Question

Roscoe and Amy are married and own 12,000 shares of qualifying small business stock that they purchased for

$150,000. During the current year, they sell 10,000 shares of the small business stock to an unrelated third party for
$30,000. Eager to sell the remaining shares, they sell the other 2,000 shares to Amy's sister for $4,000. In addition, they sell stock with a basis of $5,000 for $10,000. The stock was acquired in 2007. In 2010, Roscoe and Amy loaned her brother, Carl, $8,000 to start his business. Carl has only repaid $2,000 on his documented loan. During the year, Carl has filed for bankruptcy. The bankruptcy court liquidates all of Carl's assets and Roscoe and Amy receive nothing from the liquidation.
I. Roscoe and Amy can deduct $120,000 as an ordinary loss on the small business stock.
II. Roscoe and Amy have a net short-term capital loss of $1,000.
a. Only statement I is correct.
b. Only statement II is correct.
c. Both statements are correct.
d. Neither statement is correct.

Answer 1

After analysis, both statements are incorrect. Statement I is incorrect because Roscoe and Amy have a total capital loss of $111,000 from the stock sales, not $120,000. Statement II is also incorrect; assuming the loss from Carl's defaulted loan is considered alongside their stock sales, the total short-term loss would exceed $1,000.

Step-by-step explanation:

When analyzing the transactions presented, it appears that Roscoe and Amy are dealing with capital losses and possible ordinary losses from their different sales and the loss from a defaulted loan. To determine if either statement I or II is correct, we need to calculate the gains or losses for each transaction:

• They originally purchased 12,000 shares of small business stock for $150,000.
• They sold 10,000 shares for $30,000. This sale results in a loss because the sale proceeds are less than the proportional cost basis of these shares.
• The cost basis of the sold shares can be calculated by dividing the original purchase price by the total number of shares and then multiplying by the number of shares sold: ($150,000 / 12,000) * 10,000 = $125,000.
• The loss from this sale is then $125,000 (basis) - $30,000 (sale proceeds) = $95,000.
• They sold the remaining 2,000 shares to Amy's sister for $4,000, incurring an additional loss with a basis of ($150,000 / 12,000) * 2,000 = $25,000. Thus, the loss is $25,000 - $4,000 = $21,000.
• For the third sale of stock, they sold shares with a basis of $5,000 for $10,000. This transaction results in a gain of $5,000.
• The loan to Carl that was not repaid can potentially be deducted as a nonbusiness bad debt, which is treated as a short-term capital loss.
• Therefore, their total capital loss from the stock sales is $95,000 + $21,000 - $5,000 (gain) = $111,000, and not $120,000 as stated in I.
• The loss from the loan default of Carl can be added to this, showing that statement I is not correct.
• As for statement II, we need to net their gains and losses across all capital asset transactions, but without information on the nature (long-term or short-term) of the third stock sale, we cannot calculate the net short-term capital loss accurately. Assuming it is short-term, they would have a $111,000 short-term capital loss from the sale of the small business stock, and they could also have a $6,000 short-term capital loss from the defaulted loan ($8,000 - $2,000), which would result in a much larger short-term capital loss than $1,000, making statement II incorrect as well.

Therefore, the correct answer would be (d) Neither statement is correct.