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Course: Federal Income Tax Nofar 1999
School: University of Detroit
Year: 1999
Professor: Kaiser
Course Outline provided by Legalnut.com

§ 61. GROSS INCOME

A. Gross income means all income from whatever source derived, unless excluded by law

  1. Compensation for services, including fees, commissions, fringe benefits, and similar items

  2. GI derived from business

  3. Gains derived from dealings in property

  4. Interest

  5. Rents

  6. Royalties

  7. Dividends

  8. Alimony and separate maintenance payments

  9. Annuities

  10. Income from life insurance and endowment contracts

  11. Pensions

  12. Income from discharge of indebtedness

  13. Distributive share or partnership GI

  14. Income in respect of a decedent

  15. Income from an interest in an estate or trust

 

INCOME

  • Rent-free residence equal money equivalent to rent. Fair rental value of residence property is to be included in the taxpayers G.I.

  • Assignable frequent flyer miles by ER to EE have value and are included in GI. FFM had a personal benefit and are included in GI unless there is a restriction. It would have been different had the EE paid for the 10 previous flights. The free flight would have been considered paid for.

  • A donor who makes a gift of property on condition that the donee pay the resulting gift tax realizes TI to the extent that the gift taxes paid by the donee exceed the donor’s ADJB in the prop.

  • Reg. 1.61-2(a)(1): Tips are considered compensation for past services (business related). They are not gifts

  • Bargain purchase Basis is FMV Reg. §1.61-2(d)(2)(I)

  • Windfall Earnings: Glenshaw Glass, are fully taxable. Win a cruise vacation (raffle tickets are a form of gambling and you can deduct the cost the ticket from the windfall. Gambling losses §165(d)

  • HAIG-SIMONS INCOME; economic income for the year=consumption +[net change in worth (assets-liab)]. An increase in wealth may mean that you have income without realization. Even if you consume, it is taxable under FIT even though you cannot use it to pay the taxes.

 

  1. PRIZES & AWARDS §74

    1. Except as provided under §117, GI includes amounts received as prizes and awards.

      1. Was a prize received?

      2. At what amount is the taxpayer taxed at? FMV Reg. §20.2032.

        1. Is something else a better indicator of value; the basis could be from something other than source listed.

    2. EXCEPTIONS

      1. Prizes transferred to charities §74(b)

        1. recipient was selected without any action on his part

        2. AND the recipient is not required to render substantial future services as a condition to receiving the prize

        3. AND the prize was transferred by the payor to an organization described in §170(c) pursuant to a designation made by the recipient

      2. Employee achievement awards §74(c)(1)

        1. GI does not include the value of an employee achievement award (see §274(j)) if the cost to the employer of the EE award does not exceed the amount allowable as a deduction to the ER for the cost of the award.

 

  1. QUALIFIED SCHOLARSHIPS §117

    1. GI does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization described in §170(b)(1)(A)(ii)

      1. They don't qualify as a gift and are not compensation for services

    2. Qualified scholarships

      1. Qualified scholarship means any amounts received to be used for qualified tuition and related expenses

        1. Qualified tuition and related expenses means tuition and fees required for enrollment.

        2. Fees, books, supplies, and equipment required for course

        3. NO $ IS PERMITTED FOR ROOM & BOARD

      2. Reg. §1.117-6(a)(3)(i)“A scholarship is an amount paid for the benefit of a person in the pursuit of study or research. The recipient must be a candidate for a degree at an educational institution.

    3. Qualified tuition reduction--Employment related exclusion §117(d)

      1. Below the graduate level

 

  1. MEALS AND LODGING §119 §162 & §274 for ER

    1. NONCASH compensation.; EE is not WEALTHIER

    2. Applies to owners of a EE’s that are also the owners

    3. Meals and Lodging are excluded from GI of EE if furnished to EE, spouse, dependents (§152 for dependent requirements) by the ER for the convenience of the employer IF:

      1. the MEALS are furnished on the business premises of ER §119(a)(1)

        1. OR in the case of lodging, the EE is required to accept lodging on the business premises of his ER as a condition of his employment §119(a)(2)

          1. Business premises: means the place of employment of the EE.

          2. Compare the distance from the lodging facilities to the place where the ER’s business was conducted

      2. For the Convenience of the ER

        1. Must be furnished for a substantial noncompensatory business reason of the ER. EXAMPLES:

          1. Reg. §1.119-1(a)(2)(ii) meals furnished during working hours to have either EE available for emergency call during his meal period. CALL IT THE EMPLOYEE REQUIREMENT TEST.

          2. Must show that emergencies have actually occurred or are expected to occur and would result in the ER calling the EE to perform his job during his meal period.

    4. WHEN MEALS & LODGING ARE INCLUDED AS INCOME

      1. Reimbursed meals/meals allowance. ER is not constrained in his eating choices

      2. Meals furnished before or after work are not considered for the convenience of the ER unless Reg. §1.119-1(d) of (f) where an EE was so busy during working hours that he could not take time to eat--that would be for the convenience of the ER

      3. COMPENSATORY reasons

        1. when the meals are furnished to promote the morale or goodwill, or attract prospective EE’s

 

  1. § 132 CERTAIN FRINGE BENEFITS §162 for ER

GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent

No-additional cost services §132(b)(1)--service provided by an ER to an EE for use by EE if:

  • GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent

(1) Such service is offered for sale to customers in the ordinary course of the line of business or the ER in which the EE is performing services, and (if not then its taxable)

(2) The ER incurs no substantial additional cost (some cost is acceptable)(factors considered which are not acceptable--including forgone revenue) in providing such service to the EE.

  • Nondiscriminatory --not only the highly compensated employee, applies here (§132 (j)(6))

  • §132 (h)(2)(A) defines employee for this section: (spouse and children §152, retired, disabled). Treated as being received by the EE. When benefit is extended to family, its considered an intra-family support & is non taxable. If the benefit is extended to a non-family member then it is viewed as a gift.

  • Reciprocal agreement applies only to this section (§ 132(i))

  • Excess Capacity--no revenue lost by giving to EE rather than customer. STANDBY rather than RESERVED

  • E.g. Conglomerate, airline is owned by a cruiseline--EE at cruiseline cannot deduct the free plane ride.

Qualified employee discount §132©(4)--discount on property or services limited to:

  • GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent

(A) Limited to the gross profit percentage offered to customers (sales – CGS) / (sales)=GP %

(B) Services 20% of the price at which they are offered to customers in the ordinary course of business of the ER. Is a TICKET to an event a service or property? For goods see GP %. It may be more than 20%

  • Nondiscriminatory --not only the highly compensated employee, applies here (§132 (j)(6))

  • §132 (h)(2)(A) defines employee for this section

  • e.g. Rebates or discounts

  • e.g. Even if EE works for a mfgr and the rebate is to be used at the retailer.

  • e.g. Doesn’t apply to loans or investments Reg 1.132-3 p. 911

  • if discount goes below the cost, then the difference between cost and discount is taxable income.

  • DOESN’T APPLY TO REAL PROPERTY.

Working Condition Fringe §132(d)--property or services--IS TUITION REIMBURSEMENT INCOME? YES ER gets a deduction.

  • GI shall not include any fringe benefit, which qualifies as: Provided without compensatory intent

  • Can be discriminatory and still qualify for exclusion. (Car salesmen gets free demo to drive)

  • Excludable from GI if the property or services provided to EE would have been deductible had the EE paid for such services or property himself (cannot be personal in nature). It’s a deduction under §162. EX. free parking is a working condition fringe--the non discrimination requirement doesn’t apply

  • ex. subscriptions provided by ER/use of a company car/ bodyguard service/on the job training

  • FREE PARKING; any parking provided to an employee on or near the business premises of the ER.

  • INDEPENDENT GENERAL CONTRACTOR: Reg. §1.132-1(b)(2)(iv) includes them—don’t include in GI

De minimus fringe--the value of which is so small as to make accounting for it unreasonable/impracticable. The nondiscrimination requirement applies, except in the case of a company cafeteria

  • ex. Doughnuts, beverages, occasional (infrequent) sporting event tickets, or even a meal, photocopying

  • Nondiscriminatory & line of business requirements DO NOT apply—too small to matter

 

OTHERS FRINGE BENEFITS

  • §79 Group term life insurance

  • §106 disability & med. insurance ---no limit

  • §127 education assistance up to $5250, doesn’t have to be job related

  • §129 dependant care up to 5K/yr (but decreases 1 for 1 maximum amount )

 

 

  1. BORROWING AND LENDING

    1. An individual is not taxed on the amount that he borrows on the theory that the obligation to repay the loan offsets the amount received.

    2. CHARACTER OF A LOAN

      1. DID TAXPAYER DERIVE AN ECONOMIC BENEFIT FROM THE LOAN?

        1. Was there a wash for tax purposes? That is was that the liability the same as the proceeds. If so, then, no income is REALIZED §1001.

        2. If the liability is less than the proceed then, the taxpayer realized an economic benefit in the way of increase net worth as if he sold the property at a profit. This is a taxable event.

      2. A LOAN IS NOT INCOME

        1. The taxpayer is not taxed on the receipt of the principle amount and may not deduct the repayment of any amount except interest under §163 because the increase in cash is offset by an increase in liability.

          1. Types of debt

            1. Nonrecourse debt: a secured obligation for which the debtor is not liable. The lender’s only recourse for default is foreclosure on the property.

            2. Recourse debt: The debtor is personally liable whether or not secured by the property. Lender can garnish wages, impose liens on the other property.

 

    1. MECHANICS

      1. Interest is includable in GI by lender §61(a)(4), and deductible by the borrower §163

    2. CRANE RULE

      1. When property is transferred the amount of debt is to be added to the amount realized in calculating G/L under §1001 (difference between the FMV and AB to determine realized gain) regardless of whether it is recourse or nonrecourse

      2. BUYING PROPERTY: basis = cash outlay + Crane rule.

      3. SELLING PROPERTY: basis = cash rec’d + Crane rule.

      4. VALUE OF PROPERTY IS IRRELEVENT; TUFTS CASE

 

  1. DISCHARGE OF INDEBTEDNESS §108

    1. INCLUDED AS INCOME:

      1. The borrower must include in income the amount of the DISCOUNT (the amount owed less the amount paid to discharge the debt. §61(a)(12), DEBT FORGIVENESS, OR CANCELLATION.

        1. NOT A GIFT §102

        2. Freed-up asset theory—is a taxable event

      2. 3rd party pays the debt

        1. If a 3rd party pays the debt instead of the debtor, or the creditor discharging the debt, the debt is satisfied, not discharged. DEBTOR THEN HAS INCOME FROM THAT SATISFACTION.

        2. Exception

          1. Payment of the child’s debt by parent is like a gift and not includable in GI under §102. There must be no economic consideration or legal consideration given for the gift.

    2. Repayment by giving property:

      1. The transfer is a realization event and the amount realized is equal to the debt satisfied. Like a barter. §1001

    3. EXCEPTIONS:

      1. §108(a)(1)(A) and (d)(2) A financially troubled taxpayer can exclude discharge of indebtedness income if the taxpayer has filed a BANKRUPTCY PETITION.

      2. If the taxpayer has not filed a bankruptcy petition, the taxpayer can still exclude the discharge of indebtedness income only to the extent of the taxpayer's §108(d)(3) INSOLVENCY at the time of the debt discharge. Taxpayer's liabilities exceed FMV of its assets.

        1. To what dollar amount is taxpayer insolvent?

      3. DISPUTED DEBT OR CONTESTED LIABILITY

        1. ZARIN V. COMM. Under the contested liability doctrine, if the taxpayer in good faith disputes the amount of debt, the subsequent settlement of the dispute is treated as the amount of debt treated for tax purposes. The true amount of the debt is the amount for which it was settled. Zarin realized no income for tax purposes.

          1. Definition of debt is:

            1. §108(d)(1)(A) indebtedness that the taxpayer is liable for

            2. OR §108(d)(1)(B) subject to which the taxpayer hold property

        2. §108(e)(5) Reduction to Purchase Price--Must be a disagreement as to Price

          1. The reduction does not occur:

            1. in a title 11 case

            2. OR when the purchaser is insolvent

            3. But for this § the reduction would be treated as income to the purchaser from discharge of indebtedness

    4. MECHANICS

      1. When a debt becomes worthless, the lender has “sustained” a loss and is considered a bad debt loss §166. Under this §, a business bad debt is considered ORDINARY LOSS

      2. §1012 provided that the basis of property is the cost

    5. §108(b)(5) If taxpayer first elects to reduce his basis in depreciable assets, the debt discharge amount is applied first to reduce the taxpayers tax attributes in the following order

      1. NOL and carryovers

      2. Capital losses and carry over

      3. Basis of the taxpayers assets; §1017 if txpr excludes discharge of indebtedness then he must reduce his basis. REASON—debtor used the debt to acquire these assets, and they should reflect the value of the debt.

      4. Compare with §102

    6. 10K bank 35K other. 40K of assets. (so far insolvent 5K). If Bank discharges 6; you have income of 1K.

 

  1. DAMAGES COMPENSATION FOR INJURIES OR SICKNESS §104

    1. COMPENSATORY damages are excludable

    2. PUNITIVE damages are NOT excludable. Damages received on account of loss of reputation ARE taxable. §104(a)

    3. §104 excludes from GI damages received from personal injury or physical sickness. Purpose is to make the P whole as before the injury. This exclusion applies to recoveries for medical expense, lost wages (amount over that is income) and pain and suffering.

    4. WHAT IS PERSONAL?

      1. Reg. §1.104-1(c) provides that a claim is a personal injury claim if it is a TORT TYPE CLAIM and not a contract type claim.

        1. invasion of privacy

        2. slander

        3. assault/battery

        4. breach of a promise to marry

    5. A taxpayer can exclude damages received on account of a physical injury to his or her spouse.

    6. AMOUNTS EXCLUDED FROM INCOME

      1. §104(a)(1)Workers compensation acts as compensation for personal injuries or sickness

      2. §104(a)2 amounts from damages (other than punitive) received whether by suit or agreement and whether by lump sum or as periodic payments) on account of personal injury or physical sickness

      3. §104(a)(3) Amounts received through accident or health insurance for personal injuries or sickness.

      4. Wrongful death judgments

      5. Can exclude a recovery for emotional distress only if the distress is the byproduct of other physical injury or sickness (e.g. insomnia, headache, stomach disorders). If the emotional distress doesn’t result from any physical injuries or sickness, then the taxpayer can exclude from income the portion of the recovery that is for medical care attributable to emotional distress §104(a)

      6. Legal Fees allocable to any tax-exempt recovery are Nondeductible under §265(a)(1)

    7. AMOUNTS INCLUDED AS INCOME

      1. Recovery for future lost earnings capacity are taxable if actually earned in the future. Damages to compensate for lost business profits – GI to recipient GLENSHAW GLASS

      2. Damages for fraud = GI to recipient

      3. ATTORNEY FEES; §265(a) =GI for nontaxable and taxable awards

        1. §212 if for K damages; it may be a business expense

 

  1. ASSIGNMENT OF INCOME--INCOME SHIFTING §1(g)

    1. KIDDIE TAX §1(g)

      1. Net unearned income (investment income) of a child under 14 is taxed at the greater of the child’s tax rate or the parent’s rate. §1(g) applies to:

        1. §1(g)(2)(A) Child has not attained age of 14 by the end of the taxable year

        2. §1(g)(2)(B) either parent of the child is alive at close of the taxable year

        3. Has Net unearned income is the excess of twice the §63(c)(5) limited standard deduction or a person that is claim as a dependent by another.

        4. ALLOCABLE PARENTAL TAX Is the excess of tax imposed on the parent had the income

        5. §1(g)(4)(A) NET UNEARNED INCOME IS:

      2. MECHANICS

        1. Tax is levied on the excess of $500 (plus either expenses or $500 of the standard deduction) NUI – 500 -500

        2. Applies only to unearned income, interest or dividends

    2. INCOME FROM PROPERTY

      1. HEVERING V. HORST, ‘A’ owes ‘B’ money. ‘A’ instructs ‘B” to pay ‘C’, ‘A’’s money. Court said that ‘A’ enjoys the ECONOMIC BENEFITS of the income to the same extent as if ‘A’ would have received the money as earnings. Father was liable to pay taxes on the interest that accrued on a bond coupon before it was given as a gift to his son. You can make a VALID GIFT or ASSIGNMENT of income producing property but, cannot gift or assign income.

        1. The property owner is the one who reports income generated by it, and gain on the sale.

        2. Was D claiming the transfer was payment for past services rather than a gift? Income under §61 and a deduction under §162

          1. Was there a gift writing? Detached and disinterested generosity?

          2. What was the value of the work done? Reasonable Compensation? §162(a)(1)

          3. Was profit or property transferred?

            1. CAN GIVE AWAY THE TREE BUT NOT THE FRUIT

              1. EXAMPLES

                1. Assign as a gift, future earnings

                2. Assign as a gift, current earnings

      2. SUSIE SALVATORE, The entire planning and timing of the transaction showed NO OUTRIGHT GIFT, but were merely a plan to assign income from property in order to avoid taxes on that income. There was no actual conveyance of the property.

        1. Cannot transfer the taxable gain unless he transfers effective ownership.

          1. Was there already an existing partnership? And the property transferred was a distributive share of partnership GI?

            1. Was there an explicit agreement to carry on a business for profit?

            2. Was there a long history of dealing with one another that looked like a partnership?

            3. Who was the owner at time of sale?

            4. Who paid the capital gains?

      3. EFFECTIVE TRANSFER OF OWNERSHIP

        1. Was transfer timely and carried sufficient economic control that the sales would be treated as sale to the transferee rather than the transferor

        2. Have legal title

      4. INEFFECTIVE TRANSFER OF OWNERSHIP

        1. §102 for transferee §262 for OR

        2. §1015 for basis

 

 

  1. ONE TIME EXCLUSION §121 sale of home

    1. Basis §1012? How was the residence acquired?

      1. Gift/inheritance §1015

      2. Purchase, use cost basis §1012?

      3. Divorce settlement §1041(a)?

        1. Holding period (§121(d)(3)(A)) for the transferee is the period the transferor owned the property.

      4. INCREASING HOME’S BASIS

        1. Additions; bedroom, deck, garage, pool, fence

        2. Lawn & garden

        3. Alarm system, intercom system

        4. Electrical upgrades

        5. Built in appliances

        6. New water heater

    2. Gain from the sale of a personal residence is excluded from GI if:

      1. During the 5-year period ending on the date of the sale or exchange the property was owned and used-occupied by the taxpayer as the taxpayers principle residence for periods aggregating 2 years or more (2 out of the last 5 yr. period).

    3. LIMITATIONS

      1. 500K for joint filers; 250K single

      2. Only 1 sale every two years. 2 year period ending on the date of the sale or exchange.

        1. Reduced exclusion §121(c) if resident was not occupied for the required 2 yrs

    4. Involuntary conversion

      1. §121(d)(5); destruction, theft, seizure, requisition, or condemnation of property is treated as the sale

 

  1. HOME SALES §1034

    1. No like-kind exchange because its personal property

      1. Applies only to primary residence, not summer home

      2. EX. Buy H 65K, sell FMV H2 100K: H2 must be less than 85K or the difference will be taxed

      3. H1 100K, H2 95K: 5K CG = new basis=100

      4. Buy H1 65K, sell 85K, buy H2 100K: new basis = 100-(85-65)=80K

 

  1. PERSONAL CASUALTY LOSS §165

    1. Is it a personal casualty gain or Loss? Vs( business G/L—NOT SUBJECT TO $100 FLOOR)

    2. Is it a repair or a capital improvement?

      1. Is a gain or loss recognized from any involuntary conversion of property (can be a personal auto) arising from fire, storm, shipwreck, or other casualty, or from theft.

        1. Rev. Rul. Casualty is sudden, unexpected and unusual. Analyze the situation based on this criteria.

          1. cannot be progressive deterioration

      2. Loss cannot exceed the taxpayers AB of the property.

      3. Loss reduces the taxpayers AB in the property.

 

    1. Must be losses from property not connected with a trade or business

      1. Business losses are deducted to AB.

    2. Valuation of the loss

      1. Cost of repairs to the property damaged is acceptable as evidence of the loss of value if the taxpayer shows

        1. that the repairs are necessary to restore the property to the original condition immediately before the casualty,

        2. the amount spent is not excessive,

        3. the repairs do not care for more than the damage suffered

        4. And the value of the property after the repairs does not exceed the value of the property before the casualty. Reg. §1.165-7(a)(2)(ii).

      2. WHAT AMOUNT IS CONSIDERED CONSUMPTION? Part is consumption, part is loss that was not reimbursed, and the rest it the remaining value of the personal asset.

      3. Damage due to faulty driving

        1. Reg. §165-7(a)(3)(i) casualty loss is permitted if it’s due to the taxpayer's negligence. EX. negligent operation of an automobile. But, gross negligence (willful) is not permitted.

    3. MECHANICS

      1. §165(h)(1) subtract $100 from the casualty loss

      2. How much is over 10% of AGI? itemized deductions

      3. BUSINESS CASUALTY LOSSES are not subject to 100 floor or 10% of AGI. Loss equals the decline in FMV of the damaged portion of the property as a result OR basis in the damaged portion. §165(a) a deduction is allowed—business loss =”other”

    4. Casualty Gain

      1. §165(h)((2)(A) gain is treated as a CG

 

 

 

  1. INVOLUNTARY CONVERSION §1033

    1. May be the result of the destruction of property in whole or part, the theft, seizure, or requisition or condemnation of property. Or the threat on imminence of requisition or condemnation of property.

    2. IS A GAIN RECOGNIZED?

      1. Continuation of investment theory

      2. §1033 applies only to gains. Losses are not recognized by this §

      3. §1033 permits a taxpayer to ELECT out (compare with §1031), that is not to recognize some or all of the gain from the involuntary conversion/disposition of the property if the taxpayer “acquires property that is similar or related in service or use” within the requisite time.

      4. IF NOT RELATED?

        1. If the new property is not “similar or related in service or use” THEN MUST RECOGNIZE ENTIRE GAIN

          1. Is the original property rental property and the new property a residence?

    3. THEN, HOW MUCH GAIN IS RECOGNIZED IF RELATED?

      1. Under §1033(a), the gain is recognized only to the extent that the amount realized upon conversion exceeds the cost of the new property.

    4. WHAT IS THE CHARACTER OF THE GAIN?

      1. Was property used in a trade or business?

        1. §1231(a)(3)(ii)(I) Gain from the involuntary conversion of §1231 property

        2. Is a property used in a “trade or business” §1231 Was the property converted to rental use?

        3. §1231(b)(1) states that in order to be “property used in a trade or business”, the property must be held for more than one year. If less than a year then the gain is ordinary income.

          1. §1250 recapture

            1. §1250(a)(1) Recapture is limited to “additional depreciation.”

            2. §1250(b)(1) defines additional depreciation as the excess of the actual depreciation taken over straight-line method. This doesn’t apply because all post 1986 real property must use straight-line. No accelerated method can be used on real property.

          2. §1245 recapture

    5. TYPE of property

      1. Was the property transferred incident to divorce? §1041

      2. Was it a Capital asset? §1221

        1. If the property was a capital asset, then the gain was still §1231 gain under §1231(a)(3)(A)(ii)(II). This applies to gains from involuntary conversions of a capital asset held >1yr.

        2. Then, what is the holding period?

    6. What is the new basis in the property? §1012

 

 

  1. LIKE-KIND EXCHANGE §1031

    1. If it’s not a like-kind exchange; take the value at date of exchange or transfer.

    2. The nonrecognition provision is MANDATORY.

    3. The Realization Doctrine: for a gain to be recognized, it must be realized. There must be a change in form ---sale

    4. Viewed as a continuation of the investment

      1. Land for personality is not like kind. Not a continuation of investment

    5. Is it a like-kind exchange?

      1. §1031(a)(2) doesn’t apply to many types of property exchanges: PROHIBITED CATEGORIES:

        1. doesn’t apply to exchanges of inventory held primarily for sale

        2. doesn’t apply exchange of stock or bonds or indebtedness

        3. doesn’t apply to interests in partnerships

        4. doesn’t apply to trusts or beneficial interests

        5. doesn’t apply to contract rights or lawsuits

    6. CODE; “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” Look to the future use by the same person.

      1. REQUIREMENT:

        1. The form of the transaction is an exchange

        2. Both the property transferred and the property received are held either for productive use in a trade or business or for investment.

        3. The property is like-kind property IF:

          1. Real estate can only be exchanged for other real estate

          2. Personality can only be exchanged for other personality

            1. LIKE-KIND OR LIKE CLASS? Reg. 1.1031(a)-1 states that unimproved property and improved property are property of like-kind. Can have stock for property but not stock for stock. Like kind refers to the “nature and character of the property and not its grade or quality.” Reg. §1.1031(a).

            2. e.g. Trucks must be of the same class

            3. Computer for office equipment is in DIFFERENT business classes.

    7. What is the AB of property? Land cannot be depreciated.

      1. Was it inherited? use §1014 for basis (equals FMV at DOD)

      2. Transfer between spouses incident to divorce §1041. Basis equals the transferor’s AB in the property.

      3. Was it a gift? use §1015 (basis equals the donors basis)

      4. Is it §1231 property? AB equals cost to capital improvements that extend its useful like and minus any capital expenditure take (e.g. depreciation §167 &§168)

      5. Gain is not eliminated but deferred. No stepped-up basis.

    8. What is the amount REALIZED §1001(b)? It equals the FMV of his property at the time of exchange minus AB. This is the realized gain.

    9. Is any gain RECOGNIZED §1001(c) ?

      1. If property was held primarily for sale (then the property is not a capital asset §1221(1); and it is not §1231(b)(1)(B) property. If so, then must recognize all gain and is barred from nonrecognition--that is recognize as ordinary income.

      2. If BOOT is received then a gain is recognized to the lesser of: (1) the gain REALIZED (basis – FMV of that property) in the exchange or (ii) the FMV of the boot (CASH PLUS DEBT RELIEF) received.

      3. Losses are not recognized.

    10. Basis in new property:

      1. Is equal to basis in property given up (+CRANE RULE) in the exchange, reduced by any amount of money received and increased by the amount of gain recognized. §1031(d) This gives person a new cost basis §1012; to be used for depreciation purposes §167.

    11. SPECIAL PROVISION §2670(b)

      1. To qualify for a like-kind exchange, the taxpayer and the related party must not dispose of the like-kind property received in the exchange within a 2yr period following the date of the exchange. If disposition does occur then GAIN is RECOGNIZED.

 

    1. OTHER NONRECOGNITION PROVISIONS

      1. §102 GIFTS & INHERITANCE

      2. §104 DAMAGES

      3. §108(a)(1)(A) DISCHARGE OF INDEBTEDNESS

      4. §117 QUALIFIED SCHOLARSHIPS

      5. §118 MEALS & LODGING FBO EMPLOYER

      6. §121 SALE OR PRINCIPLE RESIDENCE

      7. §1031 LIKE KIND EXCHANGES

      8. §1033 INVOLUNTARY CONVERSIONS

      9. §1041 TRANSFERS INCIDENT TO DIVORCE

    2. REASON TO DEFER INCOME

      1. Seller may lack liquidity; no money to pay taxes now

      2. The value of property may fluctuate from yr to yr

      3. The realization requirement delays the imposition of tax until the property is sold.

 

  1. PROPERTY USED IN A TRADE OR BUSINESS §1231

    1. Business real estate or depreciable business property is excluded from the definition of capital assets. However, if business property qualifies as §1231 property & gains exceed losses, then each gain or loss is treated as though it were derived from the sale of LTC. They are NOT capital assets. §1221(2)

    2. Property Excluded:

      1. Property held less than a yr

      2. Inventory held primarily for sale to customers

      3. Intangible assets EX. acct./rec & acct./pay

      4. Casualty losses

        1. Casualty Gains are §1231 assets.

    3. §1231 states that net gain from the disposition of such property is sometimes treated as LTCG

    4. LOSSES

      1. This § treat’s losses as ORDINARY and are fully deductible FOR AGI

    5. 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

        1. Property used in a trade or business

        2. Any capital asset held greater than 1 yr. in connection with a trade or business entered into for profit.

      3. 1

    6. MAIN HOTCHPOT losses

      1. §1231(a)(3)(B) includes losses on the destruction , theft or seizure or requisition or condemnation

    7. SUBHOTCHPOT gains & losses §1231(a)94)(c)

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

 

  1. §1245 RECAPTURE

    1. This §1245(b) & §1250(d) applies to all DISPOSITIONS depreciable personal property.

      1. EXAMPLE

        1. Amortizable personal property; goodwill, patents

        2. §179 immediate expensing §1245(a)(2)(C) & §179(d)(10)

    2. This provision causes gains to originally be treated as ORDINARY gains/income.

      1. Gains are to be treated as ordinary gains to the extent of depreciation taken on the property disposed of.

      2. §1231 gain only results when the property is disposed for more than its original cost. The excess of the sale price over the original cost is §1231 gain.

  1. §1250 RECAPTURE

    1. §1250 property is depreciable REAL property

    2. Recaptured amount is OI §1250(a). Only the amount of “additional depreciation” is subject to recapture. Property placed in service after 1986 will not have §1250 recapture because it uses straight-line depreciation.

    3. §1250 (a)(1)(A)(ii) The excess of the amount realized, or the FMV over the ADJB SHALL BE TREATED AS GAIN WHICH IS ORDINARY INCOME.

 

  1. REAL PROPERTY (LAND) SUBDIVIDED FOR SALE §1237

    1. Is there a sale of a parcel of LAND §1237?

    2. This § does not apply to losses. A loss would be treated as an ordinary loss unless the property is considered a capital asset under §1221.

 

    1. Was it a sale of INVENTORY?

      1. Any lot or parcel which is part of a tract of real property in the hands of a taxpayer other than a C-Corp shall NOT be deemed to be held primarily for sale to customers in the ordinary course of trade or business if:

        1. The tract or lot was not previously held for primarily for sale to customers in the ordinary course of a trade or business.

        2. No substantial improvement that substantially enhances the value of the lot

    2. Sale of more than 5 parcels

      1. If more than 5 lots or parcels contained in the same tract or real property are sold or exchanged, gain from the sale or exchange of the 6th parcel shall be deemed to be gain from the sale to customers in the ordinary course of business to the extent of 5% of the selling price.

    3. If the seller is NOT a dealer in property then §1237 allows real estate investors capital gain treatment if they engage in limited development activities.

      1. If they are not a corp

      2. No substantial improvements

      3. Must have held lots for 5 yrs.

    4. What is the BASIS?

      1. Necessary improvements--that are NOT substantial improvements

        1. §1237(b)(2)(A) No improvements shall be deemed a SUBSTANTIAL improvement if the lot or parcel is held by the taxpayer for a period of 10yrs and IF:

          1. the improvements is for installation of sewer, drainage

    5. What is the character of G/L

      1. Was it inventory?

      2. §1231 property?

      3. §1221 capital gain property?

 

  1. INSTALLMENT SALES METHOD §453

    1. §453(b) The term “installment sale” means a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs.

    2. §453(b)(2) EXCEPTION: Installments sales do not include:

      1. any dealer disposition

      2. inventories of personal property

    3. §453(c) defines installment method as a method in which the income recognized for any taxable year from a disposition is that portion of the payment received in that year which the gross profit realized bears to the total contract price.

    4. §453(d) ELECTION OUT:

      1. Election out must be made on or before the due date prescribed by law for filing the taxpayers return

    5. §453(e) SECOND DISPOSITION BY RELATED PERSONS

      1. If property is disposed to a related person

      2. and before the person making the first disposition receives all payments, the related person disposes of the property, then the amount realized with respect to the second disposition shall be treated as received at the time of the second disposition by the person making the first disposition.

    6. §453(e)(7)TAX AVOIDANCE

      1. Taxpayer cannot use the installment sales method under this section if the Secretary of the IRS establishes that neither the first disposition nor the second disposition had as its principle purpose the avoidance of FIT.

    7. §453(i) RECOGNITION OF RECAPTURE INCOME IN THE YEAR OF DISPOSITION

      1. §453(i)(1)(A) states that any recapture income shall be recognized in the year of disposition §1250 & §1245. Recompute GI by subtracting depreciation from GP then dividing by the total contract price.

    8. §453B GAIN OR LOSS DISPOSITION OF INSTALLMENT OBLIGATIONS-SALE OD REC’

      1. If an installment obligation is satisfied at other than face value, distributed, sold or disposed of (gift), gain or loss shall result from the difference between the basis of the obligation and the amount realized or the FMV of the obligation at the time of distribution.

        1. see page 430 in code

    9. MECHANICS

      1. Add up total payments to be rec’d minus ADJB = GP. GP/total proceeds = GP%. GP% X amount of PMT rec’d in that year.

 

  1. Computation of DEPRECIATION on the property. §167-8 & §179

    1. Depreciation is allowable when property is placed into service. When was this? Covert property to rental property.

    2. Land, inventory and personal items are not depreciable. Only buildings and equipment are capitalizable.

    3. Assign costs to building and land

    4. §179 ELECTION TO EXPENSE CERTAIN DEPRECIABLE BUSINESS ASSETS BONUS DEPR

      1. only applies to §1245 property which is property other than buildings (buildings are §1250 property).

      2. §179(d). Limit for 1999 is $19,000.

    5. §168 DEPRECIATION

      1. Capital improvements: increase /prolong the life of the property greater than 1yr. Improvement/upgrade replacement,

      2. Repairs and maintenance Reg. §1.162-3 Incidental expenses do not produce a benefit beyond the current year Repairs and maintenance neither materially add to the value of the property nor prolong life. Only keep it in an ordinarily efficient operating condition. I.e. restore to original working condition. Cost to maintain the building.

      3. Prerequisites: §167(a) & 168(a) restrict the depreciation deduction to:

        1. Property used in a trade or business

        2. OR property held for the production of income

      4. §168(e)(2)(B) describes what is not residential real property. NONRESIDENTIAL REAL PROPERTY has a class life (or recovery period) of 39 yrs. EX office bldg.

      5. §168(e)(2)(B) RESIDENTIAL RENTAL PROPERTY” if 80% or more of the gross rental income of the property is rental income from a dwelling unit. Dwelling unit means house or apt bldg. to provide living accommodations, but does not include a hotel or motel. The class life is less than 27.5yrs. Condominium is residential rental property to the owner if it is leased out.

    6. RECOVERY METHOD

      1. Applicable *recovery method is straight-line, §168(b)(3)(A)

      2. Applicable *recovery period is 27.5 or 39 yrs.

      3. Applicable *convention is MIDMONTH, §168(d)(2).

      4. MID QUARTER convention applies to non-real property. EX .equipment

      5. 150% DDBM applies to 15 or 20yr prop

      6. 200% DDBM applies to all other property.

    7. §1231 CHARACTERIZATION ON THE SALE OF DEPRECIABLE PROPERTY.

      1. Held > 1yr; not inventory sold in the ordinary course of business.

      2. Sale or exchange of depreciable property/or real estate used in a trade or business, net gains are treated as capital gains and net losses are treated as ordinary losses.

    8. §1239 SALE OR EXCHANGE BETWEEN RELATED PARTIES (controlled entities >50%)

      1. No preferential tax treatment is permitted.

      2. So that you don’t sell a depreciated asset & re-depreciate it through a related company to offset a gain from the sale.

      3. Treated as ordinary income.

    9. LIMITATION ON DEPRECIATION §280F

      1. Limitations on luxury automobiles p241 code

      2. Limitation where business use of property is not greater than 50%

    10. DISALLOWANCE OF CERTAIN ENTERTAINMENT EXPENSES §274(d)

      1. §274(d)(4) with respect to any listed property (see §280F(d)(4))

    11. NEW BASIS; §1016 Adjustments

 

 

 

 

  1. DEDUCTIBLE INTEREST §163

    1. §163(a); All interest is fully deductible unless, there is a code section which made it partially or wholly nondeductible--”personal interest §163(h)(1).”

    2. Must be legal owner

    3. Interest on a loan, even a car loan, secured by a residence is “QUALIFIED RESIDENCE INTEREST

      1. §163(h)(4)(A) a qualified residence means principle residence and one other.

      2. §163(h)(A)(iii) residence not rented

      3. QUALIFIED RESIDENCE INTEREST is defined by §163(h)(3)(A) as either interest “acquisition indebtedness” or “home equity indebtedness.”

        1. §163(h)(2)(B)(i)(I) Acquisition Indebtedness must be used to build, construct, buy, or substantially improve (could be a substantial home improvement) a residence. 1,000,000 limitation; 500K married filing separately

        2. Home Equity indebtedness §163 (h)(3)(C) is secured by a qualified residence §163(h)(4)(A). The amount cannot exceed to FMV of the property. And cannot exceed $100,000 of debt. REFINANCING

    4. LIMITATION: §163 (d) INVESTMENT INTEREST. §163(d)(3)(B)(i) states that qualified residence interest is not investment interest.

      1. Investment interest is interest paid on indebtness properly allocable to property held for investment. PROPERTY HELD FOR INVESTMENT: §163(d)(5)(A) is property that produces income as described in §469(e)(1). RENTS are not listed in this §

      2. Investment interest is deductible to the extent of Net Investment Income. (NII – NI expenses).

      3. No carry-over limitation. Carry forward indefinitely and subject to the same investment interest limitations

      4. Investment income =dividends

      5. BELOW THE LINE DEDUCTION

    5. PERSONAL INTEREST

      1. is defined §163(h)(2) as all interest other than:

        1. Investment interest

        2. Passive activity interest

        3. Qualified residence interest

        4. Interest on tax liability

      2. Is nondeductible under §163(h)(2)

    6. TRADE OR BUSINESS INTEREST

      1. Is fully deductible because no limitation in §163 applies to it.

    7. IS OWNING ONE /SINGLE RENTAL PROPERTY A TRADE OR BUSINESS?

    8. §265 CANNOT BORROW MONEY TO PURCHASE TAX EXEMPT ANNUITIES

 

  1. INTEREST--FREE LOAN §7872

    1. Borrow money without interest

    2. The lendor’s intent is to create a GIFT LOAN §7872(f)

    3. For income tax purposes, the determination of the amounts transferred between the parties is made under §7872(a)

      1. Whether it is a demand loan doesn’t matter because all gift loans are governed by §7872(a)

    4. The de minimis rule of §7872©(2) applies to loans under 10K

    5. COMPUTING INTEREST

      1. Compound semi-annually. With an annual interest rate of 10%, the interest for half the year is 5%, and for three months is 2.5%. (loan made at end of 1st qtr; take loan amount X qtrly rate = 2.5% then ad the interest to loan and for the second half of yr take ½ yr interest rate (5%) X loan amt with the imputed 2nd qtr interest.

        1. Add interest for the first half of the year to the principle, then take the principle with the accrued interest and calculate the interest on the compounded amount for the second half of the year at the semi-annual interest rate. This is called the “approximate method” Reg. §1.7872-13.

    6. MECHANICS

      1. The transfer from OR to EE is treated as a gift §102 and no income tax consequences to either party (§262 not deductible by OR & §102 not includible by EE). §7872(a) creates a re-transfer from EE to OR as interest (subject to the de minimis rule). The amount of the re-transfer from EE to OR is limited by §7872(d)(1)(A).

        1. The aggregate of all gift loans from OR to EE must be less than 100,000. §7872(d)

        2. The amount treated as re-transferred by the borrower to the lender as of the close of the year shall not exceed the borrower’s net investment income for such year.

        3. Lender is treated as having received interest §7872(a) and is included in income §61(a)(4) and may be deductible by the borrower under §163 if permitted.

 

 
  1. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS §71

    1. REQUIREMENTS§71(b) GI includes amounts received as alimony or separate maintenance payments

      1. Be made in cash/check or money order. Promissory note & artwork are NOT CASH.

      2. Made under a divorce or separate instrument and received by or on behalf of spouse (under divorce decree §71 (b)(2)(A))

      3. No election not to treat as alimony must be included in payee’s income and deducted by payor §215.

      4. They were living apart at the time of the payments. SEPARATE HOUSEHOLDS

      5. No liability for payments after payee spouse’s death. otherwise it looks like child support or a property settlement. EX. Divorce decree cannot say to make pmts for next 10yrs—no post death payment is deductible.

    2. §71(c)(1) doesn’t say that CHILD SUPPORT is not alimony. But, it doesn’t say that sub§(a) shall not apply. This means that child support is not income to mother.

      1. §71(c)(2) Reduction of child support based on Contingency:

        1. Attaining a specified age

        2. Marrying

        3. Dying

        4. Leaving school

    3. INDIRECT PAYMENTS, must be made in cash

      1. Rental or Mortgage Payments

        1. If the payor spouse owns the home, then NO alimony

      2. Insurance Premiums

        1. Deductible by OR as long as EE spouse is the owner of the policy

    4. IF FATHER FALL BEHIND ON HIS PAYMENTS. §71(C)(2)(3). Whenever payments are in arrears, the full payments are allocated first to child support until arrears are made up.

      1. Then, “so much of the payment as does not exceed the sum payable for support shall be considered payment for the support.” This means the first dollars received as payments are allocated to child support. Applies to payments in arrears.

      2. Payor gets no deduction and neither child or mother has to claim it as income.

    5. WHAT PORTION IS DEDUCTIBLE BY THE PAYOR §215(a); AND INCLUDABLE AS INCOME BY THE PAYEE §215(b)?

    6. §71(f)(2) ALIMONY RECAPTURE: Excess alimony payments

      1. Large lump sum payments are considered property settlements and not alimony and therefore cannot be written off. FRONT-LOADING of disproportionately large payment.

      2. An amount is recaptured by the payor spouse as income and deducted by the payee spouse to offset prior inclusions

      3. This provision is to correct/recapture amounts that were improperly treated as alimony in the previous years.

        1. §71(f)(4) First determine the second year recapture by determining the first year recapture under §71(f)(3)

          1. First (assuming 3 yr. analysis and yr. 1 & 2 are more than yr. 3) Take the amount of yr. 2 and subtract it from (yr 3 + 15K)

          2. Second, subtract yr 1 from the average of (yr 3 + 15K) +( yr 3). Add up 1st yr and 2nd yr recapture and that is the amount to be recaptured in yr 3.

        2. EXCEPTIONS to §71(f)(4)

          1. Contingent payments

          2. payments of child support

    7. MECHANICS

      1. Payors spouse; deduction §215

      2. Payee spouse; inclusion §71

 

 

  1. TRANSFERS BETWEEN SPOUSES AND FORMER SPOUSES §1041

    1. Between spouses or former spouses, NOT PALIMONY

    2. Property settlements

    3. §1041: No gain or loss is recognized by either spouse provided that the transfer is incident to divorce/gift or sale or exchange between spouses acting at arms length Reg. §1.1041-1(a).

      1. Ex. Sell property to your wife. No G/L recognized. Purchaser spouses basis is the seller spouse’s basis.

    4. A transfer is incident to divorce §1041(a) if it occurs within one year after the cessation of the marriage.

    5. §1041(c)(1)&(2) Transfers must occur no more than 1yr after the date on which the marriage ceases OR the transfer id related to the cessation of the marriage.

    6. Transfer on behalf of spouse (3rd party)

      1. As required by a divorce

      2. Pursuant to written request of former spouse

    7. BASIS: The transferee assumes the transferor’s basis §1012 basis & §1016 ADJ to basis; in the property. Deferred gain.

    8. US v. DAVIS, If one party takes substantially all of the community property and give the spouse a cash settlement, the transaction will be considered a sale of the spouse’s one half interest.

 

  1. RECEIPT OF PROPERTY AS A GIFT IS NOT INCOME; §102(a)

    1. IS IT A GIFT?

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

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

      3. Is the transfer a gift under the meaning of DUBERSTEIN? Must imply “detached and disinterested generosity.” The common law meaning of gift is an effective transfer without monetary consideration. The cmn law and DUBERSTEIN do not necessarily go together. Whether the property is regarded as a gift is a question of fact—look at the transferor’s intent

        1. NO retained control, no benefit received by donor.

        2. Was there writing stating intent to transfer money or property?

      4. Look to the substance of the transaction. Not form.

      5. Was there an effective transfer before a sale by the donor? That is delivery of a receipt?

      6. §102(b) states that income from property received as a gift is not excluded from income. Owner of the property includes as income and income generated by the property.

      7. Is it compensation for past services? If so then, §102(c) says that it is not excluded from income and therefore ordinary income under §61 and a deduction for payor under §162?

        1. A gift to a family member who is also an employee may not be within §102(c) if the gift is unrelated to the employment of the

      8. When did title pass, was it a timely transfer? Who had dominion & economic control?

    2. GIFTS TO EE’s §102© are not gifts under this §: look under §74 EE achievement awards

      1. EXCEPTION

        1. A gift to a family member that is also am EE may be within §102 if the gift is unrelated to the employment status

    3. WHAT IS DONEE’S BASIS?

      1. §1014 basis from inheritance §2032 FMV

      2. §1015 basis for gifts (CG or ordinary income) EE inherits basis TAFT v. BOWERS. If basis is unknown then EE’s basis is ZERO. Sale would = total sale price of GI

        1. If gift is of appreciated property; take OR’s basis

        2. If gift is of depreciated property; (FMV is less than OR’s basis)

          1. To determine gain take OR’s basis

          2. To determine loss take FMV @ time of transfer

            1. EXAMPLE

              1. OR’s basis 50

              2. FMV 40

              3. Sale 60 = 10K gain

              4. Sale 35 = 5K loss

              5. Sale 45 = no gain or loss

      3. §1041 for transfers between spouses

      4. Reg. §1.1012-1(c) sale of stock purchased at various amounts.

        1. If the taxpayer can identify the specific shares sold then, that identification will control. If no specific identification can be made then, the shares sold are deemed to be the first ones required.

    4. GIFT IS NOT DEDUCTIBLE BY OR §262

 

 

  1. CHARITABLE CONTRIBUTIONS §170

    1. Cannot be Quid Pro Quo, motive must be pure. Purchase a raffle ticket (partial self-interest motive)—deduct the amount over the FMV of the raffle ticket. The other part is CONSUMPTION for gambling and is non deductible under §165(d)

    2. GIFT CANNOT BE CONDITIONAL Reg. §1-170A-1©; DUBERSTEIN CASE

    3. Qualifying charities §170(c); §501©(3); church, educational organization, organization whose purpose is to provide medical or hospital care or medical education or medical research.

    4. §170(b)(1)(B)(vii) 50%

    5. §170(b)(1)(C)(iv) if the contribution is a gift of capital gain property, the donor can deduct only 30% (LTCG STK).

    6. §170(b)(1)(F) Contribution base is defined as the taxpayers AGI not including NOL carryovers.

    7. §1.170A-1(g). Donation of SERVICES is not deductible. The person is not taxed on imputed income that they would have earned. However, Rev. Rul, 73-597-permit unreimbured expenses incurred in rendering those services (other than childcare expenses), Transportation & cost of uniform.

      1. LIMITATION Contributions of ordinary income and capital gain property is an EXCEPTION to the permission to deduct the FMV of the donated property, §170(e)(1)

        1. §170(e)(1) requires the contribution to be reduced by all or a portion of the gain that would have been realized if the donated property was sold.

          1. §170(e)(1)(A) if the gain would have been ordinary income or STCG then, the contribution must be reduced by the entire gain. That is, the donor can only deduct his AJB in the contributed property. (E.g. Donation by a dealer in property.)

          2. §170(e)(1)(B) If a sale of the donated property by the donor would have produced LTCG, the donor ‘s deduction is limited to the donor’s basis in the property IF

            1. the contributed property is tangible personal property and the donee charity’s use of the property is unrelated to the organizations charitable purpose. (e.g. a painting) Stock IS NOT tangible personal property.

            2. OR the property is donated to certain Private Organizations, which does not meet certain requirements of §509 (private foundation). A university is NOT a private organization.

              1. ELECTION; can deduct FMV @ 30% or deduct ADJB @50%. Determine which is better.

          3. If donor contributed Real property that would have produced LTCG had the donor sold it and neither of the previous two-§170(e) limitations applies, then §170(b)(1)(C) applies. This §170 deduction is limited to 30% of donors AGI. (E.g. donation of a piece of raw land held for investment.

      2. CARRYOVER

        1. §170(d) excess of the 50% contribution base is carried forward in to the succeeding 5 years. USE OLDEST CARRYOVER FIRST. Subject to the same 30% or 50% limitations

 

 

 

  1. §162 TRADE OR BUSINESS EXPENSES

    1. Can deduct all ORDINARY & NECESSARY expenses incurred in a trade or business (costs associated with earning income) *NOT CAPITAL EXPENDITURES

      1. ORDINARY EXPENSE; are those which are CMN in the line of business WELCH

      2. NECESSARY EXPENSE are those which are APPROPRIATE to the business.

      3. EXAMPLES:

        1. Reasonable allowance for salaries, maximum an employer can deduct is $1m annually. Any UNREASONABLE AMOUNT IS NOT DEDUCTIBLE.

          1. Reasonable is determined by qualifications, nature of work, complexity of business, economic conditions.

        2. Travel expenses (including amounts for meals and lodging, except that which is extravagant under the circumstances) while away from home in the pursuit of a trade or business. IF NO HOME then you cannot be away from home. Principle home is home for tax purposes.

          1. TRIP MUST SOLEY FOR BUSINESS and expenses incident to travel such as telephone, cab fares, UNLESS the trip is personal in nature, then they are personal and living expenses. Reg. 1.162-2

 

            1. OVERNIGHT RULE;

            2. If the trip is undertaken for both business and personal, traveling expenses to and from such destination are deductible only if the trip is PRIMARILY related to the taxpayers trade or business (depends on the facts and circumstances; time spent on business. Reg. §1.162-2(a)

            3. INCIDENTAL TRAVEL

              1. Telephone calls, tips, baggage charges, laundry may be either transportation or meals & lodging expense

            4. SPOUSE TRAVELS W/ YOU

              1. The travel of the spouse, dependent must be for a bona fide business purpose and such expenses would otherwise be deductible.

          1. CAR EXPENSE. Commuting between home and work is nondeductible personal expense. The cost of driving between the primary work location and other places where duties take him is an ordinary & necessary business expense deductible under §162(a). Same applies to a person who drives between two different places of business.

        1. Rental or other payments

        2. Management expenses

        3. Insurance expenses

        4. Education Expenses; Reg §1.162-5 that maintain or improve skills required for employment.

        5. Bonuses Reg. §1.162-9

        6. Investigation of a business: investigation expenses to determine the feasibility of entering a new business or expanding an existing business. Taxpayer must be in the same or similar business.

          1. Cost of travel

          2. Engineering architectural survey

          3. Legal & accounting services

    1. NONDEDUCTABLE

      1. §162(e) no deduction is permitted for influencing legislation, regardless of indirect payments Reg. §162-18

      2. §162(f) fines and penalties

      3. §162(g) Treble damage payments under the antitrust laws

      4. Charitable contributions

      5. Reg. §1.162-5; meeting minimal education requirements.

        1. Reg. §162-5(a)(3) Qualifications for a new trade or business, unless the change of duties involve the same general type of work.

      6. LIMITATIONS

        1. §162(l) On medical insurance expenditures for self employed persons

        2. §274(j) qualified plan awards shall not exceed $1600, Nonqualified plan award less than $400

        3. §280 F(d)(3)(A) does the EE need a laptop computer? No deduction by EE unless its for the convenience of the ER and required as a condition of his employment.

    2. §274 DISALLOWANCE OF CERTAIN ENTERTAINMENT EXPENSES—Misc business deductions:

      1. 50% DEDUCTION FOR MEALS & ENTERTAINMENT §274(n)

        1. ENTERTAINMENT: amusement, or recreation, hunting, fishing. Expenses for entertainment must be directly related to a bona fide business discussion associated with a trade or business. NOT Lavish or Extravagant §274(k)(1)(b) & txpr presence is required§274(k)(1)(b).

          1. OBJECTIVE TEST Reg. §1.274-2

            1. consider taxpayers trade or business

            2. Were the distractions substantial? Night club

          2. Amount deducted for tickets cannot exceed face value §274(l), unless it is a charitable sporting event

        2. MEALS: food or beverages §274(k) only applies to meals:

            1. Must not be lavish or extravagant

            2. The taxpayer or an employee of the taxpayer is present at the furnishing of the food or beverage

          1. If meals are deductible then cab fare is

      2. GIFTS: can deduct up to $25 per gift §274(b)

      3. TRAVEL EXPENSE FOR RELATIVES §274(m)

        1. No deduction is permitted unless the spouse, UNLESS

          1. dependant is a an employee of the taxpayer

          2. AND the travel for the spouse, dependant is for a bona fide business purpose

          3. AND such expenses would ordinarily be deductible by the spouse, dependant

      4. SUBSTANTIATION: no deduction is permitted unless the taxpayer substantiates by adequate records or by sufficient evidence §274(d).

        1. the amount

        2. the time and place of the travel, entertainment, amusement, recreation,

        3. the purpose of the expense,

        4. the business relationship to the taxpayer the person being entertained or receiving the gift

        5. COHAN rule, if txpr cannot substantiate amount spent, then the IRS may allow txpr to obtain a deduction for an appropriate amount which would have been spent in light of the surrounding circumstances. Except for meals & lodging while away from home, business gifts & entertainment expenses.

    3. MECHANICS

      1. ER’s expenses for determining AGI.

        1. Is it a condition that can be left alone and repaired in the future? Does this make it any less ordinary or necessary? What is the degree of need? This actually doesn’t matter.

        2. EE’s subtract from AGI §67 misc.

        3. Are they personal in nature? If so, then they are not deductible. CONSUMPTION

    4. CURRENTLY DEDUCTIBLE “ORDINARY” v. CAPITALIZABLE

      1. Compare with Capitalizable expenses §263; depreciation

        1. Have a useful life greater than 1yr

        2. Materially increase value or the useful life

      2. Repairs & maintenance COHAN rule

        1. Deducted currently, ordinary cost of doing business

    5. GOODWILL

      1. Building Goodwill is currently deductible

      2. Purchasing Goodwill is Capitalized

    6. START-UP EXP §195

      1. Not currently deductible, capitalized over 5yrs

        1. Expenses incurred in INVESTIGATIONG or STARTING a business

  1. Expenses (ordinary & necessary) incurred for the production of income §212; e.g. rental property

 

  1. NONDEDUCTIBILITY OF PERSONAL CONSUMPTION §262(a)

    1. No deduction shall be allowed for personal, living, or family expenses

    2. §165 disallows the deduction of most personal losses; cart, house sale

  2. LOSSES

    1. Wagering losses; permitted to the extent of gains §165(d) considered Consumption; enjoyment of gambling.

    2. Worthless securities; loss is permitted for completely worthless securities; losses are CL

    3. Theft losses;

    4. Sales of residential property; loss not allowed

 

  1. HOBBY LOSSES §183

    1. Business or investment expenses are deductible only if the taxpayer can show that the activity was entered into for the purposes of making a profit.

    2. Misc. itemized deduction subject to a 2% floor.

    3. FACTORS TO CONSIDER:

      1. Was the activity conducted in a business like manner

      2. Time & effort expensed

      3. History of income or loss from the activity

      4. Elements of personal pleasure or recreation in the activity

    4. PRESUMPTIVE RULE OF §183

      1. An activity is profit seeking if the activity shows a profit in at least three of any five prior consecutive years.

      2. Appropriate and helpful; that a reasonable person/company would do. That is that it is common and accepted in the particular business activity.

 

  1. REALIZATION §1001

    1. To realize a gain, you must have a change in for of the investment.

      1. Unrealized g/l; stock split

 

  1. ADJUSTED BASIS §1012

    1. Price paid (cash/property)

    2. Leasehold improvements §1019 –property improvements made by EE is not GI to OR and does not adjust basis for OR. & §109

  2. ADJUSTMENTS §1016

    1. Improvements

    2. depreciation

 

  1. AGI

    1. Above the line §62

      1. Trade and business expenses

      2. Reimbursed expenses of EE’s

      3. Losses from prop

      4. Deductions from rental prop §212

      5. Alimony§215

    2. Below the line

      1. Itemized deductions

        1. interest

        2. property taxes

        3. casualty losses

        4. medical exp.

    3. Items not deductible

      1. Personal living expenses §262

      2. Capital expenditures §263 items not currently deductible

 

 

OTHER §’S

Misc itemized deductions §67 2% floor (subscriptions)

Personal Exemption §151

Dependency Exemption §152

Standard Deduction §63

Itemized deductions §68

Extraordinary Medical Expense §213

Medical Benefits by ER §105, 106

Annuities §72

Life Insurance §101

 

PENALTIES

Willful attempt to tax evade (felony) ---100K = 5yrs §7201

Willful failure to mile (misdemeanor) – 1yr §7203

Fraud, perjury, aid & abet §7206

 

  1. CAPITAL ASSETS §1221

    1. IS IT A CAPITAL ASSETS?--everything is a capital asset except that which is listed in this §. (e.g. house, car, stock, bonds are capital assets). Capital assets do not include:

    2. Non capital assets:

      1. Stock (this means inventory) in trade of the taxpayer; inventory; property held by the taxpayer primarily.

      2. Property used in a trade or business, which is subject to depreciation § 167, Is it an integral part of the taxpayers business?

        1. Look at factor for which it was acquired

          1. Regular, Substantial, or Continuous sales? Source of normal business income?

          2. Change of purpose? at Time of sale was the taxpayer engaged in a trade or business?

          3. Sale of a leasehold interest is a capital asset.

        2. Certain copyrights or literary properties

        3. Accounts receivable acquired in the ordinary course of business--Hedging or futures K’sh

    3. SALE or EXCHANGE, is required §1222; date of conveyance or date when burdens and benefits of ownership pass to the purchaser.

    4. SALE OF STOCK: Reg §1.1012-1© if a taxpayer can identify the specific shares sold, that identification will control; if not, the shares sold are deemed to be the first ones acquired.

    5. What was the holding period? To characterizes the CG or GL >1yr; <1yr? LT or ST

        1. If it was a gift then the holding period is the combined holding period of the donor plus the holding period of the donee. §1223(2).

    6. §1(h) TAX RATES

      1. §1(h) reduces that tax rate on NET CAPITAL GAIN from 31% to 28% for taxpayers who would otherwise pay 31%. The purpose of §1(h) is to provide the taxpayer with preferential tax treatment on the sale or disposition of capital assets.

      2. NCG is the excess of LTCG over STCL. STCG are not included because they are considered ordinary income.

    7. CAPITAL LOSSES §1211(b)

        1. §1211(b) losses are deductible to the extent of CG plus:

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

          1. 3K OR

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

      1. CAPITAL LOSS CARRY OVER

        1. STCL C/O is treated as such next yr. §1212(b)(1)(A)

        2. LTCL C/O §1212(b)(1)(B)

        3. Where there is a STCL c/o & LTCL c/o, then the “additional amount” that is allowed as a loss deduction will always come out of the STCL c/o.

        4. CL is deductible to the extent of CG plus 3K if married; 1,500K if single. Any CL balance remaining is carried forward indefinitely until fully utilized, retaining its original character as either LT or ST loss.

    8. Mechanics

        1. Categorizes LT & ST & net G/L within each category. (LOSS AT THE TOP) Any 28% LTL is applied to reduce any 25% LTL and any remaining loss is used to reduce and 20% LTL. (LOSS AT THE BOTTOM) If there is a loss in the 20% category, use that amount to reduce the 28% then 25% category. (NSTL NETTED AGAINST NLTG) Any STG is first used to reduce any 28%, then 25%, then 20% gain.

        2. If NLTG > NSTL then use §1(h)

 

  1. PASSIVE ACTIVITY LOSSES §469

    1. PASSIVE ACTIVITY DEFINED:

      1. Trade or business in which the txpr does not materially participate §469©

 

      1. MATERIALLY PARTICIPATES if any one of the following:

        1. Participates more than 500 hrs

        2. His participation constitutes substantially all of the participation activity

        3. He participates for more than 100 hrs and his participation is not less than the participation of any other individual

        4. The activity is a “significant participation activity”(txpr participates more than 100 hrs during the tax year but does not materially participate under the other six tests) and his participation in all such activities exceeds 500 hrs Reg. §1.469-5T©

        5. He materially participated in the activity for any five years of the 10 years that preceded the year in question

        6. The activity is a “personal service activity” (fields of health, engineering, architecture, accounting, actuarial services, performing arts, consulting, OR any other trade or business in which capital is not a material income producing factor) and he materially participated in the activity for any three years preceding the tax year in question. Reg. §1.469-5T(d)

        7. He satisfies a fact & circumstances test that requires him to show that he participated on a regular, continuous and substantial basis §469(h)

      2. RENTAL ACTIVITY IF: is a passive activity

        1. Tangible property held in connection with the activity is used by customers or is held for use by customers

        2. AND the GI of the activity represents amounts paid for the use of the tangible property Reg. §1.469-1T(e)(3)(I)

      3. NOT A RENTAL ACTIVITY for purposes of passive loss rules IF: Reg. §1.469-1T(e)(3)(ii)

        1. The average period of customer use of the property is seven days or less

        2. The average period of use is 30 days or less and significant personal services are provided by or on behalf of the owner

        3. Without regard to the period of customer use, extraordinary personal services are provided by or on behalf of the owner

        4. The rental of the property is treated as incidental to a nonrental activity

        5. The property is customarily made available during defined business hrs for nonexclusive use of customers

        6. The taxpayer provides property for use in an activity that is conducted by a partnership, S corp, or joint venture in which the txpr owns an interest and the activity is not a rental activity

      4. PASSIVE LOSS LIMITATION §469(I)

        1. Up to $25,000 of passive losses and the deduction equivalent of tax credits that are attributable to rental real estate may be used as an offset against taxable income from nonpassive sources (e.g. dividends and wages) This $25,000 maximum is reduced by 50% of the amount by which the individuals AGI exceeds $100,000. AGI for purposes of this § disregards adjustments to income for social security benefits, US savings bonds, adoption assistance programs, qualified retirement contributions and passive activity losses §469(I)(3)(E)

        2. The $25,000 loss is completely phased out when AGI reaches $150,000 §469(I)(3)

        3. $12,500 can offset OI for married taxpayers that file separate returns or live apart. This amount is reduced by 50% of the amount by which the txpr’s AGI exceeds $50K §469(I)(5)

        4. REHABILITATION TAX CREDIT: the phaseout range for offsetting tax on up to $25,000 of nonpassive income is between $200,000 & $250,000 of AGI; no AGI limitation applies to low-income hosing credit §469(I)(3)

      5. CARRY FORWARD

        1. LOSSES are carried forward to the next year and subject to the same limitations. OR deduct any unused losses at the date of disposition of the property. §469(g)

      6. §469(j)((10) coordination with §280A. If a passive activity involves the use of a dwelling unit to which §280A©(5) applies, any income, any deduction, gain or loss shall not be taken into account of this § for any taxable year

 

 

 

 

 

 

 

 

 

 

 

 

 

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