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FEDERAL INCOME TAXATION

L6256y

Final Examination -- May 1998

Professor Chirelstein

Time Allowed -- Three Hours

This examination consists of three pages. Check now to see that
your exam has all three pages.

ANSWERS MUST BE LEGIBLY WRITTEN IN INK OR TYPEWRITTEN.

IF YOU ARE A CANDIDATE FOR GRADUATION IN MAY, 1998, WRITE ON THE
COVER OF YOUR ANSWER BOOK (OR, IF TYPEWRITTEN, AT THE TOP OF YOUR
FIRST PAGE), "CANDIDATE FOR GRADUATION IN MAY, 1998."

INSTRUCTIONS:

The exam consists of three essay questions, equally weighted. Answer all of them.
You may bring to the exam your Code and Regulations volume, but nothing else. Don’t write
any more than you really need to, and please, please write legibly. If you finish early, good.

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QUESTION I

Seller Corporation owns a factory building which it uses for its manufacturing
operations. The building has a fair market value of $1 million. Having suffered losses
recently and needing cash to pay its bills, Seller has decided to sell the factory building if it can
find a purchaser willing to pay full price. Jones, an individual investor, now proposes to buy
the building from Seller on the following terms: Jones will pay Seller $750,000 cash for title to
the building, with Seller to be granted the right, for the next 2 years, to lease the property to
any third party or to continue using the building for any purpose of its own.

Seller’s original cost for the building, which it purchased 20 years ago, was $600,000.
Its adjusted basis at the present time is $200,000.

After due consideration, Seller decides to accept Buyer’s offer on the terms just
described. What will be the federal income tax consequences to both parties?

000. for her life. Bloom intended to exercise this power only if Molly. As a result of all this. Bloom’s favorite nephew. Finally. direct the trustee to disregard Molly’s future income interest and advance Stephen’s remainder to the date of Bloom’s death.) Under the terms of the trust. Bloom approaches Stephen. and offers to amend the trust and eliminate Molly’s future income interest if Stephen will pay Bloom the sum of $500. Before the two men can act. the trust income was to be paid to his favorite niece. FEDERAL INCOME TAXATION -. Bloom retained a power. On Bloom’s death. In due course. Negotiations between Bloom. Molly. On Molly’s death. exercisable in his sole discretion. Molly and Stephen ensue. who has become quite rich. Molly concedes that Bloom has power to terminate her future income interest under the terms of the trust but asserts that local law bars him from exercising that power in exchange for a financial consideration from another beneficiary. Bloom then executes an instrument terminating Molly’s future income interest and on the same date pays over to Molly the sum of $250. In effect. that Molly will formally waive her legal rights as a trust beneficiary and that Bloom will pay over to Molly one-half of the amount to be received by him from Stephen. Molly and Bloom are now estranged (Molly having taken certain career steps of which Bloom sharply disapproves). Although the trust was irrevocable. should develop ample financial resources of her own. In addition. After briefly calculating Bloom’s age and state of health. to amend the trust instrument so as to eliminate Molly’s secondary life estate.Page 2 of 3 QUESTION II Some years ago. Originally. whether through marriage or other wise. Bloom could. however. the trust was to terminate and the principal was to be distributed to Stephen. Molly learns of their plan and war ns Bloom that she will sue him for breach of fiduciary obligation if the plan is carried out. and he so advised Molly in writing at the time the trust was created. Bloom himself was entitled to receive the trust income for life. if he wished.000 in cash. Bloom himself (now elderly) has recently suffered severe financial reverses and needs money to pay his debts. (The basis of the bonds in Bloom’s hands was also $1 million. Molly also advises Stephen that she will contest his legal right to take the trust pr operty following Bloom’s death. . created a trust to which he transferred government bonds having a value of $1 million. Stephen notifies Bloom that he is prepared to accept Bloom’s offer. an aging bachelor. namely. among other things. Stephen pays Bloom $500. Bloom. the three enter into an agreement which provides. 000. Stephen.

000 when such installation has been completed. Following the court’s decision. as agr eed. Mt. Mt. pays Mt. resists the suit. Morris.Page 3 of 3 (a) What are the income tax consequences of these events to Bloom and Molly? (b) What tax consequences should Stephen anticipate when the trust terminates? All three of the parties ask you for advice. Morris the sum of $75. In the end. is sued by F armer Green whose neighboring farmland is. having removed covering vegetation from its property in or der to build ramps for automobiles. F armer Green complains that all this flooding will cost him roughly $150. Morris agr ees to install an adequate drainage system. Morris on the ground that the Company is not responsible for coping with rainfall problems. and F armer Green agrees to pay Mt. decides the lawsuit in favor of Mt. Farmer Green.000 over the next five years or so. satisfied that his land is now protected. QUESTION III Mt.000 in cash. and it denies Farmer Green any and all of the requested relief. which lear ns from an engineer that such a drainage system would cost it between $50. and he asks the court for equitable relief in the form of an injunction and order compelling Mt. What are the tax consequences of these events to both parties? END OF EXAMINATION . after due consideration.000. Morris Dr ive-in Theatre Co. The court.000 and $60. Morris $75. now being inundated by the drainage of rain water..000. Morris to build a dr ainage system on its property that will divert the rain water to a public drain. Mt. Morris of $55. of which the consequence is to destroy a substantial part of Farmer Green’s valuable alfalfa crop. The drainage system is promptly installed at a cost to Mt. as a result. FEDERAL INCOME TAXATION -. Morris and Farmer Green enter into negotiations.