Tax I Final Outline

8/11/2019 Tax I Final Outline

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Tax II. Gross Income

A. IRC 61(a): Gross Income means al l inc ome from w hatever sourc eder ived

B. Income Def ini t ion (Glensh aw Glass)1. Undeniable Accession to Wealth2. Clearly Realized, and3. Over which the taxpayer has complete dominion and control

C. Include:1. Dont m ent ion Subs ect ion. Just ment ion Sect ion 61(a).2. Compensation for Services3. Gains Derived from Dealings in Property4. Interest5. Income from Discharge of Indebtedness6. Life Insurance and Annuities

D. Does NOT Inclu de:1. Loans

a) Loans are Not Gross Income(1) A loan d oes no t represent an accession to w ealth or inc rease the

taxpayers net worth BECAUSE the loan proceeds are

accompanied by an equal and offset t ing l iabi l i ty

b) The Equal and Offsetting liability: the obligation to repay the loan(1) Bor rower has an obl igat ion to repay the loan(2) Repayment obl igat ion negates the income payment of the loan

E. Includes in come real ized in ANY fo rm (1.61-1(a))1. Money2. Property

a) the FAIR MARKET VALUE of the prop erty taken in payment m ust beinc luded in income

3. Servicesa) The Fair Market Value of the Services taken in payment mu st be

inc luded in income

4. FMV: value a willing buyer would pay a willing seller with knowledge ofall facts and circumstances

F. Bargain Purchases1. A Bargain Purchase occurs when a taxpayer purchases a good for less

than fair market valuea) [Purchase Price of Good] < [FMV of Good ]2. Bargain Purchases do not constitute gross income

a) EXCEPT: Discoun t as Compensat ion(1) If the discount is regarded as compensation for services, the value of the

bargain is included in incomeb) EXCEPT: Bargain t o Empl oy ee (1.61-2(d)(2)(i i))

(1) If property is given to an employee at a bargain from an employer(2) the value of the bargain will be compensat ion to the employee (Discount


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is compensation)(3) EXCEPTION TO EXCEPTION: Family Member Employees

(a) This special relat ionship gives rise to an inference that the bargaindiscou nt is a gift from an employ er to emp loyee

(b) This may be rebutted by facts and circumstances(c) Discount is not compensat ion

(d) Apply Part-Gift, Part Sale rules to d etermin e Basis and Gain.G. Dist inguish Incom e wi th Gi f t

II. Gifts, Bequests, and InheritanceA. If prop erty is a gi f t :

1. IRC 61(a): Gross income includes all income from whatever sourcederived.

2. HOWEVER, under IRC 102: Gross income does not include the value ofproperty acquired by Gift, Bequest, and Inheritance

B. Gif t (Duberstein and Wolder)1. Gifts are based on a detached and disinterested generosity (Duberstein)

a) Out of affect ion, respect, adm irat ion, chari ty , or l ike imp ulsesC. Gif t V. Compensat ion

1. Test for whether the gift is a bona fide gift or method for payingcompensation (Wolder)a) Examine Transferor 's Intentb) Reason for transfersc) Part ies ' performance in accord ance with their intent ions

2. Regular sizable payments made by persons that the taxpayer providesservices for is income to the taxpayer (Goodwin)

3. EMPLOYER TO EMPLOYEE: Any amount of gift given to employee fromemployer is included in employee's income (102(c))

4. INCOME EARNED FROM GIFT: Gift itself is excluded from income;Income derived from the gift is included in income (102(b))

D. Part Gif t and Par t Sale (1.1015-4)1. Part Gift-Part Sale occurs when the Seller-Donor sells property to

Buyer-Donee at a price less than Fair Market Valuea) The bargain on the sale is no t incom e to the Buyer-Doneeb) However, Basis /Gain and L oss are affected un der 1.1015-4 for

determining g ain and loss.

2. Gain/Loss to the Seller-Donora) Seller/Donor has Gain to the extent that the Amo unt Real ized exceeds

the Adjusted Basis in that property

b) No Loss recog nized on Transact ion3. Basis to Purchaser-Donee (when property has built in gain [FMV >

Donor's Basis])a) Greater of:

(1) Amount paid for the property(2) or Seller/Donor's adjusted basis in property

b) Determin ing Lo ss (see Below):(1) For determining loss, the unadjusted basis of the property in the hands


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of the transferee shall not be greater than the fair market value of theproperty at the time of such transfer.

4. Sale of Part Gift and Part Sale from Donee to 3rd Partya) For determining loss, the unadjusted basis of the property in the hands of

the transferee shall not be greater than the fair market value of the propertyat the time of such transfer.

b) WHEN PROPERTY has bu i l t in Los s at time of gift (FMV at time of Gift< Donor's B asis):

(1) Donee's Basis in the property is u nsure un t i l he engages in asub sequent transact ion

(2) When there has been a sale which has a loss (Amount realized < FMV attime of gift and Donor's Basis), the code will want to minimize the loss.Thus the Donee's Basis will be FMV at the time of the Gift.

(3) When there has a sale which is in between the two values, no gain orloss recognized.

(4) When there has been a sale which has a gain (Amount realized > FMV attime of gift and Donor's Basis), the code will want to minimize the gain.

Thus the Donee's Basis will be Donor's basisc) Basis to Don ee(1) Amount Realized < FMV of Gift on Date Given and Donor's Basis

(a) Then Basis to Donee is FMV of Gift(2) FMV of Gift on Date Given = Amount Realized = Original Cost of Gift to

Donor(a) No Gain or Los s Recognized

(3) Amount Realized > FMV of Gift on Date Given and Donor's Basis(a) Then Basis to Donee is Donor's B asis

III. PrizesA. IRC 74: Gross Incom e includes amoun ts received as prizes or

awards1. If the award is not made in money, the fair market value of the prize oraward is included in income

2. EXCEPTION: Employee Achievement Awardsa) Award that consists of tangible personal property, given in

recogni t ion of a qual i fy ing length o f serv ice or safety achievements

B. Overal l, Pr izes are General ly Inclu dable in Gross Income

IV. Gains Derived from Dealings in PropertyA. Rules:

1. IRC 61(a): Gross income Includes Gains Derived from Dealings inProperty

2. IRC 1001(c): The entire amount of the gain or loss on the sale orexchange of property shall be recognized.

B. Gain:1. Excess over the Amount Realized over the Adjusted basis in property

(1.61-6(a))2. Applies to the SALE or OTHER DISPOSITION of property

a) Broader th an sale or exchange requirement of capi tal gain.


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C. Am ount Realized (1001(b))1. Amount of money received for the sale or other disposition of property2. PLUS the FMV of any other property received from the sale or disposition

of that property3. Includes any amount of liability assumed on the property resulting from

sale or disposition of property (1.1001-2(a))a) Amoun t real ized includes the amoun t of l iabi l i ty assumed in sale

D. Basis1. Cost of property (1012(a))2. Adjusted for depreciation or expenditures made on the property

a) Capi tal Imp rovements pro vide for an upward adjustm ent in thepro perty (Section 1016)

b) Depreciat ion prov ide for a dow nward adjustment in the property.Even i f depreciat ion d educt ion is not taken.

3. Acquired from Decedent (by bequest/inheritance) (1014(a))a) FMV of the pro perty at the date of the decedent 's death.

4. Acquired by Gift (1015(a))a) Donee's B asisb) EXCEPT: See Part Gift - Part Sale

5. Function of Basis:a) Record keeping deviceb) Record o f the dol lars that have already been sub ject to tax, wh ich has

been invested in an asset

c) When you w i thdraw from the proper ty , you do n ot have to be subjec tto tax again

E. Basis and Subdiv id ing Proper ty1. When part of a larger property is sold, the basis of the entire property is

equitably apportioned among the several parts (1.61-6(a))2. Gain or loss sustained on the part of the entire property sold is the

difference between the selling price and the cost or other basis allocatedto such part.

F. Exchange of Property (Phi ladelphia Park Am usem ent v. Uni tedStates)1. Basis of Property received in a taxable exchange:

a) Is the FMV of the pr operty received in the exchange2. Amount Realized in taxable exchange:

a) Is the FMV of the pr operty received in the exchange3. If the value of what is received cannot be determined with reasonable

accuracy, then reasonable to assume:a) the FMV of what is g iven is equal to the value of w hat is received

G. Gain Analysis:1. Has Gain been Realized? (by sale or other disposition of property)

a) Has there been a sale or other disp osi t ion in p roperty2. Yes: Calculate Gain

a) Inc lud e Gain in Gross Income


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b) UNLESS part or al l of gain is excluded from gross incom e:(1) Sale of Principal Residence(2) Proceeds from Life Insurance(3) Certain Compensation for Personal Injury/Sickness

3. What is the Character of the Gain?a) Ordinaryb) Sale of Capital Ass etc) Sale of 1231 Asset

(1) Subject to 1245 Recapture?(2) Subject to 1250 Recapture?

V. Sale of a Principal ResidenceA. Rules

1. Section 61(a): Gains derived from dealings in property are included ingross income.

2. However, under IRC 121(a): Taxpayer may exclude part of gain from saleof qualifying principal residence

B. Qual i fy ing Principal Residence: 3 Main Requirements1. Ownership: Owned the residence for 2 out of 5 years2. Use: Used the Residence for 2 out of 5 Years3. Frequency: Not used the exclusion within the past 2 years

C. Using More Than One Property--Determ ining Principal Residence1. Depends on Facts and Circumstances2. First: Check Time

a) If taxpayer al ternates b etween 2 pro pert ies, the pro perty that th etaxpayer uses a majori ty of the t ime during the year ordinari ly wi l l be

cons idered the taxpayer 's p rinc ipal residence.

3. Second: Apply to Facts and Circumstances

a) Factors to Co nsider:b) Taxpayer 's Place of Emp loym entc) Principal Place of abode of taxpayer 's fami ly m embersd) Add ress l is ted on federal and s tate tax returns , drivers l icense,

automo bi le registrat ion, and vo ter registration

e) Taxpayer 's mai l ing address for bi l ls and correspo ndencef) Locat ion o f Taxpayer 's banksg) Locat ion of rel ig ious org anizat ions and recreat ional clubs with wh ich

the taxpayer is aff i l iated

D. Gain Exclud ed1. Full Exclusion

a) Ownersh ip, Use, and Frequency Met? Then apply the fol lwoin gb) Sing le: 250,000c) Married Fil ing Separately: 250,000d) Marri ed: 500,000

2. Partial Exclusion (1.121-3)a) Ownersh ip, Use, Frequency, not Met?b) Al low s a part ia l exclusion i f the sale or exchange was do ne because

of a qual i fy ing indiv idu al 's :


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(1) Change in Place of Employment(2) Health(3) Unforeseen Circumstances

c) Change of Place of Employment(1) Safe Harbor Rule

(a) Change in place of emplo yment occurs durin g the period of the

taxpayers ownership AND use of the property as a principalresidence

(b) new place of employm ent is 50 miles farther from the residence sold(2) OR Facts and Circumstances Test

(a) Whether there has been a change in place of employm ent dependsupon:

(b) Facts Circums tances giv ing ri se to the sale or exch ange (1.121-3(b))i) The sale or exchange and the circumstances giving rise to the sale or

exchange are proximate in time;ii) The suitability of the property as the taxpayer's principal residence

materially changes;iii) The taxpayer's financial ability to maintain the property is materially

impaired;iv) The taxpayer uses the property as the taxpayer's residence during theperiod of the taxpayer's ownership of the property;

v) The circumstances giving rise to the sale or exchange are notreasonably foreseeable when the taxpayer begins using the property asthe taxpayer's principal residence; and

vi) The circumstances giving rise to the sale or exchange occur during theperiod of the taxpayer's ownership and use of the property as thetaxpayer's principal residence.

d) Qual i fy ing Indiv idual(1) Also applies to unmarried individuals:(2) A qualifying individual is a parson whose principal place of abode is in

the same household as the taxpayer

e) Calculat ion of Part ia l Exclusion(1) Partial Exclusion = Full Exclusion * ([Months test met]/24)(2) Months Test Met

(a) Use the Lesser of:i) Ownership/Use of Propertyii) Last time Exclusion was Used

3. Non-Qualifying Usea) USE not m et?b) Gain attr ibuted to non -qual ify ing us e is included in incomec) Non-Quali fy ing Use: Any t im e the property was not u sed as a

principal residence for the taxpayer (meaning owned, but n ot used)(1) Exception: If non-qualifying use was due to change of employment,

health conditions, or unforeseen circumstances, the non-use isqualifying

d) Amo unt Exc luded(1) The amount of time that is attributed to the non-qualifying use will be

included(a) Determin e Days of Quali fy ing Use(b) Determin e Days of Non Quali fy ing Use(c) Time = [Days o f NonQuali fy ing Use]/([Days o f Quali fy ing Use]+[Days


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of NonQuali fy ing Use])

(2) Reduce gain by the time of non-qualifying use

E. Other Cons iderat ion s1. Sale of Vacant Land (1.121-1(b)(3))

a) General ly , sale of vacant land is no t a sale or exchang e of pr inc ipal

residenc e UNLESS:b) Vacant land is adjacent to land containing dwel l ingc) Taxpayer ow ned and u sed the vacant land as part o f taxpayer 's

pr inc ipal residence

d) Taxpayer sel ls or exchanges the dwel ling u ni t in a sale or exchangewithin 2 years (before or after) the sale of the vacant land

e) Requirements above for Qual i fy ing Principal Residence are met2. Married Taxpayers

a) Requirem ents fo r QUAL IFIED PRINCIPAL RESIDENCE(1) Ownership: EITHER spouse may meet the ownership requirement of the

property(2) Use: BOTH spouses must meet the use requirements(3) Frequency: Exclusion must not have been used by either spouse within

past 2 yearsb) Unused Exc lus ion

(1) One spouse may not use the other spouse's unused exclusionc) When Fi l ing Indiv idual Return

(1) If each spouse meets the requirements individually(2) Then they may exclude the gain up to 250,000

d) When f i l ing Joint Return(1) If both spouses could meet the requirements, then they may exclude up

to 500,000 of gain.(2) When one spouse does not meet the requirement(3) Each spouse may exclude as if they are filing an individual return

(a) Full + Full(b) Full + None(c) Full + Partial(d) None + None

VI. Discharge of IndebtednessA. 61(a)(12): Incom e from Discharge o f Indeb tedness is includ ed in

Gross Incom e1. Exception (108): Amount that is discharged is Not included in gross

income if discharge is due to bankruptcy or the taxpayer is insolvent.a) Amo unt discharged in insolvency

(1) Rule:(a) Amount disc harged in insolvency sh all not exceed the amo unt bywhic h the taxpayer is insolvent.

(2) Senate Report:(a) I f taxpayer is ins olvent before and after cancel lat ion of debt: All

cancel lat ion is excluded

(b) I f the discharge of the debt makes the taxpayer solv ent: Exclusion tothe extent of insolv ency.

(3) Amount of Insolvency:


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(a) Amount Liabi l i t ies Exceed Ass ets prior to disch arge of debt.

B. Other Cons iderat ion s1. 108(e)(4): Acquisition of Indebtedness by Someone Related to Debtor,

The acquisition shall be treated as an acquisition by the debtora) Related:

(1) Spouse(2) Children/Spouse of Children(3) Grandchildren/Spouse of Grandchild(4) Parents

b) Debtor owes money to Credi torc) Debtor 's relat ive acquires the indebtedness and they are now l iable to

Credi tor. When debtor acquried the indebtedness i t was less than

face v alue.

d) I.e. Treated as Debtor acqu ir ing own debt for less than face value(1) Debtor will receive Cancellation of indebtedness income for the

difference2. Compensation v. Gift

a) Gif t Rules apply for disch arge of indebtednessb) Is the disch arge based on a detached o r dis interested generosi ty?c) Is the discharge comp ensat ion to the indiv idual?

3. Negotiationa) Dispute over the amount du e may be viewed as negot iation for the

price of serv ices

4. Satisfaction of Debta) If pro perty is being transferred for sat is fact ion o f debt, i t is not a

discharge of ind ebtedness.(1) It is as if the property was sold to the creditor, and the debtor used the

proceeds of the sale to pay off the debt.

b) If debt is being disc harged in as compensat ion for p ayment ofserv ices(1) It is as if the debtor is using the compensation to pay off the debt

C. Appro aching Discharge of Indebtedness Quest ion:1. Has the Debt been discharged?2. Is it Discharge of Indebtedness income?

a) NO:(1) Satisfaction of Debt(2) Negotiation(3) Disputed Debt(4) Discharge is a Gift

b) Yes:(1) Included in Income under Section 61(a):(a) Regular Discharge for no Considerat ion(b) Discharge amount do es not exceed value of property given in

satisfact ion of debt

(c) Debt acquired by som eone related to debtor(2) Can this debt be excluded by Section 108?

3. Excluded by 108?a) Discharge in Bankruptcy?


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b) Is Taxpayer Inso lvent?

VII. Life Insurance and AnnuitiesA. Li fe Insurance: Sect ion 101

1. Section 61(a): gross income includes all income from whatever sourcederived

2. However, under Section 101(a): Proceeds received by reason of thedeath of insured are excluded from gross incomea) Sectio n 101(a):

(1) Gross income does not include amounts received under a life insurancecontract, if such amounts are paid by reason of the death of the insured

b) Inc lud es Death Benef i t Payments(1) Payments having the characteristics of life insurance proceeds payable

by reason of death under contract(2) ex. Workmen's compensation(3) Ex. Endowman contracts(4) Ex. Accident and Health Insurance Contracts

c) Payments to Estate or B enef ic iary(1) Exclusion applies regardless of whether the payment is made to the

estate of the insured or any beneficiary(2) Exclusion applies whether payment is paid directly or in trust

d) Lump Sum or Ser ies of Payments(1) Amounts paid by reason of death are excluded(2) Series of Payments: Interest payments are included in gross income

3. Considerations:a) Employ er Owned Li fe Insurance Contract

(1) Proceeds will be subject to tax from the payout of the policy(2) UNLESS insured is:

(a) Director

(b) Highly compensated emp loyee(c) was an employ ee within 1 year of deathb) Payments received by some other reason than death

(1) If proceeds are being reason by reason of a debt or some othercircumstance, the proceeds are not excluded by section 101

(2) Ex. Payments being paid from Mortgagee to Mortgagor(a) Rev. Rul. 52-71: likely the proc eeds are being paid ou t by reason of

debt and not exclu ded by section 101

c) Transfers for Valuable Con sideration (101(a)(2))(1) Basically, Transferring the right to receive proceeds for $$

(a) i .e. sel ling y our rig ht to receive proceeds(2) Person who receives the proceeds can only exclude:

(a) amoun t paid to receive the right(b) Plus value of premiums p aid to retain the right(c) and any other amoun ts(d) Any excess wil l be incom e to the transferee

B. Annui t ies: Sect ion 721. Section 72(a): Gross includes any amount received as an annuity

a) However, the amount received equal to the investment in the annui tyis excluded from th e annui ty


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2. Amount Excludeda) Calculat ionb) Amoun t Received as an annu i ty * ([ Investment in the

contract ] / [Expected Return])

c) Amoun t Received as an Ann ui ty (the payment to the taxpayer)

d) Investm ent in the con tract (amou nt taxpayer paid to receive annui ty)e) Expected Return (ful l amou nt received ov er period annui ty is paidout)(1) Expected Return over Lifetime:

(a) Amount Received as an Annuity * Life Expectancy Mult ip l ier(b) Life Expect ancy Mu ltipli er is determi ned by Treas. Reg. 1.72-9

i) Tables I, II, IIA, III, and IV are to be used if the investment in the contractdoes not include a post-June 1986 investment in the contract

ii) Tables V, VI, VIA, VII, and VIII are to be used if the investment in thecontract includes a post-June 1986 investment in the contract

iii) Table V: Ordinary Life Annuity for One Life

f) ROUND ANSWERS TO THE NEAREST TENTH

VIII. Compensation for Personal Injury and SicknessA. Sect ion 61(a): Gross inc om e inclu des income from w hateversou rce derived.

B. However, under sect io n 104(a) Compensat ion for Personal Injuryand Sickness:1. Exclusion from Gross Income are amounts which 104:

a) Amo unts received u nder Workman's Compensation as compensat ionfor personal injury or sickness

b) Amoun t of damages received on account of person al phys ical injur iesor phys ical sickness

c) 104(a)(3): Amo un ts received throu gh ins uranc e (accid ent/health) forpersonal injur ies or sickness(1) WHICH, your employer did NOT finance (I.e. paying premiums to insurer,

etc.)(a) Section 105(a): amo unts received attr ibutable to con tr ibut ion s by

employ er are included in gross incom e.i) Ex. Sick Pay, etc.

(b) EXCEPT 105(b): Amo unts paid to reimburse th e taxpayer forexpenses incurred by him for m edical care are excluded from gr oss

incomei) EXCEPTION TO EXCEPTION: If the taxpayer deducted the expenses

incurred by him, and then was reimbursed, The reimbursement isINCLUDED in gross income (see below)

(2) 104(a)(3) only applies to insurance that you paid for, and excludespayments of proceeds from that.

2. Damagesa) Damages has to b e Person al Damagesb) Has to be received on accoun t of physical injury or phys ical sickness

(1) The payment must bear a close personal nexus to the personal injury3. Raytheon Products IN LIEU OF test

a) Test to see wh at payments are being made in l ieu of


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(1) If payments are made in lieu of physical injury or personal sickness, thenexcluded

(2) If payment are made in lieu of wages or is a forced sale, included ingross income(a) EXCEPTION: Payment of wages wh ich flow out of personal physic al

in jury or physic al sickness

i) If payment of wages are tied to a personal physical injury or physicalsickness, the wages are excluded from gross income

C. Other Cons idersat ions1. Payments Included In Gross Income

a) Puni t ive Damages(1) 104(a)(2): Damages paid as punitive damages are included in gross

income.b) Forced Sale

(1) Amounts paid from destruction of property usually is not payment forpersonal injury or sickness

(2) This results in a forced sale which is a disposition of property.(3) Gain is taxed

2. Pain and Sufferinga) Payments made for pain and suffer ing on accoun t of physical injury

or phys ical sickness are excludable from g ross income

3. Emotional Distressa) Medical Expenses aris ing from emotional distress

(1) Recovery for medical expenses arising from emotional distress isexcludable even if the underlying physical injury or physical sickness

b) 104(a)(2) Other Damages aris ing from emotion al distress(1) Included in gross income if underlying claim is pure emotional distress.

Even if the emotional distress results in tangible physical symptoms(2) Excludedin gross income if underlying claim is physical injury or

sickness and Emotional Distress arises from the physical injury orsickness

(3) Examine the Facts!(a) Has there been a physical injury/s ickness which g ave rise to the

Emotio nal distress?

(b) Or did the emotional distress cause physical symp toms?4. Reimbursed Medical Expenses

a) Sect ion 213 permits a deduct ion for u nreimbu rsed medical expensesb) Sect ion 105(b) excludes amounts paid to the taxpayer to reimb urse

the taxpayer for expenses incurred by him fo r the medical care of the

taxpayer(1) EXCEPT (104(a)): If the taxpayer had taken a deduction for those

expenses that were 'unreimbursed'(a) Payments received for expenses that were previously deducted is

INCLUDED in gro ss income

(b) I .e. You canno t exclude from incom e what you have alreadydeducted.

5. Future Medical Expenses (1.105-2)a) Payments for futu re medical expenses are excludable in gross

income


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6. Allocations of Settlementsa) Al locat ions must have credible reasons sup port ing the transact ionsb) IRS wi l l want to examine whether the al locat ion is fai r under an arm s

length transact ion.

7. Loss of Consortium

a) Amoun ts received by an indiv idual on accoun t of a claim for loss ofconsor t ium due to the phys ica l in jury or phys ica l s ickness of suchindiv idual 's spou se are excludable from g ross income.

b) Does not apply to puni t ive damages

IX. Fringe BenefitsA. Generally Sect ion 61(a) requires inclu sion in gro ss inc ome for

fr inge benef i ts

B. However, Certain Fringe Benef i ts which are Excluded from GrossIncome:1. MEALS and LODGING Provided by EMLOYER

a) Sect ion 119: Meals or Lod ging Furn ished for the co nvenience for theemployer(1) Section 119(a): Meals/Lodging furnished to taxpayer, taxpayer's spouse,

or dependents are excluded from income if provided for the convenienceof the employer

(2) Lodging (1.119-1): 3 requirements(a) Lodg ing mu st be furnished on the business premises of the

employeri) Means Place of employment of the employeeii) Does not have to be the actual physical place of employment; can be

anywhere that the employee is required to conduct business for theemployer

(b) Lodg ing is furnis hed for the convenience of the emplo yeri) Fact dependent inquiry on whether provided for the convenience of

employer and not convenience of taxpayerii) Benaglia: taxpayer did not have dominion or control over the receipt of

the benefit

(c) Emplo yee is required to accept such lod ging as a condit ion ofemploymenti) Employee is required to accept in order to enable him to properly

perform the duties of his employment

(3) Meals (1.119-1): 2 requirements(a) Only If, Meals are furnished on th e business prem ises of the

employeri) Means Place of employment of the employeeii) Does not have to be the actual physical place of employment; can be

anywhere that the employee is required to conduct business for theemployer

(b) Meals are furnished for th e convenience of employeri) Fact dependent inquiry on whether provided for the convenience of

employer and not convenience of taxpayerii) Benaglia: taxpayer did not have dominion or control over the receipt of

the benefit

2. Fringe Benefits Provided by EMPLOYERa) Section 132(a): No-Addit ion al-Cost Service


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(1) Any service provided by an employee to use if:(a) Service

i) is offered for sale to customersii) in the ordinary course of businessiii) in the line of business of which the employee is performing services

(b) AND emp loyer incurs no sub stantial addit ional cost of providing

such s ervice to emp loyeeb) Section 132(a): Quali f ied Emp loyee Discount

(1) Any employee discount with respect to qualified property or services tothe extent such discount does not exceed:(a) Services: discount m ay not exceed 20% of the price at which the

service is being offered by employer to custom ers

(b) Property: discou nt may not exceed gross profi t percentage at whichthe property is being offered by the employer to customersi) Gross Profit Percentage:

a. (Aggregate Sales Price - Aggregate Cost of Property toEmplo yer)/(Aggregate Sale Price) * 100

ii) Compare discount against the gross profit percentagea. May not exceed gross prof i t percentageb. I f i t does, amou nt exceeding gross p rof i t percentage is incom e to

Employee

(2) Qualified Property or service:(a) is Offered for sale to custom ers(b) in the ordinary course of business(c) in whic h the emplo yee is performin g services

c) Sect ion 132(a): Working Condi t ion Fringe(1) Any property/service provided to an employee that would be deductible

by the employer (as an O/N expense)(2) Employee:

(a) Indiv idual must be currently employ ed by the employ er(b) OR Any partner who perform s services for the partnership

(c) OR Any director of the emp loyer(d) OR Any independent contractor wh o performs services for the

employer

(3) Use primarily for personal(a) Not excludable und er 132, includ ed in taxpayer's incom e(b) HOWEVER, if use is a mix b etween bu siness and p ersonal

i) Use for business purpose would justify an exclusion of the value of theworking condition fringe

d) ALL Sect ion 132 Uses by Fami ly o f Taxpayer(1) Any use of 132 benefit by spouse or dependent child (Child younger than

25) is treated as use by the employee(a) Also Includ es domestic partners/same sex marrieds

(2) Any use which does not qualify (such as an adult child): the value of thebenefit is included in the employee's income(a) Amount Includ ed: Measure of inc ome is the fair market value of the

fr inge benefi t less any excludable port io n of the fr ing e benefi t and

any amount paid by recipient

(3) Special rule: Parents in the case of air transportation benefit fromchildren. Excluded from income.

3. Fringe Benefits Provided by THIRD PARTY


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a) Gotcher: Fringe/Expenses paid primari ly for payor 's own bu sinessbenefi t

b) Sect ion 132 only appl ies i f there is an employee-emp loyerrelat ionship

c) Abs ent, an employer-emp loyee relat ionship, examine the dom inant

purp ose of the benef i td) Value of any BENEFIT that is paid b y the abusin essman/company/person primari ly for his own (the

busin essman's/company's/person 's) benef i t shou ld be excluded from

gross income

X. Business DeductionsA. Personal Expenses

1. No deductions allowed for personal expenses, living expenses, or familyexpenses

B. Items Deduct ible: Categor ies1. Section 162: Trade or Business Expenses

2. Section 162: Reasonable allowance of salaries3. Section 212: Profit Seeking Expenses4. Section 195 Election: Start Up Expenses

C. Items Deduct ib le: Sect ion 162: Business Deduc t ions1. Deduction allowed for: ordinary and necessary expense paid or incurred

during the taxable year in carrying on any trade or businessa) Ordinary

(1) Expense that one would expect to find if you were conducting businessin this industry(a) Does not have to be one that is recurring

(2) Factual Determination

(a) IRS defers to the busin ess wh ether an expense is ord inaryb) AND Necessary

(1) Appropriate and Helpful(2) Factual determination

(a) IRS defers to th e business judgment w hether an expense isappropriate and helpful

c) expense paid or incur red during taxable yeard) in the carry ing on o f a trade or bus iness

(1) Factual Determination(2) Taxpayer must be involved in the activity with:

(a) Continuin g Regulari ty(b) AND Taxpayer primary purp ose for engaging in the activ i ty mus t be

for income or prof i t(3) Not a Trade or Business

(a) Sporadic activ i ty, hobby, or an amus ement.2. Examples/Cases:

a) Ordinary/Necessary Expense(1) Twitty Burger: Amounts paid to protect business reputation was

ordinary and necessary(2) Palo Alto Town: Plane on standby was O/N because it was a expense one


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would normally expect in taxpayers trade or business(3) Topping: Unique nature of taxpayer's business design may make it an

ordinary and necessary expenseb) Not Ord inary/Necessary Expense

(1) Helvering: Expense which is not customary in the industry is notordinary and necessary. Expense which bears no relation between the

expenditure and the business is not ordinary and necessary.(2) Henry: Expense was not necessary to conduct profession. Was deriving

primarily a personal benefit from the yacht

D. Items Deduct ible: Sect ion 162 Salar ies1. A reasonable salary or other compensation for personal services

actually rendered is an ordinary and necessary expense2. Reasonable:

a) Whether a l ike amoun t wo uld be paid to a l ike employee in a l ikeindust ry

b) Fact d ependent invest igat ion3. Payments by Corporations (1.162-8)

a) Amoun t payment that is reasonable is deduct ible salary(reasonableness analysis is same as abo ve)

b) Amoun t deemed excessive is treated as a div idend to taxpayer andnot d educt ib le by corporat ion

4. Excessive Salariesa) No dedu ct ion fo r remu nerat ion for amoun t wh ich exceeds $1,000,000.

E. Items Deduc t ible: Sect ion 212: Produ ct ion or Col lect ion ofIncome1. Allows a Deduction for expenses incurred in the production or collection

of income2. For Expenses:

a) for the product ion or col lec t ion of income;b) for the management, conservat ion, or maintenance of property held

for the product ion of income; or

c) in con nect ion w ith the determinat ion, col lect ion, or refund o f any tax.3. NO deduction allowed for expenditures that do not generate taxable

income (Section 265)

F. Items Dedu ct ible Elect ion : Sect ion 195 Start Up Expenses1. Rule:

a) Expenses incurred du ring invest igatory stage of a business are notdedu ctib le under sectio n 162 (a)

b) Sect ion 195(a): There is no deduct ion for start -up expendi tures2. However, under 195(b): Taxpayer may elect to deduct start up expenses

for entering into a new trade or businessa) expenses incurred:

(1) Investigating the creation or acquisition of an active trade or business(2) OR Creating an active trade or business(3) OR any activity engaged in for profit and for the production of income

before the day on which the active trade or business begins, inanticipation of such activity becoming an active trade or business


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b) Which w ould b e normal ly deduct ible i f i t was an O/N expensec) Deduct ible when:

(1) The first month the trade or business begins(2) Remaining Amortized over 180 months.

3. Expenses that may be deducted:a) < 5k; Deduct ion in Ful l this yearb) 5k< X < 55k; Deduc tion o f 5k this year, Remaining am ortized over 180

months

c) >55k; Deduc t ion no t allowed

G. Other Cons iderat ion s1. Job Seeking Expenses

a) Employees(1) An employee can have more than one trade or business

b) Travel reimb ursements(1) for searching for a job is not gross income. It is reimbursing for the

convenience of the employer (Gotcher)c) Deduct ion al lowed for job seeking expenses

(1) only if employee is looking for a job in the same trade or business asbefore(a) Compare the posit ion w hich th e taxpayer occupied before and after

the change of employm enti) Core Functions have to be the same as before and afterii) job duties do not have to be identical

(2) Hiatus/Unemployed Taxpayer(a) I f a TP is unemployed h e can be "carrying on" if he establ ishes that

durin g the hiatus he intended to resum e the same trade or busin ess.

d) Travel Expenses not reimbu rsed(1) Expenses To and From:

(a) Deductible only if the tr ip is p rimari ly related to seeking new

employment(2) Time spent on a personal activity is important in determining whether

the trip is personal within the regulation(3) If not primarily related to seeking new employment:

(a) Expenses at destination prop erly al locable to seeking n ewemploym ent are deductible

(b) While, Expenses To and From are not

XI. Capital ExpendituresA. Sect ion 263: No Deduct io n for Capi tal Expendi tures

1. RULEa) Sect ion 263(a) No dedu ct ion for:

(1) Any amount paid out for new buildings or for permanent improvementsor betterments made to increase the value of any property or estate

(2) Any amount expended in restoring property or in making good theexhaustion thereof for which an allowance is or has been made.

b) INDOPCO Signif ican t Future Ben efi t Test:(1) No deduction for an expenditure which provides a future benefit

extending beyond the taxable year2. (1.263(a)-1(b))GENERALLY, a Capital Expenditure is:


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a) Expendi ture which :(1) Adds Value(2) OR Substantially prolongs the useful life of asset(3) OR adapts asset to a new and different use

b) Does not apply to:(1) Incidental repairs and maintenance

B. Considerat ions:1. Repairs (Rev. Rul. 2001-4)

a) Deduct ible Repairs:(1) Repairs for keeping property in efficient operating condition(2) Restores the property and does not make it more valuable is a

deductible repair(3) Replacement for relatively minor parts of the asset and does not change

useful lifeb) Capital Expend iture Repair:

(1) Alterations, improvements, additions that prolong the life of property(2) More permanent increment in the longevity, utility, or worth of property

c) General Plan of Rehabi l i tat ion(1) Separate expenditures could be deductible, but a overall rehabilitation ofa building could add value and increase the useful life of the property.

(2) Examine:(a) Whether expenditures benefi t each other(b) Reason fo r doing expenditures at the same time(c) Are expenditures beyond incidental repairs and maintenance?(d) Do expenditures add value or sub stantial ly prolong th e useful l i fe of

the property?

2. Incidental Materials and Supplies (1.162-3 Cost of Materials)a) Taxpayer may deduct on ly what sup pl ies are used to produ ce income

for the year

b) However, if no record o f supp l ies is kept(1) Deduction for the total cost of supplies is allowed provided taxable

income is clearly reflected by this method.3. Advertising

a) Adv ert is ing is a deduct ible expenseb) Even i f taxpayer may d erive a benef it into future tax years, i t is

non etheless deduct ible

4. Expanding existing trade/businessa) Expenses incurred to expand exist ing trade or bu siness are

deduct ible(1) Ability to look into a new market is not a significant future benefit

(2) However, if the existing trade or business is expanded, the expenditureprovides a significant future benefit, and must be capitalized(1.263(a)-5(a))

5. 12 Month Rule (Freightways and 1.263(a)-4(f)):a) An exp ense may cros s 2 tax years, a deduct ion is al lowed in the

current year.(1) As long as the full benefit within 12 months is realized of paying the

amount, then you may make a deductionb) Expense may n ot extend into a thi rd taxable year


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(1) The amount must be capitalized over the life of the benefit(2) Ex. if the expense is prepaid in a year 1, but benefit begins in 2nd year

and ends in year 3: not deductible; spread deduction over 3 years

XII. DepreciationA. Sect ion 167: Depreciation Deduct ion

1. Depreciation deduction allowed for exhaustion, wear and tear, andobsolescence of property AND property used in a trade or business/heldfor the production of income

2. Deduction if:a) Property is sub ject to exhaust ion, wear and tear, or ob solecense?b) AND Used in a trade or bus iness? or held for the produ ct ion of

income?

3. See Section 168 on how much deduction you can take

B. Sect ion 168: Mechanics of Depreciat ion1. Calculate Basis:

a) Sect ion 167(c): B asis on wh ich exhaus t ion, wear, and tear, and

obso lescence are to be al lowed in respect of any prop erty shal l be theadjusted basis prov ided in sect ion 1011, for the purpo se of

determining the gain on the sale or other dispo si t ion of such p roperty

2. State Property's Classificationa) X-Year Property (wi l l be given by professor)

3. State Depreciation Methoda) Tangible Property

(1) Double Declining Balance Methodb) Resident ial Real Property u sed in a Trade or Bus iness

(1) Straight Linec) Comm ercial Real Property used in a Trade or Busin ess

(1) Straight Line4. State Conventiona) Tangible Prop erty: Hal f Year Con vent ion

(1) Property is treated as placed in service in the middle of the year(2) Property sold before all depreciation taken will get 1/2 of depreciation in

the year sold.b) Ant i -Abus e for Tangible Property: Mid -Quarter

(1) IF, more than 40% of the property for the year placed in service in the lastquarter.

(2) Treated as placed in service in middle of the quarter(3) All property placed into service for entire year will be depreciated by the

mid-quarter.

c) Real Property: Mid Month Conv ent ion5. Depreciate Property

a) FIRST: SECTION 179 Electio n(1) Rule:

(a) Taxpayer may elect to treat the co st of any section 179 prop erty as anexpense which is not chargeable to capital accoun t.

(b) Cost m ay be deducted in the taxable year in w hich th e 179 property isplaced in service


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(2) Section 179 Property:(a) Tangible property(b) whic h is Section 1245 property(c) acquired by pur chase for use in the active conduc t of a trade or

bus iness

(3) Deduction:

(a) Dedu ct $500,000(b) Amount of Deduction decreases for every dollar above $2 mil l ion

(4) Adjust Basis:(a) Section 1016(a): Property adjus tment in respect of th e property shal l

in al l cases be m ade for exhaustion, w ear and t ear, obsolescence,

amort izat ion, and deplet ion

b) SECOND: SECTION 168(k) AL LOWANCE(1) Rule:

(a) for Quali f ied Property wh ich such property placed in service shallinclud e an allowance equal to 50 percent of the adjusted b asis of the

quali f ied property

(2) Qualified Property:

(a) Property wh ich has a recovery period of less th an 20 years(3) Adjust Basis:

(a) Section 1016(a): Property adjustment in respect of the property shallin all cases be made for exhaustion, wear and tear, obsolescence,amortization, and depletion

c) THIRD: DEPRECIATE PROPERTY USING Rev. Proc. 87-57(1) Tables found on page 341(2) Adjust Basis

(a) Section 1016(a): Property adjus tment in respect of th e property shal lin al l cases be m ade for exhaustion, w ear and t ear, obsolescence,

amort izat ion, and deplet ion

C. Other Cons iderat ion s1. Land (not real property)

a) Does no t depreciateb) Land do es not decl ine in value

2. Collectibles/Antiques used in Trade or Business (Simon)a) Value as a col lectible is irrelevantb) If prop erty is subject to exhaust ion , wear and tear AND used in

conn ect ion with trade or bu siness, it is deduct ible

3. Converting Property from Personal use to Business Usea) An o ffer to sel l or rent is suff ic ient to prove that property be used in

conn ect ion with a trade or bus iness(1) Basis of property for depreciation: FMV at the time the property was

converted to non-personal use. (Treas. Reg. 1.167(g)-1)

XIII. Losses and Bad DebtsA. Los ses: Sect ion 165

1. Rule:a) 165(a) Al lows a deduct ion on any loss su stained during the taxable

year wh ich is no t compensated for by insurance or otherwise

b) 165(b) Deduct ion fo r Los ses l imi ted to:


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(1) Losses incurred in a trade or business(2) Losses incurred in any transaction entered into for profit, even if not

connected with trade or business(3) No personal losses except for fire, storm, shipwreck, other casualty, and

theft(a) 165(e): Theft los s may be taken in the taxable year in whic h th e

taxpayer discov ers such lossc) 165(f) Losses from Capi tal Assets o nly al lowed i f they m eet the

requirements o f Sect ion 165

2. Identifying a loss:a) First : Is the loss a Bo na Fide Loss?

(1) This means that is the loss an actual loss and not a transaction betweenrelated parties

b) Second: Has th ere been a real izat ion of lo ss?(1) Section 1001(a) Computation of loss is the excess of adjusted basis of

property over amount realized.(2) Loss may be realized from a Sale or Exchange.

(a) Sale of capital assets or 1231 pro perty requ ire a sale or exch ange inorder to realize a loss

(3) Disposition?(a) Sale of non-capital assets o r non -1231 property r equire a disposit io n

in or der to real ize a loss

c) Third: Is the loss recognized?(1) Section 165(b): Losses limited to

(a) Losses inc urred in a trade or busin ess(b) Losses inc urred in any transaction entered into for p rof i t , even if not

conn ected with trade or business

(c) No person al losses except for f ire, storm, shipw reck, other casualty,and theft

(2) Losses from assets held primarily for personal use are disallowed:(a) Person al hous e, vehicle, etc.(b) However, gains wil l be recognized from th is property

d) Fourth: Character of the Loss?(1) Loss from sale or exchange of 1221 Capital Asset or 1231 property?

(a) Section 1001: Deference between adjusted basis and amo unt realized(b) 1221: If the sale or exchange meets the hold ing period longer than

one year, then loss is long term otherwis e short termi) Short term losses may be deducted as a "transaction entered into for

profit" against ordinary income under section 165ii) Long term losses must be netted against long term gains, and treated as

capital under section 1211

(c) 1231: Losses wil l b e netted w ith 1231 gains from the year to

determine treatment of th e lossi) If loss is capital loss, apply section 1211ii) If loss is ordinary loss, may deduct against ordinary income under

section 165.

(2) Loss from disposition of worthless security?(a) Section 165(g)(1): Loss from a worthless securi ty sh al l be treated as

a loss from the sale or exchange. Use Section 1001 to calculate loss

rule.

3. Considerations:


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a) Transact ion Entered into for Prof i t(1) LOSS: Cowles: Offers to sell or rent are insufficient to prove that

property was used in a transaction entered into for profit; thus no LOSSALLOWED

(2) DEPRECIATION: HOWEVER, offer to sell or rent is sufficient to provethat depreciation deductions are allowed

(a) Basis of p roperty for d epreciation: FMV at the time the property wascon verted t o n on-perso nal u se. (Treas. Reg. 1.167(g)-1)

b) Property Converted from perso nal use to Business Use and SOLD(1) General ly: Basis o f pro perty for d epreciat ion: FMV at the time the

pro perty w as con verted to n on -person al use. (Treas. Reg. 1.167(g)-1)

(2) The Basis of When the pro perty is sold for determining GAIN OR LOSSDepends on how much the Property is Sold For:(a) CALCULATE:

i) Acquisition Basis - Depreciation Takenii) FMV Of Property - Depreciation Takeniii) COMPARE AGAINST AMOUNT REALIZED

(b) GAIN: Amo unt Realized > (Acq uisit ion Basis - Depreciat ion Taken)

i) Gain = Amount Realized - Acquisition Basis - Depreciation Taken(c) WASH: (Acquis it ion B asis - Depreciat ion Taken) > Amount Realized

>(FMV of Pro perty - Depreciatio n Taken)i) No Gain or Loss Recognized

(d) LOSS: Am ount Realized < (FMV of Prop erty - Depreciatio n Taken)i) Loss = FMV of Property - Depreciation Taken - Amount Realizedii) Deduction Allowed, provided 165(b) is met.

c) Always Consider:(1) Depreciation Allowed on Transaction?(2) Separate from Loss Allowed on Transaction?

B. Bad Debts : Sect ion 1661. Rule:

a) 166(a): Al lows a deduct ion for d ebts becom ing worthless or p art ial lywo rthless wi thin th e taxable year

2. Deduction:a) No deduct ion al lowed for Non-Business debts

(1) Non-Business Debt:(a) Any d ebt that is not a business debt(b) Is a ques tion o f fact in every case.

(2) Treatment/Character:(a) Not d eductible,(b) 1.166-5(a) allow s the los s to be a long t erm capit al loss.

b) Deduct ion al lowed for Business Debts(1) Business Debt:

(a) Debt created or acquired in connection w ith a trade or bus iness ofthe taxpayer

(b) OR debt which is w orthless which is incu rred in the taxpayer's tradeor bus iness

(2) Treatment/Character(a) Loss is Ordinary(b) Deductible against ordinary incom e

3. Identifying a Business Bad Debt


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a) First : Is the d ebt a Bona Fide debt?(1) There must be a debtor-creditor relationship based on a valid,

enforceable obligation to pay fixed or determinable sum of money(2) A gift is not a debt

(a) Service wil l careful ly scru t inize a family or related-party advances todetermine wh ether a bona fide debt was created

(3) Examine all Facts and Circumstances:(a) Whether there was a schedule to make payments(b) Whether there was interest due(c) Whether payments were maid/possible(d) Type of Note(e) Collateral

(4) Considerations:(a) Generes: Loan to p reserve your busin ess of being an emplo yee

i) If you are making a loan to preserve your business of being employee,then it is a business bad debt

ii) Have to examine the dominant motivating factor for making the debt

b) Second: Is the Debt worthless or p art ial ly worthless?

(1) Is the debt not collectible?(2) Examine all pertinent evidence including:

(a) Value of collateral, if any, securin g the debt and the financ ialcondi t ion of the d ebtor

(b) Legal action not required to show evidence of worthlessnessc) Third: Deduct ion

(1) Only applies to an Accrual Method Taxpayer(a) Only get a deduction for bad debt if the debt was included in income(b) A cash method taxpayer wou ld not include the debt in income.(c) Debt's adjusted basis

4. Identifying a NON-Business Bad Debta) Loss f rom non-bus iness bad debt is not d educt ib le under sect ion

166(a)b) While not deduc t ible, loss w i l l be a long term capi tal loss

(1) Loss resulting from a non-business bad debt becoming WHOLLYworthless will be treated as a loss from a sale or exchange of a capitalasset held longer than one year

XIV. Interest DeductionA. Section 163:

1. 163(a): Allowed as a deduction of all interest paid or accrued within thetaxable year on indebtednessa) Interest : amo unt one has con tracted to pay for the use of borrow ed

money

2. EXCEPT: However under, Section 163h No deduction for personalinterest paid or accrued during the taxable yeara) EXCEPTION to EXCEPTION: Deduc tion s al lowed fo r:

(1) Personal interest paid allocable to a trade or business(2) Investment Interest(3) Qualified Residence Interest

B. Quali f ied Residenc e Interest1. Acquisition Indebtedness


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a) Incu rred in acqu ir ing, cons truct ing, or substant ial ly imp roving anyqual i f ied residence of the taxpayer and secured by su ch residence

b) Also includ es indebtedness secured by such residence fromref inancing(1) Refinancing:

(a) Amou nts us ed to remodel hom e: Acquis i t ion Indebtedness(b) Amounts us ed otherwise: Home Equity Indebtedness

c) Quali f ied Residenc e:(1) Principal Residence within the meaning of section 121 (sale of principal

residence exclusion)(2) And ONE other residence selected by the taxpayer

d) Limi ted to A cquis i t ion Indebtedness of 1 Mi l l ion Dol lars2. Home Equity Indebtedness

a) ANY indebtedness, other than acquis i t ion in debtedness, secured by aqual i f ied residenc e.

b) Agg regate amount o f indebtedness m ay not exceed EQUITY in theproperty:

(1) [FMV of Residence] - [Amount of Acquisition Indebtedness]c) Deduct ion Limi ted to Home Equi ty Indebtedness o f 100,000 Dol lars

3. Points:a) True Interest Poin t

(1) If payment of points are for interest pre-payment up front, then pointsare deductible

b) Points as Fee:(1) Point could be a up front fee that you pay to get the loan and is not

deductible4. Maximum Limit of $ 1.1 Million

a) Revenue Ru ling 2010-25:(1) Indebtedness incurred by a taxpayer to acquire, construct, or

substantially improve a qualified residence can constitute home equityindebtedness to the extent it exceeds $1 million.

5. Qualified Residence Interest Question:a) Loo k for a Mortgage on a residenceb) Determin e if Quali f ied Princ ipal Residence:

(1) Is residence a principal residence or second home?c) Determin e i f Acq uis i t ion Indebtedness or Home Equi ty Indebtedness

(1) How much other indebtedness does the taxpayer have?(2) Is the indebtedness subject to limitation?

XV. Loss Limitations Between Related PartiesA. Sect ion 267(a): No loss shal l be al lowed b etween related part ies

1. Loss is Disallowed here2. Gain is allowed for sales between related parties

B. Section 267(b): Related Part ies1. Members of A Family

a) Broth ers and Sisters (who le or hal f -blood )b) Spousesc) Lineal Ancestors


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d) Lineal Descendantse) DOES NOT INCLUDE

(1) Cousins(2) Aunts/Uncles(3) Spouses of Lineal Ancestors/Spouses of Lineal Descendants

2. 2 S Corporations (S Corp. A sells to S Corp. B)a) The S Corpo rat ions are Related i f the same person own s more than

50% in value of the outstanding stock of the each co rporat ion

3. 2 Corporations (Corp. A sells to Corp. B)a) The Corporat ions are Related i f same person owns m ore than 50% in

value of o uts tanding stock of the corporat ion

4. 2 Partnerships (Pship A sells to Pship B)a) The Partnership s are Related if mo re than 50% of the capital interest,

or the pro f i ts interest , in the partnership

5. Trustsa) Trustee and Benef ic iary of SAME tru st are relatedb) Trustee and Beneficiary o f DIFFERENT trus ts are related, if same

person is grantor of both t rus ts

6. Estatesa) Executor and Benef ic iary are relatedb) EXCEPT: when sale or exchange is m ade to sat is fy a Bequest

7. Constructive ownership of stocka) Individ ual Sale to a Corpo ration : Is the Corp a Related Party?

(1) Corporation is related to the Individual when:(a) Corporation m ust be owned by more than 50% in value by indiv idu al(b) OR (c)(4) and (c)(4): Memb er of a Fami ly: Corp oratio n is ow ned by

mo re than 50% of a Member of a familyi) Ownership by one family member is ownership by another

b) Individ ual Sale to a a Partnersh ip: Is the Partnership a Related Party?(1) Partnership is related to the Individual when:(a) Partner owns sh ares owned by a Partnership, if partner has mo re

than 50% of capital interest in partnership

(b) OR Partner ow ns sh ares by another Partner: (c)3: Own ership by onepartner is cons idered owning by partner

(2) EXCEPT: (c)(5): Family member to "Partner who owns shares by anotherPartner" does not have constructive ownership of partnership stock(a) Ex. A is Related to B(b) B and C have a partnership(c) A is deemed to own w hatever B owns(d) But u nder C(5), A is not deemed to own w hatever C own s

i) Even though, under the rules B is deemed to own whatever C ownsC. Considerat ions1. Disallowed Loss v. Part Gift Part Sale

a) Disal lowed Loss :(1) Sale has to be at FMV to Related party(2) Basis to Buyer is Cost of Acquisiton

b) Part Gift-Part Sale(1) If Sale is less than FMV then the transaction is a Part-Gift/Part-Sale


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(2) Basis to Buyer is whichever is greater: FMV or Donee's Basis2. Section 267(d): Sale of Disallowed Loss Property to 3rd Party

a) If a loss is disal lowed u nder 267(a) and the TP sel ls o r oth erwisedispo ses of the pro perty at a gain then su ch g ain shal l be recogn ized

only to th e extent that i t exceeds so m uch o f the loss.

b) 1.267(d)-1(a)(3): the general rule on ly app l ies to t he or igin al transfereewh o acquired the prop erty via sale or exchage(1) If the property, where loss was disallowed, was gifted to a donee; donee

may not use 267(d) to offset the sale3. McWilliams: Sale through Stock Exchange

a) Even throug h sale of stock w ent through a stock exchange, the t imingof transact ions and nature of transact ions made the IRS disal low the

loss u nder 267

4. Miller: NO Family Hardship Exceptiona) Does not matter i f memb ers of a fami ly are estranged; Under 267

rules, if related then loss disal lowed.

D. Answ er Disallowed Los s Quest ion1. Do we have a loss?

a) 1001(c) recongize all gains/lossesb) 1001(a) calculate loss:

(1) Adjusted Basis - Amount Realized = Loss2. Is the Loss allowed?

a) Sect ion 165: Al low able loss(1) Trade/Business Loss(2) Transaction Entered into for Profit(3) Casualty Loss

b) Section 166: Bad Debt?c) Sect ion 267(a): Al lowable loss disal lowed? b/c of:

(1) Sale between Related part ies3. Realize Loss

a) Character ize the Loss :(1) Loss from Business Bad Debt = Ordinary?(2) Loss from Non-Business Bad Debt = Capital Loss(3) Loss from Capital Asset?(4) Loss from 1231 Property?

XVI. Capital Gains and LossesA. Capital Ass ets (sectio n 1221)

1. Property held by taxpayer (typically for investment purposes)2. Does Not Include:

a) Inventoryb) Depreciable Property

3. Capital assets will get capital gain treatment if it is due to:a) Sale or Exch ange

(1) Sale or exchange requirement is a narrow requirement(2) Narrower than Section 1001 (determining gain/loss/AR) from the sale or

disposition of property(3) Factors (Freeland)


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(a) Whether transfer was volun tary or involuntary(b) Whether the mo rtgage debt was released or not, and wh ether the

transferor received any addit ional considerat ion or bo ot

(c) Whether the transferor-mo rtgagor w as personally l iable on themo rtgage debt

(d) Whether the transferor-mortgagor received any tax benefi ts in h is

basis(4) Whether the FMV of the property at the time was less than the principal

b) Sat is f ies Holding Period

B. Holding Per iod1. Short Term

a) Held Less than 1 yearb) Taxed as ordinary incom e

2. Long Terma) Held Long er than 1 year

3. Holding Period Timinga) Begins on Acquis t ion

(1) Stock: Holding Period begins the day after item is purchased (TradeDate)(a) Sett lement date (day it is seen in accoun t) is irrelevant

b) Ends on Dispos i tionc) If Ac quired b y Gif t ,

(1) Holding period is tacked on from the last time the asset was acquiredother than a gift.

C. Net t ing of L ong Capi ta l Gains and Lo sses1. Capital Gains and Capital Losses are netted at the end of the year

a) Net Gains > Net Los ses(1) Go to Section 1(h)

(2) Taxed at preferential capital gains rateb) Net Loss es > Net Gains(1) Go To Section 165(f)(2) Deduct Capital Losses to the extent of capital gains you have

(a) Plus $3,000 against ordin ary income(3) Unused Loss may be carried forward indefinitely, until death of taxpayer

2. REMEMBER: Personal Losses are Disallowed by Section 165!a) Loss es are Limi ted to:

(1) Losses incurred in a trade or business(2) Transactions entered into for profit(3) Casualties

b) IF capi tal loss is not w i thin these categories, loss is disal lowed and

may n ot be netted against capi tal gainsD. Other Cons iderat ion s:

1. Optionsa) Options are propertyb) Opt ion = r ight to buy pro per ty

(1) If the underlying property is a capital asset, then selling the option is acapital asset

(2) If the underlying property is not a capital asset, then selling the option is


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ordinary income2. Change of Character of Property

a) Property ini t ial ly purch ased for investment may no longer be acapi tal asset depending on the facts of how prop erty is treated

b) Ex. (Mauldin) Subdiv iding p roperty and sel l ing i t : I f you are engaged

in the vocat ion/business o f sel ling p roperty then i t is no t a capi talasset.

3. Payment for the Right to Receive Future Incomea) Loo k at what the payment is a subst i tute forb) (Hort) If the payment was a sub st i tute for future ord inary incom e, then

subs t i tute payment is ordinary income

c) (Metro Bui lding ) If the payment was a sub st i tute for future capi tal gainincom e, then subs t i tute payment is capi tal gain income

4. Inherited propertya) Speci f ic Bequests

(1) Usually owned by the estate and given to beneficiary(2) Beneficiary may sell the property and report gain on the property

b) General /Demons trat ive B equests(1) Not owned by the estate(2) Trustee/Executor has to purchase property from money from the estate(3) If Trustee/Executor has to sell property from the estate and uses the

proceeds to satisfy the request; THEN, estate has to report a gain on theproperty sold and pay tax on it

XVII. Quasi-Capital AssetsA. 1231 Prop erty

1. Property:a) Depreciable Propertyb) Used in Trade or Bu sinessc) wh ich is NOT inventoryd) Held longer th an 1 year

2. Netting of 1231 Gain or Lossa) 1231 Gains > 1231 Los ses

(1) Gains and Losses are Capitalb) 1231 Gains < 1231 Los ses

(1) Gains and Losses are Ordinary3. Subject to Lookback Rule

a) 1231 gain w il l be ordin ary to th e extent it does no t exceed thenon-recaptu red 1231 losses for th e last 5 years.

b) Non-recaptu red 1231 loss es

(1) are the sum of net 1231 losses over the past 5 years which are notoffset by subsequent 1231 gains.

(2) 1231 gains which exceed the amount of 1231 losses taken within thepast 5 years will receive preferential tax treatment.

B. 1239 Related Taxpayers1. If property is sold between related taxpayers, gain will be ordinary

(applies both to depreciable property and capital property)2. Related Taxpayer


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a) Corporat ion/Partnership/Ent i ty /Indiv idual own s m ore than 50% of theVALUE of the business(1) Value = not percentage ownership of the business; but FMV ownership

of the business.b) Sale of asset from business to

Corporation/Partnership/Entity/Individual will be ordinary

C. 1245 Recaptu re1. Property

a) Personal Propertyb) Subject to Depreciat ion

2. Rule:a) gains from depreciable personal prop erty due to depreciat ion

deduct ion s taken wi l l resul t in ordin ary income.

b) If that personal pro perty was used in a trade or b usiness, the excessof the gain o ver depreciat ion deduct ion s taken wi l l be su bject to the

1231 gain/loss and loo kback r ules

3. Calculation:a) Calculate recomputed b asis.(1) Recomputed basis is calculated by adding all adjustments reflected in

adjusted basis for deductions allowed for depreciation taken on theproperty. 1245(2)(a).

b) Comp are Against Am oun t Real ized/Adjus ted Basis(1) The lesser of

(a) the Recomputed basis(b) Or amou nt realized

(2) which exceeds the Adjusted basis of the property is treated as ordinaryincome.

D. 1250 Recaptu re

1. Property:a) Real Propertyb) Subject to Depreciat ion

2. Rule:a) Gain from addi t ional depreciation taken over the amount o f

depreciat ion al lowable by straight l ine depreciation is s ubject to

recaptu re u nder 1250.

3. Not an issue for property placed into service after 1986

E. 1250 Unrecaptu red Gain1. Property

a) Real Property

b) Subject to Depreciat ion2. Rule

a) Gain from depreciat ion taken by straight l ine depreciat ion is knownas un recaptu red 1250 gain and is taxed at a p referential rate.

b) Subject to a 25% capital gain tax rate.c) If that real property was used in a trade or business, the excess of the

gain ov er depreciat ion deduct ion s taken w i l l be sub ject to the 1231

gain/ loss and lookb ack rules.

Documents

Tax I Final Outline