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FEDERAL INCOME TAXATION

L6256
Spring 2001
Professo r Chirelste in

Time: 3 h ours

Instructions: The exam consists of six (6) short-essay questions. Answer all of them (Question 5 has two
parts) and explain your answer to each in NOT MORE than two reasonably brief paragraphs. Irrelevant
commen ts earn a down grade! You may bring to the exam your p aperback co py of Selected Federal
Taxation: Statutes and Regulations, but nothing else.

1.

Uncle promises to transfer 100 shares of stock to nephew Willie, age 16, if Willie refrains from smoking,
drinking and spitting on the sidewalk until he reaches the age of 21. Uncle bought the stock for $5,000
some years ago. On reaching his 21st birthday, Willie tells Uncle that he has refrained from doing the
things ju st name d and Uncle hand s over the s tock, now worth $ 20,00 0. Willie waits a few days and sells
the stock for $21 ,000.

How should these events be treated for income tax purposes?

2.

Smith died owning Blackacre having a value of $100,000 but subject to a non-recourse mortgage of
$115 ,000. S mith=s daughter, D, inherited the property subject to the mortgage. Years passed. D made
paymen ts on the m ortgage re ducin g the un paid pr incipal b alance to $ 105,0 00. Sh e then so ld the pr operty
subject to the m ortgage (as reduc ed) receiving $ 5,000 ca sh from the b uyer.

How much gain or loss, if any, should D report on the sale?

3.

Higgle, Barter & Truck (HBT), a partnership, operates a large tire and auto parts store on premises leased
from Bluehill Shopping Center. A clause in HBT=s lease, wh ich has e ight years to ru n, proh ibits Blu ehill
from renting shopping-center space to any competitive retailer. Bluehill now wants to rent substantial
space to Sears, a n ational chain w hich sells tires and au to parts along w ith other produ cts. Bluehill offers
to reduce HBT=s annual rent by 25% if HBT will waive the restriction on leasing to a competitor, but
HBT refuses. So on after, Sears itself enters into negotiations with HBT, as a result of which Sears offers,
in exchan ge for the waiver, to p ay HBT 10% o f Sears= annual revenues from tire and auto part sales for
the remaining term of HBT=s lease. HBT accepts.

How sh ould the affected parties treat Sears= annual payments for income tax purposes?
4.

Mr. X bought 10 acres of land some years ago for $200,000. Recently, he received an offer from a
housing developer to buy the land for $300,000. X refused the offer. The State has now condemned a
narrow strip across X=s property for the purpose of installing overhead power lines and has awarded X the
sum of $6,000 as compensation. The State authority has advised X that it will remove the overhead lines
when it finally installs un dergroun d power lin es, but it canno t say with certainty when that will be don e.

How shou ld X treat the $6,000 con demnation award for income tax purposes?

5.

(A) Amon g the many tax proposals floating around W ashington these days, one would permit business
taxpayers -- corporation s and others -- to exp ense (that is, dedu ct in one year) the full cost o f machinery
and equipment rather than, as at present, capitalizing such expenditures and recovering them through
annual allow ances for dep reciation.

Wou ld this pro posal, if ad opted, b e welcom e to policy-m akers wh o supp ort a consu mption tax? If no t,
why not? If so, why?

(B) Your esteemed instructor made the point in class (or tried) that anti-arbitrage provisions like '265 and
'469 are chiefly aimed at protecting the taxability of personal service income.

A foreign visitor to the class was heard to remark afterwards that he couldn=t under stand a w ord the o ld
boy was saying. P lease explain th e point to our visitor B very brie fly.

6.

Jones le ased pre mises for 6 years to a com mercial ten ant, Z, w ho wish ed to mo dify the pre mises for h is
own special use as a health gym. Z was required under the lease to restore the premises to their original
condition (that of a retail store) on termination of the lease. Z became concerned, after 3 years had passed
and the costs of restoration steadily increased, about how much he would have to spend to make the
restoration when the lease finally came to an end. To protect himself against rising costs, Z paid Jones
$25,000 in consideration of Jones= releasing Z from his obligation to restore the premises.

How shou ld the two parties treat the payment for income tax purposes?