2. $95,000 and $15,000 – An involuntary conversion occurs when a taxpayer is forced to dispose and replace property that has been destroyed, stolen, condemned or repossessed. The gain from an involuntary conversion may be deferred if replacement property is purchased within the statutory time limit established by law. The statutory time period is 2 years for destruction or theft of property resulting in insurance recovery. The time limit is measured by calendar year, beginning from the year in which insurance proceeds are received. For example, if property is destroyed in Y1 and insurance proceeds are received in Y2, the time period for purchasing replacement property ends on December 31 of Y4. However, if a taxpayer does not fully reinvest the proceeds received or does not purchase a replacement property within the stipulated time period, then gain must be recognized to the extent of the un-invested amount.

For determining a gain on involuntary conversion, the basis of destroyed property is the adjusted basis of the taxpayer at the time of destruction.

Claudia’s realized and recognized gains can be illustrated as follows:

Realized Gain = Insurance proceeds – Adjusted Basis = $145,000 - $50,000 = $95,000

Recognized Gain = Insurance proceeds – Cost of replacement property = $145,000 - $130,000 = $15,000

8. Blackwing Corp and X are unrelated parties, Blackwing Corp and Y are related parties, Blackwing will recognize gain on equipment of $25,000 loss on building of $100,000. – A corporation and a shareholder are considered related parties, if the shareholder owns (directly or indirectly) more than 50% in the value of the corporation’s outstanding stock. In this case X is unrelated to Blackwing corporation as X owns less than 50% interest. Accordingly, Blackwing will recognize gain on the distribution of equipment to X of $25,000 (FMV $100,000 – Basis $75,000). On the other hand, Y owns 80% of Blackwing corporation and are considered related parties. Generally, losses between related parties are disallowed. However, in the event of complete liquidation of a corporation, the loss is allowed to the corporation. Accordingly, the loss on distribution of building to Y of $100,000 (FMV $100,000 – Basis $200,000) is allowed.

Y and XY Realty, LLC are related parties, Y will report an ordinary gain of $300,000 – In this case, Y will attribute his father’s 50% interest in XY Realty to himself which would result in Y having over 50% interest in XY Realty. Thus, Y and XY Realty will become related parties and Y will report an ordinary income of $300,000 computed as follows:

Depreciation Recapture as ordinary gain - Sec 1250 ordinary gain (1) $200,000

Section 1231 capital gain re-characterized as ordinary gain (2) $100,000

11: X and Y are related parties, X must report investment income of $8,080; Y has a tax-free gift of $8,080: Imputed interest must be computed for taxpayers whose main purpose of structuring gifts as loans is tax avoidance, i.e., shift income from higher bracket tax payers to lower bracket relatives. The rate of imputed interest, which must be compounded semi- annually, is calculated using the Applicable Federal Rate (AFR) that is published monthly by the IRS. So in general if the rate of interest charged is less than AFR, then imputed interest must be computed for the difference and reported by the payor as interest income.

In this case X and Y are related parties. As X has given an interest free loan to Y, imputed interest must be calculated using the AFR and reported by X as interest income. Since Y does not have to pay any interest on the loan, it is considered a gift of interest to Y and therefore, is non-taxable to Y. The computation of imputed interest income of $8,080 is as follows:

For 1st half of the year: Imputed interest = $200,000 x 4% x 0.5 = $4,000

For 2nd half of the year: Imputed interest = $204,000 x 4% x 0.5 = $4,080

2. The tax basis of the color copier that should be recorded is $35,000. It is the invoice cost of the asset including the sales tax. The down payment and installment payment do not affect the basis of the asset.

3. The amount to be capitalized for the manufacturing equipment is $ 205,600. The amount includes the machinery cost along with inbuilt limited warranty of $180,000, installation charges of $4,300, shipping costs of $9,200, transit insurance costs of $3,100 and sales tax of $9,000. The two-year extended warranty charges of $3,500 are not capitalized and will be charged as an ordinary expense to the period to which they relate to.

Prior to 2017, Section 1031 allowed the gain or loss realized on exchange of like-kind personal property to be tax deferred and any exchange of cash or unlike property as part of the exchange was considered boot and gain was recognized to the extent of actual boot or realized gain, whichever was lower.

However, starting 2018, as the like-kind exchange rules don't apply to delivery vans (personal property), the property is recorded at its purchase price of $32,300 ($30,400 cost price + $790.48 Destination charges + Sales tax $1,109.52) and any gain or loss realized on the sale of the old property is immediately recognized.

With regard to the exchange of the old delivery van, since it was a business use property, any gain realized is first taxable as ordinary income (Section 1245) to the extent of actual depreciation or realized gain, which ever is lower. The remaining gain if any, is taxable as a Section 1231 capital gain, . The gain on sale of the old delivery van is computed as follows:

(Less) Adjusted Basis $468 $8,125 Basis less $7,658 Accumulated Dep.

*Note: Exchange expenses would not include any costs incurred to procure the loan since those would be considered loan costs which should be amortized over the life of the loan. They also do not include interest expense items deductible on Sch E. In this case, exchange expenses include expenses incurred on sale of Florida home of $8,000 (Refer Florida sale deed, item 1400) plus expenses incurred on purchase of Texas property of $6,600 (Refer Texas Sale deed: $7,900 item 1400 - $800 items 803 to 807 - $500 items 901 & 902).