Individual Taxation – Filing Status

Must file tax return if income is equal to or greater than sum of:
Personal exemption + Standard deduction + Additional standard deduction for over 65 or blind

Exceptions:
- Earned from self-employment at least $400
- Can be claimed as dependents on another taxpayer’s return, have unearned income, and gross income of $900
- Who receive advance payments of earned income credit

Filing due date: April 15

Automatic six-month extension. Must file extension by April 15. Even with extension, due date for tax payments if April 15.

Filing Status:

Single/End of Year Test: Single on December 31 OR Legally separated

Joint Returns/End-of-Year Test: (even if married and living apart, but not legally separated/divorced) Married on
December 31. If one spouse dies during the year, a joint return may be filed.

Married Filing Separately

Qualifying Widow(er) (surviving spouse)

o For two years after spouse’s death: uses joint tax return standard deduction and rates (not the exemption for
deceased spouse)
o Principal residence for dependent child: The surviving spouse must maintain a household that, for the whole
entire taxable year, was the principal place of abode of a son, stepson, daughter, or stepdaughter (blood or
adoption).

Head of Household – Following conditions:

o Not married or legally separated, or married and lived apart from spouse for last six months. Not a “qualifying
widower”. Not a non-resident alien. Maintains as his or her home a household that, for more than half the
taxable year, is the principal residence of:

Son/Daughter (Working Families Act): example: divorced mom

Father or Mother (not required to live with): example: nursing home

Dependent Relatives (must live with): Cousins, foster parents, and unrelated dependents do NOT
qualify.

Required time period for different filing statuses:

W – Widow = Whole year
H – Head of household = Half a year (more than)

Individual Taxation – Exemptions

Generally, an individual is entitled to a personal exemption that is indexed annually for inflation. For 2008 = $3500.

Persons eligible to be claimed as dependents on another’s tax return will not be allowed a personal exemption on their
own returns.

Each spouse receives personal exemption.

Spouse as personal exemption on a separate return – Married taxpayer, who files separately, may claim the spouse’s
personal exemption if both of the following tests are met:

Becker – 2009 Edition Chapter 1 Page 1 of 14

 - Taxpayer’s spouse has no gross income AND
- AND taxpayer’s spouse was not claimed as a dependent of another taxpayer.

If a person is born or dies during the year, he or she is entitled to a personal exemption for the entire year. Exemptions
are not prorated.

Dependency exemptions: a taxpayer is entitled to an exemption for each qualifying child and relative, based on the
requirements.

Qualifying Child
C – Close relative
A – Age limit
R – Residency requirements
E – Eliminate gross income test
S – Support test changes

Qualifying Relative
S – Support (over 50%) test
U – Under a specific amount of (taxable) gross income test
P – Precludes dependent filing a joint tax return test
O – Only citizens (residents of U.S./Canada or Mexico) test
R – Relative Test
OR
T – Taxpayer lives with individual for whole year test – If NOT related

Taxpayers must obtain SSN for any dependent who has attained the age of one as the close of the tax year

Qualifying Child
C – Close relative: be the taxpayer’s (step)child, (step)sibling, descendants, legally adopted, foster child
A – Age limit: under 19 (age 24 if full-time student). No age limit for permanently disabled child.
R – Residency requirements: same household as taxpayer for more than half of the tax year
E – Eliminate gross income test: gross income test (SUPORT) does not apply
S – Support test changes: child did not contribute more than half of his support. Requirement that taxpayer (parent)
provides over half of support is eliminated.

Qualifying Relative
S – Support (over 50%) test: Taxpayer must supplied more than 50% of support of the person in order to claim him as
dependent. Support means the actual expenses incurred by or on behalf of the dependent.
• If two or more people support more than 50%, only one can claim the dependent (must contribute more than
10%).
• General rule: Custodial parents have the right to claim (instead of non-custodial). If both parents equally
contribute, then the one with higher AGI.
U – Under exemption amount of (taxable) gross income: person’s gross (taxable) income must be less than the exemption
amount ($3500 for 2008).
• Taxable income: Social Security (low income levels), tax-exempt interest income (state and municipal interest),
tax exempt scholarships – (Tax-free income is OK)
• No income test if meet age limit - CARES
P – Precludes dependent filing a joint tax return test: can`t claim dependent if they file joint tax return with someone else,
UNLESS the joint return is filed solely for a refund of all taxes paid or withheld for the taxable year (tax is zero).
O – Only citizens (residents of U.S./Canada or Mexico) test
R – Relative Test: does NOT include cousins or foster parents. Cousins and foster parents must live with taxpayer the
entire year.
OR
T – Taxpayer lives with individual for whole year test – If NOT related

**No additional exemption for being old (age 65) or blind. There is an increased standard deduction!

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Phase-out of personal and dependency exemptions: by 2% of each $2,500 increment by which AGI exceeds certain
thresholds based on filing status – R1-15 (threshold amounts and example)

Individual Taxation – Gross Income

Gross Income:
Event Income Basis
Taxable = FMV FMV
Non-taxable = N-0-N-E NBV

Realization = Real World. Accrual or receipt of cash, property, or services, or a sale or exchange
Recognition = Record for tax purposes.

Accrual method: recognition is when earned

Cash method: recognition is when actually or constructively cash or FMV property is received

***Whether on cash basis or accrual basis, taxpayers who sell stock and securities in the market must recognize gains
and losses on the trade date.***

Salaries and wages included in Gross Income:

→ Money
→ Property = FMV
→ Cancellation of debt
→ Bargain purchases
o Ex. if property is sold for less than FMV, the difference is income
→ Taxable fringe benefits (non-statutory)
o Ex. Employee’s personal use of company car is considered employee’s income. Amount is subject to
employment taxes and withholding.
→ Portion of life insurance premiums. Non-discriminatory plans only.
o Premiums above the first $50,000 of coverage are taxable income to the recipient and normally included in
W-2 wages.
→ Life insurance proceeds paid are excluded from income of beneficiary
→ Interest income from life insurance proceeds on a deferred payout arrangement is fully taxable
→ Accelerated death benefit received my terminally ill (dying within 24 months) is not taxable
→ Accident, medical, and health insurance (employer paid):
o premium payments are excludable from employee’s income when the employer paid the insurance premiums
→ De Minimis fringe benefits: benefits so minimal may be excluded.
o Employee’s personal use of company computer
→ Meals and lodging by the employer for the convenience of the employer on the employer’s premises is not taxable to
the employee.
→ Employer payment of employee’s educational expenses of up to $5250 may be excluded from gross income. Could
be for undergraduate or graduate school
→ Qualified tuition reductions at undergraduate level may be excluded from income. At graduate level, only if students
are engaged in teaching or research activities and if the reduction is in addition to the pay for the teaching or
research.
→ Qualified employee discounts are excludable from taxable income for:
o Merchandise discounts: limited to employer’s gross profit percentage. Excess is income
o Service discounts: limited to 20% of FMV. Excess is income
o Employer-provided parking: $220/month for 2008
o Transit passes: employer provided pass up to $115/month for 2008
→ Qualified pension, profit-sharing, and stock bonus plans
o Payments made by employer are non-taxable
o Benefits received are taxable
→ Flexible spending arrangements (FSA): allows employees to receive a pre-tax reimbursement of certain expenses
o Employees can elect to have up to $5000 per year deposited pre-tax into a FSA.
o Funds may be forfeited within 2 ½ months after year-end if the employer amended the plan accordingly.

Becker – 2009 Edition Chapter 1 Page 3 of 14

Interest Income:
→ Taxable interest:
o Federal bonds, premiums received for opening a savings account are included at FMV, part of proceeds from
instalment sale
o Interest paid by federal or statement government for late payment of tax refund is taxable.
→ Tax-exempt interest: reportable, but not taxable.
o State and local government bonds/obligations
o Bonds of a U.S. possession
o Series EE (U.S. Savings bond)= interest is tax-exempt when:

EE = used for Educational Expenses

There is taxpayer or joint ownership (spouse)

Taxpayer is over age 24 when issued

They are acquired after 1989

Phase-out starts when modified AGI exceeds an indexed amount
o Interest on veterans administration insurance
→ Unearned income of a child under 18  Kiddie Tax
o Net unearned income of an under 18 child (or under 24 = fulltime student), is taxed at his parent’s higher tax
rate.

Total unearned income – child’s standard deduction of $900 = taxable income

2008 Child’s Unearned Income Tax Rate
0 – $9000 0%
$901 – $1800 child’s rate
$1801 and over parent’s rate
→ Forfeited interest (adjustment): penalty on withdrawal from savings
o If included as income when earned, then the forfeited interest is deductible as an adjustment in the year
incurred
o Do not net with interest income

Dividend Income:
→ Source determines taxability:
o Earnings & profit / Current = By Year End
o Earnings & profit / Accumulated = Distribution Date
o Return of Capital = No Earnings and Profits
o Capital Gain Distributions = No E&P / No Basis
→ Three Categories of Dividends = all dividends if are distributions of corporation’s E&P, it is included in gross income
o Taxable amount (to shareholder receiving)

Cash = Amount received

Property = FMV
o Special (lower) tax rate: 15% for most taxpayers and 0% for those in the 15% or lower tax bracket

Stock must be held for 60 days during the 120 day period, beginning 60 days before the ex-dividend
date

Tax-free distributions: exempt from gross income 
 Return of capital: company distributes funds but has no earnings and profits. Taxpayer will
reduce (but not below zero) his basis in the stock held
 Stock split: shareholder will allocate the original basis over the total number of new shares
 Stock dividend:
◊ If shareholder had option to receive cash or property, but chose dividend, then it will
be taxable at FMV
◊ If no option, just simply received stock dividend:
• Same stock = original basis is divided by total shares
• Different stock = original basis is allocated based on their cumulative FMVs
 Life insurance dividend = Dividend caused by ownership of insurance with a mutual
company (premium return)
o Capital Gain Distribution: corporation has no earnings and profits, and the shareholder has recovered his
entire basis, then distribution is treated as taxable gross income

Becker – 2009 Edition Chapter 1 Page 4 of 14

State and local tax refunds:
If taxes paid was not deducted, then state or local tax refund in next year is not taxable

Prior year itemized = taxable state or local refund

1040EZ = Prior year used standard deduction = non-taxable state or local refund

Payments pursuant to a divorce:

• Alimony/spousal support (income):
o Taxable income to the recipient spouse, and deductible to arrive at AGI for contributing spouse
o Payments must be legally required pursuant to a written divorce agreement
o Payments must be in cash or equivalent
o Payments cannot extend beyond the death of the payee-spouse (receiving spouse)
o Payments cannot be made to members of the same household
o Payments must not be designated as anything other than alimony
o The spouses may not file a joint tax return
• Child Support
o Non-taxable to receiving ex-spouse
o Portion of payments fixed by divorce decree
o Payment applies first to child support then to alimony
• Property Settlements (non-taxable)
• If divorce settle = lump sum payment or property settlement by spouse, that spouse gets no deduction for
payments and are not taxable to other spouse

Business income or loss, Schedule C or C-EZ:

Sole-proprietorship, net income from self-employment is computed on Schedule C, then transferred to Form 1040.

Gross Business Income

<Business Expenses>
Profit or Loss

Farmer reports farming activities on Schedule F

Farming activities treated same as income from other business activities

Cash basis – most farmers use cash basis. Inventories of produce, livestock, etc. Are NOT considered

Gross income = cash and value of other items received from sale of produce, livestock, etc. Raised by farmer

Accrual method – inventories must be taken at start and end of tax year.

Gross Profit = inventories + sales – inventories at beginning of year – cost of inventory purchased during year

Schedule C for sole-proprietorship:

Gross Income = Cash + Property at FMV + Cancellation of Debt

Expenses: Incurred and Paid for cash basis

 COGS (inventory is expensed when sold)
 Salaries and commissions paid to others
 State and local business taxes paid
 Office expenses (included supplies, equipment, and rent)
 Actual automobile expenses (only the portion used for business auto depreciation is limited) or a standard
mileage rate (58.5 cents from July 2008)

Becker – 2009 Edition Chapter 1 Page 5 of 14

  Business meal and entertainment expenses at 50% (100% for charity and itemized deduction)
 Depreciation of business assets
 Interest expense on business loans (note that interest expense paid in advance by a cash basis taxpayer cannot
be deducted until the tax year/period to which the interest relates)
 Employee benefits
 Legal and professional services
 Bad debts actually written off for accrual basis taxpayer only (direct write off method, not allowance method). Bad
debt expense not deductible for cash basis taxpayer, because he never reported the income.

Non-deductible expense on Schedule C

 Salaries paid to the sole proprietor (they are considered a “draw”)
 Federal income tax
 Personal portion of:
o Automobile and travel and vacation expenses
o Personal meals, entertainment expenses (100% of country club dues are non-deductible)
o Interest expense (this is an itemized deduction if for mortgage or investment)
o State and local tax expense (show as an itemized deduction on Schedule A)
o Health insurance of a sole proprietor is not a Schedule C expense (permitted as an adjustment)
o Bad debt expense not deductible for cash basis taxpayer, because he never reported the income.
o Charitable contributions (use Schedule A)

***It is important to only subtract business expenses form business income. Itemized deductions and/or other adjustments
are deducted elsewhere.

Net business income or loss is taxable:

There are 2 taxes on net income:
1. Income tax
2. Federal self-employed tax (SE tax)
a. Adjustment to income is allowed for one-half (7.65% up to $102,000 in 2008) of SE tax
b. Sole proprietor can deduct the employer portion of the SE tax
c. All SE income = 2.9% Medicare tax + 12.4% Social Security tax = 15.3%
Net taxable loss:
A business with a loss may deduct the loss against other sources of income:
1. 2 year carry-back
2. 20 year carry-forward

Uniform Capitalization Rules:

- Guidelines to capitalize or expense certain costs (i.e. taxes paid in connection with the acquisition of property are
capitalized as part of the property’s cost).
- In first year, increase in carrying cost of inventory and decrease in operating expense = increase taxable income.
- Real or tangible personal property produced by the taxpayer for use in a trade or business – produced for use
- Real or tangible personal property produced by the taxpayer for sale to customers – produced for sale
- Real or personal property acquired by the taxpayer for resale – acquired for resale
- However, the uniform capitalization rules do not apply to property acquired for resale if the taxpayer's annual
gross receipts for the preceding three tax years do not exceed $10,000,000 (not $2 million).
- Costs required to be capitalized
o Include direct materials, direct labor (compensation, vacation pay, payroll taxes), indirect costs
o Indirect capitalizable expenses include utilities, warehousing costs, repairs, maintenance, indirect labor
(supervisory), rents, storage, depreciation, insurance, pension contributions, engineering and design,
repackaging, spoilage, and administrative supplies
- Costs not required to be capitalized
o Selling, advertising, marketing, administrative, research, officer compensation

Becker – 2009 Edition Chapter 1 Page 6 of 14

For inventory, even a sole proprietor will be required to apply the following rules:

Capitalized as inventory Period expense

Direct materials Selling
Direct labor General
Factory overhead Administrative
Research & development

Gains and Losses on Disposition of Property: difference between the amount realized and the adjusted basis.

Amount Realized
<Adjusted Basis of Assets Sold>
Gain or Loss Realized

IRA Income:
General Rules (Taxable when Withdrawn) 
- Cannot withdraw retirement money until age 59 ½ or elect to receive equal distribution over life expectancy
- Required to take distribution by age 70 ½

Regular Tax 
- Traditional Deductible IRA: All $$$ is treated as regular income (regardless of dividends, etc.). Regular tax rate.
- Non-Deductible IRAs: All $$$ is non-taxable
- Traditional Non-Deductible IRA:
o Principal $$$ – non-taxable
o Earnings – taxable
- 10% penalty for withdrawal before age 59 ½ – Exceptions:
st
o H – Home buyer 1 time: $10,000 max
o I – Insurance medical after unemployment or self-employed
o M – Medical expenses in excess of 7.5% AGI
o D – Disability permanent
o E – Education College
o A – and
o D – Death

Annuities  treat like depreciation

Investment Amount Example: $60,000 = $230.77 non-taxable from 260 payments

# of months of life expectancy 260 months

***Live longer than actuarial payout period  then further payments are fully taxable
***Death before full recovery  the unrecovered portion of the investment is a miscellaneous itemized deduction on the
annuitant’s final income tax return not subject to the 2% AGI floor.

Rental Income (Passive Activity)
Schedule E
Income/loss from:

- Rental real estate
- Royalties
- Partnerships & LLCs, S-Corporations, Estates, Trusts ( all from Schedule K-1)

Becker – 2009 Edition Chapter 1 Page 7 of 14

Gross Rental Income
Prepaid Rental Income (non-refundable deposits)
Rent Cancellation Payment
Improvement In-Lieu-of Rent (at FMV)
<Rental Expenses>
Net Rental Income or Loss

Rental of Vacation Home

- Rented Less than 15 Days:
o Personal residence – rental income is excluded from income, mortgage interest and real estate taxes are
allowed as itemized deductions. Depreciation, utilities, and repairs are NOT deductible.
- Rented 15 or More Days:
o Used for personal purposes for greater of 1. More than 14 days or 2. More than 10% of the rental days =
personal residence
o Expenses must be pro-rated between personal and rental use
o Different pro-ration for mortgage interest and property taxes – see example on page R1-36
o Rental expenses are deductible only to the extent of rental income

Passive Activity Losses (PALs)
any activity where the taxpayer does not materially participate
- Applies to individuals, estates, trusts, personal service corporations, closely held C corporations
- A net PAL may only be deducted against a passive active income, NOT against active income
- Non-deductible PALs can be carried forward without any time limit unused PAL held in suspension.
o Suspended losses are used to offset passive income in future years
o Unused PALs become fully tax deductible in the year the property is sold/disposed
o If taxpayer become an active participant (from passive), unused PAL can be used to offset active income
- Exceptions – may deduct rental activity losses if either of the 2 conditions are met:
o Mom & Pop exception 

deduct up to $25,000 PAL in rental real estate annually if now actively participating

Phase-out  $25,000 allowance is reduced by 50% of excess of taxpayer’s AGI (without
consideration of this loss) over $100,000. The allowance is eliminated completely when AGI
exceeds $150,000
o Real Estate Professional (not passive activity)

If the tax payer is real estate person by profession, then can deduct full losses against any
income if:
• More than 50% of taxpayer’s personal services during the year are performed in real
property businesses
• The taxpayer performs more than 750 hours of services in real property businesses
during the year

**A taxpayer MUST include the full amount of unemployment compensation in gross income.

Social Security Income:

Depends on provisional income = AGI + tax-exempt interest + 50% of Social Security benefits ***See chart on next page**
Taxpayers must include 50% (or 85%) of SS received or 50% (or 85%) of excess provisional income over threshold

1. Low Income = No Social Security benefits are taxable (income below: single $25,000/MFJ $32,000)
2. Lower Middle Income = Less than 50% of Social Security benefits are taxable
3. Middle Income = 50% of SS benefits are taxable (income up to: single $25,000/MFJ $32,000)
4. Upper Middle Income = Between 50% - 65% of SS benefits are taxable
5. Upper Income = 85% of SS benefits are taxable (income over: single $34,000/MFJ $44,000)

Becker – 2009 Edition Chapter 1 Page 8 of 14

Taxable Miscellaneous Income:
 Prizes and Awards = taxable at FMV, unless given to charity or government right away
 Gambling =
o Winnings included in gross income
o Losses may be deducted to the extent of gambling winnings. Allowable amount of these losses are deductible
on Schedule A as itemized deduction and are NOT subject to the 2% AGI limit
 Business recovery – if “in lieu of what the damages paid were”. If damage award is compensation for lost profit, then
award is income
 Punitive damages – fully taxable as ordinary income if in business context, loss of personal reputation, or personal
injury.

Partially taxable miscellaneous items: scholarships and fellowships:

1. Degree-seeking student: scholarships and fellowship grants are excludible only up to amounts actually spent on
tuition, fees, books, and supplies, if:
a. The grant is made to a degree seeking student
b. No services are to be performed as a condition to receiving the grant
c. Grant is not made in consideration for past, present, or future services of the grantee
2. Nondegree-seeking student: Scholarships and fellowships are fully taxable at FMV
3. Tuition Reductions: graduate teaching assistants who receive tuition reductions are taxed on the reduction if it is their
only compensation, but not if the reduction is in addition to other taxable compensation.

Non-taxable Miscellaneous Items:

Life insurance proceeds: Proceeds are non-taxable. Interest income element on deferred payout is fully taxable.
Accelerated death benefits received by chronically ill insured are tax-free if used to pay for long-term care

Gifts and inheritances = non-taxable

Medicare benefits = non-taxable

Worker’s compensation = non-taxable

Personal (physical) Injury Award = non-taxable

Accident Insurance = if premiums paid by taxpayer, then all payments received are non-taxable

Foreign-Earned Income Exclusion: up to $87,600 in 2008 may be excluded from foreign-earned income if taxpayer meets
any one of the following tests:
1. Bona Fide Residence Test = taxpayer is resident of foreign country for entire taxable year
2. Physical Presence Test = taxpayer must be present in foreign country for 330 full days out of 12 months

Modified Adjusted Gross Income (MAGI), also known as provisional income, includes the following items:
• Any income you excluded because of the foreign earned income exclusion
• Any exclusion or deduction you claimed for foreign housing
• Any interest income from series EE bonds that you were able to exclude because you paid qualified higher
education expenses
• Any deduction you claim for student loan interest or qualified tuition and related expenses
• Any employer-paid adoption expense you excluded
• Any deduction you claimed for an annual (non-rollover) contribution to a regular IRA.
In other words, the above items are not taken into account in determining AGI vs. MAGI

Individual Taxation – Capital Gains and Losses

Real Property = Land and Buildings (any items permanently fixed to land, i.e. paving)
Personal Property = Machinery and Equipment = Not real property

Becker – 2009 Edition Chapter 1 Page 9 of 14

Capital Assets:
Personal aautomobile, furniture and fixtures in home, stocks and securities, personal property of a taxpayer not used in
business, real property not used in business, interest in a partnership, goodwill of corporation, copyrights, literary, musical,
art compositions purchased.

Non-capital Assets:
- All types of inventory (i.e. real property)
- Depreciable personal property and real estate used in business (i.e. Section 1231, Section 1245, Section 1250)
- Notes receivable from business sales
- Copyrights, literary, musical, art compositions held by original artist (for inventory purposes)
- Treasury stock

Calculation Rules:

Amount Realized
<Adjusted Basis of Asset Sold>
Gain OR Loss

Amount Realized:
1. Cash received (boot)
2. Cancellation of debt (boot)
3. Property received at FMV
4. Services received at FMV
5. Reduce the amount realized by selling expenses

Adjusted Basis of Asset Sold:

1. Purchased Property Basis = Cost
a. Increase basis for capital improvements  Basis adjusted upward for expenditures to asset
b. Reduce basis for accumulated depreciation (=NBV)  Basis adjusted downward for depreciation amount
c. Spreading adjustments

2. Gift Property Basis

a. General Rule: Donor’s rollover cost basis = rollover cost / net book value
 Basis is increased by any gift tax paid
b. Exception: Lower FMV at date of gift
 If the FMV at gift date is lower than rollover cost basis from donor, the basis for the done depends on
the donee’s future selling price of the asset
 Sale of gifts at price greater than donor’s rollover basis (Gain basis)
• When donee sells gift for greater than rollover basis:

Sale price – Rollover basis = Gain
 Sale of gift at price less than lower FMV (Loss basis)
• If donee sells the gift for less than lower FMV at gift date, the basis of gift for purposes of
determining the loss is the FMV of gift at gift date.
 Sale less than rollover cost basis but greater than lower FMV (in middle)
• If donee seels for price less than donor’s rollover cost basis, but more than lower FMV at gift
date, there is NO gain or loss recognized.
c. Holding period: the recipient of the gift normally assumes the donor’s holding period. Unless, if FMV at time of
gift is used, then holding period starts as the date of the gift.

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3. Inherited Property Basis = Step Up to FMV
a. General Rule: Date of death FMV becomes basis = the estate has already paid taxes before distribution
b. Alternate Valuation Date: Asset is valued using FMV at the earlier of:
 Distribution date of asset OR
 OR altnernate valuation date (earler of 6 months after death or date of distribution/sale)
 It is only available if its use lowers the entire gross estate and estate tax
c. Holding period: property from descendent automatically considered to be long-term proerpty regardless of
how long it actually has been held

Sell higher  use donor’s basis to calculate gain

Donor Basis ----------------------------------------

Sell between  no gain or loss

Lower FMV at Date of Gift ----------------------

Sell lower  Use lower FMV at date of gift to determine loss

Only go to this crazy exception when the FMV of the gift is less than donor’s basis.

All realized gains and losses are recognized (i.e. reported on the tax return) unless “HIDE IT” or “WRaP” applies.

Realized, but not recognized, gains or loss:

Amount Realized: Money Received (boot)

Cancellation of Debt (boot)
FMV property (less: selling expenses)

<Adjusted basis of asset sold>: Purchase = Cost

Gift = Rollover Cost
Inherited = Step-up FMV
_______________________________________________________________

Gain: H – Homeowners Exclusion

I – Involuntary Conversion
D – Divorce Property Settlement
E – Exchange of Like Kind (business)
I – Installment Sale
T – Treasury Capital & Stock

OR

Loss: W – Wash Sale Losses

R – Related Party Losses
A – And
P – Personal Losses

============================================================

Becker – 2009 Edition Chapter 1 Page 11 of 14

Excluded or Deferred Gains
- Gain is not taxed if you can “HIDE IT” all. Gain to the extent of boot (the part that you did not “HIDE IT”) is taxable.
o Cash – kept and not reinvested = taxable
o Cancellation of debt – excess debt assumed by buyer = taxable

“HIDE IT”

H – Homeowners Exclusion: Sale of primary residence is subject to exclusion.

o $500,000 MFJ
o $250,000 S
o Must have owned and used the principal residence for 2 of 5 years
o Only one spouse must meet the use requirement with respect to the property
o No age requirement
o No rollover to another house is required
o The exclusion is renewable, but not more than once every two years

I – Involuntary Conversion
o Gains realized on involuntary conversions of property (destruction, theft, etc.) for reinvestment of
involuntarily received proceeds restores him to position he held prior to conversion = non-taxable
o Example: Insurance proceeds
o When no gain recognized = basis of old property = basis of new, replaced property
o Must use proceeds to replace lost property

Personal property = 2 years from year-end (for federal disaster areas = 4 years from year-end)

Business property = 3 years from year-end
o Gain (boot) is recognized because the amount received is greater than replacement cost. Basis of
replacement property is its cost less the gain not recognized. See example on page R1-50.
o New property costs more than cost basis, then loss would be recognized. The new purchase price is the
basis for new property.

D – Divorce Property Settlement – see notes above regarding alimony and child support

E – Exchange of Like Kind business/investment assets (tangible)

o Like kind exchange of property used in the trade or business or held for investment

Not inventory, stock, securities, partnership interests, real property in different countries
o Gain recognized when boot received
o Recognized gain = lower of realized gain or the boot
o Example: business trade-in or swapping real estate
o Basis of property received is same as property given up

Basis is decreased by money and increased by gain  Money = Gain. Net effect on basis is zero

I – Installment Sale
o The tax method of reporting gains (not losses) for sales by non-merchant in personal property and
non-dealer in real estate
o Not available for stocks or securities traded in market
o Revenue is recognized when the cash is received
o Reportable installment sale gain/income

Gross Profit = Sale – COGS

Gross Profit Percentage = Gross profit / Sales price

Earned Revenue = Cash collections x Gross profit percentage

T – Treasury and Capital Stock Transactions (by corporation)

o Exempt from gain: Stock sales, repurchase, and reissue by the corporation

Becker – 2009 Edition Chapter 1 Page 12 of 14

Non-deductible losses – WRaP these up because they are non-deductible!!

W – Wash Sale Loss

R – Related Party Transactions
a – and
P – Personal Loss

W – Wash Sale Loss – a security is sold for loss and is repurchased within 30 days BEFORE or AFTER the sale date
o Loss disallowed for tax purposes
o Basis of repurchased security = purchase price of new security + disallowed loss on wash sale
o Basis of repurchased security = purchase price of new security + basis of old security – sale price
o Date of acquisition of repurchased security is date of acquisition of original security
o If security is sold resulting in gain and repurchased within 30 days, must pay capital gains tax and use
new purchase price as basis for repurchased security

R – Related Party Transactions

o Blood relatives or entities that are more than 50% owned by individuals, corporations, trusts, and/or
partnerships. (In-laws are NOT related parties)
o Capital gains are imposed on all sales of non-depreciable property, except when between:

Husband and wife (basis is merely transferred)

Individual and a 50%+ controlled corporation or partnership (gain is taxed as ordinary income)
o Losses are disallowed on most related party sales transactions even if they were made at “arms-length”
at FMV price
o Basis rules  Same as gift = basis depends on the resale price (higher, lower, or between original basis)
o Gain recognized to the extent of future sale price exceeds the previous relative’s cost basis
o Holding period starts with new owner’s ownership period

a – and

P – Personal Loss – no deduction is allowed for loss on a non-business disposal or loss

o Example: selling our old dining table

Individual Capital Gain and Loss Rules

Net Capital Gain Rules

1. Long-term
a. Holding period = more than 1 year
b. Tax rate = 15% maximum, 5% if taxpayer is in 10% or 15% tax bracket
2. Short-term
a. Holding period – one year or less
b. Tax rate – treated as ordinary income
3. Unrecaptured section 1250 gain from depreciation taxed at 25%
4. Collectiviles and small company stock long term gains are taxed at 28%
5. Gains and losses are first netted within each tax rate group, creating net short-term and long-term gains or losses
by rate group. Then short-term and long-term losses are offset against short-term and long-term gains
respectively beginning with the highest tax rate group.

Net Capital Loss Deduction and Loss Carryover Rules

1. $3,000 maximum deduction – husband + wife = 1 person. If MFS, $1500 deduction limited
2. Capital losses limited to taxable income before personal exemptions
3. Excess net capital loss – NO carrybacks – Unlimited carryforwards
4. Personal bad deb is short-term capital loss in year debt is worthless

Becker – 2009 Edition Chapter 1 Page 13 of 14

 5. Worthless stock and securities is capital loss, treat as sold on last day of year they became worthless

Corporation Capital Gain and Loss Rules (Apples to C Corporations Only)

1. Net capital gains (long-term and short-term)  No special tax rate
2. Net capital gains (short and long term gains and losses) of corporation are added to ordinary income and taxed at
regular tax rate
3. Net capital losses (short and long term gains and losses)  use only against capital gains
4. Corporations may not deduct any capital losses from ordinary income
5. Net capital losses carried back 3 years and forward 5 years as short term capital loss

Excess
Offset Income Carryback Carryforward
Operating losses Yes 2 years 20 years
Individual capital losses $3,000 No Forever
Corporate Capital losses No 3 years 5 years

Tax law hierarchy:

1. Internal revenue code – IRC
2. Internal revenue service – IRS
3. Tax court decisions
4. IRS agents’ reports

For accrual basis income calculation:

B – Beginning A/R B
A – Add Sales +A
AB
S – Subtract Cash Collections -S
E – Ending A/R AB-S

Becker – 2009 Edition Chapter 1 Page 14 of 14