Interactive Review
Course #10071
Investment Income & Expenses
# of Questions
Investment Income 6
Interest Income
Discount on Debt Instruments
When To Report Interest Income
How To Report Interest Income
Dividends and Other Corporate Distributions
How To Report Dividend Income
Stripped Preferred Stock
S Corporations
Tax Shelters and Other Reportable Transactions 1
Investment Expenses 3
Limits on Deductions
Interest Expenses
Bond Premium Amortization
Expenses of Producing Income
Nondeductible Expenses
How To Report Investment Expenses
When To Report Investment Expenses
Sales and Trades of Investment Property 12
What Is a Sale or Trade?
Basis of Investment Property
How To Figure Gain or Loss
Nontaxable Trades
Related Party Transactions
Capital Gains and Losses
Capital or Ordinary Gain or Loss
Holding Period
Short Sales
Wash Sales
Options
Rollover of Gain From Publicly Traded Securities
Special Rules for Traders in Securities
Total Review Questions 22
Investment Income
1. If you make a below-market gift or demand loan, you must report as interest income any forgone interest from that loan.
Investment Income
2. You generally do not include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
Investment Income
3. Your taxable interest income, except for interest from U.S. savings bonds and
Treasury obligations, is shown in box 1 of Form 1099-INT.
Investment Income
Dividends and Other Corporate Distributions
4. Any liquidating distribution you receive is taxable to you until you have recovered the basis of your stock.
Investment Income
Stripped Preferred Stock
5. If you buy stripped preferred stock, you must include certain amounts in your gross income while you hold the stock.
Investment Income
6. If you are an S corporation shareholder, your share of the corporation’s current year income is taxed to you only if you receive such amount.
Tax Shelters and Other Reportable Transactions
7. In some cases, Congress has concluded that the loss of revenue from “tax shelters” is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments.
Limits on Deductions
8. Generally, you are allowed to deduct passive activity losses in excess of the amount of your passive activity income.
Interest Expenses
9. If you borrow money to buy property you hold for investment, the interest you pay is deductible investment interest.
Nondeductible Expenses
10. You may have expenses that are for both tax-exempt and taxable income. If you can
not specifically identify what part of the expenses is for each type of income, the expenses are nondeductible.
Sales and Trades of Investment Property
What Is a Sale or Trade?
11. Ordinarily, a transaction is a trade when you voluntarily sell property
for cash and immediately buy similar property to replace it.
Sales and Trades of Investment Property
Basis of Investment Property
12. If you received investment property in taxable trade for other property, the basis of the new property is its fair market value at the time of the trade.
Sales and Trades of Investment Property
How To Figure Gain or Loss
13. If you sell or trade property that is subject to a non-recourse loan, the amount you realize generally includes the full amount of the note assumed by the buyer even if the amount of the note is more than the fair market value of the property.
Sales and Trades of Investment Property
Nontaxable Trades
14. If you trade business or investment property for other business or investment property of a like kind, you must pay tax on any gain or deduct any loss at the time of the trade rather than when you sell or dispose of the property you receive.
Sales and Trades of Investment Property
Related Party Transactions
15. If you sell or trade at a loss property that you acquired from a related party, you cannot recognize the loss that was not allowed to the related party.
Sales and Trades of Investment Property
Capital or Ordinary Gain or Loss
16. Property held mainly for sale to customers is a capital asset.
Sales and Trades of Investment Property
Holding Period
17. For securities traded on an established securities market, your holding period begins the day after the trade date you bought the securities, and ends on the trade date you sold them.
Sales and Trades of Investment Property
Short Sales
18. As a general rule, you determine whether you have short-term or long-term capital gain or loss on a short sale by the amount of time you actually hold the property eventually delivered to the lender to close the short sale.
Sales and Trades of Investment Property
Wash Sales
19. Loss from a wash sale of one block of stock or securities can be used to reduce any gains on identical blocks sold the same day.
Sales and Trades of Investment Property
Options
20. If you buy a call or a put, you may not deduct its cost as it is a capital expenditure.
Sales and Trades of Investment Property
Rollover of Gain from Publicly Traded Securities
21. If you buy certain replacement property, you may qualify for a tax-free rollover of certain gains from the sale of publicly traded securities.
Sales and Trades of Investment Property
Special Rules for Traders in Securities
22. Gains and losses from selling securities as part of a trading business are
not subject to self-employment tax.
Copyright © 2011 By
CPE Accounting and Tax Institute
All Rights Reserved
1A. True – Correct Return
You must report as interest income any forgone interest from that loan, if you make a below-market gift or demand loan. If you receive a below-market loan, you may be able to deduct the forgone interest as well as any interest that you actually paid, but not if it is personal interest. The rules for below-market loans apply to:
• Gift loans,
• Pay-related loans,
• Corporation-shareholder loans,
• Tax avoidance loans, and
• Certain loans to qualified continuing care facilities.
1B. False– Incorrect Return
If you make a below-market gift or demand loan, you must report as interest income any forgone interest from that loan. For any period, forgone interest is:
1. The amount of interest that would be payable for that period if interest accrued on
the loan at the applicable federal rate and was payable annually on December 31,
minus
2. Any interest actually payable on the loan for the period.
Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Some IRS offices have these bulletins available for research. The rules that apply to a below-market loan depend on whether the loan is a gift loan, demand loan, or term loan. A gift loan is any below-market loan where the forgone interest is the nature of a gift. A demand loan is a loan payable in full at any time upon demand by the lender. A demand loan a below-market loan if no interest is charged if interest is charged at a rate below the applicable federal rate. A demand loan or gift loan that is a below-market loan is generally treated as an arm’s-length transaction in which the lender is treated as having made:
1. A loan to the borrower in exchange for a note that requires the payment of interest at
the applicable federal rate, and
2. An additional payment to the borrower in an amount equal to the forgone interest.
2A. True – Incorrect Return
Original issue discount (“OID”) is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer. A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID the difference between the stated redemption price at maturity and the issue price. All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example these instruments. The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). You can treat the discount as zero if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. This small discount is known as “de minimis” OID.
Example 1. You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)
Example 2. The facts are the same as in Example 1, except that the bond was issued at
950. The OID is $50. Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.
2B. False – Correct Return
You generally include original issue discount (“OID”) in your income as it accrues over the term of the debt instrument. In general, a debt instrument, such as a bond, note, debenture, or other evidence of indebtedness, that bears no interest or bears interest at a lower than current market rate will usually be issued at less than its face amount. This discount is, in effect, additional interest income. The following are some of the types of discounted debt instruments.
• U.S. Treasury bonds.
• Corporate bonds.
• Municipal bonds.
• Certificates of deposit.
• Notes between individuals.
• Stripped bonds and coupons.
• Collateralized debt obligations (CDOs).
The discount on these instruments (except municipal bonds) is taxable in most instances. The discount on municipal bonds generally is not taxable. The OID rules do not apply to the following debt instruments.
1. Tax-exempt obligations. (However, see Stripped tax-exempt obligations)
2. U.S. savings bonds.
3. Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
4. Obligations issued by an individual before March 2, 1984.
5. Loans between individuals, if all the following are true.
a. The lender is not in the business of lending money.
b. The amount of the loan, plus the amount of any outstanding prior loans between the same individuals, is $10,000 or less.
c. Avoiding any federal tax is not one of the principal purposes of the loan.
3A. True – Correct Return
Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form 1099-INT.
3B. False – Incorrect Return
Your taxable interest income, except for interest from U.S. savings bonds and
Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form 1099-INT. If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form1099-INT, in box 2. Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in your interest income. If part of the amount shown in box 3 was previously included in your interest income. Box 4 (federal income tax withheld) of Form1099-INT will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 63. Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. If there are entries in boxes 6 and 7 of Form 1099-INT, you must file Form 1040. You may be able to take a credit for the amount shown in box 6 (foreign tax paid) unless you deduct this amount on Schedule A of Form 1040 as “Other taxes.” To take the credit, you may have to file Form 1116, Foreign Tax Credit. The taxable OID on a discounted obligation for the part of the year you owned it is shown in box 1 of Form 1099-OID. Include this amount in your total taxable interest income. You must report all taxable OID even if you do not receive a Form 1099-OID. Box 2 of Form 1099-OID shows any taxable interest on the obligation other than OID. Add this amount to the OID shown in box 1 and include the result in your total taxable income. If you forfeited interest or principal on the obligation because of an early withdrawal, the deductible amount will be shown in box 3. Box 4 of Form 1099-OID will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 63. Box 7 of Form 1099-OID shows investment expenses you may be able to deduct as an itemized deduction.
4A. True – Incorrect Return
Any liquidating distribution you receive is not taxable to you until you have recovered the basis of your stock. After the basis of your stock has been reduced to zero, you must report the liquidating distribution as a capital gain. Whether you report the gain as a long-term or short-term capital gain depends on how long you have held the stock. If the total liquidating distributions you receive are less than the basis of your stock, you may have a capital loss. You can report a capital loss only after you have received the final distribution in liquidation that results in the redemption or cancellation of the stock. Whether you report the loss as a long-term or short-term capital loss depends on how long you held the stock.
4B. False – Correct Return
Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in one or more installments. You will receive Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9. Any liquidating distribution you receive is not taxable to you until you have recovered the basis of your stock. After the basis of your stock has been reduced to zero, you must report the liquidating distribution as a capital gain. Whether you report the gain as a long-term or short-term capital gain depends on how long you have held the stock.
5A. True – Correct Return
If you buy stripped preferred stock, you must include certain amounts in your gross income while you hold the stock. These amounts are ordinary income. They are equal to the amounts you would have included in gross income if the stock were a bond that:
1. Was issued on the purchase date of the stock, and
2. Has OID equal to:
a. The redemption price for the stock, minus
b. The price at which you bought the stock.
5B. False – Incorrect Return
You must include certain amounts in your gross income while you hold the stock, if you buy stripped preferred stock. If the dividend rights are stripped from certain preferred stock, the holder of the stripped preferred stock may have to include amounts in income equal to the amounts that would have been included if the stock were a bond with original issue discount (OID). Stripped preferred stock is any stock that meets both of the following tests.
1. There has been a separation in ownership between the stock and any dividend on the stock that has not become payable.
2. The stock:
a. Is limited and preferred as to dividends,
b. Does not participate in corporate growth to any significant extent, and
c. Has a fixed redemption price.
6A. True – Incorrect Return
If you are an S corporation shareholder, your share of the corporation’s current year income loss and other tax items are taxed to you whether or not you receive any amount. Generally, those items increase or decrease the basis your S corporation stock as appropriate. Generally, S corporation distributions, except dividend distributions, are considered a return of capital and reduce your basis in the stock of the corporation. The part of any distribution that is more than your basis is treated as a gain from the sale or exchange of property. The corporation’s distributions may be in the form of cash or property. S corporation distributions are not treated as dividends except in certain cases in which the corporation has accumulated earnings and profits from years before it became an S corporation.
6B. False – Correct Return
Your share of the corporation’s current year income loss and other tax items are taxed to you whether or not you receive any amount, if you are an S corporation shareholder. In general, an S corporation does not pay a tax on its income. Instead, its income and expenses are passed through to the shareholders, who then report these items on their own income tax returns. The S corporation should send you a copy of Schedule K-1 (Form 1120S) showing your share of the S corporation’s income, credits, and deductions for the tax year. You must report your distributive share of the S corporation’s income, gain, loss, deductions, or credits on the appropriate lines and schedules of your Form 1040.
7A. True – Correct Return
Investments that yield tax benefits are sometimes called “tax shelters.” In some cases, Congress has concluded that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Those cases are called “abusive tax shelters.” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be registered, unless it is a “projected income investment”. The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. The courts have generally been unsympathetic to taxpayers involved in abusive tax shelter schemes and have ruled in favor of the IRS in the majority of the IRS in cases in which these shelters have been challenged.
7B. False – Incorrect Return
Congress has concluded that in some cases the loss of revenue from “tax shelters” is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. Abusive tax shelters, however, are marketing schemes that involve artificial transactions with little or no economic reality. They often make use of unrealistic allocations, inflated appraisals, losses in connection with non-recourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or the mischaracterization of the substance of the transaction. The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Guidance is published in the Internal Revenue Bulletin for taxpayers’ information and also for use by IRS officials. So, if your return is examined and an abusive tax shelter is identified and challenged, published guidance dealing with that type of shelter, which disallows certain claimed tax shelter benefits, could serve as the basis for the examining official’s challenge of the tax benefits that you claimed. In such a case, the examiner will not compromise even if you or your representative believes that you have authority for the positions taken on your tax return. An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be registered, as discussed later, unless it is a “projected income investment”.
Copyright © 2011 By
CPE Accounting and Tax Institute
All Rights Reserved