CPA TCP: Property Transactions

CPA means Certified Public Accountant. TCP means Tax Compliance and Planning. Use this focused page when your CPA TCP misses are about dispositions, adjusted basis, amount realized, recognized gain or loss, character, depreciation recapture, or timing. Drill this topic before returning to mixed practice.

Topic snapshot

What this topic tests

This topic tests disposition mechanics and planning consequences for property transactions. Strong answers separate amount realized, adjusted basis, recognized gain or loss, character, recapture, holding period, and timing.

Common traps

• forgetting depreciation recapture or character conversion after computing total gain
• using original cost instead of adjusted basis
• treating tax-deferred, related-party, installment, or like-kind facts as ordinary sale facts
• missing whether the best answer is a planning recommendation rather than a pure computation

How to reason through these questions

Use a disposition checklist: amount realized, adjusted basis, realized gain or loss, recognized amount, character, recapture, and timing. Then ask whether the client objective changes the preferred transaction structure.

Sample questions

These questions are original Mastery Exam Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.

Question 1

Topic: Property Transactions (Disposition of Assets)

Assume each proposed sale would produce a realized loss.

Based on the exhibit, which conclusion is supported for federal income tax related-party loss purposes?

• A. The loss on Sale 3 is disallowed because a niece is treated as a lineal descendant for related-party loss rules.
• B. The loss on Sale 1 is allowed because only Anne’s direct ownership counts in determining whether Maple Corp is related.
• C. The loss on Sale 1 is disallowed because Anne is treated as owning more than 50% of Maple Corp.
• D. The loss on Sale 2 is disallowed because any sale between a partner and a partnership is automatically a related-party sale.

Best answer: C

What this tests: Property Transactions (Disposition of Assets)

Explanation: The supported conclusion is the one involving the sale to Maple Corp. For related-party loss rules, Anne is treated as owning her son’s 20% interest, so her deemed ownership is 55%, which makes Maple a related corporation.

For related-party loss disallowance, an individual is treated as owning stock held by certain family members, including children. Here, Anne directly owns 35% of Maple Corp and is attributed her son’s 20%, so she is treated as owning 55% of the corporation. Because the corporation is more than 50% owned by Anne, a loss on Anne’s sale to Maple is disallowed. The partnership sale does not meet the majority-ownership threshold because Anne owns only 45% of Cedar Partnership. The niece sale is not a related-party loss transaction under these family rules because a niece is not treated as a lineal descendant.

• The Cedar Partnership conclusion fails because partner-partnership loss disallowance is not automatic; the ownership threshold must exceed 50%, and Anne owns only 45%.
• The niece conclusion fails because nieces and nephews are not included in the family members counted for this related-party rule.
• The direct-ownership-only conclusion fails because family attribution from a child counts when measuring Anne’s ownership of the corporation.

Anne’s 35% direct ownership plus 20% attributed from her son gives her 55%, so the sale to Maple Corp is a related-party loss transaction.

Question 2

Topic: Property Transactions (Disposition of Assets)

A CPA is preparing Year 1 federal returns for Dana and her adult son. On January 1, Year 1, Dana sold investment land to her son for its $200,000 fair market value and accepted a demand note for the full amount. The note bears 1% annual interest, and the son paid that stated interest at year-end. The applicable federal rate for Year 1 is 5%, no exception to the below-market loan rules applies, and the son will hold the land for investment. What is the correct Year 1 tax treatment of the below-market interest element?

• A. Dana is deemed to receive $10,000 of imputed ordinary interest income, and the son is deemed to pay $10,000 of investment interest expense.
• B. Dana is deemed to make an $8,000 gift to her son and to receive $8,000 of additional ordinary interest income; the son is deemed to pay $8,000 of investment interest expense, subject to the normal limitation.
• C. Dana treats $8,000 as additional capital gain on the land sale, and the son adds $8,000 to the land’s basis.
• D. Dana recognizes no imputed interest because the land was sold for fair market value and the stated interest was actually paid.

Best answer: B

What this tests: Property Transactions (Disposition of Assets)

Explanation: The below-market demand note creates forgone interest equal to the AFR interest shortfall, not the full AFR amount. Here, the shortfall is $8,000, and for a family loan it is treated as a deemed gift from Dana to her son and a deemed interest payment back to Dana.

For a below-market demand loan, forgone interest is generally the excess of interest computed at the applicable federal rate over the interest actually charged. Dana’s note principal is $200,000, so AFR interest for Year 1 is $10,000 and stated interest is $2,000. The imputed, or forgone, interest is therefore $8,000. Because this is a family transaction, that $8,000 is treated as a deemed gift from Dana to her son and then as a deemed interest payment from the son back to Dana. Dana reports the $8,000 as additional ordinary interest income. Since the son used the borrowed funds to acquire investment land, the deemed interest is investment interest expense, subject to the normal investment interest limitation. The imputed amount is not additional sales proceeds and does not become land basis.

• Using $10,000 confuses total AFR interest with imputed interest; only the $8,000 shortfall is imputed because $2,000 was already stated and paid.
• Selling the land at fair market value does not avoid the below-market loan rules when the related-party demand note bears less than AFR.
• The $8,000 shortfall is ordinary interest treatment, not additional capital gain on the sale and not an added basis amount for the land.

The forgone interest is $200,000 × (5% − 1%) = $8,000, which is treated as a deemed gift and a deemed interest payment under the below-market gift-loan rules.

Question 3

Topic: Property Transactions (Disposition of Assets)

During review of a proposed loss sale of land, a staff memo states: “Dana’s planned sale of land to Apex Corp is not a related-party sale because Dana directly owns only 44% of Apex.”

The file shows:

Apex has one class of stock, and all stock percentages are measured by value. What is the best correction to the memo?

• A. Revise it to conclude Dana is treated as owning 56% of Apex because only direct ownership and her daughter’s stock are counted.
• B. Keep it unchanged because stock owned by LMN Partnership is attributed to Dana only if Dana owns more than 50% of the partnership.
• C. Revise it to conclude Dana is treated as owning 65% of Apex, so the planned loss sale to Apex is a related-party transaction.
• D. Revise it to conclude Dana is treated as owning 74% of Apex because all Apex stock owned by LMN Partnership is attributed to Dana.

Best answer: C

What this tests: Property Transactions (Disposition of Assets)

Explanation: The memo is wrong because related-party status is based on direct and constructive ownership, not just direct stock ownership. Dana is treated as owning 65% of Apex: 44% directly, 9% through LMN Partnership, and 12% from her daughter.

For this related-party test, stock owned directly and indirectly must be combined. A partner is treated as owning a proportionate share of stock held by a partnership, so Dana is attributed 30% of LMN Partnership’s 30% Apex holding, or 9%. Family attribution also applies, and Dana’s daughter’s 12% Apex ownership is attributed to Dana. Adding these to Dana’s 44% direct ownership gives 65% total deemed ownership. Because Dana is treated as owning more than 50% of Apex by value, the sale between Dana and Apex is a related-party transaction. In a loss-sale setting, that means the loss is not currently deductible.

• The 56% conclusion misses Dana’s indirect ownership through LMN Partnership.
• Keeping the memo unchanged is incorrect because partnership attribution does not require Dana to own more than 50% of the partnership.
• The 74% conclusion overstates attribution because Dana is attributed only her proportionate share of LMN Partnership’s Apex stock, not all of it.

Dana constructively owns 44% directly, 9% through her 30% interest in LMN’s 30% Apex holding, and 12% from her daughter, for a total of 65%.

Question 4

Topic: Property Transactions (Disposition of Assets)

A staff preparer assigned character categories on the asset disposition schedule below before any §1231 netting. Assume no related-party, installment-sale, casualty, or depreciation-recapture rule changes the basic category.

Which schedule line best supports the conclusion that a gain or loss was assigned to the wrong character category?

• A. The retail warehouse line
• B. The inventory lot line
• C. The vacant parcel line
• D. The delivery van line

Best answer: A

What this tests: Property Transactions (Disposition of Assets)

Explanation: The retail warehouse line is the misclassified item. Business real property held more than one year is generally §1231 property, so its gain first enters the §1231 netting process rather than being directly classified as long-term capital gain on the schedule.

To review disposition character, first identify the type of property and then apply the holding period. Investment land is typically a capital asset, so a gain after more than one year is long-term capital gain. Inventory is not a capital asset, so its gain or loss is ordinary. Property used in a trade or business is also not a capital asset; if it is held more than one year, it is generally §1231 property and its gain or loss is placed in the §1231 category before annual netting. Here, the retail warehouse is depreciable business real property held six years, so reporting its gain directly as long-term capital gain is the wrong category at the schedule stage. The other listed items are assigned to appropriate basic character categories.

• The retail warehouse line is the error because business-use depreciable real property held more than one year belongs in §1231 before netting.
• The vacant parcel line is acceptable because investment land held more than one year can produce long-term capital gain.
• The delivery van line is acceptable because business property held only 10 months is not §1231 property, so its loss is ordinary.
• The inventory lot line is acceptable because property held for sale to customers produces ordinary, not capital, gain or loss.

Depreciable real property used in a trade or business and held more than one year is §1231 property, so its gain should not be directly labeled long-term capital gain before §1231 netting.

Question 5

Topic: Property Transactions (Disposition of Assets)

Jordan, a calendar-year sole proprietor, disposed of the following business assets in 2026. Assume all gains and losses below are fully recognized and have already been correctly computed. Ignore tax-rate subcategories such as unrecaptured Section 1250 gain.

Jordan also has $10,000 of nonrecaptured net Section 1231 losses from the prior five tax years.

After applying the relevant gain and loss character rules, which is the best interpretation of Jordan’s 2026 recognized result?

• A. $33,000 ordinary income and no capital gain
• B. $18,000 ordinary income and $15,000 Section 1231 gain
• C. $18,000 ordinary income and $15,000 long-term capital gain
• D. $28,000 ordinary income and $5,000 long-term capital gain

Best answer: D

What this tests: Property Transactions (Disposition of Assets)

Explanation: The machine’s $18,000 gain is ordinary income because Section 1245 recapture applies first. The land and warehouse building produce a net Section 1231 gain of $15,000, but the $10,000 Section 1231 lookback converts that much to ordinary income, leaving only $5,000 as long-term capital gain.

For business assets held more than one year, Section 1231 gains and losses are netted after any recapture rules are applied. Here, the machine is Section 1245 property, and because depreciation claimed exceeded the gain realized, the full $18,000 gain is ordinary income. The land gain of $40,000 and warehouse loss of $25,000 are Section 1231 items, producing a net Section 1231 gain of $15,000. A taxpayer with nonrecaptured net Section 1231 losses from the prior five years must recharacterize current-year net Section 1231 gain as ordinary income to that extent. Jordan has a $10,000 lookback amount, so $10,000 of the $15,000 net Section 1231 gain becomes ordinary income and the remaining $5,000 is treated as long-term capital gain. Total 2026 character is therefore $28,000 ordinary income and $5,000 LTCG.

• Treating the full $15,000 net Section 1231 gain as long-term capital gain ignores the five-year Section 1231 lookback rule.
• Treating the entire $15,000 net Section 1231 gain as ordinary overstates the lookback; only $10,000 is recharacterized because that is the prior nonrecaptured loss amount.
• Leaving the $15,000 as Section 1231 gain stops too early; after netting, current-year lookback determines the final character.

The machine gain is entirely ordinary under Section 1245, the land and building net to a $15,000 Section 1231 gain, and the $10,000 lookback recharacterizes that amount as ordinary, leaving $5,000 LTCG.

Question 6

Topic: Property Transactions (Disposition of Assets)

While preparing Form 8824 for a client, a CPA notes the following qualifying like-kind exchange of investment real estate:

• Adjusted basis of land given up: $180,000
• Fair value of replacement land received: $350,000
• Cash paid by client: $30,000
• Deferred gain on the exchange: $140,000

What basis should the CPA assign to the replacement land?

• A. $180,000
• B. $210,000
• C. $350,000
• D. $320,000

Best answer: B

What this tests: Property Transactions (Disposition of Assets)

Explanation: The replacement land takes a carryover-type basis rather than a fair value basis. Using the deferred gain method, the basis is $350,000 fair value minus $140,000 deferred gain, or $210,000.

In a qualifying like-kind exchange, the basis of the replacement property is generally its fair value reduced by the gain deferred in the exchange. Here, the client received replacement land worth $350,000 and deferred $140,000 of gain, so the replacement land basis is $210,000. The same result can be checked using the carryover approach: start with the old land’s adjusted basis of $180,000, add the $30,000 cash paid, and because no gain was recognized, the new basis is $210,000. This preserves the unrecognized gain inside the replacement property for future tax recognition.

• \$180,000 ignores the effect of the additional cash paid; boot paid increases the basis of the replacement property.
• \$320,000 is a net-value style calculation, not the tax basis rule for a nonrecognition exchange.
• \$350,000 incorrectly uses fair value as basis; like-kind exchange basis is reduced by deferred gain, not stepped up to FMV.

Replacement property basis equals the fair value received reduced by deferred gain, so $350,000 - $140,000 = $210,000.

Question 7

Topic: Property Transactions (Disposition of Assets)

Olivia purchased investment stock from her father for $70,000 when his adjusted basis was $100,000. Because they are related parties, her father’s $30,000 realized loss was disallowed. Eighteen months later, Olivia sold the stock to an unrelated third party for $120,000. The stock was a capital asset in Olivia’s hands. What should Olivia recognize on the sale?

• A. Recognize a $20,000 long-term capital gain
• B. Recognize a $20,000 long-term capital loss
• C. Recognize a $50,000 long-term capital gain
• D. Recognize no gain or loss

Best answer: A

What this tests: Property Transactions (Disposition of Assets)

Explanation: When property bought from a related party is later sold to an unrelated party, the buyer’s gain is reduced by the seller’s previously disallowed loss. Olivia’s $50,000 realized gain is reduced by the $30,000 disallowed loss, so she recognizes a $20,000 long-term capital gain.

A loss on a sale between related parties is generally disallowed to the seller. But that disallowed loss is not permanently lost if the buyer later sells the property to an unrelated third party at a gain. Instead, the buyer’s recognized gain is reduced, but not below zero, by the amount of the seller’s previously disallowed loss. Here, Olivia’s basis is her cost of $70,000, so selling for $120,000 creates a $50,000 realized gain. Her father’s earlier $30,000 disallowed loss offsets part of that gain, leaving $20,000 recognized. Because Olivia held the stock for more than one year and it is a capital asset, the recognized gain is long-term capital gain.

• Recognizing a $50,000 long-term capital gain ignores the rule that the prior related-party disallowed loss offsets the later gain.
• Recognizing no gain or loss would be correct only if the later sale price did not exceed the father’s former $100,000 basis.
• Recognizing a $20,000 long-term capital loss incorrectly treats the prior disallowed loss as creating a deductible loss for Olivia; it can only reduce later gain.

Her $50,000 realized gain based on her $70,000 cost basis is reduced by the father’s previously disallowed $30,000 loss, leaving $20,000 of recognized long-term capital gain.

Question 8

Topic: Property Transactions (Disposition of Assets)

A CPA is reviewing Jordan’s 2026 dispositions. Jordan is single, held each asset for more than 1 year, has no other §1231 transactions in 2026, and has no nonrecaptured §1231 losses from prior years. The §1244 stock loss is below the annual ordinary-loss limit for an individual.

Which treatment is correct for federal income tax reporting?

• A. The equipment gain is $40,000 of §1231 long-term capital gain; the warehouse gain is $40,000 in the unrecaptured §1250 rate category; and the stock loss is $40,000 of ordinary loss under §1244.
• B. The equipment gain is $40,000 of ordinary income under §1245; the warehouse gain is $40,000 of §1231 gain, all in the unrecaptured §1250 rate category; and the stock loss is $40,000 of capital loss.
• C. The equipment gain is $40,000 of ordinary income under §1245; the warehouse gain is $40,000 of §1231 gain, all in the unrecaptured §1250 rate category; and the stock loss is $40,000 of ordinary loss under §1244.
• D. The equipment gain is $40,000 of ordinary income under §1245; the warehouse gain is $40,000 of ordinary income from §1250 recapture; and the stock loss is $40,000 of ordinary loss under §1244.

Best answer: C

What this tests: Property Transactions (Disposition of Assets)

Explanation: The equipment’s $40,000 gain is fully ordinary because the gain does not exceed prior depreciation, so §1245 recapture applies. The warehouse’s $40,000 gain is §1231 gain that falls into the unrecaptured §1250 rate category because the building was depreciated only by straight-line. The qualifying §1244 stock loss is ordinary because the stock was issued directly to Jordan and the $40,000 loss is within the individual limit.

For the equipment, adjusted basis is $30,000 ($90,000 cost less $60,000 depreciation), so the $70,000 sale creates a $40,000 gain. Because it is depreciable personal property, §1245 recaptures gain as ordinary income up to prior depreciation, so the full $40,000 is ordinary. For the warehouse, adjusted basis is $220,000 ($300,000 less $80,000), so the $260,000 sale creates a $40,000 gain. Since the building was depreciated only by straight-line, there is no ordinary §1250 recapture here; instead, with no other §1231 issues, the gain is §1231 gain treated as long-term capital gain, and the $40,000 falls in the unrecaptured §1250 rate bucket. For the stock, basis is $50,000 and amount realized is $10,000, so the loss is $40,000. Because the stock qualifies under §1244 and the loss is within the annual limit, the loss is ordinary rather than capital.

• Treating the equipment gain as capital ignores §1245 recapture, which converts gain up to prior depreciation into ordinary income.
• Treating the warehouse gain as ordinary §1250 recapture ignores the straight-line depreciation fact; that fact points to unrecaptured §1250 gain treatment rather than ordinary recapture.
• Treating the stock loss as capital ignores the §1244 facts given: direct issuance to the individual for cash and a loss amount within the ordinary-loss limit.

The equipment gain is fully recaptured as ordinary income under §1245, the straight-line real property gain falls into the unrecaptured §1250 rate bucket rather than ordinary recapture here, and the qualifying §1244 stock loss is ordinary within the annual limit.

Question 9

Topic: Property Transactions (Disposition of Assets)

Morgan, a single taxpayer, sold stock of Finch, Inc. in the current year. Assume Finch met the Section 1244 requirements when it issued the original shares.

Based on the exhibit, before any overall capital loss deduction limitation, how should Morgan classify the loss on the sale?

• A. $50,000 ordinary loss and $24,000 capital loss
• B. $50,000 ordinary loss and $10,000 capital loss
• C. $60,000 ordinary loss and $14,000 capital loss
• D. $74,000 capital loss and no ordinary loss

Best answer: A

What this tests: Property Transactions (Disposition of Assets)

Explanation: Only the loss on stock bought directly from the corporation at original issuance can receive Section 1244 ordinary loss treatment. That block produces a $60,000 loss, but Morgan is single, so ordinary treatment is capped at $50,000; the remaining loss is capital.

Section 1244 allows an individual to treat a limited amount of loss on qualifying small business stock as ordinary instead of capital. The stock must be acquired directly from the corporation when issued, and the corporation must satisfy the Section 1244 requirements at that time. Morgan’s 1,000 original-issue shares cost $80,000 and were sold as part of a 1,200-share sale for $24,000 total, or $20 per share, so those shares generated a $60,000 loss. Because Morgan is single, only $50,000 of that loss is ordinary; the excess $10,000 is capital. The 200 shares purchased from another shareholder do not qualify for Section 1244 treatment, so their $14,000 loss is capital. Total classification: $50,000 ordinary and $24,000 capital.

• \$60,000 ordinary loss and \$14,000 capital loss ignores the $50,000 annual ordinary-loss cap for a single taxpayer.
• \$50,000 ordinary loss and \$10,000 capital loss captures only the excess loss on the qualifying block and omits the separate capital loss on the shares bought from another shareholder.
• \$74,000 capital loss and no ordinary loss ignores that qualifying original-issue Section 1244 stock can produce limited ordinary loss treatment.

The original-issue shares create a $60,000 loss, but Section 1244 limits a single taxpayer to $50,000 of ordinary loss, and the remaining $10,000 plus the $14,000 loss on later-purchased shares is capital.

Question 10

Topic: Property Transactions (Disposition of Assets)

On July 1, 2026, Riley sold investment land using the installment method. The buyer’s note bears adequate stated interest, and only principal collections are treated as installment payments.

Based on the exhibit, how much gain should Riley recognize in 2026?

• A. $51,000
• B. $150,000
• C. $50,400
• D. $45,000

Best answer: D

What this tests: Property Transactions (Disposition of Assets)

Explanation: Under the installment method, gain recognized each year equals principal payments received multiplied by the gross profit percentage. Here, gross profit is $150,000 and contract price is $500,000, so the 30% ratio applied to the $150,000 principal collection yields $45,000 of gain.

For an installment sale, the seller does not recognize the entire gain immediately unless the full price is collected at once. Instead, the seller computes gross profit percentage as gross profit divided by contract price, then applies that percentage to principal payments received during the year. In this case, gross profit is $150,000, calculated as $500,000 sale price less $330,000 adjusted basis less $20,000 selling expenses. The contract price is $500,000, so the gross profit percentage is 30%. Riley collected $150,000 of principal in 2026, and interest is excluded from installment sale gain calculations. Therefore, recognized gain is $150,000 × 30% = $45,000.

• \$51,000 comes from ignoring the $20,000 selling expenses and using too high a gross profit.
• \$50,400 incorrectly includes the $18,000 interest collection as part of installment-sale payments.
• \$150,000 is the total gross profit on the sale, not the amount recognized in 2026 under the installment method.

Recognized gain equals the $150,000 principal payment multiplied by the 30% gross profit percentage, producing $45,000.

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Related focused pages

• Free CPA TCP Full-Length Practice Exam
• CPA TCP: Individual and Personal Tax Planning
• CPA TCP: Entity Tax Compliance
• CPA TCP: Entity Tax Planning

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