income tax - elkins - problems - s2007

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Page 1 1/16/2022 Income Tax Problems I. INTRO AND INCOME AS ACCRETION TO WEALTH II. 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 Employer’s 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 Employee’s 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

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Page 1: Income Tax - Elkins - Problems - S2007

Alden Crow Page 1 4/9/2023

Income Tax Problems

I. INTRO AND INCOME AS ACCRETION TO WEALTHII. CHARACTERISTICS OF INCOME AND REALIZATION

a. Pg. 65i. 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 Surea. Seems like this is appreciation in value

i. Would not realize any income until soldii. 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 sourcea. Includes windfalls

iii. 3) Employee has worked for Employer’s 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 Employee’s spouse a new car worth $15K. How much does Employee realize from these transactions?

1. GI = $40 + $20 + $15 = $75Kiv. 4) Insurance Adjuster refers clients to an auto repair firm that gives Adjuster a

kickback of 10% of billing on all referrals1. (a) Does adjuster have GI?

a. Yes2. (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 $4K1. 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 important3. c) Are there any tax consequences to T in part (b) above?

a. T would received $2.5K GI for services providedb. 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 taxed2. b) Vegy and her family consume $100 worth of vegetables?

a. No. same reasoning as above3. c) Vegy sells vegetables for $100?

a. Yes. V has $100 accretion to wealth4. d) Vegy exchanges $100 of vegetables for $100 worth of tuna?

a. Yes. Same as above

Page 2: Income Tax - Elkins - Problems - S2007

Alden Crow Page 2 4/9/2023ii. 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 services1. a) What tax consequences to each when the swap services?

a. Each has $200 GI2. b) Does L incur any income in doing her own taxes?

a. No. We do not tax self services III. DISCHARGE OF INDEBTEDNESS

a. Pg. 180-81i. 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 GI2. b) A painting w/a value of basis and a FMV $8K

a. $2K GI3. c) A painting w/a basis of $5K and FMV of $8K

a. $5K GI4. d) Services in the form of remodeling R’s office which are worth $10K

a. $10K compensation for services 5. e) Services that are worth $8K

a. $2K discharge of indebtednessb. $8K compensation for services

6. f) Same as (a) except that P’s 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 Mor’s indebtedness.

1. a) What are the tax consequences to Mor? Reg. §1.1001-2(a) and 2(c) Example (8)?

a. ***ASK ABOUT THIS ONEi. $180-$170 = $10K forgiveness of debt income

ii. $170(AR)-$100(AB) = $70K gain from the sale of property2. b) What are the tax consequences to Mor if the liabilities had nonrecourse

liabilities. See problem 1(i) on pg. 154a. 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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 3 4/9/20233. 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 payment4. d) Same as (c) above except the B has $30K net operating loss5. e) Same as (c) except that B’s liabilities exceed his assets by $25K

iv. 4) Decedent owed Friend $5K and Nephew owed Decedent $10K1. a) At D’s death F neglected to file a claim against D’s estate in time allowed

by state law and F’s claim was barred by the SoL. What is the result to D’s estate?

a. Estate has $5K discharge of indebtedness incomei. 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 D’s widow?

a. F made the estate a $5K gifti. F had donative intent

3. c) What result to N if D’s will provided that his estate no collect N’s debt to the estate?

a. N has $10K inheritancei. This is the same situation that would occur if D let N pay the

$10K, then gave it back to him in his will IV. EMPLOYEE BENEFITS/AWARDS

a. Pg. 106i. 1) Employer provides employee and family a residence on employer’s premises

having a rental value of $5K per year, but charging employee only $2K per year.1. a) What result if the nature of employee’s 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 employee’s 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 §119i. 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 ELKINSi. 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 employer’s 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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 4 4/9/20231. Seems like meals lodging can be excluded under §119

a. All three conditions are meti. Small issue as to whether she is actually living on the premises

2. Problema. 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. Kowaskia. 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 GI1. a) Employee of a nat’l hotel chain stays in a hotel in another town for free

while on vacation. There are several empty roomsa. Is a no additional cost service under §132(a)(1)

2. b) What if clerk has to kick someone out to provide the rooma. Not a no addt’l 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 add’t cost servicesi. Reg. 1.132-2(a)(3) says that no additional cost services include

cash rebates4. d) What if E’s family uses the room too

a. Makes no difference5. 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) V. GIFTS AND INHERITANCES

a. Problems pg. 82i. 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

employera. “Gift” will be considered GI

2. ELKINS SAYS must look at the state of the mind of the mother in this casea. 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 – GIa. Seems like he is being compensated for the service of getting a good table

2. Croupier – seems more like a gifta. 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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 5 4/9/2023iii. 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 following1. a) Father leaves daughter $20K in will

a. Excludable under §1022. 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 irrelevant4. d) F leave D $20K in his will stating that it is in appreciation of her long and

devoted services to hima. Looks to be in the middle

i. ELKINS SAYS it is likely that §102 still applies5. e) F leaves D $20K pursuant to a written agreement under which D agreed to

care for F in his declining yearsa. 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. Same7. g) Same as (f) except that D settles here $20K claim for $10K payment

a. $10K GI for Db. 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 from8. h) F appointed D executrix of the estate and will said she would received

$20K for services as executrixa. Is the opposite case discussed in Merriam

i. Is obviously compensation for services1. 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 Merriami. 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 doesn’t 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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 6 4/9/2023i. Seems that she is making a claim that he should pay her for her

servicesb. Would be are more difficult case if he actually left her the $ in the will

i. Would have to ascertain B’s intent iii. 3) If Wolder arose today would §102(c) apply to resolve the issue?

1. §102(c) would not applya. Refers to gifts b/w employer and employee

i. A lawyer is not an employee, but an independent contractor VI. DAMAGES AND RELATED RECEIPTS

a. Pg. 193-194i. 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 §1042. b) $50K of the recovery in (a) is allocated to compensation for scheduled

performances that she could not makea. 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 windfalli. 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 stressa. 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 fori. 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 $25001. 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. Can’t get double tax benefiti. $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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 7 4/9/2023under 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 excludableb. Employers policy under Rev. Ruling 69-154

i. Deemed to pay for (2/(2+3))*$4K = $16001. $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 ELKINSi. 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 isi. 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 payments1. Would be taxed on his interest income

VII. 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 parentsa. 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 Gianninii. However, is different in that she didn’t merely refuse the salary,

but directed its disposition to a charityb. Thus, taxation depends on how broads E’s 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: Income Tax - Elkins - Problems - S2007

Alden Crow Page 8 4/9/2023a. 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 PROPERTYa. 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 couponsa. Unclear ***ASK ELKINS what answer he wants

i. Similar to Horst - in that there is a horizontal cut1. F keeps underlying asset and gave away the income

a. Would suggest that coupons are taxed to Fii. Different than in Horst

1. Here F gave away ALL couponsa. Would suggest that coupons are taxed to D

2. b) On Apr.2 F gives D the bond w/the right to all interest couponsa. F gives away both the underlying asset and the income

i. D will be taxed on the coupons3. c) On Apr.2 F gives D a ½ interest in the bond and a right to all of the

interest couponsa. This is a vertical cut

i. D owns part of the asset and part of the income stream1. 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 Blairi. 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 couponsa. ***ASK ELKINS HOW TO SOLVE THIS

i. 3 months interest had accrued at the time F gave away the bond1. F is taxed on the accrued interest2. 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 salea. ***ASK ELKINS

i. F is taxed on the $600 received from the saleii. 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

Page 9: Income Tax - Elkins - Problems - S2007

Alden Crow Page 9 4/9/2023a. F pays $300b. D pays $100 (400-300)

ii. Gift Half – Apply Horst1. F pays on both PV and appreciation

a. F pays $400 (list is because the gift he his giving is merely income)

iii. Total1. F pays tax on $7002. D pays $100

b. Formula for F’s Payment = PV +(1- (SalesPrice/PV))(Future Appreciation)

1. 600 + (1-(300/600))(200) = 700ii. Horst (total gift)

1. 600 + (1-(0/600))(200) = 0iii. Stranahan (total sale)

1. 600 + (1-(600/600)(200) = 800c. Timing

i. Stranahan1. F paid tax when sold2. D paid tax at coupon maturity

ii. Horst1. F and D taxed at the time of maturity

iii. Solution1. F pay tax on $300 now

a. Pays tax on $400 at the time of maturity2. 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 D9. h) Prior to Apr.2 F negotiates the sale. Transfer bond to D, who transfers it

to Buyer, who pays D $9Kii. 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. It’s 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 assets1. Inventive Skills2. Patent itself

a. This is the accepted wisdom today2. 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 IX. BUSINESS DEDUCTIONS AND DEPRECIATION

a. Depreciation Hyposi. 1) Machine costs $1000, lasts for 10yrs, expected to produce income of 120/yr, 40%

tax rate?1. Taxable income = 120 – (1000/10) = $20yr2. Tax per year = 20*.40 = $83. After tax income = 120-8 = 112/yr4. ROI = 112/1000 = 11.2%

ii. 2) What if you a current depreciation deduction?

Page 10: Income Tax - Elkins - Problems - S2007

Alden Crow Page 10 4/9/20231. Total value of depreciation deduction = 1000*.4 = 400

a. Is like you are only paying $600 for the machine2. Tax per year = 120*.4 = $483. After tax income = 724. 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 fronti. Thus, you really pay only $600

b. After tax income = 100(1-.40) = $60c. 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 onei. 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 didn’t get to take (if it is

a total loss, deduct that amount of remaining depreciation as a loss)a. Significantly extending useful life – capitalizeb. 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 replaced1. 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 ratea. Much more likely that it would be considered a capital expense

b. Pg. 319

Page 11: Income Tax - Elkins - Problems - S2007

Alden Crow Page 11 4/9/2023i. 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 currentlya. Here he is merely maintaining his goodwill (Elmer W. Conti)

X. CAPITAL EXPENDITURESa. 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 apartmentsa. 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 Empirei. Didn’t 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 lota. Seems questionable

4. d) $750 for adding a carporta. Capital

i. Are making an improvement that wasn’t there before5. e) $100 for advertising for a tenant to occupy an empty apartment

a. Deductible under §195i. 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 §195i. 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?

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Alden Crow Page 12 4/9/2023a. 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 student’s 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 joba. 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 joba. 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 aren’t all that different XI. EDUCATION EXPENSES

a. Pg. 392i. 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. Capitali. Is essentially moving into a field that she wasn’t 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 takesi. Graduates – non deductible under 1.162-5(b)(3)

ii. A few class – line becomes blurrier4. 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 D’s 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.

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Alden Crow Page 13 4/9/20231. 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 bachelor’s 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. Can’t deduct anya. 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 deductibleb. Personal expenses are not

XII. TRAVEL AWAY FROM HOMEa. 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/mealsa. 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 expensei. 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 homeb. 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 SAYSi. It is a personal choice to marry a person who works in a different

city1. Thus, when they visit each other it is a personal expense

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Alden Crow Page 14 4/9/2023iii. 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 B’s 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 B’s tax home1. 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 HYPOi. What if B only had a home in City during the season, but not

the offseason1. Theoretically should not be able to deduct expense for his

home in Metro since he has no duplicate expensesa. HOWEVER, the Code does not address this

iv. 4) T works for Employer in City where T and his family live1. a) Employer has trouble in branch city office in another state. Asks T to

supervise Branch City office for 9mths. T’s 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 T’s transportation, meals, and lodging deductible?a. Likely to be primarily for business

i. Travel to and from is deductible1. 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 tripa. Not deductible under §274(m)(3) unless spouse is there for bona fide

business purposes3. 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

XIII. REASONABLE SALARIES

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Alden Crow Page 15 4/9/2023a. 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 Corporation’s 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 corporation’s possible alternative tax treatments for the salary 1. All dividend2. All salary3. Part dividend/Part salary

ii. B) What factor’s should be considered in determining the proper tax treatments for the payments

1. Independent Investor testa. Would an independent investor pay this amount for the employee on the

open marketi. Look to ROR on the company’s 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 Franki. A) Should Frank’s expenses have been deductible under §212 or §165(c)(2)

1. Not deductible under §212a. 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 deduction1. 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) Homeowner’s 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?

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Alden Crow Page 16 4/9/20231. Issue – was the property converted into income producing property

a. If soi. 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 wasn’t 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 wellXVI. INTEREST DEDUCTION

a. Pg. 502-503i. 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 T’s 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 T’s 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 = $1.2Mi. Exceeds the $1M cap under §163(h)(3)(B)(ii)

1. Can deduct $1M as acquisition interstb. $100 of the remaining of the remaining $200K is home equity

i. The other remaining $100K is non-deductible

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Alden Crow Page 17 4/9/2023ii. 5) Investor Incurs investment interest of $100K. To what extent is it deductible in

the current year if1. 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 = 70Kii. Deductible investments interest = $70K

1. Rollover remaining $30K2. 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. 502i. 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 gifta. Gift Side – L is giving B a gift of $10,250

i. Borrower – no incomeii. Lender – no deduction

b. Interest Side – B uses the $ to pay $10,250 interesti. Borrower – get an interest expense deduction since the $ is being

used to purchase a residenceii. Lender – has interest income upon which he is taxed

2. b) compensationa. 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 expense1. Depends on if he was paid for services actually received

b. Interest Side – B is using his salary to pay the interest on the bondi. Same results as (a)

c. ELKINS ASKS – Is this a total wash? i. B has taxable salary and a corresponding interest expense

deduction1. 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

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Alden Crow Page 18 4/9/2023ii. If B used the $ for a business expenses his deduction would be

above the line1. 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 incomeii. 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 washb. 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 D’s new residence

a. §7872(c)(2)(A) says that §7872 does not apply to loans of $10K of lessi. 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 eitherii. Interest Side

1. M – has interest income $1K2. 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) appliesi. However since B’s 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 – don’t ignore gift.

ii. L – Has $10K interest incomeiii. 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 Sidei. Same as above

b. Interest Side – No interest is deemed to be retransferred under §7872(d)(E)(ii) since B’s net investment income is not greater than $1000K

i. No tax consequence to either B or Lii. From B L zero interest if below $1000 (No imputed interest)

XVIII. CHARITABLE DEDUCTIONS

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Alden Crow Page 19 4/9/2023a. Pg. 804-05

i. ****ASK ELKINS what we need to know about charitable deductionsXIX. CASH METHOD

a. Pg. 611-12i. 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 year’s 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 receivedb. D has expense on 12/31 when sent

i. Check is paid when it is out of the control of the T2. b) D mails check in (a) on 12/30 which is delivered to L on 12/31 after banks

are closeda. 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. onea. 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. D’s expense must be amortized over the life of the loan1. 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 yr1’s $5K interest in cash on 1/2 of yr 2. And as agreed pays yr2’s interest on 12/31 of yr 2.

a. L has $10K interest income in yr2b. 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 yr1i. He has constructively received the $

b. D does not get a deduction until yr.2i. No such thing as constructive payment (Vander Poel)

7. g) D gives L a promissory note on 12/31 of yr1 agreeing to pay yr1’s 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 equivalenti. L has income in yr1

ii. D does not give a deduction until yr21. 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 $

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Alden Crow Page 20 4/9/2023ii. 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 yr2a. L has taxable income on 1/4b. 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 12/15i. L can’t 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 madei. 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 yr2b. 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 L’s 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 C’s 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 C’s apt. is in another state

b. L has a deduction on ½i. 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

XX. ACCRUAL METHODa. 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 yr1a. This is because this is when he is entitled to the $

2. C has a deduction in yr1a. 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 year’s 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

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Alden Crow Page 21 4/9/20231. a) D pays all 5yrs interest ($35K) to L in cash on 12/31 of yr1

a. L’s sidei. IRS would argue that L must declare income for prepaid services

when received1. L could argue that here, like in Artnell, the extent and

timing of payments is very explicit and certaina. Thus, should be able to spread out income of the

period of performance of the serviceii. 2 year rule (allows you to spread out income over 2 years) does

NOT apply1. The loan is for more than 2 yrs2. 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 5yrs2. b) D pays 1st 2yrs interest ($10K) to L on 12/31 of yr1

a. Same thing as (a)i. 2 year rule still doesn’t apply on the income side

ii. §461(h)(3) does not apply on the deductions 3. c) D pays all of yr1’s interest on 1/2 of yr 2

a. L has income in yr1b. D has a deduction in yr 1

4. d) On 12/31 of yr1 D who is having “serious financial trouble” fails to pay La. L accrues income until the point where there is serious doubt, then stops

thereafteri. This a day-to-day examination rather than a tax-year by tax-year

situation b. D’s 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

5. e) On 12/31 or yr1 D does not pay interest because of a legitimate dispute over D’s obligation to pay the 1st year’s interest

a. L does not accrue income since there is uncertaintyb. D doesn’t 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

6. f) On 12/15 of yr1 D legitimately disputes the obligation to pay yr1’s 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 weren’t liable, then you will add that

amount to income

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Alden Crow Page 22 4/9/2023iii. 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 A’s tax consequences

1. Under Artnella. Would argue that since timing and cost of the lessons are fairly certain,

income will be accrued when earned2. Under Trilogy

a. Prepaid income is accrued when receivedi. 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. 121i. 1) O purchases land for $10K and later sells it for $16K

1. A) What is O’s gaina. 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 differencei. 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) = $5004. 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 mortgagei. 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 $18Ka. Basis = 10+2 = 12K

i. Gain = 18-12 = $6K6. 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 differencei. $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 O’s income tax was increased $3K by reason of the receipt of the land?

a. Philadelphia Parki. The basis in an exchange is the basis of what you received

1. Thus the value of his services are irrelevantb. Basis = 10, Gain = 6

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Alden Crow Page 23 4/9/20238. 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 argumentsi. $10K basis

1. Here T paid $9K cash and $1K fringe benefitsa. The intention of the code is to exclude fringe

benefitsb. If you don’t 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 basis1. Code says that your basis is what you paid, and here T paid

only $9Ka. Fringe benefits are excluded solely because of

valuation problems i. Ex. don’t know if the painting was worth the

full $10K to Tb. However, upon realization there are no longer any

valuation problems XXII. PROPERTY TRANSACTION: PROPERTY ACQUIRED BY GIFT

a. Pg. 128i. 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 if1. A) Property cost Dor $20K, FMV of $30K, and Dee sold it for

a. 1) $35Ki. 35-20=15gain

b. 2) $15Ki. 15-20=(5)loss

c. 3) $25Ki. 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 gain1. 35-30 = 5gain

b. 2) $15Ki. Basis>FMV>selling price

1. 20-15 = 5lossc. 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. F’s gain = 120-120 = 0ii. D’s basis = the greater of F’s basis and selling

1. Both are $120, so she a $120 basisb. What if he sold it for $150

i. F’s gain = 150-120 = $30

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Alden Crow Page 24 4/9/2023ii. D’s basis = $150

c. What if he sold it to her for $100i. 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 F’s gain and D’s 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 basisi. Basis in 2/3 = 2/3(120) = 80

ii. Basis in 1/3 = 40b. Sold 2/3 for $120

i. Gain 120-80 = $40K1. D gets basis of $120

c. Gift 1/3i. No tax consequences for F

ii. D takes basis of $40Kd. Total

i. F pays on $40K gainii. D has $160 basis

e. Which method is preferredi. 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 immediatelyii. 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/DECEDENTa. 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 A’s tax consequences?a. No tax consequences under §1041(a)

2. b) What is S’s basis in the property?a. S takes A’s 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 basisii. S gets $4K basis

b. No gains or losses

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Alden Crow Page 25 4/9/2023b. 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 nowa. Will give the Dee a benefit of a higher basis = less gain

2. Give the $50K in willa. Heir will get a $1M basis no matter what

i. Doesn’t have $950K in gains XXIV. PROPERTY TRANSACTIONS: NON-RECOURSE LOANS

a. Pg. 153i. 1) Mor purchases a parcel of land from Seller for $100K. Mor borrows $80K from

bank and pays that amt and an addt’l $20K in cash to S, giving the bank a non-recourse mortgage on the land which is the security for the mortgage, which bears an adequate interest rate.

1. a) What is the Mor’s 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 realization1. She bought the property for $100 and is now able to take

out a total for $180K in mortgagesa. 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 court’s have chosen not to3. c) What is Mor’s 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 = $200K4. d) What is Mor’s basis in the land if the $100K of mortgage proceeds are

used to purchase stocks and bonds worth $100Ka. 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 P’s cost basis in the land?

a. Mor’s Gaini. Amt Realized = $120 cash + $180 forgiveness of debt = $300K

1. Gain = $300-100 = $200Ka. Thus, she is taxed on $200K gain even though she

only receives $120K cashi. If her tax bracket is >60% she loses $ by

sellingb. P’s basis = $120cash + $180loan = $300K

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Alden Crow Page 26 4/9/20236. f) What result under (d) if instead Mor gives the land subject to the

mortgages still worth $300K to her son. What is the son’s basis?a. Is a sale

i. S is buying land for $180K debt relief1. Mor’s gain = $180 - $100 = $80k gain

b. S’s basis = $1807. 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 = $100Ki. 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 gaini. 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 Tuftsi. 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 $10Ki. I has a $4K gain in yr1 and a $6K gain in yr2

XXV. CAPITAL GAINS: THEORY AND MECHANICSa. Pg. 694

Taxable Income LTCG LTCL STCG STCL

a) $10,000 $2,000 $6,000 $2,600 $1,000b) $10,000 $2000 $10,000 $2000 $4000

b. For each year separately, w/o regard to computations for other years, determine the amount of the T’s 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) lossb. NSTCG/L = $2600-1000 = $1600gain

2. Resulta. Can use $1600 NLTCL to offset 1600 NSTCGb. 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)lossb. 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

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Alden Crow Page 27 4/9/2023XXVI. MEANING OF A CAPITAL ASSET

a. Pg. 726i. 1) Agent entered into kx w/N to manage it’s 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 A’s 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 T’s gain in Stranahan?

1. In Stranhan T sold his interest in dividends to sona. 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 parcelsa. L is still selling the right to receive income

i. T is taxed on $20K of ordinary income3. c) To T if L pays T $20K to cancel the leases on both parcels

a. T has $20K of capital gainsi. 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 T’s 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 parceli. 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 T’s 10yr period

a. Gain is ordinary incomei. 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 B’s adjusted basis in the remaining interest is $50K

1. a) If B sells the entire interest for $60Ka. Since the income interest is all that B has, he is selling his underlying

asset, any gain/loss will be capitali. Gain = 60-50 = $10K

2. b) If B sells the right to ¼ of the income interest for $15Ka. This is a vertical cut of the underlying asset (like Blair)

i. Just like selling one of 4 parcels land1. 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 $60Ka. Since the property is a gift and B did not pay for it §1001(e)(1) applies

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Alden Crow Page 28 4/9/2023i. Says that when you sell a term interest in property that was

received by gift, you disregard the basisb. Gain = 60 – 0 = $60K

i. The $50 basis is added to the remainderman’s interest4. 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 $60Ka. When B and R sell at the same time, B keeps his basis

i. B has a $10K LTCG5. e) If R sells R’s remainder interest when it has an adjusted basis of $100K for

$150Ka. R has a $50K LTCG gain