Regulation (REG) Sample Questions
The following are actual retired questions from the Regulation (REG) section of the CPA Exam.
The answers are provided by Roger CPA Review.
View questions for the other sections of the exam.
QUESTION: In Year 1, Gardner used funds earmarked for use in Gardner’s business to make a personal loan to Carson. In Year 3, Carson declared bankruptcy, having paid off only $500 of the loan at that time. In Year 1, Gardner purchased equipment for use in Gardner’s business. In Year 3, Gardner sold the equipment at a $5,000 loss. In January of Year 3, Gardner received shares of stock as a gift from Smith; the shares had been purchased by Smith in Year 1. In November of Year 3, Gardner sold the property for a $5,000 gain.
Which of the above transactions will Gardner report as a long-term capital gain or loss for Year 3?
- The bad debt write-off
- The sale of equipment
- The sale of shares
- II and III only.
- None of the above.
- I only.
- III only.
ANSWER: D. The uncollectibility of a personal loan represents a nonbusiness bad debt, which is treated as a short-term capital loss, regardless of the holding period. Depreciable business property held longer than one year is Section 1231 property and losses on sale are treated as ordinary, not capital losses. Shares received by gift will retain donor’s holding period and basis. Since the shares had been purchased by the donor more than 1 year before their sale, the result would be a long-term capital loss.
QUESTION: Quanti Co., a calendar-year taxpayer, purchased small tools for $5,000 on December 21, 20X14, representing the company’s only purchase of tangible personal property that took place during 20X14. On its 20X14 tax return, how many months of MACRS depreciation may Quanti Co. claim on the tools?
- One-and-a-half months
- One month
- Six months
ANSWER: A. In most cases, MACRS involves applying the half-year convention under which assets are amortized for ½ year in the year of acquisition and in the year of disposal. When an entity acquires at least 40 percent of its depreciable and amortizable assets in the final three months of the year, the mid-quarter convention is applied under which depreciation is calculated only for ½ of the last quarter of the year, or 1 ½ months.
QUESTION: Hank’s home is burglarized on December 22, 20X14. Personal property with a fair market value of $40,000 and an adjusted basis to Hank of $25,000 is stolen. Hank paid an independent appraiser $700 on December 29 to determine the fair market value of the property at the time of the break-in. Hank’s homeowner’s insurance policy leads him to believe he is entitled to receive $15,000 in reimbursement for the event, but no settlement has been made with the insurance company by year-end. Hank’s AGI in 20X14 is $30,000. How much may Hank deduct from AGI as a result of these facts on his 20X14 tax return? Assume Hank itemizes and assume there has still been no settlement with the insurance company at the time of filing.
ANSWER: A. Theft and casualty losses are deductible to the extent that they exceed both $100 and 10% of AGI. The loss is measured by the lesser of the reduction in fair value of the property as a result of the casualty or the excess of the basis in the property over its fair value after the loss. Since the reduction in fair value from $40,000 to $0 exceeds the excess of the basis of $25,000 over the new fair value of $0, the lower loss, $25,000, will be used. This will be reduced by the $15,000 in insurance proceeds to which the taxpayer is entitled, giving a net amount of $10,000. This is reduced by $100 and by 10 percent of AGI, or $3,000, for a net amount of $6,900. The $700 appraisal fee is also deductible as a miscellaneous expense. The amount is reduced by 2 percent of AGI, or $600, for a net deduction of $100. As a result, total deductions from this theft will be $6,900 + $100 or $7,000.
QUESTION: Regarding the tax treatment of a business’s research and experimental (R&E) expenditures, which of the following statements is true?
- A common reason for electing tax deferral of such expenses is the expectation of lower tax rates in the future.
- Expenses associated with the acquisition of land upon which a purpose-built R&E facility is constructed are considered R&E expenditures for tax purposes.
- Companies generally prefer to expense R&E costs immediately, but may elect instead to defer and amortize such costs over a minimum of 60 months.
- Companies may elect to immediately expense R&E costs incurred in the first applicable taxable year and all future years through an appropriate filing with the IRS.
ANSWER: C. A taxpayer generally elects to deduct R&E costs in the period occurred. The election, if made in the first tax year in which R&E expenditures are incurred, requires no filing with the IRS. Such an election is binding for the current and future periods unless a change is approved by the IRS. As an alternative, the taxpayer may file an election to defer and amortize R & E expenditures over a period that does not exceed 60 months. One reason companies will defer and amortize R&E costs is the anticipation of higher, not lower, tax rates in the future. For tax purposes, costs incurred in acquiring land or depreciable property are not considered R&E expenditures, though later depreciation expense in relation to such property could qualify.
QUESTION: Identify the correct statement below regarding the Domestic Production Activities Deduction (DPAD).
- Qualified Production Activities Income (QPAI) is calculated by applying a percentage to net income from an IRS rate table based on specific criteria.
- The DPAD cannot exceed attributable W-2 wages paid.
- A sole proprietorship cannot claim the DPAD, but a partnership or S corporation with more than one shareholder can.
- Taxable income for the purposes of calculating or amending the DPAD includes any net operating loss (NOL) deduction, such as an NOL carryforward or NOL carryback.
ANSWER: D. A DPAD is allowed to taxpayers that have Qualified Production Activities Income (QPAI); AGI or taxable income, as appropriate for the taxpayer; and W-2 wages paid to employees engaged in the production of the QPAI. The amount of the deduction is not determined using a rate table; it is 9% of the lesser of QPAI or taxable income, subject to a limit of 50% of attributable W-2 wages paid. Sole proprietorships, partnerships, and S corporations all may take advantage of the DPAD. For purposes of calculating the DPAD, taxable income does not include a deduction for the DPAD but does include net operating losses.
QUESTION: Kudzu, Clemmons and Clancy form KCC Partnership with the following contributions:
Fair Market Value
What amount of taxable income to Kudzu results from the formation of KCC?
ANSWER: A. When cash or property is contributed to a partnership in exchange for a partnership interest, the transaction is not taxed and the tax bases and holding periods remain unchanged. Services contributed in exchange for a partnership interest, however, are taxed at their fair market value, $5,000 in this case.
QUESTION: Identify the correct statement below regarding similarities and differences of corporate and individual taxation.
- If long-term capital losses exceed their allowable yearly offset to ordinary income, both individuals and corporations may carry forward the losses and claim them as long-term capital losses in future years, subject to certain limitations for corporations.
- Both individuals and corporations can utilize the like-kind exchange provisions of Code Section 1031.
- Both individuals and corporations must distinguish between deductions for and deductions from in calculating taxable income.
- Corporations can claim the Domestic Production Activities Deduction (DPAD), but individuals cannot.
ANSWER: B. Section 1031 of the Internal Revenue Code relates to exchanges of property for similar property in “like-kind” exchanges and applies to corporations and individuals. An individual may carry forward nondeductible capital losses and they retain their character as being long-term or short-term. A corporation may carry nondeductible losses back 3 and forward up to 5 years with all carrybacks and carryforwards treated as short-term. While a corporation does not distinguish between deductions for and deductions from taxable income, these distinctions are important to an individual due to the different limitations placed on various income and deduction items. The Domestic Productions Activities Deduction is available to both individual and corporate taxpayers.
QUESTION: Harold gives one share of stock in Harold Corp., an S Corp, to each the following individuals:
- His nephew
- His son
- His adopted step-daughter
- His grandson
- His cousin
What is the minimum number of additional S-Corp shareholders under Code Section 1361 that will result from this distribution of stock?
ANSWER: C. For purposes of determining that there are no more than 100 shareholders of an S corporation, shareholders that are directly related, going up to six generations, may be treated as a single taxpayer. As a result, Harold’s son, adopted step-daughter, and grandson may all be considered the same as Harold and will not result in any additional shareholders. Harold’s nephew and cousin will each be an additional shareholder, indicating an addition of two.
QUESTION: Identify which of the following would be a separately stated item on Schedule K-1 of an S Corporation’s Form 1120S:
- Salaries paid to employees who are not shareholders.
- Salaries paid to officers who are shareholders.
- Collectibles gain or loss.
- III only.
- None of the above.
- II and III only.
- All of the above.
ANSWER: A. Separately stated items on Schedule K-1 of an S corporation include those items that receive special tax treatment such as being taxed at specific rates or being subject to various limitations. Salaries paid to employees, whether or not they are shareholders or officers, are ordinary business expenses and do not receive special tax treatment. As a result, neither would be a separately stated item. Gains and losses on collectibles are treated as long-term capital gains and losses, which do require special treatment and would be separately stated items.
QUESTION: Zunilda is 77-year-old individual with an AGI of $25,000 in 2014. She began living in a nursing home in 2014 upon the recommendation of her primary care physician in order to receive medical care for a specific condition. She had the following unreimbursed expenses in 2014:
Nursing home health care costs
Nursing home meal and lodging costs
As a result of these unreimbursed expenses, how much may Zunilda deduct from AGI on her 2014 tax return? Assume Zunilda elects to itemize deductions.
ANSWER: C. The $1,500 cost of prescription drugs and the $5,000 of nursing home health care costs would be included in Zunilda’s medical expenses. When a taxpayer resides in a nursing home due to needed medical care, as is the case, the cost of meals and lodging are also included, resulting in total medical expenses of $14,500. Taxpayers who are 65 or older reduce medical expenses by 7.5% of AGI to determine the deductible amount. As a result, Zunilda may deduct $14,500 – 7.5% x $25,000 ($1,875) for a deduction of $12,625.
QUESTION: In Year 1 Jorge buys a home for $200,000, making a down payment of $40,000 and taking out a loan from the bank for $160,000 to finance the balance. In Year 5 the remaining loan balance is $130,000 while the home has increased in value to $270,000. Jorge refinances with a loan company that agrees to lend 125% of the value of the home, or $337,500, using $130,000 to repay the bank loan and providing $207,500 in cash. Jorge immediately spends $10,000 of the cash on a lavish vacation to the Bahamas, and $20,000 to pay down credit cards. How much of the $337,500 home equity loan balance is allowable for calculating the home mortgage interest deduction on Jorge’s Year 5 tax return?
ANSWER: B. Home mortgage interest on acquisition indebtedness, or on loans that replace acquisition indebtedness, up to $1,000,000, and interest on home equity loans up to $100,000 may be deducted as long as the total debt does not exceed the fair value of the residence. The use of the proceeds of a home equity loan does not affect the deductibility of the interest. Upon refinancing, $130,000 of the new loan would be considered a replacement of acquisition indebtedness, with the remainder considered a home equity loan. As a result, Jorge could deduct interest on $130,000 + $100,000 or $230,000 since it does not exceed the fair value of the property.
QUESTION: On office building owned by Milo was destroyed by Hurricane Mel on September 25, 20X14. On October 2, 20X14 the President of the United States declared the area where the office building was located a federal disaster area. Milo received settlement of his insurance claim for the destruction of his building on January 2, 20X15. In order to qualify for nonrecognition of gain on this involuntary conversion, what is the last date for Milo to acquire qualified replacement property?
- December 31, 20X18
- October 2, 20X18
- December 31, 20X19
- January 2, 20X19
ANSWER: C. In order to avoid being taxed on a gain resulting from an involuntary conversion, the property subject to the conversion must be replaced within a specified time, measured from the end of the calendar year in which the proceeds are received. In general, the period is 2 years, but it is 3 years when the involuntary conversion results from government condemnation or eminent domain and is extended to 4 years when the loss is in connection with a declared federal disaster area. Since Milo received the recovery on January 2, 20X15, the property would have to be replaced within 4 years from the end of 20X15 or by December 31, 20X19.
QUESTION: Claire is a self-employed individual who owns and runs Claire’s Creations, LLC. In 20X14 she had $225,000 in net self-employment earnings, including a deduction for 50% of self-employment tax, prior to any Keogh deduction. Claire has a defined contribution, stock bonus Keogh plan. What is the highest deductible Keogh contribution Claire can make for the 20X14 tax year? Assume no excess contribution carryover from prior years.
ANSWER: D. The deductible contribution to a Keogh plan by a self-employed taxpayer is limited to 25% of income from self-employment after subtracting the contribution. If Claire has income from self- employment of $225,000 before subtracting the contribution, and if we call the contribution amount X, the equation becomes X = 25% ($225,000 – X). Multiplying both sides of the equation by 4 will give 4X = $225,000 – X, or 5X = $225,000 and X = $225,000/5 or $45,000. This would give taxable income of $180,000 and a contribution equal to 25% of that amount.
QUESTION: Delius Corp. has outstanding 1,000 5% bonds, issued in Year 1 at their face value of $1,000 each, which are currently selling at $1,150 each. In Year 3 Delius Corp. reaches an agreement with its bondholders to issue 100 shares of stock for each bond instead of paying off the bonds at the maturity date. The stock has a fair market value of $18 per share. As a result of the above, what recognized gain must Delius’s bondholders, now shareholders, report in Year 3?
- $650,000 long-term capital gain
- $800,000 long-term capital gain
- $650,000 dividend
ANSWER: D. An exchange of bonds for stock is a Type E reorganization, which is a recapitalization designed to change the capital structure of a single corporation. In a corporate reorganization, a security holder will not recognize a gain or loss when the stock or securities of a corporation that is involved in the reorganization are exchanged solely for stock or securities in the same corporation or another one that is part of the reorganization. Since the previous bondholders are receiving solely stock in exchange for their bonds, no gain or loss would be recognized.
QUESTION: Which of the following generates a permanent difference between book and taxable income?
- The Domestic Activities Production Activities Deduction (DPAD)
- Section 179 bonus depreciation
- Tax credits
- II only.
- I, II, and III.
- I only.
- I and III only.
ANSWER: D. In reconciling book income to taxable income on Schedule M-1, all differences between book and tax income are identified. Temporary differences are those that will ultimately be the same for tax and book purposes but in different periods, such as bonus depreciation, taken in the year of acquisition for tax and spread out over the life of the asset for book purposes. Permanent differences are items that are deductible or taxable for tax purposes but not for book purposes, or vice versa. This would include the DPAD, which is deductible for tax purposes but is not an expense for financial reporting purposes, and tax credits, which are reductions in tax as a result of the operation of tax law but do not represent either income or expense for financial reporting purposes.
QUESTION: Which of the following situations will result in a tax preparer’s penalty?
- At a client’s insistence, the preparer takes and properly discloses a tax position which does not meet the reasonable basis standard.
- The preparer discloses a client’s personally identifying information to outside parties in order to permit the electronic preparation and submission of the client’s return.
- The preparer provides his Preparer Tax Identification Number but fails to sign a client’s tax return.
- II only.
- I, II, and III.
- I only.
- I and III only.
ANSWER: D. A tax preparer will incur a penalty for an understatement of a tax liability as a result of a tax position that lacks substantial authority and is not disclosed or a position that has no reasonable basis supporting it, regardless of whether or not it is disclosed. A preparer will also be penalized for failing to sign a return. Although a preparer will generally be penalized for disclosing confidential information obtained through the preparation of a return, there will be no penalty if the information is provided to permit the electronic preparation or submission of the taxpayer’s return.
QUESTION: In 20X14 Colossus Corporation incurred net capital losses in the amount of $25,000. Colossus had the following net capital gains in the previous five years:
20X13 - $7,000
20X12 - $2,000
20X11 - $5,000
20X10 - $4,000
20X09 - $3,000
How much of the 20X14 capital loss may Colossus carry over to 20X15?
ANSWER: C. A corporation may not deduct a capital loss. Instead, it may be carried back to any or all of the preceding three years to be offset against previously taxable capital gains with the remainder carried forward for up to 5 years. Colossus will carry $7,000 back to 20X13, $2,000 to 20X12, and $5,000 to 20X11 for a total carryback of $14,000. The remaining $11,000 will be carried forward to 20X15.
QUESTION: On March 1 of the current year Reiter, an individual, sold an office building for $300,000 that had an adjusted basis of $220,000, resulting in a gain of $80,000. Reiter had purchased the building for $260,000 on April 1 of the previous year, and $30,000 of the total depreciation taken took advantage of a special tax incentive program Reiter qualified for. How should Reiter report this gain on the current year tax return?
- $80,000 ordinary gain
- $30,000 ordinary gain and $50,000 long-term capital gain
- $50,000 ordinary gain and $30,000 long-term capital gain
- $40,000 ordinary gain and $40,000 short-term capital gain
ANSWER: D. Depreciable real property is section 1250 property subject to recapture of excess depreciation. Since the building was held for less than 1 year, all depreciation taken, $40,000, would be considered excess depreciation and would be recaptured, resulting in ordinary income of $40,000. The remainder of the gain would be a short-term capital gain due to a holding period of less than 1 year.
QUESTION: In Year 7 Standard Corp., a C corporation, sold Section 1250 property for $600,000 that had an adjusted basis of $550,000, resulting in a $50,000 gain. The property had cost Standard $720,000 when purchased in Year 1, and $170,000 of accelerated depreciation had been taken. Had straight- line depreciation been used, depreciation would have been $100,000. How should Standard report the gain on its Year 7 tax return?
- $20,588 ordinary gain and $29,417 long-term capital gain
- $28,824 ordinary gain and $41,176 long-term capital gain
- $70,000 ordinary gain
- $50,000 ordinary gain
ANSWER: D. When section 1250 property that has been held for more than 1 year is sold at a gain, excess depreciation is recaptured, resulting in an ordinary gain with the remainder, if any, recognized as long-term capital gain. Excess depreciation for a C corporation consists of the difference between the amount taken using an accelerated method and the amount that would have been allowed under straight-line, $170,000 - $100,000 or $70,000, plus 20% of the amount allowed under straight-line, $100,000 x 20% or $20,000 for a tot6al of $90,000. Since this exceeds the amount of the gain, the entire $50,000 gain would be ordinary.
QUESTION: Mary gives Joanne a gift of land worth $80,000. The land’s original cost to Mary was $30,000. As a result of the transfer, Mary paid a gift tax of $12,000. What is Joanne’s basis in the land? Assume an annual gift exclusion of $14,000.
ANSWER: A. A donee’s basis in an appreciated gift is equal to the donor’s basis plus gift tax paid with respect to the gift’s appreciation. The amount of gift tax added is the amount of tax paid, $12,000, multiplied by the ratio of the net appreciation in the value of the gift, $50,000, to the amount of the gift, which is calculated after eliminating the annual gift exclusion, $80,000 - $14,000 or $66,000. As a result, the amount of gift tax that will be added to the donor’s basis of $30,000 will be $12,000 x ($50,000/$66,000) or $9,091 and the basis will be $39,091.
QUESTION: On November 1, 20X13, Ruth gave Helen a gift of stock worth $15,000. Ruth had purchased the stock on February 1, 20X13 for $17,000. Helen sold the stock to an unrelated party on November 1, 20X14 for $17,700. What is the amount and character of Helen’s gain or loss upon the sale?
- $700 short-term capital gain
- $2,700 short-term capital gain
- $700 long-term capital gain
- $2,700 long-term capital gain
ANSWER: C. When property received by gift has a fair value that is lower than its basis on the date of the gift, the basis for determining gain or loss is determined using the sales price. If the sales price is lower than the fair value at the date of gift, that amount is used to calculate the loss and the holding period is calculated from the date of the gift. If the sales price exceeds the donor’s basis, the donor’s basis is used to calculate the gain and the donor’s holding period is included. Since the property was sold for $17,700, which exceeds the donor’s $17,000 basis, a gain of $700 would be recognized. The holding period would extend from Ruth’s date of acquisition, 2/1/X13, to the date of sale, 11/1/X14, which is greater than a year. Helen will recognize a $700 long term capital gain.
QUESTION: Ravi, a prosperous businessman, owns devalued property – its basis to him exceeds its fair market value (FMV), which is $600,000. He would like to give the property to his daughter, Ritu, but is unsure about the tax consequences to Ritu depending on the timing of the gift. Should he give it as a gift now, or leave it to her in his will? Why? Assume it is highly unlikely the FMV will have risen to the level of Ravi’s basis by the time of Ravi’s death.
- Give as gift now, because devalued property will be subject to step-down basis when given as part of the estate, but will benefit from dual basis if given as a gift during the giver’s lifetime.
- Leave in will, because giving devalued property as part of an estate leads to better tax consequences for the beneficiaries due to the annual exclusion rules.
- Give as gift now, because receiving devalued property during the giver’s lifetime leads to better tax consequences for the recipient due to the annual exclusion rules.
- Leave in will, because devalued property will benefit from step-up basis when given as part of the estate, but will be subject to the dual basis rules if given as a gift during the giver’s lifetime.
ANSWER: A. If Ritu inherits the property from Ravi, her basis will be the fair value at the date of death, or six months after the date of death if the alternate valuation date is elected, which is presumed to be lower than Ravi’s basis. A sale would result in a gain equal to the difference between the sales price and that amount. If Ritu receives the property as a gift, since it is worth less than Ravi’s basis on the date of the gift, her basis will be Ravi’s basis if sold at a gain and the fair value at the date of the gift if sold at a loss. As a result, Ritu will only have a taxable gain if the property is sold for more than Ravi’s basis, making a gift the more advantageous way for her to receive the property.
QUESTION: Identify the correct statement concerning issues of estate taxes, gift taxes, and family tax planning.
- A gift for a minor child, distributable to the child upon the child’s 18th birthday, is a taxable gift to the extent that it exceeds a present value of $14,000.
- Upon the death of one its owners, a property owned in joint tenancy automatically goes to the survivors and bypasses the estate of the decedent.
- Gifts given in contemplation of marriage, such as an engagement ring to a fiancée, are excludable from taxable gifts so long as the marriage occurs no later than sometime within the following tax year.
- Income in respect of a decedent, includable on the fiduciary income tax return, is excluded from the valuation of the gross estate of the decedent.
ANSWER: B. Joint tenancy is the ownership of property by two or more persons with each having an undivided interest in the property. This gives joint tenants the right of survivorship indicating that, upon the death of a joint tenant, that tenant’s share in the property reverts to the other joint tenants, not to the deceased’s estate. Only a present interest, which is an unrestricted right to the immediate use of the gift, is subject to the annual exclusion. A gift distributable upon a child’s future birthday is a future interest and is fully taxable. While gifts to a donor’s spouse are not subject to gift tax, there is no exclusion for gifts in contemplation of marriage, such as an engagement ring. The gross estate of a decedent includes income in respect of the decedent, which is a receivable to the estate, despite the fact that it is also includable on the fiduciary income tax return.
QUESTION: Identify the correct statement regarding portability of a deceased spouse’s unused lifetime exclusion amount.
- It can be granted via an amended tax return of the surviving spouse.
- It permits the surviving spouse to apply the decedent’s unused exclusion amount to the surviving spouse’s own transfers during life, but not at death.
- It is granted via an election on the decedent’s fiduciary income tax return.
- It can be elected only through a timely filing of a Form 706.
ANSWER: D. Portability refers to the ability of a surviving spouse to take advantage of any unused portion of their deceased spouse’s unified estate and gift tax credit. To take advantage of this, the estate is required to file an estate tax return on form 706. It may not be granted by filing an amended tax return for the surviving spouse. The credit may be applied to gifts given during the surviving spouse’s lifetime with the remainder applied to the surviving spouse’s estate. It may not be claimed on the decedent’s fiduciary income tax return filed on form 1041.