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Federal Income Tax Outline Introduction:





Power to Tax & Sources: A. Constitution: Article I; 16th Amend. (IT not subject to rule of apportionment). B. Sources of Law: 1. Tax Code: (also found in Title 26 of USC). 2. Regulations: Released by treasury (not law but aids). 3. Constitution: Power to tax but not much information on how to tax. C. Purpose: Raise revenue. Tax Jurisdiction: a. Trial Level: A. Non-Refund Court: Require that no pay Taxes. 1. US Tax Court: You can not have paid taxes to go here; technical understanding; apply law according to your circuit. (may not pay to go here b/c highly specialized). B. Refund Courts: Require that deficiency paid for jurisdiction. 1. District Court: jury 2. Federal Claims Court b. Appellate Level: A. Federal Court of Appeals: Jurisdiction in circuit where you paid taxes. B. Federal Circuit Court: Only applies from appeal from Federal Claims Court. C. Supreme Court: Only allow limited no. tax claims; resolve disputes among circuits. Tax Procedure a. 30 Day Letter: First letter you receive from IRS indicating that you paid X but you really owe X and Y. (indicates deficiency) A. Choices: (1) you may wait for 90 day deficiency letter; (2) you may file with Appeals Office. b. 90 Day Letter: (letter of deficiency) Provides you with further notice of deficiency; A. Choices: (1) Pay file for refund = dist. Ct. /fed claims; (2) No Pay (and file required pet./failure to state a claim and will be dismissed) Tax Court. Taxing Formula: Gross Income -Sec. 62 Deduc. Adjusted Gross Income (AGI) -Exemptions (personal/Dependent) -Standard Deduction (or itemized deductions, if greater in amount). Taxable Income X Tax Rate Tax Liability -Credits +Additional Taxes Final Tax Liability

V. Types of Reductions: a. (1) deductions (savings depends upon marginal rate); (2) exemptions; (3) standard deduction; (4) credits (better than deduction, b/c 1.00 savings is 1.00). VI. Tax Rate (marginal rate): b. Graduated/Progressive (6 total) c. Determined by your gross income. d. Example: 2003: (based on 100K GI) Falls in 68,800-143,500 income (14,010 + 28% bot) 14,010 + (28%)(100,00 -68,800) 14,010 + (31,200)(28%) or 8,736 22,746 = Sally Tax Liability: Gross Income: I. Definition: (generally) a. Code 61(a): Except as otherwise provided, gross income means all income from whatever source derived, including but not limited to the following: 1. Compensation for services, including fees, commissions, fringe benefits, and similar items (normal compensation for labor). 2. Gross income derived from business 3. Gains derived from dealings in property 4. Interest 5. Rents 6. Royalties 7. Dividents 8. Alimony and separate maintenance payments 9. Annuities 10. Income from life insurance and endowment contracts 11. Pensions 12. Income from discharge of indebtedness 13. Distributive share of partnership gross income 14. Income respect of a decedent; and 15. Income from an interest in an estate or trust. b. Regulations: (1.61-1): All income from whatever source derived, unless excluded by law. Includes income realized in any form, whether in money, property or services. It may be realized in form of services, meals, accommodations, stock, or other property, as well as in cash. c. Case Law: a. Cessarini: Treasure Trove = GI; (1) Congress definition of GI broad and (2) no statutory exclusion. b. Old Colony: Taxes paid on individuals behalf as part of compensation = GI. c. Siegal Ex.: GI includes realization of property. 1.61-1. Reg. Determined by FMV (20.2031-1b) Price at which property would change hands b/en a willing buyer and a willing seller, w/o compulsion and w/reasonable knowledge of relevant facts. d. Glenshaw Glass: SC defines GI: undeniable accession to wealth, clearly realized, and over which the tax payer has complete dominion. Thus, exemplary damages meet criteria as undeniable accession to wealth d. Economist Def. GI: a. Hague Simons: GI = Net Worth (assets liabilities) + (consumption).

i. This would include above-stated cases, but (no include clearly ii.
realized or taxpayer dominion like SC def. (e.g. 100k house which increases annually in value = no realizing event per SC def.) Problem: This would create problem of valuation and liquidity.

Included & Not Included in GI Computation: (per problem sets) Included 1. 200.00 Watch Raffle Winner. 1.61-1(a) @ FMV 20.2031(1)(b). 2. Stocks Id.; Salary 61(a)(1); Car to Wife; 1.62-2(d)(1) & Old Colony. 3. Illegal Referral Kickback: IRC 61(a)(1) & James v. US. 4. Rent: IRC 61(a)(5); improvements: 1.61-1(a). 5. Accommodations for Services: 1.61-1(a); 1.61-2(d)(1). Dean v. Commr 6. Assignable FFM; Unassignable FFM Used for Personal Ticket 7. Bartered Services: RR 79-24. Not Included 1. Appreciated Property (no realizing event GG) 2. Imputed Income & Use of Own Property Helvering v. Indep. Life. 3. If excluded by law 1.61-1(a) & Cessarini. 4. Return on Capital: (e.g. purchase house for 75K and sell for 75K, no GI). Exclusions from Gross Income: Gifts, Bequests, Devises, & Inheritances:


IRC Sec. 102(a): Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance. (rule of exclusion).

a. Examples: (1) receipt of stock from mother; inherit house; devise of condo; b.
devise of personal property. Statutory Gift (SC): Detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses. AND most importantly transferors intent. Duberstein. (Duberstein car is GIhope for further kickbacks).


102(a) III. Bequest & Inheritance: (per problems)

Exceptions to 102(a): a. Sec. 102(b)(1): Subsection (a) shall not exclude from GI(1) the income from any property referred to in subsection (a). i. Examples: (1) receipt of dividends from gift of stock; (2) money from property sold. b. Sec. 102(b)(2): Subsection (a) no exclude from GI(where the gift, bequest, devise, or inheritance) is of income from property, the amount of such income. i. Examples: (1) receipt of rent from devised property; money from sale of real estate. c. Sec. 102(c): Subsection (a) no exclude from GI any amount transferred by or for employer to, or for the benefit of, an employee. i. Examples: (1) Dubersteins car; Employee TV EXCEPTIONS: (a) Employee Achievement; and (b) De Minimis Fringe Benefits; (c) 1.102-1(a)(f)(2) if show that b/c relative/non-employee related reason.

1. Daughter Inherited Money: Bequest covered under 102(a). 2. Same but Real Estate: This would be pursuant to device. Id. 3. Settlement as Rightful Heir: Pursuant to heirship so Lyeth v. Howie says 102(a) applies. 4. Daughter long and devoted service: Closer to Wolder v. Commisioner but McDonald found 102(a).. 5. Care for father in declining years: Falls under Wolder v. Commissioner (mere compensation for past services.) No 102(a) exclusion even though inherited. 6. What if settle for above facts: You are not wearing heir hat, so compensatory. 7. In Lieu of Executrix Money: Merriam is on point, but it is obscure and would likely be overruled. 8. Boyfriend include girlfriend in will if no marry but stay: Argue C/L marriage. 9. Wolder 102(c): No, b/c no employee relationship that necessitated by 102(c). Cases: 1. Lyeth v. Howie: Settlement pursuant to heirship dispute ruled to be still pursuant to bequest, and thus, excludable under 102(a). 2. Wolder v. Commissioner: Although bequested money, the intent was mere compensation for services, and therefore, fell outside of 102(a). 102(c) problems IV. Employee Relationship: 1. 100 gift to employees and 500 dollars to employee son? Son would have to prove not 102(c) b/c not due to Ee relationship but b/c relative. Maybe deduct 400. but 102(a). 1.102-2(a)(f)(2) 2. Tips to Maitre D and Crepiere: Hosed. This falls under 102(c) employee services 3. Money to reverend by congregation: No 102(c) b/c no requisite relationship, and likely will pass Duberstein detached generosity requirement. 5. Retiree Gift (2k from employer and 3k from employees) (a) Employer: Likely 102(c). But you have to look how detached the relationship is. (b) Employees: No 102(c) and will likely meet Duberstein requirement.

III. Tax Cost Basis Provision: a. Sec. 1.61-2(d)(2)(i):

1. Property transferred by employer to employee or IK, as compensation for services, less than FMV, then, when a 1001(a), difference in amount paid and AR is GI. 2. To compute gain or loss, the basis is the amount paid for the property plus the amount included in GI.

i. Example: (1) Duberstein if pd. 30K for 40K car, his GI is 10K,
subsequent sale for 45K only result in 5K more; (2) hypo wifes car from 15K (pd. GI) + amount realized from sale (5K for 20K sale). Fringe Benefits: Sec. 132 I. Five Types Covered: (1) (2) (3) (4) (5) No-Additional-Cost Service: 132(a)(1) Qualified Employee Discount: 132(a)(2) Working Condition Fringe: 132(a)(3) De Minimis Fringe: 132(a)(4) Qualified Transportation Fringe: 132(a)(5)

II. Classified: 1. No-Additional-Cost-Services: 132(a) & 132(b) (a) Requirements: 1. No Substantial Addl Cost (include foregone revenue) 132(b)(2) 2. Same Course of Business as Ee. 132(b)(1). 3. Non-Discriminatory 132(j)(1): Offered to highly compensated 414(q)1 & other employees in substantially equal manner. 4. 1.132-2(a)(2) additional cost services include excess capacity services (e.g hotel/train), Services which are non-excess capacity services are not no additional cost services. 2. Qualified Employee Discount: 132(b) 1. (a) Qualified services = 20% cap; (b) property = no exceed GP%. i. No include real estate. ii. Same Course/Line of business. 2. Non Discrimination under 132(j)(1). 3. Provisions Applicable to 132(a)(1) and (a)(2) 1. 132(h): (a)(1)-(2) Employee includes: 1. Former retired or disabled individual in same line of business. 2. Widow or Widower & retired/disabled spouse in same line of business. 3. Dependent Child. 2. 132(j): 132(a)(1)-(2) apply to highly compensated employees only if benefit is also available on substantially the same terms to each employee. 3. 414(q) Highly compensated employee means any employee who 1. was a 5-percent owner during proceeding year. 2. Had compensation of over 80K, and in the top 20% of pay scale. 4. 1.132-8(c) If fringe under 132(a)(1)-(2) not available on substantially the same terms to all employees, no exclusion shall be available to highly compensated employee. 4. Working Condition Fringe: Any property or services provided to employee, if the employee paid for the property or service, it would be a deduction under sec. 162/167. 5. De Minimis Fringe: (1) Property/Service where the value of which (taking into account its frequency) so small that accounting for it would be unreasonable or administratively impossible. i. 1.132-6(e)(1) Includes traditional holiday and birthday gifts at low costs, and occasional cocktail parties etc (2) Eating Facility on Business. (414(q) applies) 6. Qualified Transportation Fringe: (1) Transportation in a commuter highway vehicle, transit pass, qualified parking in connection w/employee residence and employment. (2) As long as amount no exceed 100 per month for commuter vehicle or transit pass and 175 for qualified parking. III. Problems: 1. Ee at Ritz Hotel and works for Ritz: This falls w/in 132(a)(1) b/c meets (3) criteria.

(a) 5-percent owner; (b) +80K salary; top 20% paid group, Applies to (a)(1) and (a)(2).

2. Paying Customer no Stay b/c Ee: This would violate 132(b)(2) b/c addl cost, and thus, Ee no exclude all, but could exclude under 132(a)(2) up to 20%. 3. Pay and rebate: Falls under 1.132-2(a)(3) Applies whether service is provided at no charge, reduced price, or through partial or total cash rebate 4. Discount too generous: Then may exclude part under 132(a)(2), but pay GI on the rest. 5. Ee spouse and dependent children use: 132(h)(2) would include them as Ees. 6. Written K with rival chain: 1.132-2(b) ok if pursuant to K. 7. Ee officer and available rent free to officers and 60% other employees? The exclusion would not apply 132(j)(1) and 1.132-8(a)(2). 8. Ee goes to hotel when works for shipping line: Not same line of business so no exclusion per 132(b)(1) & 1.132-4(a). 9. What if Comptroller for both: 1.132-4(a)(iv) would apply & include b/c considered as both where substantially benefits both. 10. Ee sells insurance and allowed 20% discount: Ok pursuant to 132(c)(1)(B). 11. Em picks up Ee meal out of town: This is working condition fringe 132(a)(3). 12. Happy hour cocktails each week: Occasional de minimis fringe OK under 132(a)(4) but frequency of this may take it out. See 1.132-6(e)(1). 13. Scotch for X-Mas: If low cost and traditional falls under 1.132-6(e)(4). S 14. Ee officer and parking paid. Non-officers pay own parking: No officer discrimination clause for parking under 132(a)(5). 16. Er puts in gym for use to Ee and families: Ok under 132(j)(4). GAINS DERIVED FROM DEALINGS IN PROPERTY 61(a)(3) Computation of Gain/Loss: 1001(a): Gain from sale/other disposition of property is the excess of AR over AB, and the loss shall be the excess of AB over AR. 1. Realizing Events: (1) Any sale OK; (2) exchange in property OK. PhiladelphiaPark. 1001(b) Amount Realized: AR from sale r other disposition of property is sum of any money received + FMV of the property received. 1001(c): Recognition: Entire amount of gain/loss determined under subsection , on sale or exchange shall be recognized. See 165. 165(c): Individuals no loss unless: 1. Trade or Business 2. Transaction entered into for profit. 3. Arise from fire, storm, shipwreck, theft or other casualty. Adjusted Basis Adjusted Basis Calculation: Philadelphia Park: Cost basis under 1012 for exchange of property is property received. determine this, you look @ FMV of property given if dealt at arms length. Code: ADJUSTED BASIS & BASIS: A.1011(a): AB for gain/loss from sale or disposition of property is the basis as determined by 1012 & adjusted per 1016. See Philadelphia Park.

If cant

B. 1012(a): The basis of the property is the cost of the property. C. 1016(a)(1): Adjustments made for: 1. for expenditures, receipts, losses, or other items properly chargeable to capital account. (a) 1019: No apply if made by lessee & chargeable under 109. 2. Exhaustion, wear and tear, obsolescence, amortization, and depletion: 1. Allowed as deductions 2. Not less than the amount allowable under this section. (greter amt allowed & allowable). 1016(a)(2) ex: Proper ACRS deduction is 40K: (a) takes 40K; (b) takes 45K; (c) takes 35K. 1. 40K is amount allowed so OK. 2. 45K is greater of amt allowed & allowable so OK. 3. Deducted too little, so must 40K deducted anyway. Problems: Problem Owner purchases some land for 10K and later sells it for 16K a. determine amount of owners gain on the sale. AB is 10K (1012) & AR is 16K 1001(b), triggering is sale 1001(a) o His realized gain and recognized would be 6K which would be taxable. Sec. 1001(a) b. What if 1K Option + 9K later. If purchased land by paying 1K for option and 9K for land, then Option included in cost under 1012, so AB=10K & AR is 16K AG: would be 6K. c. What if sold option for 1,500? Option is property and this is realizable event. (AR-AB=500). d. Purchase 10K, spent 2k in clearing the land prior to its sale and sold it for 18K? AB would be 10K + 2K (1016/Capital Account): AR-AB=6K. e. What if lessee made 2K improvements and reported under 109? The 2K improvements would not be included under 1019! f. What if FMV 10K & salesperson received it from Er as a bonus? Cost Tax Basis would include the 10K as basis. AR-AB=6K. g. What if painting w/1K discount & purchase for 9K and sells for 16K? A/R=16K and A/B=10K so you have 6K GR and R (1001(a) & (b). Congress intended exclusion. This is not deferral from taxesyou never have to pay. Adjusted Basis Pursuant to Gifts (1015) COMPLETE GIFT: Sec. 1015(a): The basis for property acquired by gift is same as it would be in the hands of the donor, except that if the AB (adjusted by 1016) is greater than the FMV of the property at the time of the gift, then loss shall be determined by the FMV. Two Prong Exception Rule: I. Rule 1015(a): 1. Donee receives by gift Prong One: FMV is less than AB at time of gift. Prong Two: Donee sells for a loss, then Donees AB is the FMV.

Typical: Dor gives to dee property w/FMV of 10K & his AB is 5K=dee takes AB no exception. Lost Basis Rule: where FMV is 5K and AB is 10K=dee takes FMV where loss effectuated by subsequent sale/disposition). Between Rule: where AR from subsequent sale/disposition (1001(a)) is b/en FMV and AB (where FMV is less @ time of receipt), then 1.1015-1(a)(2) states that you have no GI.

Cases: Taft v. Bowers: Rule: Donee takes carry over basis of donor to avoid loophole. Gain Rule: Donor has no tax consequences pursuant to normal gift. PART SALE and PART GIFT: Donor Gain: 1.1001-1: Donor receives gain to the extent to which AR exceeds AB. However, donor does not effectuate loss where no gain from subsequent sale. Ex: F gives D 120K for 160K property, where his AB is 120K. Father has no gain. But if she gave 130K, father would have 10K gain b/c greater than his A/B. 1.1015-4: Donee from part sale-part gift has newly acquired basis of the greater of (a) donors AB; or (b) the amount she paid. Ex: Id. Daughter selects higher of father AB (120K) & (1012) amount paid. No difference b/c 120K. But if fathers AB was 130K, this would be her new basis. (also: Gift Tax Included). Analysis: 1. Do we have a gift pursuant to Duberstein & 102(a)? 2. Do we have (1) complete gift w/o gift tax; (2) complete gift and gift tax paid by donor; (3) part sale-part gift; (4) part-sale/part gift w/gift tax? 3. Does the two prong rule apply to 1001(a) transfer? Problem: II. A purchases property for 75K, and he donates to B, B claims ACRS deduction (business) for 10K, the FMV is 40Kwhen donated to C, and C sells property for 35K Identify Tax Liability: As AB (applicable b/c transferor per 1015(a) was 75K B takes pursuant to gift, and he takes As AB of 75K. B then claims ACRS deductions pursuant to Sec. 168 of (10K), this lowers his AB to 65K. B then gifts pursuant to 1015 to C. Pursuant to 1016(a)(2), Bs AB at time of transfer was 65K. C takes carry over basis based on 1015(a). At time of receipt, however the FMV was less than the donor AB (40K); thus the (1015(a)) exception applies when C transfers property for 35K, b/c loss. Key: You have both prongs of exception: (1) FMV< TAB and (2) sale for loss. Thus: For calculation of loss, Donee calculates loss based on the FMV (40K), giving him a <5K> loss.

Gift Tax Rule: 1015(d)(6) Rule 1015(d)(6): Where Donor pays gift tax, donees AB is increased by the ratio of the tax bears to: 1. the net appreciation in value of the gift, bears to 2. the amount of the gift. Calculation: GT x (Amt of gift AB)/(Amt of gift) = Amt to be added to AB. EXAMPLE: (1) Donor has 30K AB, he donates to C & there is gift tax of 20K, & @ time FMV is 50K; What is donees tax consequence?

Donee would take Ps carry over balance plus the the amount of gift tax paid w/respect to such gift. 1015(d)(1)(A). This would be 30K pursuant to 1015 plus the amt of gift tax that bares to the gift. 1015(d)(6)=20K x (50K 30K) / (50K) = 8 (40% x 20K). Thus you add 8 pursuant to 1015(d)(1)(A) and (d)(6)(A). Therefore, Cs Basis would be 38K. Transfer b/en Spouses: 1041

1041: (a) No gain or loss shall be recognized on a transfer of property from an individual to (1) spouse; (2) former spouse if incident to divorce. (b) Where a transfer occurs pursuant to (a)(1) property treated as acquired by gift; (2) basis of transferee is the AB of the transferor. 1015(e): 1041 rules trump 1015. Reg. 1.1041-1T(b) A-11:Carry over basis rule applies whether: 1. AB is less than, equal to, or greater than its FMV 2. Sold or disposed subsequently for gain or loss. Analysis: 1. Do we have the proper 1041 relationship? 2. 1041(a) no recognition rule. 3. 1041(b) AB rule where treated as 102(a) gift and 1015 applies to some extent. Rules: 1. Tax Neutral Rules b/e spouses 1001(c) is trumped by 1041(a), b/c no recognition. 1012 is trumped by 1041(b) b/c no cost basis. 1015(e) States that 1041 rules trump 1015, so no two prong loss basis rule. Problems: (1) H purchased property for 4K, he sells to W for 7K, what consequences? Pursuant to 1041(b), W takes Hs carryover balance, despite sale. o If W later sells, she uses 4k base to calculate gain under 1001(a). (sucks for her)

Pursuant to 1041(a), H has no gain recognized. Pursuant to 1001(a), he realized 3K, but he does not recognize. (2) H purchases for 4, it declines in value to 3 and sells to W for 3. What happens when W sells to S for 3? (note exception). Under 1041(a) H does not recognize, though he realizes gain under 1001(a). Under 1041(b) W takes carry over balance from H, 4K. Exception to 1012. When W sells (1001(a)) triggering event, W uses Hs AB of 4K, despite the fact that she paid 3K. Thus, she would have a 3K loss realized and recognized. KEY: you don not apply the loss/fmv 1015 exception deal. (3) H bought property for 4K/7K and W has property that is 5/7K. What happens when exchange property? This is a realizing event pursuant to Philadelphia Park based on the exchange of the properties. W takes 4K basis and H takes 5K basis pursuant to 1041(b) and they do not recognize their gains under 1001(c) pursuant to 1015(a). HERE Basis in Property Acquired by Decedent: 1014 I. Rule 1014 (a): The basis of property of transferee who acquires property from decedent shall be: b (1) FMV of property at the date of decedent death. Stepped Up Basis Rule: (b) The following property is considered acquired by decedent: (1) Property acquired by bequest, gift, devise, or inheritance. (6) The surviving spouses share of community property held by decedent, if at least of the whole of the community property was includible in determining decedents gross estate tax. (e) Problems: (1) T buys property for 200K. What tax results? pursuant to 1012, T takes 200K AB (2) What tax result if increases in FMV to 600K? No tax consequence b/c mere appreciation in value of property. (3) Decedent AB 200K and FMV @ death is 600K, what tax consequence to successor? Under 1014(a) successor takes basis of FMV at time of decedent death; thus successor takes 600K AB. (note he qualifies under 1014(b)). Stepped up income!!! Thus, successors income tax consequence @ time of receipt is 0. This was NOT a sale/disposition of property pursuant to 1001(a) based on 1014(a). (4) T buys property for 700K and devises @ death FMV is 600K, what result? Pursuant to 1014(a), successor takes Ts basis, which is 600K. There is no loss recognized under 1001(c). She should have been directed to sell it!! Problems: 1014(b)(6) (1) JTWROS: 70/200: H dies leaving W his portion, and then sells for 200K W takes stepped up balance based on 1014(a) in Hs property, so W takes 100/100 stepped up in husband and 35/100 in her property. Thus when sells for 200, her AB is 135. (2) Community Property 70/200: what happens when husband goes to son? What if all goes to wife? Son takes pursuant to 1014(a)100/100; and (b) wife takes pursuant to 1015(b)(6) 100/100, b/c CP in husband estate.


W takes 100/100 in her share pursuant to 1014(b)(6) and she takes 100/100 pursuant to 1014(a), so 200/200. When sells for 200, she has nothing to recognize. (3) CPWROS: 70/200: what happens when H deeds to W all ? W receives stepped up value in both pieces of property. This is treated under 1014(b)(6). II. Rule 1014(e) Property Acquired by Decedent by gift w/in 1 Year of Death: EXCEPTION RULE A. Rule: 1014(e): Where appreciated property acquired by decedent by gift during 1 year period ending on date of decedent death, and the property is acquired from decedent by donor of the property (or spouse of donor), the basis in the hands of donor/spouse is the AB of the property in the hands of decedent immediately b/fore death. Problems: (1) S w/AB of 200 gives property (500FMV) to M in Sept. In Oct, mom kicks the bucket, what is Ss FMV when mom devises back to son? Pursuant to 1014(e) M died too soon. She died 1 month after gift, so S receives basis as it was in the hands of M just b/fore death (200K). ((too bad!)) AMOUNT REALIZED!! 1001(b) I. Rules: Treatment of non-recourse debt and AR: Non-Recourse debt treated as AB at time of (1) acquisition under 1012 Crane and (2) 1016(a)(1) improvements. Exception: Where (1) sham b/c debt from non-recourse loan greatly exceeds FMV of property; (2) there is slight discrepancy where FMV is less than non-recourse debt. ACRS DEDUCTIONS: Once established that non-recourse debt is not a sham, the amount of the non-recourse debt plus any amount paid may be used for ACRS deduction adjustments under 1016(a)(2). II. Cases: A. Crane: established that where you purchase property by way of non-recourse debt, it is included in your AB. When your debt is assumed or taken subject by subsequent sale/disposition, the assumption of the non-recourse debt is similarly treated as AR 1001(b). When you have a non-recourse loan, you can still take ACRS deductions for the entire amount of the property under 1016(a)(2) ((allowed and allowable)). B. Tufts: FMV irrelevant when you purchase w/non-recourse and FMV goes lower than the non-recourse loan. (1) You have to look out when one purchases property by way of non-recourse debt for less than FMV. They will claim ACRS deductions. Sham Deals: C. Franklin: Where amount of non-recourse loan exceeds AB and appears to be a sham, the IRS has the option of excluding all from transferee AB. (CPU hypo); however, under Pleasonton where it is a Tufts type of situation (not a sham) the transferee may take the transferors AB. (1) No claim ACRS deductions for sham deal. NET GIFT: D. Diedrick: Where a gift tax is paid by the Donee, the computation should be made pursuant to the part gift/part sale analysis. (1) Donor Gain: Determined under 1.1001(e) (remember loss not recognized here).


(2) Donee AB: Determined under 1.1015-4 (greater of donor AB and amt Paid plus you add the amount of gift tax paid. Payment to Employee with Appreciated Property: A. Cases: International Freighting Co. Er gave Ee bonus in company owned stock. Its AB in the stock was 16K and the stocks FMV was 24K. When did gave the stock to it Ees, company Realized consistent with the FMV in the property at the time of the disposition. Furthermore, the Court ruled that they had a Gain Realized under 1001(a) of 6K based on receiving their moneys worth. Lastly, they were able to claim the FMV of the thing given as a deduction. 1. Rule: Where employer pays an employee with appreciated property, the employer has Gain Realized consistent with the difference in the FMV of the appreciated property given over her adjusted basis pursuant to Philadelphia Park (i.e. you assume that the FMV of the exchange was equivalent). However, the employer is able to take deductions on the equal to the FMV of the appreciated property given. The gain is characterized under 1001(B) because it is considered an employers money worth. See Problem 13. 1.161-6(a) Gain Realized from Divided Property: 1.61-6(a): When a part of a larger property is sold, (a) the cost or other basis of the entire property shall be the equitably apportioned amount of the several parts, (b) and the gain realized or loss sustained on the part of the entire property sold is the difference between the selling price basis allocated to such part. See Problem 12. Terms: Recourse: Personally liable for loanthey can seize your assets, b/c security in property. Non-Recourse: Not personally liable for loan. II. Problems: (1) P purchases property for 40K cash and 80K promissory note then took 20K ACRS deduction: The 40K(cash) and (80K) non-recourse debt (per crane) are included in 1012 Cost Basis; and thus, 120K is Ps basis. The 20K subsequent ACRS deductions are also taken which give a basis of 100K pursuant to 1016(a)(2) and crane even though nonrecourse. (2) What happens when pay off note? AB per Crane remains the same. Not looking at equity. (3) FMV goes up to 400K (100/400) and no debt paid (80K encumberance remains) and P gives to C subject to loan, what consequence? Note: Looking at relationship (P-S) and amt (lower than FMV) you conclude that this is part sale-part gift. Under 1.1001-1(e) donor has gain if Amt Pd (80K) is greater than (100K) AB, which it is not, so he has no gain. He also has no loss, b/c unable to claim it under 1.10011(e). Under 1.1015-4(a) donee (C) has AB of greater of AP (80K) (even though nonrecourse crane) and TAB (100K). Here the 100K is greater so he takes the AB of donor. (4) A gifts to B subject to gift tax: 100K/400K & 120K gift tax liability & C pays it?? This is part sale/Part gift (look at parties). Thus, under 1.1001-1(e), gain is calculated by APD (120K) (100K) AB, thus, A realizes and recognizes under 1001 20K.


Pursuant to 1.1015-4 B takes greater of GT (120K) and (100K) so he takes the 120K + gift tax % pursuant to 1015(d)(6). So 120K (gt) x (280 0)/(280) = 120. Thus the answer is 240!! Book Problems: (1) 100K purchase made up of 80K non-recourse and 20K cash, what consequences? 100K is AB: (a) the 20K cash fall under 1012 (cost) and (b) non-recourse debt of 80K falls under Crane and Tufts (i.e. that non-recourse debt included). Note: It would not matter if this was recourse either, b/c personal liability. KEY: The 100K can be used for collecting ACRS deductions. Debt Inclusion Exception: No apply b/c FMV is greater than non-recourse debt. Franklin. (2) What if you took out a 2nd mortgage for 100K? There would be no immediate tax consequence, b/c this is not AR b/c there is a proviso to pay it back. (3) What if 100K 2nd mortgage used for improvements to the property? This would properly be included under 1016(a)(1) adjustment, so you would have a 200K AB. (thus this type of non-recourse debt would affect AB too!) (4) What if A takes out 2nd mortgage for stock? This amount is not included in AB of land. This amount would be included in stock AB. (5) What if A purchases from mortgagor subject to mortgage plus an additional 120K under facts above? Mortgagor: AR is 300K (120K + 180K) and AB is 100K=200K GR and Recognized. A: New AB is his cost=300K under 1012 (120K cash and 180K non-recourse). The non-recourse is included pursuant to (1) Crane; and (2) Tufts (not debt inclusion exception b/c FMV>debt). (6) What if mortgagor gifts to son subject to non-recourse loan. Part Sale-Part Gift: The facts (relationship + low cost) lets us know that this is PS/PG. Mortgagor: 1.1001(e) states that Donor has AR if 180K (amt received pursuant to Crane) exceeds AB, which is 100K. The 180K does exceed his AR, so mortgagor has 80K gain. Donee: Under 1.1015-4(a) Kid takes greater of 180K (AP pursuant to Crane) and 100K (AB of transferor) so he takes the 180K. (7) What if mortgagor gives to wife subject to debt? Mortgagor: You clearly have gain realized (80K) but not recognized under 1041(a). Spouse: She takes mortgagors AB, which is 100K pursuant to 1041(b)(2). (8) Quitclaim to Bank where FMV falls to 180K? Mortgagor: He has AR of 180K (pursuant to Tufts) and his AB is only 100K, thus he has gain realized and recognized of 80K. Bank: Pursuant to 1012 and Crane they take an AB in the amount that they paid, which is the 180K. There is no debt inclusion exception under Franklin and Tufts. (9) Quitclaim where FMV falls to 170K by bank again. Mortgagor: He still has a gain realized of 80K under the same facts. The key is that pursuant to Tufts, you are no longer looking at the FMVit does not matter. Bank: This is more of problem b/c debt is less than FMV. Thus, this would likely fall under Pleasonton facts where FMV would be affixed as banks AB as opposed to having no AB under Franklin.


(10) 20/30 and Relative Pays 6K gift tax when transfers to Gainer. Relative: He has no tax consequences pursuant to Taft v. Bowers and 102(a). Gainer He has no immediate tax consequence b/c excluded from GI under 102(a); however his AB is the 20K (Relative AB pursuant to 1015(a)) plus pursuant to 1015(d) (6) the rate at which the gift tax bears to the net appreciation over the fmv of the gift, which would be 6 x 30-20/20=2K. Thus, donee would have an AB of 22K. (11) Relative pays 8K and takes subject to 12K and FMV is 30K. Gives to Gainer subject to non-recourse debt. R pays 3K gift tax. G sells for 12K (subj.loan) plus 20K to S for 20K + debt. Part sale-Part Gift: The transfer tells us that this is part sale part gift due to relationship and fact that FMV is 30 and pays 12K (b/c subject to debt under Crane). Relative: 1.1001(e) no gain b/c 12K is less than his 20K (AB); however there is an loss realized of 8K but not recognized under 1.1001(e). Gainer: He takes greater of 20K/12K under 1.1015-4(a) plus the amount of gift tax under 1.1015-4(a)(2). You calculate under 1015(d)(6) which gives you 3 x 18K (amt gift)-8K (remainder of AB pursuant to 1.1001(e))/18K = 1,667.00. This gives Gainer an AB of 21,667.00. When he sells to S for 32K, he realizes 10,333.00 and recognizes it. S: He takes subject to 12K plus pays 20K. Under Crane the 12K would be included. The 20K is normal 1012 payment, so you would have 32K AB for S. (12) A purchases three plots of land in one deal for 30K. A sells B one plot of land for 14K, and then he sells C one plot of land for 16K Under 1.61-6, the property is equitably divided in order to determine the propertys AB. In this situation, you assume that the 3 pieces of property are each worth equal value, so A has a 10K AB in each partial. His first sale of 14K, he realizes and recognizes a 4K gain. In the 2nd disposition, he realized a gain of 6K (16K-10K). (13) 40/40 (but 30K ACRS deductions taken by employer): Mohawk purchased equipment for 40K. It later took 30K in ACRS deductions. Subsequently, it provided this property to Edna as a bonus for her work performance. Mohawk: They have an initial CB under 1012 of 40K. The subsequent claim of ACRS deductions allowed lowered her AB pursuant to 1016(a)(2) to 10K (40K-10K). The subsequent transfer to Edna was a disposition of property pursuant to International Freighting Co., triggering a 1001(a) event. The FMV of the property 40K minus the 10K AB gives Mohawk a 30K gain realized and recognized b/c the equipment was exchanged to Edna for past services provided, and thus Mohawk got their moneys worth. This is assumed under Philadelphia Park to be the FMV of the property given. Mohawk may deduct the entire 40K. CAPITAL GAIN Capital Asset; Sale or Exchange; Holding Period; Mechanics I. Capital Gains: (generally): Dependent upon whether: (1) CA involved; (2) Sale or Exchange of Property; (3) Holding Period; (4) Mechanics. IS IT A CAPITAL ASSET?? 1221(a) General Definition Break-Down: 1. means property held by the taxpayer (whether or not connected with his trade or business): A. 1221(a): Property Exceptions: 1. Hort v. Commissioner: Tenant settlement payment to LL for rent not


considered 1221(a) property pursuant to the rules. (falls o/side definition; it is a gloss on meaning created by SC.) 2. Claims or rights on ordinary income: (see K problem).This is not 1221 property. Additionally, there is no sale or exchange 3. Metropolitan Building Co. Where underlying property (lease) is sold, there is capital asset. (i.e. 1221 property) 4. Corn Products: Although introduced the business motive test to classify corn futures, Arkansas Best later found the futures to fall within the broad definition of inventory under 1221(a)(1), and thus not an exception. 5. Arkansas Best: Despite the fact that stock was used for a business purpose. The Court held that it was a capital asset, an in this case resulting in capital loss. The court reasoned that the stock was property w/in 1221(a) and that no exceptions could apply. The court reasoned that there was no way the company was a broker. Example: T bought stock for 200K to ensure his co. had mfg part. Later the mfg. process no require this part. They sold for 150K The stock according to Arkansas Best is capital asset b/c no prove that falls under 1221(a)(1) inventory exception; thus the loss is capital in nature. B. Very Broad definition that would include all property if inquiry stopped here. But Excludes the following EXCEPTIONS to 1221(a) Property: 2. 1221(a)(1): (1) stock/other property held by which would be included in inventory of T; or (2) property held by T primarily for sale to customers in course of trade or business. A. Mauldin: (change) Determination of whether property held primarily in the use of trade or business is determined by how the property is held at the time of sale/exchange of the property. (in Mauldin ruled that RE initially purchased for purpose of investment was subsequently used for purpose of trade or business, and thus, when sold while being used in course of T/B was considered ordinary income. B. Mallat: (dual purpose) Where property purchased by T for dual purpose (here=for sale or rent) the Supreme Court held that the property determination is whether the purpose of the property is principally, of first importance/primarily. for a particular use in determination if ordinary income/capital asset. If T gets a gain, he wants it to be characterized as capital asset b/c lower % tax. If T gets a loss, he wants ordinary loss b/c 1211 permits you to use loss to (1) offset capital gain; or (2) be taken at a per annum rate of 3K (trickle effect). C. Example: (A tie is a tie??) Siegal buys tie from Dillards for 40K. Dillards paid 15K for the tie. Siegal subsequently sold to Guneighn for 50K. How characterize transaction? Dillards: The property fits under the 1221(a)(1) exception (property primarily held for sale to customers in course of trade or business). Thus, it would trigger a 1001(a) 40-15 computation and the GR & R 1001(c) would be ordinary income. Siegal: When Siegal sells, it is noteworthy that he did not principally hold the tie to sell it in course of his trade or business. Thus, the characterization of the tie would be different. The tie would be considered a capital asset and the gain would be capital in nature. 1221(a)(2) (1) Property used in (T or B) of a character which is subject to 167 depreciation; or (2) RE used in (T or B). A. 1221(a)(2) Wrinkle: Although 1221(a)(2) property is specifically excepted from 1221 capital asset characterization, it may be included in quasi capital asset characterization


under 12312, as long as it meets the requirements above-stated and is held for more than one year. 1. Note: If property not held for more than one year, no fit 1221 or 1231. B. Examples: (1) Vehicles used w/in trade/business; (2) Real Estate; (3) buildings; etc Quasi Capital Assets 1231(a): A. Generally: T is able to characterize gains as capital asset and losses as ordinary income. B. Definitions: A 1231 property is either (1) property held in (T or B); depreciable under 167; and held by T for over 1 year; or (2) real property held in (T or B) and held for a period of over one year. Problems: A. Molly Motorcycle has a Motorcycle Repair Shop. She owns (1) land (no acrs) (2) building; (3) motorcycles; (4) repair truck to service; (5) tools; (6) and spare parts. She sells all, how characterize? (1) land: If it has been held for a year it is likely a quasi capital asset under 1231 b/c it is used for trade/business, it is real estate. (2) Bldg: If held for over 1 year, likely quasi capital asset 1231 b/c used for trade/business and depreciable under 167. (3) motorcycle: this is property held by T primarily for sale to customers in ordinary course of business under 1221(a)(1), so ordinary income. (4) Repair Trucks: likely quasi CA under 1231 b/c (1) used for trade/business; (2) depreciable under 167; and (3) must have been held for over a year. Not principal purpose to sell. (5) Spare Parts: ?? 1221(a)(3): a copyright, literary, musical, or artistic composition, a letter or memo, or similar property held by (A) T who created such property; (B) T for whom such property prepared; (C) T who takes the basis in the hands of (A) or (B) (e.g. 1014, 1015, and 1041). 1221 (a)(4): Accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or trade for property in paragraph (1). 1221 (a)(5): A publication of the US Government (including Congressional record) which is received from the Government other than by purchase at the price at which it is offered for sale to public and (A) a T who received the publication; or (B) a T in whose hands basis of publication is determined in whole or in part by reference to the basis of such publication in the hands of the T described in (A). Example: If congressional record given to senator (1st) and then given to son (2nd). Capital Asset Problems: 1. Agent received 50K in exchange for relinquishment of rights to her wages for next 3 years. What result? Hort says that a release of an obligation of ordinary income does not effect a recharacterization in property. This is ordinary income. 2. What result to LL if Buyer pays LL to take over the lease? Hort this is the same as Hort. You just broaden the holding of it a bit. The key is that someone is taking over the rent payments. This is ordinary income. 3. What result if T pays LL to cancel lease?

1231 allows you to characterize property as capital gain when you have a gain and ordinary loss when you have a loss.


Hort again this is identical to Hort. This is a mere release of obligation. Ordinary income. 4. What result to T if L pays T 20K to cancel rent? This is Metropolitan Building company. You have capital gain. This is also governed by Section 1241. However, you do have to look at whether T is acting as a dealer in rents under 1221(a) (primarily for sale to customers in ordinary course of business). Trusts, Capital Assets 1001(e) Definitions: 1. Settlor: He is creator of the will. 2. Trustee: Owns legal title and access in favor of beneficiary. 3. Beneficiary: He gets the proceeds from the trust. He has equitable title. Rules Term Interests: 1001(e)(2): 1. LE; 2. interest in property for term of years; 2. income interest in a trust. 1001(e)(1): To determine gain or loss from sale or other disposition of term interest in property, where the property was obtained pursuant to (1014, 1015, and 1041) the AB shall be disregarded. Exception: 1001(e)(3) Exception: This section no apply where the residuary interest and the term interest are transferred. Explanation: The key is that when you have a life interest (e.g. a life interest in trust), you cannot include the AB pursuant to a sale or other disposition, despite the fact that you have a uniform basis in the property. The key is that this property does have to be received pursuant to 1014, 1015, or 1041) to have its B disregarded, otherwise the AB is included. Problems: (1) B purchases life interest in trust for 50K. He subsequently sells it for 60K. What result. The key is that B purchased the trust interest, so 1001(e) (1) is not triggered. Thus, he would have an AB of 50K in the property pursuant to 1012. You have a sale of some underlying interest in a capital asset (the trust) so Metro would include this in 1221 property. (2) What occurs if B sells an undivided interest in the trust for 15K? You would equitably distribute the value of the FMV (1.61-6(a)). Thus, you equitably distribute % AB 12.5K. The sale or other 1001(a) disposition would result in GR and Recognized under 1001(c) of the amount the AR (15K) exceeds the apportioned amount of 12.5, giving you 2.5K. (3) B receives as a gift rather than by purchase and sells for 60K? Now we fall under 1001(e)(1) and the AB (50K) is disregarded. Thus, the capital gain resulting from the sale is 60K (AR 60K 50K AB) = 10K. (4) What happens if the remainderman also sells underlying property? If sold together, the 1001(e)(3) Exception would apply, and both parties could utilize their respective basis, notwithstanding 1001(e)(1). SALE or EXCHANGE I. You must now determine whether the sale or disposition can fit under the Sale or Exchange Requirement for CG or CL. First you must determine if you have a 1001(a) sale or other disposition. A. Sale: Occurs where T make an exchange in property and receives consideration in the form of a sale or note. B. Exchange Requirement: Exchange is a reciprocal exchange of property Philadelphia Park 1. Payment by Debtor for Release of Claim: Under Kenan [payment by debtor w/appreciated property for release of claim] is viewed as an exchange, and thus, a capital gain results. (e.g. Kenan Trustees settled claim w/appreciated property.) 2. Amounts Received by Retirement of Debt to Creditor: (IRC 1271(a)(1) & Hudson). Although Hudson (settlement money received by T after purchase of debt


instrumentcole settlement) is deemed to extinguish title and result in ordinary income, congress enacted 1271 which provides that amounts received by holder upon retirement of debt is an exchange, provided that if person is a natural person, the obligation was issued after June 8th 1997. 1. Hudson was statutorily reversed==but you still need to look at relationship of parties and the date. 2. You must determine (1) if issued after 1997 where it is issued by a natural person. 3. Destruction of Property and Payment by insurance proceeds: this does not result in an exchange, b/c there is no reciprocal exchange pursuant to Flakas. 4. Foreclosure Sale: Helvering v. Hammil says that although not voluntary, it still constitutes a sale or exchange. It applies to both recourse & non-recourse Nebraska Bridge Supply and Lumber. 5. Debtor transfers property back w/o foreclosure: Still exchange under Littleton. 5. Cancellation of Lease by Lessor: The consideration received by tenant is an exchange. 1241. 6. Abandonment: Abandonment of property which has a recourse or nonrecourse debt affixed to it constitutes a sale or exchange. Yarboro v. Commr. Problems: In 1996, D has 5K debt and he is going to pay with 4K appreciated stock. C purchased note for 2k/5K FMV. What occurs at time of exchange? o D: Chapter 6: This triggers 1001(a) b/c it is a sale or other disposition pursuant to International Freighting Company. AR 1001(b) would be 5K and CB would be 4K. The appreciated property disposition would result in a 1k GR and R under 1001(c). Chapter 21: First: The stock would be a CA under Arkansas Best (nothing says that inventory or primarily for sale to customers). Second: Pursuant to Kenan he would have a sale/exchange b/c relief of debt payment. o C: Triggering event occurs under 1001(a). C has GR and R of 3K. Second: The note is a capital asset; however, the extinguishment of the note falls under Hudson and there would not be an exchange. However, the important point is that this occurred prior to June 8, 1997. If it occurred afterwards or if debt did not originate from a natural person, Section 1271 would make this disposition an exchange. HOLDING PERIOD Key: Once you are here, you know that you have a capital gain/loss, but you need to determine if it is long-term or short-term. 1222: (1) (2) Short Term Gain/Loss: If held not more than one year. (3)=(4) Long-Term Gain/Loss: If held more than one year. Revenue Ruling 66-7: You do not include the date of acquisition but you do include the date of sale. (e.g. Purchase CA on Jan. 2 nd then no count and it becomes long-term after Jan. 3rd (you would include if date of sale). Revenue Ruling 66-97: Where you purchase securities or stock via a broker, the date to initiate counting for holding purposes is the trade date not the settlement date. Revenue Ruling 93-84: Where a sale of securities is made on a preceding year as to the settlement date, taxes are to be filed for that transaction on the preceding year, regardless of the fact that money never exchanged hands until the subsequent year. o E.G: A directs broker to purchase stock Dec. 31st of 2001. Settlement does not occur until 5 days later on January 5 th, 2002. Taxes are to be pain in 2001, the trade date.


1223 Special Rules: Carry-Over and the Like: 1223(2) Where you take part or all of donors basis, you are permitted to tack the donors holding period. Application: This applies to 1015 gifts and 1041 spousal transfers. Exception: This would not apply where you had 1015 2 prong exception (FMV lower than AB and sell for a loss). 1223(11) Where you take pursuant to a decedent transfer, you receive automatic long term gain/loss when you sell w/in one year. Ex. A Dies and devises CA to B (A purchased 1 month prior to dying). B obtains and sells 1 month later, this is still long-term gain/loss. Problems: (1) On January 16th 2003, A buys 100 stock for 50.00 per share, and then sells it on January 17th of 2004 for 60.00 per share. Step One: As 1012 CB is 5,000. His subsequent transfer in 2004 constitutes a 1,000 gain realized and recognized under 1001(a) pursuant to the triggering sale. Step Two: This is a Capital Asset under 1221(a) b/c it is property and none of the exceptions apply. It is an exchange pursuant to Arkansas Best. Step Three: RR 66-7 instructs that you start counting the day after acquisition, January 17th 2003 and include the sale date, January 17 th 2004 for determining Ts H. This is over one year, so you have a Long Term Capital Gain pursuant to 1222(3). (2) A purchases property on February 28th 2001, a leap year, and sells on February 29th of 2002. What result? Stock price is same above. Step One: Repeat from above. Step Two: Under 66-7, you start counting the day after acquisition, March 1, 2001 and you include February 29th of the following year. This is less than a year, so you have short term capital gain under 1222(1), less than a year. (3) T told Ts broker to purchase 100 shares of stock on Dec 29, 2002 at a time when its price was 50.00 per share. The stock was delivered to T on Jan 3, 2003 when it was selling for 52.00 per share. T told Ts broker to sell the stock on December 30, 2003 when it sold for 60.00 per share, and it was delivered to buyer on January 4, 2004 when it was selling for 63.00 per share. Step One: You go through the Chapter 6 analysis and determine that you have 1 1,000 gain realized and recognized. Step Two: Revenue Ruling 66-97 informs you that you need to use the day after the trade date [not settlement date] as your holding period commencement date. Thus, you start on December 30th 2002, and likewise the trade date, January 3rd 2003 is utilized to calculate holding period. Thus, you clearly have more than a one year holding period. You dont even need to look at the settlement date numbers. Step Three: Under RR 93-84, the trade date fell in 2002. This date, not the settlement date is used to determine when you pay taxes for that year. Here, you would clearly file your income tax returns in 2002, despite the late year sale. (4) Same as above except that the value of the stock on Dec. 30, 2003 was 45.00 per share and on January 4, 2003 was 48.00 per share. Step One: Under Chapter 6 you have a loss realized (& hopefully recognized) of 500.00. Step Two: This is still long term (more than one year) but it constitutes a long term loss under 1222(4). (5) T bought 100 shares at 50.00 on January 4th 2002 and another for 50.00 per share on March 10, 2002. To sold 100 shares on February 15 th 2003 for 60.00 per share. Step One: Go through Chapter 6.


Step Two: FIFO pursuant to 1.1223-1(i) and 1.1012-1(c)(1) instructs you that you can take the first amount first to obtain a long term gain (January February) if you cannot identify the stock. If you can you may choose which stock to sell first. (6) Ts father bought 10 shares of stock on January 10, 2002 at 30.00 per share. On March 10, 2002 when they were worth 40.00 per share he gave them to T who sold them on January 15, 2003 for 60.00 per share. (1223(2)). Under 1223(2) the holding period is tacked due to the transferred basis pursuant to the stock gift from Father to T. Thus, the additional time starting from January 10th 2002 gives T a Long Term Capital Gain. This is carryover basis; however so the AB would be the same 30.00 as it was in the hands of father. (7) Ts father purchased 1000 shares of stock for 10.00 per share several years ago. The stock was worth 50.00 per share on March 1, 2002, the date of father death. The stock was distributed to T by the executor on January 5, 2003 and T sold it for 60.00 per share on January 15, 2003. 1223(11) instructs you that any transfer pursuant to 1014 results in an automatic Long Term Capital Gain under 1222(3). The date of fathers acquisition and the date of the sale are not important, b/c the long term gain is automatic. (8) Same as above, except that T was executor of Ts fathers estate and as such T sold the stock on January 15, 2003 for 60.00 per share to pay the estates administration expenses. The same result occurs pursuant to 1014 and 1223(11). Thus, there is automatic LTCG. MECHANICS 1222(1) Short-term capital gain: gain from the sale or exchange of capital asset held for to more than 1 year. 1222(2) Short-term Capital Loss: loss from the sale or exchange of a capital asset held for not more than 1-year 1222(3) Long-Term Capital Gain: gain from the sale or exchange of a capital asset held for more than 1 year. 1222(4) Long-term Capital loss: loss from the sale or exchange of a capital asset held for more than 1 year, if and to the extent that such loss is taken into account in computing taxable income. 1222(5) Net Short-Term Capital Gain: Gain from sales or exchanges not held for more than one year. 1222(6) Net Short-Term Capital Loss: Loss from sales or exchanges not held for more than one year. 1222(7) Net Long Term Capital Gain: Gain from sales or exchanges held for more than a year. 1222(8) Net Long Term Capital Loss: Loss from sales or exchanges held for more than a year. 1222(9): Capital Gain Net Income: the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges. 1222(10): Net Capital Loss: The losses from sales or exchanges of capital assets over the sum allowed under section 1211. 1222(11) Net Capital Gain: The excess of the net long-term capital gain for the table year over the net short-term capital loss fro such year.

This is the goal, and you must have an excess of long term capital gain to receive it. 1211(b): Ts other than corps: losses from sales or exchanges of CA shall be allowed only to extent of gains from such S & E, plus (if losses exceed gains) the lower of (1) 3K (1.5 if married filing jointly) (2) excess of such losses over such gains.
1212(b)(1): If a T has a net capital loss for any taxable year,


(A) The excess of the net short-term capital loss over the net long-term capital gain for such year shall be a short-term capital loss in the succeeding taxable year, and (B) The excess of the net long-term capital loss over the net short-term gain for such year shall be a long term capital loss in the succeeding taxable year. 1212(b)(2): Treatment of amounts allowed under 1211(b)(1) or (2). (A) In general: For purposes of determining the excess referred to in (A) or (B) of (1), there shall be treated as a short-term capital gain in the taxable year an amount equal to the lesser of: (i) the amount allowed for the taxable year under paragraph (1) or (2) of section 1211(b), or (ii) the adjusted taxable income for such taxable year. MATRIX PROBLEMS: I. A has a 200,000 dollar salary and the below-stated information: What result for the mechanics. 12 LTCG 5 STCG 8 LTCL 7 STCL First: You net out the amounts. Here you have 4K Net LTCG 1222(7) and <2K> STCL.1222(6) You have a Net Capital gain, b/c your LTCG exceed your STCLs. You have 2K Net Capital Gain 1222(11). Second: Because you have a gain, there is no need to proceed to 1211(b). Your ordinary income is also not affected. II. You have the following information with the same 200,000 dollar salary. What results under these facts? 8 LTCG 5 STCG 12 LTCL 7 STCL First: You Net out vertically under the matrix. You have a net capital loss of <4k> and a net capital loss of <2K>. You have a net capital loss 1222(10). Second: You have 13K capital gain net income 1222(9) and <19K> capital loss 1222(10). Thus, you know that you have to proceed through 1211(b) you have a total of <6K>. Third: Under 1211(b), you have to calculate 1222(10) your net capital loss. 1211(b) first lets you take out losses to the extent you have gains--<6k>. Then you are permitted to take the lesser of 1211(b)(1) and 1211(b)(2). So you take 1211(b)(1) the 3,000. This leaves you with <3k>. This amount is carried over to the next year. Fourth: Characterizing the 3k. You first apply statutory 3K to the extent that you short term capital losses, leaving you with +1K STCG which is then applied to the LTCL to give 3K Long Term Net Capital Loss, which can be carried over pursuant to 1212(b)(1)(B). III. Taxable LTCG LTCL STCG STCL Income 1. 10k 2k 6k 2,600 1k Step One: Net out amounts under 1222: (a) first you have < 4K> net long term capital loss and 1,600 STCL. Now you know that you cannot have a NET Gain, b/c you do not have the requisite LTCG to the extent it exceeds STCL. Step Two: You determine your overall gross income and deductions under the horizontal matrix. You have 4,600 Net in capital gain, and thus gross income. You also have 7K in net capital losses. Step Three: Since you have a loss you trigger Section 1211(b). (1) You are first able to offset your loss to the extent you have gain, which will give you 2,400.00 Net capital loss. (2) you may add the statutorily proscribed less than 1212(b)(1) or (2). Here 2,400 is less than 3,000, so you take the 2,600.00. This amount is all LONG TERM CAPITAL LOSS. The 2,400 comes from your ordinary gain. (7,600.00).


IV. Taxable LTCG LTCL STCG STCL Income 2. 10K 2k 10K 2000 4K First: The looking at the vertical matrix, you have <8K NET LTCL> and <2K net short term capital loss>. This does not get you to preferential rates, b/c you dont have a LTCG over the extent of the STCL under 1222(11). Second: Under the horizontal matrix, you have 6K in net capital gain, and thus includible in gross income and 14K in net capital losses. Third: You know that the losses exceed the gains (14 v. 6K) so you go to 1211(b). Under 1211(b) you may offset the losses to the extent you have gains, so this gives you <8k>. However, you can next go under 1211(b)(1) and (2) and also deduct the lesser of the 3K statutory STCG or excess of the loss over gain. Here the 3K is less than the 8K, so you may deduct the 3K. This gives you 5K net capital loss. 1222(10). This amount carries over. Fourth: You characterize the carry over: You deduct 1212(b) from short term which gives you + 1K. This is then applied against the LTCL which leaves you with 7K. 1212(b) tells you that this is carried over as LTCL for the following year. The 3K is deducted from your ordinary gross income. Sectio n 165 Loss Rule 165(a): There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. 165(c): In case of an individual, the deduction under (a) shall be limited to (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with trade or bus. (3) Losses in property not connected with trade or business or entered into for profit, if such losses arise from fire, storm, shipwreck, theft or other casualty. 165(f): losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in 1211 and 1222. LIFE INSURANCE & ANNUITIES 101(a)(1): Except as otherwise provided in paragraph (2)(d) and (f), gross income does not include amounts received under a life insurance K, if such amounts are paid by reason of the death of the insured. 101(a)(2): Transfer for Value Rule: In case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance K or any interest therein, the amount excluded from GI shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. (ex. A sells life insurance to B, a non-relative) Transfer for Value Rule Exception: 101(a)(2)(A): 101(a)(2) does not apply where (A) such K or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by reference to such basis of such K or interest therein in the hands of the transferor, or (B) 101(a)(2)(B) If such transfer is to (1) the insured, (2) to a partner of the insured, (3) to a partnership in which the insured is a partner, or (4) to a corporation in which the insured is a shareholder or officer. Interest Payments: 101(c): In the case that you have interest paid to you on the proceed amount, that Installment Payments: 101(d): Where you receive installment payments pursuant to life insurance proceeds, you prorate and pay taxes to the extent that the payments ration exceeds the face amount of the proceeds.


Calculation: Face Amount Total/Total Amt Paid (based on life-expectancy or term to be paid the installments. Non-Limitation: 1. If live beyond expectancy: The prorated amount continues even where the face value amount is absorbed. (e.g. A receives installments from life insurance for duration of his 25 year life expectancy. On year 26, he is still permitted to exclude from taxes the prorated amount which corresponded to the face policy amount. (note: This is not the case for annuities). 2. If Die before Expectancy: If you do not live a sufficient length of time to collect all of the insurance policys face amount, you cannot collect the non-recovered amount. (this s opposite of annuities). Viatical Payments: 101(g)(A): Where person is pronounce terminally ill or chronically ill, a viatical settlement may treat the amount paid as if it were paid under the policy. (pursuant to 101(i)(ii)-(iii). 101(a); (c); (d)Problems: Problem: Insured died in the current year owning a policy of insurance that would pay Beneficiary 100K but under which several alternatives were available to beneficiary. (1) B receives 100K face amount as the beneficiary. A. The entire amount is excludible under 101(a). (2) B leaves 100K amount with the insurance company and is paid 10K in interest: A. under 101(c) the insurance is not excluded from taxes. (3) Daughter elects to take 12K payments for the remainder of her 25-year life expectancy: A. 101(d) Step One: Pro rate exclusion rule: 100K/300K gives you 1/3 exclusion ratio. You have left with an 8K inclusion and 4K exclusion for each payment. Step Two: This was a capital asset but it is extinguished and daughter is on the creditor side. Thus, Hudson says that this is not a capital gain. So you have ordinary income. (4) What if Beneficiary Died after 25 Years? A. Reg 1.101-4(c) says that you would continue to received the prorated amount. (5) What if Beneficiary Died before 25 years? A. 101(d) States that you not get to deduct the remaining face amount of the insurance. Problem: Jock agreed to play football for Pro Corporation. Pro, fearful that Jock might not survive, acquired a 1 million insurance policy on Jocks life. If Jock dies during the term of the policy and the proceeds of the policy are paid to Pro, what different consequences will Pro incur under the following alternatives? (1) With Jock consent, pro pays for 20K policy under his name? A. 101(a) would allow the entire amount to be excluded. (2) Jock owned a paid-up 1 million dollar policy and he sold it to Pro for 20K? A. This triggers 101(a)(2) (transfer for value rule) which permits Pro to only exclude the amount it pays for the policy (i.e. 20K). Thus, in this situation, 980K would be taxable based on the exclusionary rule. B. This property is extinguished so this would be ordinary income. (3) Same as (2) but Jock is a shareholder? A. 101(a)(2)(B) includes shareholders in the transfer for value rule exception. The key is that you have to look at the relationship. This gives Pro a complete deduction of the 1 Million. (the same could be accomplished of he was an officer. Problem: Insured purchases a single premium 100K life insurance policy on her life for a cost of 40K. Consider the income tax consequences to insured and the purchaser of the policy in each of the following alternative situations. (1) Insured sells policy to child for 60K FMV and, on insureds death, the 100K paid to child?


A. 101(a)(2): Transferred for Value Rule applies and the exclusion only applies to the extent of the 60K. B. This is ordinary income. (2) Same as above except spouse takes under 1041? A. This triggers the 101(a)(2)(A) exception to the transfer for value rule b/c she takes the basis of transferor spouse, and excludes all. B. The spouse who transfers the property does not recognize his gain under 1041. (3) Insured certified as terminally ill and she sells the policy for its 80K FMV to Viatical Settlement Provider. A. Ths falls under 101(g)(A) and the entire amount is excludible as to the terminally ill. B. As to the Viatical provider, this amount falls under the transfer for value rule under 101(a)(2). Thus the amount is only excludible up to the 80K amount paid under the K. Part-Sale Part Gift: (1) A has a life insurance policy with a 100k face value. A purchased the policy for 4K and it is now worth 10K. What is the result when he sells it to his son B for (a) 3K; A. This is a part sale part gift. Thus we are directed to 1.1015-4 to determine As AB. He would take the 4K (donor basis b/c greater than amt. pd. of 3K). He would not recognize this gain, b/c part gift. 102(a). Next under 101(a)(2(A) he would be permitted to exclude all of the proceeds from the life insurance b/c he took all or part of the transferors basis. (2) Same situation as (1) except that B purchased the policy for 5K. A. You have a different result. First, A takes his own 5K payment basis under 1.1015-4, b/c this amount exceeds donors AB. Second, 101(a)(2) applies w/o a 101(a)(2)(A) exception b/c donee did not take donors AB in all or part. B. Quantify: Under 1001(a) you have a triggering even w/the transfer of life insurance proceeds. This results in a gain realized of 95K. C. Characterize: This is Hudson. (1) The life insurance is an extinguished capital asset, which is received by the creditor. This triggers Hudson and you determine that this is ordinary income. Annuities 72(a) General Rule: Annuities payments are included w/in GI to the extent that they are not return of capital under 72(b). 72(b) Exclusion Ratio: You may exclude annuities based on the portion which is attributable to the Ts return of capital/investment. Amount of Investment Total Expected Return Annuity Definition: Where one enters into a contract by paying consideration in exchange for the right to future income. 72(b)(2) Limitation of Ratio: The exclusion ration may be taken only to the extent of your actual return of investment. Once this amount is exhausted, the whole amount is included in gross income. (contrary to life insurance). 72(b)(3): Exclusion Ratio Remainder: Where T dies b/fore excluding all of his investment in an annuity, his estate is permitted to deduct the remainder as an misc. itemized deduction. 67. Problems: Problem One: T purchase a single life annuity with no refund feature for 48K under the K. T is to receive 3k per year for life. T has a life expectancy of 24 years. (1) T is paid 3K per year for 24 year life expectancy, what consequences: A. 48K (investment)/72K (expected return)=2/3 exclusionary ratio. 2K is excludable per year and 1K is includable. (2) What if T lives 30 years past life expectancy? A. This entire 3K is included in GI completely under 72(b)(2). (3) What if T dies after only 9 years? A. Ts estate may deduct remainder. 72(b)(3). The remaining 30K would be an itemized deduction by his estate.


Problem 2: To what extent are T and Ts spouse taxed on the 3K in the current year that they receive for an annuity which they paid 76,500 and their joint life expectancy is 34 years. A. The amount of investment 76,500/102K (expected return) giving th exclusion ration. 2,250.00 of it can be excluded. The 750.00 is included in ordinary income. Discharge of Indebtedness Overview: A. Do we have 61(12)? 61(a)(12): Discharge of indebtedness is expressly included within gross income. Kirby Lumber: Where one obtains a loan for a certain amount and later repays it for a lesser amount, he has a discharge of indebtedness, which is a taxable event. Key Factor: You must distinguish GI in other from that which results pursuant to a discharge of indebtedness. Problem One: Poor borrows 10K from Rich several years ago. What consequences to Poor if he pays off the undiminished debt with: (1) A settlement of 7K in cash? A. This results in 3K of discharge of indebtedness. There is no other income to consider, it is all 61(a)(12) and could possibly fall under some 108 exception. Kirby Lumber. (2) Poor pays settlement with 8K property w/AB of 8K: A. Step One: You have 2K of 61(a)(12) GI. B. Step Two: You have a sale or other disposition resulting in no gain realized under 1001(a). C. Step Three: The character of the painting is likely a capital (but no gain or loss). (3) Back to problem. What if Painting is 8K and 5K AB in settlement for the 10K? A. Step One: You have 61(a)(12) of 2K. (no facts on 108). B. Step Two: You have a gain realized 8K-5K of 3K. C. Step Three: If the painting was a capital asset under 1221(a), this would result in a long term capital gain. The sale or exchange is on the debtor side pursuant to Kenan. (4) Same problem and receive services in the form of remodeling Richs office w/FMV of 10K? A. Step One: This all goes under 61(a)(1) GI. This is services in exchange for compensation in the form of debt discharge. (5) What if under the same problem, the service rendered has a FMV of 8K? A. Step One: You have DOI to the extent of 2K. B. Step Two: You have GI to the extent of 8K under 61(a)(1). (6) Same as (1) above, except that Poor employer makes the 7K payment to Rich, renouncing any claim to repayment by Poor. A. Step One: You have 3K discharge of indebtedness. B. Step Two: You have 7K GI pursuant to 61(a)(1) and Old Colony (indirect payment). Problem Two: Decedent owed friend 5K and Nephew owed Decedent 1K: (1) At decedents death Friend neglected to file a claim against decedents estate in the time allowed by state law and Friends claim was barred by the SOL. (result to decedent) Answer: Decedent owes 61(a)(12) tax on the 5K from the DOI through the running of the SOL. (2) What result to the estate in (a) if instead Friend simply permitted the statute to run saying that she felt sorry for Decedents widow, the residuary beneficiary of his estate? Answer: This would be 102(a) gift through Duberstein. (3) What if decedent provides that Nephew debt no pass through his will to his estate? Answer: This is 102(a) bequest! This is excluded. Look at the intent. B. Non-Recourse v. Recourse Loan


I. Discharge of Indebtedness incident to Sale or other disposition: 1. Recourse: (Reg. 1.1001-2(c)(8): If you have a recourse note, secured to property that has decreased in FMV, and such amount is relieved, ones amount realized is limited to the extent of the FMV. The remaining amount is included in GI as discharge of indebtedness. 2. Non-Recourse: (Reg 1.1001-2(c)(7); Tufts): Where one has a non-recourse note secured only by property whose FMV has declined under the amount of the note, the Amount Realized pursuant to a relief of indebtedness includes the amount of the note. Problem Two: Mortgagor purchases a parcel of land held for investment from Seller for 100k with 20K of cash paid directly by Mortgagor and 80K paid from the proceeds of a recourse mortgage incurred from Bank. Mortgagor is personally liable for the loan and the land is security for the loan. When the land increases in value to 300K, Mortgagor borrows another 100K from Bank again incurring personal liability and again with the land as security. Mortgagor uses the 100k of loan proceeds to purchase stocks and bonds. Several years later when the principal amount of the mortgages is still 80K, the land declines in value to 170K, Mortgagor transfers the land to the Bank, and the Bank discharges all of Mortgagors indebtedness. What Tax Consequences? (1) What consequences to this transaction: A. 1.1001-2(c)(8). Step One: You take the FMV of the property 170K as your amount realized. Pursuant to 1001(a) you have a gain realized of 70K (170-100). B. Step Two: The remaining 10K is 61(a)(12). C. Step Three: The 70K is likely capital gain and the 10K is ordinary income and perhaps subject to an exclusion under 108. (2) What if non-recourse note? A. 1.1001-2(c)(7). You look at Tufts which tells you that the entire 180K recourse note is included as GI. This gives you 80K gain realized. (180-100). There is no discharge of indebtedness for the non-recourse note in this situation. B. This is capital gain. Likely long term. Problem Three: You have a personal residence under the same facts as above. However, it declines all the way down to 90K. What result for a Recourse loan? A. Step One: you have 100k AB and you have 90K (FMV) AR under 1.1001-2(c)(7). Thus you have a loss realized under 1001(a); however 1001(c) tells you that you have to go to 165. 165 does not let you recognize this amount b/c the personal residence is not (1) in trade or business; (2) purchased for profit; or (3) casualty or theft, thus you cant recognize the loss!! B. Step Two: You have to account for your 61(a)(12) discharge of indebtedness 1.10012(a)(8). Here you were discharged the amount b/en 180K and 90K. You have 90K of ordinary income pursuant to 61(a)(12). C. Step Three: You might want to file for bankruptcy and go under 108 exception if you can. II. Non-Recourse and Recourse Pursuant to Prepayment: Revenue Ruling 82-202: T bought property (non-recourse or recourse) when interest rates were low. Bank offers borrower the option to prepay 18K of the 20K face amount of the debt. This results in a discharge of indebtedness pursuant to a non sale or other disposition Revenue Ruling 91-31: A borrows non-recourse 1 million from C and purchased 1 million property from B. Property declines in value to 800K. A goes to C and asks to lower the debt to 800K. C agrees. Pursuant to this non-sale or other disposition, you have only a discharge of indebtedness of 200K. This is all included in GI under 61(a)(12). C. 108 Exclusions Pursuant to Discharge of Indebtedness: 108(a)(1) Gross income does not include amount that would be includible in GI, where (A) Discharge comes from Title 11: (you can exclude all. No need purchase under 105(b). (B) Discharges is pursuant to insolvency: (must ask if you have to purchase it back under 105(b). 108(b)(1): You must pay for 61(a)(12) by tax attributes. (a) NOL


(b) Tax Credit (c) Capital Loss Carryover (d) Basis Reduction. 108(d)(3): Insolvency determined by amount that liabilities exceed assets. 108(b)(5): You may opt to purchase back 61(a)(12) through lowering of basis first. After lower, you must pay through 108(e)(5): Rule: Reduction of price if (1) seller agrees to reduce; and (2) you are not bankrupt/insolvent. Also, if you adjust your basis under 0 you have to include the remaining amount as GI. (no apply where SOL ran). 1017(b)(2): If basis of property under 108(b)(2) must be reduced, only to the extent of the lesser of (i) 108 exclusion remaining and (ii) excess of aggregate basis over property at time of discharge. (no apply if elect 108(b)(5)). Thus: It is excluded by the lesser of (1) the amount remaining after excluding (1)-(3) or the excess AB over liabilities after discharge. II. Structural Analysis: A. Step One: Do we have Kirby or 61(a)(12)? B. Step Two: Are we insolvent or Bankrupt under 108 or 108(e)(5). ). i. If insolvent to what extent 108(d)(3)?? C. Step Three: To what extent do we have to pay for our exclusions. 108(b)(1). 1. Rule: You only have to pay to extent that you have Tax Attributes. 1017(b)(2) 2. Rule: If you exclude pursuant to 108(b)(5) election, there is no basis reduction limitation. 2. Rule: You may opt to lower your basis first. 108(b)(5). Problem Three: Businessman borrows 100K from Creditor to start an ambulance service. He then purchases ambulances for use in his business at a cost of 100k. Assume the ambulances are his only depreciable property and, unrealistically, that after some time their AB and value are till 100K. What consequences under108 and 1017 in the following: (1) Businessman is solvent but is having financial difficulties and creditor compromises the debt to 60K? A. You take it all out of 61(a)(12). There is no 108 application, so you are done and hosed. You have GI to the extent of the 40K of which you were relieved (2) Same as (1) except the creditor is also the ambulance dealer who sold the ambulances to Businessman and, as a result of depreciation deductions, the AB of the ambulances is 35K. (a) Thus under 108(e)(5) How much can you reduce? A. Three Step Approach: Step One: He has a discharge of indebtedness of 40K. Step Two: Not insolvent but 108(e)(5) applies b/c this is the seller making the reduction, and thus, this acts retroactively to lower the decedents original purchase price. This would go down to 60K. Step Three: You have to account for the ACRS deductions. Here the 35K AB is reduced by 40K (the amount of (e)(5) reduction). This results in a negative 5K. This is not shielded from 61(a)(12) and counts as ordinary income. (3) Only to the extent that you have AB. Problems: Assume the same facts as in (a) above, except that Businessman is insolvent and his liabilities of 225K exceed his assets (100K) by 125K. Further assume Businessman has no net operating losses, general business credit carryovers, minimum tax credit, capital loss carryovers, passive activity loss or credit carryovers, or foreign tax credit carryovers. Creditor discharges 40K of the 100K loan w/o any payment. Answer: Step One: He has DOI of 40K. Step Two: You have 108(d)(3) apply b/c insolvent to the extent of 125K. Step Three: You have only adjusted basis to minimize under 108(b), so your basis in the ambulance will be lowered to 60K. (1) Same facts except that you have NOLs of 30K.


Answer: Step One and Two are the same: Step three is accomplished by going to 108(b) and reducing the NOLs to 0 and you still have 10K which you would apply against your AB in the ambulance, so you would adjust it down to 90K. (note: You could also opt through 108(b)(5) and just reduce your basis in the ambulance to 60K. Not sure b/c 1017(b)(2)!! (2) Same Problem except no NOLs and only 25K of insolvency (liability assets)? Step One: You have Kirby to the extent of 40K. Step Two: You have insolvency under 108(d)(3) to the extent of only 25K!! Step Three: You may first pay for your insolvency only to the extent of 25K by paying by way of the ambulance basis, lowering it to 75K. Second, have 15K in ordinary 61(a)(12) income. Damages and Physical Personal Injury 104(a)(2) and Raytheon Raytheon: To determine income tax consequences for damages, you must turn to the nature of the basic claim from which the compromised amount was realized. 104(a)(2): (a) Unless 213, damages, for any prior taxable year, not GI if: (1) Workmans compensation (2) personal physical injuries or physical sickness (other than punitives). (a) Only applies to damages from personal physical injury, except medical expenses from IIED. (b) 104(c): Exception for punitives where wrongful death action (if only punitives). (3) Personal accident or health insurance. (other than amounts paid by employer contribution). 105(b) Unless 213, gross income does not include amounts received by employer provided accident or health insurance if they are directly or indirectly to the taxpayer to reimburse the taxpayer, spouse, or children for medical care. 106(a) GI excludes premiums paid by Er. Raytheon Problems & Return of Capital: Problem One: Plaintiff brought suit and unless otherwise indicated successfully recovered. Discuss the tax consequences in the following alternative situations: (1) Plaintiffs suit was based on a recovery of an 8K loan made to Debtor. Plaintiff recovered 8,500 cash, 8,000 for the loan plus 500K interest. Answer: Step One: You do not have 104(a), b/c no PI or Sickness. This is breach of K. Step Two: There is 8K return of capital; Step Three: 500.00 in interest which is ordinary income under 61(a)(4). The 8k thus is not included and the 500 is. (2) What result to Debtor under the facts of (a), above, if instead Debtor transferred some land worth 8,500.00 with a basis of 2,000 to Plaintiff to satisfy the obligation? What is Plaintiffs basis in the land? Answer: Creditor: Has 8,500.00 AB based on FMV (8,500.00) of the property received. Philadelphia Park. You assume that it is worth what you gave (8,500.00). This is Hudson b/c creditor side so you have ordinary income of 500.00, b/c the 8K is return of capital Raytheon. Debtor: He has AR of 8,500.00 (International Freighthe paid with appreciated property). This is a sale or other disposition 1001(a), so you have 8,500.00-2,000=6,500.0. Characterize: If this is a capital asset under 1221(a), then this is capital gain (maybe long term) under 1222. Problem Two: Plaintiff suit was based on Breach of a Business K and Plaintiff recovered 8K loss profits and also recovered 16K of punitive damages. Answer: The 8K is loss profits pursuant and is ordinary income; the 16K punitive damages is taxable under Glenshaw Glass. Problem Three: Plaintiffs suit was based on a claim of injury to the goodwill of Plaintiffs business arising from a breach of a business K. Plaintiff had a 4K basis for the goodwill. The


goodwill was worth 10K at the time of the breach of K What result to Plaintiff if the suit is settled for 10K in a situation where the goodwill was totally destroyed? Answer: There is a sale or other disposition here when the entire amount of good will is extinguished. Thus, 4K of the goodwill is return of capital Raytheon and there is a gain realized under 1001(a) of 6K. (1) What result if Plaintiff recovers 4K b/c the goodwill was partially destroyed and worth only 6K after the breach of K? Answer: Exception: 1.61-6(a) no apply b/c this is goodwill (not a divisible asset). Thus, you do not have a disposition of property for partial loss of goodwill. However, the 4K settlement amount may be applied towards reducing your AB in the property. The key is that the 4K is again just return of capital. Thus, the AB goes down to 0 in the goodwill for any subsequent sale or other disposition of the property. (2) What result if Plaintiff recovers only 3K from goodwill? Answer: Same as above, but AB is left at 1K. ROC under Raytheon. Physical Personal Injury: 104(a)(2): Question One: Your damages must stem from an underlying claim of Physical Personal Injury or this section no apply. Question Two: Who is paying for it: (a) 213 deduction: You can not exclude this amount against under 104 or 105. (b) tortfeasor; Damages can extend beyond the injury itself as long as stems from the PI. (c) personal insurance; 104(a)(3) allows you to exclude it all. (d)Er insurance: You are limited under 105(b) to the amount that it is a reimbursement. (69-154) i. (Proportionate amount based on the total amount provided by Er and Ee insurance). (8 + 4) 12 (2/3) amt. Problems: Problem One: Plaintiff brought suit and successfully recovered in the following situations. Discuss the tax consequences to Plaintiff: (assaulted by tire iron). (1) Pl., a professional gymnast, lost the use of her leg after a psychotic fan assaulted her with a tire iron. Pl. was awarded damage of 100k. Answer: The key is to look at the underlying coa (tort for personal physical injury in this case). Therefore, you have 104(a)(2) deduction of the entire 100K. (2) 50K of the recovery in (a), above, is specifically allocated as compensation for scheduled performances Pl. failed to make as a result of the injured leg. 50K of the recovery in (a), above, is specifically allocated as compensation for scheduled performances Pl. failed to make as a result of the injured leg. Answer: The key is the underlying COA again. The COA is TORT. Thus, you have 104(a)(2) application for all damages that come out of personal physical injury/illness. Both the compensation damages and the actual injury damages stem from the injury, so both 50k are excludible. (3) The jury also awards Pl. 200K in punitive damages: Answer: Punitives are expressly excluded under 104(a)(2) from personal physical injuries. (104(c)) exception. (4) The jury also awards Pl. damages of 200K to compensate for Pl. suicidal tendencies resulting from the loss of the use of her leg. Under 104(a)(2) the code makes an exception for IIED to be tacked on if the underlying tort is physical personal injury, which in this case it is. Thus the 200K is also excludible. Raytheon (nature of claim). (5) ) Pl. in a separate suit recovered 100K of damages from fan who mercilessly taunted Pl. about her unnaturally high, squeaky voice, causing Pl. extreme anxiety and stress. Answer: If you look under 104(a)(2) damages that result only for emotional distress type of damages do not result in a deduction, with the exception of medical expenses. (these damages not incurred incident to injury). (6) Pl. recovered 200k in a suit of sexual harassment against her former coach? Answer: There is no physical personal injury involved in this coa, so it does not fit w/in the express definition of 104(a)(2).


(7) Pl. dies as a result of the leg injury, and the Pls parents recover 1,000,000 of punitive damages awarded in a wrongful death action (for physical personal injuries!!! under long-standing State statute? Answer: 104(c) provides an exception for these type of damages, and thus, you can exclude for wrongful death and state law says that only punitive damages may be awarded. Problem Two: Injured and Spouse were injured in an automobile accident. Their total medical expenses incurred were 2,500. (1) In the year of the accident they properly deducted 1,500.00 of the expenses on her joint income tax return and filed suit against Wrongdoer. In the succeeding year they settled their claim against Wrongdoer for 2,500. What income tax consequences on receipt of the 2,500.00 settlement? Answer: The key under section 104(a), you can only deduct to the extent that is not deducted under 213 (deduction for medical expenses) the preceding year. Here the 1,500.00 was deducted already, so you can now only exclude another 1,000. (2,500 -1,500). (2) In the succeeding year spouse was ill but, fortunately, they carried medical insurance and additionally Spouse had insurance benefits under a policy provided by Er. Spouses medical expenses totaled 4K and they received 3K benefits under their policy and 2K of benefits under Er policy. To what extent are the benefits included in their GI: Answer: Rev. Rul 69-154: There is interrelationship b/en 104(a)(3) and 105(b): 104(a)(3): You can exclude all of the 3K provided by own insurance. 105(b) (tricky) (a) you may take the amount of reimbursementhere you have 2/5 of the amount received that can be applied by 105(b); so the amount of the injury is 4k and 2/5 of 4k=1,600.00 (essentially you can exclude 40% of it)!! The remaining 400.00 is includible as GI. (3) Under the above (spouses problem) may injured an No. Under 213, a deduction is only allowed to the extent it is not covered by insurance. d spouse deduct the medical expenses (from the above problem) under 213? PROBLEM Three: Injured, who has a 20-year life expectancy, recovers 1 million in a PI suit arising out of a boating accident: (1) What are the tax consequences to Injured if the 1 million is deposited in a money market account paying 5% interest? Answer: First, the original 1 million is excludible under 104(a)(2); however, the 5% is expressly not included by this section b/c it is not a damage arising out of the injury but income on top of the damages. (Ordinary income). (2) What are the T consequences to Injured if the 1 million is used by injured to purchase an annuity to pay Injured 100K a year for Injureds life? Answer: The annuity falls under 72(b) where you apply the exclusion ratio in which (1) the amount of investment (damages of 1 million) is the numerator and (2) the 2 million is the denominator; thus you have exclusion and inclusion. 1 Million includible and 1 Million excludible. (3) What are the tax consequences to Injured if the case was settled, and in the settlement, injured received payment from D. of 100k a year for life? Revenue Ruling 79-313: Provides that either periodic payment or lump sums are both excludible. 104(a)(2) also provides damages on account of physical personal injury whether periodic payment or agreement Alimony and Maintenance Payments 71 & 215 Alimony: 71(b)(1): 1. Cash: 1.71-1T (A-8)-checks, money orders, money, not property! 2. Under Divorce/Separation Instrument to or on behalf of spouse. (see (b)(2)(A)) 3. Instrument no Designate that 215/71 no apply.


4. If legally separated from spouse under a decree of divorce or separate maintenance, no live together3. 5. No liability to pay payee spouse after death. 71(e): 71(b) and 215 (exclusion and inclusion no apply where they file jointly) 72(b)(2): (A) A decree of divorce or separate maintenance or a written instrument incident to such a decree (B) A written separation agreement, (C) A decree (not A) requiring a spouse to make payment for support or maintenance of the other spouse. 215: A. Payor of Alimony may exclude alimony payment to the extent that the payments are includible under 71(b). (she cant screw you by just not paying). 71(f) Frontloading Prevention by Recapture of Excess Alimony: A. Creation of Phantom Income: B. Applies only to first three years. 1. 71(f)(4): Year 2 Alimony Recapture: {(Yr. 2 Alimony (Yr. 3 Alimony + 15K)} = Year 2 Recapture 2. 71(f)(3) Year 1 Alimony Recapture Yr. 1 Alimony [(Yr. 2 Alimony Yr. 2 Recapture) + Yr. 3 Alimony)/2 +15K) = Year 1 recapture 3. 71(f)(2): Total Recapture: Year 1 Alimony Recapture + Year 2 Alimony Recapture Exceptions: 71(f)(5) (A) Either spouse dies or payee remarries b/fore 3rd post separation year. (B) Support payment pursuant to 71(b)(2)(C) (decree requiring payment). (C) Business fluctuations where payment is fixed based on income from business, property, compensation, or self employment. Problems: Determine whether the following payments are accorded alimony or separate maintenance status and therefore are includible in the recipients gross income under 71(a) and deductible by the payor under 215(a). Unless otherwise stated, Andy and Fergie are divorced and payments are called for by the divorce decree: (1) The divorce decree directs Andy to make payment of 10K per year to Fergie for her life or until she remarries. Andy makes a 10K cash payment to Fergie in the current year? A: The 10k fits the rule under 71(b)! This is (1) under instrument under 71(b)(2); instrument no direct otherwise; (no know if live together); and payment end @ death. Andy: Excludible Fergie: Includible. (2) Same as (a) except that Andy finding himself short on cash during the year, transfers his 10K promissory note to Fergie? A: This is no payment as cash, and it fails the definition for alimony under 71(b) for this reason (payment in cashsee also 1.71-1T(a)(A-6). (3) Same as (b) except that instead of transferring his promissory note to Fergie, Andy transfers a piece of art work, having a fair market value of 10K? A. This is property. So it is the same as abovenot cash! (4) Same as (a) except that in addition the decree provides that the payments are nondeductible by Andy and are excludible from Fergies GI? A. 71(b)(1)(B) would classify this as outside of 215 and 71, so you would have no application

only applies to 71(b)(2)(A) (the other OK!!)


(5) What if Andy decided to not deduct b/c it would be worthless to him, difference? A. No! 6. X pays Y 25K per year for life and then 10K per year. A. Under 1.71-1T-Q-13-14, only 15K of this amount can be deducted. The amount attributable to the after death payment cannot be alimony, and thus, is includible and out of the reach of 71 and 215. (6) What result in (a) if the divorce decree directs Andy to pay 10K cash each year to Fergie for a period of 10 years? A. Based on the chance that this payment could endure past death, the total amount does not fall under 71 or 215. 71(b)(1)(D). (7) Same as (f) except that under local law Andy is not required to make any postdeath payments. A. We defer to local law when there is no express statement w/in the document. Therefore, this would be alimony. (8) Same as (f) except the divorce decree directs Andy to pay 10K cash each year to Fergie for a period of 10 years or her life, whichever ends sooner. Additionally, the decree reqires Andy to pay 15K cash each year to Fegie or her estate for a period of 10 years. Andy makes a 25K cash payment to Fergie in the year? A. Under 1.71-1T-Q-13-14, Andy may exclude and Fergie include the 10K; however, the 15K to which could be payable to her estate/her for a period of 10 years is not alimony. (9) Same as (a) except that at the time of the payment, Andy and Fergie are living in the same house. A. This would be governed by 71(b)(1)(C) (which this document is covered by (b)(2) and thus not alimony b/c they are living together under a divorce decree. (10) Same as (i) except that Andy and Fergie are not divorced or legally separated and the payments are made pursuant to a written separation agreement instead of divorce decree? A. This does not take it out of alimony pursuant to 71(b)(1)(C) b/c this only covers divorce instruments and separate maintenance payments. Thus, no problem and this is still alimony. 71(f) Problems: (1) A divorce decree requires Tina to make the following payments (which meet all the requirements of 71(b) to Ike: Year 1: 80K; Year 2: 40K; Year 3: 10K: A. Step One: We have 71 and 215 Application (exclusion/inclusion)Step Two: Determine if we have frontloading and move under 71(f)(4) to determine if excess second year frontloading. (40K (10K + 15K) = 15K 1 st year recapture b/c excess. Step Three: Determine 1st year excess. 80K - (40K -15K) + 10K)/2 + 15K) =(80K 32,500)=47,500 first year recapture. Step Four: Second Year Recapture (15K) + First Year Recapture (47,500K) gives you 62,500.00 Total Recapture which is Deducted and included by the opposite spouses. (2) Below: Year 1 80K; Year 2 70K; Year 3 60K A. First: You have Alimony. Second: You have no second year recapture: (70K (60K + 15K)) = -5K (you are kosher). Third You have no first year frontloading (80K (70K 60K)/2 + 15K) = 0. Thus, there is no recapture amount to be adjusted. (3) Tina pays Ike 50 percent of the net income (b/fore taxes) of her oil business for three years. The payment above represent 50 percent of the net income from the oil business for the respective years. What consequences? A. This is a fluctuating income exception under 71(f)(5)(C) b/c pursuant to business for payments not less than 3 years. Thus, there is no recapture amount. (4) Decree provides for level payment of 80K per year for three years, but Ike dies at the end of year 2 and the payments terminate at that time according to the express provisions of the instrument?


A. 71(f)(5)(A)(i) exception applies and their would be no excess alimony payments. This is due to death of one of the spouses. (5) What result in (a), above, if the payments are made pursuant to a 71(b)(2)(C) decree for support? A. 71(f)(5)(B) This does not fall w/in the recapture rules, because it is pursuant to a mere decree requiring the spouse to pay support. (rule applies to only (b)(2)(A)-(B). (6) Tina and Ike are legally divorced and live in the same household in year one. Tina moves to a new apartment at the beginning of year two. Under the divorce decree, Tina makes payments to Ike of: Year 1: 120K; Year 2: 80K; Year 3: 70K; Year 4: 60K A. First: Year (1) under 71(f)(6) does not constitute alimony b/c rules only apply to post separation payments. The counting starts on year two and you have no problem w/excess. (7) What is the shortest # of months to cover the three years? A. 14 Months (Dec 00 Jan 03. (you need to focus in on when the post separation date is!) Indirect Alimony Problems: 1.71-1T(a) & 1.1041-1T (Q & A-7): 1.71-1T(a) Q & A 6: (who owns??) 1. Cash payments of rent, mortgage, tax, or tuition liabilities of the payee spouse under divorce or separation instrument will qualify as alimony. 2. Payment to maintain property owned by the payor spouse and used by the payee are not payments on behalf of a spouse. 3. Premiums paid by payor spouse for term or whole life insurance pursuant to divorce instrument will qualify as payments will PROBLEM: Tom and Nicole are divorced. Pursuant to their written separation agreement incorporated in the divorce decree, Tom is required to make the following alternative payments which satisfy the 71(b) requirements. Discuss the tax consequences to both Tom and Nicole. (1) Rental payments of 1K per month to Nicoles landlord. A. Payment is on behalf of the spouse b/c she has the legal obligation, so this qualifies as indirect alimony. (2) Mortgage payments of 1K per month on their family home which is transferred outright to Nicole in the divorce proceedings. A. This depends on whether Tom still has some liability in the property (is his name on the mortgage??) If he had it taken off, then this is alimony. (3) Mortgage payments of 1K per month as well as real estate taxes and upkeep expenses on the house where Nicole is living which is owned by Tom. A. 1.71-1T(a)(6) covers this puppy. This is outside of on behalf of b/c Tom has an interest in the property. Problem: Roseanne agrees to pay Tom 15K a year in alimony until the death of either or the remarriage of Tom. The alimony satisfies the 71(b) requirements. After 3 years, Tom is concerned about Roseannes life expectancy and they agree to reduce the alimony amount to 10K a year if Roseanne provides Tom 100K of life insurance on her life. (1) What are the tax consequences to Tom and Roseanne if Roseanne purchases a single premium 100K policy on her life for 60K? A. This is not alimony under 71(b)(1)(A) b/c the payment is not pursuant to the divorce instrument! However, .1041-1T (Q & A-7) says that application of 1041 (property) allows A MODIFICATION/Amendment of the original divorce decree. (2) What if she purchases and transfers the policy to Tom? A. This is not payment by cash, and thus, does not qualify as alimony. (3) Under this same arrangement is there a 71(f) frontloading problem? A. NO. The facts indicate that this is after three years so there is clearly no problem b/c this section only applies to the first two years.


(4) What would be key about the 60K if it was given to Tom to purchase the agreement as a cash amount? (unfettered control). A. He must be free to do with it as he chooses; otherwise it is not really cash if he has to purchase capital with it. (5) What result if Roseanne buys an ordinary policy on her life for 5K, transfers it to Tom, and agrees to transfer 5K cash to him each year, so he can pay the annual premiums on the policy? A. First: The original 5K cannot be deducted pursuant to 71 and 215, b/c it is property; however, Second: the subsequent premium 5k payments fall under 1.71(a) (Q & A 6) b/c the PROPERTY OWNERSHIP IS Toms, the payor, and thus this would be INDIRECT Alimony. (71 and 215 apply to either party). (6) Same as (d), except that instead of transferring the policy to Tom, Roseanne retains ownership of the policy but irrevocably names Tom as its beneficiary. A. This is key b/c the legal obligation or property interest is no longer retained by Tom, but by Roseanne, and thus, there would be no indirect alimony. 1.71-1T (Q & A 6). No deduction (Roseanne) or inclusion by (Tom). 1041(a)-(c) Anti-Davis Rules 1041(a)-(c) (Anti-Davis) Davis would have given FMV to transferee and taxed transferor. (a) No gain or loss shall be recognized on a transfer of property from an individualif (2) a former spouse incident to divorce. (b) The basis of the transferee in the property shall be the AB of the transferor. (c) A transfer of property incident to divorce (1)One Year Rule: occurs w/in 1 year after the date on which the marriage ceases; or (2) Is related to the cessation of marriage. 1.1041-1T(b) Q & A-7 Incident/Related to Divorce: 1. If not more than 6 years after divorce and pursuant to an instrument, it is related to divorce. 2. Presumed not related if (a) not pursuant to divorce or separation agreement (modification counts) or (b) the transfer occurs after 6 years. 3. Presumption rebutted if the delivery was hampered or impeded by legal or business matters. INCIDENT TO DIVORCE PROBLEMS: Problem: Michael and Lisa Maries divorce decree becomes final on January 1, 2000. Discuss the tax consequences of the following transactions to both Michael and Lisa Marie: (1) Pursuant to their divorce decree, Michael transfers to Lisa Marie in March, 2000 a parcel of unimproved land he purchased 10 years ago. The land has a basis of 100K and a FMV of 500K. Lisa Marie sells the land in April, 2000 for 600K. A. Michael: Step 1-The one year rule applies under 1041(c) so this is incident to divorce. Thus, there is a gain realized of 400K Philadelphia Park (FMV what gave if no determine what received), but it is not recognized under 1041(a). Thus, no tax consequences. Lisa: Step 2: This is incident to divorce, so she takes Michaels AB of 100K. There is no tax consequence initially b/c it is treated as 102(a) gift under 1041(b). Her subsequent sale results in a GR and R of 500K. Step 3: It is likely a long term capital asset b/c she takes carryover 1223(a)(2). (2) Same as (a) except that the land is transferred to satisfy a debt that Michael owes Lisa Marie. The land has a basis of 500K and FMV of 400K at the time of the transfer. Lisa Marie sells the land for 350K. A. First: This is incident to divorce under the 1041(c) one year rule so no recognition by Michael. However, this could be a 61(a)(12) but there is no indication that the debt is over 400K FMV Lisa: She takes the 500K AB pursuant to the 1041(b). Next she obtains a loss realized <150K> pursuant to the 350K sale. However, she may not be able to recognize, b/c this likely falls outside of 165 unless FOR PROFIT or pursuant to trade or business.


(3) Does the Loss Basis Rule apply under 1015? A. No 1015(e) says that 1041 is its own section and does not apply the Loss Basis Rule. (4) What result if pursuant to the divorce decree, Michael transfers the land in (a), to Lisa in 2005. A. This is related to divorce, and thus incident to divorce. Therefore, 1041 rules apply. No consequence to Michael and carry over to Lisa. The key is that (1) incident to a divorce decree; and (2) less than 6 years. (5) Same as (c) except that the transfer is required by a written instrument incident to the divorce decree. A. this is the same. It should be noted that this must be the same type of divorce agreement as is mentioned under 71(b)(2)(A). This is related to and you have the same consequence as the above problem; CHILD SUPPORT 71(c)(1)-(3) Anti-Lester Rules: (Lester said must be expressly fixed). (1) No 71 or 215 deduction where amount is FIXED in instrument as child support. (2) Fixed includes the following: (A) On the happening of a contingency specified in the instrument relating to a child (age, marrying, dying, leaving school, etc) (B) At a time which can clearly be associated with a contingency specified in (A). (3) If payment less than the amount specified in the instrument, then payment is first allocated toward the support. Problems: Problem: Sean and Madonna enter into a written support agreement which is incorporated into their divorce decree at the time of their divorce. They have one child who is in Madonnas custody. Discuss the tax consequences in the following alternative situations: (1) Agreement says that 4K is child support out of 10K. A. This amount is Expressly fixed as Child Support, and thus, falls under 71(c)(1). (even pre anti lester). The 4K amount is not deductible under 71(b). However, the 6K (as long as it meets all of the 71(b) requirements is deductible. (2) The agreement requires Sean to pay Madonna 10K per year, but when their child reaches 21, dies, or marries prior to reaching 21, the amount is to be reduced to 6K per year. A. This time period is related to (child dying, marrying, leaving school etc) contingency as stated by 71(c)(2), so the 6K is not excludible or includible under 71 or 215 while the 4 is!! This is the Anti-Lester rule. It works the same as the express fixed rule above. (3) What result in (a) if Sean pays Madonna only 5K of the 10K obligation in the current year? A. 71(c)(3) Allocation rule. You first have to apply towards the support, and then you later apply to the alimony. TRADE OR BUSINESS DEDUCTION 162 Deductions Generally: 1. Deductions are a matter of LEGISLATIVE GRACE. 2. You must meet all elements and T has the burden to prove. 3. The statutes are narrowly construed. Trade or Business: MNEMONIC: ONCEPT 162 1. Ordinary: Where an expense is common and accepted in the business community to which the T belongs, even though the expenditure may be extraordinary to a particular T. Welch. (paying the debts of others not ordinary. 2. Necessary: If it is appropriate and helpful to the trade or business (deference to T). HOWEVER, not if could be compensated.


3. Trade or Business: (a) Engaged in the trade; (b) With continuity or regularity; and (c) Primary purpose is for income or profit. Commr v. Groetzinger (gambling permitted). 4. Expense: An expenditure is not 162 if it (1) creates and enhances a separate asset or (2) creates more than an incidental benefit beyond the taxable year incurred. INDOPCO (where incurred expenses to b/come subsidiary of co. and had long term benefits). A. 162 Includes Repairs and expenses to keep property up that do not appreciably increase their worth. B. 1.162-1 Resale goods; commissions; labor/supplies; insurance; advertising). C. 263: (1) Adds value; (2) Prolongs life; (3) Adapt to different use. i. 1.263(a)-2 Costs to erect new bldgs; machinery; equipment; furniture are capital. 5. Carrying On: Expense incurred while in existing trade or business. A. 195 This does not include investigation expenditures. 195; Morton, and 75120. 1. Amortize is investigation/transaction expenses if can deduct under 162 over 60 mo. 2. Abandon: If abandon after active trade/business, may treat non-deducted portion as loss under 165(c)(1); however, if abandon in transaction, you can deduct only transaction under 165(c)(2). 3. Allowable under 162 (not 163; 164; 164). B. 75-120: No deduct if first job seeking. You may deduct if w/in trade or business already subject to a time limit. Hundley allows deduction if new trade and expense conditioned upon obtaining job. 6. Paid Same Tax Year: Obvious 262: 1. Expenses for personal, living, or family are not deductible under 162. Repairs v. Capital Improvements: 1 162-4: (repairs) Cost of incidental repairs that do not add value to property, but merely keep in ordinarily efficient operating condition. 1. Example: (repair roof part, plumbing problem, paint one room). 1.263(a)-1 Amt paid for (1) new bldg or permanent improvements (2) betterments to increase value of property, (3) restore by making good the exhaustion where amortized. 1. Example: (new fridge, repair whole roof, etc..) 195 PROBLEMS: (1) Tycoon, a doctor, unexpectedly inherited a sizeable amount of money from an eccentric millionaire. Tycoon decided to invest a part of her fortune in the development of industrial properties and she incurred expenses in making a preliminary investigation. 195 would permit you to deduct ratably over 60 months if (1) elect to and (2) you actually start the business up. (if you do not elect to you can keep your basis under 1001(a) disposition. (2) The facts are the same as in (a), above, except that Tycoon, rather than having been a doctor, was a successful developer of residential and shopping center properties. You have to show that this is the same trade or business, which is narrowly construed, and then you may be able to deduct if you meet the other requirements under 162. If 162 does not work for you, you can still turn to 195. (3) The facts are the same as in (b), except that Tycoon, desiring to diversify her investments, incurs expenses in investigating the possibility of purchasing a professional sports team. 162 would only apply if you are expanding an EXISTING IDENTICAL trade or business. Thus, this would not apply under the facts.


(4) The facts are the same as in (a), except that Tycoon then begins developing industrial properties. Tycoon is advised by her lawyer that her prior expenses qualify as 195 start-up expenditures. Since Tycoon has commenced developing the properties, may she forego a 195 election and deduct her prior expenses under 162? Not residually deductible. Only those in expansion of original trade or businessnot failure to claim 195. You cannot deduct these under 162 now. (5) The facts are the same as in (d). However, after two years Tycoons fortunes turn sour and she sells the business at a loss. What happens to the deferred investigation expenses? The deferred amount can be deducted under 165(c)(1) as a Loss Deduction. 2. This is found under 195(b)(2). (the loss is limited as an individual). Note, if you abandon early, you can deduct only losses for transactional fees under (after target) under 165(c)(2). RR 75-120 Employment: 2. Law students Spouse completed secretarial school just prior to student entering law school. Consider whether Spouses employment agency fees are deductible in the following circumstances. 1. Agency is unsuccessful in finding Spouse a job. This is just start-up and she is not in a trade or business. 75-120 no eduction. 2. Agency finds a job ? Same. 75-120 makes no distinction. 3. Same as (b) except that Agencys fee was contingent upon its securing employment. Hundley (baseball dad deal) provides narrow exception where the expense is contingent upon getting a job. The key is that the door is slightly opened with this. 4. Spouse and the payments will not become due until Spouse has begun working. This would not be deductible, unless she can show some facts (documents) that show that she was looking w/in the same trade or industry. 75-120 says that you do not have to be SUCCESSFUL. So documentation will help you out and you can deduct it. 5. She was already a secretary in previous town? This would be w/in same trade or business, and thus, 162 would apply. However, there is a time limit under 75-120 that must be satisfied. REASONABLE COMPENSATION 162(a)(1) Reasonable Salary Factor Test: 1.162-7 Is the amount really for services or is a dividend? (1) Qualifications (2) Nature of work (3) Size and complexity of business (4) Comparison with Net and Gross Income of payor (5) Economic conditions (6) Comparison with distribution to shareholders Independent Investor Alternative: 1. Managers paid on basis of rate of return. (a) Where high rate of return, salary is presumed reasonable but rebutted if titular manager. Exacto. Contingent Compensation: 1.162-7 1. Merely b/c contingent does not mean compensation unreasonable must determine: a. Whether it was a product of a free bargain. (Not free where major shareholder; Harolds Club where holders are wimps.) b. The arrangement reasonable when made. c. If you fail to meet (a and b) then you now have to look at whether the amount is reasonable when paid.


Problems: What if 50, 50, 50, 200K salary (he owns 98% stock) nominal base and contingent amount? (1) What are the two types of compensation methods that can be deductible? Regular compensation (reasonable determined per statute at time paid); and contingent compensation (reasonableness determined at time entered into agreement (failure to meet criteria no mean that you fail under 162(a)(1) you divert back to the statute. (2) What type of payment could this be? This could be reasonable compensation or a dividend. The dividend is taxable to the Er and Ee but is deductible if found to be a reasonable compensation to the Er not the Ee. (3) What if he only owned 5% of the stock as shareholder? This makes a huge difference b/c (a) it shows that there was a free bargain; and (b) it shows that reasonable when entered in to. (4) What if the salary is determined to be excessive and unreasonable? There can still be a deduction for the reasonable amount. (to the extent reasonable). (5) What was mentioned in class that might be able to trump the presumption that this type of salary was not unreasonable if officer? Where it is a start-up enterprise. The officers may initially leave money in the company for capital etc Reasonable Travel Expenses 162(a)(2) 162(a)(2) Traveling expenses (meals (174(n) 50%), lodging other than amounts which are lavish or extravagant) while away from home in the pursuit of trade or business. Travel Away From Home: 1. Tax Home: This is where you work. Your travel MUST be away from where you work for deduction. 2. Correl: Sleep or rest rule. You must be out overnight in order to deduct TRAVEL EXPENSES. (note that this does not include RR 99-7 transportation). 3. Flowers Test: You must be (a) away from home; (b) exigent to business; (c) reasonable and necessary. 4. Rosenpan: You must have a home. 1.162-2(e): Commuting: 1. Commuting is non-deductible and falls under 262 (personal expenditures & no matter what doing in the car) 2. Parking would not be covered unless fringe benefit. Reason: Where you decide to live is personal choice RR 99-7: Local Transportation 1. Local transportation is deductible b/en businesses or b/en home and temporary work location (162(a)(2) under 1 year & 93-86). Example: T goes from work to client location; T goes from firm to client location. (meals not deductible). RR 93-86 Temporary v. Indefinite Rule: 1. 162(a)(2) deduct only amounts where you are located temporarily at behest of your business away from home. 2. 93-86 Test: (a) If reasonably last only a year, then you can deduct the amounts for temporary expenses away from home, as long as the actual time stays w/in 1 year. (b) If you overestimate that will take over a year and really takes under a year, you cannot deduct. (c) if you anticipate that it will take under one year and it takes over one year, then you cannot deduct. Andrews 2x Home: Where you have two homes to accommodate for work, you may only have one tax home. Expenses from the other home are deductible. Test: length of time, where you earned most money, greatest amt business activity.


1.62-2(b)(1): Mixed Purpose whether your are primarily there for trade or business (primarily related for trade or business test). Determination is primarily made by the amount of time that you spend for each. (fact specific). Problems: 1. You go from home to law office? Commuting so non-deductible. 1.162-2(e) 2. You go from work to client location? Local transportation so deductible if temporary (Correl) and 99-7. 3. You go from your home to your other business? Commuting and not deductible 1.162-2(e). 4. You go from home to client? Deductible under 99-7 if (a) temporary (over 1 year rule) applies. 5. You go from home to Dallas business and come home that day (meals and travel) Deductible under 99-7 b/c transportation from home outside of metro in which work. However, you are not away from home under sleep or rest rule under Correl so no deduction for meals. 6. You eat lunch at work/next door? You are not away from your tax home. 7. You stay in Dallas for the night? Your travel is deductible as away from home travel and your meals are paid 50% under 274(n). 8. You open new business in Austin and rent apartment for 6 months. Can you deduct? The determination is whether you have temporary/indefinite employment. 93-86 would indicate that this is temporary if under one year (see above). EDUCATIONAL EXPENSE DEDUCTIONS First, you must meet 162 ordinary or necessary expense while carrying on T or B. Deduction Step One: Satisfy one of these 1. 1.162-5(a)(1) New Skill or Maintenance w/in profession. Coughlin. 2. 1.162-5(a)(2) Required by State law. Hill. Step Two: Must NOT be one of 1. 1.162-5(b)(2) Minimum Education of Job. 2. 1.162-5(b)(3) New Trade or Business (objective test). (a) Must not constitute part of program/study that lead to new T/B. Problems: 1. Alice, who is often called to give medical testimony in malpractice suits, decided to go to law school so as to better understand this aspect of her medical practice. Alice may pass step 1 (the education might be ordinary and necessary and incurred for business) and 1.162-5(a)(1) would suggest that this is to improve her skills or maintain what she is doing. BUT the objectively different nature of a JD under 1.162-5(b)(3) disqualifies her from the deduction. (the subjective fact that she will remain in the same practice does not matter). 2. Barbara enrolled in a course of postgraduate study in orthodontics, intending to restrict her dental practice to that specialty in the future. This would be deductible. She is merely specializing or changing her duties w/in the same profession. RR-74-78 allows if related to change in DUTY but no trade or business like Alice. (Note this does not apply to lawyers who change states and take bar in another state even though it would to teachers). 3. Cathy enrolled part time in laws school (with prospects of attaining a degree) so as better to perform her accounting duties in areas in which law and accounting tend to overlap.


Cathy is an accountant. A JD is objectively different in trade and business than an accountant. So it would not pass the muster under 1.162-5(b)(3). 4 Denise took a leave of absence from her firm to enroll in an LLM course in taxation, intending to practice exclusively in the tax area. Which, if any, is incurring deductible expenses of education: (also application to lawyers and change of state). The LLM is deductible when already w/in trade or business. However, this may be strictly construed against one that is a prosecutor and goes for an LLM in tax. (advanced degree ok). 5. Assume Denisee expense is deductible, if she travels to school to attend for one year, what can she deduct? Reg 1.162-5(e) and 274(n)? (what is the basis?) She can deduct, travel, meals, lodging and incidentals; however under 274(n) the meals would be limited to 50% deduction. The key is that she is away from home, and this is why she can deduct these expenses. (this is the Correl casemust be AWAY FROM HOME SLEEP AND REST. 6. What if Denise went to Florida on a trip to Disney World while at school? Not deductible. Also, there is a factual test under 1.162-5 to ensure that the travel expenses are principally for her education. 7. Carl earned a bachelors degree in education and he teaches world history in a junior high school. In the current year he contemplates a summer European tour doing things that will be beneficial to his teaching efforts. He wishes to know if he may deduct his expenses. What do you advise? Travel Education is expressly excluded under 274(m)(2). You can not travel as a form of education and deduct. 274 Meals and Entertainment and other Miscellaneous Deductions Pass Test under 162(a) Necessary and Ordinary Expense while carrying on T or B. 1.274(a) (a) Directly Related to T or B (T or B nexus) (not time requirement) 1. reasonable expectation of business benefit; 2. actively engage in business discussion/negotiation; 3. business must be principal reason for the entertainment. OR (b) Associated With T or B: Precedes or follow a bona fide business discussion or negotiation during the entertainment. (strip club?) 2. 274(k)(1)(A)-(B): (A) Must not be lavish. (B) T Must be present. 3. 274(n) (a) Limit of 50%. Uniforms and Uniform Maintenance: Meets 162 and a. Clothing must be a condition of Er; and b. Not adaptable to ordinary use. Problems: Employee spends 100.00 taking 3 business clients to lunch at a local restaurant to discuss a particular business matter. The 100.00 cost includes 5.00 in tax and 15.00 for a tip. They each have two martinis before lunch. 1. To what extent are Ees expenses deductible? First: You likely pass the muster under 162(a) ordinary and necessary. Second: 274(a) would permit this b/c it is directly related to the business. Third: 274(k) would probably be OK b/c does not seem lavish and T is present. Fourth: You can only deduct the 50%. Legislative history indicates that you can deduct the tip and the tax too.


2. To what extent are the meals deductible if the lunch is merely to touch base with clients? You do not satisfy 274(a) b/c this is not directly related under the regs to the activity, b/c it was not primarily for business. 3. What result if Ee merely sends the 3 clients to lunch w/o going herself but picks up 75.00 tab? This fails the muster under 274(k)(1)(B). T must be present. 4. What would be the tax consequence here to the clients? This would be a gift and is allowable under 274(b) only to the extent of 25.00 per year. Not governed by 102(c), b/c not Ee/Er relationship but Er-Client relationship. 5. What result in (a), above, if, in addition, Ee incurs a 15.00 cab fare to transport the clients to lunch? This would be deductible. Note that this is not a meal or entertainment, so it would fall outside of 274(n) and it could be deductible at 100%. 6. What result in (a), above, if Er reimburses Ee for the 100.00 tab? The payor of last resort is permitted to deduct. This would be the employer. The regulations indicate that there are no tax consequences to Ee here, b/c it is a economic wash, b/c he is reimbursed the expenditure. (note: you may want to deduct if it shows up on your salary though). 2. Businessperson who is in New York on business meets with two clients and afterward takes them to a Braodway production of The Producers. To what extent is the 300.00 cost of their tickets decutible if the marked price on the tickets is 50. each, but Businessperson buys them from the hotel concierge for 100.00 each? Under274(l)(1) & (n) you may only deduct 50% of the face value of this guy. Thus, you may only deduct 75.00 of the 300.00. This occurs regardless of whether scalper or not. Miscellaneous Deductions: (deduct under itemized deductions-must exceed 2% (AGI). 1. When may uniforms be deducted? 2. 3. Airplane Pilot incurs the following expenses in the current year: (1) 250 for the cost of a new uniform. (2) 30.00 for dry cleaning the uniform (3) 100.00 in NP ads to acquire a new job as a property manager in his spare time. (4) 200.00 union dues. (5) 50.00 in political contributions to his local legislator who he hopes will push legislation beneficial to airplane pilots. (6) 500 in fees to a local gym to keep in physical shape for flying. a. The uniform and maintenance are deductible 280. b. the 100.00 in ads is not deductible b/c of 75-120 (new employment). c. the union dues are deductible b/c organization. d. the political contributions and local gym fees 174(e) are excluded. 165(c)(3) Casualty theft or loss RULE: Casualty loss (fire, flood, theft etc) may be deductible as a loss if not covered by insurance. (this is a fixed identifiable event/transaction) Calculation: FMV at time of the casualty minus the FMV after loss, to the extent of AB. (E.G. 10/15 and 10/10 you can claim losses up to the 5k loss.) (E.g. 10/15 and 10/2 you can claim loss up to 10K (not the 3k b/c limited by AB0. Limitation: (insurance) You may only claim to the extent that insurance does not cover. Insurance may result in a gain for you. DEPRECIATION 167 & 168; 179; 197; 280


Cheat Sheet on 1820 for depreciation: 167(a) : Depreciation allowed for exhaustion, wear and tear of property: (1) In T or B; (2) held or production of income; 212. 168(a)(1) ACRS (mandatory for tangible property): Must determine: (1) Applicable method; (2) recovery period; (3) convention. I. Convention: 168(a) A. 200% Declining Balance Method & straight line when yields a larger allowance. 1. includes all personal property under 15-year. B. 150% Declining Balance Method & straight line method when yields larger allowances. 1. Includes 15-20 yr property, C. Straight line method 1. Includes residential rental real estate (80% rule) and non-residential real estate. D. 168(g) Alternative Depreciation System: 1. Straight line method 2. Applicable convention under (d); and 3. recovery period determined by class life (unless special provision). II. Recovery Period: 168(c) (c) the applicable recovery period treated under this chart. 3 year 3 years 5 yaers 5 years 7 years 7 years 10 years 10 years Residential Property 27.5 years Non residential Property 39 Years. 168(e) Classification occurs based on this graph. Property Treated as Class Life 3 Year Less than 4 years 5-Year More than 4 but less than 10 years 7 Year 10 or more ut less than 16 10 Year 16 or more but less than 20 years. III. 168(d) Applicable Convention: 1 is year convention unless otherwise provided. (you start at year point no matter when you buy (1/1 or 12/31 is mid year, unless too much). 2. Real property is mid month convention 3. Special rules where substantial property placed in service during last 3 months. If this occurs then it is midquarter. Sharpe: Where you use otherwise depreciable property for personal and business/for profit use, you may only depreciate to the extent that it is used for 167 qualifying use. SPECIAL PROVISIONS: I. Bonus Depreciation Allowance: 168(k) 1. Additional First year depreciation deduction equal to 50% of qualified property in year in which placed into service. 2. Must take after 179 but before computing 168.


3. If elect out of class applies to all property w/in class. 4. Qualifying Property: a. Recovery period 20 years or less b. CPU software c. qualified leasehold property. d. Property must begin prior to may 5, 2003. II. Expensing Rule: 179 1. May Deduct qualified property up to 100K. 2. Limitation: a. Only property up to 400K b. No carry over. 3. 179 Property a. Tangible or computer software and 1245 and acquired in conduct of trade or business. b. Purchased: Not acquired by gift or 1014. 4. Amount must be deducted prior to 168. III. 168(k)(2)(i): You may still elect under 179 and 168 if you deduct through the alternative depreciation system under 168(g). Intangibles: 197 1. Intangibles are entitled to amortization ratably over 15 years beginning in the month it was acquired. 2. Qualified Intangible: a. Acquired b. Held for trade or business or for production of income. c. No include self-created intangible 3. Examples: a. Good will b. Going concern value c. Workforce d. Computer software. PROBLEMS: On January 2 of the current year after 2001, for 300k Depreciator purchases new equipment for us in her business. The purchase is made from an unrelated person. The equipment has a 6-year class life and is 5-year property under 168(c). Depreciator plans to use the equipment for seven years, and expects it to have a salvage value of 30K at the end of that time. Depreciator is a single, calendar year taxpayer, and she uses the equipment only in her business. (a) Depreciator elects under 168(b)(5) to use the straight-line method for the equipment and all other property in its class placed in service during the year and elects out of 168(k). Year % of Unadjusted Amount of ACRS 1016(a)(2) AB 1 2 3 4 5 Basis 10 20K 20K 20K 20K 30K 60K 60K 60K 60K 270K 210K 150K 90K 30K

6 10K 10K 0 The key is that this election took place as elected under 168(a)(3). There is no salvage amount taken out. The 1st year starts under 168(c) convention of year, so the 6th Year must also be for years so you have a full five years. The class life was already stipulated at five yrs. (b)Depreciator uses the accelerated ACRS method provided by 168(a) and elects out of 168(k). Year % of Original Amount of ACRS 1016(a)(2) AB Unadjusted Basis


1 20 60K 240K 2 32 96K 144 3 19.2 57.6K 86.4 4 11.52 34.56K 51.84 5 11.52 34.56K 17.28 6 5.76 17.28K 0 1. This is 200% (double) depreciating balance method. 2. This is recovery period of 5 years under (b) as determined by (e) 3. This is mid year convention under (c). (c) Same as (b) except that Depreciator disposes of the equipment on December 1 of year five. Year % of Original Amount of ACRS 1016(a)(2) AB 1 2 3 4 5 6 Unadjusted Basis 20 32 19.2 11.52 11.52/2 60K 96K 57.6K 34.56K 34.56K 240K 144 86.4 51.84 17.28

1. The key is that you disposed of the property on year five. Thus, you must apply the DISPOSAL RULE. If you dispose of property in mid year, you can depreciate only the amount of the year. (what if you dispose in January?) The key is that the last year, you apply the convention rule. (d) Depreciator uses the accelerated ACRS method provided by 168(a) and does not elect out of 168(k). Year % of Original Amount of ACRS 1016(a)(2) AB Unadjusted Basis 168(k) 50% 150K 150 1 20 30 120 2 32 48 72 3 19.2 28.8 43.2 4 11,52 17.28 25.92 5 11.52 17.28 8.64 6 5.76 8.64 0 (e) What differences from (d) if the year is 2003 and Depreciator also elects to use 179? What additional facts do you need to know. Year % of Original Amount of ACRS 1016(a)(2) AB

Unadjusted Basis 179 100K 200K 168(k) 50% 100K 100K 1 20 20 80 2 32 32 48 3 19.2 19.2 28.8 4 11.52 11.52 17.28 5 11.52 11.52 5.76 6 5.76 5.76 0 1. The key is that you take the 179 first. You next use the 168 Bonus provision. Lastly you apply the accelerated method for the excess. (f) The equipment has a 6-year class life and depreciator elects to use the 168(g) alternative depreciation system for the equipment and all other property in its class placed in service during the year. (168(K)(2)(C) (i). Year % of Original Amount of ACRS 1016(a)(2) AB Unadjusted Basis


168(K)(2)(c)(i). 168(k) 50% 150 1 8.33 12.5 2 16.6 25 3 16.66 25 4 16.66 25 5 16.66 25K 6 16.66 25K 7 8.33 12.5 1. You can still claim the bonus depreciation. Luxury Automobiles: 1. The amount of depreciation deduction for a passenger automobile cant exceed: (i) 2,560 280(f) PLUS 7,650.00 for bonus depreciation property (168)(K)(4)(D). (ii) 4,100 for 2nd year (iii) 2,450.00 for 3rd taxable year (iv) 1,475 for each succeeding year.

150 137.5 112.5 87.5 62.5 37.5 12.5

A. Automobiles have a five year class life, but 280(f) force you to take them over a period of nine years. Problem: Hi Roller buys a luxury automobile for business and personal use at a cost of 20K in the current year. Assume for simplicity that there is no inflation in the CPI automobile component after October, 1987. 280F(d)(7). (a) Compute the maximum depreciation deductions available to Hi assuming no 179 election is made and there is no personal use of the car. Year Amount of ACRS 280(f)(d)(7) and 168(k)(4)(D) The first year, you may deduct the original 2,650.00 as indicated under 280, and then you may deduct the additional 7,650 allowed under 168(k)(4)(D). This equals 10.21k 2 4,100.00 (for year two) under 280 3 2,450 (for year three). 4 1,475 (for remaining years). 5 1,475 6 1,475 7 1,475 8 1,475 9 1,475 10 .865 (remainder). (b) What result to Hi under the facts of (a) if the car is used for business purposes the following percentages of the time in the following years: year one 70%; year two 80%; year three 70%; year four and later 60%. Year 280(F) Limitation % of Business Use Amt of ACRS. 1 10.21 70 7.147 2 4,100 80 3.28 3 2.45 70 1.1715 4 1,475 ( 60 .885 5 1,475 60 .885 6 1,475 60 .885 7 1,475 60 .885 8 1,475 60 .885 9 .865 60 ..519 25K Total .17,086


KEY: You depreciate under Sharpe dependent. Note that these rules make recovery 9 years even though 5 year is typical. REAL ESTATE DEPRECIATION 1. Method is always straight line (no salvage) 2. Applicable convention is mid month. (if Jan 1, then you calculate 11.5% of typical yearly amount for the first year). 3. The Recovery Period: a. Residential Rental 27.5 years (must be 80% for residential 168(e)(2)(A). b. Non-residential Real. Note: Real Estate applies to NON DIRT! Problem: During the current year, Depreciator purchases a piece of new improved real property at a cost of 130K of which 100K is attributable to the bldg and 30K to the land. Depreciator immediately rents the property to others. Compute Depreciators depreciation in the subsequent year in the following situations: (a) Apartment Building: 1. If satisfy the 80% test under 168(e)(2)(A), then this is 1/27.5 of the 100K so 3,636.36. (b) Office Building: 1. 1/39th of the 100K, so you have 2,564.10 per year. DEDUCTIONS FOR NONBUSINESS-PRODUCTION OF INCOME EXPENDITURES 212: An individual may deduct all ordinary and necessary expenses paid or incurred during the tax year: (also requires carrying on the practice). (1) for production or collection of income. (2) management of property held for the production of income; or (3) dealing with tax matters. 1. Higgins: Although managing a portfolio does not fit into 162 deduction, it is holding for production/collection of income. 2. Legal Fees: ORIGIN OF THE CLAIM TEST! a. Fleishman: Preservation of a source of income from a spouse (or preserving title) is not a deductible expense. The expense is inherently personal. b. Alimony-Seeking Spouse: The spouse may deduct alimony negotiation or enforcemen c. Taxes: Both parties may deduct for hiring tax help. a. Merriams: lawyers must keep track of the amount attributed to taxes. Problems: Speculator buys 100 shares of Sound Co. stock for 3K, paying her broker a commission of 50.00 on the purchase. Fourteen months later she sells the shares for 4K paying a commission of 60.00 on the sale. (1) She would like to treat 110 paid as commissions as 212 expenses. Why? Can she? 1.263(a)(2). A. Her initial adjusted basis is 3,050 due to the expenses initially incurred for the commission. 1012. The 60 commission is just knocked off of your AR, so you actually only have 3,940 AR. Your gain realized and recognized is 890.00. 2. What result in (a) if instead she sells the shares for 2,500? 2. The key is that you would have a loss. (the 50 and 60 would still work to reduce basis and amount realized). The key inquiry is whether you can deduct loss under 165(c)(2). B/c this is investment activity, you would likely qualify under entered into for producing income. Thus, you can deduct the loss. Held, Converted, Entered into for Production of Income Tests 212, 265(c); 1.165-9(b); 1.167(g)-1 1.212-1(h): Costs to conserve personal residence not deductible; however, if converted to rental property (production of income), then deductible. 165(c)(3): Loss recognized when enter into a trasaction for profit. Case Law:


1. Horrman: Where abandon residential property and list for rent. This is sufficient to establish intent to hold for production of income; however, insufficient to meet 265(c) requirement that entered into for profit (must actually rent to get loss). 2. Lowry: 212 conversion may occur simply by holding previously residential property for post conversion profit by subsequent disposition of highly appreciated property. (212 appropriate). 1.165-9(b) If property converted from personal residence to income producing purposes, a loss shall be permitted. However, for determining a loss the AB shall be the lesser of: i. The FMV at the time of the conversion. ii. The AB at the time of the conversion. (1.1015-1(a)(2)) basis rule applies). 1.167(g))-1: Basis for depreciation shall be the AB. However, when property converted for personal to T or B/for production of income, the FMV is the amount from which to depreciate. PROBLEM: Homeowners purchased their vacation residence for 180K (20K allocable to land). When it was worth 160K (20K allocable to land) they moved out and put it up for sale, but not rent, for 170K. 1. May they take deductions for expenses and depreciation on the residence? If so, what types of expenses would qualify? A. In order to meet 168 (ACRS deductions) and 212, the property must be held for the production of income. Merely moving out is probably not enough. He would have had to put it up for rent b/c he can not show the appreciated value of the property and he did not try to rent it, unlike Horrman. Thus, no deduction. 2. What may be depreciated? 2. If you rent, you meet Horrman (held for production of income 212). Thus, you may only depreciate the real property. 3. What if sold the house for 145K after took 10K in ACRS deductions? 3. 1.165-9(b): In this case the 145K would represent a loss, so you would take the FMV at the time of the conversion minus the ACRS deduction of 10K. This amount pursuant to 1.167(g)-1 is taken from the FMV at the time of the conversion b/c it was less than the AB at such time. Thus, you have a loss of only 5K (150 AB 145 AR = <5>. This is recognized under 165(c)(2), b/c you meet 165(c) (did more than Horrman). (4) What if the same property was sold for 175K? You do not meet the 1.165-9(b) 2-prong inquiry, b/c the even though the FMV was lower than the AB at the time of the conversion of use, the 175K represents a gain (175>150); thus you have a gain of 5K, using pursuant to 1.167(g)-1 the 180K for ACRS depreciation (residential) and 1.165-9(b). The gain is realized and recognized pursuant to 1001(a). (5) What if the property was sold for 165K? This is just like the 1015 loss basis rule. It is b/en the 150K (if it was a loss) and (170k) if it was a gain). Thus, you have no gain and no loss. (if it is anywhere b/en 150 and 170, you would have this outcome. See 1.1015-1(a)(2). RECAPTURE 1245 1245(a)(1): Except as provided, if 1245 property is disposed of the lower of (A) the recomputed basis of the property; or (B) the amount realized to the extent it exceeds the adjusted basis in the property is ordinary income. 1245(a)(2): (recomputed basis): means the AB of plus any depreciation adjustments made to it. 1245(a)(3) 1245 property means any property which is or has been property of a character subject to depreciation or amortization which is: 1245(a)(2)(B): If T establishes by records or evidence that the amount allowed was less than the amount allowable, the amount shall be recomputed as AGI. KEY: Even if you have 1231 or 1221, you may still be required to have an ordinary income gain due to 1245. PROBLEMS: Mary purchased a delivery truck several years ago for $50,000. She properly claimed ACRS deductions of $30,000.


1.Discuss the income tax consequences if she were to sell the asset for $45,000. A. Under 1245, you apply the lesser of the recomputed gain and the AR gain: AR AB = 15k); and (RB AB = 20K) (b/c you put back the 20k 2.What result if she were to find a buyer willing to pay $55,000? 2. Under 1245, she takes the lesser of RB/AR amount again. (AR AB = 35K) and (RB AB = 30K). The lesser is 30K so you would have 20K ordinary gain and 5K long term capital gain (1231 property gain rule). 3.Assume the facts of problem 2 except that she claimed ACRS deductions of $25,000. See section 1245(a)(2)(B). 3. This is the trick rule under 1245(a)(2)(B). If she has evidence (records) that she took the amount allowable of 25K as opposed to the allowed (30k), she is cut a break. She may use the amount allowable as her RB. Thus (AR AB = 25K); however (RB(45k) AB = 25K). She would only have to apply 25K to ordinary income. The 10K excess would be long term capital gain. DEDUCTIONS 62 Overview: GI -62 AGI (above the line deduction). GI -Exemption Std (itemized Deduction) Taxable Income

1. Above the Line Deductions: (AGI Treatment) A. First: It must be deductible under authority of code: B. Second: It must satisfy 62 1. AGI GI minus: (1) trade or business deductions of the Employer (no include employee 162) (2) Certain T and B deductions of Employee a. Expenses reimbursed by employer to employee. d. Elementary and secondary teacher expenses that meet 162 and under 250.00 (3) Losses for sale or exchange of property. (221 capital losses included). (4) Deductions attributable to rents and royalties. (212 no include all). (10) Alimony 215 (15) Moving expenses 217 (17) Interest on education loans 221 (18) Higher education 222. PROBLEMS: Assume the following expenses are properly deductible. Does the deduction fall under 62, or may it be claimed only as a 63 deduction. (a) Ee, a policeman, purchases a new uniform at his own expense. 62(1) not here. It is itemized b/c 62(a)(1) is for the employer only. (162 only applies here for employer expenses) (b) Ee Salesman (not outside) pays the cost of entertaining purchasers in ocial circumstances that are directly related to her trade or business and is not reimbursed by the Er. 62(a)(1) allows deduction for the Er only through 162. However, the Ee cant collect, b/c not reimbursed. (see 62(a)(2). (expenses incurred in Ee capacity is the key). Furthermore, these deductions are limited to the extent of 274. (1/2 off). (2) Same as (b), except that Er reimburses Ee for the exact cost incurred. How should Ee treat the expenses and reimbursement on her return?What result to Er?


62(a)(2) allows for a deduction. Thus, you have a wash. You only deduct, however, if it is included in your GI. The Er can deduct above the line 62(a)(1), as long as meets the 162 requirements. Note that the 100.00 is reduced to the extent that 274 requires it to be pursuant to (a), (k), and (n). Note: If the amount is not included in your GI, you do not have to report the wash as an employee. 2. What if the amount paid to Ee as reimbursement exceeds her actual expenses? (e.g. extra 20.00) 1.162-17(b)(2) says that excess is included in return, but you do not have to include the 100.00 and then deduct. 3. What if the actual expenses exceed her reimbursement? 1.162-17(b)(3) must state the amount and you can deduct. However, the deduction does not come under 62(a)(1) so it is not above the line. It can only be itemized. (d) Same as (b) except that Er, an individual, rather than Ee, entertained the purchasers. 62(a)(1) and 162. This would be deductible above the line. (e) Ee, at his ownexpense, pays 500.00 tuition for a refresher course in Home Town to bring himself up to date on current business techniques relating to his employment. This would be deductible if meets education for trade or business test under 1.162-5 (required by er or maintain or improve existing skills) and NOT (for new trade or business or to meet minimum education requirements). However, this is below the line b/c not included w/in 62 anywhere!! 62(18) would not apply b/c not higher education. (no take itemized deduction here unless exceeds standard deduction though. (f) Ee makes payments for medical expenses and charitable contributions and for taxs on her residence and interest on a note secured by a mortgagte on the residence. First: locate in the code! 1. Taxes: 164 2. Interest 163 3. Charity 1704. Medical 213 BUT none is covered under 62, so no deduction. g) Same as (f) except that the taxes and interst relate to a residence that Ee rents to tenant. 62(a)(4) and 212. If you can satisfy 222 Lowry or Horrman, then you can deduct this puppy above the line. (h) Ee has la loss on the sale of some stock that he held for investment?? 62(a)(3) and 265. This is 221 capital asset loss. Thus, you can deduct this amount in the current year. (Meets 265 criteria if entered into for profit). (i) Ee deducts 1k of interest on student loans. 62(a)(17). 1. 221!! 2. You meet both criteria so you are above the line! (k) Er pay accountant 400.00 to prepare hs federal income tax return, 150.00 of which is allocable to preparing the schedule related to the income from his sole proprietorship business. 1. The 150.00 is deductible above the line under 162 and 61(a)(1); however, the 250.00 is below the line b/c it is deductible under 212(a)(3) but not deductible under 62. Thus, itemized. 212(a)(3) and 63 (itemized) 1. 400.00 own250 v. 150??? (l) Single pays ex-spouse 6K alimony. Is this w/in common thread of 62? Yes, 62(10) and 215. 1. You meet both tests and this is above the line. (m) Ee incurs properly deductible moving expenses. 62(a)(15). 1. 217 2. Above the line!


(n) Ee is an elementary school teacher who pays 350 worth of classroom materials in 2003. 62(a)(2)(D). Only up to 250.00 62(a)(2)(D). The 100.00 excess falls under itemized deduction. Moving Expenses: (helps you out despite 75-120 but to lesser extent) 62(a)(15) and 217 (a) Deduction for moving expenses incurred in connection of commencement of work by the T as an Ee or self employed with a new principal place of work. (b) Moving Expenses means only the reasonable expenses (A) moving goods and effect. (B) traveling (lodging) (C) individual w/in household. (NO MEALS) (C) No deduction unless (1)(A) principal place of work 50 miles farther than previous or (B) 50 miles from residence if no employed. (2)(A) must work 39 weeks full time in next job/ 1 year. (f) Self employed if owner business or partner. (2)(B) must work 78 weeks/2 years if self employed. PROBLEMS: Lawyer has been practicing law in Town X and he and his family live in Suburb of Town X ten miles away. He decides to open an office in town Y. Consequently he moves himself and his family to a home in Town Y. (a) How far away from suburb must town Y be located in order of lawyer to be allowed to deduct moving expenses? 60 miles pursuant to 217(1)(A). (b) How far away from Suburb must Town Y be located in order for lawyer to be allowed a moving expense deduction if lawyer hasjust graduatd from law school in Town X and he was not employed? Only 50 miles 217(1)(B). (no formal place of principal place of work). (c) Assuming Lawyer is a sole practitioner what time requiments are imposed on him in order for 217 to apply? 217(c)(2)B)78 weeks w/in 2 years. (d) What difference in result in (c), if Lawyer joins a frm in Town Y as a partner? 217(c)(2)(A): (you have deduction allowed if 39 weeks and 12 months. (e) What difference in result in (c) if lawyer goes to work for a firm in Town Y but as an assocaiate rather than a partner? No difference. (f) Assuming the necessary time and distance requirements are met, and that a joint return is filed, what is the amount of Lawyers 217 deducdtion if he incurs the following expenses: 400 in moving his familys belongings; 150 in transporting his family; and 100 in lodging and 200 in meals in conjunction with transporting the family? 217(b)! 400.00 Deductible 150.00 Deductible 100.00 Deductible (200.00 for meals not deductible) 217 650. (g) Is there any difference in the result in (f) if Lawyers spouse also takes a job in Town Y and meets the necessary time and distance requirements? No, this would be fine, assuming they file a joint tax return. (h) If Lawyers firm reimburses Lawyer for 850.00 of his expenses in the year that they are incurred what tax consequences will the reimbursement have? 1. 82 says that reimbursements are included in GI. They are not deductible to the extent that they exceed the amount paid by the employee, so included in GI. Thus, the net 200.00 is includible in GI.


2. 132(g) and (a)(6) provide for a fringe benefit exclusion for moving expenses paid by the Er, however, it is limited to the extent it would be deductible under 217. Thus, no meals. Extraordinary Medical Expenses 213 213 (a) Deduction allowed for deduction of medical expenses, not paid for by insurance for medical care of T or dependent (152), as long as the expenses exceed 7.5% of Ts AGI. (b) Medicine and drugs covered only if prescribed or insulin. (d) Medical care means amounts paid for diagnosis, cure, mitigation treatment, prevention of disease, or other purpose affecting body. (1) transportation primarily essential to medical care. (2) qualified long term care services, or insurance premiums. (8) Cosmetic surgery not included unless to ameliorate deformity arising out of PI or disfiguring disease. 1-213-1(e)(iii) Capital expenditures may qualify as medical expense, if primary purpose is medical. It may also included if improvement exceeds increase in value to related property. (e.g. air conditioner/elevator). Expenditures for maintenance of the capital asset are also deductible. Girard. (even if only part qualified when purchased). Farris: Deduction for 263 expenditure also limited to extent that 1(c) the insurance is not excluded from taxes. (3) Daughter elects to take 12K payments for the remainder of her 25-year life expectancy: A. 101(d) Step One: Pro rate exclusion rule: 100K/300K gives you 1/3 exclusion ratio. You have left with an 8K inclusion and 4K exclusion for each payment. Step Two: This was a capital asset but it is extinguished and daughter is on the creditor side. Thus, Hudson says that this is not a capital gain. So you have ordinary income. (4) What if Beneficiary Died after 25 Years? A. Reg 1.101-4(c) says that you would continue to received the prorated amount. (5) What if Beneficiary Died before 25 years? A. 101(d) States that you not get to deduct the remaining face amount of the insurance. Problem: Jock agreed to play football for Pro Corporation. Pro, fearful that Jock might not survive, acquired a 1 million insurance policy on Jocks life. If Jock dies during the term of the policy and the proceeds of the policy are paid to Pro, what different consequences will Pro incur under the following alternatives? (1) With Jock consent, pro pays for 20K policy under his name? A. 101(a) would allow the entire amount to be excluded. (2) Jock owned a paid-up 1 million dollar policy and he sold it to Pro for 20K? A. This triggers 101(a)(2) (transfer for value rule) which permits Pro to only exclude the amount it pays for the policy (i.e. 20K). Thus, in this situation, 980K would be taxable based on the exclusionary rule. B. This property is extinguished so this would be ordinary income. (3) Same as (2) but Jock is a shareholder? A. 101(a)(2)(B) includes shareholders in the transfer for value rule exception. The key is that you have to look at the relaat about an estimate that 400 of the years electricity bill is attributable to ruunnin the AC system? Yes. To the extent that you have capital asset for medical services, the operation or maintenance is completely deductible, even if none/part qualified as 213 capital asset expense. Personal Exemption; Spousal Exemption; and Dependent Exemption


151 and 152 (also 63) I. 63(b)(1)(2): Taxable income is AGI minus Personal Exemption (but this is really above the line). 151(a) For individual exemptions allowed as deduction for computing taxable income (really above the line) to the extent of 2,000. 151(b) (spousal exempt) Ts spouse may be claimed as additional exemption if no joint return, and the spouse has no GI and is not a dependent of another. Exemption also allowed if file jointly but this is just double personal exemption NOT spousal. 151(c) Dependence Test: Exemption allowed for each dependent if: 1. Relationship: (152(a) . son, daughter, or descendent 2. stepson or steptdaughter 3. brother, sister, or stepbro/step sister 4. Father/mother, or ancestor 5. Stepfather/mother 6. Nephew or niece 7. Uncle or Aunt 8. Son-in-law, daughter-in-law, father-in-law, motherin law, brother-in law, or sister in law or 9. individual who for taxable year has principal abode in home of T and is member of household. unless violate state aw. 2. Earnings: 151earnings of dependent may not exceed 2,000 in the taxable year, UNLESS (a) child of T and not yet 19; or (b) full time student not yet 24. 3. Support: (a) deduction allowed only to the extent that T provides over of support in taxable Unless: 1. Multiple Support Agreements: No one person contributed over support, but provided over 10%, would have been able to claim otherwise, and other contributors file a written declaration waiving their right to the exemption. 2. Students: Amounts received as scholarship for study at educational organization not taken into account to determine support. 3. Divorce: Custodial parent gets exemption if legal custody, separated under written agreement (or live apart for 6 mths) and both parents provide over of childs support. a. Or other non-custodial spouse if custodial spouse signs written declaration that no claim. 151(d)(2) Where person claimed as dependent, there person exemption is 0. 1.151-1(c)(2) For determining age of an individual, the last day of the taxable year is the controlling date. The exception is if January 1st you attain the age the year before. Problem: In the following part of this question, state the number of deductions for personal exemptions available. The fllowing factsmay be assumed unless otherwise indicated: T was married; Ts spouse had no GI during the year and was not a dependent ofany other person; and T files a separate return. Treat each part separately unless otherwise indicated. (a) T married H on Dec. 31, and Hs only income for the year was 50.00 of interest on tax exempt bnds. 151(b) Spousal exemption OK, b/c meets test and the interest is 103 exclusion. (b) Same as (a) except that on Dec 31 H also receive 100 as a wedding present from Uncle. 1. 102(a) exclusion!! Thus, you are fine under 151(b). (c) Same as above except that the 50.00 was a gain from the sale of the bonds. No exclusion. 151(b) cannot apply, so no claim.


(d) Under the facts of (c) may T claim a dependency exemption for H if a spousal exemption is foreclosed? No. Wife cant be dependent. She fails 152(a) relationship test. (e) Same as (c)except that T and H file a joint return. They could claim each other under151(b). They just combine there personal exemptions. Problem: In each of the following parts state whether T was entitled to a dependency exemption for the particular person involved. Assume he following facts for each of these parts, unless otherwise indicated: the taxable year is 1989; T was married but filed a separate return; and T furnished over of the support for the particular person involved. Also assume, unless otherwise indicated, that such person earned less than 2,000 gross income during the year, and did not live with T. Treat each part separately unless otherwise indicated. RELATIONSHIP (a) X was Ts wifes brother. Exemption allowed. You satisfy relationship test under 152(a) b/c brother-in-law. (b) Same as (a) but assume that: (1) Ts wife died the year before. Death does not sever brother-in-law relationship. (2) T and W were divorced the year before. Divorce no sever (cX was Ts wifes sisters husband. This is nothing. No exemption. (d) Same as (c) except that X lived with T the entire year. Exempt under (a). 152(a)(9). As long as principal place of abode & lives in same household for taxable year, unless violates state law. Earnings: (e) X is Ts son who will be 19 next January 1st and who earned 2K from summer jobs during the year but who is a full-time college student, except in the summer. 1.151-1(c)(2) 1. Earnngs test: 2k but this is an exception to earnings test b/c child of T as long as under 19 or full time student. 1.151-1(c)(2)19 you are deemed to turn 19 if 1stthis would make you 19?? (I think). 2. Kid no meet earnings test, but T can claim child 151(d)(2)-kid personal exemptionhe has PE amount of 0. (f) X is Ts 18 year old daughter who had only 500 of gross income during the year, but who married Y during the year with whom she files a joint return. 1. No exemption b/c married and filed jointly. (relatinsihp OK, and earnings test OK, but you have married 151(c)(2) will foreclose this (married plus joint return filedthey will ordinarily do this b/c lower marginal rates). (g) Same as (f) but Y also had relatively little income from which tax was withheld and their return was filed only for purposes of obtaining a refund. Rev 65-34. 1. If file joint return, where you do not owe anything at all, you can still be claimed. 65-34; Martino. (you no owe tax to begin with). (h) X was Ts 18 year old son for whom T contributed 2K in support, while X, who had no GI, applied 3K out of gifts from Uncle U to his support. (SUPPORT: 1. This fails the 152(a) support test b/c not over . (i) Same as (h) except that X only contribution to his own support was 3K scholarship enabling him to attend Embraceable U. 1. scholarships excludible nder 117. 152(d) does not include scholarships in determining support. 3. Ts father X, who has no GI, was supported in the current year by T, Ts two brothers (A and B), and C, an unrelated friend. A total of 4K was spent for the fathers support which was contributed in the following proportions by the above persons: X, 15%; T, 25%; A, 20%; B, 10%; and C, 30%. Which of these persons, if any, is entitled to claim X as a dependent and which procedures must they follow?


This is exception under 152(c) multiple support agreements. As long as you would qualify but for the requirement, but you have provided over 10%, you can meet the test. C is out b/c unrelated friend; B is out b/c only 10%. Thus, it is b/en T and A. Either could take if other part writes written declaration, attached by the party trying to exempt to tax return that no claim. Problem: W, upon graduation from law school, decides to divorce H after 3 years of marriage. The divorce becomes final in the current year and W is awarded custody of their son J,who is entitled to the dependency deduction in the following circumstances? (a) W furnishes 40% of Js support and H 60%. (custodial parent)! 1. W entitled b/c she has custody. 152(e)! 50% by parents, divorced, and legal custody belongs to W, so she takes. % support no matter. (b) Same as (a) except that W waives claiming any dependency deduction. H could take under 152(e)(2). (c) Same as (a) except that Jr. lives with Grandpa for 9 months out of the year. 1. W is custodialmore than support provided by parentscustody is legal custody! No alter result that 9 mos kid lived with grandpa. (custody-legal custody no necessarily physically). (d) Instead of getting divorced, W moves out of the house into her own apartment on May 1 of the current year and continues to reside there throughout the year. Jr. lives with H and both W and H equally provide for Jrs support. 1.152-4(b) you do not have legal custody, so you resolve by physical custody. Divorce decree no required as long as both live apart for over 6 months. 152(e). Thus, H would take. Where else situation where legal custody no resolve issue: Joint custody. Standard Deduction 63 v. Itemized 67 Taxable Income 63((a) TI: GI minus deductions allowed by this chapter. 63(b) If no itemize deductions, then TI is GI minus (a) Std Ded, and (b) Personal exemption 151. 63(c) Standard Ded Means (basic + additional) a. 63(c)(2): Basic is 3K for single and 5K for married. b. 63(c)(3) Additional is 500.00 if not married and 750.00 if single if over 65 or blind (if both you 2x). i. Jan. 1st rule under the regs! 63(e) Election: If itemized deductions exceed Standard deduction, you elect to take them in lieu of Std Ded. 63(c)(5) If claimed as Dep: You take greater of a. 500.00 or 250.00 + earned income (not interest) not to exceed your standard deduction, or you take it. 63(c)(6) Spouses cannot claim standard deduction where other spouse itemizes, or you get 0 std. ded. for that spouse. 63(e) Election 67(a) If miscellaneous itemized deduction, you may only take if they exceed 2% of AGI and you subtract that 2%. 67(b) Miscellaneous Itemized Ded: Means all BUT: 1. 163 Interest 2. 164 Taxes 3. 165 (casualty and therft) 4. 170 Charitable contributions 5. 213 Medical 6. 72(b)(3) Annuity Note: If one of these then no 2% deduction rule. 67(b) Misc. Examples: 1. Unreimbursed T or B; 2. Bar/Union dues; 3. 212 not covered by 62(a)(4)!


Problems: Single T in the current year has 20K of AGI, a single persona exemption and the following allowable itemized deductions: 1K in interest 500 in taxes, 1,500 in unreimbursed ee travel expenses, 200 in tax preparation fees and 300 bar association dues. No inflation. (a) What is Ts taxable income for the current year? 1. 20K AGI; 2. PI is 2k; 3. Std Ded v. Itemized. You elect to take itemized under 67. This gives you 3,100 (1,500 67(b) non misc. and 2K (67(a) misc. subject to 2% reduction gives you 2K 400 = 1,600 + 1,500 = 3,100 which exceeds the 63(c)(2) std deduction. You have TI per 63(b) of 14,900 (20K 2K 3,100). (election made pursuant to 63(e). (b) What difference in result (a) if Ts 65th Bday is Jan 1 of the succeeding year (1.151-1(c)(2). 1. Under 1.151-1(c)(2) you determine that the Jan 1st is part of the previous tax year. Under 63(c)(3) you are allowed the additional 750.00 std. ded (b/c 65). Thus, you add 3K and 750.00 which gives you 3,750 (greater than 3,100 itemized), so no itemize 63(e). This gives you TI of 14,250 (20K (2K + 3K + 750)). (c) What difference in result under the facts of (a) if T is married couple filing a joint return? Under 63(c)(2) you can take the 5K, which is greater than itemize (schedule A election) of 3,100. Your TI is 11,000 (20K 4K personal exemption under 151 (both) + 5K (Std ded)). (d) What difference in result under facts of (c) Ts deductible interest is 4K rather than 1K? A. 6,100 pool of itemizedyou elect to itemize under 63(e). TI is now 9,900.00. Problem: T, who is single, a child of X and a full-time law student has gross investment income of 4K in the current year and no 62 or itemized deductions. For simplicity assume that there are no inflation adjustments after 1988. See 63(c)(4), 151(d)(4). X properly claims T as a dependent for the year. 63(c)(5) (a) What is Ts taxable income for the current year? 1. You have 4K investment income. (GI). AGI! 2. T no personal exemption. He is dependent, so you lose 151(d)(2). 3. STD Ded: 500.00 (63(c)(5). Greater of earned income. 0 + 250 v. 500=greater of rule so STD ded. 500, so you have 3,500.00. (b) What difference in result in (a) if instead T has a 1K of earned income (911(d)(2)) and 3K of investment income? 1. Under 63(c)(5), he can take 1,250.00. Thus, his TI is 2,750.00 2. AGI: 4K 3. No 151 4. Std is 1,250.00 by applying greater of rule! (c) What difference in result in (a) if T has 4K of earned income and no investment income? A. Limitted to 3,000 (the 4,250 would exceed). (c)(5) is a limitation provision so you cant exceed your 63(c)(2) deduction. 3. A lives in New York and B in Fl. Both are single and have very substantial allsalary incomes of identical amounts in the current year. A pays state incometax in the amount of 4,000. B pays no state income tax. Assume that neither has any other costs, expense, or expenditure that could be claimed as a deduction. Which should claim the standard deduction? Explain. Would your answer be different if the 4K paid by A was deductible alimony? 1. B: Standard deduction, b/c no misc. 2. A would take the 4K (not miscellaneous under 67!) TI reduces by 4K! a. 164 (4K exceeds) amountno 2% b/c not 67 (not misc. itemized). 3. What if A takes 4K for alimony? (this is above line so goes against AGI). (this is above the line under215 and 62(a)(10). ((still take standard deduction and personal exemption!) Total deduction paying alimony is (total deduction A will experience4K (above line + 3K=7K).


4. Husband and Wife file separate returns. Husband has a substantial itemized deductions, but Wife has very few. Why does Congress prohibit the use of the standard deduction by Wife if Husband itemizes his deductions? ((63(b)(6) where either spouse itemizes, STD deduction shall be 0! this prohibits taking all deductions to get over standard deduction hurdle and allow other to take the standard deduction. (((STD ded. Will be 0 if you do this))). If one itemizesthe other itemizesso 0. Interest 163(h) 163(h)(1) T, unless corporation, no deduction for personal interest. 163(h)(2) Exceptions: 1. Where accrued in T or B (other than if Ee). 2. Investment interest. 163(d). 3. Qualified Residence 4. Interest under 221 as educational loan. 163(h)(3) Qualified Residence Indebtedness: Interest paid or accrued for: 1. Acquisition Debt: (B) Incurred in acquiring, constructing, or substantially improving qualified residence and secured by residence. a. 280: Either principal residence or 1 other residence used by T where exceeds 14 days, or 10% of number of days rented at FRV. b. Not over 1 Million in aggregate. c. Cannot exceed the AI when used to refinance. d. Refinancing also OK but may not exceed amount of the refinanced indebtedness. Exception: 2. Home Equity Debt: (C) Any indebtedness secured by qualified residence if: a. Statutory Cap: No exceed 100K; or b. Definitional Amount: FMV AD. POINTS and Prepaid Interest: 1. 461(g)(1): (Prepaid) Interest paid by T is charged to capita account and not deductible. 2. 461(g)(2) Points that is indebtedness incurred for improvement or purchase off residence and secured by it is deductible to the extent that it is an established business practice in the area and no exceed amount generally charged. a. If disguised for other fees not deductible. Problems: T purchases a home in 1998 which they use as their principal residence. Unless otherwise stated, they obtain a loan secured by the residence and use the proceeds to acquire the residence. What portion of the interest paid on such loan ay Ts deduct in the following situations. (a) The purchase price and FMV of the home is 350K. T obtain a mortgage for 250K, the purchase price. 1. You have QRI as AI b/c incurred through acquisition and under 1 million. Meets first test under 163(h)(3). (b) Same as (a) except that T by 2000 have reduced the outstanding principal balance of the 1998 mortgage to 200K and the FMV of the residence has increased to 400K. In 2000, T takes out a 2nd mortgage for 100K for a fourth bedroom and den to the residence. This is deductiblethis is QRI. This is a substantial improvement (construction). You pay an extra 100k. It meets test b/c you still have 200K worth of original AI. (c) The facts same as (b) except that T use the proceeds of the 100K mortgage to buy a Ferrari. 1. Not acquisition indebtedness b/c not for 2. HEI Test: a. Ask yourself how much equity (FMV less debt) =200K! (definitional limit) b. HEI limit is 100K. Thus, this works as HEI. (you can use for anything).


(d) The facts are same as (a). By 2010, T have paid off 200K of the 250K 1998 mortgage and the residence is worth 500K. In 2010, T borrow 200K on the residence, 50K of which is used to pay off the remaining balance of the 1998 loan and the remainder is used to pay personal debt. 1. 500 FMV (50K outstanding). A. AI: you may also use under 163(h)(B)(3) for refinancing, but only to the extent that it does not exceed the AI already existing. Here you have 50K. B. HEI: (def-450K; but 100K cap). Thus, you can deduct 100K of the remaining 150K. (answeronly 75% of interest is deductible). (e) The facts are the same as in (a) but additionally at end of 1998, Ts financial prospects improve dramatically and they purchase a luxury vacation residence in Fl for FMV of 1,250.00. They finance 950K of the purchase price with a note secured by a mortgage on the Fl. house, use the house 45 days of the year, and elect to treat the residence as a qualified residence. 1. 280 qualification b/c 45 days. (2nd residence). 2. 950K + 250K is 1,200. This exceeds aggregate amount allowed as AGI. You take the first residence first (250K) and then you take 750K of the second, leaving 200K. 3. HEI: you can take 100K (statutory limit). Thus, you have 100K that is not deductible. Student Loan Interest: 221: Current year you can deduct interest on student loan to extent of 2,500.00 subject to being reduced if: 50K (single) or 100K (MFJ) overage. 1. Red Calc: (2,500 x Mod AGI 50K/100K over 15K/30K). If exceed 15 or 30K, you may not deduct. 2. Relative: A loan from a relative does not count. 3. 62(17): This is above the line. Problems: Single T, who graduated from law school in 1998, pays 3K interest in 2002 on qualified education loans. 221 (a) If T has 40K of modified AGI in 2002, what amount can T deduct? T may deduct 2,500.00. (500.00 not deductible under 221(b)). (b) Same as (a) except T has 57,500 of modified AGI in 2002. 1. 7,500/15,000 gives you multiplied by the 2,500 gives you 1,250 deduction. (c) Same as (a) except T is married and T and spouse file a joint return and have 140K of modified AGI in 2002. The 140K exceeds 30K over the allowed 100K. Thus, there is no deduction. (d) Same as (c) except that T and Spouse delay paying the 3K interest from 2002 to 2003 when their modified AGI is 80K and when no other interest payments are made. 1. You get the 2,500 in 2003. b/c you delayed payingyear paid! Investment Interest 163: 1. Deduction allowed for investment interest, even where personal interest. a. 163(d) Limited to the extent that you have NET INCOME. b. Carry over is allowed to extent you cannot deduct. 2. 265(a)(2): No deduct amount used to purchase excludible property. (e.g. 103). Problems: Investor incurs investment interest of 100K. To what extent is it deductible in the current year if: (a) She sells stock during the year at a 60K gain, that under 163(d)(4)(B) does not qualify for 1(h) preferential treatment, has 20K in dividends on all her stock, and has 10K in deductible investment adviser fees? Are there any other tax consequences to the investor? 1. Compare your expenses with your investment income: You have 80K -10K=70K NET Investment Income: Thus, you can deduct the 100K to the extent of 70K. The 30K can be carried over. (b) The interest of 100K is on loans whose proceeds are used to purchase tax exempt bonds?


1. 265(a)(2) you cannot deduct b/c used to purchase tax exempt bonds. (c) The facts are the same as in (a) and (b) except that the proceeds of the loans are used 50% to purchase tax exempt bonds and 50% to buy stock and the bonds and stock are her only investment? HYBRID: (50/50) 165(a)(2) would only disallow deduction to extent of 50K. The remaining 50K can be deducted. HYBRID: 164 Deduction of Taxes 164(a) Deduction permitted for following types of taxes: 1. State/local or foreign real property taxes: (principal residence too). 2. State and local personal property taxes (Ad Valorem-tax on car in VA). 3. State and local income taxes. a. Whether or not 212 or 162. Sales Tax not included: 4. State, local, and foreign taxes not here if 212 or 162. (where does it go 62??). KEY a. Acquisition of Property: Must be included in your basis. (CPU example).