Basic Tax Mini-OutlineCalculation of Income Tax: (1) GI, §61) minus business expenses/ above-the-line deductions, property losses (§62) = AGI (“the line”)(2) AGI minus personal itemized and standard deductions, other losses, dependency exemptions (“below the line”) = TI (3) TI x tax rate §1/§11 = T (see chart for rates/brackets)(4) T minus credits = liabilities. NB: GROSS INCOME DOES NOT EQUAL CASHTax rates: Marginal = top rate, last dollar (35%, eg); Effective = actual percentage of income (total tax =x%/TI)

Gross Income §61 Includes: Income from whatever source derived: salary, wages, other accessions to wealth

o Tax cost basis = FMV of property received in place of cash Eg, car in exchange for legal services. If car worth $40k, legal services worth $30k, lawyer has

gain of $10k. If services worth $40k, gain = 0. FMV of prop rec’d is not only value of income, but also becomes the basis in that property

o Bargain purchases vs. treasure troves (piano, Cesarini, was income when discovered/undisputed): bargain purchase only taxed on gain realized on disposition, unless from ER, include in GI when receive property

o Glenshaw: “undeniable accessions to wealth, clearly realized, over which TP have complete dominion” Decrease in liabilities, assumption of debt/Discharge of indebtedness

o Recourse vs. non-recourse debt: recourse means debtor is liable not only to specific property, but also personally liable. Most are recourse! Non-recourse = no personal liability, can only go for the specific property in question. Reg § 1.1001-2(a)(4).

o Old Colony case, ER can’t pay TP’s taxes, counts as compensation (“gross up,” pyramid of taxes)o 108(a): insolvency, no income if still insolvent after discharge, but if becomes solvent, only income to

extent assets exceed liabilities after dischargeo Retro-active purchase price reduction NOT usually incomeo Co-signer, preponderance of evidence (50%+) to show will have to pay the debt & above FMV/assetso Contested debt: not taxed until resolved (can allocate?)o Related parties: can’t assign discharge of debt to 3P corporation; if related TP acquires, as if TP dido If payment of liability would have resulted in a deduction, discharge is not income, 108(e)(2)

Realized and recognized gains from disposition of property (see below) NOT gifts indifferent out of affection, §102 (INTENT): gifts from ER are compensation, NOT bequests/inheritance NOT imputed income or unrealized gains/losses (cash method) 1341 Claim of Right doctrine, obligation to repay, was there intent to compensate? 1341(a) calculation:

o If included in GI in prior taxable yr but didn’t have claim AND exceeds $3k, tax for current yr is lesser of: Tax for taxable year computed w/ deduction (as if current, leave prior be), OR Amount equal to

Tax for this taxable year w/o deduction (regular) MINUS Decrease in tax under this chapter for prior taxable year which would result solely from

exclusion of such item from GI for prior taxable year (new version of prior yr)o In other words, less of either difference in prior yr if not included OR this year with as-if-present deduction

NOT compensation for personal injury/sickness (see 213 for rules re: medical expenses)o BUT include: punitive damages because of their nature, not compensatoryo Lump sum/periodic doesn’t matter, exclude if compensating for physical personal injury

104(a)(3), if pay for own insurance, proceeds for personal injury not included in GI 105, if company plan, include in GI to extent attributable to contrib. by ER or paid by ER

o KEYS: in lieu of WHAT were damages awarded, what is the ORIGIN and character of the claim If “on account of” emotional distress, include in income. “On account of” reputation/good will damage NOT income, restoring capital

Other business losses/lost profits don’t count, include in income: recovery is taxed as underlying item they are replacing would have been taxed (eg, building $ is capital gain)

Raytheon case: in lieu of WHAT? Ask: does this ADD wealth or restore capital?

o If physical personal injury and THEN emotional distress, can exclude all damages from income

GI from property:CALCULATE: Amount Realized (AR) minus Adjusted Basis (AB) = Gain/Loss Realized

Amount Realized = amount of cash or FMV at time of thing received (“tax cost basis,” 1.61-2d2)

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Basic Tax Mini-Outline AB = original basis plus other costs, “recovery of capital” = TP recovers cost w/o being taxed on extra gain Assumption of liability (taking over mortgage, eg) is included in cost, as if paid that amount in cash – does NOT

decrease the basis when you make payments on debt.TERMS:

Basis: amount invested in property minus adjustments (cost) Adjustments: long-term additions, etc. Recourse debt: all assets subject to liability Non-recourse debt: only asset on which lien is subject to liability 1012: exchange of property, gain = AR (FMV of thing rec’d) – AB (AB of thing given) – new owner’s basis in thing

rec’d becomes the FMV of thing rec’dPROPERTY REC’D AS GIFT OR BEQUEST:

Cannot exclude income from gifts that produce income (stock/prop), just value of gift itself 102(b) Basis, §1015(a+): same basis as donor or last buyer: “Carryover basis” or substitute/transfer basis

o Adjust if before gift, §1016o Losses don’t carry over

§1014(a): basis of property devised by decedent is FMV at the date of death, unless received within one year of previous transfer. Dying isn’t business strategy unless donee transferred to dying person w/in 1 year.

o Stepped up basis: FMV at time of death (bequests ONLY!), original AB irrelevanto Stepped down basis: FMV at time of death where lower than original, but don’t use original AB at all

Part gift/part sale (EXAM): Donee’s basis becomes the GREATER of what s/he paid OR AB of donoro 1.1001-1(e): transferor/donor can recognize gain but NOT losso 1.1015-4, remainder of new basis from FMV is amount of gifto 1015(a): if the FMV AT THE TIME OF GIFT is lower than the original AB/donor, use FMV!

Trade and Business Deductions (Business Expenses) 162: Deductions allowed for ordinary and necessary expenses paid or incurred in carrying on trade/business

o Ordinary : common to the business community, nature & scope (remember Conway Twitty case)o Necessary : appropriate, helpful, reasonable, beneficial (concrete floor renovation)o Carrying on : a business in progress, not start-up expenses in most circumstances (see case law)

Exception: start up expenses, §195 195 amortize if (a) paid/incurred by TP in creating or investigating creation or acquisition of

business and (b) expense is one which would be allowable otherwise OR expanding current bus Amortize over period no shorter than 60 months (amortize = not set useful life,

depreciation = asset’s predicted “useful life” (term of art for depreciation)) Current deduction for up to $5,000 BUT $5k is reduced by excess over $50k

o eg: $52k – reduced by 2k – can deduct $3k now, amortize $49k over 180 moso Rev Ruling 92-29, reg 1.212-1e: tax prep bus owner above, other below

o Trade or business: activity engaged in for profit (see 183 exception). Factors (1.182-2(a)): Manner carried on, expertise of TP, time and effort, expectation that assets will appreciate Success in similar activities, history of income/loss w/ that activity, profits if any Financial status/TP, elements of personal pleasure/recreation (doc filmmaker, eg) No one factor determinative (doc filmmaker, no profit but carried on for a while, etc.)

Examples of typical expenses: o Salaries – must be reasonable (see §280g?). Factors:

EE’s role, comparison/similar salaries, size and complexity of company, Relationship of company w/ EE, is the program of compensation (overall) reasonable, long-standing

o Traveling expenses – trans, lodging, meals, NOT commute, primary reason must be business, allocate.o Rentalso Expenses for education IF maintains or improves skills in existing business (CLE) or helps qualify for new

duties in same business/job. Can’t be deducted if not carrying on business, new venture.o Entertainment – only if ordinary and necessary for business benefito Uniforms/clothing – if required as condition of job and not street wear, not used personally (objective)o Dues – if organization is directly related to trade or business (eg annual & recurring, bar dues)

Above-the-line:o Business expenses, wages, office supplieso Capital Expenditures (expenses w/ benefit more than 1 year)o 168 Depreciation

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Basic Tax Mini-Outlineo Tax prep for TP’s OWN BUSINESS

Below-the-line:o 212 (INDIVIDUALS ONLY) non-trade/business, investment activities/expenses for production of incomeo Charity, etco Interest payments, property taxes, state taxeso All other tax prep expenses

Expenses/deductions vs. Capital expenditures; Losses Expense: repair/maintenance, not prolonging life of prop. Unforeseen expenses that arise & don’t add value to prop.

Egs: advertising, repairs, office supplies.o Non-business expenses that can be deducted if ordinary and necessary:

Production and collection of income Attorney’s fees (defending trade/business, tax advice) Management of property held for the production of income Dealings in tax matters, expenses preparing returns, etc.

o §165 Losses that can be deducted: Generally, any loss sustained and not compensated (a) Limitations under (c), for individuals, only if connected to trade/business OR transactions entered

into for profit (c2 below the line), NOT personal loss. For conversions, basis FMV @ converted. Measured by closed & completed transactions, evidenced by identifiable events, 1.165-1(b),

1.165-4. No-go if reasonable prospect of reimbursement. 1.165-1(d) Incurred in a trade or business §165(c)(1) (above the line); look at primary purpose Casualty losses/sudden and unexpected events §165(c)(3); theft – when discovered 165(e) Worthless securities are capital loss (stocks, bonds, etc, not usually promissory notes) (165g2),

treated as sale on last day of taxable year, timing see capital loss treatmento §166 Losses from bad debts:

Business debts: deduct whole or partial worthless debts/ordinary: all corp. debts presumed bus. Non-business debts: only deduct wholly worthless/ST capital loss – shareholder giving money to

corporation is not a business debt (see capital losses). Bad personal loan, limited deduction. Amount to deduct, AB (loan – amt paid), 166(b). Brewer: USE REGS to get through losses!

o Limits on deductions: No personal, family, living expenses No deductions related to gift income §265(a)(1) No deductions for pmt of interest, debt incurred re: tax exempt obligations (eg, bonds) §256(a)(2) No on trans between related TPs: siblings, spouse, lineal OR individual and corporation when

owns 50% (constructive ownership, can’t double impute?) OR fiduciary duties (trust, grantor) Capital expenditure: gives prop useful life past tax year, adds value, adopts prop to new & different use, foreseen.

o §§161, 263, 263A, 1.263+, Capital expenditures: matter of degree, not kind If ordinary and necessary, short-term benefits, no added value/future benefit: deduct as EXPENSE Policy: temporal matching. 12-mo rule. If deductible expense, doesn’t add to adjusted basis cost. Typical capital expenditures: acquiring property, cost to defend title, investigating specific prop,

improvements to prop that prolong life, aren’t ord & necessary, esp if “part of a general plan.” Functional interdependence : airplane parts, eg. Look at thing repaired versus the whole, can argue

based on what the “whole” is... entire plane or just engine, eg. Adv rentals, prepaid insurance capitalize, otherwise would distort income, prepaid services +1 yr Expansion costs: mere ability to sell in new markets, without more, does not result in future

benefit; concrete relationship to prop, eg barter exchange where services related to building design Rent or lease costs ONLY IF TP has some equity or interest in the land (162a3 auths deduction) Bar exam, new trade/business, long-term asset, reg 1.263a-4d5ii Ex: 2 Case law: Midland Empire: oil lining, expense b/c necessary, didn’t operate on larger scale, higher

value afterward. Drive-in theater case: repair was foreseeable and affected value of the land. Intangibles: 1.162-3T(a)(1,2); 1.162-4T(a); 1.162-11(a); 1.263(a)-1T(a, b, c, d); 1.263(a)-2T(d-f)

o KEYS: First ask if have asset, separate and distinct. Does it produce future benefit? Beyond a year? If so, capitalization might apply. Second, consider case law examples for general guidance.

o §§167, 168, 179: Depreciation: cost of wear and tear, must be used in trade/bus or held for prod/income Main methods: straight line (spread cost evenly over useful life), accel/double declining (charts) Useful life is recovery period: not actual life of property, use charts. 3,5,7 yr prop; (straight line):

residential rental property 27.5, nonresidential real property 39 years. (168(c)) Applicable conventions §168, “placed in service” (and held for more than 1 yr):

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Basic Tax Mini-Outline Half-year (default): assumed half-year, 1st year depreciation only half the amount Mid-quarter: use if 40%+ of all depreciable property is placed in service during last 3

months of tax year, denom. is 8. Deemed in service mid-4th quarter, 1/8 yr depr allowed. Also mid-month (real prop), denominator 24.

Depreciation of Real Estate: buildings, NOT LAND – use chart! NOT personal residence. Selig v. Commish: exotic automobiles held to eventually become obsolete, not museum pieces Calculate under 168(a)

What is adjusted basis (when placed in service)? (unrecovered cost of property) [later improvements, depreciate separately as if purchased new building]

What is applicable recovery period? What is applicable depreciation method? What is applicable convention?

Section 179 property: tangible personal property (1245 & 168) acquired by purchase for use in active conduct of trade/business. ELECTIVE, can currently deduct, limited: for 2012, it is now $139,000 (up from $125K); max amount is $560K (up from $500K) [see outline for truck ex.]

1245 = personal property; 1250 = real property

Timing/Methods of Accounting CASH: income when received, deduct when paid (deductions include depreciation and other losses)

o Actual or constructive receipt: AVAILABLE and CONTROL not subject to substantial restrictions, set aside for, credited to account, otherwise made available to draw upon. Eg, interest coupons, avail dividends

o Factors: distance, knowledge, contractual arrangements (refusal of pmt not yet due is OK w/ K), forfeitures or other penalties (substantial restrictions), relationship of TP to payor. Pre-payments ARE included in GI.

o Exceptions to actual/constructive receipt: Cash equivalency doctrine – prop w/ clear value, bargained-for consideration, not notes or letters

or other things that can’t be readily exchanged for cash. Ask: can I sell this or take it to the bank? Economic benefit doctrine – ER’s promise to pay if capable of valuation, escrow accts if access Deferred compensation arrangements – defer until retirement, ask whether EE has control/access Eg, lottery prizes: if annuities and TP does not have access, not includable in income

o Deductions, 12-month rule, could argue leases subject to renewal and therefore capital not deductible exp.o Section 83! Prop in exchange for services (restricted stock). How it works: EE buys stock for present value,

conditioned on emp’t for certain # of yrs, otherwise corp can buy back for lower of what EE paid or FMV. Election: EE can elect under 83(b) to declare value of what rec’d or not elect, hold onto stock

When rec’d stock, value is 0, report as GI; sell vested stock later, double money, cap gain If didn’t elect, sold stock later, make less money and ordinary income. Explanation: http://www.fairmark.com/execcomp/sec83b.htm

Include in GI: FMV at time of transfer minus the amount paid, if any, for the property. ACCRUAL: GI when right to money arises, deduct when liability/obligation arises, ALL EVENTS test 451(a)

o Reasonable certainty, 1.451-1(a): income includable in GI when all events which fix right of income AND can be determined with reasonable accuracy. “Fixed and determinable,” earliest of paid or fixed.

If an estimate is made and actual amount is different, account for difference in yr in which det’d When doubts about collectability, must be objective manifestation (bankruptcy, etc.)

o Liability: same requirements PLUS economic performance (TPs were attempting to work the system by creating a contract that made liability) ***NB: All Events Test not satisfied w/o economic performance – it’s fixed & determinable PLUS economic performance for DEDUCTIONS. Can apportion certain amt.

o 461(h): all events test not earlier than economic performance, but if services and property are being provided to the TP, then economic performance occurs as the services or property are provided, used.

o One exception, very narrow: recurring item exception §461(h)(3): KNOW FOR EXAM AND APPLY!*** If met first two prongs of “all events test” – fixed & determinable, and then economic

performance occurs w/in shorter of Reasonable period after close of year OR (interpreted/applied as 8.5 months, never

argued shorter, kind of redundant) 8.5 months after close of such year

Then, CAN take deduction even though economic performance occurring in next year Nature of expense needs to be recurring, results in proper matching, not material, constituently

treated as recurring item, eg refunds, rebates, taxes (recurring item exception to 12-month rule)o 1.461-4 (esp (g)5): time when economic performance occurs, if liability contested not fixed until resolved

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Basic Tax Mini-Outline Claim of Right doctrine (which method??): party required to include prepayment in GI though portion may be

returned later, deduct in later year. Exception: amt to repay exceeds $3k, can option lesser ofo Deduct the amount repaid ORo Compute the tax w/o deduction and credit amt tax liabilities would have decreased earlier (statute??)

Proper Taxpayer/Assignment of Income Married parties may file joint returns Two main rules (p. 818-821):

o Income taxed to person who controls the earning (can’t assign salary to family members)o Income from property is earned by owner of the property

Assigning income through entities: is OK if legit. Fruit of tree metaphor, can’t assign fruit but keep tree.o Stranaham case: sold right to receive dividends to son, is OK b/c arms length, FMV sale not gifto May v. Commish: gave rental property to trust, court said OK, gave away tree, donor no control over prop

Lucasfilm example: with letter of intent, can donate stocks to foundation, foundation sells to Disney. Deduct. Key question: DO YOU HAVE POWER over the income in the future? Have you already earned it? Or transferred

BEFORE fruit was ripe (like Lucas example)?

Capital Gains/Losses Gain or loss from sale or exchange of a capital asset. +1 year, long-term (LTCG). Eg, investment property, long-

term stocks. Basic rules:o Net gains from sale/exchange of assets held for more than 1 year, taxed at a preferential rate. IE: only long-

term capital gains are taxed at lower rate. Short-term gains are taxed as ordinary income.o Net LOSS from sale/exchange, limited to $3k per year (1211(b)), IE: capital losses over & above capital

gains limited to $3k per year. Capital gains, especially long-term, are good. Capital losses suck, don’t want.o Policy: avoid “bunching” of income, encourage long-term savingso LOSS from the sale/exchange of capital asset held for personal use is NOT deductible.

http://www.irs.gov/instructions/i1040sd/ch01.html Capital gains are property held by TP (not always appreciable):

http://www.irs.gov/publications/p225/ch08.html#en_US_2012_publink1000218357. Capital gains are NOT:o Inventory property, held primarily for sale to customers

Future contracts, most promissory notes Subdivided lots example, sold regularly over time Factors:

Frequency, substantiality of sales Improvement made to land Solicitation advertisement Utilization of real estate brokers/agents A is most important, facts/circs analysis, difficult, but illustrates point that capital assets

do NOT include property that is inventory-like, realize income in ordinary course of business. Normally don’t sell land but selling many lots consistently is ordinary.

o Depreciable and real property used in trade or businesso Copyrights, art, letters if in the hands of creator or person connected/rec’d from creatoro Accounts or notes receivableo Publications of US government if held by TP who received or person rec’d from that TP

Codes and case law, §1221 and 1222. Narrowly interpret 1221(a): appreciate over substantial period of time. Doesn’t permit allocation, looks at purpose of property at the time of sale/exchange and taxes accordingly.

o Arrowsmith doctrine: repayment so tied w/ the liquidation/corporation that still capital, would be unfair to give ordinary loss treatment when what WOULD have happened is reduced capital gain b/c pay creditors THEN paying smaller amount to shareholders. Stands for if ORIGIN of claim is SO RELATED TO prior transaction, characterize that payment/receipt-of-addt’l $ same as original.

o Kenan case, bequest $5 million but rec’d stocks instead: capital gain, effect of sale/exchange: niece had a right to $5 mil, satisfied w/ transfer of appreciated property. When transf. property in satisfaction of obligation/liability = triggers gain! Just as if trust had sold then paid. SALE/EXCHANGE can be broader than commonplace notion of sale/exchange.

If had transferred inter vivos – different. If bequest of specific asset (Home Depot stock): not included under §102. Why diff? If specific

bequest, not sure what value is. If for specific value and get in form of stock, diff b/c right of claim

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Basic Tax Mini-Outlineo KEY: What is it? Does it fall under 1221 definition or exclusions?

Calculating – net short-terms and long-terms separately:o If both gains, net short-term gain treated as ordinary, net long-term treated as capital gainso If both losses, deduct max of $3k for the year, first from short-term then remaining from longo If loss and gain, net long-term and short-term together to get net loss or net gain, character of net gain or

less will be that of the number with the largest Quasi-Capital Assets, §1231

o Definition: real or depreciable property used in trade or business – NOT capital assets, but sale, exchange, or involuntary conversion of such property may be treated as capital gain, loss remains ordinary.

Still a +1 year requirement Inventory is not included (always ordinary loss/gain), must be depreciable or real property

o PRINCIPAL HOTCHPOT: If 1231 gains in taxable year EXCEED 1231 losses = long term cap gain/loss If 1231 gains DO NOT EXCEED 1231 losses (tied or less) = ordinary

o PRELIMINARY HOTCHPOT: 1231(a)(4): losses, including not compensated by insurance/otherwise, on destruction, theft in

whole or in part, used in tr/bus OR held for more than 1 year and in connection tr/bus or transaction entered into for profit (eg rental prop)

Cuts TP a break, in the case of involuntary conversion when capital asset, does not apply, get to claim ordinary loss, ONLY IF PRELIM H 1231 LOSSES EXCEED THE GAINS. (so no $3000 limit if you lose the property involuntarily instead of selling/exchange)

Prelim hotchpot: if losses exceed gains in PRELIM H, all ordinary, stays out of 1231. If gains exceed loss in PRELIM H, both go to PRINCIPAL H for analysis.

o Presumption pro-TP, loss is ordinary, gain is capital. See slides/flow chart: http://www.cpaexamacademy.com/lessons/regulation-reg/4-0-c-corporation-taxation/4-5-section-1231-1245-and-1250-assets/

Recapture (see flow chart!!!) §1245: depreciable personal property used in a trade or business (§179)

o Take 179 deduction first, then depreciation calculation. o If AR is greater than original purchase price, then (AR minus original cost) may be capital gain, the rest of

gain (what’s left of AR minus AB) will be ordinary income.... BUT if AR is NOT greater, then AR minus AB (w/ depreciation) equals ordinary income.

Eg, J purchased $200k boat for business Jan 1 Yr 1, sold June 1 in Yr 3 for $175k. $100k 179 deduction leaves $100k. 5-yr property: 1st year depreciates 20% (20k), 2 32% (32k), 3 ½ of 19.2 (9.6k), total of $61,600 depreciated. New AB = 38,400. Gain from sale = $136,600, ord income.

If sold $210k, $10k prelim hotchpot. THEN use lower of actual amt realized (210) or “recomputed basis” (original cost). $161,600 ordinary income – $10k excess gain goes through 1231 analysis. ABOVE THE LINE income. Don’t forget to calculate income above the line, not just the net gain/loss, etc.

§1250: depreciable real estateo Based on straight line onlyo Won’t have to do recapture for this on exam.

PROBLEMS BY CHAPTER

Overview & Ch. 1, calculating for married couples (X plus Y% x (TI-Z)):1. Taxable income separately, $500k and $60k (see rules about chart, etc.)

a. Separately: $159,569.75 + 11,030 = 170,599.75b. Jointly: $105,062 plus 35% of 171,650 (excess of 388,350) = 165,139.50

2. Taxable income separately, $260k and $300ka. Separately: $52,531 plus 35% of (260k-194,175) + $52,531 plus 35% of (300k-194,175) = (75,570.10 +

89,569.95) = 165,140.05b. Jointly: $105,062 plus 35% of (560k-388,350) = 165,139.50

3. CH. 1 calculation in problems, p. 1.a. $275k consulting fees: GI, $10k FMV rec’d in barter for services: GI, etc. – see Ch. 1 for Qs

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Basic Tax Mini-OutlineChapter 2, gross income:

1. What is GI?a. Salary – YES, withholdings – can only deduct state income taxesb. Bonus – YESc. Bookcases – need more facts, probably bargain purchase, not enough to be considered compensationd. (e) Barter or family gift, is the FMV significantly different? Who do you represent? Look at facts and

circumstances, whether agreement in writing, intention2. Bought stock for $1000, $1500 value later, etc, etc, etc. Doesn’t sell until year 5. Calculate on DISPOSITION.

a. Amount realized (AR): $3,000b. Adjusted base (AB): $1,000c. Gain realized (GR): $2,000 (AR – AB)

Chapter 3, obligation to repay:1. Shoe salesman, commission too high

a. $3k commission one year, repayment next. Claim of right, 1341. Include in GI now, deduct next year if two different taxable years. No loan without consent!

b. Received $7k, used as interest-free loan, definitely include in GI that year, owe $5k in January, can’t just decide the money was a loan and underreport. Should claim then deduct. (Eg, if immediate obligation to repay, hang onto money – see Snavely case)

2. Mark should report over-/advance pmts now instead of when he actually earns the money unless accrual method

Chapter 4, Gains from dealings in property:1. AR 300 – AB 100 = G 200, if 5 tracts sold for $75k, subdivide basis ($20k ea), $55k gain ea = $275 total gain

(1.61-a, equitable apportionment)2. Basis = $500k regardless of whether $100k cash + $400k borrowed from bank or paid over time.

a. (b) Paying down the principal does NOT change the basisb. (c) Borrowed $250k more, $75k used to remodel, $175k for other things. New basis is $75k + original basis

500k = $575k. $125k separate basis on investment land.c. Maggie sells for $700k (300k cash, 400k assumed balance), gain = $125k. Purchaser = $700k basis.

3. Exchange: C owes L $6k for legal fees. L buys C’s painting for $6k. C uses $ to pay legal fees. Later, L sells painting for $10. L’s tax consequences? $6k basis, $4k gain (6k to C is ordinary income for her). If just painting in exchange for legal fees, FMV of painting is ordinary income. Cost basis is excess of FMV/painting minus FMV services. (Eg, FMV of painting was $4k, L paid $2k for it, sells $10k = 8k gain.) If FMV painting MORE, basis 0?

4. K’s land FMV $750k, AB is $450k. Exchange w/ P: land, FMV $750k, AB $100k. a. K: AR is $750k (FMV of P’s land), AB is $450: $300k gain. P: AR FMV of K’s land), AB is 100: $650 G.b. If K’s land had FMV of $800 and P gave his land plus $50k cash:

i. K: AR is $800 (FMV of P’s land + 50k cash), AB still 450, 350 gain. (new AB = FMV plus cash)ii. P: AR is $800 (FMV of K’s land), AB still 100, 700 gain. (new AB 800, prop rec’d)

c. If P assumed 50 of K’s mortgage, same answer. But basis different when liability assumed vs. cash.i. If he sold land later for 900k, AB in land is FMV of value rec’d (800) PLUS mortgage assumed:

50, gain is 50k? K’s new AB 750. ii. Patrick’s part:

iii. REVIEW, FOLLOW FORMAT OF REGS ON EXAM (reg 1.1031(d,2) example 2a, 1031 code)iv.

Chapter 5, Gifts:1. $250 gift certificate from employer, treat as bonus/income. Sweater from associate, probably gift. Candy: arguable.

a. FACT-SENSITIVE inquiry, MOTIVE. Did other side deduct? ER no deduction for gifts over $25.b. Key, “detached, disinterested generosity,” “tested by main strains of human conduct” (Duberstein case)c. Did the other person want something in return? Use common sense, don’t assume it’s all income.

2. Look at the intent of the GIVER, not p.o.v. of recipient. Could be compensation for services, but usually §102 assumes family will take care of family, etc, do not include in income.

3. Father gifts land to son. AB to Father is $100k, FMV is $250k. Can shift gain but not loss, also is inter vivos.a. Son takes father’s AB, “carryover.” If sells, THEN would be income. b. If father also son’s ER, might be add’l compensation. (Proposed reg, 1.102-1f2, EE show not comp)c. If father sold to son, part-sale part-gift, greater of donee’s cost (50/200) or donor’s AB (100) (1.1015-4)

i. If 50, father no gain (can’t recognize loss); son’s AB becomes 100. $150k gift.ii. If 200, father AB 100, 100 gain; son’s AB is 200 (greater of); $50k gift.

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Basic Tax Mini-Outlined. If father’s land encumbered by mortgage $125k and son agreed to assume, same as cash. Father AR $125k,

$25k gain (100 AB). Son’s AB becomes greater of 125/100, so 125k.e. If father’s land worth only $90 when made gift, what consequence to son when sells land for 90k? AB is

NOT carried over: 1015(a), use FMV because lower than AB. Can’t transfer losses.i. Sells for 90: AB 90, sells 90, no gain or loss

ii. Sells for 80: AB 90, 10 loss but can’t claimiii. Sells for 95: look at the FMV in sale/disposition to determine whether gain or loss. TP should sell

and get cash, make gift of cash. Weird middle ground. (Why?? Ask about in review)iv. Sells for 110: 10 gain

f. Father devised to son in will, FMV of $250k at the time of father’s death, becomes “stepped up” basisg. What if FMV of $75k at time of death? “Stepped down” basis, no loss – don’t use original AB at all.h. Tax loophole, donor to donee, donee back to donor in will w/in one year, use carryover basis 1014(e)

Chapter 9, Discharge of Indebtedness:1. Lender forgives balance of $2k. What if lender bank? Income. ER? Compensation income. Brother? Maybe 102 gift.2. K receives $10k bill, unhappy. Bill reduced to $6k. Retroactive purchase price reduction? (a)

a. (b) What if judgment against K for full and paid $6k as settlement? 108 inapplicableb. (c) What if no dispute but for business and accepted $6k because couldn’t pay? K can deduct as business

expense, claim $4k income?3. S borrows $50k (business), lender accepts $25k in full settlement of $45k remaining.

a. Solvent. Income $20k.b. What if parents purchased the note then forgave? (gift)

4. ***#5, B borrows $200k from J. To settle debt, J rec’d $150k FMV (B’s basis $50k). Insolvent before, but after, $50k debt to others, $75k assets. Now solvent. Income is excess of assets over liab = $25k. J’s basis $150k.

a. Formula: PRE-transaction – total liabilities minus total assets (250-225 = 25): 25 Insolv. EXCLUSIONb. THEN: COD is Amount originally owed minus FMV/amt paid (200 debt – 150 FMV prop) 50 CODc. 50 COD income, plus income from disposition of property (150 FMV – 50 AB = 100 GAINd. Subtotal: COD income plus GAIN (150), MINUS insolvency exclusion: 125 total GI!

5. #6, Actor insolvent, receives $10k for appearance (ordinary income, 61), still insolvent. What if producer canceled $10k in dept for commercial in lieu of payment? Rev ruling, bifurcated analysis, what are services worth?

Chapter 10, Compensation for Injury and Sickness:1. Business building destroyed, lost profits. $150k gain from insurance loss of building, maybe capital gain. $150k

recovered for lost profits would be ordinary income (61(a)(2)).2. Self-employed T injured, settled amount. Paid $100k own money medical expenses, deducted $70k under §213.

a. Pain and suffering $500k – EXCLUDE from income, “on account of” physical injuryb. Reimbursed medical expenses $100k – EXCLUDE $30k from income, include $70 b/c deductedc. Future medical expenses $50k – EXCLUDE d. Lost income $100k – Can EXCLUDE if “on account of” physical injury/sicknesse. Punitive $150k – INCLUDE in income

Chapter 12, Business and Profit Seeking Expenses, Deductions:1. Salary and bonus? Yes, ordinary and necessary; bonus could be unreasonable, look at factors.

a. (b) If bonus was excessive, how would it be treated? 1.162-7 and -9: Deduct reasonable amount (maybe $10k), the rest is a gift, not deductible. Recipient claims as GI.

b. (c) If incorporated, no gifts between ER and EE, would be dividend?2. Avoiding hard feelings, business reputation: use Twitty case. Chauffer service: probably not ordinary or necessary,

argue horses case for TP to deduct as business expense, use landscaping/private plane cases if arguing for IRS.3. Job hunt expenses: if same trade/business, probably deductible. If changing jobs/fields, probably not. 1-212(f). But

see Rev Ruling 75-120, old rule can’t deduct unless you actually get a new job, primary purpose, 162-7, now is OK.4. 212 egs: stock/bond portfolios: not trade/business (usually, Higgins case), but production of income. WSJ

subscription, arguably yes. Safe deposit box, no produc. Book re: “tax free” – can’t deduct b/c tax exempt activities. 5. Attorney’s fees? To defend trade/business, yes. Re: investments, maybe. Wills, divorce? Maybe if tax advice.

Chapter 13, Capital Expenditures:1. §152 currently deductible or §263 capitalize?

a. Replacing roof of 50-year old store after inspection, rotting: deductible unless purchased defective or “part of a general plan”; but major component, long-term benefits from IRS side.

b. Repainting exterior: part of “general plan” if same time as roof, otherwise maintenance

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Basic Tax Mini-Outlinec. Remodeling, rewiring, etc: capitalize, general plan of improvementd. New furniture: capitalize. What if leased? Looks like buying. Option to purchase, capitalize, intangible.e. Office supplies: deduct, even if stocking up, because not keeping records/inventory (even tho 12-mo rule)f. Contractor for website design, could be long-term asset, capitalize. Advertising, deduct (1.162-1).g. Pre-paid insurance premium, intangible, capitalize. Use 12-month rule. 1.263(a)-4, 4(f)1-7, [election to

capitalize option in 7], 12-month rule trumps for a benefit if fits in narrow definition: can extend into 2nd year but not as far as 3rd if spread across time.

2. Second store: after investigatory costs, capitalize if real estate: -2T(f)(2)(iii) for exception, but notice applicable only to real estate. Compare to -2T(f)(4) ex. 5, lawyer hiring interior design for health club, new trade/business.

Chapter 14, Depreciation:1. Depreciable or non-depreciable? Tract of land, NO. Fences, concrete sidewalks, driveways on hotel grounds,

probably, subject to wear & tear, long-term. Antique furnishings and carpets part of décor, Yes, can wear out regardless of salvage value. Art on display, not unless being used, subject to wear & tear. Violins, maybe.

2. New equipment, $200k. 5-yr, half-year chart. Yr 1 20%, yr 2 32%, yr 3 19.2%. New AB: 57,600 (200k minus 40k (yr 1, 20%), minus 64k (32% yr 2), minus 38,4k (yr 3 19.2%).

a. (b) AB in year 7? Zero, have depreciated everything (but see recapture, later)b. (c) What if she sells in Dec. 31 in Yr 3? Formula: Use PREVIOUS year AB (yr 2, $96k), then depreciate

HALF a year (38,400/2 = 19,200), new AB is $76,800. $100k AR minus 76,8 – gain of $23,200.c. What if she elects to treat as §179 property? Max in 2012 is $139k, so $61k depr start in Yr 2 w/ 20%.d. 168(k) bonus depreciation: 50% of post-179 AB ($30,500), start w/ 30,500 in Yr 2 (2012 only)

3. 179 does NOT apply to real property (1250). Depreciation in year of purchase is based on mid-March, 2.879% ($28,790, new AB is 971,210). Year 2? Same column, next row down: 3.636% ($36,360, new AB is 934,850). BREWER example: what if disposed of property in Jan of Year 3? AB from year 2 is $934,850. Depreciate half of one month into Year 3, if $36,360 per year, divide by 24: $1,515. New AB is $933,335, plus land value $500k (unless value of land appreciated) = $1,433,335, sold for $1.6 million, Gain = $166,665.

Chapter 15, Losses:1. D bought truck for $60k (business), sold for $35k to Unrelated person. FMV $40k, AB $38,400. Use LESSER of

FMV/AB, so $38,400. Loss is AR (35k) minus $38,400: $3,400. If stolen, never recovered, $38,400 loss, 165c1.2. 100 shares of stock for $15k. Fell in value to $5k. Can’t claim loss until disposition or theft. Part (b), intention to

steal, Bernie, then yes, when discovered, no recovery. $15k purchase price, plus $10k claimed gains: $25k total loss.3. #4, Apartment for $1.2 mil, principle residence for 5 years. Tried to rent but unsuccessful: NEVER business use, no

loss. Only loss if actually rented or somehow used in business. a. When rented for 2 yrs (d), can get maintenance deductions, depreciation, AND loss. FMV of $1 mil, Basis

$1.2 mil, $70k depreciation. AB = $1,130,000.b. Loss: LESSER of AB/FMV, $1 mil. (1.165-9: converting from personal use, if FMV lower than original

cost basis, for purposes of determining loss & depreciation, use FMV). Basis $1 mil – 70 dep (take again?) = $930k, sold $900k, claim $30k loss.

c. If sold for $950k, still lower than original cost basis, use $1 mil. 930 AB, $20k gain. No, use higher amount, $1,130,000 for gain... weird middle ground?

4. #5, M devised home to H. AB was $100k, but worth $300k at death. So H’s AB is $300k. H sells for $250k. Primary purpose? Personal res but not his. If investment/for-profit, $50k loss.

5. #6 P loans brother $200k for business. Promissory note (security?). Bankruptcy, can’t pay. Deduction for P? Worthless debt 166, not trade/business. Maybe deduct if accrual method. Not in business of loans. 1.166-1(e)

6. #7 G is EE and owned 5% of corp stock, parents 95%. G loaned corp $100k. Corp failed. May G deduct loan never repaid? Worthless debt, not for-profit. Character of loss? Arguable business motive or non-business. Deduct loss on stock? Family-owned, related parties, but 267(a)(1): doesn’t apply, can deduct in complete liquidation. 165(g).

Chapter 27, Limitations on Deductions:1. Related parties #1: D buys 100 shares XYZ for $30k. D sold stock to granddaughter for $20k.

a. May he deduct loss realized? No, related parties, 267b. If FMV were $20k? Irrelevant.c. If D sold to granddaughter’s husband? In-laws not related. What if husband gave to wife? Constructived. What if D sold stock to ABC, company which he owns 60% of stock? No, related party. What if

granddaughter owned 60% of ABC? Constructive, indirect, still no.e. What if hadn’t spoken in years and unknowingly sold to corp owned by granddaughter? Doesn’t matter.f. What if sold to GHI, corp owned 60% by granddaughter’s husband? Allowed. 267(c)5, 2-steps.

2. Related parties #2: Same facts but granddaughter sells to unrelated party for $15k. What if she sold for $35k? 25k?

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Basic Tax Mini-Outlinea. Use HER basis, $20k. $5k loss allowed.b. Sold for $35k, gain allowed, can also include previously disallowed loss (D’s $10k), so only $5k gain. 267dc. Sold for $25k, weird middle ground, no gain/loss?

3. Related parties #3: D 60% shareholder, accrual method. M&M are cash, EEs and related. M owns 40% stock. Corp fails to pay $25k salary to each M&M. Paid the next year.

a. When may corp deduct salaries owed? Year 1. When must M&M include in GI? Match corporation because related parties. Probably just husband M, because can’t double attribute >50% to wife.

b. Would answer change if corp willing and able to pay M&M but requested later? Depends.4. Other example: lawyer for social security claim, half excludable. Can deduct half atty’s fees.

Chapter 28, Cash method of accounting:1. M legal services to many clients, sends D bill for $50k from services rendered Oct-Dec Yr 1. D mailed check Dec.

30 Yr 1. M rec’d on Jan 2 Yr 2. When must M recognize income? Yr 2, not available. Must KNOW check ready.2. Same facts but delivered on Dec 31 Yr 1, M on vacation. Deposited Jan 15 Yr 2. Was available Yr 1.3. What if D called M and asked for statement, M asked D to pay in Year 2? Constructive receipt, money should be

due because services completed, D ready to pay. Highly unusual to turn back on income.4. Same facts as 1, but D is low on money and can’t pay until Yr 2. Signed promissory note. Paid Yr 2: claim income

in Yr 2 because not available in Yr 1, promissory note is not cash equivalent.5. Assume legal fees deductible under 162. When may D claim deduction? When he pays.

Chapter 29, Accrual method of accounting:1. Recognize income when fixed & determinable. If asked to wait, doesn’t matter. If D couldn’t pay, still irrelevant. If

dispute over amount, claim amount undisputed and delay the rest, not fixed & determinable.2. Look at collectability AT the TIME of SALE, can’t exclude unless objective manif of doubt. Except: §448(d)(5)

Chapter 34, Assignment of Income:1. Income checks payable to son? No. Employ son? Yes, if actually earning the money. Earn proceeds from sales? No,

not actually doing anything, mother is controlling the earnings.2. Gift the building to son, lease back the space with reasonable rent? Yes, reasonable, gave away the whole tree.

Chapter 31, Capital Gain and Loss:1. T&M own Friendly Car Dealership. Which are capital assets?

a. New sedan for showroom? No, ordinary business, inventory, primarily for sale to customersb. Van to transport customers? No, ordinary businessc. Family station wagon? Yes, though personal, 1221 broad, excludes tr/bus used. Land and building for dealership? No, used in trade/businesse. Vacant land for investment? Yes, more than 1 yearf. Promissory note on sale of new car? No, sale to customers, 1221(a)(4)g. Family home? Yesh. Painting from mother? No, gift, carryover basis. After she died? Yes, FMV at time of death, stepped up

basis. 1221(a)(3) does not apply because only if property’s basis determined by creator’s.i. Stock in family business? Yes, “stock in trade” only means inventory, not stock in own business.j. Computer used for dealership converted to family investments? No, conversion to depreciable property

held for the production of income.2. Coach selling bought-out contract as property – capital gains? No, contracts are not capital assets, ordinary income.3. Tracts of land? Primary purpose was for sale to customers. Look at factors.

Chapter 32, Quasi-capital assets:1. Do these go in the hotchpot (2013)?

a. $150k gain from sale of parcel of land used in rental business? Yes, 1231, principalb. $60k loss on sale of summer cabin? No, personal loss not deductiblec. Theft loss: $25k AB, $30k FMV, used in business. Yes, 1231 preliminary H

i. FIRST: do losses in the preliminary hotchpot exceed the gains? Not enough facts. ii. Put in preliminary hotchpot. Use BASIS, not FMV when calculating loss. $25k.

d. Corporate stock $30k loss. Not 1231, regular capital loss, 1221.e. $2k loss on sale to sister of computer used in business. Maybe 1231 but related party, 267, not recognized.

2. What if also recognized $25k gain from collection of insurance re: earthquake, business land?a. Prelim: $25k gain (G over L, goes to principal) (If had been $25k loss, just ordinary, stays out)b. Principal H: $150k gain, $25k gain (G over L, so capital) = $175k gain

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Basic Tax Mini-Outlinec. After 1231 analysis, can include regular cap loss $30k stock, $145k net cap gains.

3. Problem #1 plus in 2012, $45k 1231 loss (principal H), $15k prelim gain from theft:a. (Problem 1, 2013: $150k gain from sale/land; $25k theft loss would be ordinary)b. 2012: $15k gain in prelim H, goes up to principal hotchpot. $45k loss. Loss over gain, both ordinary.c. Now in 2013, IRS recaptures under 1231(c) when net loss in last 5 years. d. SO: $30k net loss from 2012 goes into computing NET GAIN in 2013. $150k gain under 1231, $30k loss

from corporate stock under 1221, $30k net loss recaptured = $90k net capital gain in 2013.

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