Tony's factory building was destroyed in a fire (adjusted basis of $90,000;fair market value of $140,000).Of the insurance proceeds of $128,000 he receives,Tony uses $88,000 to purchase additional inventory and invests the remaining $40,000 in short-term certificates of deposit.What is Tony's recognized gain or loss?
A)$0.
B)$12,000 loss.
C)$38,000 gain.
D)$40,000 gain.
E)None of the above.

Question

Quizplus · Accepted Answer

To calculate the recognized gain or loss, we need to determine Tony's adjusted basis in the building and compare it to the amount of insurance proceeds he received.

Tony's adjusted basis in the building is $90,000, but it was destroyed in a fire, so its basis is reduced to zero. Therefore, Tony has a realized gain of $140,000 (fair market value of the building) - $0 (adjusted basis) = $140,000.

However, Tony used $88,000 of the insurance proceeds to purchase additional inventory, which increases his basis in the inventory but does not affect the recognized gain or loss. The remaining $40,000 he invested in short-term certificates of deposit, which is considered a reinvestment of the insurance proceeds and does not affect the recognized gain or loss.

Therefore, Tony's recognized gain is $140,000, and he will owe taxes on that amount. The amount he reinvested in short-term CDs does not affect his recognized gain. Thus, the answer is C) $38,000 gain.

Tony's Factory Building Was Destroyed in a Fire (Adjusted Basis