Chapter 11 - Investments

Chapter 11 Investments SOLUTIONS MANUAL

57. [LO 2] Dahlia is in the 28 percent tax rate bracket an has p!rchase the "#ll#$in% shares #" &icr#s#"t c#mm#n st#ck #ver the 'ears( Date )!rchase 7,1-,2--2 .,2-,2--1 1,22,2--. 11,-2,2--3 Microsoft common stock *hares .-1-5-25+asis /120--/1-075/12021/701--

I" Dahlia sells 8-- shares #" &icr#s#"t "#r /.-0--- #n December 2-0 2-1-0 $hat is her capital %ain #r l#ss in each #" the "#ll#$in% ass!mpti#ns4 a. *he !ses the 5I5O meth# . Under the FIFO method, the first 400 shares sold have a $12,000 basis, the next 300 have a $10,750 basis, and the last 100 shares have a basis of $2,446 100!500 " $12,230# for a total basis of $25,1$6% &he res'ltin( )a*ital (ain +o'ld be $40,000 less the $25,1$6 tax basis of the shares sold or $14,,04% b. *he !ses the speci"ic i enti"icati#n meth# an she $ants t# minimi6e her c!rrent 'ear capital %ain. &he shares *'r)hased in 2002 )ost $30 *er share, the shares *'r)hased in 2003 )ost $35%,3 *er share, the shares *'r)hased in 2004 )ost $24%46 *er share, and the shares *'r)hased in 2006 )ost $2$%20 *er share% &o minimi-e her )a*ital (ain, .ahlia sho'ld s*e)ifi)all/ identif/ the 300 shares *'r)hased in 2003, then the 400 shares *'r)hased in 2002 and then 100 of the shares *'r)hased in 2006% Under the s*e)ifi) identifi)ation method, the 300 shares *'r)hased in 2003 have a $10,750 basis, the 400 shares *'r)hased in 2002 have a $12,000 basis, and the 100 shares *'r)hased in 2006 have a basis of $2,$20 100!250 " $7,300# for a total basis of $25,670% &he res'ltin( )a*ital (ain +o'ld be the $40,000 sales *ro)eeds less the $25,670 tax basis of the shares sold or $14,330% 3-. [LO 2] &att an &e% C#mer are marrie . 7he' # n#t have an' chil ren. &att $#rks as a hist#r' pr#"ess#r at a l#cal !niversit' an earns a salar' #" /520---. &e% $#rks part-time at the same !niversit'. *he earns /210--- a 'ear. 7he c#!ple #es

11-1

Chapter 11 - Investments

n#t itemi6e e !cti#ns. Other than salar'0 the C#mers8 #nl' #ther s#!rce #" inc#me is "r#m the isp#siti#n #" vari#!s capital assets 9m#stl' st#cks:. a. ;hat is the C#mers8 tax liabilit' "#r 2-1- i" the' rep#rt the "#ll#$in% capital %ains an l#sses "#r the 'ear4 *h#rt-term capital %ains /70--*h#rt-term capital l#sses 9/20---: L#n%-term capital %ains /150--L#n%-term capital l#sses 9/30---: 0alar/ $73,000 1et short2term )a*ital (ain 5,000 1et lon(2term )a*ital (ain $,000 34I $,7,000 0tandard ded')tion 11,400# 5ersonal exem*tion 7,300# &axable in)ome $6,,300 6ess *referentiall/ taxed in)ome $,000# In)ome taxed at ordinar/ rates $5$,300 tax $1,675 7 $6,3,2%50 8 $,,057%50 In)ome s'b9e)t to )a*ital (ains rates $,000 tax $,,700 x 0:# 7 $300 x 15:# 8 $0 7 $45 8 $45 &otal tax liabilit/ 8 $,,057%50 7 $45 8 $,,102%50 b. ;hat is the C#mers8 tax liabilit' "#r 2-1- i" the' rep#rt the "#ll#$in% capital %ains an l#sses "#r the 'ear4 *h#rt-term capital %ains *h#rt-term capital l#sses L#n%-term capital %ains L#n%-term capital l#sses 0hort2term )a*ital (ains 0hort2term )a*ital losses 1et short2term )a*ital (ain /105-//150--9/1-0---: $1,500 $0 $1,500

6on(2term )a*ital (ains $15,000 6on(2term )a*ital losses $10,000# 1et lon(2term )a*ital (ains $5,000 0alar/ 6on(2term )a*ital (ains 0hort2term )a*ital (ains 34I $73,000 5,000 1,500 $7$,500

11-2

Chapter 11 - Investments

0tandard ded')tion 11,400# 5ersonal exem*tion 7,300# &axable in)ome $60,,00 6ess *referentiall/ taxed in)ome 5,000# In)ome taxed at ordinar/ rates $55,,00 tax $1,675 7 $5,,57%508 $7,532%50 In)ome s'b9e)t to )a*ital (ains rates 5,000 tax $5,000 x 0:# 8 $0 &otal tax liabilit/ 8 $7,532%50 7 $0 8 $7,32%50 31. [LO 2] <ra's#n is in the 25 percent tax rate bracket an has the s#l the "#ll#$in% st#cks in 2--2( *t#ck = *t#ck + *t#ck C *t#ck D *t#ck ? a. Date )!rchase 1,21,1283 .,1-,2-18,21,2--8 5,12,2--8,2-,2-1+asis /7025/1.0--/1-075/5021/701-Date *#l 7,22,2-12,11,2-11-,12,2-11-,12,2-111,1.,2-1=m#!nt >eali6e /.05-/1705-/1501-/120.-/105--

;hat is <ra's#n8s net sh#rt-term capital %ain #r l#ss "r#m these transacti#ns4 4ra/son;s net short2term )a*ital loss is $300, +hi)h is the net of the short2 term (ains and losses for the /ear% &his $300 loss is the short2term )a*ital (ain of $3,500 from 0to)< = i%e% $17,500 > 14,000# less the short2term )a*ital loss of $3,,00 from 0to)< ? i%e% $3,500 > 7,300#% ;hat is <ra's#n8s net l#n%-term %ain #r l#ss "r#m these transacti#ns4 4ra/son;s net lon(2term )a*ital (ain is $,,$70, +hi)h is the net lon(2term (ain less the lon(2term loss for the /ear% &his is the net of the lon(2term )a*ital (ain of $11,720 i%e% $4,550 from 0to)< @ $15,300 > 10,750# and $7,170 from 0to)< . $12,400 > 5,230## less the lon(2term )a*ital loss of $2,750 from 0to)< 3 $4,500 > 7,250#%

b.

c.

;hat is <ra's#n8s #verall net %ain #r l#ss "r#m these transacti#ns4 4ra/son;s net )a*ital (ain is $,,670, +hi)h is the net short2term loss offset a(ainst the net lon(2term )a*ital (ain for the /ear be)a'se the si(ns are o**osite% &his $300 short2term )a*ital loss from *art a# is netted a(ainst the $,,$70 net lon(2term )a*ital loss from *art b#%

;hat am#!nt #" the %ain0 i" an'0 is s!b@ect t# the pre"erential rate "#r certain capital %ains4

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Chapter 11 - Investments

4ra/son;s entire net )a*ital (ain of $,,670 +ill be taxed at the *referential rate% 3.. [LO 2] D!rin% the c!rrent 'ear0 Aen an &arie s#l the "#ll#$in% assets( Capital Market Tax Holding Period Asset Value Basis > st#ck /1.0--/.80--B 1 'ear * st#ck 180--270--B 1 'ear 7 st#ck 110--110--C 1 'ear D st#ck 170--180--C 1 'ear *tamp B 1 'ear C#llecti#n 80--110-->ental h#me 15-0---E 2-0--B 1 'ear E/7-0--- #" the %ain is 25 percent %ain 9"r#m acc!m!late epreciati#n #n the pr#pert':. a. <iven that Aen an &arie have taxable inc#me #" #nl' /1-0--- 9all #r inar': be"#re c#nsi erin% the tax e""ect #" their asset sales0 $hat is their %r#ss tax liabilit' "#r 2-1- ass!min% the' "ile a @#int ret!rn4 Aen and Barie;s nettin( *ro)ess is refle)ted in the follo+in( tableC Description 0to)< & 0to)< U Step 1: 0tam*s Unre)a*t'red D1250 4ain Eemainin( 4ain from Eental 5ro*ert/ 0to)< E 0to)< 0 Step 2: Steps 4 and 5: $ 14,000# $ $,000# $234,000 $ 14,000# $ $,000# $167,000
11-.

ShortTerm $2,000 $ 1,000 # $1,0 00

Long-term Overall

LongTerm 28%

LongTerm 25%

LongTerm 15%

$ 3,000# $70,000 $1$0,000

$ 3,000# $70,000 $1$0,000

Chapter 11 - Investments

Step 6: Step Step 8 S!mmar"

$ 3,000# $1,000

$ 3,000# $67,000 $67,000

$167,000

Aen and Barie;s ordinar/ in)ome +ill in)rease from $30,000 to $31,000 d'e to their $1,000 net short2term )a*ital (ain% &heir (ross tax liabilit/ of $41,$12%50 is )om*'ted as follo+sC #mo!nt and T"pe o$ %ncome $16,750F ordinar/ #pplica&l e 'ate 10: Ta( )(planation

$14,250F ordinar/

15:

$37,000F 25: rate )a*ital (ain $30,000 25: rate )a*ital (ains $167,000F 15: rate )a*ital (ains *ross ta( lia&ilit"

15:

25:

15:

$1,675 $16,750 x 10: &he first $16,750 of Aen and Barie;s $31,000 of ordinar/ in)ome is taxed at 10: see BFG tax rate s)hed'le for this and other )om*'tations#% $2,137%50 $14,250 x 15:% Aen and Barie;s remainin( $14,250 of ordinar/ in)ome 31,000 > 16,750# is taxed at 15:% $5,550 $37,000 x 15: $37,000 $6,,000 2 $31,000 ordinar/ in)ome# of 25: rate )a*ital (ain fits into 15: ordinar/ bra)<et $7,500 $30,000 x 25: $30,000 $67,000 25: rate (ain 2 $37,000 25: rate (ain alread/ taxed in 15: ordinar/ bra)<et# taxed in 25: bra)<et% $25,050 $167,000 x 15:

+41,-12.5 /

b. <iven that Aen an &arie have taxable inc#me #" /12-0--- 9all #r inar': be"#re c#nsi erin% the tax e""ect #" their asset sales0 $hat is their %r#ss tax liabilit' "#r 2-1- ass!min% the' "ile a @#int ret!rn4

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Chapter 11 - Investments

&he nettin( *ro)ess 'sed to determine Aen and Barie;s (ross tax liabilit/ for the /ear is 'n)han(ed from the *ro)ess 'sed in *art a% Aen and Barie;s ordinar/ in)ome +ill in)rease from $120,000 to $121,000 d'e to their $1,000 net short2term )a*ital (ain% &heir (ross tax liabilit/ of $64,412%50 is )om*'ted as follo+sC #mo!nt and T"pe o$ %ncome $16,750F ordinar/ #pplica&l e 'ate 10: Ta( )(planation

$51,250F ordinar/

15:

$53,000F ordinar/

25:

$67,000F 25: rate )a*ital (ains $167,000F 15: rate )a*ital (ains *ross ta( lia&ilit"

25:

$1,675 $16,750 x 10: &he first $16,750 of their $121,000 of ordinar/ in)ome is taxed at 10: see BFG tax rate s)hed'le for this and other )om*'tations#% $7,6,7%50 $51,250 x 15:% &he next $51,250 of their $121,000 of ordinar/ in)ome is taxed at 15:% $13,250 53,000 x 25: &he remainin( $53,000 $121,000 2 $51,250 taxed at 15: 2 $16,750 taxed at 10:# of their $121,000 of ordinar/ in)ome is taxed at 25:% $16,750 $67,000 x 25:

15:

$25,050 $167,000 x 15:

+64,412.5 /

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Chapter 11 - Investments

35.

[LO 2] In 2--20 7#m an =man a Facks#n 9marrie "ilin% @#intl': have /2--0--#" taxable inc#me be"#re c#nsi erin% the "#ll#$in% events( On &a' 120 2-1-0 the' s#l a paintin% 9art: "#r /11-0--- that $as inherite "r#m <ran ma #n F!l' 210 2--8. 7he "air market val!e #n the ate #" <ran maGs eath $as /2-0--- an <ran maGs a @!ste basis #" the paintin% $as /250---. =pplie a l#n%-term capital l#ss carr'#ver "r#m 2--2 #" /1-0---. >ec#%ni6e a /120--- l#ss #n 11,1,1- sale #" b#n s 9acH!ire #n 5,12,-1:. >ec#%ni6e a /.0--- %ain #n 12,12,1- sale #" I+& st#ck 9acH!ire #n 2,5,1-:. >ec#%ni6e a /170--- %ain #n the 1-,17,1- sale #" rental pr#pert' 9the #nl' I1211 transacti#n: #" $hich /80--- is rep#rtable as %ain s!b@ect t# the 25 percent maxim!m rate an the remainin% /20--- is s!b@ect t# the 15 percent maxim!m rate 9the pr#pert' $as acH!ire #n 8,2,-.:. >ec#%ni6e a /120--- l#ss #n 12,2-,1- sale #" b#n s 9acH!ire #n 1,18,1-:. >ec#%ni6e a /70--- %ain #n 3,27,1- sale #" +J st#ck 9acH!ire #n 7,1-,-2:. >ec#%ni6e an /110--- l#ss #n 3,11,1- sale #" K!ikC# st#ck 9acH!ire #n 1,2-,-1:.

>eceive /5-- #" H!ali"ie ivi en s #n 7,15,1-. C#mplete the reH!ire capital %ains nettin% pr#ce !res an calc!late the Facks#ns8 2-1- tax liabilit'. 0& 6& 28% d# 4,000 a# 20,000 25% e# ,,000 )# e# (# h# 15% 12,000# $,000 7,000 11,000#

f# 12,000#

$20,000 ,,000#

$,,000

$7,000#

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Chapter 11 - Investments

7,000# $,,000 ,,000# ,,000 $202 $13,000 ,,000# $ ,,000 $ 5,000 b# 5,000# b# 5,000# $ 0 2010 &axable In)omeC &I b!4 $200,000 H'al% .ividend 500 $ 0 $3,000

7,000 $ 0

$ 202

$ 0

2010 &ax 6iabilit/C OIC 2,: x $200,0002137,300# $17,556 726,6,7%50 44,243%50 @4C 7 25: x $3,000 750 .ivC 7 15: x $500 75 &otal tax liabilit/ $45,06,%50

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Chapter 11 - Investments

6&@4 25: &axable In) 72.

3,000 $203,500

[LO 2] L)lannin%M *ha!n b#!%ht 1-- shares #" Dental ?H!ipment0 Inc. several 'ears a%# "#r /1-0---. C!rrentl' the st#ck is $#rth /80---. *ha!n8s mar%inal tax rate this 'ear is 25 percent0 an he has n# #ther capital %ains #r l#sses. *ha!n expects t# have a mar%inal rate #" 1- percent next 'ear0 b!t als# expects t# have a l#n%-term capital %ain #" /1-0---. 7# minimi6e taxes0 sh#!l *ha!n sell the st#ck #n December 11 #" this 'ear #r Fan!ar' 1 #" next 'ear 9i%n#re the time val!e #" m#ne':4 If 0ha'n sells the sto)< in the )'rrent /ear, he ma/ ded')t his $2,000 )a*ital loss a(ainst his ordinar/ in)ome% 4iven that his tax rate in the )'rrent /ear is 25 *er)ent, this +ill *rod')e a tax benefit of 25 *er)ent of $2,000 or $500% On the other hand, if he +aits 'ntil the follo+in( /ear to re)o(ni-e the $2,000 )a*ital loss, he m'st a**l/ the loss a(ainst his $10,000 lon(2term )a*ital (ains taxed at a 15 *er)ent rate% If he +aits, his loss +o'ld *rod')e a tax benefit of onl/ 15 *er)ent of $2,000 or $300% &herefore, 0ha'n sho'ld sell his sto)< in the )'rrent /ear%

77.

[LO 1] L'nette Nan;a%#ner p!rchase a li"e ins!rance p#lic' t# ins!re her m#ther I #n. I #n is c!rrentl' 3.. Ins!rance c#mpanies pre ict that $#men in her c#n iti#n $ill live0 #n avera%e0 t# be 81 'ears #l . L'nette makes a #ne-time pa'ment #" /1--0--- t# p!rchase a li"e ins!rance p#lic' #n I #n8s li"e. 7he p#lic' pr#vi es "#r a /10---0--- eath bene"it an a cash s!rren er val!e eH!al t# the #ri%inal /1--0--- premi!m pl!s a 7 percent ann!al rate #" ret!rn #n the premi!m. 1. J#$ m!ch $ill L'nette receive a"ter taxes i" I #n ies in 1. 'ears4 If 6/nette re)eives the life ins'ran)e *ro)eeds after Idon;s death, she +ill re)eive $1,000,000 after taxes +itho't re(ard to the n'mber of /ears Idon lives after the *oli)/ is *'r)hased be)a'se death benefits from life ins'ran)e *oli)ies are tax free% 2. J#$ m!ch $ill L'nette receive a"ter taxes i" I #n ies in seven 'ears4 3(ain, if 6/nette re)eives the life ins'ran)e *ro)eeds after Idon;s death, she +ill re)eive $1,000,000 after taxes +itho't re(ard to the n'mber of /ears Idon lives after the *oli)/ is *'r)hased be)a'se death benefits from life ins'ran)e *oli)ies are tax free% 1. J#$ m!ch $ill L'nette receive a"ter taxes i" L'nette eci es t# cash in the p#lic' a"ter "#!r 'ears $hen I #n is still livin% an L'nette8s mar%inal tax rate is 28 percent4 If 6/nette de)ides to )ash in the *oli)/ fo'r /ears after *'r)hasin( it, she +ill re)eive $131,0,0 or 100,000 x 1%07#4 before taxes% @om*arin( the $131,0,0

11-2

Chapter 11 - Investments

*ro)eeds to her ori(inal $100,000 investment, 6/nette;s taxable earnin(s +ill be $31,0,0% 4iven her ass'med tax rate of 2, *er)ent, she +ill *a/ $,,702 or %2, x $31,0,0# in tax leavin( her +ith $122,37, or $131,0,0 2 $,,702# after taxes% 81. [LO .] L)lannin%M On Fan!ar' 1 #" 'ear 10 Oick an >achel *!tt#n p!rchase a parcel #" !n evel#pe lan as an investment. 7he p!rchase price #" the lan $as /15-0---. 7he' pai "#r the pr#pert' b' makin% a #$n pa'ment #" /5-0--- an b#rr#$in% /1--0--- "r#m the bank at an interest rate #" 3 percent per 'ear. =t the en #" the "irst 'ear0 the *!tt#ns pai /30--- #" interest t# the bank. D!rin% 'ear 10 the *!tt#ns #nl' s#!rce #" inc#me $as salar'. On December 11 #" 'ear 20 the *!tt#ns pai /30--- #" interest t# the bank an s#l the lan "#r /21-0---. 7he' !se /1--0--- #" the sale pr#cee s t# pa' #"" the /1--0--- l#an. 7he *!tt#ns itemi6e e !cti#ns an are s!b@ect t# a mar%inal #r inar' inc#me tax rate #" 15 percent. a. *h#!l the *!tt#ns treat the capital %ain "r#m the lan sale as investment inc#me in 'ear 2 in #r er t# minimi6e their 'ear 2 tax bill4 In /ear one, the 0'ttons in)'rred $6,000 of investment interest ex*ense b't did not have an/ investment in)ome so the investment interest ex*ense is not ded')ted and is )arried over to /ear 2% In /ear 2, the 0'ttons in)'rred another $6,000 of investment interest ex*ense% @ombined +ith the )arr/over from /ear 1, the 0'ttons had $12,000 of investment interest ex*ense the/ )o'ld *otentiall/ ded')t in /ear 2% In /ear 2, the 0'ttons have $60,000 of lon(2term )a*ital (ain% 1one of this lon(2term )a*ital (ain is investment in)ome 'nless the 0'ttons ele)t to have some of it taxed at ordinar/ rates% If the 0'ttons don;t ele)t to tax an/ of the )a*ital (ain as ordinar/ in)ome, the/ +o'ld not be able to ded')t an/ of the investment interest ex*ense and the/ +o'ld o+e taxes of $$,000 i%e%, $60,000 x 15 *er)ent#% &he 0'ttons +o'ld have a $12,000 investment ex*ense )arr/ for+ard to next /ear% If the 0'ttons ele)t to in)l'de $12,000 of the lon(2term )a*ital (ain in investment in)ome and have it taxed at ordinar/ rates, the 0'ttons +o'ld o+e tax of $4,200 $12,000 x 35 *er)ent# on this *ortion of the )a*ital (ain and the/ +o'ld o+e $7,200 of taxes on the rest of the )a*ital (ain i%e%, $4,,000 x 15 *er)ent#% &he $12,000 investment interest ex*ense ded')tion +o'ld save the 0'ttons $4,200 in taxes i%e%, $12,000 x 35 *er)ent#% &he end res'lt is that if the 0'ttons ma<e the ele)tion, the/ +ill o+e $7,200 in taxes i%e%, $4,200 7 $7,200 2 $4,200#% &he/ +ill not ho+ever have an investment interest ex*ense )arr/ for+ard% Ba<in( the ele)tion +o'ld ma<e sense for the 0'ttons if the/ did not ex*e)t to have an/ investment in)ome for the foreseeable f't're% b. J#$ m!ch #es this c#st #r save them in 'ear 24

11-1-

Chapter 11 - Investments

In terms of the /ear 2 tax bill onl/, ma<in( the ele)tion to tax some of the lon(2term )a*ital (ain at ordinar/ rates saves the 0'ttons $1,,00 in taxes i%e%, $$,000 2 $7,200#% 81. [LO5] Larr' recentl' investe /20--- in p!rchasin% a limite partnership interest. Jis share #" the ebt in the partnership is /110---0 b!t he is n#t pers#nall' resp#nsible "#r pa'in% the ebt in the event the partnership cann#t pa' it. In a iti#n0 Larr'8s share #" the limite partnership l#ss "#r the 'ear is /20---0 his share #" inc#me "r#m a i""erent limite partnership $as /10---0 an he ha /10--- #" ivi en inc#me "r#m the st#ck he #$ns. a. ;hat is Larr'8s tax basis in the limite partnership a"ter c#nsi erin% his /20--- l#ss "#r the 'ear4 6arr/;s tax basis in the limited *artnershi* is $1,,000, +hi)h eI'als his $$,000 *a/ment for his *artnershi* interest *l's his $11,000 share of *artnershi* debt less his $2,000 share of *artnershi* loss for the /ear% b. ;hat is Larr'8s at-risk am#!nt in the limite partnership a"ter c#nsi erin% the /20--- l#ss "#r the 'ear4 6arr/;s at2ris< amo'nt is onl/ $7,000 $$,000 investment less $2,000 share of loss# be)a'se he is not at ris< for his share of *artnershi* debt% c. J#$ m!ch #" Larr'8s /20--- l#ss "r#m the limite partnership can he e !ct in the c!rrent 'ear4 =efore )onsiderin( his $2,000 loss, 6arr/;s tax basis is $20,000 $$,000 investment *l's $11,000 share of *artnershi* debt# and his at2ris< amo'nt is $$,000 at2ris< amo'nt doesn;t in)l'de nonre)o'rse debt#% &herefore the basis and at2ris< h'rdles do not a**l/% Jo+ever, 6arr/ still ma/ not ded')t $1,000 of the $2,000 loss be)a'se he onl/ has $1,000 of *assive in)ome for the /ear% &herefore, 6arr/ has a $1,000 *assive a)tivit/ loss )arr/over%

11-11