tax purposes. Only the $500 loss on the sale of the computer ($1,500 purchase price less the $1,000 sale price) would be deductible.
Example Question #2 : Involuntary Conversions
Parallel Corporation’s building was destroyed as a result of a hurricane. The fair market value of the building at the time of the hurricane was $400,000 and its adjusted basis was $350,000. The insurance proceeds totaled $500,000 as follows ($400,000 for the building, $100,000 for lost profits during rebuilding). Parallel does not defer any gain under the involuntary conversion provisions of Code Sec. 1033. What amount of the insurance proceeds is taxable to Parallel?
$150,000
$50,000
$100,000
$0
$150,000
In determining gains or losses from involuntary conversions, only the basis of the property involuntarily lost is considered in addition to the boot received. Here, since the adjusted basis was $350,000 and $400,000 of the insurance proceeds were for the building, Parallel would recognize a taxable gain of $50,000 (since they do not defer gains for involuntary conversions). The additional $100,000 for lost profits is also taxable, since it relates to profits the company would have otherwise earned in the tax year. The total taxable amount is $150,000 ($50,000 + $100,000).
Example Question #3 : Involuntary Conversions
Veronica, Inc.’s warehouse (with an adjusted tax basis of $75,000) was destroyed by fire. The following year, Veronica received insurance proceeds of $195,000 and acquired a new warehouse for $167,000. Veronica elected to recognize the minimum gain possible. What is Veronica’s basis in the new Warehouse?
$167,000
$47,000
$139,000
$75,000
$75,000
For an involuntary conversion, when a company reinvests insurance proceeds into an asset that would replace the property lost, the basis of the new property equals that of the adjusted basis of the lost property (here, $75,000). A gain would be recognized for the proceeds not invested, while there would be a deferred gain not yet recognized for the new asset’s cost above the basis of the lost property.
Example Question #4 : Involuntary Conversions
How should insurance deductibles and payouts be treated for proceeds on a warehouse destroyed by a fire?
None of the proceeds in excess of the adjusted basis of the warehouse before the fire should be taxed as a gain
The deductible should be deducted from the payout and any proceeds in excess of the adjusted basis of the warehouse before the fire should be taxed as a gain
The deductible should not be deducted from the payout and any proceeds in excess of the adjusted basis of the warehouse before the fire should be taxed as a gain
None of the above
The deductible should be deducted from the payout and any proceeds in excess of the adjusted basis of the warehouse before the fire should be taxed as a gain
Proceeds that cover the cost of the warehouse’s adjusted basis will not be taxed as a gain as the proceeds are for the destroyed asset.
Example Question #5 : Involuntary Conversions
A married couple abandoned their principal residence in March. They had purchased the home five years ago for $350,000. The home had a current FMV of $300,000. What is the maximum loss if any that they are allowed to deduct on the current year’s tax return for the abandoned property?
$0
$50,000
$300,000
$350,000
$0
No deduction is allowed for the loss on disposal of a personal use asset.
Example Question #5 : Involuntary Conversions
_______ would not be included in the calculation of realized gain or loss by a taxpayer on the transaction between one piece of real estate for another.
FMV of property given up
Adjusted basis of the property given up
FMV of property received
Boot (if any) received
FMV of property given up
In calculating the gain or loss realized during a like-kind transaction, the FMV of property given up would not be relevant in the calculation.
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