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Course: Federal Income Tax Fall 2003
School: Wayne State University
Year: 2003
Professor: unknown
Course Outline provided by Legalnut.com
 

Fundamentals of Federal Income Taxation

 

Income Tax Outline

 

GROSS INCOME - § 61 - income from whatever source derived.

A. § 1.61-1(a) - GI means all income from whatever source derived, unless excluded by law. GI includes income realized in any form, whether in money, property or services.

B. Cesarini v. U.S. - Found $ in piano. Filed return claiming $. Filed claim for refund. See outline

1. Filed action in District Court since tax already paid, claiming refund. Taxpayer argued (p. 43):

a) Not gross income within §61.

b) Statute of limitations question. Piano purchased in 1957, not applicable to 1964 return; SOL tolled.

(1) SOL for return is 3 years from date of filing.

(2) Taxpayer may waive SOL though to avoid immediate assessment.

(3) SOL is 6 years, if greater than 25% of gross income was omitted from.

c) Capital gain treatment.

2. Held: Treasure is treated as Gross Income § 1.61-14

C. Old Colony Trust Co. v. Commissioner - Dude making some serious cash, company decided to pay tax liability for him also. 1918 GI = $978K; Tax liability = $681K. 1919 GI = $548K, Tax liability = $351K.

1. Issue - If company pays tax liability, is this payment of tax liability by the company also income?

2. Held - Yes, it is GI.

D. Commissioner v. Glenshaw Glass - Litigation originated in tax court and then also won in court of appeal without paying any of tax liability. However, when lost at the Supreme Court had to pay interest from date tax due.

1. Issue - If you sue and receive treble damages from a judgment, is that income under §61?

2. Held - Yes, it is GI.

E. Charley v. Commissioner - Travel expenses billed to client at first class rates, however travel agent would book coach tickets and then use frequent flyer miles to upgrade and difference between 1st class and coach was set aside for him to use for other purposes (in a kitty for him to draw).

1. Held - this additional money was income under §61.

2. Rationale - Trading/selling his frequent flyer miles for cash to his company.

F. Frequent flier miles generally - outside of this kitty situation in Charley. IRS treats this as a reduction in purchase price, not as income; even if use for personal use when your company purchases original ticket.

G. Unless you can find an exclusion (except repayment of loan, or return of capital), it is probably GI.

H. Problems (58 - 59)

1. Only becomes an issue if he sells it. Recognition v. Realization. Mere appreciation in value happens all of the time, until you convert it to cash it isn’t income.

2. When you win a raffle it is included as gross income unless you can find a statutory exclusion.

3. Employee realizes the additional $20K of stock as GI as well as the $15K of the car as GI. Realizes additional $35K of GI. GI of property = fair market value of the property. Even though to spouse, indirect payment to the employee.

4. Adjuster gets kickback for referral.

a) Yes, compensation for services is GI.

b) Still included in GI if illegal activities.

5. Rent = $1,000, Services = $3,000

a) GI = $4K rent + improvements §1.61-8

b) Still $4k of GI for lessor.

c) $2,500 reduction in rent, service coming back to lessee, receipt of an economic benefit.

6. Frequent Flyer Miles

a) No, miles part of price of the ticket, nothing to do with business context.

b) Business flights for the employer, since assignable they have value (fair market value)

c) If non-assignable, do they have value? Not GI, can’t do anything with them, must be used for business.

d) No authority on point; however if used for personal trip, likely to be classified as GI, since using for personal benefit unless find a employer/employee exclusion.

Income Without Receipt of Cash or Property - Code §61, Reg §1.61-2(a)(1), -2(d)(2)(.i).

A. Revenue Ruling (Treasury Department’s Litigating Position) 79-24.

1. Situation 1 - Fair market value of the services received by the lawyer and the house-painter are includible in their gross incomes under §61 of the Code.

2. Situation 2 - The fair market value of the work of art and the six months fair rental value of the apartment are includible in the gross incomes of the apartment-owner and the artist under §61 of the Code.

B. Dean v. Commissioner - 80% owned by wife, 20% owned by husband, house transferred in as an asset of the corporation; corp. owns the house. Living in the house is GI since corp. flipping the bill for them staying in the house.

C. Problems (62)

1. Veggy growing vegetables.

a) Harvest does not constitute GI.

b) Consume does not constitute GI.

c) Sales of vegetables = GI.

d) Exchange for tuna = GI.

e) Exchange for providing service = GI. She must pay tax on her proceeds along with the fair market value ($50) of the renting of the space.

2. Doctor/Lawyer swap services.

a) Exchange of services, must pay GI on fair market value of services.

b) Can’t charge yourself for your own services.

EXCLUSION OF GIFTS AND INHERITANCES

A. Rules of Inclusion and Exclusion - Code §102(a) and 1st sentence of 102(b). Reg §1.102-1(a) and (b).

1. Gross Income includes the receipt of any financial benefit which is:

a) Not a mere return of capital, and

b) Not accompanied by a contemporaneously acknowledged obligation to repay, and

c) Not excluded by a specific statutory provision.

2. Inclusions -

a) IRC § 61 - GI

b) IRC § 71 - Alimony, etc.

3. Exclusions -

a) IRC § 102 - Gifts and inheritances.

(1) IRC §102(a) - GI does not include the value of the property acquired by gift, bequest, devise, or inheritance.

(2) IRC §102(b) - Revenue from the value of the gift can’t be excluded.

(3) Commissioner v. Duberstein - Referral fee (Cadillac) was not a gift. Whether the property is regarded as a gift or not is a question of fact, looking basically at the transferor’s “intention.” Quoting Bogardus.

(4) Employee Gifts

(a) IRC §102(.c) - Exclusion of gifts should not apply to “any amount transferred by or for any employer to, or for the benefit of , an employee.”

(b) Exclusions - despite express provision in §102(.c), the following exclusions allow transfers from employers t employees to be excluded from GI.

(i) IRC § 132(e) - certain traditional retirement gifts are excluded as de minimis fringe benefits.

(ii) IRC § 74(.c) - Certain employee achievement awards are excluded from GI.

(c) Problems (76-77)

(i) Argue both ways, depends on facts, circumstances surrounding transfer, etc.; if mother/son gift, no GI. If employer/employee then might be viewed as GI.

(ii) Tips and Tokes are included as income. Roberts v. Commissioner.

(iii) $5K from congregation probably not GI, intent is gift, no duty to give her $ for retirement.

(iv) $2K likely to be considered GI, however the $3K is gift from other employees.

b) IRC § 109 - Improvements by lessee on lessor’s property.

c) IRC § 121 - Gain on sale of principal residence.

AMOUNT REALIZED

A. § 1001(b)

1. Cash

2. Property

a) Value of Services Rendered

(1) Int’l Freighting Co. - Amount received in determining G/L includes VOSR when paying a bonus. The A/R is FMV of the stock when given b/c that is the value of services rendered. (§ 1001(a) G/L=A/R - A/B)

3. Relief of Debt (Judicial Decision)

a) Crane - Gross Income includes the relief of non-recourse debt. Liability is included in the A/R and A/B—(Only A/B in case where part of purchase, not a § 1014, etc.).

b) Tufts - Gross Income includes the relief of a non-recourse debt even where the debt exceeds the A/B or FMV of the property.

ADJUSTED BASIS

A. § 1011 - A/B shall be the basis …

1. § 1012 - Cost Basis

a) Philadelphia Park - Cost basis is determined by the value of what is received. If the FMV of what received is unascertainable, then the FMV of the property given may be used to determine basis.

b) Taxpayer taxed on difference b/w the FMV of property received and adjusted basis of property sold.

c) Property Received Included in Income

d) Property Received Permanently excluded from income (Ee discount is exclusionary not deferral so retail price is basis)

e) See Crane (A/B includes non-recourse or recourse debt)

f) Problems (116 - 117)

(1) Purchased for $10K, sold for $16K

(a) $6K gain.

(b) If $1K option, then $9K paid, still paid $10K and sold for $16K. A/R = $16K, A/B = $10K ($1K + $9K) - - $6K gain.

(c) Sold option for $1500. A/R = $1500, A/B = $1000 -- gain = $500.

(d) A/R = $18K, A/B = $12 [Cost basis (Code § 1012) of $10K + improvement (Code § 1016) of $2K].

(e) A/R = $18K, A/B = $10K, gain = $8K. Don’t realize the $2K of improvements made by lessee as adjusted basis until you sell, so that you have pay for the increase in value?

(f) A/R = $16K, A/B = $10K; $3K of income tax not included to adjust basis since it was actually income in the form of property and not a gift and treated as an “improvement.”

g) A/R = $16K, A/B = $10K, gain = $6K. Since §132(a)(1) excludes employee benefit as GI. If you only use basis of $9K would actually act as a deferral, so you treat basis as if discount does not exist and = value of product w/o discount.

2. § 1016 - Adjustments

a) Improvements - Increase Basis

b) Depreciation - Decrease Basis

3. § 1019 - Property improvements made by lessee is not income to lessor and does not adjust basis for lessor

4. § 1015 - Gift Basis

a) Basis shall be the same basis as donor’s basis

b) Except if basis is greater than FMV, then basis is FMV for determining loss.

(1) If A/R falls between, then no G/L in this situation

c) Donee’s A/B becomes the greater of the gift tax paid or donor’s A/B, if donee pays gift tax on gift

d) Problems (123)

(1) A - §1015

(a) 1 - $15K gain

(b) 2 - $5K loss; A/R = $15K, A/B = $20K.

(c) 3 - $5K gain; A/R = $25K, A/B = $20K.

(2) B - Exception to §1015

(a) 1 - $5K gain; A/R = $35K, A/B = $30K

(b) 2 - $5K loss; A/R = $15K, A/B = $20K

(c) 3 - No loss or gain; A/B falls between the basis and the FMV.

5. § 1041 - Transfers between spouses or former spouses

a) Treated as gift and transferee’s basis is the same as transferor’s basis, even if FMV < Basis and computing loss

 

b) Problems (126)

(1) D purchased land $4K, appreciated to $7K, sold to wife Marla for $7K.

(a) $0; gain realized = $3K, however under 1041(b) no gain is recognized.

(b) Marla’s basis = $4K, which is Donald’s basis under §1011/§1012 - transferred to Marla under 1041(b).

(c) $3K gain §1001(.c) since her transferred basis is $4K under §1041(b).

(d) a - $0; loss recognized. b - $4K. c - $1K loss recognized. If Marla was Donald’s daughter under §1015 g/l = $0 since when determining loss, take lower of FMV/Basis.

c) No recognized gain/loss; exchange basis with Marla’s @ $4K and Donald’s @$5K.

6. § 1014 - Basis of Property Acquired from a Decedent

a) Basis = FMV of Property at date of death

b) If ½ or more is held in community property state and was subjected to estate tax, then FMV also.

(1) EX: Wife gets step-up basis to FMV for entire community even though only half taxed.

§ 1011 : G/L = AMOUNT REALIZED MINUS ADJUSTED BASIS

A. § 1041 - No G/L between spouses or former spouses if divorce decree - (Probs. Pg 126)

a) A/R 7K (§1001(B)) A/B 4K (§1012) G Real 3K (§1001©) G Rec 0 (§1041)

b) 4K § 1041

c) 3K § 1001©

d) same, same,(1000)

e) Don 0,0,5000 Basis: Marla 0,0,4000 Basis

B. Gain to Donor when Donee pays gift tax (Diedrich)

1. Gain is amount of gift tax paid over the donor’s A/B

2. Donee’s A/B becomes the greater of the gift tax paid or donor’s A/B

C. Crane - Relief of non-recourse debt over A/B is income (Gain)

a) Problems (153-154)

(1) Purchase price = $100K; takes loan for $80K, and $20K cash.

(a) Basis = $100K.

(b) Loan does not = income.

(c) Add $100K of improvements to $100K basis = $200K basis.

(d) Basis = $100K, not used to improve the land.

(e) Mortgagor - A/R = $300K, A/B = $100K; G/L = $200K. Purchasor’s basis = $180K (mortgage) + $120K (cash) = $300K.

(f) Mortgagor - A/R = $180K; A/B = $100K; G/L = $80K. Son’s basis = $180K (mortgage).

(g) No gain/loss spouse’s basis = transferred basis of $100K. When she pays off mortgage no taxable result.

(h) A/R = $180K (debt incurred), A/B = $100K; Gain realized and recognized = $80K (Similar to Crane case).

(i) A/R = $180K, A/B = $100K; gain realized and recognized = $80K. (Similar to Tufts case).

§ 71 - ALIMONY AND SEPARATE MAINTENANCE PAYMENTS

A. § 71(b) Req’s to make alimony deductible for payor and income for payee (Must satisfy all)

1. Must be made in cash, check or money order

2. Payment is received bu, or on behalf of, spouse under a divorce or separation instrument

3. Is not designated as a non-alimony payment

4. Not members of same household at time payments are made (in the case of decree (order by court) of legal separation or divorce)

5. There is no liab. To make payments after death of payee spouse (Be careful if for set period of years for payments)

6. Not child support.

a) If one of these req’s is not met, then amount that does meet the req’s is considered alimony and the rest not.

B. Don’t worry about recapture of alimony

C. Problems (Pg. 202)

1. A) Yes, B) No - Not Cash, C) No - Property not cash, D) No, E)No, F) No, G) Yes - Makes payments alimony because no post-death, H) Yes - 10K alimony because for a term of years, I) No - Live in same house, J) Yes - Because only a written separation agreement not a legal seaparation or divorce so payments may be alimony

D. Indirect Payments (Alimony or Not) Still follow 71(b) Req’s

1. Rental and Mortgage Payments paid by spouse for other spouse

a) If payor spouse owns home, then no alimony

b) If payor spouse does not own home or is paying rental for payee spouse, then it is alimony

2. Insurance Premiums paid by spouse for other spouse

a) Payments to third party for premius on life insurance policy covering the life of the payor spouse is allowed as alimony as long as the payee-spouse is the owner of the policy

(1) Look to make sure that transfer is cash, not just giving a life insurance policy

(2) Payee spouse must own the policy or have been assigned the policy and be irrevocable beneficiary. It does not matter if payee spouse is only the irrevocable beneficiary.

b) Problems (Pg. 206)

(1) Yes - Rental Payments to LL are indirect alimony

(2) Yes - Mortgage payments on house not owned by payor

(3) No - Payments made on house owned by payor

PROPERTY SETTLEMENT (INCIDENT TO DIVORCE)

A. Davis (Overturned)

1. Transfer of property for suspension of dower rights in a non-community property state is a taxable exchange.

2. A/R by Davis is presumed to equal the FMV of the stock given, so marital rights is assumed to be equal in value to the property for which they were exchanged.

3. The basis of property to the wife is equal to the FMV of the property.

4. Now § 1041 controls and no G/L is recognized and transferred basis to transferee spouse.

B. Timing of “incident to divorce” and related to cessation of marriage”

1. Look to § 1041 © and 71(b)(2) for “incident to divorce”

a) seems to mean the same thing as cessation of marriage?

2. Look to Reg 1.1041-1T Ques. 7 for “cessation of marriage”

a) Pursuant to divorce or separation instrument

b) Within six years

C. These are only rebuttable presumptions and can be overcome by examples given in Reg. 1.1041-1T Ques. 7

D. Problems (Pg. 218, 232)

ADJUSTED GROSS INCOME (ABOVE VERSUS BELOW THE LINE)

A. AGI=GI - Above the Line Expenses (§ 62)

1. Trade or Business Expenses

2. Reimbursed Expenses of Employees

3. Losses from sale or Exchange of Property

4. Deductions from Rents/Royalties - § 212

5. Alimony - § 215

B. Below the Line Expenses (§ 63(d))

1. Itemized deductions

a) Deductions other than § 62 Expenses

b) Look to § 67(b) for list of Itemized Deductions

(1) Interest Deduction - Only one we will study

(2) Property Taxes

(3) Casualty Losses

(4) Medical Deductions

2. Personal Exemptions (§ 151)

C. Items not Deductible

1. § 262 - Personal, living and family Expenses

2. § 263 - Capital Expenditures

a) Payments made to permanently improve or better to increase value must be capitalized and depreciated

BUSINESS DEDUCTIONS - § 162 TRADE OR BUSINESS EXPENSES

A. Ordinary and Necessary

1. Welch - T/P made payments on obligations of his former bankrupt company to restore his credibility with customers for new business

a) Ordinary expenses are those which are common in the business community

b) Necessary expenses are those which are appropriate to the business.

c) Holding - Payments are nondeductible capital expenditures because they were made for the development of his reputation and goodwill of his new business.

B. Expenses

1. Capital Expenditures

2. Capital Expenditures are capitalized and depreciated through the asset’s life. If no specific asset or useful life can be ascertained, then the cost is recovered upon dissolution of the enterprise.

3. Acquisition or Construction Costs

a) Reg. § 1.263(a)-2 - Cost of acquiring or constructing bldgs, mchnry, eqpt, or other property that has useful life of more than one year.

4. Prolong Useful Life

a) Amounts paid which substantially prolongs or adapts the property to a new or different use is a capital expenditure

5. Repair

a) Costs that merely the property in its ordinary efficient operating condition. It neither materially increases the value of the property nor life beyond original expectation

6. Plan of Rehabilitation

a) Norwest Corp

(1) T/P removes asbestos 50 years later. Court rules that making improvements to put in efficient operating condition is a capital expenditure. To keep efficient, repair

(2) Look to value before and after

(3) Look to extension of useful life

C. Carrying on Trade or Business

1. Expanding an existing business

a) Ordinary and necessary expenses incurred in expanding an existing trade or business are deductible

2. New Business

a) Generally not deductible because they are incurred when the T/P is not carrying on a trade or business. (See Start-Up Expenses)

3. Investigating a New Business

a) Not currently deductible but may give rise to a loss deduction under § 165(c)(2)

Start-Up Expenses - Not currently deductible but may be capitalized and deducted over 5-year period - § 195

a) Type of Expenses:

(1) Expenses incurred in investigating the creation or acquisition of an active trade or business,

(2) actual expenses in starting an active trade or business, or

(3) any expenses in starting an activity giving rise to the production of income.

(4) Start-up expenses must have been allowable or currently deductible if the business was presently being carried on.

(a) Investigatory Cost - These expenses include costs incurred before the final decision to enter into a business. (Market studies, evaluation of products and labor supplies)

(b) Start-Up Costs - Costs incurred after decision to establish business but before business begins. (Advertising, training employees, lining up distributors and potential customers, and fees for professional services in setting up the books)

(c) Exclusions - Interest (§ 163), Taxes (§ 164), and research expenses (§ 174). These may be currently deductible to extent allowed in the certain sections

b) Disposition of Business prior to 5-year Amortization

(1) Unamortized start-up expenditures may be deducted to extent provided for in § 165(c)(2) and 195(b)(2).

c) Transactional

(1) If an investigation of a trade or business reaches a “transactional” stage and is dropped before the trade or business is developed or acquired, transactional expenditures may be deducted under § 165(c)(2)

(2) Transactional stage is reached at the point where the preliminary investigation has led to the decision to purchase a specific trade or business, but further investigation of the trade or business continues.

d) Election

(1) Must make the election on the first return or expenses may be lost forever.

e) Problems (Pg. 346)

(1) Not currently deductible (§ 195 Amortization), 2) Deductible under § 162, 3) Not currently deductible (§ 195), 4)No, must amortize start-up costs, 5) Under § 195(b)(2) and § 165(c)(2) may deduct all

Employees

a) Employee counts as carrying on a trade or business

b) Expenses incurred in obtaining another job in same line of business are deductible

 

(1) New Line of Work

(a) Expenses incurred in finding a new line of work are non-deductible

(2) First Job

(a) Expenses are non-deductible

(3) Payment Contingent on Becoming Employee

(a) These are deductible

(4) Duration

(a) Length of time that an employee is unemployed has a bearing on whether that Employee is carrying on a trade or business

(b) RR 75-120 - No § 162 deductions for individuals who have been unemployed for such a period of time there is a lack of continuity b/w past and future employment

(c) § 195 is inapplicable for employees

c) Problems (Pg. 346)

(1) a) No, b) no, c) Yes, d) Yes, e) No

Reasonable Salaries

1. Determination of whether a salary is reasonable:

a) The nature and extent of the services performed; and

b) Comparisons with amounts paid in similar circunstances.

(1) Ee’s qualifications

(2) Nature of work

(3) Size and complexity of business

(4) Comparison with Net and Gross Income of payor

(5) Economic conditions

(6) Comparison with distribution to shareholders

(7) Salary policy of the taxpayer to all employees

(8) In small corporations, amount paid in previous years to officers

2. Contingent Payment

a) If amount of payment is paid pursuant to an agreement providing for the amount to be contingent on future events, such as a percentage of profits, the amount paid will be considered as reasonable if the following 2 conditions exist:

b) Free Bargain - If the agreement was made at arms-length then this criteria is satisfied. All relevant factors bearing on the ability of the employer to exercise a free and independent judgment are relevant

c) Reasonable when contract made - If the agreement was reasonable under the circumstances existing at the time the contract for services was made, then the criteria are satisfied

TRAVEL AWAY FROM HOME - § 162(a)(2)

1. Requirements for Deductibility

a) Reasonable and Necessary

b) Away from Home

(1) If a T/P satisfies being “away from home”, then trans. and meals and lodging are deductible

(2) OVERNIGHT RULE - A T/P is considered to be staying overnight if he is away from his tax home long enough to require him to stop for substantial sleep or rest no matter what distance he travels or mode of transportation used

(a) Transportation expenses are deductible whether or not stays overnight (assuming business related)

(b) Meals and Lodging Expenses are deductible only if overnight rule is satisfied. Correll

(3) No Home

(a) Can never be away from home

(4) Abode and a principal place of business

(a) Tax home will be considered the principal place of business

(5) Abode and More than one place of business

(a) Tax home will be the principal place of business. Question of fact as to Prin. place of Bus.

(i) Amount of income earned in each location

(ii) Nature and extent of business at each location, and

(iii) amount of time spent at each location

(6) Temporary Assignment

(a) If reasonably expected to last less than 1 year, then deductible. If in fact it lasts more than 1 year then no deductions for any expenses § 162(a)

c) Pursuit of Trade or Business

2. Types of Travel Expenses

a) Transportation

(1) Expenses incurred to get to and from your tax home to the place of your destination including airline, car travel and taxi

b) Meals and Lodging

(1) Expense deductions for all meals must be taken at 50% of cost § 274(n)(1)

(2) Unless traveling away from home, expense for meals will be treated as an entertainment expense and must be directly related to associated with business to be deductible

c) Incidental Travel

(1) Includes telephone calls, tips, baggage charges, laundry, etc. These may be either transportation or meals and lodging

3. Travel for Business and Personal Reasons

a) Traveling expenses incurred to and from the location are deductible only if the primary purpose of the trip is business (Must be greater than 50% in total days) § 1.162-2

b) If the transportation expenses are not deductible because the primary purpose of the trip is not business, the T/P may nevertheless deduct meals and lodging incurred on the trip that are attributable to business purposes Id.

4. Spouses

a) Expenses related to spouse on travel are deductible only if:

(1) The spouse, dependent, or other individual employee is an employee of the T/P;

(2) The travel of the spouse, dependent, or other individual is for a bona fide business purpose, and

(3) Such expenses would be otherwise deductible.

5. Commuting Expenses

a) Home to Business / Business to Home

(1) Not Deductible § 262

b) Business to Business

(1) Travel expenses are deductible, but meals are not unless the “overnight rule” applies

B. **************PROBLEMS**************** Pg. 369-371 1-5d

EDUCATIONAL EXPENSES Treas. Reg. § 1.162-5

1. Requirements for deduction

a) Maintaining or improving skills, or

(1) Coughlin

(a) Expenses for education may be deductible if skills which are used in a taxpayer’s employment are maintained or improved by education § 1.162-5©(1)

b) Meeting requirements of employer or law

(1) Hill

(a) Educational expenses incurred to satisfy requirements imposed by an employer or by law may be deductible. Lawyer going to tax conference to keep current. §1.162-5©(2)

2. Tests for non-deductibility

a) Minimum education requirement, or

(1) Expenses for education are non-deductible if applicable laws, regulations, professional standards require t/p to obtain the education in order to meet the minimum educational requirements for his employment. 1.162-5(b)(2)(I)

b) Qualification for a new trade or business

(1) Expenses for education may also be non-deductible if the education is part of a program of study leading to qualify the t/p for a new trade or business. § 1.162-5(b)(3)

(a) Exception - Does not apply if the employee obtains education to qualify him to perform new duties, if the new duties involve the same general type of work as is involved in the present employment.

3. Carrying-On Requirement

a) Educational expenses must meet the § 162 requirements. Must be ordinary and necessary expense in carrying-on a trade or business.

b) Educational expenses leading to a first job are not deductible. Johnson - Law school graduate enrolling in graduate tax program

4. Travel to Obtain Education

a) If a t/p travels away from home primarily to obtain education and the educational expenses are deductible, then the traveling expenses, meals and lodging, and incidental expenses are also deductible

5. Problems (Pg. 391)

a) a) No - Qual. For new bus. and min educ, b) OK -Specialization, c) No - Same as Alice, d) OK - Specialization

b) Travel, Meals and Lodging, and incidentals

c) No - § 274(m)(2) travel cannot be used for expenses as educational deductible expenses

MISCELLANEOUS BUSINESS DEDUCTIONS

1. Business Meals and Entertainment

a) 50% Allowance §274(n)

b) “Directly Related to” or “Associated with Business” § 274(a)(1)

c) Not “Lavish or Extravagant” § 274(k)(1)(a)

d) Presence by Taxpayer or Employee § 274(k)(1)(b)

2. Entertainment Facilities : Non-deduction: § 274(a)(b)

a) Exceptions

(1) Facility expenses used in business for non-entertainment expenses (Ex: Airplane)

(2) Entertainment activities relating to the use of such facilities are deductible if they satisfy the “directly related to” test

3. Dues for social, athletic or sporting club

a) Non-deductible § 274(a)(3)

4. Uniforms

a) Allowed as a deduction only if :

(1) the uniforms are specifically required as a condition of employment, and

(2) are not of a type adaptable to general or continued usage to the extent that they take the place of ordinary clothing

5. Advertising

a) Currently deductible even though benefits last for years

6. Dues

a) Deductible if paid to organizations directly related to taxpayer’s business

7. Lobbying Expenses

a) Local lobbying is deductible but not state or national

8. Substantiation

a) Cohan Rule

(1) If the IRS disallows a deduction and if a taxpayer does not have substantiating proof of an expenditure, the taxpayer may be able to obtain a deduction for an approximate amount which would have been spent in light of the surrounding circumstances, unless a statute requires more specific substantiation.

(2) EXCEPTION: §274(d) - Meals and lodging while away from home, business gifts, entertainment expenses, business meals, and certain listed property (autos, cell phones, and p.c.’s).

9. Exceptions from Limitations for Employee Reimbursed Expenses

a) §274(e)(3) - Excepts the limitation of §274(a), which requires the directly related to test.

b) §274(k)(2)(a) - Excepts the requirement of §274(k) prohibiting lavish or extravagant expenses and also requiring presence of the taxpayer or employee.

c) §274(n)(2)(a) -Excepting requirement of §274(n), allowing only 80%.

d) Overall - although the employee is exempted from the above limitations, the employer is still subject to these same limitations.

10. Face Amount - Deductions are limited to the face amount of any expense - §274(3)(1)(A).

11. Problems (Pg. 399)

a) a) $100 deductible subject to 50% limitation, b) technically no but come on, c) Not present so No, d) OK, e) Company takes deduction so employee gets wash

b) $75 § 274(l)(1) 50% limitation on face value (Meals and Entertainment)

c) $250+$30+$200+$50+=$530

DEPRECIATION

A. Three Critical Things to Know

1. Method

2. Life

3. Convention

B. Problems (Pg. 437-438)

1. a)

2. a) 2560,4100,2450,1475…, b) 1792, 3280,1715,885,885, c) (1792+3280+1715=6787 Reg s/l v. (1500*.7=1050 + 3000*.8=2400 + 2450(Max allowed) *.7=1715=5165. 6787-5165=$1622 Recapture

C. Alternative method uses class life for recovery period on straight line. That is the difference b/w regular s/l and alternative s/l

D. Real Property

1. Straight Line Only § 168(b)(3)(A)&(B)

2. Alternative depreciation may be elected on a property by property basis (versus class basis for personal property) § 168(g)(7)

3. Mid-Month Convention

4. Recovery Period

a) Residential Rental - 27.5 Years § 168©

b) Non-Residential Real - 39 years § 168©

5. Problems (Pg. 441)

 

a) a) $3636, b) $2564, c) Does not matter, d) 40 year life under 168(g)(2), $2500, no (e) or (f) ******Breaks to Adrian’s Outline ***********

E. Requirements to Determine Depreciation

1. Depreciation Method

2. Recovery Period

3. Convention

F. Relationship of depreciation deduction to basis

1. Cost or other basis

2. Improvements/ <Depreciation>

3. Adjusted Basis

4. §280F Limitations

G. Methods

1. 200% Declining Balance

a) Applies to property < 10 yr recovery period

b) Remember to switch to straight line

2. 150% Declining Balance

a) Applies to 15 year and 20 year property

b) Remember to switch to straight line

3. Straight line

a) Applies to residential and non residential rental property and where the election is made to use straight line

4. Alternative Depreciation Systems §168 (g)

a) Straight line

b) Generally uses a longer life

(1) Class life for most property

(2) 40 years for residential and non residential rental property

5. Recovery Periods §168 ©

a) §168 © and (e) classifies “recovery period property” based on old ADR class life under §167

b) §168 © “recovery period property” determines its recovery period

6. Conventions

a) Half Year Conventions: treats all personal property as if was placed in service precisely in the middle of the year §168 (d)(4)(A)

(1) Applies to both year of acquisition and year of disposition

b) Mid Quarter Convention: treats property as if it was placed in service at the midpoint of the quarter §168 (d) (3) & (4) ©

(1) An attempt to prevent taxpayers from placing substantial amount of property in service near the end of the taxable year and receiving credit for depreciation based on a half year

(2) Applies when 40 % of the total basis of property is placed in service during the last six months of the taxable year

c) Mid Month Convention: treats property as if it were laced in service during the middle of the month §168 (d)(4)(B)

(1) Applies to residential and non residential real property

H. §179 Bonus Depreciation

1. Allows extra depreciation deduction (in addition to §168) with respect to property placed in service during the year

2. “Section 179 Property” includes property which qualifies for current ACRS deductions §48

3. Limitations

a) Dollar limit: maximum deduction on the aggregate property placed in service §179(b)(1)

b) Phase out disallowance: bonus depreciation is reduced dollar for dollar for the cost §179 property placed in service during the year in excess of $200,000 §179 (b)(3)

c) LOOK TO OUTLINE FOR NUMBERS

d) Taxable income: Bonus depreciation is limited to amount of taxable income §179 (b)(3)

(1) Carryover: Amounts disallowed based on the taxable income limitation is carried over to the net taxable year §179 (b)(3)

4. Recapture: if §179 property ceases to be used predominantly in a trade or business (for whatever reasons), the taxpayer must include in income the tax benefit derived form the deduction §179 (d)(10)

§280F Limitation

5. Luxury Autos

a) Depreciated under the straight line method over five years

b) Deduction limited to $12,800 over the initial five years

6. AMOUNTS

(1) Year one $2560 Years 6-10 (if applicable) $1475

(2) Year two $4100

(3) Year three$2450

(4) Year four $1475

(5) Year five $1475

7. Other Limitations

a) Alternative Depreciation System: If the property is used less than fifty percent in a qualified business, then depreciation deductions must be determined under the alternative depreciation system for that taxable year and all subsequent taxable years §280F(b)(2)

b) Recapture: If the business use exceeds fifty percent in one or more taxable years, then the taxpayer must recapture as ordinary income the:

(1) depreciation deductions taken in the earlier years, less

(2) depreciation deductions under alternative depreciation system

c) Substantiation: Depreciation deductions for listed property must be substantiated by adequate records §274(d)

8. 280F(d)(4) Listed Property

a) Passenger automobiles

b) Any other property used as a means of transportation

c) Property generally used for entertainment, recreation, amusement

d) Any computer or peripheral equipment

e) Cellular telephone

f) Other property specified in regulations

I. Realty Rules

1. Straight line depreciation only §168 (b)(3)(A)&(B)

2. Alternative depreciation system may be elected on a property by property by property basis (versus class basis for personal property) §168(g)(7)

3. Mid Month Convention applies §168(b)(4)(B)

4. NO Anti Churning since depreciation deductions are not as favorable

DEDUCTIONS FOR PROFIT-MAKING, NON-BUSINESS ACTIVITIES

A. Deductions are specifically allowed under § 212 because they are not allowable as an ordinary and necessary business expense under § 162

B. Higgins - T/P ran a real estate business and traded in stocks and bonds. Court ruled that RE is trade or business but investments are not and disallowed the deductions. This was pre § 212.

C. § 212 - Two aspects of a non-business deduction

1. Ordinary and necessary, and

2. Expenses

3. Carrying on is implied in the statute

D. Three categories of deductions

1. Production or collection of income

2. Management, Conservation, maintenance of property held for the production of income

3. Determination, collection or refund of any tax

E. § 212 is synonymous with § 162(c)(2) ‘transaction entered into for profit”

F. Above or Below the Line

1. Rents and Royalties are above the line

2. Others are below the line

a) § 62 - Not included

b) § 63(d) - Defines itemized deduction

c) § 67(b) - Not specifically excluded from misc. itemized deductions

3. Seminars - No deduction § 274(h)(7)

G. Problems (Pg. 473)

1. a) No because carrying on is implied in § 212, b) Yes, § 165(c)(2), c) § 195(b)(2)

CHARGES ARISING OUT OF TRANSACTIONS ENTERED INTO FOR PROFIT

A. Deduction for depreciation (§ 167) and maintenance (§ 212) expenses

1. Property abandoned or converted and put up for rent

a) Horrman - Inherited property and lived there. Abandoned property and tried to rent but was never successful. Court held that the depreciation and maintenance expenses were deductible because the property was held for the production of income. Could not deduct the loss on the sale because it was not a transaction entered into for profit

2. Property abandoned and held for post-conversion profits

a) Lowry - Property was held for 5 years post residential use and was never used for residential use in those 5 years. Court ruled that a property need not be actually rented to be converted in to income producing property but that the intent of the owner is the key question whether the house is residential or income producing allowing deductions. The court looked at 5 factors from previous Newcombe case to decide:

(1) Amount of time the taxpayer occupied his former residence prior to abandonment

(2) Availability of house for personal use while unoccupied

(3) The recreational character of the property

(4) Attempts to rent the property

(5) Whether the offer to sale was an intent to realize both conversion and appreciation

B. Loss deduction under § 165

1. Abandoned and converted, and

2. Actually rented

C. Post-Conversion Profits

1. Presumption - The property is not held for post conversion profits. But look to Lowry for case that ruled differently

2. Sales Price - The sales price merely has to be at or above FMV at the time of conversion

D. Sale of Converted Residential Property (Reg. 1.165-9)

1. If property is converted from personal to income producing prior to sale and is used for such up to time of sale, a loss can be deducted.

2. Basis of such property for LOSS is lesser of:

a) FMV of property at the time of conversion

b) Adjusted basis for loss, at time of conversion, determined under § 1011-1 but w/o reference to FMV

c) Adjust the basis from the basis after conversion for depreciation or improvements

d) If amount falls in the middle then like § 1015 it is a wash. No G/L

E. Problems (Pg. 473)

1. 2. A) Maybe. Must argue post conversion appreciation against presumption. Only depr. and maint. No loss b/c pers. Res. B) Basis for LOSS = (160(FMV)-10(Depr.), a) (5K), b) 5K, c) No G/L

DISALLOWANCE OF INTEREST

A. Categories of Interest Deduction

1. Personal Interest - Not allowed under § 163(h)(1)

2. Trade or Business Interest - Allowed under § 163(H)(2)(A)

3. Investment Interest - Allowed under § 163(h)(2)(B)

B. Qualified Residence Interest § 163(h)(3)(A)

1. Defined

a) Principal Residence, and if election made

b) One other residence § 163(H)(4)(A)

(1) Look to § 280(A)(d)(1) for “residence)

(a) 14 days, or

(b) 10% of rental days at fair rental price

2. Acquisition Indebtedness § 163(h)(3)(B)

a) Acquiring, constructing or improving a qualified residence, and

b) is secured by such residence

c) Limit: $1,000,000 aggregate limitation

d) Refinancing: Limit is principal amount of refinanced loan

3. Home Equity Indebtedness § 163(h)(3)(c)

a) Any indebtedness secured by a qualified residence

b) Limit shall not exceed the lower of the following:

(1) FMV - Acquisition indebtedness (Net Equity)

(2) $100,000 (50,000 if MFS)

4. Grandfather - Applies to indebtedness incurred on or before October 13, 1987 § 163(h)(3)(d)

a) Treated as acquisition indebtedness

b) No limit on amount

c) Reduces the post 1987 limit

d) Refinancing à Limited to principal amount of debt

C. Problems (Pg. 502) Look at Both QRI and Equity for 2 residences

1. 3. A) 100%, B) 100%, C) 100%, D) 50K Refinance (Acq), of the other $150K, only 100K is deductible b/c of the limit on Equity, E) $750K (Acq.) + $100K (Equity) = $850K (B/C 1000K aggregate limit on both loans

DEDUCTIONS LIMITED TO AMOUNT AT RISK

A. Definition §465(b): A taxpayer is considered “at risk” to the extent

1. Amount of money

2. Adjusted basis of other property contributed

3. Amounts borrowed which the taxpayer is personally liable for or has pledged other assets outside of the activity as security for the loan

B. Limitation: Losses not allowed except to the extent that a taxpayer is at risk for such an activity §465(a)(1)

 

C. Deduction in a subsequent year: Any loss disallowed under this section, shall be treated as a deduction to such activity in the first succeeding taxable year §465(a)(2)

D. Applies: to individual and closely held corporations §465(a)(1)

E. Qualified Non-Recourse Financing is treated as an “amount at risk” §465(b)(6) Includes any borrowings in which the taxpayer is not personally liable and which meets the following criteria:

1. Borrowing with respect to the activity of holding of real estate

2. Borrowing satisfies

a) Qualified person

b) From the Government

c) No person is personally liable

d) Not a convertible debt

3. Qualified Person

a) § 49(a(1)(d)(iv) - A person who is engaged in the business of lending who is not:

(1) a related person,

(a) if related à commercially reasonable and substantial terms as unrelated person

(2) the seller of the property, or

(3) receives a fee

F. Recapture Rule

1. Where there is a negative amount at risk, then a T/P is required to recapture the negative amount as gross income in the current year §465(e)

a) Where the T/P takes negative amount in to GI, the T/P takes a deduction in that amount in immediate succeeding tax year

ACTIVITIES NOT ENGAGED IN FOR PROFIT § 183

A. No loss deduction for activities not engaged in for profit

1. Does not take away Schedule A expenses

2. Can have deductions to the extent of income earned from activity

3. Defined as any activity not covered under § 162 (Trade or Business) or § 212 (Production of Income) - Grey area between the two of these

4. Presumption is if you make money 3 out of last 5 years then in it for profit

PASSIVE LOSS RULES § 469

A. A passive activity is a trade or business in which the t/p does not materially participate

1. Material participation is one who is involved in the operations on a regular, continuous and substantial basis. § 469(h) & 1.469-5T

a) 500 or more hours per year

b) Does all the work of activity

c) >100 hours but no one else worked more than that

d) It is a significant participation activity and aggregate amount of all sign. part. act is >500 hours

e) Materially participated for 5 out of the last 10 years

2. Limited partnerships, and

3. Rental real estate activities are per se passive activities

a) Exception - $25,000 offset for rental activities if the t/p:

(1) Is in a rental real estate activity

(2) actively participates

(a) Involved in management of property in a bona fide sense

(b) Limited partnership does not satisfy active participation for Rental RE

(3) minimum of 10% ownership

b) $25,000 offset is reduced by 50% of the gross income of the t/p exceeding $100,000

B. Portfolio income is defined as interest dividends and royalties § 469(e)(1)(A)

C. Separates active portfolio passive income

D. Cannot use passive losses to offset active or portfolio income (Except after disposition)

E. Must carry forward to offset passive gains in subsequent years

F. Losses are allowed in the following order:

1. Income from that activity for the year

2. Over any net income or gain from all other passive activities

3. Against active activity or portfolio activity on disposition (See 1d)

G. If a passive activity has a loss in one year then becomes an active activity in the next with a gain, the passive loss can offset the active (passive) gain.

H. Problems (Pg. 535-536)

1. a) 200K active, 10K portfolio, <50K> passive è No deduction for passive loss it carries forward, b) 30K of gain is offset, but 20K of loss carries forward, c) 50K of loss offsets 90K è 40K gain, d) Can deduct prior losses against gain from other activities, e) T/P gets the $25,000 offset for rental, but phase-out takes it all away (>150K NI will never get), f) Same as e, g) 120K NI (10K offset after PO)

2. a) <50K>, b) Arguable, c) Not working the 500 hrs b/c retired so passive activity, d) <50k> from prior year passive offsets 60k gain even though now activeè 10K Income

I. Don’t Worry about gifts

TAXABLE PERIODS AND METHODS OF ACCOUNTING

A. Taxable Period

1. Taxable income is computed based on the taxable year. Most individuals are on the calendar year

a) Calendar Year

b) Fiscal Year

c) 52-53 Week Year

d) Short Year, less than 12 months

2. Change in Taxable Year

a) Prior approval is needed from the Commissioner, and

b) Substantial Business purpose exists

3. Death terminates the taxable year, so T/P will have short year

B. Methods of Accounting - Method must clearly reflect income

1. Cash Receipts and Disbursements Method

a) Tax Shelters, C Corps cannot use this method

(1) Exceptions:

(a) Farming/Timber

(b) Qualified personal service corp.

(c) August Gross Receipts < $5M

2. Accrual

a) Required for inventory if substantial income producing factor

3. Installment

4. Percentage of Completion

CASH METHOD

A. General Rules

1. Prepaid Income

a) Income is recognized when cash is received

2. Prepaid Expenses

a) If useful > 12 months then you must capitalize and amortize Boylston

b) If useful life < 12 months then you can deduct in current year Zaninovich

c) Interest § 461(g)

(1) A prepayment of interest must be capitalized and amortized over the life of the loan

d) Points § 461(g)(2)

(1) Deductible if for improvements on a home § 461(g)(2)

B. Cash Receipts

1. A T/P using a cash method must include the items into gross income in the year which the cash is received

a) Checks

(1) Checks are treated as cash and included in GI in the year in which the cash is received LAVERY

(2) Even if received on Dec. 31 and all banks are closed KAHLER

b) Property

(1) If property is received which is included in GI, the amount to be included in GI is the FMV of the property as of the date of receipt HORNUNG

c) Promissory Notes - Is it a cash equivalent?

(1) The receipt of a promissory note which is 1) non-negotiable and 2) non-assignable, is not treated as cash and not included in GI upon receipt

C. Constructive Receipt

1. A cash method T/P must include items of GI in the year in which they are constructively received

a) An item is constructively received by a T/P when it is credited to his account, set apart for him, or otherwise made available so that he may draw on it at any time

(1) An item is not constructively received if its actual receipt is subject to substantial limitations or restrictions. 1.451-2(a) Telling not to cash check is this.

D. Disbursements

1. A cash basis T/P will generally take allowable deductions in year paid

a) Checks

(1) Payment by check is considered made when the check is delivered, unless the check bounces or is dishonored RR 54-465

(2) The check is not considered payment if when delivered if there are restrictions as to the time and manner of payment. Fischer

(3) Mailbox Rule

(a) Paid when put in mailbox

b) Credit Cards

(1) Payment is considered made when the charge is made not when CC company is paid

E. Constructive Payment as Deduction

1. No such thing, only get deduction when paid

F. Problems (Pg. 608)

1. a) DèYr 1, LèYr. 2, b) DèYr. 1, Lè Yr. 1, c) Dè1-5 5,000 Each, Lè 25,000 Yr. 1, d) Same as C, e) Dè 10,000 Deduction Yr. 2, Lè 10,000 Yr. 2, f) Ded. To D in yr. 2, Income to L in Yr. 1, g) Dè yr. 2, Lè all income in year 2

2. a) Lè Yr.2, CèYr.2, b) Lè Yr. 1, Cè Yr. 1, c) Lè500 Yr. 1 500 Yr. 2, Cè Same thing, d) Yr.2 for both

ACCRUAL OF INCOME - For accrual method taxpayers, the “All Events Test” is used for determining whether the taxpayer should recognize (for accrual) items of income and deductions.

A. Accrual of Income §1.446-1(c)(2)(ii) - Income should be accrued and recognized as taxable income when the following tests (i.e. “the all events test”) have been satisfied:

1. Fixed - The right to receive the income is fixed; AND

2. Amount - The amount of the income could be determined with reasonable accuracy.

3. ALSO LOOK AT:

a) Economic Contingencies - Even though the right to receive income is fixed and the amount determined with reasonable accuracy, there still may be some doubt as to recognizing the amount as income if there is some doubt whether it will be actually received due to economic contingencies.

(1) Rule - Income is recognized when the “All Events Test” is satisfied even though economic considerations or contingencies may exist which make it uncertain that the taxpayer will actually receive the item of income.

(2) Spring City Foundry v. Commissioner.

b) Legal Contingencies - Where a legal contingency arises, an accrual method taxpayer’s right to the item of income generally does not become fixed until the litigation is concluded (including appeals). RR 70-151.

(1) Exception - Notwithstanding a legal contingency, an accrual method taxpayer recognize as income the amount actually received when the taxpayer receives a beneficial right to the money. North American Oil.

c) Advance Payment for Services - An accrual method taxpayer must generally accrue the amount received for payment for services in gross income in the taxable year in which it is received.

(1) Exceptions

(a) Case Law - Artnell - (White Sox) Income should be deferred and recognized and properly matched against the expenses of providing the games to the public. Since the prepaid admissions approach a much closer certainty than the situations presented in the prior Supreme Court decisions (Automobile Club of Michigan, American Automobile Association, and Schlude). Here, prepaid admissions may be recognized ratably as the games are played in the upcoming season.

(b) IRS Exceptions - Allows an limited deferral for one year for prepayments of income for services.

(i) Rev. Proc. 71-21: If an accrual taxpayer received a prepayment for services that will be rendered by the end of the following tax year, then the taxpayer may prorate the income according to when the services are performed.

(ii) Rev. Proc. 71-21 does not apply for prepayments of rent or interest.

(c) Exceptions under statutes

(i) §455 - Prepaid subscriptions income.

(ii) §456 - Prepaid dues income of certain membership organizations.

d) Advance payments for goods and property

 

(1) An accrual method taxpayer who receives advance payments for goods is required to recognize income in the year the money is received.

(2) Exception for Goods: Allows a taxpayer to defer recognizing the advance payments as income until the goods are supplied. However, there are exceptions to this general rule. Treas. Reg. §1.451-5.

ACCRUAL OF DEDUCTIONS

A. An accrual method T/P recognizes a deduction when all 3 requirements are met:

1. Fixed - The fact that a liability is fixed

2. Amount - Amount can be determined with reasonable accuracy

3. Economic Performance - Even with satisfying the All Events test set forth above, the deduction shall not be allowed until economic performance has been satisfied § 461(h)

a) Services - When services are performed

b) Property - When the property is provided

c) Use of Property - When property is used

d) Worker’s Compensation - As payments are made

e) Tort Liabilities - As payments are made

4. Exception to Economic Performance for Reoccurring Items

a) Economic performance not required if 4 requirements are met

(1) All Events test satisfied

(2) Economic performance occurs within shorter of:

(a) Reasonable period after close of taxable year, or

(b) 8 ½ months after close of taxable year

(3) The item is reoccurring and T/P consistently treats the item the same, and

(4) Either of the following is applicable:

(a) Item is not material, or

(b) Accrual of the item properly matches the expense against the income relating to item

5. Economic Contingencies

a) All Events test is satisfied even though uncertain if T/P will actually pay the deductible item

6. Legal Contingencies

a) The All events test is not satisfied if the item is the subject of litigation. Does not become deductible until litigation is concluded (including appeals) RR 70-151

(1) Exception: If a T/P transfers money or other property to satisfy a certain liability and if the contest still exists after the transfer, then he may take the deduction in year of transfer § 461(f)

INTRODUCTION OF CAPITAL GAINS AND LOSSES Ordinary income: 39.6% is highest marginal rate; capital gains (long term): 28% is highest marginal rate.

A. Three requirements for an item to be characterized as a capital gain or loss:

1. Capital Asset,

2. Sale or exchange, and

3. Holding period.

B. Statutory Provisions

 

Acronym
Netting Process
Code Section
LTCG
long-term capital gains
§1223(3)
LTCL
<long-term capital losses>
§1223(4)
NET LTCG/LTCL
net long-term capital gain/loss
§1223(7) or (8)
 
STCL
short-term capital losses
§1222(2)
STCG
<short-term capital gains>
§1222(1)
NET STCL/STCG
 
net short-term capital loss/gain
§1222(5) or (6)
NET LTCG/LTCL
net long-term capital gain/loss
 
NET STCL/STCG
<net short-term capital loss/gain>
 
NET CG/CL
net capital gain/loss
§1222(11)

A. Capital Gains

1. Maximum Rate - 28% §1(h).

2. Definition - SEE ABOVE

B. Capital Losses

1. Allowed only if there is statutory authority for a loss deduction since capital losses amount to a deduction.

a) §165(c) - Losses are allowed only if incurred in a trade or business, transactions entered into for profit, or casualty losses.

b) Contrast - Principal residence (no loss allowed) v. rental property (loss allowed).

2. Limit on Capital Losses

a) §1211(b) - Losses are allowed to the extent of capital gains, plus

b) §1211(b)(1) & (2) - “Additional Amount,” the lessor of

(1) $3K, or

(2) Excess of capital losses over capital gains if the excess is less than $3K.

c) Capital Loss Cary-Overs (“C/O”)

(1) STCL C/O - The excess of short-term capital losses will be carried over as a short-term capital loss. §12112(b)(1)(A).

(2) LTCL C/O - The excess of long-term capital losses will be carried over as a long-term capital loss. §1212(b)(1)(b).

(3) General Rule - Where there is both a short-term capital loss carry-over and a long-term capital loss carry-over, then the “additional amount” that is allowed as a loss deduction will always come out of the short-term capital loss carry-over.

3. Problem, p. 698.

MEANING OF CAPITAL ASSET

A. Requirements for Capital G/L

1. Capital Asset

a) § 1221 “all property except …”

(1) Inventory/For Sale in Trade or Business

(2) Depreciable property or real property used in trade or business

(3) Copyright, Etc.

(4) A/R or N/R

(5) Gov’t Publication

2. Sale or Exchange

3. Requisite Holding Period

§ 1231 - SALES AND EXCHANGES OF DEPRECIABLE PROPERTY

A. § 1231 Assets

1. Property which is depreciable property used in a trade or business and held greater than one year

2. Real Property which is used in a trade or business and held for greater than one year

3. Casualty Losses of Capital Assets on Involuntary Conversion?????

4. § 1231 specifically excludes:

a) Inventory § 1221(1) & 1231(b)(1)(A)

b) Property held for sale to customers in the ordinary course of business

c) Copyright, etc.

d) Publication of the government

e) A/R

f) Property held less than one year

B. Main Hotchpot Gains

1. Recognized gain from the sale or exchange of property used in a trade or business

2. Recognized gain from the compulsory or involuntary conversion of

a) Property used in a trade or business, or

b) any capital asset held greater than 1 year in connection with a trade or business or a transaction entered into for profit

C. Main Hotchpot Losses

1. § 1231(a)(3)(B)

a) Includes losses on above property on the destruction, theft or seizure or requisition or condemnation

D. Subhotchpot Gains and Losses § 1231(a)(4)©

1. Includes gains and losses from an involuntary conversion arising from fire, storm, shipwreck, or other casualty or from theft of

a) Property used in a trade or business, or any capital asset held greater than 1 year in connection with a trade or business or transaction entered into for profit

E. Recapture

1. A net §1231 gain in a taxable year is treated as ordinary income to the extent of the taxpayer’s non-recaptured net §1231 loss § 1231 ©

a) Is the excess of the total amount of net § 1231 losses for the 5 most recent preceding taxable years over the portion of such losses previously recaptured? § 1231©(2)

F. Problems (Pg. 774-775)

1. a) 10,000è LTCG, <2,000>èLTCL (Don’t Net b/c different tax rates), b) 3 month holding period cured by §1223(11)=> 4,000 LTCG, <2000> LTCL, c) 10,000è LTCG, <2000>è Ordinary Loss (Casualty), d) 10,000 & 4,000è LTCG, 2,000èLTCL (B/C Casualty nets a gain so all is treated as 1231, also the painting was a capital asset but the casualty loss makes it § 1231 (1231(a)(3)(ii), e) 20,000 of loss makes it a loss so all is characterized as ordinary èTotal of <8,000>(Individually though), f) No, then only <3000> per year would be deductible, g) 8,000 è ordinary recapture and 4,000 èLTCG, h) 12,000 è Ordinary, I) 4,000 è Ordinary, 8,000 è LTCG

DEPRECIATION RECAPTURE

A. Depreciation recapture is treated as ordinary income

B. Amount is generally limited to the prior depreciation taken or the gain on disposition, whichever is lower

C. Disposition is defined broadly in § 1245(b) & 1250(d)

1. A change from business to personal use does not constitute a disposition RR 69-487

D. Excess gain after recapture is treated as § 1231 gain

E. § 1245 RECAPTURE

1. Depreciable personal property. § 1245(a)(3).

2. Recaptured amount is ordinary income

3. The amount of recapture is the lower of:

a) Recomputed Basis - Adjusted Basis, or

b) Amount Received - Adjusted Basis

(1) Recomputed Basis is basically the cost of the asset (Adjusted Basis + Depreciation Deductions Taken)

4. Depreciation deduction includes depreciation taken by another if received in a non-taxable exchange § 1250(a)(2)(A)

5. Section 179 Deduction is considered as additional depreciation § 1245(a)(2)(C); also 179(d)(10)

6. Exceptions to § 1245 Recapture:

a) Gift

b) Death

c) Tax-Free Exchange

d) Like-Kind Exchange

(1) Limited to amount of gain recognized

7. Problems (Pg. 787)

a) a) 30K § 1245 Ord. Income, b) No difference, c) 100K § 1245 Ord, 10K § 1231 Gain (LTCG), d) SKIP, e) (10K+<11K>)= 1,000 § 1231 Ordinary Loss, 100k 1245 ord. Inc. f) § 1231 LTCG 10K & 5K, 100K 1245 Ord. g) No recognition b/c under § 1041(B)(1) IT IS TREATED AS A GIFT, SO EXCEPTION

F. SECTION 1250 RECAPTURE

1. Depreciable Real Property

2. Recaptured amount is treated as ordinary income § 1250(a)

3. Amount Recaptured

a) Applicable % (always 100% after 1975) x the lower of:

(1) Additional Depreciation, or

(a) Property held less than 1 year è all depr.

(b) Property held greater than 1 year èthe excess of Accelerated depreciation - Straight Line

(2) A/R - A/B (Gain)

4. Exceptions § 1250(d)

a) Gifts

b) Death

c) Tax free transaction

d) Like Kind exchanges

5. There is no recapture for property after 1986 b/c it all needs to be straight line. Only if not held for 1 year does it come into play.

 

 

 

 

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