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Income Tax Problems

I. II. INTRO AND INCOME AS ACCRETION TO WEALTH CHARACTERISTICS OF INCOME AND REALIZATION a. Pg. 65 i. 1) Would the results to the taxpayers in Cesarini be different if, instead of discovering $4,467 in old currency in the piano, they discovered that the piano, a Steinway, was the 1st Steinway piano ever built and was worth $500K? 1. **NOT Sure a. Seems like this is appreciation in value i. Would not realize any income until sold ii. 2) Winner attends the opening of a new department store. All persons attending are given free raffle tickets for a digital watch worth $200. Disregarding any possible application of IRC 74, must Winner include anything w/in the GI when she wins the watch in the raffle? 1. Yes. GI includes income derived from any source a. Includes windfalls iii. 3) Employee has worked for Employers business for several years at a salary of $40K/yr. Another company is attempting to hire employee buy Employer persuades Employee to agree to stay for at least 2 more years by giving Employee 2% of the company stock, which is worth $20K, and by buying Employees spouse a new car worth $15K. How much does Employee realize from these transactions? 1. GI = $40 + $20 + $15 = $75K iv. 4) Insurance Adjuster refers clients to an auto repair firm that gives Adjuster a kickback of 10% of billing on all referrals 1. (a) Does adjuster have GI? a. Yes 2. (b) Even if the arrangement violates local law? a. Not sure **** i. Still has an accretion to wealth v. 5) Owner agrees to rent Tenant her lake house for the summer for $4K 1. a) How much income does O realize if she agrees to charge only $1K if T makes $3K worth of improvements to the house? a. $4K 2. b) Is there a difference if T effects exactly the same improvements but does all the labor himself and incurs a cost of only $500 a. No. It is the value of the improvements that are important 3. c) Are there any tax consequences to T in part (b) above? a. T would received $2.5K GI for services provided b. Pg. 68 i. 1) Vegy grows vegetable in her garden. Does Vegy have GI when: 1. a) Vegy harvests her crop? a. No. V is providing a self service. Is non taxed 2. b) Vegy and her family consume $100 worth of vegetables? a. No. same reasoning as above 3. c) Vegy sells vegetables for $100? a. Yes. V has $100 accretion to wealth 4. d) Vegy exchanges $100 of vegetables for $100 worth of tuna? a. Yes. Same as above


Page 2 12/9/2011 ii. 2) Doctor needs to have his income tax return prepared. L would like a check up. D exchanges a $200 checkup w/L for $200 of services 1. a) What tax consequences to each when the swap services? a. Each has $200 GI 2. b) Does L incur any income in doing her own taxes? a. No. We do not tax self services DISCHARGE OF INDEBTEDNESS a. Pg. 180-81 i. 1) Poor borrowed $10K from Rich several years ago. What tax consequences to Poor if Poor pays off the undiminished debt w/? 1. a) A settlement of $7000 cash? a. $3K GI 2. b) A painting w/a value of basis and a FMV $8K a. $2K GI 3. c) A painting w/a basis of $5K and FMV of $8K a. $5K GI 4. d) Services in the form of remodeling Rs office which are worth $10K a. $10K compensation for services 5. e) Services that are worth $8K a. $2K discharge of indebtedness b. $8K compensation for services 6. f) Same as (a) except that Ps employer make the $7K payment to R, renouncing any claim against P a. $3000 discharge of indebtedness b. $7000 compensation for services ii. 2) Mortgagor purchases a parcel of land held for investment from Seller for $100K w/$20K of cash paid directly by Mor and $80K paid from the proceeds from a recourse mortgage from bank. Mor is personally liable fore the loan and the land is security for the loan. The land increases in value to $300K. Mor borrows another $100K from the bank again incurring personal liability w/the land as security. Mor uses the $100K of loan proceeds to purchase stocks and bonds. Several years later when the principal amt. of the mortgage is still $180K, the land declines in value to $170K. Mor transfers the land to the bank and the bank discharges all of Mors indebtedness. 1. a) What are the tax consequences to Mor? Reg. 1.1001-2(a) and 2(c) Example (8)? a. ***ASK ABOUT THIS ONE i. $180-$170 = $10K forgiveness of debt income ii. $170(AR)-$100(AB) = $70K gain from the sale of property 2. b) What are the tax consequences to Mor if the liabilities had nonrecourse liabilities. See problem 1(i) on pg. 154 a. Would be the same iii. 3) B borrows $100K from C to start an ambulance business. He then purchases ambulances for $100K. Adjusted basis and FMV of ambulances is $100K. What are the consequences under 108 and 1017 in the following circumstances 1. a) B is solvent but is having financial difficulties and C compromises the debt for $60K a. $40K discharge of indebtedness 2. b) Same as (a) except that C is also the ambulance dealer who sold the ambulances to B and as a result of depreciation deductions, the adjusted basis of the ambulances is $35K.


Page 3 12/9/2011 3. c) Same as (a) except that B is insolvent and his liabilities are $225K and exceed his assets by $125K. C discharges $40K of the $100K loan w/o any payment 4. d) Same as (c) above except the B has $30K net operating loss 5. e) Same as (c) except that Bs liabilities exceed his assets by $25K iv. 4) Decedent owed Friend $5K and Nephew owed Decedent $10K 1. a) At Ds death F neglected to file a claim against Ds estate in time allowed by state law and Fs claim was barred by the SoL. What is the result to Ds estate? a. Estate has $5K discharge of indebtedness income i. Net Wealth of the estate increased by $5K 2. b) What is the result in a) if F simply permitted the SoL to run since she felt sorry for Ds widow? a. F made the estate a $5K gift i. F had donative intent 3. c) What result to N if Ds will provided that his estate no collect Ns debt to the estate? a. N has $10K inheritance i. This is the same situation that would occur if D let N pay the $10K, then gave it back to him in his will EMPLOYEE BENEFITS/AWARDS a. Pg. 106 i. 1) Employer provides employee and family a residence on employers premises having a rental value of $5K per year, but charging employee only $2K per year. 1. a) What result if the nature of employees work does not require employee to live on the premises as a condition of employment? a. E has $3K GI. i. Value of rental is not excluded under 119 since it is not a condition of employment 2. b) What result if Employer and Employee simply agreed to a clause in the employment kx requiring employee to live in the residence? a. Lodging would not be excludable under 119 since it is not for the convenience of the employer 3. c) What result if employees work and kx require him to live on the premises and employer furnishes employee and family w/$3K worth of groceries per year a. Lodging would be excludable under 119 i. ELKINS SAYS it is unclear whether groceries constitute meals since the employee has some choice over the groceries he buys 4. d) What result if employer transferred residence to employee in fee simple in the year that the employee accepted the position and commenced work? Does the value of the residence constitute excluded lodging? a. ***ASK ELKINS i. Giving some a residence does not seem to be the same thing as lodging 1. Seems like pure payment a. How can it ever be for the employers benefit to give you a house ii. 2) Planner incorporated her motel business and the corporation purchased a piece of residential property adjacent to the motel. The corporation by kx required Planner to use the residence and also furnished her meals. Planner worked at the motel and was on call 24hrs a day. What can P exclude from GI?


Page 4 12/9/2011 1. Seems like meals lodging can be excluded under 119 a. All three conditions are met i. Small issue as to whether she is actually living on the premises 2. Problem a. P is both employer and employer i. Call into questions whose convenience this is really at iii. 3) State highway patrolman is required to be on duty from 8-5. At noon he eats lunch at various privately owned restaurants adjacent the highway. AT the end of each month the state reimburses him for his lunch. Are such cash reimbursements included in GI. See Kowalski. 1. Kowaski a. Since meals are being reimburses, rather than provided, the exclusion does not apply b. Pg. 101-02 i. 1) Are these fringe benefits that may be excluded from GI 1. a) Employee of a natl hotel chain stays in a hotel in another town for free while on vacation. There are several empty rooms a. Is a no additional cost service under 132(a)(1) 2. b) What if clerk has to kick someone out to provide the room a. Not a no addtl cost service i. Employer is incurring the cost of forgone revenue under 132(b) (2) 3. c) Same as (a) except that employee pays the bill and receives a cash rebate from the chain a. Is a no addt cost services i. Reg. 1.132-2(a)(3) says that no additional cost services include cash rebates 4. d) What if Es family uses the room too a. Makes no difference 5. f) Same as (a) except employee is an officer and free use is allowed on for officers a. Not a fringe since it is being provided in a discriminatory manner i. Violation for 132(j) GIFTS AND INHERITANCES a. Problems pg. 82 i. 1) Employer gives all of her employees, except her son, a TV at Christmas worth $100. She gives her son a TV worth $500. Does the son have GI? 1. 102(c) says that there is no such thing as a gift from any employer to an employer a. Gift will be considered GI 2. ELKINS SAYS must look at the state of the mind of the mother in this case a. See if she deducted any of the gift as a business expense ii. 2) At casino L give the maitre de a $50 tip to assure a good table and gives the croupier a $50 toke after a good night w/the cubes. Do either of them have GI? 1. Maitre de GI a. Seems like he is being compensated for the service of getting a good table 2. Croupier seems more like a gift a. L is getting the same dice he would have had he not paid the tip i. You could argue that C is being compensated for the service of being friendly

Page 5 12/9/2011 iii. 3) The congregation for whom Reverend serves as a minister gives her a check for $5K on her retirement 1. Could probably argue either way (**ASK ELKINS) a. I would argue that Reverend is the employee of the Congregation, and that there can be no gift under 102(c) iv. 4) Retiree receives a $5K trip on his retirement. Employer contributes $2K, employees contribute $3K. 1. $2K from the employer is GI b. Pg. 91 i. 1) Consider whether it is likely that 102 applies to the following 1. a) Father leaves daughter $20K in will a. Excludable under 102 2. b) Father dies intestate and D receives $20K in real estate as his heir a. 102 Includes property received by devise 3. c) F leaves several family members out of the will and D and others attack the will. D receives $20K from the settlement. a. Still excluded since D received money as an heir i. The fact that it was received out of a dispute is irrelevant 4. d) F leave D $20K in his will stating that it is in appreciation of her long and devoted services to him a. Looks to be in the middle i. ELKINS SAYS it is likely that 102 still applies 5. e) F leaves D $20K pursuant to a written agreement under which D agreed to care for F in his declining years a. Not excluded i. There is an express kx for compensation for services 1. Like Wolder, the estate had a debt to D 6. f) Same as (e) except F dies intestate and D successfully enforced the $20K claim under the agreement a. Same 7. g) Same as (f) except that D settles here $20K claim for $10K payment a. $10K GI for D b. No GI for the estate i. Settlement retroactively settles the amount of the debt (this is if the debt is disputed) 1. ***ASK ELKINS where this comes from 8. h) F appointed D executrix of the estate and will said she would received $20K for services as executrix a. Is the opposite case discussed in Merriam i. Is obviously compensation for services 1. Is included in GI 9. i) F appointed D executrix of his estate an made a $20K bequest in lieu of her compensation a. This is exactly like Merriam i. Amounts are excluded from GI ii. 2) B agrees to leave everything w/T upon his death in return for agreement to stay w/him w/o marriage. She does, he doesnt pay, she sues his estate under a theory of quantum meruit and settles. Is her claim excludable under 102? 1. ELKINS ANALYSIS*** a. Probably not excludable


Page 6 12/9/2011 i. Seems that she is making a claim that he should pay her for her services b. Would be are more difficult case if he actually left her the $ in the will i. Would have to ascertain Bs intent iii. 3) If Wolder arose today would 102(c) apply to resolve the issue? 1. 102(c) would not apply a. Refers to gifts b/w employer and employee i. A lawyer is not an employee, but an independent contractor DAMAGES AND RELATED RECEIPTS a. Pg. 193-194 i. 1) What are the tax consequences 1. a) P, professional gymnast, lost the use of her leg after a fan assaulted her w/a tire iron. She was awarded damages of $100K a. Excludable under 104 2. b) $50K of the recovery in (a) is allocated to compensation for scheduled performances that she could not make a. Is excludable i. 104(a)(2) speaks of damages on account of personal, physical injury or sickness 1. Includes lost earning 3. c) Jury awards P $200K in punitive damages a. Are taxable as a windfall i. Not meant to compensate for injury, but to punish 4. d) The jury also awards $200K to compensate for suicidal tendencies arising from the injury a. Is excludable since mental injuries arose out of a physical injury 5. e) P in a separate suit recovers $100K from damages from a fan who taunted her about her high voice causing her anxiety and stress a. No excludable i. Damages do not arise out of physical injury or sickness 6. f) P recovers $200K from he ex-coach in a sexual harassment suit a. Depends on what she is being compensated for i. Pure mental anguish = taxable ii. Mental anguish arising out of physical assault = excluded 7. g) P dies as a result of a leg injury and parents recover $1M of punitives under a wrongful death state statute? a. 104(c) i. There is a special exception for punitive damages received from a wrongful death suit based on a law in place in 1995 ii. 2) Injured and spouse injured in auto accident. Total medical expenses were $2500 1. a) In the year of the accident they properly deducted $1500 of expense on their join income tax return and filed suit against their wrongdoer. In the succeeding year they settled their claim against the wrongdoer for $2500. What are the income tax consequences of receiving the $2500? a. Cant get double tax benefit i. $1500 is taxable 1. Was already deducted ii. $1000 remaining is excludable 2. b) In the succeeding yr spouse was ill but fortunately they carried medical insurance and spouse had insurance benefits under policy provided by employer. Spouses medical expense totaled $4K and received $3K of benefits


Page 7 12/9/2011 under their policy and $2K of benefits under employers policy. To what extent are benefits included in GI? a. $3K paid under own policy is all excludable b. Employers policy under Rev. Ruling 69-154 i. Deemed to pay for (2/(2+3))*$4K = $1600 1. $1600 is excludable 2. Remaining $400 from employer policy is taxable 3. c) Under the facts of (b) may I and S deduct the medical expenses. See 213(a) a. **ASK ELKINS i. Cannot deduct under 213 since they were already reimbursed by insurance iii. 3) I has a 20 life expectancy, recovers $1M in a personal suit arising out of a boating accident. 1. a) What are the tax consequences to I if the $ is put into a money market account yielding 5% interest? a. 5% interest is taxable even though it comes from tax free funds 2. b) What if I uses the $1M to purchase an annuity to pay I $100K a year for the rest of his life? a. Return of capital is not a tax, but the money beyond that amount is i. There is a formula in the code to determine how much if the $ is return of capital, and how much is interest 3. c) What are the tax consequences to I if the case was settled and in the settlement I received payments from D for $100K for life? a. All would be excludable as compensation for injury i. Does not matter what form it is paid in b. Problem w/this type of arrangement i. D would have to invest money to be able to make these payments 1. Would be taxed on his interest income ASSIGNMENT OF INCOME FROM SERVICES a. Pg. 254-55 (***MAKE SURE TO ASK ABOUT THESE) i. 1) Executive has as position w/H making $80K a year. 1. A) Who is taxed if E at the beginning of the year directs that $20K of her salary be paid to her aged parents a. E is taxed 2. B) Who is taxed if E at the beginning of the year directs that $20K of her salary be paid to any charity that the board of H selects a. Similar to Giannini i. However, is different in that she didnt merely refuse the salary, but directed its disposition to a charity b. Thus, taxation depends on how broads Es discretion over the disposition was 3. C) Same as (b) except that E makes the same request w/respect to a $10K year end bonus announced an the end of the year for services rendered at the end of the year a. ***Seems different than Giannini in that income has already been earned and E is now trying to control its disposition i. Seems no different in that if she just gave the money to the charity herself 4. D) Who is taxed if E in her corporate role gives a series of lectures and pursuant to her kx w/H turns her $1K honorarium over to the corporation?

Page 8 12/9/2011 a. Income is taxed to the principal (H) under Rev. Ruling 74-581 i. Is true even if the client does not know that money is being paid to the principal VIII. ASSIGMENT OF INCOME PROPERTY a. Pg. 274-75 i. 1) Father owns a registered corporate coupon bond which he purchased several years ago for $8K. Has a face value of $10K to be paid in 2010. Current FMV of bond is $9K. Pays 8% interest semi-annually Apr.1 and Oct.1 ($400 each payment). What are the tax consequences to D and F? 1. a) On Apr.2 of the current F assigns D all of the interest coupons a. Unclear ***ASK ELKINS what answer he wants i. Similar to Horst - in that there is a horizontal cut 1. F keeps underlying asset and gave away the income a. Would suggest that coupons are taxed to F ii. Different than in Horst 1. Here F gave away ALL coupons a. Would suggest that coupons are taxed to D 2. b) On Apr.2 F gives D the bond w/the right to all interest coupons a. F gives away both the underlying asset and the income i. D will be taxed on the coupons 3. c) On Apr.2 F gives D a interest in the bond and a right to all of the interest coupons a. This is a vertical cut i. D owns part of the asset and part of the income stream 1. Is taxed on her half of the coupons 4. d) F owns an income interest in the trust that owns the bonds. On Apr. 2 F gives income interest to D a. Case is similar to Blair i. Income interest in the coupons here is the underlying 1. Thus, when F gives this interest to D, she owns the assets, and will be taxed on the income 5. e) On Dec. 31 F gives D the bond w/the right to all of the interest coupons a. ***ASK ELKINS HOW TO SOLVE THIS i. 3 months interest had accrued at the time F gave away the bond 1. F is taxed on the accrued interest 2. D is taxed on the interest that accrues for the point she is given the bond b. ****HYPO Who is taxed on the appreciation in value i. See Tatum and Campbell 6. f) On Apr.2 F sells D the right to the 2 remaining coupons for $600, their FMV at the time of sale a. ***ASK ELKINS i. F is taxed on the $600 received from the sale ii. D is taxed on the difference in what she paid for the coupons and what she received 1. 800-600 = 200 income b. Is a simple sale like Stranahan 7. HYPO what if he sold it to her for $300 a. Would be a sale of $300 and a gift of $300 i. Sold half Apply Stranahan 1. F pays tax on PV, D pays on appection

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a. F pays $300 b. D pays $100 (400-300) ii. Gift Half Apply Horst 1. F pays on both PV and appreciation a. F pays $400 (list is because the gift he his giving is merely income) iii. Total 1. F pays tax on $700 2. D pays $100 b. Formula for Fs Payment = PV +(1- (SalesPrice/PV))(Future Appreciation) 1. 600 + (1-(300/600))(200) = 700 ii. Horst (total gift) 1. 600 + (1-(0/600))(200) = 0 iii. Stranahan (total sale) 1. 600 + (1-(600/600)(200) = 800 c. Timing i. Stranahan 1. F paid tax when sold 2. D paid tax at coupon maturity ii. Horst 1. F and D taxed at the time of maturity iii. Solution 1. F pay tax on $300 now a. Pays tax on $400 at the time of maturity 2. D pays tax on the $100 at the time of maturity 8. g) On Apr. 2 F sells the bond and directs that the $9K sales price be paid to D 9. h) Prior to Apr.2 F negotiates the sale. Transfer bond to D, who transfers it to Buyer, who pays D $9K ii. 3) Inventor develops a new electric switch which she patents. Who is taxed on the proceeds of its subsequent sale if: 1. a) The patent is transferred gratuitously to Son who sells it to Buyer? a. Its unclear whether the patent is the underlying asset or merely the right to received income from that at assets i. 2 possibilities for the underlying assets 1. Inventive Skills 2. Patent itself a. This is the accepted wisdom today 2. b) Inventor transfers all her interest in the patent to Buyer for a royalty contract gratuitously to Son prior to receiving any royalties? a. Heim Gift of a royalty interest is taxed to the donee i. Thus, son is taxed BUSINESS DEDUCTIONS AND DEPRECIATION a. Depreciation Hypos i. 1) Machine costs $1000, lasts for 10yrs, expected to produce income of 120/yr, 40% tax rate? 1. Taxable income = 120 (1000/10) = $20yr 2. Tax per year = 20*.40 = $8 3. After tax income = 120-8 = 112/yr 4. ROI = 112/1000 = 11.2% ii. 2) What if you a current depreciation deduction?

Page 10 12/9/2011 1. Total value of depreciation deduction = 1000*.4 = 400 a. Is like you are only paying $600 for the machine 2. Tax per year = 120*.4 = $48 3. After tax income = 72 4. ROI = 72/600 = 12% iii. 3) What if you could deduct expenses for non-wasting assets? 1. Ex. 1000 asset that is expected to produce $100/yr forever, 40% rate a. Get a savings of 40%*1000 = 400 up front i. Thus, you really pay only $600 b. After tax income = 100(1-.40) = $60 c. ROI = 60/600 = 10% = the same ROI you would have gotten if there was no tax at all iv. 4) What if I purchase a machine for $1000, 5yrs useful life, used for 2yrs to build a building? 1. 2 years depreciation = 2*(1000/5) = 400 a. Thus, will include $400 in he cost of the building which will be depreciated over the life of the building v. 5) Have a machine that wears out and has to be replaced after a few years. Is the cost of replacement a capital expense or is it currently deductible? 1. When you purchased the original machine you already took wear and tear into account through depreciation deductions a. Thus, must fully capitalize the new machine just like the old one i. Otherwise, you would be allowed double depreciation deduction vi. 6) What if the original machine does not last for its entire useful life? 1. Here, it seems that there was depreciation beyond that which was expected 2. ***ASK ELKINS what happens to the depreciation you didnt get to take (if it is a total loss, deduct that amount of remaining depreciation as a loss) a. Significantly extending useful life capitalize b. Restoring/Repairing currently deductible under 162 i. See Midland Empire vii. 7) What if hotel was required to install a sprinkler system to meet w/some city fire ordinance? (Hotel Sulgrave Case) 1. 2 arguments a. 1) This is an ordinary and necessary business expense to restore the building to its useful status b. 2) This is a capital expense since it is making an improvement to the building that it did not have before i. This is the argument the Court sided w/ viii. 8) Would this be the same if the city inspector found that an existing sprinkler system had to be replaced 1. 1) If sprinkler system was depreciated as part of the cost of the building a. Could argue that a sprinkler system, like tires on a car, is a part that is expected to wear out i. This, repairing the system is simply a business expense that is necessary to allow the building to reach its useful life b. This is because in reality the sprinkler system has a different useful life than the building 2. 2) If the system has a separate depreciation rate a. Much more likely that it would be considered a capital expense b. Pg. 319


Page 11 12/9/2011 i. 1) T is a businessman, local politician who is also an office director of a savings and loan association of which he is a founder. When partially due to his mismanagement the S&L began to go under he voluntarily donated nearly half a million dollars to help bail it out. Is the payment currently deductible under 162? 1. ELKINS SAYS this should be deductible currently a. Here he is merely maintaining his goodwill (Elmer W. Conti) CAPITAL EXPENDITURES a. Pg. 336-37 i. 1) LL incurs the following expenses during the current year on a ten unit apt. building. Are the expenses capital or currently deductible as repairs? 1. a) $300 for painting 3 rooms of one of the apartments a. Deductible i. Just like tires on a car 2. b) $1500 for replacing a roof of the apt that had suffered termite damage a. Deductible under Midland Empire i. Didnt add anything of value, or increase useful life 1. Apt was no more suitable for the purpose it was used prior to the repair 3. c) $500 for patching the entire asphalt parking lot a. Seems questionable 4. d) $750 for adding a carport a. Capital i. Are making an improvement that wasnt there before 5. e) $100 for advertising for a tenant to occupy an empty apartment a. Deductible under 195 i. Once business starts operating, advertising is a current business expense b. Pg. 344-45 i. 1) Determine the deductibility under 162 and 195 of the expenses incurred in the following situations 1. a) T, a doctor, unexpectedly inherited a sizeable amount of money from an eccentric millionaire. T decided to invest a part of her fortune in the development of industrial properties and she incurred expenses in making a preliminary investigation. a. Are capital start up expenses under 195 i. Would be amortized over a 15 yr period 2. b) The facts are the same as (a) except that T, rather than having been a doctor, was a successful developer of residential and shopping center properties a. ELKINS SAYS this is currently deductible since the expense are incurred in the continuation of the same trade i. I would argue that T is moving into a different type of real estate and is thus a new trade 3. c) Same as (b) except that T desiring to diversify her investments incurs the expense of investigating the possibility of purchasing a professional sports team. a. This is not the same business so they are capital expense 4. d) Same as (c) and T purchases a sports team, however after 2 years T sells the team at a loss. What happens to the deferred investigation expense?


Page 12 12/9/2011 a. Deferred start-up expenses are currently deductible under 195(b)(2) when you dispose of the business before the end of the 15 yr amortization period ii. 2) Law students Spouse completed secretarial school just prior to L entering law school. Are her employment agency fees deductible in the following circumstances? 1. a) Agency is unsuccessful in finding S a job a. Not deductible (most likely are personal) i. There is a general rule that if you are looking for a new job is it not a deductible expense 2. b) Agency is successful in finding S a job a. Same as (a) 3. c) Same as (b) except that agencies fee was contingent upon securing employment for spouse and payments not due until S starts working a. Are currently deductible since they are not being paid until engaged in the trade/business (Hundley) 4. d) Same as (a) and (b) except that S previously worked as a secretary in another town. a. Is likely deductible since she is continuing in the same trade 5. e) Same as (d) except that agency is successful in finding S a job as a bank teller a. Likely to not be deductible since she is shifting careers i. However, careers arent all that different EDUCATION EXPENSES a. Pg. 392 i. 1) A, B, C, and D are college roommates who went on to become a doctor, a dentist, and accountant, and a lawyer respectively. 1. If the current year after some time in practice as an orthopedic surgeon, A, who was often called upon to give medical testimony in malpractice suits decided to go to law school so as to better understand this aspect of her medical practice. a. Capital i. Is essentially moving into a field that she wasnt in before 1. She will be qualified for a new trade or business, thus it is not deductible under Reg. 1.162-5(b)(3) 2. B enrolled in a course of post-graduate study in orthodontics intending to restrict her dental practice to that specialty in the future a. ELKINS SAYS that it is likely to be deductible for administrative purposes since it is hard to tell if she is improving her skills for her current field, or gaining new skills. 3. C enrolled part time in law school w/eventual prospects of obtaining a degree to better perform her accounting duties in areas in which law and accounting tend to overlap a. Depends on how much school she takes i. Graduates non deductible under 1.162-5(b)(3) ii. A few class line becomes blurrier 4. D took a leave of absence from her firm to enroll in a LLM course in taxation intending to practice exclusively in the tax area. a. Same as (B) ii. 2) Assumed Ds expense in problem 1 are deductible, if she works in Seattle who travels to Fla for a year to participate in the LLM, what additional expenses can she deduct.


Page 13 12/9/2011 1. Since the education expenses are deductible, so are her meals and lodging under 1.162-5(e) a. However, can only deduct 50% of the meals under 274(n) iii. 3) Carl earned a bachelors degree in education and teaches world history. He wants to travel to Europe to do things that will be beneficial to his teaching efforts? 1. Cant deduct any a. Education if the form of travel is non-deductible under 274(m)(2) iv. 4) Dentist attends a 5 day seminar at a ski resort. All seminar proceedings are taped. Dentist skis on clear days and watches tapes on snowy days. Are travel, meals and lodging deductible? 1. Is a joint education/personal trip 1.162-5(e) a. Expense incurred w/education are deductible b. Personal expenses are not TRAVEL AWAY FROM HOME a. Pg. 377-79 i. 1) Commuter owns a home in the Suburb and drives to city every day to work. He eats lunch at various restaurants in city 1. a) May commuter deduct costs of transportation/meals a. No deductible i. Commuting expenses are not deductible under 1.162-2(e) and Rev. Ruling 99-7 2. b) Same as (a) but Commuter is an atty and often must travel b/w his office and the courthouse. May C deduct all/any of his costs of transportation and meals. a. Elkins says this is deductible as a pure business expense i. Unlike choosing to commute to work, here C has no say in the decision to travel, and there is no consumption value 1. Meals, however, would not be deductible since he is not staying overnight 3. c) Commuter resides and works in city but must occasionally travel to Other City on business. He eats lunch in other city and returns home in late afternoon. May he deduct all/part of his costs. a. Travel is deductible since it is away from home b. Meals not deductible since he is not staying over night (Correll) ii. 2) T lives w/husband and children in city and works there. 1. a) If her employer sends her to metro on business for 2 days and one night each week and T is not reimbursed for her expenses, what may she deduct a. She may deduct all of her travel and half of her meals under 274(n)(1) 2. b) Same as (a) except that T works 3 days and spends 2 nights each week in Metro and maintains her apartment there? a. She will be able to deduct the expenses associated w/whichever apartment is not her tax home (Andrews) i. Will be able to deduct the travel expenses in going between the 2 homes no matter what 3. c) T and husband own a home is city and H works there, T works in metro maintaining an apt. there and travels home each weekend to see her family? a. ELKINS SAYS i. It is a personal choice to marry a person who works in a different city 1. Thus, when they visit each other it is a personal expense


Page 14 12/9/2011 iii. 3) Burly is a professional football player in City. He an his wife own a Home in metro where they reside during the 7mth offseason. 1. a) If Bs only source of income is his football salary, may he deduct City living expenses he incurs during the football season. a. Non deductible i. City is Bs tax home 1. His choice to live in Metro is personal 2. b) Would there any difference in the result in (a) if during the offseason he worked as an insurances salesman in metro a. Would be able to deduct expenses associated w/whichever home is not his tax home i. City would probably be his tax home since he presumable makes a lot more money playing football b. ELKINS HYPO i. What if B only had a home in City during the season, but not the offseason 1. Theoretically should not be able to deduct expense for his home in Metro since he has no duplicate expenses a. HOWEVER, the Code does not address this iv. 4) T works for Employer in City where T and his family live 1. a) Employer has trouble in branch city office in another state. Asks T to supervise Branch City office for 9mths. Ts family stays in City and he rents an apt. in Branch City. Are his Branch City expenses deductible? a. Are deductible temporary living expenses since they are expected to last, and do last, for less than a year 2. b) What result in (a) if time period is expected to be 9mos, but after 8mos is extended to 15mths? a. Once he finds out that duration is >1yr., expenses are no longer deductible (Rev. Ruling 93-86) 3. c) What result in (a) if T and his family had lived in a furnished apt in City and he and family gave up the apt. and move to Branch City where they lived in a furnished apt. for 9mths? a. Here there are no duplicate expenses i. ELKINS SAYS code does not address this problem 1. Unclear what we do v. 5) Traveler flies from personal and tax home in NY to a business meeting in FL on Monday. Meeting ends late Wed. and she flies home on Fri. afternoon after 2 days of sunshine 1. a) To what extent are Ts transportation, meals, and lodging deductible? a. Likely to be primarily for business i. Travel to and from is deductible 1. However, meals/lodging associated w/pleasure are nondeductible under 1.162-2(a) and (b) ii. Can deduct lodging and 50% of meal from Mon-Wed 2. b) May traveler deduct any of her spouses expenses if he joins her on the trip a. Not deductible under 274(m)(3) unless spouse is there for bona fide business purposes 3. c) What result in (a) if T stays in FL until Sunday afternoon a. Lodging/50% of meals from Mon-wed are deductible no matter what i. If primary purposes is found to be personal, no travel is deductible REASONABLE SALARIES

Page 15 12/9/2011 a. 1) Employee is the majority shareholder and president of Corporation. Shortly after Corporation was incorporated, its directors adopted a resolution establishing a contingent compensation kx for employee, the plan provided for Coroporation to pay Employee a nominal salary plus annual bonus based on a % of Corporations net income. In the early years of the plan payments to the employee averaged $50K annually. In recent years Corporations profits have increased, and a result E had received compensation reaching more than $200k/yr i. A) What are corporations possible alternative tax treatments for the salary 1. All dividend 2. All salary 3. Part dividend/Part salary ii. B) What factors should be considered in determining the proper tax treatments for the payments 1. Independent Investor test a. Would an independent investor pay this amount for the employee on the open market i. Look to ROR on the companys assts 2. Look at the relationship b/w Employee and Corporation a. Was the salary paid as the result of a Free Bargain 3. Is the corporation closely held a. Since E owns part of the corporation, looks like this might be a disguised dividend iii. C) What if they compensation was decided when E only held 10 shares of the company? 1. Yes appraise the kx at the time it was made and not at the time it was questioned a. Shows less control b. Looks less like a disguised dividend XIV. NON-BUSINESS EXPENSES XV. CHARGES ARISING OUT OF TRANSACTIONS ENTERED INTO FOR PROFIT a. 1) Recall Morton Frank i. A) Should Franks expenses have been deductible under 212 or 165(c)(2) 1. Not deductible under 212 a. 212 allows deductions for expenses in the production of income i. Here Frank has yet to produce any income 2. Not deductible under 165(c)(2) a. 165(c)(2) allows deductions for losses incurred in any transaction entered into for profit i. Frank is only investigating and has not begun the transact ii. B) If F had decided to buy the newspaper and in incur capital expenditures to begin operations, but then abandoned his plans, would he have been allowed a deduction 1. Seems like these would be start up expenses amortized over 15yrs a. If you abandon, can deduct team all when you abandon 195(b)(2) iii. C) If F entered into the business and elected to use 195 but ceased operation w/in the 60mth period to what extent could he take a 165(c) 1. 165(c)(2) says that his loss will be limited to his losses incurred in the transaction entered into for profit b. 2) Homeowners purchase their vacation residence for $180K ($20K of which is allocable to land). When it was worth $160K ($20K land) they moved out and put it up for sale, but not rent, for $170k i. A) May they take deductions for expenses and depreciation on the residence. If so what type of expenses would qualify?

Page 16 12/9/2011 1. Issue was the property converted into income producing property a. If so i. Can deduct maintenance expense since they are for the production of income under 212(1) b. Renting strengthens the argument that property is held for the production of income, but is not necessary (Lowry) i. Lowry found that property was held for post conversion profits even though it wasnt rented since it was held in expectation of post conversion profit 1. However, case at hand is different than Lowry in that here they are only asking for $10K over FMV, where as in Lowry he wanted 3x market value 2. ELKINS SAYS depreciation is likely deductible as well XVI. INTEREST DEDUCTION a. Pg. 502-503 i. 3) T purchases a home in current year which he uses as his personal residence. Unless otherwise stated, they obtain a loan secured by the residence and used the proceeds to acquire the residence. What portion of the interest on such loan may T deduct in the following situations? 1. a) The purchase price and the FMV of the home is $350K and T obtains a mortgage for $250K a. Is deductible as acquisition indebtedness under 163(h)(3)(B)(i) 2. b) Same as (a) except that 2 years Ts have reduced the outstanding principle balance of the mortgage to $200K and the FMV of the residence has increased to $400K. In a later year Ts take out a 2nd mortgage for $100K secured by their residence to add a fourth bedroom and a den a. Is still considered acquisition indebtedness under 163(h)(3)(B)(i)(I) i. Acquisition indebtedness includes substantially improving 3. c) Same as (b) except that T uses the proceeds of the $100K mortgage to buy a Ferrari a. Is deductible home equity indebtedness under 163(h)(3)(C)(i) 4. d) Same as (a) 10 years later T has paid off $200K of the $250K mortgage and the residence is worth $500K. In the later year T borrows $200K on the residence, $50K of which is used to pay off the remaining balance of the original mortgage and the remainder is used to pay personal debts a. $50K used to pay off acquisition indebtedness still counts as acquisition indebtedness b. $100K used to pay the personal debt is home equity indebtedness under 163(h)(3)(C)(i) c. Remaining $50K is not deductible since it is over the $100K home equity limitation in 163(h)(3)(C)(ii) 5. e) Same as (a), but additionally, towards the end of the current year Ts financing prospects improve dramatically and they purchase a vacation home for FMV of $1.25M. They finance $950K of the purchase price w/a note secured by mortgage on the vacation. They use the house 45 days a year and elect to use the residence as a qualified residence a. Aggregate amount acquisition interest = $250K + $950 = $1.2M i. Exceeds the $1M cap under 163(h)(3)(B)(ii) 1. Can deduct $1M as acquisition interst b. $100 of the remaining of the remaining $200K is home equity i. The other remaining $100K is non-deductible

Page 17 12/9/2011 ii. 5) Investor Incurs investment interest of $100K. To what extent is it deductible in the current year if 1. a) She sells the stock during the year at a $60K gain and has $20K in dividends on all her stock, but assume that under 163(d)(4)(B)(iii) neither qualifies for 1(h) preferential treatment and she has $10K is deductible investment advisor fees? Are there any other tax consequences to investor? a. 163(d)(1) says that investment interest which is deducted cannot exceed investment income i. Investment income = 60+20-10 = 70K ii. Deductible investments interest = $70K 1. Rollover remaining $30K 2. b) Interest of $100K is on loans whose proceeds are used to purchase tax exempt bonds? a. Cannot deduct investment interest used to purchase tax-free bonds under 265(a) 3. c) Same as (a) and (b) except that proceeds of the loans are used 50% to purchase tax exempt bond and 50% to buy stock and bonds and stock are her only investments a. ***ASK ELKINS*** XVII. IMPUTED INTEREST a. Pg. 502 i. 1) Lender makes a $100K interest free demand loan to Borrower on Jan.1 at a time when the applicable federal rate is 10%. The proceeds of the loan are used to purchase the principle residence for borrower. 10% interest compounded semiannually on $100k is $10,250/yr. consider the tax consequence to both parties at the end of the year if the loan is still unpaid and is in the nature of. 1. a) a gift a. Gift Side L is giving B a gift of $10,250 i. Borrower no income ii. Lender no deduction b. Interest Side B uses the $ to pay $10,250 interest i. Borrower get an interest expense deduction since the $ is being used to purchase a residence ii. Lender has interest income upon which he is taxed 2. b) compensation a. Salary L is paying B a $10,250 salary i. Borrower taxed on salary as ordinary income ii. Lender can presumably deduct the salary as an ordinary and necessary business expense 1. Depends on if he was paid for services actually received b. Interest Side B is using his salary to pay the interest on the bond i. Same results as (a) c. ELKINS ASKS Is this a total wash? i. B has taxable salary and a corresponding interest expense deduction 1. HOWEVER mortgage deduction is taken below the line (interest deductions that are non-business expenses are below the line) a. Might not be worth very much to B, might have to waive his standard deduction

Page 18 12/9/2011 ii. If B used the $ for a business expenses his deduction would be above the line 1. Then the transaction would be a total wash 3. c) dividend a. Dividend L pays B a $10,250 dividend i. Borrower dividend is taxed to borrower at potentially a lower rate than GI ii. Lender gets no deduction for making a dividend payment b. Interest Side B uses the dividend to pay the interest on his loan w/L i. Lender has taxable interest income ii. Borrower has a below the line interest deduction c. Is it a wash for B? i. Has dividend income and a corresponding interest deduction 1. However, dividend is likely taxed at a lower rate a. Paying tax at a low rate and taking a deduction now is better than a wash b. However, deduction is below the line ii. 2) Mother makes an interest free demand loan to daughter under the following situations when federal rate is 10%. What are tax consequences to M and D? 1. a) M loans D $10K that D uses as part of a down payment on Ds new residence a. 7872(c)(2)(A) says that 7872 does not apply to loans of $10K of less i. Thus, the loan is tax free 2. b) M loans D $10K that D invests in a residence that she rents to others a. 7872(c)(2)(B) says that de minimis exception does not apply if proceeds are used to acquire income producing asset i. Gift Side 1. No tax consequences for either ii. Interest Side 1. M has interest income $1K 2. D has $1K deduction investment interest 3. c) M loans D $100K that D uses as a down payment on a new residence at a time w/D has $20K of net investment income a. Gift Side i. Same as above b. Investment Side - 7872(d) applies i. However since Bs net investment income > interest, the entire amount of interest is deemed to be retransferred by borrower to the lender under 7872(d)(1)(A) 100,000 ceiling only applies to gift loans dont ignore gift. ii. L Has $10K interest income iii. B has $10K no secured mtg. No deduction. Non-deductible personal interest. 4. d) Same as (c) except that D has $1K of net investment income a. Gift Side i. Same as above b. Interest Side No interest is deemed to be retransferred under 7872(d) (E)(ii) since Bs net investment income is not greater than $1000K i. No tax consequence to either B or L ii. From B L zero interest if below $1000 (No imputed interest) XVIII. CHARITABLE DEDUCTIONS

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a. Pg. 804-05 i. ****ASK ELKINS what we need to know about charitable deductions XIX. CASH METHOD a. Pg. 611-12 i. 1) Lender lends out money at a legal rate of interest to Debtor. D is required to pay $5000 interest each year on the loan which extends over a 5 yr period. The interest is deductible by D under 163. The agreement calls for payment of each years interest on 12/31 of the year. Both parties are calendar year, cash method taxpayers. Discuss the tax consequences to both parties under the following alternatives: 1. a) D mails a check for $5K interest to L on 12/31 which is delivered on 1/2 of year 2 a. L has $5K income on 1/2 when received b. D has expense on 12/31 when sent i. Check is paid when it is out of the control of the T 2. b) D mails check in (a) on 12/30 which is delivered to L on 12/31 after banks are closed a. L has income of $5K on 12/31 when received even though banks are closed (Kahler Case) b. D has expense on 12/30 when sent 3. c) D pays all 5 years interest ($25K) to L in cash on 12/31 of yr. one a. Pre-paid interest i. L has $25K in income in yr. 1 when received if he accepts it 1. However, could reject that $20K that not due if he wants to ii. Ds expense must be amortized over the life of the loan 1. D can deduct only $5K a year even though he paid it in yr 1 4. d) Same as (c), but D does so because L makes it a condition of extending D another loan a. Same as (c) i. ******ASK ABOUT THIS ONE 5. e) D pays yr1s $5K interest in cash on 1/2 of yr 2. And as agreed pays yr2s interest on 12/31 of yr 2. a. L has $10K interest income in yr2 b. D has $10K deduction in yr2 6. f) D offers to pay L the $5K interest due on 12/31 of yr.1 but L suggests the D pay it on 1/2 of yr.2, which debtor does a. L is taxed in yr1 i. He has constructively received the $ b. D does not get a deduction until yr.2 i. No such thing as constructive payment (Vander Poel) 7. g) D gives L a promissory note on 12/31 of yr1 agreeing to pay yr1s interest + $50 on 1/30 of yr2. D pays of the note on 1/30 of yr.2 a. Depends on whether there is considered a cash equivalent i. Depends on whether or not D is creditworthy b. If a cash equivalent i. L has income in yr1 ii. D does not give a deduction until yr2 1. A promissory note is different than other cash equivalents (like a check) a. Here D still retains cash to pay his taxes and thus does not deserve a deduction until he actually pays the $


Page 20 12/9/2011 ii. 2) Lawyer renders services to Client which are deductible to C under 162. What result to both L and C if both are cash methods, calendar year taxpayers in each of the following circumstances 1. a) L sends out a bill for $1K on 12/24 of yr 1, C pays the bill on 1/4 of yr2 a. L has taxable income on 1/4 b. C has a deduction on 1/4 2. b) L sends a bill for $1K on 11/15 of yr1. C immediately pays using her American Express Card and American Express pays L $1K on 12/15 of yr1. C pays American Express the $1K credit card bill on 1/15 of yr2 a. L has income on 12/15 i. L cant have possibly constructively received the money when she pays w/card on 11/15 since there was no way for him to get the cash b. C has a deduction on 11/15 when made i. Paying on a credit card is a cash equivalent 3. c) Prior to rendering the services L and C agree that L will be paid $500 in year 1 and $500 in yr 2. C pays L $500 on 12/24 and $500 on 1/5. a. L has $500 income in yr1 and $500 income in yr2 b. C has $500 deduction in yr1 and $500 deduction in yr2 4. d) C calls L at 4:00pm on 12/31 of yr1, saying she has Ls fee statement, has made a check out in full payment and, as she is about to leave for Europe, will leave check w/desk clerk at Cs apt. L is ill, has no one to send to pick up check, and finally picks it up on 1/2 of yr2. a. Seems here that he has constructively received the cash equivalent 12/31 even though he is ill i. ELKINS SAYS there might be some reasonableness requirement for constructive receipt 1. Ex. might not have constructive receipt if Cs apt. is in another state b. L has a deduction on i. There is no such thing as constructive payment 1. Might be able to make an analogy to the post office, for if D mailed it on 12/31 he would obviously get a deduction at that time a. However, once you mail something it has completely left your control ACCRUAL METHOD a. Pg. 639 i. 1) Lawyer renders services to Client which are deductible to C under 162. L sends C a bill for $1K on 12/24 of yr1 and C pays bill on 1/5 of yr2 discuss tax consequences to L and C assuming, even if unlikely, that both are calendar year, accrual method taxpayers 1. L has income in yr1 a. This is because this is when he is entitled to the $ 2. C has a deduction in yr1 a. That is when his obligation accrues ii. 2) Lender lends $ at legal rate to Debtor. D is required to pay $5K interest each year on the loan which extends over a 5yr period. The interest is deductible to D under 163. The agreement calls for payment of each years interest on 12/31 of the year. The loan is made on 1/1 or yr1. Both parties are calendar year accrual method payers. Discuss tax consequences



3. 4.



Page 21 12/9/2011 a) D pays all 5yrs interest ($35K) to L in cash on 12/31 of yr1 a. Ls side i. IRS would argue that L must declare income for prepaid services when received 1. L could argue that here, like in Artnell, the extent and timing of payments is very explicit and certain a. Thus, should be able to spread out income of the period of performance of the service ii. 2 year rule (allows you to spread out income over 2 years) does NOT apply 1. The loan is for more than 2 yrs 2. Is not applicable interest and rent b. C may not deduct the interest until it is due under the economic performance test i. 461(h)(3) recurring items does not apply 1. This section says that an item may be treated as incurred during the tax year if economic performance occurs w/in a reasonable period after the close of the tax year a. Here the loan goes on for 5yrs b) D pays 1st 2yrs interest ($10K) to L on 12/31 of yr1 a. Same thing as (a) i. 2 year rule still doesnt apply on the income side ii. 461(h)(3) does not apply on the deductions c) D pays all of yr1s interest on 1/2 of yr 2 a. L has income in yr1 b. D has a deduction in yr 1 d) On 12/31 of yr1 D who is having serious financial trouble fails to pay L a. L accrues income until the point where there is serious doubt, then stops thereafter i. This a day-to-day examination rather than a tax-year by tax-year situation b. Ds deduction is uncertain i. All events test and economic performance are met since he has already received the use of money and is liable to pay 1. However, might not make sense to give him a deduction when he may never pay e) On 12/31 or yr1 D does not pay interest because of a legitimate dispute over Ds obligation to pay the 1st years interest a. L does not accrue income since there is uncertainty b. D doesnt get a deduction since all events test has NOT met, even though the economic performance test might have been met i. This is because the liability is not set f) On 12/15 of yr1 D legitimately disputes the obligation to pay yr1s interest but D pays it and, in year 2, sues to recover it a. L accrues income when received since even though it was uncertain since it was taken under a claim of right i. If it is later decided that L was not entitled to the $, he will get a deduction in the year the claim was settled b. C gets a deduction when paid under 461(f) i. If it is later found that you werent liable, then you will add that amount to income

Page 22 12/9/2011 iii. 3) Accrue, a calendar year accrual method taxpayer, runs a dance school which offers lesson over 30mths w/one lesson each month. No make up lessons are offered nor is the 30mth period extended for a participant who misses any scheduled lessons. The cost of the lessons is $300 which is required to be prepaid in Jan of the 1st year. Based on prior experience, A has found that each lesson costs $4 per person. On 1/1 of yr1 100 students sign up and pay for lessons which commence in Jan of yr1. Discuss As tax consequences 1. Under Artnell a. Would argue that since timing and cost of the lessons are fairly certain, income will be accrued when earned 2. Under Trilogy a. Prepaid income is accrued when received i. Although this case seems more similar to Artnell, Artnell is a court of appeals case and the Trilogy is an old USSC case XXI. PROPERTY TRANSACTION: PROPERTY ACQUIRED BY EXCHANGE a. Pg. 121 i. 1) O purchases land for $10K and later sells it for $16K 1. A) What is Os gain a. Gain = 16(AR)-10(AB) = $6K 2. B) What difference in (a) if O purchased the land by paying $1K for an option to purchase the land for an additional $9K and exercised the option? a. No difference i. Both the option fee and the purchase price are part of the cost of the property, and are thus included in its basis 3. C) What if O in (b) if sold the option to I for $1500 a. Gain = 1500(AR)-1000(AB) = $500 4. D) What difference in (a) if owner purchased that land by making a $2K cash payment and paid $8K from a recourse mortgage? What if mortgage was nonrecourse? a. Basis = $2K cash + $8K mortgage i. Still a $6K gain 1. Does not matter of mortgage is recourse or nonrecourse 5. E) What result in (a) if O purchases the land for $10K, spent $2K clearing the land prior to its sale, and sold it for $18K a. Basis = 10+2 = 12K i. Gain = 18-12 = $6K 6. F) What difference in (d) if O had previously rented the land to L for 5 years for $1K/yr and permitted L to expend $2K clear the land? Assume that O properly reported the cash rental payments as GI and the $2K expenditures were properly excluded under 109. See 1019 a. Makes no difference i. $6000 gain 7. G) What difference in (a) if when the land has a value of $10K O, a real estate agent, received it from Employer as a bonus for putting together a major real estate development, and Os income tax was increased $3K by reason of the receipt of the land? a. Philadelphia Park i. The basis in an exchange is the basis of what you received 1. Thus the value of his services are irrelevant b. Basis = 10, Gain = 6

Page 23 12/9/2011 8. H) What difference if O is a salesperson in an art gallery and O purchases a $10K painting from the gallery, but is required to pay $9K (due to employee discount which O is allowed to exclude from GI under 132(a)(2)) and O later sells the painting for $16K a. 2 possible arguments i. $10K basis 1. Here T paid $9K cash and $1K fringe benefits a. The intention of the code is to exclude fringe benefits b. If you dont include $1K as part of the basis, you will taxed on that fringe benefit in the form of a gain when you sell ii. $9K basis 1. Code says that your basis is what you paid, and here T paid only $9K a. Fringe benefits are excluded solely because of valuation problems i. Ex. dont know if the painting was worth the full $10K to T b. However, upon realization there are no longer any valuation problems XXII. PROPERTY TRANSACTION: PROPERTY ACQUIRED BY GIFT a. Pg. 128 i. 1) Dor gave Dee property under circumstances that required payment of a gift tax. What gain/loss to Dee on the subsequent sale of the property if 1. A) Property cost Dor $20K, FMV of $30K, and Dee sold it for a. 1) $35K i. 35-20=15gain b. 2) $15K i. 15-20=(5)loss c. 3) $25K i. 25-20=5gain 2. B) Property cost Dor $30K, had a FMV of $20K, and Dee sold it for a. 1) $35K i. Basis>FMV, but here there is a gain 1. 35-30 = 5gain b. 2) $15K i. Basis>FMV>selling price 1. 20-15 = 5loss c. 3) $24K i. Basis>selling price>FMV = no gain/loss ii. 2) Father had land that he purchased for $120K but which had increased in value to $180K. He transferred it to Daughter for $120K in cash in a transaction properly identified as part gift and part sale. Assumed no gift tax was paid. 1. A) What gain to F and what basis to D under Reg. 1.1001-1(e) and 1.1015(4)? i. Fs gain = 120-120 = 0 ii. Ds basis = the greater of Fs basis and selling 1. Both are $120, so she a $120 basis b. What if he sold it for $150 i. Fs gain = 150-120 = $30

Page 24 12/9/2011 ii. Ds basis = $150 c. What if he sold it to her for $100 i. F has no loss ii. D has $120K basis 2. B) Suppose the transaction was viewed as a sale of 2/3 of the land for full consideration and an outright gift of the other 1/3. How would this affect Fs gain and Ds basis? Is this a more realistic view than the regulations? See 170(e)(2) and 1011(b) relating to bargain sales to charities? a. Allocate the basis i. Basis in 2/3 = 2/3(120) = 80 ii. Basis in 1/3 = 40 b. Sold 2/3 for $120 i. Gain 120-80 = $40K 1. D gets basis of $120 c. Gift 1/3 i. No tax consequences for F ii. D takes basis of $40K d. Total i. F pays on $40K gain ii. D has $160 basis e. Which method is preferred i. D prefers method 2 1. Has a higher basis (160>120) ii. F prefers method 1 1. He has no gain compared to $40 gain which f. Time Value of $ i. Method 2 F must pay gains tax immediately ii. Both Methods D does not pay tax on her gain until she sells 1. Might be able to put this off for a long time iii. For the sake of the family take method 1 1. Choose for D to be taxed on $40k gain in the future rather than for F to be taxed on $40k gain today XXIII. PROPERTY TRANSACTIONS: PROPERTY ACQUIRED FROM SPOUSE/DECEDENT a. Pg. 131 i. 1) A purchases some land 10 years ago for $4K. The property appreciated to $7K at which time A sold it to his wife S for $7K, its FMV 1. a) What are As tax consequences? a. No tax consequences under 1041(a) 2. b) What is Ss basis in the property? a. S takes As basis of $4K 3. c) What gain to S if she immediately resells the property? a. $3K gain 4. d) What results in (a-c) if the property has declined in value to $3K and A sold it to S for $3K a. Pure transfer of his $4K basis 5. e) What results (gains/losses/bases) to A and S if S transfers other property w/a basis of $5K and a value of $7K to A in return for his property? a. Merely trade bases i. A gets $5K basis ii. S gets $4K basis b. No gains or losses

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b. Pg. 133 i. 1) In the current year G holds 2 blocks of identical stock, both worth $1M. G purchased the 1st block for $50K and the 2nd block more recently for $950K. G plans to make an intervivos givft of one block and retain the 2nd block until death. Which block should G transfer intervivos and why? 1. Transfer the $950K block as a gift now a. Will give the Dee a benefit of a higher basis = less gain 2. Give the $50K in will a. Heir will get a $1M basis no matter what i. Doesnt have $950K in gains XXIV. PROPERTY TRANSACTIONS: NON-RECOURSE LOANS a. Pg. 153 i. 1) Mor purchases a parcel of land from Seller for $100K. Mor borrows $80K from bank and pays that amt and an addtl $20K in cash to S, giving the bank a nonrecourse mortgage on the land which is the security for the mortgage, which bears an adequate interest rate. 1. a) What is the Mors cost basis? a. Basis = 80loan +20cash = $100K 2. b) 2 yrs later, when the land has appreciated in value to $300K, and Mor has only paid interest on the $80K mortgage, Mor takes out a 2nd non-recourse mortgage for $100K w/adequate rate of interest from bank again using the land as security. Does Mor have income when she borrows the $100K? a. Mor has no realization, and therefore no income i. ELKINS ARGUMENT could argued that allowing her to take out the 2nd mortgage is in fact realization 1. She bought the property for $100 and is now able to take out a total for $180K in mortgages a. Could argue that this is a $80K gain 2. There are no liquidity and valuation problems, and therefore no good reason not to tax a. However, the courts have chosen not to 3. c) What is Mors basis in the land if the $100K of mortgage proceeds are used to improve the land? a. 1016(a)(1) says that capital expenses are included in basis i. Basis = $80K loan + $20K cash +$100K improvements = $200K 4. d) What is Mors basis in the land if the $100K of mortgage proceeds are used to purchase stocks and bonds worth $100K a. Still has $100K basis in land i. Now also have $100K basis in stocks and bonds 5. e) What result under (d) if the when the principal amount of the 2 mortgages is still $180K and the land is still worth $300 Mor sells the property subject to both mortgages to P for $120K cash. What is Ps cost basis in the land? a. Mors Gain i. Amt Realized = $120 cash + $180 forgiveness of debt = $300K 1. Gain = $300-100 = $200K a. Thus, she is taxed on $200K gain even though she only receives $120K cash i. If her tax bracket is >60% she loses $ by selling b. Ps basis = $120cash + $180loan = $300K

Page 26 12/9/2011 6. f) What result under (d) if instead Mor gives the land subject to the mortgages still worth $300K to her son. What is the sons basis? a. Is a sale i. S is buying land for $180K debt relief 1. Mors gain = $180 - $100 = $80k gain b. Ss basis = $180 7. g) What results under the facts of (f) if the Mor gives the land to her spouse instead of her son. What is the spouses basis in the land? What is spouses basis in the land after he pays off $180K of mortgages? a. Spouse takes over other spouses basis = $100K i. Basis does not change when he pays off the mortgage 8. h) What result to Mor under (d) if the land declines in value from $300K to $180K and Mor transfers the land by means of a quitclaim deed to bank? a. Gain = 180 forgiveness of debt 100basis = $80K gain i. This is so even though Mor might not have the cash to pay the tax 9. i) What result to Mor under (h) if the land declines from $300K to $170 at the time of the quitclaim deed? a. See Tufts i. FMV is irrelevant (even if FMV<non-recourse debt) 1. Gain = $180discharge - $100 = $80K gain ii. 2) Investor purchased 3 acres of land each worth $10K for $30K. I sold one of the parcels in yr1 for $14K and a 2nd in yr2 for $16K. The total amount realized by investor was $30K which is not in excess of the total purchase price. Does I have any gain or loss on the sales? 1. 1.61-6(a) Says that when part of a larger property is sold, basis shall be allocated amongst the part a. Here each parcel has a basis of $10K i. I has a $4K gain in yr1 and a $6K gain in yr2 XXV. CAPITAL GAINS: THEORY AND MECHANICS a. Pg. 694 Taxable Income LTCG LTCL STCG STCL a) $10,000 b) $10,000 $2,000 $6,000 $2,600 $1,000 $2000 $10,000 $2000 $4000 b. For each year separately, w/o regard to computations for other years, determine the amount of the Ts capital loss that is allowed as a deduction from ordinary income under 1211(b)(1) or (2) and the amount and character of his capital loss carryover under 1212(b) i. A) a. NLTCG/L = $2000-$6000 = ($4000) loss b. NSTCG/L = $2600-1000 = $1600gain 2. Result a. Can use $1600 NLTCL to offset 1600 NSTCG b. Can use the remaining $2400 to offset ordinary income since it does not exceed the $3000 cap ii. B) a. NLTCG/L = $2000-$10000 = ($8000)loss b. NSTCG/L = $2000-$4000 = ($2000)loss i. $2000 NSTCL can be used to offset ordinary income as wells as $1000 NLTCL 1. The remaining $7000 of LTCL must be rolled over

Page 27 12/9/2011 XXVI. MEANING OF A CAPITAL ASSET a. Pg. 726 i. 1) Agent entered into kx w/N to manage its state office for a 10 yr period. After 2 years N decides to stop its state operations and pays A $50K to terminate his kx. What result to A? 1. Here As own human capital is the underlying asset. Kx is merely a means to produce income from that tree a. Thus, selling the kx=selling the income stream = ordinary income ii. 2) Recall Stranahan, what is the character of Ts gain in Stranahan? 1. In Stranhan T sold his interest in dividends to son a. Selling dividends = selling income = taxed as ordinary income iii. 3) L owns 2 contiguous parcels of land. L leases both parcels to T for $1K/mo/parcel for a total of $24K/yr. The rent is payable at the end of each yr. The lease is for a 10yr period. Upon the following events which occur more than 1yr after the lease is signed, what results 1. a) To L if L sells the right to rents on both parcels prior to any rental payments being due or paid to a 3rd party for $200K a. L is selling a right income and maintaining i. L is taxed on $200K as ordinary income 2. b) To L if T pays L $20K to cancel the leases on both parcels a. L is still selling the right to receive income i. T is taxed on $20K of ordinary income 3. c) To T if L pays T $20K to cancel the leases on both parcels a. T has $20K of capital gains i. T has capital losses of zero 4. d) To T after T subleases one of the parcels of the land to S for $1200/mo for 5yrs. S pays T $10K for all Ts rights in the lease in that parcel and L releases T from the lease and accepts S as the new tenant a. T has LTCG of $10K since he is selling his entire interest in that parcel i. Makes no difference that he is selling it to S instead of L 5. e) To T if S subleases one parcel of the land from T at $1200/mo for the remainder of Ts 10yr period a. Gain is ordinary income i. This is because T is retaining his rights to the underling assets (the lease) and is merely selling his use iv. 4) Beneficiary B owns an income interest in a trust which B purchased several years ago. The remaining income interest has 20 yrs to run after the date of the sale described below and Bs adjusted basis in the remaining interest is $50K 1. a) If B sells the entire interest for $60K a. Since the income interest is all that B has, he is selling his underlying asset, any gain/loss will be capital i. Gain = 60-50 = $10K 2. b) If B sells the right to of the income interest for $15K a. This is a vertical cut of the underlying asset (like Blair) i. Just like selling one of 4 parcels land 1. Basis in the quarter = 50/4 = 12,500 b. LTCG = 15-12.5 = $2500gain 3. c) If B received the income interest as a gift rather than by purchase, but assuming the same adjusted basis and B sells the entire interest for $60K a. Since the property is a gift and B did not pay for it 1001(e)(1) applies

Page 28 12/9/2011 i. Says that when you sell a term interest in property that was received by gift, you disregard the basis b. Gain = 60 0 = $60K i. The $50 basis is added to the remaindermans interest 4. d) If B inherited the income interest and a B and the remainderperson R both sell their interests to a 3rd party, w/B receiving $60K a. When B and R sell at the same time, B keeps his basis i. B has a $10K LTCG 5. e) If R sells Rs remainder interest when it has an adjusted basis of $100K for $150K a. R has a $50K LTCG gain