CTC Portfolio Management & Strategy 3 — Questions and Answers
Question 1: A portfolio manager uses the specific identification method for selling mutual fund shares. What is the primary tax advantage of this method over FIFO?
- It automatically defers all gains to the following tax year
- It allows selection of high-basis shares to minimize current taxable gain (Correct answer)
- It converts short-term gains into long-term gains by law
- It eliminates wash-sale rule applicability on fund shares
Correct answer: It allows selection of high-basis shares to minimize current taxable gain
Specific identification lets the investor designate which shares (typically highest-cost) to sell, minimizing the recognized gain or maximizing the recognized loss.
Question 2: A client receives a Schedule K-1 from a limited partnership showing a $20,000 passive loss. Under the passive activity rules, this loss can generally be deducted against:
- Any ordinary income including wages
- Only income from the same partnership
- Passive income from other passive activities (Correct answer)
- Portfolio income such as dividends and interest
Correct answer: Passive income from other passive activities
Under IRC §469, passive losses may only offset passive income; they cannot offset active income (wages) or portfolio income (dividends, interest).
Question 3: For alternative minimum tax (AMT) purposes, which portfolio-related preference item is added back to regular taxable income?
- Long-term capital gains exceeding $50,000
- Accelerated depreciation on real property in excess of straight-line
- Qualified dividend income
- Municipal bond interest from private activity bonds (Correct answer)
Correct answer: Municipal bond interest from private activity bonds
Interest from private activity municipal bonds is exempt for regular tax but is an AMT tax preference item that must be added back when calculating AMTI.
Question 4: A taxpayer has $8,000 of net short-term capital losses and $5,000 of net long-term capital gains. What is the net result for the current year?
- $3,000 net short-term loss deductible against ordinary income (Correct answer)
- $3,000 net long-term loss deductible against ordinary income
- $3,000 capital loss carried forward to next year
- $8,000 capital loss carried forward; $5,000 gain taxed currently
Correct answer: $3,000 net short-term loss deductible against ordinary income
Short-term losses first offset long-term gains; the remaining $3,000 net short-term loss is deductible against ordinary income (up to the $3,000 annual cap).
Question 5: A CTC recommends placing growth stocks in a Roth IRA rather than a traditional IRA. What is the primary tax rationale?
- Growth stock dividends are tax-exempt in all account types
- Roth IRA contributions receive an upfront deduction reducing current taxes
- Tax-free Roth growth benefits are maximized when assets appreciate significantly (Correct answer)
- Traditional IRA distributions are always taxed at capital gains rates
Correct answer: Tax-free Roth growth benefits are maximized when assets appreciate significantly
Since Roth IRA qualified distributions are tax-free, placing high-growth assets there maximizes the benefit because the entire appreciation is never taxed.
Question 6: Which of the following is an example of tax alpha in portfolio management?
- Selecting securities with the highest expected pre-tax returns
- Generating excess after-tax returns through tax-loss harvesting and asset location (Correct answer)
- Eliminating all capital gains realizations from the portfolio permanently
- Investing solely in tax-exempt bonds to avoid all federal taxes
Correct answer: Generating excess after-tax returns through tax-loss harvesting and asset location
Tax alpha refers to the incremental after-tax return gained through deliberate tax strategies like loss harvesting, asset location, and tax lot selection — independent of investment selection.
Question 7: A client sells investment property at a $100,000 gain that includes $30,000 of unrecaptured Section 1250 depreciation. What is the maximum federal tax rate on the unrecaptured depreciation component?
- 0%
- 15%
- 20%
- 25% (Correct answer)
Correct answer: 25%
Unrecaptured Section 1250 gain (depreciation on real property) is taxed at a maximum rate of 25% under IRC §1(h), regardless of the taxpayer's overall capital gains rate.
CTC Portfolio Management & Strategy 3
A portfolio manager uses the specific identification method for selling mutual fund shares.
What is the primary tax advantage of this method over FIFO?