Federal Income Tax - Brown
Federal Income Tax - Brown
Federal Income Tax - Brown
Professor Brown
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I. OVERVIEW & BASIC PRINCIPLES
1. Overview
a. Study & Practice of Law
i. Three Sections of Federal Income Tax:
1. Income;
2. Deductions; and
3. The merging of the two.
b. Brief History
i. Federal Income Tax is outlined in USC, Title 26.
1. The most recent edition is 1986.
2. The Tax Code is a revenue maker and a means used to curb or
encourage certain behaviors.
ii. Amendment Sixteen set the groundwork for Congress to impose a federal income
tax.
1. The Amendment trumped the Apportionment Clause in Article 1, 8 & 9
because it would be impossible to impose.
2. Article 1, 8 gives Congress the power to levy taxes.
3. Courts consistently reject DPC and EPC taxpayer arguments
iii. Reagan is responsible for dropping the tax rates. Clinton raised the tax rates.
Currently, Bush is attempting to lower the tax rates again.
c. Tax Policy
i. This countrys federal income tax system is based upon Schanz-Haig-Simons. It
takes into account both wealth and personal consumption.
1. Individuals Income for a Year = Net increase in wealth plus the market
value of consumption for personal purposes during the year, measured at
year-end.
a. Arrived at indirectly by measuring: Current-year receipts minus
business and investment deductions plus the increase in wealth
or less the decrease in wealth.
ii. The Federal Income Tax is progressive, not proportionate (flat tax).
1. Taxpayers in higher marginal brackets benefit less from additional income
than taxpayers in lower marginal brackets, while taxpayers in higher
marginal tax brackets benefit more from deductions than taxpayers in
lower brackets.
2. FICA is a flat tax.
iii. This country generally has a time-based system of reporting, not a transactionbased system of reporting. An exception is gains and losses derived from
dealings in property.
iv. Higher Tax Rates versus Lower Tax Rates:
1. Lower Rates (Conservatives)
a. Lower rates result in more efficiency.
i. Eg. Purchasing machinery and investing.
b. Favor a Consumption Tax.
i. An individual is only taxed on personal consumption;
thus, the burden of a consumption tax falls hardest upon
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iii. 62(a). Adjusted gross income defined (GI minus the following deductions).
1. The deductions listed under 62 are above-the-line deductions. Thus, an
individual takes these deductions to get to AGI, and may take their
personal exemption and either the standardized deduction or itemized
deductions in addition to these above-the-line deductions.
iv. 151. Personal exemption defined.
1. (d). Personal exemption amount. (c). Dependents defined.
2. Allowance for living to meet the most basic needs.
v. 63(c). Standard deduction defined.
1. Allowance for living to meet the most basic needs.
vi. 63(a). Taxable income defined (GI minus the deductions allowed by this chapter
(other than the standard deduction)).
1. 63. Determines what is deducted from GI to get to taxable income.
2. TI is the tax base and the tax base is what is subject to taxation.
3. Tax Liability is what each individuals owes after their tax is determined.
vii. Problem 1.1.
1. Jorge (S)(No dependents)
a. Salary = 50,000
b. Dividend Income = 500
c. GI = 50,500
d. AGI = 50,500
e. TI = 50,500 - 500 (dividends) - 4,750 (standard) - 3,050 (personal)
= 42,200
f. TL = 500*15% + 3,910 + (25%*(42,200 - 28,400) = 7,345
b. Earned Income Credit
i. 32. Money is transferred back to taxpayers whose income is below a certain level
(transfer payment). Refundable credit, so a taxpayer does not have to pay this
amount back to the IRS.
1. 32(c). In order to qualify for this section, the taxpayer must be at least 25
and not over 65. This section also defines qualifying children.
ii. Problem 1.2(a).
1. Natasha (HH)(3 dependents)
a. Salary = 15,000
b. Standard = 7,000
c. Personal (x4) = 12,200
d. TI = Negative
2. Analysis.
a. (b)(1)(A): Get credit percentage by # of children.
i. 40%
b. (b)(2)(A): Get earned income amount by # of children.
i. 10,510
c. Credit percentage * earned income amount = maximum earned
income credit.
i. 40%*10,510 = 4,204
d. Limitation under (a)(2) (but see handout): Depending on amount
of children, once earned income (earned income defined in (c))
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i. Thus, start with everything being included in GI (and tax base) and then determine
if may be excluded or deducted, etc. pursuant to 61s except as otherwise
provided
b. Glenshaw Glass (US 1955)
i. Rule. To be included in GI under 61, there must be three things:
1. Accession to wealth;
2. Clearly realized; and
3. Complete dominion.
ii. Importance. If not enumerated under 61, it must pass this three prong test to be
included in GI.
2. Windfalls & Property in Kind
a. Problem 2.1(a).
i. Winning new home on game show, or gambling winnings.
ii. Analysis.
1. Included in GI because passes Glenshaw Glass, and falls under 74, and
not 102 (thus falling under 61), because this is not a flat out gift,
because as a contestant some work had to be put in to get the house.
2. 74. Prizes and awards part of GI.
3. 102. Gifts are excluded from GI.
4. 1001. The amount of the winnings is the AB so the taxpayer is not taxed
twice.
5. Policy. Horizontal equity (similarly situated people should be treated the
same).
b. Problem 2.1(b).
i. Tanyas employer transfers to her title to land in exchange for services rendered.
ii. Analysis.
1. 61(a). Treated as compensation for services and FMV included in GI.
2. Policy. Horizontal equity.
c. Problem 2.1(c).
i. Finds a new handbag worth $500.
ii. Analysis.
1. Included in GI because Glenshaw Glass.
2. 1.61-14. Treasure trove constitutes GI when undisputed possession.
3. Note. If a taxpayer does not step forward and report, this is practically
impossible for the IRS to track.
3. Realization of Income
a. Problem 2.1(f).
i. Martha leases land. Tenant improves by adding a building in 2003 with AB of
500,000. In 2028, transfers back to Martha, and the FMV of the building is
550,000. Marthas AB in the land is 100,000. She sells later for 700,000 (100,000
allocated to land).
ii. Analysis.
1. 109. Overruled Bruun. The value of the improvement not included in GI
upon reversion. Thus, exclusionary section.
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2. 1.61-2(d)(2)(i). Confirms this holding.
3. 102(c). Employer gifts must be included in GI.
a. Exception. Birthday gift.
4. AB = 5000
5. Barter Exchanges
a. Problem 2.1(h).
i. Brothers: Wedding cake (600) for will-drafting (600).
ii. Analysis.
1. 102. When relatives or friends in barter exchange, assumed to be
excludable. However, the parties must attempt to prove that there was
no reciprocity. They did it for each other just out of love.
2. Rev Rule 79-24 & 1.61(2)(d)(1). When strangers, treated as
compensation paid other than cash, so included in GI.
6. Imputed Income
a. The term imputed income refers to the gross annual fair rental value of consumer assets,
such as residences, automobiles, and the like, or the value of self-provided services.
i. Not included in GI because impossible to administer and people should not be
forced into the labor market. Also, can be seen as barter exchange and reciprocity
from the family standpoint.
1. Economists think that imputed income should be taxed because for
efficiency reasons.
b. Problem 2.1(i).
i. Thomas stays home and cares for the house and children when the wife works.
ii. Analysis.
1. Not included in GI.
2. Again, this is actually beneficial for tax purposes to Thomas and his wife
because of the Condoleeza problem.
a. Because this may provide incentive for taxpayers to stay at home,
there are two sections that mitigate this incentive:
i. 21. Allows a credit.
ii. 129. Allows a 5,000 credit when child-care is provided
by employer.
c. Problem 2.1(j).
i. Benefits of owning a home.
ii. Analysis.
1. Not included in GI, thus, an incentive is created for home ownership.
a. Again, economists hate this because they argue for market
efficiency, some should invest in the stock market and not in
homes.
III. IN-KIND CONSUMPTION BENEFITS
1. Introduction: Why Tax In-Kind Benefits (Fringe Benefits)?
a. 132(a). Lists fringe benefits that are excluded from GI. Why do we have this section?
i. Industry practices and employee expectations;
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d. Problem 3.4.
i. Fred accumulates frequent flyer miles when on business trips that are deductible
under 162. He uses these miles for other client related trips.
ii. Analysis.
1. 132(d) or Gotcher. Working condition fringe, meaning, if employee paid
for it, and was able to exclude it under 162, or 167, it is excluded under
132 if the employer pays for it.
a. If primarily benefiting employer, than it is excluded from GI. Thus,
excludable by Fred.
2. Note. Even if Fred used these miles for personal use, they would not be
included in GI because it is impossible for IRS to administer. Actually, the
IRS put out a Notice, stating that personal use of frequent flyer miles
should be included in GI, but that they are delaying enforcement because
they dont know how to enforce.
e. Problem 3.5.
i. Freds wife accompanies on trip for personal purposes and the company
reimburses for that.
ii. Analysis.
1. 132(d). Must include her portion of the trip in Freds GI because Fred
cannot deduct her trip under 162 or 167. See also Gotcher (wifes trip
value included in GI).
a. Gotcher. The amount is included in Freds GI, not the wifes GI
because it is treated as a gift to the wife.
2. 274(m)(3). No deduction for spouse travel.
3. Meals & Lodging
a. Problem 3.6.
i. Firefighters work three day on, and three day off. On their days on, they are
provided free room and board.
ii. Analysis.
1. 119(a). Not included in GI because requirements for meals and lodging
are met.
a. For meals to be excluded, two requirements must be met:
i. For convenience of the employer; and
ii. Furnished on business premises.
b. 1.119-1(b). For lodging to be excluded, three requirements must
be met:
i. Furnished on business premises of employer;
ii. Furnished for convenience of the employer; and
iii. The employee is required to accept such lodging as a
condition of his employment.
1. Example of who would qualify:
a. Superintendent of building.
2. Example of who would not qualify:
a. Professor given housing because
requirement three missing.
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b. 119(d) Exception. If school owns
building and subsidizes, the professor
does not need to include the difference in
market rate and her rate in GI.
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i. If a person just does not want to repay, but has the ability
to that does not meet this standard.
b. 166(a). This is a wholly worthless debt.
c. 166(d)(2). Considered a non-business debt because they are
friends, and interest alone is not enough to turn into business.
d. 166(d)(1)(B). Because non-business debt, must be treated as
STCL, thus, may only take deduction up to the amount to offset
against STCG.
i. If no STCG, may still deduct up to 3,000.
ii. This is why business loans are favored. There does not
have to be CG to offset the worthless debt.
iii. Problem 2.4.1(c).
1. Now, Monique can only repay 2,500.
2. Analysis.
a. 166(a). For business debts, partially worthless debts are
deductible. But for non-business debts, no such deduction exists.
i. Thus, Jessica may not take a deduction.
b. Policy. The IRS does not want disguised gifts.
iv. Problem 2.4.2.
1. Anne recovers judgment for wrongful death of relative. She cannot
collect.
2. Analysis.
a. Rev Rule 93-27. A taxpayer is not entitled to a bad debt deduction
under 166 for the amount of the taxpayers own payment in
support of the taxpayers children caused by an arrearage in
court-ordered child support payments owed by a former spouse.
b. Thus, in this problem, Anne does hot have a basis in the money;
thus, she is not able to take a deduction. In fact, in all cases, if an
individual has a piece of paper stating that money is due them,
and they do not receive it, no deduction is permitted.
c. Debt Discharge Income
i. Problem 3.4.1.
1. Joshua loaned Mona 60,000 and discharged it because she filed
bankruptcy or her liabilities outweighed her assets by 85,000.
2. Analysis.
a. 61(a)(12) & Kirby. Generally, have to include debt discharge in
GI as ordinary income when the taxpayer knows that they are not
responsible for paying back any longer.
b. 108(a) Exceptions.
i. Four exceptions when taxpayer does not have to include
debt discharge in GI, including:
1. Filed for bankruptcy; or
2. The taxpayer is insolvent pursuant to 108(d)(3).
ii. 108(b). Although the taxpayer does not have to include
in GI, they have to take the amount they are not including
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i. A nonrecourse debt is, in general, a secured obligation for which the debtor is not
personally liable. The nonrecourse lenders only remedy on default of a
nonrecourse debt is foreclosure on the property security.
ii. A recourse debt is, in general, one for which the debtor is personally liable;
whether or not the debt is secured by property, the lender can hold the debtor
personally liable if the recourse debt is not repaid.
iii. Point. Both types of loans included in AB.
b. Effects of Debt on Basis
i. Problem 4.4.1 & 4.4.2.
1. Crystal purchases building with 20,000 cash and 280,000 in recourse debt
or non-recourse debt.
2. Analysis.
a. 1012. Basis of property includes cost both cash and recourse
or non-recourse loan.
b. Thus, Crystals AB is 300,000.
ii. Hypo of Debt Relief Less than Property Value.
1. Crystal sells the building for 325,000. The buyer takes subject to the
debt, and pays 45,000 cash.
2. Analysis.
a. 1001(a) &(b) and Cranes Economic Benefit Theory. Debt relief
is included in AR.
b. Thus, 325,000 300,000 = 25,000 recognized capital gain.
iii. Problem 4.4.3.
1. Same as 4.4.1, but the value of the building rises to 340,000, and Crystal
borrows 40,000 to buy a car for personal use, using the building as
security.
2. Analysis.
a. Not indebtedness related to the building, so her AB in the building
does not change.
b. Also, it is a loan, so her AB in the car becomes 40,000, with no
recognition of GI because obligation to repay.
c. 1016(a)(1). If the loan was taken to improve the building, it would
be a capital expenditure, and it would have raised the AB of the
building 40,000.
c. Effect of Debt on Amount Realized when Debt Relief is Greater than Property Value
i. Problem 4.4.4.
1. Debt Relief Greater than Property Value: Crystals AB is 272,000
(because of depreciation). Debt is 280,000. FMV of building is 275,000.
Bank accepts conveyance in full satisfaction of the debt.
2. Recourse Analysis.
a. Rev Rule 90-16 (OConnors Tufts Concurrence). Must take a
bifuricated approach.
i. Discharge of indebtedness ordinary income: Recourse
debt FMV = 280,000 275,000 = 5,000
ii. Disposition of property capital gain: FMV AB = 275,000
272,000 = 3,000
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to 100,000. In 2003, the Bank agreed to lower loan to 100,000 from
250,000. Jose is not bankrupt or insolvent.
a. Note. Because two year time has passed, he has taken 12,000 in
depreciation deductions, and his AB becomes 238,000.
2. Analysis.
a. Note. This falls under 108(c) and not 108(e) because this is not
seller financed. Better to fall under (e) because just reduces your
basis and defers gain.
b. Old Rev Rule 91-31 (Bad Law). Would include 150,000 of
discharge of indebtedness income, and that would side-step
Tufts. So Congress enacted 108(c).
c. 108(c)(1). There is an election to make:
i. Option One: Include the discharge of indebtedness in GI
and no change in AB; or
ii. Option Two: Exclude from GI, and reduce his AB.
1. Option Two Limitation (c)(2). Can only reduce AB
in the amount of the principal amount of the loan
minus new FMV of property.
d. In this case:
i. Option One: Jose would include 150,000 in GI.
ii. Option Two: Jose would reduce AB to 88,000, which is
238,000 (Current AB) 150,000 (amount discharged).
1. Limitation: 250,000 100,000 = 150,000. So
Jose may only reduce AB by 150,000, which he
is able to do here.
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b. Standard = 4,750
c. Personal = 3,050
d. TI = 117,200
e. TL = 27,562 * 2 = 55,124
4. Note. Table 1(d) is married couples filing separately.
5. Married Couple versus Single.
a. Illustrates marriage bonus and single penalty built into tax tables.
b. Tax tables assume that the standard of living for one individual is
lower than married individuals.
c. 33% rate kicks in later for married taxpayers.
6. Married Couple versus Unmarried Couple.
a. Illustrates marriage penalty.
b. Unmarried Intact Couples
i. Problem 5.2
1. Gay Couple with Only One Earner (Table 1(c))
a. Salary = 250,000
b. Standard = 4,750
c. Personal = 3,050
d. TI = 242,200
e. TL = 67,497
2. Married Couple in Same Situation
a. TL = 58,797
3. Importance.
a. Gays cannot take advantage of marriage bonus because they
cant get married (Mueller in 7th Circuit).
b. Gays cannot even take advantage of head of household:
i. Would have to try under 2(b)(1)(A)(ii).
ii. But when flip to 151(c)(1)(A), can claim an exemption for
a dependent as long as GI is less than the exemption
amount. So that fits here, but now need to flip to 152 to
see if he is a dependent.
iii. 152(a)(9) may provide an in here to filing as head of
household. However, must look at 152(b)(5).
iv. 152(b)(5) was a hurdle, but it may not be anymore
because of Lawrence. However, now must look at 2(b)
(3)(B)(i).
v. 2(b)(3)(B)(i) means that head of household status would
not work for gays because can't take it if fall under
152(a)(9).
c. Couples Who Break Up
i. 71.
1. (a). Overrules Gould in defining alimony and separate maintenance
payments and states that alimony payments received are included in GI,
and are an above-the-line deduction (215) by the payor.
a. Note. If the parties still want Gould to rule, they just must explicitly
state it and no GI for payee, and no deduction for payor.
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property with an AB of the transferors FMV and the transferor would suffer the tax
consequences).
i. 1041 does two things:
1. (a). There is no loss or gain realized on the transfer if married, or if it is
incident to the divorce. Thus, property transfers are not taxable to
anyone.
2. (b). The property transfer is treated as a gift. Thus, no GI, and the
transferee takes the AB of the transferor.
a. Effect: The gain or loss is built in and the tax consequences are
borne by the transferee.
ii. Regulations define (c)(2) as meaning within six years of the divorce. Thus,
incidence of the divorce lasts for six years, and the parties have that long to do
these property settlements.
b. Problem 5.4.
i. As incidence to the divorce, Max transferred to Sandra residence with AB of
275,000 and with FMV of 500,000. Sandra transferred to Max land with AB of
295,000 and FMV of 265,000 and 10,000 cash.
ii. Analysis.
1. Sandra: No GI, and takes an AB of 275,000. Sandra gets no deduction.
2. Max: No GI, and takes an AB of 295,000. Max gets no deduction.
3. Thus, the losses and gains are built into the land. Even the 10,000 cash
has no tax consequences, not even treated as GI.
a. Again, Max and Sandra could have agreed and made it fall under
71(b), it then there would have been tax consequences.
c. Problem 5.5.
i. Roberta owns land in which she has an AB of 40,000. The land has a FMV or
320,000 and is subject to 250,000 non-recourse mortgage. As part of a court
order, had to transfer to ex-husband as part of divorce settlement.
ii. Analysis.
1. Ex-husband: No GI, and takes an AB of 40,000.
2. Roberta: No tax consequences. (1041 trumps Crane).
3. If ex-husband sells for FMV, without paying off any of the debt:
a. AR = 320,000
b. AB = 40,000
c. Thus, gain recognized of 280,000.
i. Remember, if the ex-husband paid off any of the debt,
that would boost his AB.
VI. GRATUITOUS TRANSFERS
1. Introduction
a. 102(a). As a general rule, the value of property is not included in GI when it is a gift,
bequest, devise, or inheritance.
b. 102(b). States that exclusion of gifts from income does not extend to the income earned
on the property given as a gift.
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c. 102(c) & 1.102-1(f)(2). There cannot be a gift between employer and employee unless it
can be proven the gift was not given in recognition of the employees employment
(meaning, relatives or birthday).
d. Duberstein (US 1960)
i. Rule. In determining if a transfer is a gift, it depends on the transferors intent.
1. This is an extremely fact-based analysis and provides no bright lines.
2. A gift in the statutory sense proceeds from a detached and diminished
generosity, out of affection, respect, admiration, charity, or like impulses.
3. Olk and Harris agree. It is a factual analysis and it cannot be quid pro
quo.
a. Olk (Treated as GI because the gift was for services previously
rendered)
b. Harris (A person is entitled to treat cash and property received
from a lover as gifts, as long as the relationship consists of
something more than specific payments for specific sessions of
sex; but remember, donors intent controlling)
i. When personal relationship, it may not be quid pro quo,
and may be treated as a gift.
e. 1014(a). Addresses property received by death, provides that the basis of the property of
the transferee is the FMV at the date of the death. (Thus, loss eliminated if there is one).
i. 1022. Effective only for the year 2010. After 2010, 1014 is the relevant rule
again. In 2010, the AB of the beneficiary is the lower of:
1. The AB of the decedent; or
2. The FMV of the property as the date of the decedents death.
f. 1015(a). Addresses inter vivos gifts, states that the donors AB carries over to the donee if
the FMV exceeds the AB at the time of the gift, and if the AB exceeds the FMV at the time
of the gift, there are three possible outcomes (to discourage transfer of loss property):
i. If the AR on a sale by the donee is less than the gift-time value, the gift-time value
fixes the donees basis;
ii. If the AR by the donee is greater than the donors date of gift basis, the donee
takes the donors basis; or
iii. If the AR realized by the donee is greater than the gift time value but less than the
donors basis, the donees basis is effectively deemed to equal the amount
realized, resulting in no gain or loss to the donee.
g. There are always two types of taxes in the air when discussing gifts or inheritances:
i. Gift Transfer Tax; and
1. Remains intact.
2. The transferor must pay, and it is applicable when addressing inter vivos
gifts.
ii. Estate Tax
1. Slowly being repealed, and by 2010 there will be none.
2. Applicable when addressing transfer upon death.
h. Gift Transfer Tax Analysis.
i. General. Gift tax, with top rate of 35% is imposed on the transferors FMV without
deducting the donors AB.
ii. Exclusions.
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1. Lifetime Exclusion:
a. 1,000,000
2. Yearly Exclusion:
a. 11,000
iii. Example: If parents give you an inter vivos gift of 16,000, they may exclude the full
16,000 from the transfer tax.
1. 11,000 yearly, and then there 1,000,000 lifetime exclusion is reduced by
the excess 5,000. Thus, leaving their life exclusion at 9,995,000.
2. Once, the lifetime exclusion is tapped out, may only exclude up to
11,000/year.
3. Thus, if the lifetime exclusion has not been used ever, a one-year
exclusion can reach as high as 1,011,000.
4. Husband and wife count as two different taxpayers; so in essence, a
lifetime exclusion of 2,000,000.
iv. When the gift transfer tax is paid, the donee may increase her basis. See
Problem 6.4.
i. Estate Tax Analysis.
i. General. In 2003, there is a top 50% estate tax rate. In 2009, there will be a top
45% estate tax rate. In 2010, there is no estate tax (however, IRS compensates
by lowering AB).
1. These are graduated schedules, the larger the estate, the higher the tax.
ii. Exclusions. In 2003, may exclude up to 1,000,000 of estate from the tax. In 2009,
may exclude up to 3,500,000. Again, in 2010, no estate tax.
iii. See Problem 6.3(c) for 2010 AB analysis.
2. Gift, Bequest & Inheritance (Inter Vivos)
a. Problem 6.2(a).
i. Sayuri transfers land in which she has an AB of 50,000 and FMV of 75,000 to
Keren as an inter vivos gift. (Assume no transfer taxes).
1. Analysis.
a. 1015(a). Keren: AB is 50,000.
b. 102(a). Keren: No GI.
c. 1001. Sayuri: Gifts are no dispositions, so there is no gain
recognition. The gain is built in and transferred to Keren.
d. Sayuri: No deduction permitted for gifts.
b. Problem 6.2(b).
i. Sayuri transfer land in which she has an AB of 50,000 and FMV or 42,000 to
Keren, and two years later, Keren sells for:
1. 70,000
a. Keren: AB 50,000. AR 70,000. GR 20,000.
2. 40,000
a. Keren: AB 42,000. AR 40,000. Loss 2,000 (and may take under
165(c)(2)(1).
3. 80,000
a. Keren: AB 50,000. AR 80,000. GR 30,000.
4. 45,000
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a. Keren: AB is sales price, so no gain or loss. If Keren sells
anywhere in between FMV transferred to her and AB transferred
to here, her AB becomes the sales price.
c. Problem 6.4.
i. Winston owns land with AB of 100,000. Worth 400,000 when transfer inter vivos
gift to daughter Mitzi. Winston paid 80,000 gift transfer tax (note: may exclude if
lifetime exclusion not tapped out).
1. Analysis.
a. 1015(d)(1)(A). If the donor pays the gift transfer tax, the donee
may increase her AB.
b. 1015(d)(6)(A). Determines how much the AB may be raised:
i. First, determine percentage:
1. Numerator is donors appreciation; and
a. 400,000 100,000 = 300,000
2. Denominator is FMV of the gift.
a. 400,000
3. 75%.
ii. Second, take percentage and multiply it by the gift tax
paid:
1. 75% * 80,000 = 60,000.
iii. Thus, Mitzi may increase her AB by 60,000. So,
1. 100,000 + 60,000 = 160,000 AB
2. Important Note.
a. In order for there to be a gift transfer tax, there must be
appreciation in the property. Because the numerator/denominator
analysis, in determining the numerator, it must be a positive
number.
3. When gift tax rates and federal income tax rates are equal (30%), is
1015(d) successful in tax parity? Yes, the total tax burden is the same;
however, the tax is borne by different parties.
a. Gift Tax:
i. 400,000 (FMV) * 30% = 120,000
ii. 120,000 * 75% (calculation from above) = 90,000
iii. Mitzis AB is now 190,000
iv. If Mitzi sold for 400,000, RG of 210,000.
v. 210,000 * 30% (tax rate) = 63,000
vi. Total taxes paid by both parties = 183,000
b. If Winston sold the property and gave proceeds to Mitzi:
i. If Winston sold for 400,000, RG of 300,000.
ii. 300,000 * 30% = 90,000.
iii. Mitzi would receive 310,000 cash, and Winston would
have to pay gift tax of 30% on the 310,000.
iv. 310,000 * 30% = 93,000
v. Total taxes paid by Winston = 183,000
3. Gift, Bequest & Inheritance (Death)
a. Problem 6.3(a).
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i. A dies. AB in residence was 250,000 and on date of death, the FMV was 320,000.
Residence left to M in will.
1. Analysis.
a. 1014(a). Ms AB is 320,000.
i. Stepped up basis good for taxpayers because gain not
transferred over.
ii. Can act as a huge tax shelter if keep in family through
wills.
b. Problem 6.3(b).
i. A dies. AB in residence was 250,000 and on date of death, the FMV was 200,000.
Residence left to M in will.
1. Analysis.
a. 1014(a). Ms AB is 200,000.
i. Takes on FMV again, and cannot receive built in loss.
c. Problem 6.3(c).
i. In 2010, A dies. AB in residence was 250,000 and on date of death, the FMV was
320,000. Residence left to M in will.
1. 1022 Analysis.
a. Must take lower of decedents AB or FMV, so in this case,
250,000.
b. (b). Possibility of AB increase.
i. (b)(2)(B). Executor only allowed to distribute an
aggregate increase of 1,300,000 across the entire estate.
However, AB cannot be raised over FMV.
1. So, in this problem, Ms AB may be raised to
320,000.
c. (c). If the beneficiary is the spouse, only the spouse may get an
additional 3,000,000 AB adjustment. Again, cannot exceed FMV.
4. Part-Sale/Part-Gift
a. Problem 6.5(a).
i. Susan and Ulrike are sisters. S has AB in land of 15,000 with FMV of 40,000. S
sells to U for 25,000. (Note: Gain for transferor in part-sale/part-gift).
1. 1.1015-4 Analysis.
a. This is a part-sale/part-gift transaction because it is a sale for less
than FMV that is not an arms length transaction.
b. Susan:
i. Capital Gain Realized = AR AB
1. 25,000 15,000 = 10,000
ii. Gift Transfer Tax = FMV sale price
1. 40,000 25,000 = 15,000 gift
2. So, Susan, if cannot exclude because of yearly
or lifetime, would have to pay gift transfer tax on
that amount.
c. Ulrike:
i. AB = Greater of:
1. Transferors AB; or
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2. Amount paid.
ii. So, in this case, Ulrikes AB will be 25,000.
1. If Susan does pay gift tax, Ulrike can raise her
AB.
ii. Hypo. Instead of paying cash, Ulrike just assumes the 25,000 non-recourse debt
Susan had on the land.
1. Same result pursuant to Crane and the disposition of the loan.
b. Problem 6.5(b).
i. Susan and Ulrike are sisters. S has AB in land of 60,000 with FMV of 50,000. S
sells to U for 40,000. (Note: Loss for transferor in part-sale/part-gift).
1. Analysis.
a. 1.1001-1(e)(1) & 267(a)(1).
i. In a part-sale/part-gift transaction, losses may not be
recognized. Thus, Susan may not take her 20,000 loss.
b. 1.1015-4. The transferee must take the transferors FMV as her
AB unless the transferee ends up selling the property for more
than transferors AB they she must take the transferors AB.
i. In this problem, Ulrike would take on an AB of 50,000
unless she sells the property from more than 60,000.
5. Interest-Free or Below Market Loans
a. 7872(c). 7872 applies to the loans listed under (c). The most common ones are gift
loans (including below the market loans).
i. Gift Loan defined in (f)(3).
ii. Below Market Loan defined in (e)(1).
iii. Demand Loan defined in (f)(5).
iv. Compensation Related Loan defined in (c)(1)(B).
1. Loan between employer and employee or corporation and shareholder.
b. 7872(a). Gift Loans and Demand Loans (both below the market loans) fall under (a)
analysis for interest calculation.
i. Analysis. See Problem 6.6.
c. 7872(b). Term Loans (still a below the market loan) falls under (b) analysis for interest
calculation.
i. Analysis. Complicated, thus, not responsible for.
d. Problem 6.6.
i. Michael loans 100,000 to sister with 0% interest on January 1, 2003. It is a
demand loan because his sister only has to pay it back when requested by
Michael and falls under gift loan under (c)(1)(A). She pays back on January 1,
2008. For 2003, federal interest rate is 4% compounded semi-annually.
ii. Compounding.
1. First Half of Year: 100,000 * 2% = 2,000.
2. Second Half of Year: 102,000 * 2% = 2,040.
3. Thus, 2003 interest = 4,040.
iii. 7872(a) Analysis for 2003.
1. In essence, a fictional transfer because the interest is transferred and
retransferred on the last calendar day of the year.
2. Andrea:
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a. Under 102, may exclude the interest from GI because it is
treated as a gift.
b. 163(h). She may deduct the 4,040 if she uses the loan for a
business even though she does not have to recognize the interest
as income because of 102.
i. Point. These gift loans are great for the borrower, and
suck for the lender.
3. Michael:
a. Under 61(a), must include 4,040 interest in GI as interest
income.
b. Because a gift, Michael must also pay gift transfer tax on the
4,040 if he cannot exclude it under yearly exclusion or lifetime
exclusion.
4. Exceptions.
a. (c)(2). De minimus. If loan is under 10,000, then it is excluded
from 7872 rules. However, gift tax still applies.
5. Limitations for Gift Loans.
a. (d)(1)(A). When a loan does not exceed 100,000, no interest will
be retransferred back to the lender to recognize in GI, and if the
loan is over 100,000 and the borrower used the loan proceeds to
run a business or to derive net investment income, the interest
does get retransferred back to the lender to include in GI;
however,
i. The interest that gets retransferred back may not exceed
the borrowers net investment income.
1. So, in this problem, 4,040 would be the cap.
ii. And, according to (d)(1)(E), if there is net investment
income but it does not exceed 1,000, then it will be
treated as 0, and no interest will be retransferred back to
the lender to include in GI.
b. This limitation only applies to GI, the gift tax is still applicable.
e. Hypo.
i. If a compensation related loan, what are the consequences?
ii. Employee/Employer Analysis.
1. Borrower (employee):
a. 61: 4,040 included in GI because free interest treated as
compensation.
b. 163(h): If the employee can fall under one of these exceptions,
may deduct the interest.
2. Lender (employer):
a. 61: 4,040 included in GI because interest income.
b. 162: Lender may deduct 4,040 because may treat as salary or
compensation.
3. Note. No 100,000 exception/limitation in this type of below market loan.
4. Note. Again, this is only addressing GI, there are still the gift tax
consequences.
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ii. Kai borrowed 25,000 from bank to purchase an SUV for personal purposes.
1. In this case, not told if Kai borrowed money against the house, so no
interest is deductible.
2. However, if told he borrowed against his house, the interest on the loan for
the SUV would be deductible under (h)(3)(A)(ii).
a. (h)(3)(A)(ii). Home equity indebtedness interest is deductible.
i. Hypo: Kais FMV of home is 360,000 and his debt
outstanding is 285,000 and borrowed against that.
1. Limitation. As said, if secure a loan with house as
security, can deduct the interest on that loan too.
But there is a limit: whatever is lessor 100,000
or difference in FMV and acquisition debt of the
house. In this problem, Kai would only be able to
borrow 75,000 (360,000 285,000), so he does
not hit the 100,000 limitation.
a. But if Kai borrowed 100,000 from the
bank and used the house as security, he
would only be able to deduct the interest
on 75,000.
c. Two Limitations on Below-the-Line Deductions
i. 67. 2% Floor Limitation.
1. Analysis.
a. First, take AGI * 2%.
b. Second, aggregate all itemized deductions that are not excluded
from this limitation under 67(b).
c. Third, may only take the itemized deductions that exceed the 2%
of AGI.
2. In this problem, both charitable deductions, and personal interest are
exempt from this 67 because listed under (b).
ii. 68. Overall limitation.
1. Remember: Must do 67 before 68, and that 67 amount is what is
relevant under 68.
2. Analysis.
a. First, under (b)(1), the applicable amount for single people is
139,500. So AGI must be over that amount for 68 limitation to
apply.
b. Second, pursuant to (a), must reduce itemized deductions by
whatever is lessor:
i. (AGI applicable amount) * 3%; or
1. 175,500 139,900 = 35,600 * 3% = 1,080
ii. 80% * itemized deductions.
1. 80% * 18,000 = 14,400
3. So, in this problem, Kai must reduce his itemized deductions by 1,080.
a. So, total itemized deductions = 18,000 1,080 = 16,920.
d. Standard Deduction versus Itemized Deduction
i. A taxpayer should take whatever is larger.
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ii. In this problem, because Kai is Head of Household, his standard deduction would
only be 4,400 pursuant to 63(c)(2). So, he should take his itemized deductions.
e. Personal Exemptions
i. 151(d). Amount is 3,050.
1. (a). Taxpayer gets one.
2. (b). Spouse gets one.
3. (c). Other qualifying dependents get one.
a. 152(e)(1). The parent who has the children more than half of the
year get the personal exemption.
b. (a)(9). If another lives in household and has under 3,050 in GI,
they may also be counted as an exemption.
i. For our purposes, we will treat Oscar as not receiving the
500,000 and not an illegal relationship under 152(b)(5).
ii. Limitation under 151(d)(3).
1. For every 2,500 increment AGI is over head of household applicable
amount of 174,400, the personal exemption amount must be reduced by
2%.
a. Note. Different numbers for different status.
2. So, in this problem, Kais AGI is 175,500, which is only over 174,400 once,
so his personal exemption of 12,200 must be reduced by 2% = 11,956
personal exemption permitted.
10. Computing Federal Income Tax of Individuals
a. Kai Computation.
i. GI:
1. Salary (125 exclusion)
174,500
2. Prize (74)
10,000
3. Property Part-Gift
15,000
4. GI =
199,500
ii. AGI:
1. Alimonry
24,000
2. AGI =
175,500
iii. TI:
1. Personal Exemption (x4)
11,956
2. Itemized Deductions
16,920
3. TI =
146,624
iv. TL = 33,802.22
b. Oscar Computation.
i. GI and AGI = 500,000
ii. Standard Deduction = 4,750
iii. Personal Exemption = 0 (phaseout completely reduced)
iv. TI = 495,250
v. TL = 154,669.50
VIII. BUSINESS, PERSONAL OR INVESTMENT
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1. Examples: Tracking stock investments,
dividends, owned rental property, and other side
businesses.
d. Primuth (Employee already in trade or business, but spends
money looking for another job in trade through employment
agency the court held that was deductible)
b. Problem 8.1.1.
i. Joan is self-employed and puts ad in paper for 290,000 correcting the fact that
she was part of a Nobel Prize scientist team.
1. Rev Rule 92-80. All advertising is deductible under 162(a) although there
are future benefits.
c. Problem 8.1.2.
i. Sylvester is employed as an auto mechanic with a GI of 35,000. Pays 600 to clean
uniform. Pays 400 in union dues. Pays 500 for WSJ subscription to track his side
investments.
1. Analysis.
a. May deduct the cleaning of the uniform and union dues under
162(a). May deduct the WSJ under 212.
i. All below-the-line because not employer reimbursed, so
would have to do 67 and 68 limitation analysis:
1. 67.
a. None of his itemized deductions are
excluded under (b), so he has total of
itemized deductions for 67 purposes of
1,500.
b. 35,000 * 2% = 700
c. So, may only take 1,500 700 = 800 in
itemized deductions.
i. Thus, he should take his
standard deduction.
b. Hypo. If Sylvester also had and interest deduction under 163(h)
(3), that would not be subject to 67 because listed under (b), and
68 is not relevant because only relevant if AGI is over certain
amount.
2. Loss Deductions
a. 165(a). General Rule. Losses in a trade or business entered into for profit are deductible.
i. 165(c). Limitations (only for individuals). May only deduct loss if:
1. (c)(1). Incurred in a trade or business; or
2. (c)(2). Incurred in any transaction entered into for profit, thought not
connected with a trade or business.
b. 183. Address hobby (activities that are not for profit, like puppy breeding for fun) losses.
i. General Rule. Deductions related to that activity may only be allowed up to the
income generated from that activity.
c. Problem 8.1.3.
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c. Third, 1.162-1.
i. Must be directly connected with or pertaining to the
taxpayers trade or business.
d. Fourth, 274(a).
i. Must be directly related to, or in the case of an item
directly preceding or following a substantial and bona fide
business discussion, that such item was associated with,
the active conduct of the taxpayers trade or business.
1. Directly related to defined in 1.274-2(c)(3)(i-iv).
There are four requirements.
2. Associated with defined in 1.274-2(d)(1)(i-ii).
As long as business discussion occurred directly
before or directly after.
e. Fifth, 274(k). Must not be lavish or extravagant and the
employer or an employee must be present at the furnishing of
such food or beverages.
i. If primarily business trip, does not apply, and entire cost
is deductible.
ii. If primarily personal, applies.
f. Sixth, 274(n).
i. If primarily business trip, does not apply, and entire cost
is deductible.
ii. If primarily personal, applies.
ii. Transportation (Actual Travel from Place to Place)
1. Process.
a. First, 162(a).
i. Must be ordinary and necessary.
b. Second, 162(a)(2).
i. Must not be lavish or extravagant.
c. Third, 1.162-1.
i. Must be directly connected with or pertaining to the
taxpayers trade or business. Two categories:
1. Business to business; and
a. Gets no commuting deduction.
2. Away from home (meaning, taxpayer lives in MA,
but works in CA).
a. Deductible if three Flower requirements
met:
i. Reasonable and necessary
travel expense;
ii. Incurred while away from
home; and
iii. Incurred in the pursuit of
business.
d. Fourth, 1.162-2.
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d. Fourth, 274(n).
i. Only 50% of the meal is deductible by the employer.
1. Note. If the employee pays, the employer
reimburses the employee the full amount, and
then they (the employer) may only deduct 50%.
iv. Problems
1. Problem 8.2.3.
a. Associate sent to LV for deposition and treated like a king. Hotel:
2,100. Meals: 1,500. Celine Dion show with client: 400. Airfare:
1,000. Firm reimburses.
i. Hotel.
1. If worked all save days, even if some gambling
involved, then all deductible. If worked for first
four days, and personal last three days, pro-rate
the deduction.
ii. Meals.
1. If reasonable, may deduct 50%. If traveling, it is
irrelevant if client is at the meal, the employer
may still deduct 50%. Also, if traveling, the
employer may not deduct more than 50%.
iii. Celine Dion.
1. May deduct 50% if passes 274(a) test of being
associated with.
iv. Airfare.
1. All deductible.
2. Problem 8.2.4.
a. Same as 8.2.3, but wife accompanies him so she may vacation.
The firm also reimburses the cost of her trip.
i. 274(m)(3). Non-deductible by employer.
1. Also, he would have to include the reimbursed
amount in his GI, and it is treated as a gift to his
wife.
3. Problem 8.2.5.
a. Associate lives in DC. Sent to SF for three months on project.
Cost totals 20,000, some of which includes trips home on the
weekends to take care of personal matters. Also, did not stay in
hotel, but rented an apartment.
i. Analysis.
1. Henderson
a. Rule. If an employee is on temporary
stay away from principal place of
employment, the employer may deduct
expenses from temporary location back
to home as long as three requirements
met:
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i. The business connection to the
locale of the claimed home;
ii. The duplicative nature of the
taxpayers living expenses while
traveling and at the claimed
home; and
iii. Personal attachment to the
claimed home.
ii. Note.
1. Correll
a. Overnight Sleep and Rest Rule.
Traveling salesman could not deduct
meals because he was home every
night; thus, he never had to sleep away
from home. He just left in morning, and
returned at night.
iii. In this problem, employer may deduct all. Of course, only
50% for meals.
IX. CAPITALIZATION & DEPRECIATION
1. Capitalization
a. Basic Concepts & Consumption Tax Issues
i. Many taxpayers would favor a consumption tax model for capitalization because it
supports investment due to a larger net return. However, this country uses an
income tax model for capitalization. See calculations:
1. Consumption Tax.
a. Gross Wages Available for Investment
100,000
b. Tax on Wages (Assume 30%)
0
c. Net Investment after Tax
100,000
d. Gross Return (Assume 10%)
110,000
e. Tax
33,000
f. Net Return
77,000
2. Income Tax.
a. Gross Wages Available for Investment
100,000
b. Tax on Wages (Assume 30%)
30,000
c. Net Investment after Tax
70,000
d. Gross Return (Assume 10%)
77,000
e. Tax on Income
2,100
f. Net Return
74,900
b. Doctrine When is Capitalization Required?
i. 263(a) & 1.263(a)-1 & (a)-2. Any amount paid out for new buildings or property
or for permanent improvements or betterments made to increase the value of any
property or estate when related to business or trade must be capitalized.
ii.
iii.
iv.
v.
vi.
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a. Analysis.
i. Staley and Proposed Regulation 1.263(a)-4(iii).
1. Costs of fighting a hostile takeover are
immediately deductible.
3. Note. Regardless if friendly or hostile, for the acquiring company, the costs
are added to the AB of the cost of acquiring the company.
x. Notes.
1. Although it seems that some costs should be capitalized instead of
immediately deductible under the preceding analyses, the IRS has issued
many Rev Rules stating that certain expenses are immediately deductible:
a. Advertising expenses,
b. Hazardous waste clean up,
c. Employee training, and
d. Severance benefits.
c. Development of Business Opportunities (Start Up Costs)
i. 195. Overrules Frank, and states that start-up costs may be amortized over a 60month period ((b)(1) beginning when the business is up and running) if two
requirements are met:
1. (c)(1)(A). The costs were paid or incurred in connection with (three types
of costs); and
a. Investigating the creation or acquisition of an active trade or
business;
b. Creating an active trade or business; or
c. Any activity before the day on which the active trade or business
begins.
2. (c)(1)(B).The costs would have been deductible under 162, if the
business or trade was already up and running.
ii. Problem 9.8.
1. Herman is about to begin a publishing company. Travels to investigate
possible acquisitions. Pays attorney for drafting purchase agreement.
Pays appraisal fee for new building. Pays salaries to train office manager
before the business begins.
a. Analysis.
i. Travel: Passes 195, so may be amortized over 60
months.
ii. Attorneys Fees: Does not meet (c)(1)(B) requirement;
thus, must be capitalized with the building.
iii. Appraisal Fee: Same as attorneys fees; thus, added to
AB of building and depreciated with the building.
iv. Training: Rev Rule 96-62. May be amortized over 60
months.
1. If business was already up and running,
remember that training costs are immediately
deductible.
iii. Problem 9.9.
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i. Can take either Lifetime Learning Credit or 222. Would
take Lifetime here, because 10,000*20% = 2,000 credit.
Which is valuable.
2. Depreciation
a. Introduction
i. Once a taxpayer has a capital expenditure under 263, he is going to want to
depreciate. However, to depreciate (recovery cost), there are four requirements:
1. Property must be used in a trade or business (167);
2. Property held for the production of income (167);
3. Asset has a finite life; and
4. Exhaustible (subject to wear and tear).
a. Examples of non-depreciable: Art, corporate stock, unimproved
land.
ii. Once the taxpayer has a depreciable asset, three things must be determined
under 168:
1. What depreciation method is used?
2. What recovery period is used?
3. What convention is used?
iii. 167 gives authorization to depreciate. All depreciation is an above-the-line
deduction.
iv. 1011 determines the AB for the cost that may be recovered.
v. 1016(a)(2) states when deduct the depreciation, reduce the AB by that amount.
vi. This country has a favorable depreciation for four reasons. See page 537. It is
more similar to a consumption tax regime than an income tax regime to encourage
purchases.
vii. Three Provisions for Depreciation. Analysis should be done in this order:
1. 179. (Bonus Section).
a. (d). Only personal property and computer software in trade or
business fall under this section. Also, from (b) limitation, assumed
just for small businesses.
b. (b). For property put into effect between 2002 and 2005, there
may be a 100,000 immediate deduction. After 2005, 25,000
immediate deduction.
i. Two limitations.
1. (b)(2). If equipment purchased is over 400,000,
then each dollar over 400,000 must be deducted
from the 100,000 immediate deduction permitted.
a. Example: Purchase 410,000 machine,
may only be able to deduct 90,000.
2. (b)(3).The depreciation deduction under this
section may only be used to offset GI, it cannot
create a loss.
2. 168(k). (Bonus Section).
a. (k)(2)(A). Only personal property with a recovery period of 20
years of less and computer software qualify.
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ii. Use Chart xvii because non-residential real property.
1. In 2003, 350,000 * .96% = 3,360.
2. In 2004, 350,000 * 2.564% = 8,974.
c. Depreciation of Intangibles
i. 197(a). Intangibles that qualify must be amortized ratably over 15 years using
straight line.
1. Ratably means must actually, for the first year and last year, count down
to the days.
2. This is an above-the-line deduction like depreciation.
3. (c) & (d). To qualify as an intangible must be used in trade or business and
purchased after August 10, 1993 and cannot be self-created. Thus, this
includes:
a. Goodwill;
b. Going concern value;
c. Licenses; and
d. Covenant not to compete.
i. (f)(1)(B). Even if covenant not to compete is for three
years, must be amortized over 15 years.
ii. Note. Computer software is eligible for the 179 and 168(k) bonuses, and then it
falls under 197.
iii. Problem 9.14.
1. Leslie, on July 1, 2003, purchased goodwill for 50,000 and covenant not
to compete for 25,000.
a. Analysis.
i. Not computer software, so does not qualify under
bonuses.
ii. 197.
1. In 2003, 75,000 * 6/12 * 1/15 = 2,500.
2. In 2004, 75,000 * 1/15 = 5,000.
X. ADVANTAGES OF PROPERTY OWNERSHIP
1. Introduction
a. We have see property gains all semester, this topic is just variations on that.
b. 1001. Addresses recognition of gain or loss on the sale or disposition of property. Again,
AR AB.
i. (b). Addresses calculating AR.
ii. (c). States 1001 is subject to all others in the Code and determines recognized
gain.
c. 1011 & 1012.
i. Address calculating AB.
ii. 1016. Improvements increase AB and depreciation deductions decrease AB.
2. Realization & Recognition
a. Realization. An exchange gives rise to a realization even so long as the exchanged
properties embody legally distinct entitlements.
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b. Recognition. With respect to gains, the term recognition refers to the issue of whether a
realized gain is included in GI.
c. Problem 10.1.
i. Margaret owns vacant land (which means, unimproved) which she bought for
125,000. Sold to Jide for 138,000.
1. Analysis.
a. Margaret: Recognized gain is 13,000 and must include in GI
under 61.
b. Jide: AB is 138,000.
3. Non-Recognition Disposition of Principal Residence
a. Problem 10.2.
i. Mark and Millie married. Purchased principal residence on January 1, 2001 for
500,000. Sold in February 2003 for 795,000. In the summer months (June, July
and August) they spend most of their time in their beach house.
1. 121(a). One of the sections that trumps 1001(c), and states, that if a
taxpayer sells their principle residence, the gain is not recognized if they
have lived in the residence at least two years out of the five years
preceding the sale.
a. Two Limitations.
i. (b)(1) & (2). May only exclude up to 250,000 if single.
And may exclude 500,000 if joint if meet three
requirements:
1. At least one of the spouses owns;
2. Both spouses meet the use requirement; and
3. Neither of the spouses has used this section in
the past two years.
ii. (b)(3). May only take every two years.
2. 1.121-1(c)(2). Addresses determining if principal residence. States that it
is primarily a time based test and asking what residence was used most.
a. Further states use of vacation house still goes towards the time of
using the principle residence.
3. So, in this problem, Mark and Millie may exclude the 295,000 gain.
b. Problem 10.3.
i. Sandra, single, bought her house in January 2003 for 250,000. In June 2004, she
sold it for 475,000 and used the proceeds to buy a condo with one level because
she was old.
1. 121(c)(2)(B). Exception to two-year requirement:
a. May exclude gain from GI if sell principal residence for health
reasons, or new employment (can be different employer or same
employer in a different location).
i. 1.121-3T(d)(2). Safe harbor provision that says taxpayer
will qualify if gets recommendation from physician.
b. Limitation. Must pro-rate the dollar limitation if have not lived
there for two years. In this case, Sandra has lived there for 1.5
years.
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b.
c.
d.
e.
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f.
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70,000 (debt assumed) 90,000 (old AB) =
80,000.
2. AB = 90,000 (old AB) + 70,000 (debt assumed)
60,000 (debt relief) + 8,000 (old AB in stock) +
12,000 (stock recognized gain) = 120,000.
XI. CAPITAL GAINS & LOSSES
1. Introduction
a. 1(h). Congress injected it preference for net capital gains.
i. A net capital gain is pulled out from ordinary TI before it is plugged into the tax
table. And then, that net capital gain will be tax preferential. Note. These
preferential rates are only permitted for individuals, not corporations.
ii. Under 1(h), net capital gain is taxed at:
1. 5% if ordinary income is taxed at marginal rate below 25%;
2. 15% otherwise;
3. 25% if sale of depreciable property under 1250; or
4. 28% if collectibles.
b. 1221 & 1222. To qualify for a capital gain or loss, must have:
i. A capital asset;
1. Everything (whether or not trade or business) except:
a. Inventory;
b. Personal property used in trade or business subject to
depreciation;
i. Note. See 1231 & 1245.
c. Real property used in trade or business;
i. Note. See 1231 & 1250.
d. Copyright; or
e. Notes (accounts) receivable.
ii. That is sold or exchange.
1. Short Term: Property held under a year.
2. Long Term: Property held more than a year.
c. Policy. This country has a preferential rate for four reasons:
i. Revenue raiser because encourages sales and exchanges of assets;
ii. Efficiency (property moves where it is needed most);
iii. Prevent bunching (because allows people to sell accumulated gain); and
iv. Encourage investment in capital (expands economy).
1. Huge Doubts to this Policy: Empirical evidence to the contrary.
d. Process.
i. First, 61. All capital gains (short term and long term) are added to arrive at GI.
ii. Second, 165(c)(2). All capital losses (short term and long term) are deducted to
arrive at AGI (thus, above-the-line deductions).
1. Limitations.
a. 1211.
i. Corporations: May only offset gains.
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c. Problem 11.8.
i. On May 6, 2003, Tamara purchased a commercial building for 350,000 which she
used solely for her advertising business. She sold it on July 1, 2006 for 340,000.
1. 1250 Analysis.
a. Take lower of additional depreciation (which will always be 0 in
our cases because real property may only use straight line) or
actual AB after depreciation.
b. Deprecation Taken:
i. By putting in chart xvii, the total deprecation Tamara took
before she sold was 28,417. Leaving her with an AB of
350,000 28,417 = 321,583.
c. Realized Gain:
i. = 340,000 321, 583 = 18,417 and this is always
recognized as LTCG because we always take 0 from
above.
1. So what is the point of 1250?
a. Because although will always be treated
as LTCG, under 1(h), 1250 property
gets its own preferential rate of 25%.