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1998 Exam Model Answer

1998 Exam Model Answer

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Published by Yin Huang / 黄寅

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Published by: Yin Huang / 黄寅 on Nov 30, 2010
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Federal Income Tax exam summaryProf. Chirelstein. Spring, 1998QI. Possible characterizations are at least three:(a)Sale for $1 million plus leaseback for 2 years for an advance rental payment of $250,000 (or $125,000/yr ratably). Seller recognizes a § 1231 gain of $800,000 and has rentdeductions totaling $250,000; Jones includes $250,000 of rent in income and depreciates property on a basis of $1 million.(b)Just a sale of a future interest of $750,000. Seller's basis would be$750,000/$1,000,000 x $200,000 = $150,000 and gain would therefore be $750 - $ 150=$600,000. No rental deduction for S but amortization totaling $50,000 over the 2-year period; norental inclusion for J, and a basis for J of $750 after 2 years.(c)Loan of $750 repayable with $1 million property value at the end of 2 years; gain to Sof $1 million minus adjusted basis on repayment in yr 2; ratable interest deduction of $1 25/yr toS and ratable inclusion of $125/yr by J. J's basis $1 million after 2 years.Alternative (b) would mean a shift from J to S (which apparently has offsetting losses) of $250,000 of ordinary rent, plus a shift from S to J of $250,000 of gain that would otherwise betaxable to S and recoverable by J through later depreciation. In effect, S would be "selling" J theright to defer $250,000 of income from yrs 1 and 2 to much later periods, making the deal moreattractive to J while being harmless to S-- all at the Treasury's expense.Alt. (c) is probably the economically correct answer, but Alt. (a) is easier to come by, judicially.QII. Different outcomes can be argued for, as follows:(a)No income tax consequences whatever to Bloom or Molly. Bloom's interest in thetrust includes a right to the income for life plus a power to eliminate Molly's secondary life estateand advance Stephen's remainder (or not to do so) and thus to pick and choose between the two.All that, arguably, adds up to continued ownership of the trust property (citing Cliffordor what-have-you). Certainly a right to revoke would be so treated, wouldn't it? Maybe a retained lifeestate together with a power to pick-and-choose would be similarly regarded.Viewed thus, Bloom now sells a remainder to Stephen for $500,000. The trust propertyhasn't appreciated, so the $500 received would not exceed Bloom's allocable basis for theremainder interest sold; hence no gain or loss to Bloom. The $250,000 paid over to Molly wouldsimply represent the completion of a nontaxable gift to her. Stephen would have a basis of $500for his purchased remainder and he would presumably have ordinary income (on analogy to adiscount bond; see Jonescase) of $500,000 ($1 million - $500,000) when the trust terminates andhe receives the entire trust corpus.(b)In the alternative, since he can't recapture the property for himself, maybe treatBloom's gift of future interests as complete when made. Then, capital gain of $250 to Mollyunder § 1001(e) on the theory that what she's done is to sell a "term interest" to Stephen. But didshe really sell a "term interest" as defined in § 1001(e)(2), or was she merely being paid for thesettlement of a legal claim against Bloom? If the latter, where's the "capital asset"? Etc.As to Bloom, how do we classify a "power" under § 1221? Should we regard that power 

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