AICPA Exam CPA-Regulation Topic 2 Question 18 Discussion

Choice 'b' is correct. An investment in a capital asset (e.g., stock) results in the income being capital (either a capital loss or a capital gain). Ownership percentage is not a factor in the calculation, and, in this question, nor is the fact that the corporation is not an S corporation. The calculation is simple:

Wallace invested $25,000 in the stock and received $200,000 for 100% of his investment 15 years later.

The capital gain is $175,000 ($200,000 - $25,000), and it is considered long-term because the stock was held for greater than one year.

Choice 'a' is incorrect. There is $175,000 of gain on the transaction ($200,000 - $25,000). This type of transaction is not a transaction that is excluded from tax in the tax code.

Choice 'c' is incorrect. An investment in a capital asset (e.g., stock) results in the income being capital (either a capital loss or a capital gain). Although the calculation of the income is correct (i.e., $175,000), ordinary income is not the proper treatment for this transaction.

Choice 'd' is incorrect. Although this transaction does result in a long-term capital gain, Wallace has basis in the stock ($25,000), and the gain is calculated as the proceeds from the sale ($200,000) less the basis in the stock.