CH. 31 - CAPITAL GAINS & LOSSES

I. SIGNIFICANCE OF THE CHARACTER OF G / LA. Preferential Tax Rates Applied To LTCG

i. CG: gain from sale of CAii. LTCG: taxed @ lower rate than OI, e.g. 15%

1. § 1223: LT held > 12 monthsB. Limitation on Deduction of CL

i. Deductible a/g CG for year + 3Kii. If CL > CG + 3K, can carry forward & offset

a/g CG + 3K in that yearC. Justification For CG Treatment

i. Bunching: lumped into higher bracket, w/ gain accruing each year; but, only realized in one

ii. Encourage Investments: if have excess income, can invest and get preferential rates1. Problem: applies only to new investment,

not shifting around existing 2. Fix: apply CG trtmt to only new stocks,

e.g. those generating add’l investment3. Problem: doesn’t acct for risk element

iii. Lock In Effect: discourages un-investing / steadies the market

iv. Inflation: many gains are inflationary1. Tax code does bad job at treating inflation2. Tradeoff b/t complexity and accuracy

II. ID CAs: §1221(a) - PROP HELD BY TP, BUT NOT…A. (1) Stock in T, inventory, or prop held primarily for

sale in OCOBi. Excluding normal operating profits

ii. Specially made inventory? Sold in OCOB?B. (2) T/B real prop or T/B prop eligible for § 167 ded

i. N: §§ 1231 & 1245 may apply insteadC. (3) Copyright or artistic composition held by…

i. (A) TP who created;ii. (B) If letter / memo, TP for whom made (Anti-

Agnew); ORiii. (C) TP taking same AB as creator (gift)

D. (4) A/R acquired in OCOB (Back Stop / Anti-abuse)i. Ex: sale car for note, can’t sale note to bank and

treat as CAii. Ex: can’t sale salary / rent and treat as CA

E. (5) Fed gov’t publication (anti-politician)F. (6) Commodities held by dealer (inventory / dealer)

i. Arkansas Bestii. Corn Products

G. (7) Hedging transactionsH. (8) Supplies regularly used in OCOB

i. Congress: § 162 ded enough!ii. Ex: prevents airlines from selling fuel and

treating as lossI. N : doesn’t say anything a/b LT or ST; just specific

exclusions

III. CHARACTERIZING GAIN OR LOSSA. I : judicial gloss on § 1221(a)(1)B. R : balancing factors under Bynum

i. Frequency / substantiality of sales;ii. Improvements made to land;

iii. TP’s solicitation / advertising efforts;iv. Utilization of RE brokers / agents;

v. Proportion of incomeC. Bynum - Investor or T or B Hat?

i. Nursery land divided / developed for sale at bank’s suggestion; IRS says OI, TP says CG

ii. Analysis : all or nothing problem, e.g. must classify as either all CG or no CG

iii. Rule : only time may allocate is § 1237, real prop subdivided for sale, whereby CG unless…1. You are a dealer;2. No subst. improvement to value;3. Prop held > 5 years4. (b): first 5 parcels CCG, but 5% of 6th OI5. (b)(3): can improve if held > 10 yrs, and

only those listed 6. N: if not under § 1237, argue not w/in §

1221(a)(1)D. N : character comes from underlying asset

i. Ex: PN for non-T or B land CAii. Ex: PN for T or B truck NOT CA

E. N: character may change w/ new holderi. Ex: does new holder manage investment assets?

IV. OI SUBSTITUTES UNDER HORT & DAVISA. Hypo : lease buyout; disputed amt essentially

substituting rent pmts, which are GIi. MUST treat as OI, NOT CG

ii. N: similar trtmt of lottery pmtsB. Hort

i. TP bequested comm. rental prop w/ 14 yr lease; bank cancelled & paid off; TP claims loss (lease value -- payoff)

ii. I: tax loss?iii. Analysis:

1. Basis in uncollected rent zero; never paid tax on

2. 140K is GI, b/c was rent substitute, and rent would have been GI

C. Davisi. TP wins lottery; sells right to receive remainder

of pmts for lump sumii. TP argues CA t/f CG. How diff from Hort?

1. Here, no underlying prop to f(x) as CA2. Only a stream of income3. Court: right to pmt is prop, but like Hort,

only a substitute for incomeiii. TP next argues b/c of AK Best, should be CG

1. AK Best: shouldn’t carve out judicial exceptions, but stick to statute

2. Ct: was limited situationiv. Rule : if merely substitute for OI, treated as OI

V. RECOGNIZING CORN PRODUCTS PROPERTYA. Options : K to buy / sell at stated price, lasting

certain amt of timei. Call option: right to force sale as specified price

ii. Put “”: “” purchase of specified goods at specified price

iii. Ex: currency, commodities, IRsB. Corn Products - Call Option

i. TP buys “futures” to protect a/g price ii. Held : § 1221 preferential trtmt applies to prop

transactions not the normal source of B income

iii. Test : intimately connected to inventory so that really hedging B risk?

iv. N : TPs using to take ordinary losses on holdings w/ dual purpose…1. Stock assuring supply source; AND2. Investment

C. Arkansas Besti. TP buys bank stock, has loss; diff from above,

b/c not exercising right to particular asset; ii. TP : under CP, stock losses NOT capital losses;

investment, not B purposeiii. H : narrowed CP to simply broad reading of

inventory exclusion in § 1221(a)(1)iv. S : buying stock in companies = CA, t/f CL trtmtv. Too Far ? Congress adjusted w/ § 1221(a)(7)

1. As soon as buy asset, must classify as hedging / not hedging

2. Defined in (b)(2)…a. Normal course of T or Bb. If asset ordinary, hedging risk

ordinaryc. Managing risk of price / iR

3. Regs: can NOT use stocks as hedge for reasons stated in Arkansas Best

VI. COMPUTE NCG & ADJUSTED NCGA. NCG :

i. Preferential rates require NCG. § 1211(11)ii. § 1222: NCG = Excess of NLTCG over NSTCL

1. NLTCG = LTCG -- LTCL2. NSTCG = STCG -- STCL

B. Adjusted NCG i. 15% and 5% rates

1. § 1(h)(3): NCG 28% gains & un-recaptured § 1250 gaina. Add QDI, insuring gain preserved

where no NCG or have CL2. If in 15% bracket 5% preferential rate

a. N: wealthy still preferred more, b/c 35% to 15%

ii. Qualified Dividend Income1. Previously OI, h/w, Congress felt PR

capital cost & econ grow / jobs2. Now, part of ANCG, taxed at 15 or 5%

rates; must be extended each year

VII. §1(h) AND MAX RATES APPLICABLE TO VARIOUS COMPONENTS OF NCGA. Introduction :

i. Series of inter-locking definitions dropped into right categories by § 1(h)

ii. Use when have more gains than lossesiii. Provides what gets preferential ratesiv. (1)(h)(1): total tax liab from each sub

paragraph, provides total tax liab1. (A) OI2. (B) 0%: for people in bracket < 15%3. (C) 15%4. (D) 25%5. (E) 28%

B. 28% Rate Gain: Collectibles Gain and §1202 Gain i. N: IF OI rate < 28%, CG taxed at OI rate

ii. § 1(h)(5): Collectibles Gain1. S/E of any rug, antique, metal, gem,

stamp, coin, or other under § 408(m), which is CA held > 1 year

iii. § 1202 Gain1. 50% of gain from S/E of certain stock2. PP: encourage investment in small corps;

questionable, b/c if corp fails, no benefitC. 25% Rate Gain: Unrecaptured §1250 Gain

i. § 1(h)(6): 25% rate for LTCG from dep allowed on RE held > 1 year; remainder gets 15%

ii. S: when sale dep RE at gain, must determine portion of § 1250 gain

iii. PP: much RE gain caused by dep, NOT appreciation, and generates OI deductions

iv. Davis: technical catch-up provisionD. 15% Rate Gain: Adjusted Net CG

i. Leftover CG, e.g. everything not taxed elsewhere

E. Qualified Dividend Income: §1(h)(11)(B) i. NCG; taxed at 15%, even if no NCG

ii. NOT CG, b/c NOT S/E of CAiii. Can NOT use to offset CL

VIII. TAX PREFERENCE AFFORDED QUALIFIED SMALL B STOCK HELD > 5 YEARSA. § 1202

i. Exclude from GI 50% of gain from S/E of qualified SBS held > 5 years

B. Congressional Steps i. If 1202 stock bought w/in certain period, 75%

excluded; 1(h) only taxes 25% of gain, e.g. effective TR only 7%

ii. Latest step: FULL exclusion, if bought w/in certain period (began 2010, has been extended)

C. See statutory handout

IX. MAX CL DEDUCTED IN GIVEN YR?A. Deduct $ for $ to extent of CG; w/o/r/t LT or ST.

i. Pro TP rulesii. Max of 3K of excess may be used to offset OI

iii. Disallowed amt carries overiv. Although given preferential TR, div inc NOT

CG, t/f NOT part of loss calcB. STCL : net 1st a/g STCG, then 28% NCG, then 25%,

then 15%i. Excess netted a/g LTCG

ii. Deemed deducted 1st in OI offset part of § 1211(b)

C. Limitation on Deduction of CL i. §1211(b): to extent CL > CG, up to 3K

deductible1. N: 1211 NOT ded granting provision

ii. § 1651. (f) permits CL ded to extent of 12112. (c)(2) permits ded on loss from stock sale

as trans entered for Πiii. §1212(b): may carry over un-deducted losses

D. N : can NOT deduct personal type losses, unless casualty per § 165

X. APPLY THE ARROWSMITH RULE

A. W/ present yr trans, legit to look at characterization of related trans taking place in previous year

B. Ex: in previous yr, would’ve been CG/CL; t/f, ded this year is CG/CL

C. S: trans covering > 1 yr & generating CG/CL may be characterized as CG/CL, even if S/E req not met

XI. IMPACT OF CG & CL ON TIA. S/E Requirement

i. Broad meaning, e.g. would cover…1. Bequest satisfaction w/ appreciated prop2. Abandoning unimproved RE subj to NR

mortgage > FMV3. Owner’s conveyance of land by quit-claim

deedii. §165(g)(1): if CA security becomes worthless,

shall treat as S/Eiii. §1271(a): amts rec’d from debt instrument

retirement treated as rec’d from S/Eiv. §1231 property, involuntary conversions treated

as S/EB. Holding Period : LT MUST be held > 1 year

i. § 1223(9): Bequest treat as holding yr & dayii. Gift “tap,” e.g. add on donors

iii.C. Kenan

i. Trustees get stepped basis; option to receive prop or marketable securities (avoid TC)

ii. Analysis :1. If paid in $, must sale assets to 3rd party &

recognize G b/c S/E trans2. If paid in prop, NOT S/E b/c is specific

prop held for beneficiary, who then bears risk of price

iii. S: giving asset to satisfy obligation IS S/E1. Judicial gloss on abandonment /

foreclosure cases2. Voluntariness / force NOT required, so

long as satisfies debt

XII. CAPITAL ASSET DECISION TREE FROM BYNUMA. Property?B. Held for sale?C. To customers?D. In the ordinary course?E. In T or B?

CH. 32 - QUASI-CAPITAL ASSETS - § 1231

I. INTRODUCTIONA. Davis : win on upside; best possible trtmt on

downsideB. G/L characterized under § 1231 (NOT deduction

granting provision)i. Deductions granted by §§ 165, 167, & 169

ii. “” disallowed under § 267C. Primary Purpose of § 1231

i. Special / favorable trtmt on S, E, or involuntary conversion of T or B real / depreciable prop

ii. Gain CG; Loss Ordinary Loss!

II. TYPES OF PROP / DISPOSITIONS TO WHICH § 1231 APPLIESA. Applies to…

i. S/E or invol. conv. (theft, seizure, destruction, threat / imminence of condemnation)1. N: if can’t resale, NO S/E

ii. Of real or depreciable prop used in T or B; ORiii. Any CA held > 1 year & in connection w/…

1. T or B; OR2. For profit transaction

iv. *Essentially, prop included in § 1221(a)(2), t/f NO inventory

B. Must consider both…i. Events triggering G/L;

ii. Nature of prop involvedC. Ex : G/L from S/E or involuntary conversion of

depreciable equip used in T or B held > 1 year

III. § 1231 NETTING PROVISIONS & HOW FAVOR TPA. Once ID all § 1231 G/L, §§ (a)(1) & (2) says

compare total G & Li. G > L CG

ii. G < L Ordinary Lossiii. Hotchpot Analysis: all § 1231 G/L combined in

hotchpot for characterization purposesB. SUB Netting Process (Prelim) :

i. (a)(4)(C): for any IC arising from fire, storm, or shipwreck, or from casualty / theft, of any…1. (i) T or B prop; OR2. (ii) Any CA held > 1 year & in connection

w/ profit transaction3. N : condemnation NOT included

ii. IF G > L put assets in REG Nettingiii. IF G < L assets are ORDINARY

1. Deduct L under § 165 or other2. G reported under § 61

iv. IF G = L enter REG analysisv. See examples p. 799-800

C. REG Netting Process (Primary) :i. (a)(1): G > L treated as LTCG or LTCL

ii. (a)(2): G < = L NOT “”

IV. RECAPTURE OF NET ORDINARY L: § 1231(c) A. Prob : two assets sold same year, thereby generating

LTCG and LTCLi. If sold in diff years, would have LTCG and OL

ii. Recapture provision attempts to solve problemB. (c)(1) : Net § 1231 G treated as OI to extent does not

exceed “non-recaptured net § 1231 L”C. Non-Recaptured Net § 1231 Losses

i. Excess of total net § 1231 L for 5 most recent yrs OVER

ii. Portion of such Ls taken into acct as net § 1231 G for such preceding taxable yrs

D. R : applies ONLY to taking losses first

V. § 1239: G FROM SALE OF DEPRECIABLE PROP B/T CERTAIN RELATED TPsA. Hypo : TP may sale to related corp, take FMV basis,

and generate depreciationi. TP recycling assets to regenerate basis & dep

B. § 1239 : can sell to RP, but entire G taxed at OI

i. No longer “fun,” b/c must make tradeoff

VI. ANALYSIS FRAMEWORKA. Authority for deduction?

i. § 165 (profit transaction) (related party disallowance)?

B. Character of Asset?i. Capital?

ii. § 1231?C. Preliminary or Primary?

i. G < = L Preliminary (involuntary)ii. G > L Primary

D. § 1222 Netting Processi. NCG = LTCG -- LTCL

ii. NCG § 1(h)iii. Any § 1250 recapture?

E. § 1231(c) Recapture?

CH. 33 - RECAPTURE OF DEPRECIATION

I. RATIONALE FOR § 1245A. If TP had not taken depreciation, would not have

realized as much gainB. § 1245 - Fixing Perceived Unfairness

i. (a)(1): recognized recapture inc OI (ordinary deduction = OI)

ii. G on disposition of PP attributable to dep, rather than econ appreciation, NO CG trtmt

iii. Trump Provision: to this extent, § 1245 overrides § 1231, e.g…1. § 1221(a) Ordinary Asset2. § 1231 LTCG or LTCL3. § 1245 Final Say OI

C. Recapture Provisions, Generally i. Mainly a/b character, h/w, also recognition

ii. Sometimes, req earlier recognition (§ 453(i))D. Major Benefits

i. N: dep accelerated for PP reasons,ii. TV of $; subsidizes purchase of certain assets;

defer tax pmt1. Free Marketers: a/g direct subsidies, but in

favor of accelerated dep 2. Davis: ideological stumbling block

iii. W/ real prop, pay later, and pay less!

II. INTERRELATIONSHIP AMONG §§ 1221(2), 1231, 1245, & 1250A. §1221(a)(2) : prop may not be CA, t/f any G is OI…

BUT under § 1231 G might be CGi. R : G from econ appreciation characterized by

§§ 1221 & 1231B. §1245 : rec G from sale of dep “§ 1245 prop” is OI

to extent of dep taken on such propi. Generally, apply § 1245 to dep PP (tangible &

intangible), and § 1250 to dep RP1. Diff §, b/c Real Prop has good lobby, e.g.

more generous recapture provisions2. N: § 1245 DOES apply to horticultural

structures (non-SL dep) ii. Does NOT apply to losses

iii. (a)(1): label as OI difference b/t…1. TP’s AB; AND

2. Lesser of…a. “Recomputed basis;” ORb. AR (or FMV, if not S/E or IC)

iv. (a)(2)(A): Recomputed Basis = basis resulting from AB & previous dep / amortiz, & other adj.1. Generally, TP’s original basis, e.g. dep

getting TP back to original basis2. N: § 179 treated as amortiz. ded

v. Remaining Gain?1. Likely, characterized by §§ 1231 &

1221(a)(2), and may be LTCG. 2. NOT treated by § 1245

C. §1250 Recapture - Mostly Dead Letter i. (c): applies to depreciable RP, excepting limited

categories in § 1245ii. (a)(1)(A), (b)(1): When § 1250 prop generates

G, in general, ONLY dep taken in excess of SL is subject to recapture / characterization as OI1. § 168: dep only SL, so can have no excess

of SL (unless pre-1986), t/f § 1250 N/A2. H/w, if § 1250 prop held < 1 year, all dep

IS add’l dep. (b)(1)iii. Unrecaptured § 1250 G taxed @ 25%;

remainder @ 15%

III. § 179 RECAPTUREA. §179 : Election to XP certain depreciable B assets

i. Trigger if prop not used predominately for B purposes (50%)

ii. Reg. § 179-1(e)(3): N/A if § 1245 appliesiii. Rev. Rul: conversion of auto from B to

personal use is NOT “disposition”B. (d)(10) - Owner Version of Recapture

i. If prop which § 179 deduction was taken on converted to personal use, must give up benefit

ii. Reg. § 1.179-1(e)(1), (5)1. Benefit = amt of add’l dep would o/w had

been entitled to w/out election. 2. Amt taxed currently as OI

iii. To reflect triggered inc, AB to extent of § 179 recapture1. Imp to TP “stepping into shoes”

C. N : 125K level extended; PO at 500KD. N : off shelve computer software covered

IV. UNRECAPTURED § 1250 GAINA. Recall §1(h)(1)(D): 25% rate applied to

unrecaptured § 1250 gaini. More favorable than 28% applied to collectibles

ii. “” favorable than 15% rate applied to stock held > 1 year

B. § 1(h)(6) - Unrecaptured §1250 Gain i. § 1250 prop LTCG from dep allowed & not o/w

recaptured as OIii. Unrecaptured § 1250 G gets 25% rate, while

remaining G gets max 15% rate C. Recall § 121 - Gain from Sale of PR

i. (d)(6): G from dep w/r/t PR NOT excludableii. N: see w/ home offices

V. § 1239 ORDINARY INCOME

A. Anti-Abuse Provision : if sell depreciable prop to RP, depreciable in their hands, t/f ALL OIi. G recognized by transferor treated as OI

ii. N: § 167 gives deduction; § 168 gives amountB. RP?

i. Controlled Entities: “in this §, means corp where > 50% owned by TP”

ii. § 267(c): Constructive Ownership Rules1. Corporate / Family Ownership2. Family: brothers, sisters, spouses,

ancestors, & lineal decedentsC. § 1239 is Characterization, NOT Recapture rule like

§§ 1245 and 1250i. R: any G rec on S/E of dep prop b/t RP IS OI;

none of rec G eligible for CG trtmt under §1231ii. S: b/t RP, ALL G will be OI

iii. Narrow, in that only applies to RP transiv. Broad, in that characterizes ALL G as OI

D. Ex : indiv sells depreciable pro to wholly owned corp (RP); all G t/f OI

VI. DISPOSITIONS WHERE §§1245 & 1250 APPLY; EXCEPTIONSA. §1245 Prop : any that is / has been subj. to § 167 dep

AND is personal propi. For real prop, see (a)(3)

B. § 1250 Property : same def, but includes other things

C. Exceptions to Recapture i. 1245(b): mainly, dispositions where prop’s

basis carries over to transferee; preserves recapture potential in transferee’s hands

ii. 1250(d): iii. Gifts, death transfers, LK exchanges, ICs,

transfer to tax exempt org, Timber prop1. Preserves taint for later recapture2. Limit on LK property!

VII. ANALYSIS FRAMEWORKA. Step One: Depreciation DeductionsB. Step Two: Compute Gain (AB -- AR)C. Step Three: Characterize Gain

i. If Personal § 12501. Recovery = Excess of SL (taxed as OI)

ii. If NOT Personal § 1245

CH. 38 - NONRECOURSE DEBT: AB & AR REVISITED

I. RECOURSE & NONRECOURSE DISTINGUISHEDA. Generally, turns on lender’s available remediesB. Recourse

i. Secured: specific prop stands as loan security, so SP can grab w/out procedural speed bumps

ii. Unsecured: can collect full debt from borrower’s assets, unless protected

C. Nonrecourse : prop standing as security will always satisfy debt, even if value i. Tipping point: prop’s FMV, e.g. once equity

gone, risk of loss shifted to lenderD. Included in Basis ?

i. Must repay recourse, t/f more logical inclusionii. If assume will pay unless FMV , more

conditional obligation

II. CRANE & TUFTS A. I : relationship b/t debt (especially NR), basis, & ARB. R : R / NR liab treated same in calculating AB & ARC. Crane and FN 37

i. Considerable NR debt inherited; dep based on FMV @ decedent’s death; later sold

ii. I : gain realized on sale?1. Basis? TP said subtract debt; IRS said no

adj for outstanding liab, including NR2. AR? S. Ct. said NR taken subject to by

purchaser IS part of ARiii. Rules :

1. Liab, whether R or NR, are part of basis2. “”, are part of seller’s AR3. IF FMV > Debt AR includes debt

assumed + FMV of other propa. Debt treated as $b. Justification: econ benefit

iv. FN 37 : IF FMV < Debt, mortgagor not liab for it can NOT realize benefit = mortgage1. Millar, 3d Cir.: enables large dep ded

D. Aizawa - Recourse Debt i. TP still liab on R debt after foreclosure (liab for

amt > foreclosure proceeds)ii. R: w/ R debt, if FMV < Debt AR includes

debt satisfied (here, was FMV). Why?1. If pay later, get ded2. If don’t, RoI & would be double taxed

(unless sheltered by § 108 on insolvency)E. The Tufts Controversy

i. LLP bought housing, econ , FMV < Debtii. I : debt included in AB?

1. TP: NO (FMV -- AB = L)2. IRS: YES (Debt -- AB = G) [winner]

iii. H : entire NR debt included in TP’s ARiv. R : W/ NR debt, IF FMV < Debt AR includes

debt assumed + FMV of other propv. Justifications

1. TP’s PoV: w/ NR, RoI has ended, as full debt satisfied; using FMV not right result

2. Why does TP end up w/ gain? Dep ded.a. Essentially dep recapture, e.g.

include in basis, although contingentb. T/f, include in AR too balance

3. Put Optiona. R Debt: AR = Cash rec’d b. NR Debt: AR = Debt + put option

vi. N : § 108 N/A; only applies to RoI, NOT prop disposition

III. NR BORROWING & § 108 INSOLVENCY EXCLUSIONA. Recall, NOT permanent exclusion, but basisB. Rev. Ruling 92-53

i. I : NR Debt > FMV securing prop, & insolvency determination in § 108

ii. H : Amt NR > FMV acct for in determining insolvency, but only to extent NR discharged

iii. PP : ensure § 108 fresh start; should NOT tax insolvent TP

IV. NR BORROWING & APPRECIATED PROPERTYA. I : does new borrowing…

i. Generate add’l basis; ORii. Represent RE resulting in G recognition

B. R : If new loan used in unrelated venture & doesn’t improve underlying prop, NO basis adj. § 1016

C. Woodsam Assoc.i. TP incurred NR debt > AB; contributed to corp,

who sold at foreclosure (same basis as TP)ii. Corp: when TP incurred NR debt, rec G = Debt

-- AB (would basis corp rec’d)iii. H : TP did NOT dispose of prop, but merely

indebtednessiv. S : favors TPs who have high equity in prop w/

low AB, b/c can w/draw (via NR) from prop and not be deemed to have realized G

v. GR : w/ NR, post acq borrowing NOT RE

V. IMPACT OF CONTINGENT LIABILITIESA. Opportunity for Abuse

i. Agree to inflated price for dep prop; finance purchase w/ NR note to seller

ii. Would allow basis to = inflated purchase price1. Buyer: greater dep ded than if purchased

at FMV; could claim int ded2. Seller: report on installment basis, t/f

report gain only if / when rec’dB. Rev. Ruling 91-31

i. IF debtor still in possession, NO RE, t/f § 1001 not triggered, t/f w/in RoI (assuming solvency)

ii. TP’s Counter:1. Should respect econ substance, e.g. deal

was to transfer full debt2. FMV < Debt, t/f not true debt & shouldn’t

recognize RoIC. Tax Benefit Rule

i. I : do tax / int ( loan amt) become part of basis?ii. R : if receive tax benefit in earlier yr, later have

recovery, must pay taxes on $ in later yriii. Ex: challenge prop taxes and win; recovered

previously deducted $, t/f have GID. Estate of Franklin

i. PP of RP > FMV, t/f TP not expected to make investment in prop represented by NR debt

ii. T/f, ct ignored NR debt for dep / int deductionsiii. Rev. Ruling 77-110: NR too contingent for

consideration in basis, int, and dep1. Basis includes only portion of purchase

price paid in $E. Evaluating the Genuineness of NR Debt

i. Bergstrom: when NR PM debt > R approx. of prop’s FMV, disregard in basis / int ded calc

ii. N: Tufts & Franklin factually distinguishable1. Franklin: debt > FMV of security prop, t/f

NOT true debt (contingent)2. Tufts: original debt NOT > prop value

CH. 44, PART A: TAX SHELTERS, § 465 - THE AT RISK RULES

I. INTRODUCTION A. Methods

i. TVM benefit along w/ conversion of ratesii. Funnel income to tax exempt related party

1. Ex: parent corp in no tax juris; child corp in U.S. and pays 35%

2. Ex: LLP b/t foreign & U.S. corp; inc in early yrs, deduct in later; foreign 99% owner in inc yrs, U.S. in ded yrs

B. Correlation b/t AB & Depreciation i. Cost basis of acquired prop includes portion of

purchase price financed by NR borrowing1. TP’s basis may include borrowed funds

TP has no personal liab too2. Tax shelter, e.g. claim ded > amt at risk

ii. I : encouraging econ unsound investment1. Advance credit in basis given for NR2. Utilize ded for NR to offset inc from

unrelated activitiesC. Estate of Franklin

i. Hotel leaseback used to shift dep dedii. R : NO dep unless actually invested

iii. A : never actually invested, never going to, purchase price extremely overstated

iv. S: pigs fed, hogs slaughtered (too abusive)D. Congressional Response - § 465

i. PP : prevent abuse in Estate of Franklin1. Timing (§ 465)2. Sheltering (§ 469)

ii. GR : ded limited to amt at risk (gen, prop basis)iii. Activities Subj to Rules

1. Covers indiv, estates, trusts, and most closely held corps

2. § 466(c)(3)(A): ANY B or inc producing activity (imp exception for RE activity)

II. OPERATION OF AT RISK RULESA. § 465 At Risk Limitations

i. Can ded up to…1. Inc from activity; AND2. Amt of risk (assets on the line)

ii. (d) Loss Limits: Activity Ded -- Activity Inc1. Disallowed, unless have amt at risk or

generate more inc2. NOT permanent, but deferral (TVM)

B. Initial Amount at Risk is the Sum of …i. TP’s $ contrib. to activity;

ii. AB of other prop contrib.;iii. R debt used to pay for activity;iv. NR debt up to amt of other prop pledged;v. Qualified NR borrowing

C. Qualified NR Financing - § 465(b)(6) i. Applies where TP borrows $ w/r/t holding real

prop, and nobody liab for pmtii. Reg. 1.465-27(b)(1): Includes…

1. Amts borrowed by TP from gov’t;2. Gov’t guarantees amt borrowed;

3. Borrowing from qualified persons, e.g. actively / regularly in B of lending $

a. NOT seller or related person;b. Promoter receiving fee

iii. RP: exception, if commercially R & on subst. same terms as unrelated persons. (d)(ii)1. CR: written / unconditional promise to

pay; R IR (considering loan’s maturity)2. NOT CR: loan term > UL; limited right

of foreclosure / collection

III. ADJUSTMENTS TO AMOUNT AT RISKA. A@R adjusted yearly for income / L / w/drawls

from the activity. Reg. §. 1465-22(b) & (c)B. R : NR loan repmt w/ $ gen. by activity does NOT

affect A@Ri. Loss > A@R disallowed, sometimes CO

ii. Reporting inc w/ NO offsetting ded A@RC. R : A@R by…

i. Direct pmt of NR debt;ii. Cash contrib. by TP;

iii. Prop “”;D. At disposition, deduct suspended lossesE. Recapture Rule - § 465(e)

i. W/drawl > A@R triggers recaptureii. Excess reported as GI

iii. If recapture ded taken in excess of A@R, carry over upon recapture

IV. ANALYSIS FRAMEWORKA. PP: do NOT allow ded for another’s risk through

inflated prices / basisB. Initial A@R?

i. Cashii. Basis of any prop

iii. R debtiv. NR debt up to extent pledged other securityv. Qualified NR debt

C. Adjustment to A@R?i. Income

ii. Loss iii. W/drawl iv. Carryover v. Exception for NR repmt w/ activity gen. $

D. Loss deduction?i. Limited to A@R (but up to inc). (a)(1)

ii. Remaining L disallowed / carried over (suspended)

E. § 465(e) W/drawl Recapture?i. Negative balance in A@R triggers

ii. Can NOT use CO to offsetiii. (1) Include excess of w/drawl over A@R in

GI; may deduct amt a/g following year activity

CH. 44, PART B: § 469 PASSIVE ACTIVITY LOSSES & CREDITS LIMITED

I. INTRODUCTION TO § 469A. TP Behavior Triggers Congressional Response

i. Needed to prevent excessive sheltering, w/out eliminating subst. all tax preferences in IRC

ii. Wanted to benefit / incentivize TPs active in Bs preferences directed toward

iii. T/f, bar use of L from B TP does not materially participate in to offset positive income sources

iv. Flaws in Logic: if must incentivize activities, mkt must be failing (e.g. farmers selling ded)1. Creates negative spillover effects

B. § 469 - In General i. (a)(2): applies to indiv, estates, trusts, and

closely held corps (C corps NOT caught!)ii. GR : TPs must classify: Income, L, & credits as

gen. by Passive or Non-Passive Activitiesiii. PA Ded: only offset passive activitiesiv. (b): L CO & suspended

1. NO limit to CO2. SL allowed in full when interest in PA

disposed of. (g)(1)(A)v. Result: deferral (not permanent) of excess ded

& credits gen. PA

II. PASSIVE ACTIVITIESA. (c)(1) : PA involves conduct of any T or B TP does

NOT materially participate ini. T or B in § 162 sense

ii. (c)(6) includes § 212 XPiii. (c)(7) excludes real prop B

B. (h)(1): Material Participation : regular, continuous, and subst. involvementi. Rationale:

1. Intended TPs should rec tax preference2. These have signif. econ. non-tax motive

C. Temp. Reg. 1.469-5T(a) : MP if… i. TP’s participation > 500 hrs per year;

ii. “” subst. all in the activity;iii. “” > 100 hrs per year, & not less than anyone;iv. MP in any 5 of 10 previous years;v. MP based on all facts / circum;

vi. Personal Services Test: activities are T/B where capital NOT material income-producing factor1. Any three prior years?

D. Special Rule for Limited Partners i. (h)(2): limited partner does NOT MP w/r/t his

interest in limited partnershipii. Exception : satisfy i., iv., or vi. above

E. Rental Activities i. (c)(2): generally, passive

1. (j)(8): any RA “where pmts principally for use of tangible prop”

2. Exception: signif services rendered in connection w/ rental (hotel rooms, cars)

ii. (c)(7)(B): NOT passive per se if…1. (1) > ½ PS performed during year in RP

T/B in which TP MP; AND2. (2) > 750 hrs “”

iii. (i): Exception for AP in Rental RE:1. If natural party TP APs in rental RE, may

apply L / credits to max of 25K of NP inc. (1), (2)

2. (3)(A): PO for TP’s w/ GI > 100K3. (6): AP if own at least 10% interest.

a. N: more lenient than MPb. See outline

F. Scope of Activity i. Importance

1. Need to determine MP2. Must know b/f apply § 469(g), e.g. ded SL

of passive activity when dispose entire intii. Can combine hours into one activity

1. Must be related; may create MP2. If don’t, want separate, so sale of one

crosses over to NPiii. Reg. § 1.469-4(c)(2):

1. Similarities / diff in types of Bs;2. Extent of common control;3. Geographical location;4. Interdependence b/t activities

G. Trtmt of L & Credits i. Must compute G / L from each passive activity

ii. L from activity 1st offset by G from that activity; any aggregate excess carried forward

H. Portfolio Income and Expenses i. (e)(1): excluded from passive G / L calc

ii. Why? Ordinarily gen + inc; not likely to gen L to shelter other inc

III. DISPOSITION OF TP’s ENTIRE INT IN PASSIVE ACTIVITYA. (g)(1)(A): any SL allocable to activity no longer PA

L, but are deductible a/g incB. (g)(1)(A), (B): must have fully taxable disposition

of TP’s interest to unrelated partyC. Consequences of a TP’s Death

i. SL allowed only to extent > amt, if any, by which AB of prop in activity by § 1014

ii. To extent basis by § 1014, SL of activity forever disallowed

D. Consequences of Gift i. (j)(6): NOT disposition causing release of SL

ii. donor’s AB by SL; donee takes that AB, unless have L, whereby L disallowed

IV. ANALYSIS FRAMEWORKA. Divide Income & Deductions into Two Pools

i. Passive: NO MP, limited LLP int, rental activity (w/ exceptions)

ii. Non-passive: MP, portfolio incomeB. Apply Statutes

i. § 465: can deduct L up to A@Rii. § 469: ded from activity limited to income

CH. 45 - ALTERNATIVE MINIMUM TAX - §§ 55, 56, & 57

I. INTRODUCTIONA. Originally designed to apply to 2 dozen extremely

wealthy indiv paying less IT than secretariesB. Companion tax : stack too many benefits in 1 yr,

limit those; wealthy should pay some min amti. Add back some, subtract some

C. AMT objective : prevent abuse of exclusions, ded, & credits to point of significant tax avoidance i. Measures something closer to econ inc (bigger

than TI), but imposes lower rate

D. § 55(a) : AMT = Tentative Min Tax -- Regular Taxi. Adjusted by §§ 56 & 58

ii. Add back in § 57iii. Pay regular tax liab, plus AMTiv. Analysis Framework

1. AMTI -- Exemption = Taxable Excess2. Apply AMT Rates to Calculate Tentative

Minimum Tax3. Pay Regular Tax, plus [Reg Tax -- TMT =

AMT]v. Separate AMT, b/c may be potential credit to

offset AMT; must know add’l min tax, b/c some yrs may not owe AMT

II. MECHANICS - § 55(b)A. TMT = 26% of 1st 175K in “taxable excess” + 28%

thereafter (minus AMT foreign tax credit). (1)(A).i. If part of taxable excess is NCG, separate lower

max rates from § 1(h). (3)ii. Can keep 155 & 25% rats, but 28% gain taxed

at reg AMT rates (26 or 28%)B. T/f, Taxable Excess = AMTI -- Exemption Amt. (1)

(A)(ii).i. Indiv not married, not surviving spouse = 42.5K

ii. Married indiv filling separately = 31,275Kiii. PO exemption when AMTI reaches 112.5K. (d)

(3)C. Adjust TI to calc AMTI…

III. DETERMINING AMTIA. AMTI = TI adj by §§ 56 & 58 & § 57. § 55(b)(2).B. Calc TI (GI -- ATL = AGI -- BTL = TI)

i. ATLii. BTL

1. Misc ID (reduced by 2% of AGI, § 67)a. § 212 ded, e.g. attny fees & invest

XP2. Overall limitation on ID in § 683. Std deduction (if > ID); AND4. Personal exemptions

C. TI adj per §§ 56 & 58 to determine AMTIi. Depreciation:

1. § 1250 prop (real) dep under SL, convert to 150% declining bal

2. Tangible personal prop using 200% declining bal adj to 150% ( adj)

ii. Limitation on IDs, SDs & PEs - § 56(b)1. Misc ID NOT allowed. (1)(A)2. Attny Fees: if ded under § 212 but not

162, AND not ATL under § 62(a)(4) /(20) not allowed

3. Med XP: amt > 10% of AGI. (1)(B)4. SD & PE not allowed. (1)(E)5. §68 overall limitation on ID N/A. (1)(F)

D. TI adjusted per § 57 to determine AMTIi. Include certain tax exempt int, e.g. “specified

private activity bond.” (a)(5)ii. Include 7% of amt excluded under § 1202 as

QSBS. (a)(7)E. Subtract out Exemption, Note POs

i. Taxable Excess = AMT - Exemption Amt

1. PO: (AMTI -- Threshold) * 25%; if > exemption amt, zero exemption

ii. IF NCG, use lower rates in §55(b)(3)F. Calculate TMT

i. TMT -- Reg Tax = AMT

IV. AMT PATCHA. Congress doesn’t index for inflation, and add more

preferences, t/f many more people getting caughtB. Rather than permanently change, patch year to year,

so don’t violate budgeting rules & have flexibilityC. Who likely to get caught…

i. e’ee XP ded under § 212ii. Lots of children, b/c PE & SD disallowed

iii. High property / IT states (NE, Midwest, CA)

CH. 42 - SALE OF BUSINESS & SALE-LEASEBACKS - §§ 1060 & 197

I. INTRODUCTIONA. I : Sale / purchase of unincorporated B, as well as

sale-leaseback arrangementsi. Seller concern gain’s character

ii. Buyer concern basis in new propB. Determining what is sold creates allocation problem

i. Must acct for some premium pdii. Buyers / sellers have diff incentives, w/ gov’t

getting whipsawedC. § 1060 : w/ sale of assets part of T/B, value prop

category-by-category (7 total classes)i. Easier valuation assets come first, so have less

PP allocated to harder to value assets

II. SALE OF SOLE PROPRIETORSHIP - SINGLE OR SEPARATE ASSET?A. Williams v. McGowan Standard

i. Π sold B after bought out partner’s int, reported OL; IRS said B was asset, t/f CG trtmt

ii. R : when sale B, separate G or L analysis made for each tangible & intangible asset in B

iii. H : despite functional interrelationship of B’s assets, & fact value if sold separately, TP must perform separate tax analysis for each1. Character of each asset sold, e.g. ordinary,

capital, or § 1231; AND2. G or L recognized w/r/t its disposition by

allocating portion of PP to each assetiv. PP: prevent distortion/abuse of tax system (e.g.

thwart LT/ST & G/L distinctions)

III. GW, GOING CONCERN VALUE, & COVENANTS NOT TO COMPETEA. Valuable intangibles often part of B sale, & under

Williams, must allocate part of PP to these items…B. Solomon Solution

i. Lists assets, say some have NO identifiable ULs, some have very short ULs

ii. Rough justice: 15 years for alliii. § 197 application triggered when acquire assets

by purchasing entire T/B1. If not, in § 167, & may write off over UL

2. O/w, must use 15 yr period, w/o/r/t ULiv. Assets Involved:

1. Workforce in place;2. B books & records / operating systems;3. Customer relationships;4. Other similar items

C. Goodwill i. Reg. §1.197-2(b)(1): value from expectancy of

continued customer patronageii. PP > FMV of tangible / intangible items

indicate GWiii. Common factors…

1. Established reputation in area2. Good location3. Well recognized name

iv. Ex: Meyer & Rosenbaumv. CG for seller

D. Going Concern Value i. Where GW questionable, part of PP should be

allocated to GCVii. Reg. §1.197-2(b)(2)

1. Add’l value of prop d/t existence as integral part of ongoing B activity;

2. Value d/t ability to continue functioning & making $, even if change T/B’s owner

iii. Ex: fixtures / furniture in barE. Covenant Not to Compete

i. Agree not to compete in same type of B for stated period

ii. Diff tax trtmt than GW, e.g. OI for selleriii. Severability Test: can CNC be separated and

independently valued?1. If CNC only to ensure GW transfer, no

part of PP allocated to it2. If parties understand CNC to be distinct &

separate item, ct will respect R allocationiv. Economic Reality Test: did parties intend to

allocate part of PP to CNC, & does it have indep basis in fact or relationship to B reality1. More common; Annabelle Candy Co.

IV. TAX CONSEQUENCES OF ALLOCATION OF PP TO GW, GCV, & CNCA. Strategic Decisions

i. Seller: determines AR, G/L, & characterii. Buyer: determines dep ded, G/L, & character on

later salesB. Historically

i. Until 1993, GW & CNC were assets w/ no determinable UL, t/f NOT depreciable

ii. Buyers: carve out & treat as separate intangibles w/ limited UL so can amortize

iii. Sellers: amts rec’d were OI, t/f preferred little allocation to CNC

C. § 197 - Amortization of B Intangibles i. Amortization for GW, CNC, GCV, & other B

intangibles over 15 yr period1. Negates incentives for carve outs2. New planning considerations…

a. Buyer amortizationb. Seller CA characterization

ii. N : 5 yr CNC amortized over 15 years (unless not w/in § 197)

iii. I : buyer pushes to maximize allocation to dep assets w/ short UL (3,5, & 7 yr prop)1. B/c of recapture potential, allocation to

such may OI. See § 1245.iv. N: under new framework, buyer doesn’t care

much (feather in cap), but seller does (CA v. O)D. Exceptions to Amortized Intangibles

i. (e)(4): patents / copyrights not acquired as part of acquisition of assets constituting T/B or subst. portion thereof

ii. (e)(3): certain computer software (§ 167(f) - SL dep over 36 month UL)

iii. (c)(2): certain self-created § 197 intangibles1. Ex: ad XP deducted in yr incurred or paid

iv. No Ls permitted on resale of intangibles if TP retains other amortizable intangibles. (f)(1)1. L allocated to remaining intangibles, t/f

AB E. Recapture Rules

i. (f)(7): § 197 amortizable intangibles treated as of character subj to dep allowance under § 167

ii. If sale such at gain, may be subj to § 1245 recapture rules, and/or § 1231 characterization

V. VALUATION OF GW, GCV, & CNCA. IRS gen respects party’s valuation, especially where

interests adverse; t/f, should doc negotiations so that allocation reflected in K

B. § 1060(c) : req residual method of valuation for GW & CNC when purchase assets of a T/Bi. GW/CNC = PP -- total FMV of tangible &

identifiable intangibles (other than GW/CNC)1. Allocate GW/CNC last!

ii. Curves valuation problems / potential for abuseC. Reg. § 1.1060-1(c)(2) : allocate amongst 7 classes in

following order…i. Class I: cash & general DAs

ii. Class II: actively traded personal prop, CoDs Y foreign currency;

iii. Class III: assets TP marks-to-market at least annually for FIT, & debt instruments; 1. S: w/ MtM, recognize G/L w/out RE (only

certain TPs, industries, & assets)2. Ex : A/Rec. 3. NOT Ex : certain contingent/convertible

DIs; DIs issued by RPs iv. Class IV: Stock in trade of TP (inventory)v. Class V: All other assets not included above

1. Ex: equip, truck, etc. (bulk of assets)vi. Class VI: All §197 intangibles except GW &

GCVvii. Class VII: GW & GCV

1. Residual method: allocating whatever’s left

D. 1060(a) : Ps bound by written agreement as to FMV, unless IRS finds inappropriate (free to challenge)i. Both Ps must send in information report

ii. N : if have CNC, gov’t assumes some valueiii. Danielson Factors

1. Ps intent;

2. Nature of B, e.g. uniqueness, reputational concerns

3. Likelihood seller will resume B

VI. SALE-LEASEBACKA. “Sometimes, a cigar is just a cigar.”B. Sale vs. Lease ?

i. Lease: lessee could report rental XP > dep & int available to buyer of same prop

ii. Shifts tax benefits1. Seller/Lessee: rent ded > ded if were the

owner; may raise subst. $, continue possession / use, & pay rent lower than int

iii. Service: prevent shifting & in revenue; t/f, may re-characterize as sale-leaseback

C. Characterized as Financing Arrangement i. TP sells prop to lender, then leases back w/

option to purchaseii. Service: financing arrangement, if more like

mortgage, & disregard transaction’s formiii. Estate of Star

1. TP needed sprinkler system; manuf installed, sign L; gov’t contested

2. Factors:a. LH of continued ownership;b. Option to buy @ lease’s end;

i) FMV leaseii) Di minimus sale

iii) Who controls disposition?c. Rent is FMV vs. PP + interestd. Title (bundle of sticks)e. Who insures / takes risk of loss

iv. But see Frank Lyon - not disregardedD. Characterized as a Tax-Free Exchange

i. Service disregards form & calls it LK exchange1. 1.1031(a)-1(c): 30 or more yr term lease

& fee int in RE are LK properties 2. PP: §1031 negates G/L if TP in essentially

same position post-transaction3. Swap or sale?

ii. But see Leslie – TP overcame IRS challengeE. Analysis Framework

i. Really a sale or financing arrangement?ii. Really a sale or § 1031 exchange?

VII. FRANK LYON CO.A. Bank entered sale-leaseback K w/ Frank Lyon Co.B. SCOTUS : got it wrong!

i. Focus on wrong things to determine who owned building, e.g. that 3 parties involved, terms R, bank regulation, & downside risk

ii. Should focus on fact Frank Lyon only entered K for dep ded, bundle of sticks, etc.

C. Gov’t : sham transaction doctrine, e.g. substance over form (NOT ownership transaction)

D. Future TPs : if on hook for debt, & on my balance sheet, SCOTUS said I’m the owner!

CH. 39 - LIKE KIND EXCHANGES - § 1031

I. OVERVIEW

A. § 1001(c) : generally, must recognize G/L on sale/exchange of prop

B. H/w, under § 1031, NO G/L recognized when...i. Prop held for productive use in T/B/I;

1. “Relinquished” prop, i.e. given up2. Intent must be present when exchange

takes place3. Phrased in conjunctive

ii. Exchanged solely for prop of LK to be held for productive use in T/B/I

C. “Non-recognition” rule: deferral, not permanentD. § 1031(a)(2) : Six Exceptions

i. Provision abused by brokerage houses who exchanged appreciated stocks w/out rec G, but rec L when sold shitty stocks for cash1. Exceptions curve abuse

ii. (A) Stock in trade, or other prop held primarily for sale;

iii. Exchanges of…1. (B) Stocks, Bonds, or Notes;2. (C) Other securities or evidence of debt3. (D): int in an partnership (Meyers)4. (E) Certificates of trust or beneficial int;5. (F) Choses in action (enforceable things

representing rights)E. Overall Objective

i. Zero tax liability currentlyii. NOT complete forgiveness, but deferral

F. Criticisms i. Shapes financial decisions for tax purposes

ii. May cause over investment in RE, t/f priceG. N : NOT elective! But… can get out by making cash

sale.

II. CONTINUITY OF INTERESTA. Exchange equivalent to cashing in one’s investment

in prop exchangedi. § 1031 assumes prop rec’d simply continuation

of that investment in modified formii. TP has only technically (not effectively)

“realized” G/L, t/f tax or ded inappropriate1. N: symmetrical trtmt of G/L

B. Policy Underlying §1031 i. Exchange as continuity of investment in

modified formii. Admin difficulty in valuing prop

1. Administrative convenience2. Valuation issue

iii. Liquidity issueC. Problems w/ Logic

i. Parties often DO know value of propii. Not really liquidity prob if TP in same position

post transactioniii. Continuation of investment assumes prop are

really LK; h/w rule so broad, not always case

III. THE LIKE KIND REQUIREMENTA. Particular Properties LK ?

i. Reg. § 1.1031(a)-1(b): LK = nature/character, kind/class, NOT quality/grade

ii. Improved/unimproved nature of RE irrelevantiii. Ex of qualifying transactions:

1. City RE ranch or farm2. 30 yr leasehold in RE RE3. Improved RE unimproved RE

iv. Liberal approach where int in Q is in real prop1. Rev. Rul. 73-476: tenancy in common

fee simple int LK2. I: natural resources (see class notes)3. See examples in outline

B. Generalizing When Prop Are LK - § 1.1031(a)-2 i. Depreciable tangible personal prop exchanged

for prop either of a LK or a like classii. Like Class: both are in same general asset class.

(b)(1)1. 13 General B Asset Classes, drawn from

Rev. Pro. 87-56, described in Regs. a. Ex: office furniture, fixtures, &

equip all in same GBAC2. Req also met if w/in same “Product

Class.” (b)(1)iii. For intangibles, mainly determined by ct

holdings, which can be narrow1. Ex: book copyright book copyright

ok, but not for songs. 2-(c)(3)2. Ex: GW or GCV of one B NOT LK to

same for another B. 2-(c)(2)

IV. HOLDING REQUIREMENTSA. N : personal use property excluded from §1031; h/w,

one TP may qualify while other does noti. Personal Residence

ii. Personal Vehicle B. Two Holding Requirements

i. Prop given up must be held for T/B/Iii. “” received “”

C. §1031 applies when TP exchanged real property and then promptly transferred the real property received to a two person partnership in return for a general interest in the partnership

D. (f), (g) : 2 yr holding period for exchanges b/t RPsi. (f) prevents swapping of basis b/t RPs

1. Each must recognize G/L currently2. Taken into account on later disposition

ii. Rev Ruling 72-151: shows §1031(d) controls, L preserved even if Boot rec’d

iii. GR : if RP disposes w/in 2 yrs of 1st exchange, TP must recognize currently

V. BASIS CALCULATIONSA. Deferral, NOT Permanent Exclusion

i. Unrecognized G/L preserved in LK prop rec’dii. Since non-LK prop is boot, winds up w/ FMV

basis in recipient’s handsiii. In effect, TP treated as having purchased non-

LK propB. Formula - 1031(d)

i. AB of ALL LK & Non-LK transferred;ii. + G recognized, liab assumed, & cash paid;

iii. – L recognized, liab shed, & cash rec’d;iv. = The Basis to be Allocated v. Rules:

1. Basis allocated 1st to non-LK prop up to FMV (generates gain, so makes sense)

2. Remaining is basis of LK prop (preserves any unrecognized G/L)

C. Basic Concept i. TP in effect receiving partial return of I, &

should t/f basis when…1. Money rec’d;2. Liab relief occurs; OR3. L recognized

ii. TP in effect I, and t/f should basis as a result, when…1. Money paid;2. Liab taken on; OR3. G recognized

D. Testing Answers i. Non-LK prop rec’d should have FMV basis

ii. LK prop rec’d should have basis that preserves unrecognized G or L in prop given up

VI. SOLELY FOR LK PROPERTY: THE PRESENCE OF “BOOT”A. Boot : non-LK prop added in to even up exchange

i. Congress: “pound of flesh”ii. Solely doesn’t really mean solely. (b)

B. If give boot, remain in § 1031(a), b/c still receiving solely LK prop i. Part of basis in prop acquired

C. If receive boot, NOT solely LK propi. Recognize G up to amt of boot, but not > G

realized; LK exchange still permitted, w/ remaining G preserved

ii. Can NOT recognize L on LK propD. G/L on non-LK prop NOT governed by § 1031;

recognized pursuant to § 1001(c)

VII. TREATMENT OF LIABILITIESA. “Cash changing hands”B. Common to transfer subj to liab, or assume liab

i. Treated as money rec’d by TP relieved, & t/f boot. (d)

ii. TP assuming liab gets in basis.C. I : both prop transferred subj to liab

i. Reg. § 1.1031(d)-2: only net liab relief, by any cash pd, constitutes money rec’d.

ii. See examples, p. 930D. N : if P getting debt relief & paying $, other P should

ask to just pay off part of debt (unless wants $)

VIII. RELATIONSHIP B/T § 267(a)(1) & § 1031A. Preserving UR L in exchanges b/t RPs may create

apparent inconsistency b/t § 1031 & §267(a)(1)B. § 267 : disallows certain Ls b/t RPs

i. (b): members of family1. (c)(4): bros & sis (whole or ½ blood),

spouse, ancestors, lineal decedents C. Which applies?

i. Matters, b/c in 1031, L preserved; in 267, may not preserve L, & have to take FMV basis1. Not permanent, i.e. if prop appreciates,

can add basis back ii. Rev. Rul. 72-151: § 1031 controls!

1. Counter: § 267 more specific disallowance rule

D. See example in outlineE. Rev. Ruling 72-151

IX. SALE OR EXCHANGE?A. Former Reg. § 1.1002-1(d): exchange ordinarily a

“reciprocal transfer of prop, not transfer of prop for $ consideration only.”i. Ex: TP “sells” LK for $, immediate “purchases”

qualifying LK from same personii. R: if, in substance, trans. is exchange rather

than sale/purchase, § 1031 applies!B. Exchange in Substance Rule

i. Parent selling & subsidiary buyingii. Sale and Lease Back Context

1. Reg. § 1.1031(a)-1(c): 30 or more yr LK

X. THREE-WAY EXCHANGES & DEFERRED EXCHANGESA. Three-way Exchange Defined

i. See Rev. Ruling 77-297ii. Receiving $ for prop, even if immediately

invested in LK, fatal to § 1031 trtmt iii. T/f, allow use of qualified intermediary in

simultaneous exchange. Reg. § 1.1031(b)-21. Safe harbor. Reg. § 1.1031(k)-1(d)(1).2. (k)-1(g)(4): Must not be a “disqualified

person”a. NOT e’ee/agent of TP in last 2 yrsb. Exception: solely § 1031 exchange

or routine financial servicesB. Simultaneous Transfer Required?

i. Starker: TP got §1031 trtmt even though…1. Prop to be rec’d not ID when transferred

prop given up; AND2. TP had 5 yr right to get pro, several, or $

ii. Congressional Response (a)(3): TP req to…1. ID replacement prop w/in 45 days of

transfer; AND2. Receive “” w/in 180 days after transfer, or

due date of tax return, whichever earlierC. Anti- Starker Rule

i. May ID 3 replacement properties of any value OR any # of “” in total not exceeding twice value of relinquished prop. 1. Name, legal st address, meets & bounds2. Must give notice 3. See Reg. § 1.1031(k)-1(c)(4)(i).

ii. If break rule, NO § 1031 trtmt, unless receive prop w/in 95% of total FMV

iii. N : ID as much as possible!D. Reverse Starker Exchanges

i. Replacement acq b/f relinquished transferred1. Reg. § 1031(k)-1: above rules N/A2. Need QEAA, e.g. someone holds title

ii. Rev. Pro. 2000-37: provides safe harbor1. R : exchange accommodator must hold

“qualified indicia of ownership”E. Alt : lease prop; get $ for rent, just not for prop

(“more than one way to skin cat”)

XI. INTERFACE OF §§ 121 & 1031A. Overview

i. § 121: exclusion for gain realized on S/E of PR owned & used 2 or more yrs in last 5 yrs

ii. May qualify where @ disposition holding for B or I purposes

iii. § 1031 may also apply if exchange prop for other LK prop

B. Rev. Pro. 2005-14: must apply § 121 to gain realized firsti. § 121(d)(6): exclusion N/A to dep, but § 1031

may apply to such Gsii. § 1031: boot taken into account only to extent >

gain excluded under § 121; AB by amtC. § 121(d)(10) - Prop Acquired in LK Exchange

i. Must be held for at least 5 yrs to use exclusionii. Extended to person whose basis in prop

determined by ref to TP’s (e.g. gifts)D. See Problem 4E. Framework

i. How much G realized?1. AB?2. AR?

ii. Apply § 121, exclude G up to ABiii. Apply § 1031

1. Boot allocated to § 121 1st

iv. Determine basis of replacement prop1. Adjust for § 121 exclusion

XII. CASE LAW & SERVICE GUIDANCEA. Rev. Ruling 77-297

i. I : prefer LK so can defer G recognition, h/w, if can’t, should Ps still sale prop?

ii. A : three-way exchange, w/ debt on both sidesiii. Problems :

1. High transaction costs2. One P put potentially in chain of title

(bad, if lien put on prop)iv. Rev. Rul. 75-291: § 1031 N/A to TP acquiring

prop solely to exchange as LKv. N : hypo is simultaneous, NOT deferred

exchange1. Today, structure as qualified intermediary

via Reg. 1.1031(b)-2B. Rev. Ruling 72-151

i. Prop exchanged b/t corp & sole SHii. § 267: NO ded for Ls from S/E b/t RPs

iii. §267(b)(2): indiv & corp which indiv owns > 50% of outstanding stock

C. Bolker - Intent to Dispose?i. TP exchanged real prop, then promptly

transferred prop rec’d to LLP for gen intii. H : holding req met by lack of intent to liquidate

investment or use of personal pursuits iii. PP : continuity of interest

D. Bell Lines, Inc. v. United Statesi. Old trucks sold, new bought, then dep @ full

PP of new truck claimedii. H : indep sale of old equip & purchase of new

does NOT create LK exchangeiii. PP : defer G/L recognition when have direct

exchange of propiv. Test : mutually dependent transactions?v. Focus : TP intent in knowledge

E. Rev. Rul. 90-34 i. S: transfer may qualify for NR, even if

transferee never holdsF. Rev. Pro. 2000-37

i. Safe Harbor / Reverse Starker problemii. See Problem 3

CH. 40 - INVOLUNTARY CONVERSIONS - § 1033

I. GENERAL POLICYA. § 1033 : relief provision; gives NR of G when would

create severed hardshipB. Ex: farm land condemned; AB much less than FMV

i. If purchase replacement, technically GRii. G NOT recognized; NR NOT by § 1031

II. TRIGGERA. Prop “compulsorily or involuntarily converted” d/t

destruction, theft, seizure, or condemnation; ANDB. TP gets…

i. (a)(1): new prop (qualified replacement) direct conversion § 1033 mandatory

ii. (a)(2): $ / non-qualified & later replaced w/ qualified § 1033 elective

C. N : unlike § 1031, L specifically exempt, & applies to personal use propi. BUT… if T/B prop, see § 165 Casualty Ls!

III. INVOLUNTARY CONVERSION EVENTSA. “Destruction” - “casualty” analogy, e.g. result of

fire, storm, or shipwrecki. N: no sudden, unusual, or unexpected req

B. “Seizure” - confiscation by gov’t entity w/out compensationi. N: does NOT have to be for public use

IV. SIMILAR/RELATED IN SERVICE OR USE - (a)(2)A. Reg. § 1033(a)-2(c)(9): std NOT met when…

i. (i) $ from unimproved condemnation invested in improved RE;

ii. (ii) “” real prop conversion used to debt on leasehold;

iii. (iii) Requisition tug owner use $ to buy bargesB. Rev Ruling: functionality test appliedC. § 1033 vs. §1031

i. § 1033 more narrow than LK std1. End user test: who actually uses prop?2. Lessor test: obligations, duties, &

services provided by lessorii. §1033(g), Condemnation of Real Prop in T/B/I,

adopts LK/1031 stdiii. §1033(h), Damage from Federally Declared

Disasters, uses broader std 1. (1) favorable trtmt for PR & contents2. (2) T/B/I prop gets special trtmt in service

or use testa. Prevent B failureb. Give relief if invest in diff B

D. Time for Replacement i. Unlike § 1031, NO holding req

ii. (a)(2)(B): w/in 2 yrs following conversion

iii. (a)(2)(A): replacement prop must be purchased to replace prop converted1. (i): If buy b/f prop converted, TP must

hold on date of disposition2. (ii): But for (b) basis rules, unadjusted

basis must be § 1012 cost basis (e.g. NO gifts, Reg. § 1.1033(a)-2(c)(4)).

iv. (i) : if replacement acq for RP, may lose NR1. E.g. total realized G for year on all

involuntarily converted prop > 100K2. N/A if RP acq replacement from URP

during replacement periodv. § 1223: if CA, holding period tacks

V. BASIC COMPUTATIONSA. Gain Recognized

i. Nonrecognition Req1. 2 year period to find replacement2. All proceeds spent on new prop3. Similar or related in use (if req)

ii. Partial Recognition of Gain1. (a)(2): GR recognized to extent AR @

conversion > cost of replacement B. Basis of Replacement Property

i. (b): Two Different Rules1. (1): if direct conversion 1031 AB rules2. (2): if $, then qualified replacement prop,

AB = Cost -- GR on conversion NOT recognized b/c of 1033a. Ex: ins proceeds

ii. T/f, NOT permanent exclusion, but deferral

VI. INVOLUNTARY CONVERSION OF PRA. § 121 : max exclusion of 250K (500K for joints)B. §1033 may apply where §121 does also

i. § 121(d)(5)(A): if IC, § 121 permittedii. § 121(d)(5)(B): for § 1033, AR = IC Proceeds

-- G excluded under § 121 (t/f, apply § 121 1st)C. See examples, p. 968-69

VII. CASE LAW & REV. RULINGSA. Liant Record, Inc. - “Similar or Related Use”

i. Commercial T building condemned; Π used proceeds to buy residential apartments

ii. Arguments:1. IRS: end user test, not “similar/related”2. Court: look at use by TP (investor test)

iii. R : where TP is investor & not user, nature of TP’s relation to prop is determinative1. Extent & type of TP’s mgmt activity2. Amt & kind of services rendered by TP 3. Nature of TP’s B risks connected w/ prop

B. Rev. Ruling 64-237 i. I: meaning / application of “similar/related”

ii. H: reject functional use test for service-or-use-relationship test

iii. BUT… still use functional w/ owner-usersC. Rev. Ruling 79-261

i. Cannot divide b/t some similar/related use prop; if get back & use for two f(x)s, can’t divide

D. Rev. Ruling 89-2 i. Chemical spill; TP sells to gov’t

ii. I: involuntary conversion? YES!iii. IRS: anything rendering prop unfit for it’s useiv. Caveat: pmts can NOT be for damages

1. Ex: ship damaged, compensated; sell unrepaired; NOT IC, b/c was repairable

E. Willamette Industries, Inc.i. Π owned/processed timer, damaged from nature

1. Here, know proceeds clearly, smart to sell2. Instead salvaged, processed, deferred G

ii. IRS : NOT ICiii. TP : mitigating damagesiv. Ct : agreed w/ TP; critical factor was that Π was

compelled to harvest trees / extensive damagev. Problems :

1. Often can’t separate out FMV2. What would damaged goods o/w sale for?

CH. 41 - INSTALLMENT SALES - § 453

I. OVERVIEW – §§ 453 & 453AA. Problem Presented

i. G/L typically recognized at sale. § 1001(a), (c)ii. H/w, when sale at G on deferred pmt or

installment basis, such a rule may be harsh.1. Liquidity problems w/ bunching G in yr of

sale, when some SP not yet rec’dB. Congressional Response

i. § 453: 1. G on sale spread over period pmts rec’d2. Inc from prop disposition, NOT from

collection of obligation3. N/A to Ls

ii. BP: b/c of sale’s nature, TP can defer TL!iii. (b)(2): installment sale does NOT include...

1. Publicly traded stock; OR2. If you are dealer in certain prop

iv. Benefit: int-free loan = tax on G from sale!C. Statutory Framework

i. (a): inc reported under installment method; does NOT apply to Ls

ii. (b)(1): Installment Sale Defined1. GR: disposition where at least 1 pmt to be

rec’d following disposition yr2. NOT req to rec pmt 1st yr; irrelevant that

large % rec’d 1st yriii. (c): Installment Method Defined

1. Prorate total G over total pmts to be rec’d2. Gross Profit Ratio = [Gross Profit / Total

K Price], e.g. G / AR3. Gross Profit Ration * Pmt = Inc for yr

II. PAYMENTS & LIABILITIESA. Mortgage or Debt Assumed

i. Reg. § 15A.453-1(b)(3)(i): tax free return of basis; not included in GP; total K price

ii. BUT… if liab > AB, excess treated as pmt, so total K price will 1. GP ratio will be 100%2. Qualifying debt offsets SP only to extent

of basis. (2)(iii)B. Debt Instruments as $ (PN)

i. GR: notes issued NOT pmt, even if guaranteed by 3rd P. (f)(3)

ii. H/w, debt payable on demand / readily tradable considered pmt. (f)(4),(5).

C. Nonqualifying Debt i. NO in total K price, t/f NO in GP ratio.

ii. Shouldn’t treat relief as basis return for seller, but treat as pmt, e.g. part basis return, part inc

III. RECAPTURE INCOMEA. (i) : b/c seller rec’d tax benefit via dep b/f sale, must

recognize dep recapture inc in yr of salei. = amt §§ 1245 & 1250 would classify as OI if

all pmts rec’d in 1st yearii. Seller’s AB by amt of recapture income

B. S : adj GP , since AB (avoids over-reporting inc)

IV. ELECTING OUT OF INSTALLMENT METHODA. (d): NOT mandatory; report under normal acct’g

method; must elect out, o/w automatically appliedi. Must make in timely manner

ii. May revoke w/ IRS’s consentB. Effect of Electing Out - Reg. § 15A.453-1(d)(2)

i. (i): recognize FMV of obligationii. (ii): AR can NOT be < FMV of prop rec’d

C. Why ? i. Unusually low tax bracket in yr of sale, want to

accelerate inc recognition ii. Will gen LTCG, & have huge LTCL that year,

w/ no other CGsiii. Can argue open transaction doctrine

V. EXCLUSIONSA. (k) : certain deferred pmt sales, e.g…

i. Publicly traded prop (sufficiently liquid);ii. Sales pursuant to a revolving credit plan

B. (b)(2)(A) : “dealer dispositions,” e.g…i. Personal prop reg sold on installment plan;

ii. Real prop held by TP for sale in OCOB.iii. Does NOT include…

1. Farm property2. Time shares & residential lofts

C. (b)(2)(B): dispositions of personal prop includable in inventory

VI. CONTINGENT PMT SALESA. I : total amt of deferred pmt uncertain at time of sale,

e.g. contingent on future eventsB. Burnett v. Logan

i. Stock sale contingent on future mining opsii. SCOTUS: report G on open trans approach, e.g.

basis 1st 1. Hold trans open till all pmts made2. Here, promise of future pmts had no

ascertainable FMVC. (j)(2): apply basis recovery ratably over term;

foreclosed Burnett approach in most casesD. Reg. § 15A.453-1(c) - Three Rules (E&E) E. IF elect out, then use FMV of contingent payments

i. §1001(c): AR -- AB = Gain / Loss

VII. DISPOSITION OF INSTALLMENT OBLIG - § 453B

A. B: when oblig disposed, tax deferral ends; to determine G/L, subtract basis from either…i. (a)(1): AR, if less than face value or a S/E;

1. N: gift b/t RPs, FMV NOT < face valueii. (a)(2): FMV at disposition, if other than S/E

iii. Ns : 1. Character of G/L determined by that of

underlying prop. (a)2. If b/t spouses or incident to divorce,

spouse steps in transferor’s shoes. (g)B. Basis of an Obligation

i. Face Value -- Inc if oblig fully satisfied. (b)ii. See example in outline

C. Rev. Ruling 79-371 i. I: transferee’s basis following gift disposition

ii. § 453B(a)(2): basis to reflect inc recognized by transferor

VIII. SECOND DISPOSITIONS BY RELATED PERSONSA. See TP abuse hypo in outlineB. (e) - Second Dispositions by RPs :

i. Triggers G recog by initial seller ONLY up to AR on resale > actual pmts made under inst sale

ii. Exceptions / Limitations1. (2)(a): unless marketable securities, only

applies to resale w/in 2 yrs of 1st sale 2. (6)(b): If resale involuntary, & 1st sale b/f

threat/imminence of conversion, N/Aiii. S : § 1001 determines G for initial seller

IX. SALE OF DEPRECIABLE PROP TO RPsA. GR : here, can NOT use installment method. (g)(1)

i. (g)(3): “RPs” defined by § 1239…B. RPs - § 1239

i. (a), (b): can NOT use installment method w/ sale b/t TP and…1. (1): controlled entity (TP owns > 50% of

stock);2. (2): trust w/ TP or spouse as beneficiary;3. (3): executor & beneficiary of an estate

ii. § 267: family member definedC. PP: deter abuse whereby RP gets stepped up basis

for dep b/f seller must recognize G (recycling dep)i. Rule N/A where FIT avoidance not a principle

purpose. (g)(2).

X. SPECIAL RULES FOR NON-DEALERS - § 453A & PLEDGINGA. (d)(1) : If installment oblig pledged as security, loan

proceeds treated as pmt of obligation, triggering G. B. (d)(3) : later pmts disregarded up to aggregate amt of

deemed pmt.C. (a)(1), (2) : if installment pmts > 5 mil, must pay

gov’t int on tax deferredi. Determined w/ max tax rate. (c)(3).

D. (b)(1) : SP must > 150K.

XI. INSTALLMENT OBLIG & LK EXCHANGESA. I : LK exchange, receive installment oblig as “boot”B. § 453(f)(6) :

i. LK prop NOT treated as pmt; AND

ii. Total K price does NOT include LK prop, & GP amt of G not recognized by LK exchange

C. Basis Calculation i. 1st allocate to LK prop rec’d (but not > FMV),

w/ remaining basis used to determine GP ratioii. See example p. 999-1000

D. TP should get nonrecognition treatment on LK exchange

XII. ANALYSIS FRAMEWORKA. Qualify for § 453?

i. Payment past 1st year?ii. Any exclusion?

B. Apply GP ratio to each pmti. GPR = GP / Total K price

1. GP = Gain2. K Price = AR

ii. GPR * Yearly Pmt = Yearly Inclusioniii. Ensure recovery of basis

CH. 43 - OID: §§ 1271 - 1275; § 483

I. INTRODUCTIONA. I : how to deal w/ TVM

i. IRC: impute int equivalent (OID) if debt instrument doesn’t bear adequate int rate

ii. Such int currently included in incomeB. Topical Preview

i. Calc / trtmt of OID on DIs issued for cash or prop ( §§ 1271-1275)

ii. “” of “unstated int” on certain deferred-pmt sales of prop (§ 483)

C. See hypo in outlineD. Compounding of Interest

i. Today: both Ps put on accrual method for OID purposes, but reject ratable for econ accrual

ii. W/ compound int, apply int rate to sum of…1. Amt originally loaned; PLUS2. Any int on debt accrued but not yet paid

iii. BP: more rapidly compounded, greater total amt of int earned1. As compounding freq , iR must to earn

same total int over same time period

II. OID: DEBT INSTRUMENTS ISSUED FOR CASHA. Determining Amt of OID

i. Must know four things…1. Redemption price2. Maturity date3. Issue price4. Interest rate

ii. §1273: Determination of Amt of OID 1. (a)(1): OID = Stated Redemption Price –

Issue Price2. (a)(2): SRP = all pmts & unqualified

stated interest3. (b)(2): IP = public offering price4. (a)(3): OID = zero, if OID < ¼ % of SRP

* yrs to maturity (de minimus rule)a. Ex: 102 SRP, 100 IP.

iii. See examples, p. 1048-49B. Current Inclusion of OID - § 1272

i. GR: DI holder w/ OID must currently include earned portion

ii. (a)(1): include daily portions of OID for each day TP held DI

iii. (a)(2): N/A to…1. Tax exempt obligations;2. US savings bonds;3. DIs w/ fixed terms of 1 yr or less;4. Oblig issued by NPs b/f 3/2/1984;5. Outstanding loans b/t NPs < 10K, not

issued in lender’s T/B, not for tax avoid6. 1272(a)(1)(E)7. See Problem 2

iv. (c)(1): N/A to bonds bought at premium, amt > principal amt

v. (a)(3): Determine Daily Portions of OID1. Yield to Maturity = Constant IR * IP,

compounded at least annually2. KIM: if semi annually, ½ iR & apply

ratably per dayC. Deduction of OID

i. §163(e)(1): Interest – OIDii. PP: match int inc & XP by placing Ps on

accrual basis w/r/t intiii. Issuer of instrument has debt expense = to daily

portions of OIDD. G/L on Sale, Exchange, or Retirement

i. GR: amts rec’d on DI retirement treated as amts rec’d on an exchange. § 1271(a)(1)1. If bond CA, generates G/L via AR -- AB2. If DI held as CA, gain is GG

ii. § 1272(d)(2): in AB of bond when OID included in inc

iii. § 1272(a)(7): daily OID portions to acct for premium & eliminate built-in loss/excess OID

E. Market Discount i. See hypo in outline

ii. § 1276(a)(1) & (b)

III. OID & UNSTATED INTEREST: DIs ISSUED FOR PROPA. Overview

i. Incentive to IRs1. Seller: higher SP w/ lower iR = extra CG,

r/t int inc2. Buyer: if prop dep, higher SP = add’l

basis to dep, r/t int XPii. If sell on deferred pmt basis, Ps must provide

adequate int on unpaid balance; if not, imputed, & nominal SP adj to acc’t for unstated int1. Statutorily set price of prop2. “” appropriate iR

iii. N: must acc’t for int accrual AND prop disposition

B. Determining IP Under § 1274 : Inadequate Stated Int i. (c)(1): § 1274 applies if…

1. DI given up for S/E of prop;2. Stated RP > IPA; AND3. Some or all pmts due > 6 mos after sale

ii. § 1273(b)(3): when publicly traded, IP = FMV; if not publicly traded, consult § 1274…

iii. (d)(2): use Test Rate, e.g. lowest AFR in 3 month period…1. Ending w/ month S/E occurs; OR2. “” have binding written K for S/E

iv. (a): If NO adeq stated int, 0% IR surely inadequate, IP = imputed principal amt of note1. (b)(1): IPA = total PVs of all pmts due

under such DI2. PV: discount pmts to sale date using

compounding period & test rateC. Determining IP Under § 1274 : Adequate Stated Int

i. (c)(2): stated int adeq ONLY if note’s IPA > or = SPA1. Here, re-characterization of principal as

int unnecessary, b/c sufficient int charged2. N: if some int, but not adequate, will RP

ii. BP: Ps stated int IS treated as int, but relabeled OID, & currently included in inc. § 1272(a)

D. Adeq Int Charged & Paid Currently i. Here, NO OID. § 1273(a)(1)

ii. Likely, NO adj to IP & RP.E. Exceptions - (c)(3)

i. Sales of farms under 1 mil. (A)ii. Sale of PR. (B)

iii. Sale for DI where total pmts < 250K. (C)F. Unstated Interest: §483 , When Sales < $250K

i. Imputed int here is called “unstated int”ii. Unlike OID, int included in inc under TP’s

regular acct’g method1. Ex: $ method includes upon receipt2. N: mismatch if issuer accrual & holder $

iii. § 483(c)(1) - Unstated Int?1. Deferred pmt, e.g. on acc’t of S/E due > 6

mos later, & at least 1 pmt due > 1 yr after sale

2. Total unstated int under K?a. = Total deferred pmt under K -- PV

of such pmts & any int pmts dueb. PV determined w/ test rate

iv. De minimus: N/A to sales < 3KG. Special Rules

i. Cash Method Election of § 1274A - $2M Rule1. (c)(1): may elect to apply $ method rules 2. (c)(2): election requires…

a. Qualified DI;b. NOT new § 38 tangible personal

prop;c. Stated principal < 2 mil;d. Seller not on accrual method;e. Prop sold not dealer prop;f. § 1274 o/w applicable;g. Seller / buyer jointly make election

3. S : seller reports unstated int under § 483 as inc as pmts made; buyer ded int as paid

ii. IR Limit on Qualifying Sales of $2.8M or Less1. § 1274A(a): w/ any qualified DI, discount

rate limited to 9% semiannually2. Qualified DI: SPA < 2.8 mil & prop not

new § 38 prop. § 1274A(b)iii. IR Limit on Certain Land Transfers in Family

1. § 483(e)(1): w/ unstated int calc, max DR is 6%, compounded semiannually

2. § 483(e)(3): rule N/A if calendar yr sales > 500K

iv. Personal Use Property (not T/B/I)1. § 1274 & 483 N/A to obligor on deferred

pmt sale here2. Deduct OID when paid, not when accrues

IV. FORCED MATCHINGA. § 83 : must include pmt for services currently, unless

substantial risk of forfeitureB. Ex: signing bonus, but lose if leave w/in 2 years

i. Accrual method e’er deduct in 1st yearii. E’ees basis = FMV @ inclusion; may defer, but

may end up including more (if FMV ); can elect to include earlier (smart if IPO start up)

C. Intentional Mismatching Retirement Savings

CH. 37 - TAX CONSEQUENCES OF DIVORCE - §§ 71, 215, & 1041

I. OVERVIEWA. § 71 : alimony rec’d included in incomeB. § 215 : alimony paid deductible by payor (ATL)C. § 1041 : prop transfers b/t spouses & former spouses,

incident to divorce, are nontaxable D. PEs for dependent children of divorced parents, &

proper filing status post separation/divorceE. I : who is proper TP, now that familial unit not intact

i. PP: b/f divorce, tax borne by single econ unit; now, must allocate b/t Ps w/ adverse int

II. ALIMONY: GENERAL REQUIREMENTSA. § 71(b)(1) : Any pmt in cash…

i. (A) made to spouse or on behalf of spouse;1. Rev. Rul. 67-420: pmts to 3rd Ps may be

o.k., e.g. mtg w/ 1 spouse still living thereii. (A), (2) rec’d by spouse under written K;

1. N: oral K not enough, need meeting of minds / mutual assent. Ewell

iii. (B) divorce K does not say includible in GI by payor, & not deductible by payee;

iv. (C) If legally separated, not living in same house when pmts made;1. PP: fight “tax divorces” to avoid

“marriage penalty”v. (D) pmts end on payee’s death;

1. PP: prevent disguised prop settlements2. T:

a. Unambiguous condition to terminateb. If non, K as a whole?

B. 3 rd P Pmt on Behalf of Spouse i. Ex: rent, mtg, utilities

ii. BUT… if TP still on mtg…1. ½ pmt alimony, other ½ not;2. ½ deductible, other ½ gets home mtg ded

iii. Term LI with FS as beneficiary1. Reg. 1.71: NOT alimony, unless FS owns

policyC. Planning Considerations

i. GR: default more advantageous (payee in lower tax bracket, better to stack inc here)

ii. H/w, Ps can agree o/wiii. Incentives often adverse, create later problems

III. CHILD SUPPORTA. 71(c) : NOT deductible / NOT includible

i. PP: pre-existing parental support responsibility; not terminated by divorce

B. Temp. Reg. § 1.71-T(c) : in alimony which really is child supporti. If w/in 6 mos of maj age, presume is in CS

IV. EXCESS FRONT-LOADING - § 71(f)A. Why? Accelerate ded currently

i. Trigger: big drop off b/t post sep yrs 2 & 3ii. Unless pmts relatively small, won’t be alimony

iii. “Excess” alimony recaptured in next yr, e.g. tax trtmt reversed (payor includes, payee deducts)

B. § 71(f): recapture can be in 1 yr only, e.g. “3rd post separation year,”i. (6): Excess pmts determined in 1st, 2nd, & 3rd

post separation yrsii. See problem 3

C. Exceptions - § 71(f)(5) i. Payee spouse remarries or either spouse dies

D. Analysis Framework i. (f)(4): 2nd PS Yr Pmts -- (3rd PS Yr Pmts + 15K)

ii. (f)(3): 1st PS Yr Pmts -- [((2nd PS Yr Pmts -- (f)(4) Excess) + 3rd Yr Pmts) / 2]

iii. Total excess recaptured in Yr 3

V. DEPENDENCY EXEMPTION - § 152A. Parent w/ custody for > part of year ordinarily gets.

(a)(1), (c)(1)(B),(c)(4)(b)B. (e)(1) : Requirements

i. Parents satisfy divorce/ separation reqii. Provide > ½ child’s support (days, not $)

iii. Have custody > ½ yearC. Planning Considerations

i. If non-custodial in higher bracket, may be smartii. Need written agreement attached to return

1. Prevents argument / gov’t whipsaw2. Bargaining chip, e.g. CS!

VI. FILING STATUSA. Either file single OR HoHB. Determines tax rateC. Head of Household

i. Defined in § 2(b)1. Not married2. Not surviving spouse3. Principal place of abode for qualifying

child / dependent4. Pay ½ costs

ii. N: if give up §152 exemption, do not lose status

VII. PROPERTY TRANSFERS - § 1041A. (a), (b): No G/L recognition; transferee assumes

transferor’s basis; L carryover in ABi. PP: in effect, transfer w/in single econ unit, &

t/f, should not be taxedii. Also catches “transfers incident to divorce”

1. T : closeness in timeB. RE : any time $ rec’d

VIII. SPECIAL RULES REGARDING PR - §121(d)(3) A. (A): tacking ownership period allowed. B. (B): “” use “”C. N : exclusion amt determined by filing status

IX. LEGAL XPs - DEDUCTIBLE?A. T : origin of the claim (NOT consequences)

i. See Gilmore, problem 6B. Misc ID for tax preparation/planning

i. Amt for divorce deductible subj to 2% AGI limitation

ii. Bifurcate out tax advice & rep in divorceC. FS’s attorney fees

i. § 212 XP to generate inc, tax advice D. TP paid attorney fees for former spouse

i. As long as terminates at deathE. TP’s own attorney’s fees - Bifurcate

CH. 35 - THE KIDDIE TAX - §§ 1(G), 63(C)

I. INTRODUCTIONA. Joint Returns: families share resources, e.g. split inc

i. H/w, kids file own return as separate TPsii. Rich parents incentivized to give kids (taxed at

lower rates) inc generating assetsB. “Kiddie Tax” - subst. eliminates benefits of inc-

shifting to child subject to tax (“covered child”)i. § 1(g): tax “net unearned income” of covered

child at top marginal TR of parents (unless child in higher bracket)1. Earned: personal services inc (still taxed

at child’s ordinary rate)2. Unearned: inc from prop transferred by

parents, & also that from any others (overbroad)

3. N: also catches unearned inc from assets child acquired w/ OWN earned income

II. KIDDIE TAX APPLIEDA. § 1(g)(2) - Applies Too…

i. (A)(i): Kids not 18 by close of tax yearii. 2007 Amendments: also applies to child if…

1. Attained age 18 by close of tax yr, but not yet 19, or is full-time student under 24 ((A)(ii)(I) & § 152(c)(3)); AND

2. Earned inc NOT > ½ child’s support ((A)(ii)(II))

iii. Further, will NOT apply UNLESS child…1. (B) has at least 1 living parent; AND 2. (C) NOT married filing jointly.

B. Special Provisions i. § 63(c)(4): SD adj for inflation

ii. § 63(c)(5): for dependents whose § 151 ded avail to another TP, SD limited to…1. (A) $950 in 2010; OR2. (B) $300 + earned income

iii. § 151(d)(2): if dependent’s § 151 ded avail to another TP, dependent can NOT claim PE

C. Tax Imposed - § 1(g) i. (1): Greater of…

1. Tax imposed w/o/r/t § 1(g); OR2. Sum of…

a. Normal tax if child’s TI by net unearned inc; AND

b. Child’s share of “allocable parental tax.”

ii. (4): Net Unearned Inc: UI -- sum of…1. Limited SD ($950); AND2. > of 2nd SD, or ID directly connected w/

UI 3. N: typically, child’s UI, minus 2 * ltd SD.4. N: Can NOT exceed TI. (b).

iii. (3)(A)(i): Allocable Parental Tax: tax at marginal parental rate of all NUI of all applicable children. 1. N: if have multiple children, allocate

amongst them based on share of UI inc

CH. 19 - MOVING, CHILD CARE, & LEGAL EXPENSES - §§ 217, 21,

I. MOVING EXPENSESA. Contrast w/ §162

i. Here, not already in T or B, t/f 162 deduction NOT available

B. § 217 - Moving XP i. Preliminary Requirement

1. (a): Incurred “in connection w/ commencement of work”

2. Reg. 1-217-2(a)(3)(i): Must bear “R proximity in both time & place”

ii. (c)(1): New work at least 50 miles further than old residence was from work1. PP: ensures moved for B purpose; o/w,

would cover simple moves2. N: if don’t have commute, just 50 miles

from residence3. N: can’t get over threshold by taking

scenic route (anti-abuse)iii. Timing Requirement

1. (c)(2): Must be full time ee’ in gen local of new work for > = 39 weeks during year following move

2. (d)(1): wavier of timing req in case of…a. Deathb. Disabilityc. Involuntary separations from work

C. What’s Deductible ?i. Cost of transporting TP and other household

members and belongingsii. R cost of lodging in route

1. Reg. 1.217-2(b)(4): all family members NOT required to go together, but must…a. Have been living in old houseb. Plan to live in new house

D. NOT Deductible i. 2 month stay in hotel awaiting move

ii. House hunting XPE. E’er Reimbursement

i. § 82: Moving XP reimbursement GIii. § 132(a)(6): exclusion for qualified

reimbursement XP (e.g. everything but hotel)

1. (g): exclude or deduct, but not both

II. CHILD CARE EXPENSES A. Personal & B Elements

i. Allows parents to not go insane, and to workii. H/w, still have personal obligation to children

iii. I : how do you divvy b/t two?B. Credits in General

i. Ded: subtract from GI; value is in overall inc subj to TR, t/f value connected to TR1. Up-side-down effect: > value to TP’s in

higher inc bracket2. Solution: credit r/t deduction

ii. Credit: $ for $ of tax liab1. NOT f(x) of TR, unless made specifically

related by code §2. Neither progressive nor regressive, b/c

regardless of TR, get exact same benefitiii. Refundable v. Nonrefundable Credit

1. Non-Refundable: TL $-for-$ down to 0, but NO refund of excess credit (e.g. § 21)

2. Refundable: “”, then get leftover as refundC. § 21 - B / Employment Related Child Credits

i. Credit for certain CC XPs allowing parent to be gainfully employed1. Progressive, b/c as GI 2. Requires…

a. Dependent children below age 13b. Employment related expense

3. Dollar limitationsii. 152(a)(1): dep is qualifying child or relative

1. (C)(1): Qualifying Childa. (A) Indiv who bears relationship w/

TP described in (2);b. (B) Has same principal place of

abode for more than ½ of year;c. (C) Not attained age 19, or student

not attained age 24d. (D) Who has not provided over ½ of

their own support e. (E) Who has NOT filed joint return

w/ spouse2. What a/b elderly parent? Yes, if…

a. Physically / mentally incapable of self-care; AND

b. Has same home as TPiii. 21(b)(2): employment related XP

1. Overnight camp NOT2. Can have outside of home if…

a. Qualified individual; b. Spends 8 hrs a day in HH;

i) Catches those who go to assisted living every day

c. Day care must be qualified / licensediv. (c): 3K max for qualifying child; 6K if have > 1

1. H/w, credit phases as income a. Joint return: ltd to lesser of incomes

v. Computation1. Qualifying XP * % available to you2. % starts out at 35% if TP’s AGI > = 15%;

gets by one % point for every 2K in AGI. 21(a)(2)

vi. Analysis Framework1. Which children qualify?

a. Age restrictionsb. NO allocation to non-qualifying

2. Which XPs qualify?a. Watching kids / chores during workb. Summer time baby sittingc. NO wilderness outingsd. Day camp?e. If primarily to see relatives, NOTf. 21(e)(6): prohibits paying child

3. Amt limitations4. Percentage exclusion?5. E’er reimbursed?

III. LEGAL EXPENSESA. Standard :

i. Origin of the claim; did the claim originate in a personal XP or a T/B?1. If personal NO deduction2. N: success of claim/defense NOT

relevant; use of B’s lawyer also irrelevant3. N: if Corp brings claim, presume ONLY

has T/B personaB. See GilmoreC. See Problem p. 471D. See artist w/ mental health issues hypoE. See wreck on route to Tupelo for deposition hypo

CH. 7 - SCHOLARSHIPS & PRIZES - §§ 74, 117

I. § 74 - PRIZES & AWARDSA. Generally, GI includes prizes and awards.

i. Issue: how much?ii. Rule: FMV

1. Willing buyer, willing seller, each party knowing all material facts

B. (b) : Exception i. Prizes/awards in recognition of religious,

charitable, scientific, educational, artistic, literary, or civic achievement; AND

ii. You give the prize away to charity.

iii. N: If not in recognition of above, prize gets taxed (but can take charitable ded)

C. (c) : Exception for E’ee Achievement Awards i. Will NOT be taxed except for amt above which

e’er can deduct. D. § 274(j) : E’ee Achievement Awards

i. (2): Deduction Limitations1. 400 Limit if NOT qualified plan2. 1600 Limit IF qualified plan

a. Formal, e.g. every 20 yrs, watchb. Established / written; doesn’t

discriminate in favor of highly paidc. E’er can deduct cost; e’ee can

exclude FMVii. (3)(A): tangible personal prop which is…

1. Transferred from e’er to e’ee for lengthy service or safety;

2. Part of a meaningful presentation;

3. NOT disguised compensation.iii. (4)(B): Length of Service Awards

1. Only allowed every 4 yearsE. N : can’t argue gift here, b/c given for past services

II. § 117: SCHOLARSHIPSA. Qualified edu XP NOT included in GI up to amt of

qualified XP incurredB. Must be candidate for degreeC. Must be amts used for qualified tuition & XP

i. Tuition & fees1. Books / supplies

ii. Equip req for educationD. Ex : 10K scholarship, 8K QE, 2K taxed

III. CASE LAWA. McCoy v. Comm’r

i. E’ee gift FMV reported as GI, NOT cost to e’er1. GR: retail rather than wholesale

ii. N: basis may be issue for fact finderB. Bingler v. Johnson

i. Compensation for services NOT given scholarship trtmt

C. See problems

CH. 18 - EDUCATION EXPENSES

I. DEDUCTIBILITY OF EDUCATIONAL XPs UNDER § 162A. Gen., NOT deductible b/c courts consider personal.

Carroll v. Comm’r.B. H/w, deduction allowed if edu either…

i. Maintains or improves skills required indiv’s T/B; OR

ii. Meets legal req imposed by law as condition of doing work of type performed by TP

C. Clearly Deductible i. Already lawyer, have continuing education req.

ii. If required to take 12 hrs every yr, deductible.D. Blurry Ground

i. Maintain skills, but prepare you to enter new T/B

ii. If incurred to meet the min req of NEW T/B, NOT deductible. Reg. 1.162-5(a) &(b)

II. EDUCATION TAX INCENTIVESA. Hope Scholarship Credit - § 25A

i. NR 100% credit on 1st 1K of “qualified tuition & related XP” & 50% credit for next 1K. (b)(1)(A), (B)

ii. by scholarships excluded from GI & certain forms of educational assistance (e.g. grants). (g)(2)

iii. Must be enrolled on at least a ½ -time basis at qualified edu institution. (b)(2)(B), b(3), (f)(2)

iv. Can be taken only for 1st 2 years of post-secondary edu, and no more than twice by one student. (b)(2)(A), (c)

v. Disallowed if student convicted of federal or state drug offense. (b)(2)(D)

vi. Determined on a student by student basis. (b)(1)

B. Lifetime Learning Credit - § 25A i. NR credit of 20% of up to 10K of “qualified

tuition and related XP” paid by the TP. (c)(1)ii. Creditable edu XP by scholarships excluded

from income & certain forms of educational assistance (e.g. grants). (g)(2)

iii. Unlike Hope Scholarship, can take each yr of undergrad & grad

iv. Qualified Tuition and XP does NOT included books, R&B, student activity fees, etc. (f)(1)(C)

v. If student dependent on parent’s tax return, they take the credit.

vi. NOT determined on student by student basis. (c)(1)

III. DISTINGUISHING CHARACTERISTICS OF COVERDALL & 529 PLANS 4/26A. Tuition, books, fees, supplies, equipment, R&B w/

½ limitsB. Coverdall: college, post secondary, & pre edu (e.g.

private school)i. Like IRA, but for education

ii. Beneficiary must be under 18, or have special needs

iii. Limit on what can be contributed each year (2K per beneficiary); must be in $

iv. PO : AGI over 110K if single, 220K if married; over these amts, can’t contribute

v. Amts must be paid out when child reaches age 301. If use for non-edu XP, taxed on earnings,

but not on contrib. amounts; 10% penalty2. Can roll over for another child

vi. S : MUST use if need for primary of pre-secondary; o/w, 529 much better

C. 529 Qualified Tuition Plans : i. ONLY available for post-secondary

ii. Initially offered only be statesiii. Basically, tuition pre-pmt plans iv. Two Types :

1. State plan: restricts were kids can go to school

2. Qualified: more like Coverdall, but specifically for higher edu

v. Benefits :1. Don’t have Coverdall limits, e.g. no PO

a. Still, h/w, contributions not deductible

b. Earnings are tax free2. Can roll over for family member (broad)

IV. CASE LAWA. Takahashi v. Comm’r

i. Science teacher goes to Hawaiiii. I : deductible?

iii. R : NO; O & N B XP only if education…1. Enhances skills req by indiv in his trade;

OR2. Meets express req of indiv’s e’er3. TP has BoP

iv. A : trip’s content NOT rationally related to T/B

B. Wassenaar v. Comm’ri. Attny wants deduction for LLM

ii. I : deductible as O & N if TP not yet practiced?iii. R : NO; must be firmly established in T/Biv. A : ongoing endeavor to be tax specialist

C. Furner v. Comm’ri. Teacher left job to go to grad school

ii. I : deductible?iii. R : YES; deductibility not contingent on

whether or school interrupts carrying on T/Biv. A : must analyze XP in context of T/B in Qv. Rev. Rul. 68-591: suspension of employment

for year or less ordinarily considered temporary.

DEFERRED COMPENSATION

I. UNQUALIFIED DEFERRED PLANSA. Ex : promise to provide something in future, like

stocki. NOT includable nor deductible

B. Funded deferredi. Putting $ in account that can NOT be touched

C. § 83i. Transfer of prope for services is GI UNLESS

there is substantial risk of forfeitureii. E’er can leave them completely unfunded; e’ee

stuck relying on GF & solvency of e’er

II. TWO TYPESA. Unfunded: promise to pay in future (no tax

consequences); no accession to wealth, RE, etc.i. Problem: risk of non-pmt; depends on whether

e’er new start up or blue-chip ii. E’ee taxed on receipt or constructive receipt

1. Constructive: can’t turn back on income available, unless do b/f earned, & inc for fixed period of time

2. Substantial risk of forfeiture: 409AB. Funded

i. E’ee taxed when $ set aside on their behalf1. But, $ method TP doesn’t usually have inc

until receiptii. Economic Benefit: there when $ set aside for

e’ee; t/f, tax when $ set aside for e’ees benefitiii. Ex : e’er puts $ in trust, e’ee eventually gets

payout1. E’er gets deduction in same year2. Led to Rabbi Trusts

iv. Rabbi Trusts 1. E’er sets aside $ in trust, e’ee entitled to

everything put in, plus earnings, BUT… subject to claims of creditors

2. TP: substantial risk of forfeiture, t/f no inclusion when monies set aside

3. I: how significant is risk of forfeiture? A/g, depends on e’er’s status

III. 409A - INCLUSION IN GI UNDER NQ PLANSA. Trigger: w/ Rabbi plans, high level mgmt e’ees

quitting so get payouts b/f creditors show up

i. Solution: penalty, but better than being unsecured creditor of e’er

B. Rule : unless meet req, current inclusion…i. Redefines substantial risk of forfeiture

ii. Also, accounts for past years inc, to extent not included

C. (a)(2) Distributions: can’t distribute earlier than…i. (i) Separation from service

1. N: special rule for certain e’ees (top hat), who must wait 6 months after separation

ii. (ii) Disability;iii. (iii) Death;iv. (iv) Specified time;v. (v) Change of ownership;

vi. (vi) Unforeseen emergency (defined narrowly)D. (a)(4) Elections

i. Must defer earlier than other plans, and must for long period of time

E. (3) Acceleration of BenefitsF. Funding

i. E’er: subject to creditors1. But … prohibitively expensive for

creditors to grab2. (b)(1): can no longer set aside in foreign

countries so that creditors can’t getii. § 83: compensation for services (prop transfer)

included by e’ee at time of transfer1. UNLESS have substantial risk of

forfeiture2. § 409: being subject to gen. creditors

NOT a substantial risk of forfeiturea. Can’t just move $ out of USb. “” make pmt so easy that not at risk

G. Do Rabbi Trusts still work?i. Yes, but must meet 409A requirements

1. Can’t transfer outside of US, broadly available at e’ee’s election, etc.

IV. HOW DO THESE PROVISIONS FIT TOGETHER? A. § 83 Funded : Must include, unless substantial risk

of forfeiturei. $ very available to TP; included once SRF

lapsesii. Options : e’er gives e’ee option to purchase

stock (no susbt. risk of forfeiture)1. Include FMV at time of grant?2. T: transfer of property taken place?3. Very mobile; easy to value “Readily

ascertainable value”a. Rare, b/c if not publicly traded

option, harder to adjustb. In gen., if not readily ascertainable,

transfer doesn’t happen till exercised4. Ex: e’er grant $50 option; § 83 NOT

triggered, b/c no transfer of propertya. When exercise, FMV is 75, NOW

have a transfer of propb. Must include in GI 75 -- 50 = 25 OI

iii. N : Generally, does exercise of option trigger gain?1. NO; buying stock not recognition event;

just completing purchase

2. Basis = option price + purchase “”3. No gain recognition until dispose

iv. N : what if sale option? GI = SP -- OPB. “Unfunded Plans:” not taxable to e’ee until receipt,

or constructive receipti. Constructive receipt: 409A

1. Unless meets these req, current inclusion (e.g. looks pretty funded to us)

2. S: tells when e’ee includesii. 404(a)(5): anything NOT a qualified plan

1. Can’t deduct until e’ee includes (forced matching)

2. S : tells when e’er deducts