Tax Considerations

A is correct. The client held the stock for more than one year (specifically, from March 1 of last year to March 15 of this year is 1 year and 14 days), which qualifies the gain for long-term capital gains treatment. Long-term gains receive preferential tax rates of 0%, 15%, or 20%, depending on the taxpayer's income level. To qualify as long-term, the holding period must be MORE than one year (over 365 days).

B (Ordinary income tax rates) is incorrect because ordinary rates apply only to short-term capital gains from assets held for one year or less. C (Qualified dividend rates) is incorrect because this is a capital gain from a stock sale, not dividend income, though qualified dividends do receive the same preferential rates as long-term capital gains. D (Tax-free) is incorrect because capital gains are taxable, though long-term gains receive preferential rates that can be as low as 0% for taxpayers in the lowest income brackets.

B is correct. Qualified dividends receive preferential tax treatment at the same rates as long-term capital gains: 0%, 15%, or 20%, depending on the taxpayer's income level. These rates are significantly lower than ordinary income tax rates.

A (All dividends automatically qualify) is incorrect because dividends must meet specific requirements to be qualified, including a holding period requirement. The stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. C (30-day holding period) is incorrect because the actual requirement is more than 60 days during a specific 121-day window, not simply 30 days. D (Tax-free) is incorrect because while some taxpayers in the lowest income brackets may pay 0% on qualified dividends, they are not tax-free for all investors.

C is correct. This scenario triggers the wash sale rule because the investor repurchased substantially identical stock within 30 days of the sale (only 13 days later). The $2,000 loss is disallowed for current tax purposes, but it is not lost permanently. Instead, the disallowed loss is added to the cost basis of the repurchased shares, which will reduce the gain (or increase the loss) when those shares are eventually sold.

A (Full loss deductible) is incorrect because the wash sale rule disallows the immediate deduction when substantially identical securities are repurchased within the 30-day window (30 days before or after the sale). B (Loss completely disallowed) is incorrect because while the loss cannot be claimed immediately, it is preserved through basis adjustment. D ($1,000 deductible) is incorrect because there is no partial allowance under the wash sale rule; the entire loss is disallowed when the rule is triggered.

C is correct. Specific identification allows the investor to choose exactly which shares to sell, providing maximum flexibility for tax planning. The investor can select shares with the highest cost basis (to minimize gains) or lowest cost basis (to maximize losses for tax-loss harvesting), depending on the tax strategy.

A (FIFO) is incorrect because this method automatically sells the oldest shares first, which may not be optimal for tax purposes. In a rising market, the oldest shares often have the lowest cost basis and highest gains. B (LIFO) is not actually an allowable method for securities in the US (it's used for inventory accounting but not for stocks). D (Average cost method) is incorrect because while this method can be used for mutual fund shares, it calculates an average cost across all shares and provides less flexibility than specific identification.

A is correct. Capital losses must first offset capital gains. The client has a net capital loss of $7,000 ($22,000 losses minus $15,000 gains). However, the maximum amount of net capital losses that can be deducted against ordinary income in a single year is $3,000. The remaining $4,000 loss will carry forward indefinitely to future tax years.

B ($7,000) is incorrect because while the client has a $7,000 net capital loss, only $3,000 per year can offset ordinary income. C ($15,000) is incorrect because this represents the total capital gains, which are already offset by losses. D ($22,000) is incorrect because this is the total capital losses before netting against gains, and annual deductions are limited to $3,000.

D is correct. Interest from private activity municipal bonds is a tax preference item that must be added back when calculating Alternative Minimum Tax (AMT). While this interest is exempt from regular federal income tax, it is not exempt from AMT, making these bonds less attractive for investors subject to AMT.

A (Treasury bonds) is incorrect because Treasury interest is taxed the same way under both regular tax and AMT calculations. There is no add-back required. B (General obligation municipal bonds) is incorrect because interest from GO munis is exempt from both regular tax and AMT. Only private activity bond interest is an AMT preference item. C (Qualified dividends) is incorrect because qualified dividends receive the same preferential treatment under both regular tax and AMT calculations.

B is correct. The Net Investment Income Tax (NIIT) is a 3.8% surtax on the lesser of: (1) net investment income, or (2) the amount by which MAGI exceeds the threshold. For married filing jointly, the threshold is $250,000. The couple's MAGI exceeds the threshold by $30,000 ($280,000 minus $250,000). Since $30,000 is less than their $45,000 of net investment income, the NIIT applies to $30,000. The tax is $30,000 × 3.8% = $1,140.

A ($0) is incorrect because the couple's MAGI exceeds the $250,000 threshold for married filing jointly. C ($1,710) would result from incorrectly calculating 3.8% of $45,000 (the total net investment income) without considering that only the excess over the threshold is taxed. D ($9,500) is incorrect and does not reflect the proper NIIT calculation.

C is correct. The tax-equivalent yield formula is: Municipal Yield ÷ (1 - Tax Rate). Calculating: 4.0% ÷ (1 - 0.35) = 4.0% ÷ 0.65 = 6.15%. This means a taxable bond would need to yield 6.15% to provide the same after-tax return as the 4.0% municipal bond for an investor in the 35% tax bracket.

A (2.6%) would be the after-tax yield of a 4.0% taxable bond, calculated as 4.0% × (1 - 0.35), but this reverses the calculation. B (5.4%) results from an incorrect formula. D (11.4%) results from incorrectly dividing by the tax rate instead of (1 - tax rate).

D is correct. Repurchasing shares in a different account (such as an IRA) does NOT avoid the wash sale rule. The wash sale rule applies across all accounts controlled by the same taxpayer, including IRAs, taxable brokerage accounts, and even accounts of the taxpayer's spouse. This is a common misconception that the exam frequently tests.

A (Waiting 31 days) is an effective strategy because it exceeds the 30-day window in the wash sale rule. B (Similar but not substantially identical security) is effective because the wash sale rule only applies to substantially identical securities. For example, selling Ford stock and buying GM stock would not trigger the rule. C (Different index ETF) is effective because an ETF tracking a different index is not considered substantially identical. For example, selling an S&P 500 ETF and buying a Russell 2000 ETF would avoid the wash sale rule.

A is correct. Inherited assets receive a step-up in basis to the fair market value at the date of death. The client's basis is $100,000 (the value at death), not the father's original $30,000 purchase price. The taxable gain is therefore $5,000 ($105,000 sale price minus $100,000 stepped-up basis). Additionally, inherited property is always treated as long-term capital gain property, regardless of how long the heir held it, so this is a long-term gain eligible for preferential tax rates.

B ($5,000 short-term) correctly calculates the gain amount but incorrectly classifies it as short-term. Inherited property is automatically long-term. C ($75,000 long-term) incorrectly uses the father's original $30,000 basis instead of the stepped-up $100,000 basis. D ($75,000 short-term) makes both errors: using the wrong basis and classifying it as short-term.