Tax 8-14-12

Brewer 2012

Overview

I. Tax law: statutory interpretation, intense reading

A. Major Sources

1. Internal Revenue Code (The Code) force/effect of law

a. Title 26 of United States Code

i. Often abbreviated by tax lawyers as IRC xxx

ii. Will generally refer to as either IRC or Code

iii. Legislative history is often vital (explaining the code)

2. Treasury Regs (Reg or treas reg), cited often as Reg 1.61 force/effect of law but can be overturned if unreasonable

3. Cases force/effect of law

4. Other IRS Administrative Guidance: IRSs litigating position, not force/effect of law

a. Revenue Rulings (Rev Rul)

b. Revenue Procedures (Rev Proc)

B. Case Law

1. Generally three courtsa. Tax Court administrative only place dont have to pay the tax before going to court poor persons court no jury trial, vast majority of tax casesi. Regular decisions (TC): officially published, valuable precedent

ii. Memorandum decisions (TCM): not officially published, apply settled law to facts, less important than regular decisions (ex: tax protestors)

b. District Court pay tax first, sue for refund, possible jury trial

c. Court of Federal Claims pay tax first, sue for refund, no jury trial

2. Appeals lie to US Cts of Appeals (often from TC), decisions of which may be reviewed by SCOTUS (health care bill, circuits split, appealed to Supreme Court)

C. Administrative

1. Revenue Rulings, p 38

a. IRSs officially published position on tax treatment of particular fact pattern

b. If relied on revenue ruling, IRS estopped, had effectively stipulated interpretation

c. Provides less authority than regulations, are NOT law

d. Taxpayers may cite as precedent when dealing w/ IRS, generally may rely upon

e. Some cts give some deference to rev rulings others dont, taxpayers may challenge, but this is risky answer not clear

2. Revenue Procedures, p. 52 procedural rules, eg how to request letter ruling, contains safe harbors

3. Private Letter Rulings IRSs response to taxpayers request regarding tax treatment of particular transaction or set of facts, other taxpayers cant cite as precedent ($10k)

D. IRS Forms and Explanatory Material

1. Can provide helpful background but cant rely upon

2. Dont have force of law, not binding on IRS

3. 1040 US individual income tax return

4. Forms, instructions, general publications at irs.gov plain English but not very useful

5. Why is tax important? Influences behavior.E. Authority:

1. Sup Ct

2. Title 26

3. Treasury Regs

a. Legislative

b. Interpretive

4. Judicial Opinions

a. Trial Courts District Court, jury trial, but have to pay first

b. Tax Court dont have to pre-pay, no jury, just judge/tax expert

c. Court of Federal Claims have to pay, no jury trial

d. Appellate Courts

5. Public Guidance from Office of Chief Council

a. Revenue Ruling gen. guidance from IRS on type of transaction

b. Revenue Procedure guidance on filling out specific form, etc.

c. Notice & Announcement

d. Actions on Decisions

e. Publications

6. Taxpayer-Specific Guidance from Office of Chief Council

a. Private Letter Ruling yes or no to lawyer, go through facts, etc. Only applies to individual, not good to rely on it.

b. Determination Letters

c. Information Letters

d. Technical Advice Memorandum from field agent

7. Documents Generated by Office of Chief Council for Internal Use

a. See: http://libguides.law.gsu.edu/basictaxresearch

F. Other sources:

1. IRS Website

2. ABA Tax Section

3. Committee on Ways-Means (House)

4. TaxProf Blog

5. Others on research site, link above: includes tab for primary & secondary

6. RIA (Thompson Reuters Checkpoint)

7. CCH Checkpoint

G. Primary:

1. Case law: Income tax litigation begins in one of three forums: (1) United States Tax Court, (2) Federal District Court, or (3) Court of Federal Claims. If the taxpayer has not paid the tax, then the forum is the United States Tax Court. If the taxpayer has paid the disputed tax and is then refused a refund, the forum is either the federal district court (where he/she is entitled to a jury trial) or the Court of Federal Claims. http://libguides.law.gsu.edu/content.php?pid=142630&sid=12148422. A revenue ruling is a published official pronouncement of the I.R.S. containing its interpretation of the tax law with respect to a specific factual situation. They provide guidance to the public and I.R.S. personnel, and are binding on the I.R.S. until revoked. (SAME LINK AS ABOVE)

3. Title 26 (CFR) from SAME LINK AS ABOVE, also from FedSys: http://www.gpo.gov/fdsys/browse/collectionUScode.action?collectionCode=USCODE

4. For leg. history, can see when updated, amendments, public law #, can search PL # on Proquest Congressional Publications, THOMAS, Leg History library (Hein Online), USCCAN (dont use this one)

H. Secondary: http://libguides.law.gsu.edu/content.php?pid=142630&sid=1214846

1. Also have primary sources...

a. Bloomberg BNA tax & accounting center, report, stay up to date on tax happenings. Research also, tons of info, portfolios, tools, source documents, proposed regs, agency docs, daily tax report organized by IRC section (code) current docs, etc.

b. Checkpoint (Thompson Reuters) click three times to login, accessing primary content, editorial materials, table of contents

c. CCH search bar for all content, also searching tree for browsing, focus on Federal tax area, editorial content & primary, but known for Standard Federal Tax Reporter (like BNAs IRC docs by section), brings everything together, examples, etc.

2. Treatises also at link above, summaries, laymens terms, citations; links to Westlaw & Lexis treatises. Link to Mertens, well-respected.II. Problems Approach

A. Know the facts given AND NOT GIVEN important!

B. Know the law but also know the exceptions, special rules

C. Problem from handout Section I (p. 1) is subject to inflation, Revenue Procedure is NEW (ix, Rev Proc 2011-52, used in problem)

1. Taxable income separately, $500 and $60k adjusted for inflation for 2012

a. Joe 60k - 4867.50 plus 25% of 24,650 (excess of 35,350) = 11,030

i. Joe 60k - $4,867.50 plus 25% of 24,650 (excess over $35,350) 6,162.50 + 4867.50 = 11030

b. Jane 500k - 52531 plus 35% of 305,825 (excess of 194,175) = 107,038.75

i. Jane 500k - $52,531 plus 35% of 305,825 (excess over $194,175) - 107038.75 PLUS 52,531 = 159569.75

c. Separately = 118,068.75 (179?) (REDO!)

i. NEW ANSWER 159569.75+ 11030 = 170,599.75d. Joint 560k - 105062 plus 35% of 171650 (excess of 388350) = 165,139.502. Other example:

a. Joe 260k 52531 plus 35% of 193,915 (excess of 194,175) = 67,870.25 = 120,401.25

b. Jane 300k 52531 plus 35% of 105,825 (excess of 194,175) = 37,038.75 = 89,569.75

c. Total, 209,971??

d. Same tax bracket/marginal tax rate, same proportionate share

e. Separately = 209971 / Joint 560k 165,139.50 (is this right??)

3. Marginal/effective

a. Marginal - top rate of taxation last dollar 35 cents on the dollar - 35% (joint), (separately) 25% joe, 35% jane

b. Effective - actual percentage of income (165139.50 = x * 560000) 29.5% (joint), 30.5% effective (separately)

c. Effective = total tax/taxable income

i. No one ever really pays their marginal rate

ii. If ordinary income extremely high, will approach 35% rate, but still less than (because on scale adjusted by inflation, etc? progressive rate structure the more TI you have, the higher the rates are (as opposed to regressive))

4. Downside to filing separately when married? Credit score, etc??

Calculating Individual Income Tax Liability

A. Gross Income, 61 (GI)

1. Except as otherwise provided in this subtitle other parts of tax code may define exceptions to gross income

2. All income from whatever source derived from Constitution

3. Including but not limited to: services, fees, benefits, business, gains, etc. (61a1-15)

B. Other Deductions, 62 (above the line)1. For purposes of tax (a) AGI, in the case of an individual, GI deduction enumerated in (a1, 3, 4, 10) pp. 59-60

a. 62a1: Trade/Business Deductions attributable to trade or business if not as EE

b. a3: Losses from sale/exchange of property

c. a4: Rents and Royalties distinction made between trade/business and other income, real estate investment (recurring theme)

d. a10: Alimony, seems personal but allowed deduction, implications in domestics

2. Equals Adjusted Gross Income (AGI) interim amt (the line), close to cash estim.

C. Personal and Dependency Exemptions (151-152) & Standard Deductions (63c, f)

D. Itemized Deductions (usually non-trade/business) 63(d) (below the line)1. Effectively limiting higher-income tax payers, higher revenue for IRS

2. Equals Taxable Income (TI)

E. See overview for rest Tax Rates, Tax Before Credits, Credits, Tax Due/Refund Owned

1. Credit is cash, a definite dollar amount

2. Vs. deductions, only worth the amount by which will reduce tax liability, marginal rate

3. Re-read about credits/deductions, difference

II. Obama/Romney Tax Returns

A. Obama (2011)

1. Wages: 394,821 (presidential salary); business income (book sales?)

a. Loss, $3k (later in semester, bad tax planning?)

b. Gross income: 844,585

2. AGI: minus self-employment tax deduction, retirement plan contributions: $789,674

3. Tax & Credits on p. 2:

a. Itemized deductions: 278,498 (worksheet, Schedule A)

b. Underpaid estimated tax, had to pay penalty

c. Home mortgage interest (owns home in IL?)

d. $172k charitable contributions (rando Q: election rules, paid to campaign??)

4. Actually paid, total tax: $162,074

B. Romney (2010) [estimated return 2011, hasnt released b/c ext Oct 15, still must pay]

1. Wages: Nothing; business income, capital gains, etc. ($5mil div, $3mil interest, etc.)

a. Gross income, $21mil+ (see notes)

b. AGI self-employment tax, domestic production AGI almost same as GI

c. Negative numbers in income, unusual, why not categorized as other losses?

2. Deductions

a. Medical and dental expenses: $14k, code said cant deduct, 7.5% line?

b. Charity ($3mil), mortgage interest, etc.

3. Progressive tax rate doesnt apply to Romney because he makes more money but has a lower rate how is that possible? More deductions, capital gains cap 15%

a. 17.5 mil of his income qualified for reduced capital gain rate

b. POINT: understand GI, AGI, TI, effective rate [tax lawyers dont calculate income for returns, etc, thats a CPAs job... thank god.] Our goal: know what the items ARE and how it works is this deductible, etc.?

III. Chapter 1: introduction to federal income tax (individuals)

A. Basic Questions Addressed by Income Tax Rules

1. What items of economic income or gain will be includable in gross income?

a. Cash and checks fees? Yes

b. Exchanging consulting services for landscaping? Yes FMV

c. Still owed $30k hasnt been realized, claim later

2. What costs will be allowable as deductions against that income?

a. Loaning/gift money to family member deductible? Gifts usually excludable for INCOME purposes

b. The building? Cant deduct price of building, deprecation

3. TIMING: When is an economic gain includable in gross income and when is the taxpayer entitled to take any deductions relating thereto?

4. Who is the proper taxpayer or, ie, who should be taxed upon the income?

5. Finally, what is the character (ordinary vs capital gain) of the income?

B. ****SECRET?! Gross Income does not equal cash! Clients hate income w/o cash, clients love cash or property w/o income

IV. Gross Income: What is and what isnt? Not just cash!

A. Sources:

1. Sec. 61 The Code: Except as otherwise provided in this subtitle... all income from what ever source derived. Lists examples, not exhaustive.

2. Next source: Regulations: 1.61-1, 2, 8, 14

a. Reg 1.61-1 (p. 1024): income realized in any form, whether money, prop., serv.

b. Compensation: 1.61-2:

i. (a)(1): wages, salaries, commissions, bonuses, severance, rewards, jury fees, prizes, awards, etc.

ii. (d)(1 & 2): services paid for in property, fair market value of property taken in; or paid for in services, fair market value of services taken in

A. Statement in contract doesnt automatically dictate FMV, but K price will be PRESUMED to be accurate, but may not be reality

B. Indie Kr/EE as compensation for amt less than FMV, regardless of sale or exchange, difference between amt paid and FMV is compensation

C. Why different in case of EE buying at discount price, different from bargain (Heller case), just getting a deal? (policy later)

iii. 1.61-8: Rents and Royalties: Not just services, also right to use property

iv. 1.61-14: Miscellaneous items of gross income: in addition to items enumerated: punitive damages, someone else pays your income taxes, gambling income, illegal gains, treasure trove (PIRATES! value in US$)

3. Cases:

a. Glenshaw Glass, 1955: lawsuit damages

i. Deficiency action or refund action? Deficiency: have not paid, didnt report

ii. What was taxpayers reasoning? Was a reward for unlawful conduct, shouldnt be punished by having to pay tax on rightful money

A. Compensatory damages: making whole - underlying amount was treated the same way it would have been under the contract, would have been income if hadnt needed to sue (what about promissory estoppel cases?)

B. Punitive damages: windfall

iii. Here we have instances of undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion. The Rule! Do you feel wealthier? Brewers favorite quote.

b. Old Colony, 1929: employer paying income taxes (deficiency case)

i. Taxpayer argument: gift (section 102 code, exclusion)

ii. Not a gift because taxes paid upon valuable consideration: services performed by the employee

iii. Other argument: would create a tax upon a tax upon a tax

iv. Court argument: wouldnt be reductio ad ridiculous (?).... punted, IRS had not attempted to collect another tax upon that (pyramid tax)

v. Facts:

A. 1918 salary $978,725; tax $681,169 paid by company, ee kept gross salary, taxes didnt come out of his salary

B. 1919 salary $548,132; tax $351,179 paid by company

C. Basically saved est. $1 million ($20 mill inflation with salary and savings), said was gift from company, not WITHHELD like they should have been

D. What did the company do? Paid his liability! If that happens, you are taxed on the money you kept that you owed. Income = richer.

E. IRS double-dipping? (Refund co.?) Company could have paid more. ALSO IRS could have taxed what company paid to employee, left some money on the table. (headache) take away rule: if someone else satisfys my liability, is gross income.c. Gross Up: company will sometimes undergo payment of taxes for you, but taking on that liability is additional income, which generate additional tax, which generates additional income, etc. mostly for key executives: pay more money and release of liability to deal with taxes. At some point reach $1 (formula avail.) [if done for every taxpayer, may affect enough to regulate to get money left on table concept is to make taxpayer whole, paid enough to cover taxes if done for every tax payer, too complicated for every employer b/c every taxpayers position separately determined. High bracket: high gross up, low bracket: low gross up, typically reserved for high up execs w/ bargaining power.] JUST understand concept, vocabulary, wont have to calculate, just know what it is.

d. Cesarini, 1970: Refund case, went through District Court, not Tax Court

i. Found money in piano, originally reporter but then amended and wanted back

ii. Treasure trove regulation, value in US$, owed when realized, not barred by SOL (tax year closed) even though purchased piano earlier

iii. Looked at state law the finder owns the cash when reduced to undisputed possession accession to wealth, clearly realized, dominion

iv. Federal law: whether right is taxed, state law: whether liability exists (hmm)

v. Taxpayer argument: not a prize, no provision, not meant to include court: overlooked statutory scheme, which is to tax all income, broadly construed

e. Pellar case, 1955: bargain purchase v. EE/ER or other exceptions

i. Reg 1.61-2, d2: independent Kr for services amt less than FMV

ii. Contractor not paid FMV for house in exchange for good will, not EE/ER

iii. Dont tax for a good deal unless extenuating circs: here is more like bargain

B. Limitations:

1. Realization (generally ownership of property)

a. Ex: buy a property, dispose/sell = realization. Fair Market Value of investment is not yet gross income until realized.

b. Policy: administrative problems, if every year had to account worth of stocks, loss AND gain. Also, may not have cash to pay, would have to liquidate, possibly at a loss, just to pay tax on FMV.

2. Bargain purchase

a. Good deal on a new car, etc. tax difference in FMV? NO!

b. Unless: other circumstances, something else going on, EE/ER example, is additional compensation (or barter?)

3. Imputed income (B.S.)

a. If handled own case as lawyer, include own hourly rate in income?

b. Moving own stuff, declare value of work as income? Friends? Not taxable

c. Rental value of home example: bull. Costs of repair/maintenance

d. Administrative headache how to value, keeping track, subject to manipulation

4. Common characteristics in limitation? No cash/liquid asset in hand to pay the tax (sometimes will have to pay whether have the cash or not)

5. Revenue Ruling: lawyer and plumber bartering (SXM barter dollars)

a. Is included in gross income

b. If avoiding by bartering, would do it all the time

C. US Tax system: self-assessment, unique reporting found treasure.

1. Storage unit: bought the unit, found $500k bargain purchase or treasure trove? Like piano? (Next class) bid on contents / Similar to an investment, risk, not purchasing found money, certainly richer/domain, should err on the side of reporting. Would be taxed on gain from stock. Not a bargain purchase b/c not specific object of purchase... intent? Treasure trove, or both...? Just investment?

2. Antiques Road Show: bought something for 50 cents, worth $10,000

3. Answer: depends. Who do you represent? Argue for your client: bargain purchase v. treasure trove (gold & silver is basically cash, realized income), return on investment, be an ADVOCATE. No right answer.

4. Brewers opinion: Storage Wars, bifurcate allocate payment to everything bargain purchase, realized, unless item readily convertible to cash, claim in GI, liquid assets; road show bargain purchase, saw item, bought it, thinks it had value but not sure, small risk, could be fake, etc.

D. Problems, Chapter 2, p. 19

1. 1(a): Salary, yes; (b) bonus yet; (c) bookcases, not enough to be considered additional compensation could change with facts and circumstances; (e) barter or family gift, FMV significantly different? Represent taxpayer add some 0s; no cash from other sources? ... sign a document/agreement that legal services were free/gift, building greenhouse as a gift from brother. Bookcases bill of sale/agreement, buying for $x, may be worth more, but firm selling to liquidate, not as compensation b/c worth more. (Employer might take deduction for additional compensation.) works to put things in writing so that tax consequences not heavy (within reason). (A for participation, yay!)

2. 2, stock for $1000, $1500 value later, never sells, etc. Borrowed against, repays loan. Finally exchanges stock at end, appreciation $2,000 gain by paying off $3,000 debt w/ stock in Yr 5. Gross income: $2,000. (Didnt dispose/realize at ALL till Yr 5).

a. AR (amt realized) 3000 minus

b. AB (adjusted base) 1000 equals

c. GR (gain realized) 2000

V. Obligation to Repay

A. Loans: Borrowing is NOT income.

1. If you say its a loan, does that automatically mean its a loan? No. Especially if 0% interest, no maturity date, etc.

2. Look at facts and circumstances what does it look like?

B. Claim of Right: IS income.

1. Receives money/property under legitimate claim, not restricted as to disposition IS income even though may be claimed later, may be obligated to restore

2. Finders keepers, but if rightful owner comes forward later, will have to turn over

3. Taxable year: include in one year, repay the next year. Calculation (1341).

C. Deposits: NOT income.

1. Doesnt matter if didnt have to return, turns on whether customer has control: IPL case, customer could put in deposit and turn around, cancel, get money back.

2. Future point at which company gets to keep the deposit, becomes income.

3. Renting: security deposits, not in landlords control, separate/escrow.

D. Illegal Gain: IS income, notwithstanding obligation to return (property/policy)

1. Snavely, tried to argue embezzlement was a loan.

a. She had intent to pay it back (she says), but boss didnt know what was going on, she was hiding it doesnt LOOK like a loan at all (facts and circumstances). Included in income in tax years at issue.

b. Snavely 1990, paid it all back, deduction. Calculate 1341.

2. IRS doesnt care about criminal justice, just want their money.

3. James: thief, odd set of facts, no claim of right to stolen money but crazy policy to not tax someone in illegal gains.

E. Definitions:

1. Taxable year loan now, forgiven later, figure out if certain income is income for that year (individuals usually calendar year) [also versus closed year] cant hold off taxes until resolved, etc.

2. Cash basis of accounting almost all individuals, doesnt mean only income if cash, just that dont have to account until received. [e.g. outstanding accounts receivable]

3. E.g., work all the way through year, entitled to $100k fee, paid on Jan. 1, 12:01, 2013, when to pay those taxes? 2013, regardless of when the money was EARNED. OR dont work at all in 2012, but demand payment up front for 2013. Pay in 2012.

F. Problems, CH. 3, p. 51

1. Shoe guy, commission is too high

a. (a) $3k commission in one year, repayment in the next year claim of right GI now, deduct next year if in two different taxable years. If $5k com and $4k overage difference?? (next class, 1341....)

b. (b) Received $7k, knew, but used as interest-free loan, DEFINITELY claim that year on taxes, owe $5k in January cant just decide was loan, underreported, should claim then deduct. Immediate obligation to repay, hang onto $ (Snavely).

c. 1341:

d. Problem 1(a) and (b) no loan without consent. 1341 applies. IF:

i. Item included in GI in prior taxable year b/c claim of right... AND

ii. Allowable for TAXABLE year because established that claim of right didnt exist (obligation to repay)... AND

iii. Amount EXCEEDS $3k

iv. THEN: tax in taxable year is lesser of either:

A. Tax for taxable year computed w/ deduction (as if current, leave prior be),

B. OR Amount equal to

1. Tax for taxable year w/o deduction (regular) MINUS

2. 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 prior)

v. Doesnt affect amount of deduction or GI, but affects how much he pays in taxable income: This year minus deduction from prior, OR prior year with deduction.

A. Because it is LESSER, taxpayer can choose whichever is more favorable to taxpayer. (WILL NOT HAVE TO CALCULATE FOR EXAM!!!)

B. Deduction is less valuable when in lower tax bracket, could affect decision

C. Brewer posting an example for 1341, questions next class if needed

VI. Chapter 4: Gains derived from dealings in property (important, need to grasp well)A. Section 61, Code: included in gross income gains / property

1. Section 1001(a): gain from sale or other disposition of property = excess of amount realized therefrom, over adjusted basis provided in 1011. Loss = excess of adjusted basis over amount realized. (Amount realized similar to consideration)

a. GAIN = AR AB (Gain realized is recognized fully unless exception, 1001c)

b. LOSS = AB AR

c. GR = GI

2. Amount realized (AR) = consideration = sum of any $ received + fair market value (FMV) of property OTHER than $ received. (Dont worry about 1001b1,2 for now)

3. Adjusted basis (AB) = Basis = cost (1012), adjusted per 1016 (expenses properly chargeable under capital account, deal with later...).

4. Bought stock for $10 (AB), sold for $20 (AR) = Gain is $10 (AR AB)

a. Gain here is realized but may not all be recognized: realized is general rules, recognized is computed for tax (eg, paid in stocks during merger)

b. Common example of non-recognition: merger transactions, reorganizations

B. TERMS TO KNOW!

1. Tax Cost Basis (property = fmv cash, similar to barter policy)

a. Definition: taxpayer receives property instead of cash, basis = fair market value

b. E.g. car in exchange for legal services. Car = $30,000 and legal services $30,000 = adjusted basis, paid $30k essentially. BUT if car = $40,000, AB = $30k and AR = $40k, so gain = AR-AB = $10k (unless paid $10k cash AND got car, income $30k because paid cash, AB = 40, G=0)

2. Sale or other disposition

a. Other disposition = exchange, gain or loss, taxable sale or exchange

b. Sometimes taxpayers exchange real property, unless non-recognition provision applies, will be a taxable exchange and GI

3. 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. SEE: 1.1001-2(a)(4).C. CH. 4 Problems (Exam: SHOW YOUR WORK and reference regs and code)

1. AR 300 AB 100 = G 200; AR 75/375 AB (no cost to subdivide in theory, may normally increase basis) 20/100 = (55*5)/275; curveball, what if 4 lots in yr 1: AR 75*4 (300) AB 20*4 (80) = GR 120 / 1yr2: AR 75 AB 20 = GR 55

a. Subdivision: regulations 1.61-6a (see Examples) equitable apportionmentb. Brewer ex: $100mil land (see slides) not equal value spread across the land, if representing the developer, equitably apportion more to the more valuable parcels and less money to the less valuable portions. Will help you prove the basis later, instead of marking each portion equal value, more cost apportioned to higher price land, LESS gross income! More gain on landfill, still same income overall, but taxed on less where cost was higher. (What if loss on landfill??) Is that kosher w/ IRS? Was litigated, court said equitably means just, reasonable. If sell all parcels, comes out to the exactly the same, but only if in same tax year.

2. CH. 4, problem 4, p. 74 (Review #2, 3 on own time!!!)

a. AB $450k, FMV $750k: what she paid for the land. Exchanges for FMV $750k, AB $100k. What gain will each recognize and what basis received?

i. Katie: $300k G, $750 AB b/c value she gave (also b/c taxed on 450 original AB and taxed on 300 gain)

ii. Patrick: $650k G, $750 AM b/c value he gave

iii. Would 1031 change the answer, for investment or used in a trade or business if solely for like kind? Doesnt apply here, was for their HOMES, personal use. If DID apply, 1001 notwithstanding, would carry no gain/loss.

b. If Katie FMV $800k, Patrick traded for his land + $50k:

i. Katie: AB $450k, AR $800k (750+50cash): G $350k, new AB: Basis in property $750 (given), but also has cash $50k, if sells, no gain/loss, basis = FMV... so $800k?? review! 50 cash included??ii. Patrick AB $100k+50kcash, AR $800k: G $650k, new AB: $800 (given)

c. Same as (b), but instead of cash, Patrick assumed $50k liability same result. ALSO assume that later, Patrick paid $10k on mortgage and sold land for $900k. Buyer paid $860k and assumed $40k liability.

i. Patricks tax consequences on sale of the land?

ii. What basis does Katie have in property SHE acquired? Katies same: AR 800, AB 450, G 350: Patricks $50 assumption of liability is same as cash, include in AR (Old Colony, reg 1.1001-2. Assume recourse as usual.) Katies new AB: $750 b/c what she received.

iii. Philadelphia park: AB is in the value of what you receive.

iv. Difference between B/C liability discharged isnt an asset like cash

v. Patricks part: AR 750 (net, 900 recd minus original AB), AB 150 100 AB + 50 liability assumption, GR = 650

A. technically correct/IRS: add liabilities assumed to adjusted basis

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

VII. Gifts and Inheritances, 102: gift, bequest, devise, or inheritance

A. 102(a)

1. Shall not exclude: income from property recd under 102(a), e.g., cant exclude dividends from stock, but can exclude value of stock itself

2. Shall not exclude amount of income where income WAS the devise, gift, inheritance, e.g. given income/dividends from stock owned by father, versus stock itself; e.g. principle amount of bond, yes, but no income stream from the bonds.

B. 102(c): Shall not exclude gift by or from employer to employee. E.g., meals, parking, employee discounts: other provisions may apply, but not if gift under 102(c), generally.

C. 1015(a+): Income from gift

1. Basis = same basis as donor or the last person that paid. Carryover basis.2. APPLIES, except that if such basis adjusted before the date of the gift (1016) if its a loss, doesnt carry over, except loss between what you recd it at and what you sold it for, but gain will carry over. IRS doesnt want donee to take deduction (trafficking in losses).

D. 1014(a): Basis of property devised by decedent: except as otherwise provided... acquiring from decedent, FMV of prop at date of death, unless recd w/in 1 year. No special rules about basis going higher or lower. Why different? Dying isnt business strategy, also estate & gift tax, dont want double taxation. Also hard to track basis.

E. Tax planning:

1. Stepped Up Basis:

2. Stepped Down Basis:

3. 10 mill prop, 0 basis or 10 mil bond, 10 mil basis: recommend bond b/c basis would carry over: sell for 10 mil, gross income: 0. Sell property $10 mil, GI 10 mil taxable.

F. Part Gift/Part Sale rules, N.B.: wonderful multiple choice questions! (EXAM)

1. 1.1001-1(e)

2. 1.1015-4

G. Rules to remember:

1. ....

2. carryover unless loss

3. 3 stepped up or stepped down

4. 4 special rules for part gift/part sale

5. Community property will NOT be on the final exam, dont want to know

H. Problems, Ch. 5

1. Problem 1:

a. Duberstein case more facts, gift vs. contribution, other side deducted value of Caddy: magic language, GIFT = detached, disinterested generosity. Fact-sensitive. Gifts have to be tested by the main strains of human conduct: Duberstein.

b. Here: is the sweater small enough to just be a gift? $250 probably not excludable. Is it a spontaneous gift? Did they want something in return?

c. $25 rule: 274 ERs do not get a deduction for gifts to EEs in excess of $25, is for convenience, keeps ERs from trying to deduct xmas gifts, retirement, etc. (Amt hasnt changed in many years.)

d. What if Lucille, Inc. versus just Lucille? Lucille gives YOU a card... still employer? Is it a gift? Even though Lucille Inc is boss and not Lucille personally? Maybe. Would make a difference if family. Proposed section in regs: show more about relationship as family than EE/ER not officially law yet, but taxpayers generally can rely on it.

e. From associate? What are the facts? If just a coworker, might be friendly gift. Look at intentions, facts surrounding the situation.

f. Dont assume everything income, use common sense.

g. What about gift from a client? Just a box of candy, looks like appreciation, not in the nature of compensation, more like generosity. Look at motive.

2. Problem #2

a. Not p.o.v. of receiver but intent of the giver; deviser in gratitude for her care balance in equal shares to Maria and 2 siblings

b. Income or gift? Spent 3 years taking care. Wolder case: different because more clear that set up to be income (lawyer scumbag, circumventing taxation, unethical). Here is family, shorter period of time.

i. Not income: general rule of 102, family, normal for children to take care and receive special requests as result. Would Maria have K claim against father if no compensation? Probably not. If devise under law of the state carries argument? No, this is a federal question, federal law, IRS. Characterizes right, not dispositive. Federal law determines taxation. (Wolder.)

ii. IS income: argue compensation for services. No right answer.

c. Problem #3 THURSDAY, will go through at beginning of class, just look at rules 1014, 1001 regs, part sale/gift... facts/circs, but:

d. Brewer transaction, $16 mil, client gives as appreciation, after bill, Ritz gift certificate... income or gift? Associated duty? Report to partners, fiduciary duty to share in that income. $1500 value, Brewer said gift. Asked client whether they deducted, gift came from individual, not the company. Facts/circs.

3. Problem 3: Basis is $100k (purchased for investment purposes), land gifted to son, FMV $250k. AB $100k. 1015(a) is important rule for these sections.... carryover basis unless paid more for gain, carryover basis unless lower FMV for loss.

a. (a) Will son recognize income on the transfer? No, because purchased for investment purposes, no sale or exchange (1001 doesnt apply, no amount realized or realized event?) just a GIFT (102). What basis does he take? $100k because its a carryover basis (1015): gift basis is basis of donor or last purchaser. (only stepped up 250 when donor dies, too difficult to track, FMV on day of death).

b. (b) If he were also employer, 102c, maybe change, but family relationship trumps? [Proposed reg, 1.102-1f2: .... if employee can show not made in rec of empt]

c. (c) What if father sold to son for $50k instead of giving as gift? AR (50k) is less than AB (100k), so NO GAIN. Son has $100 basis b/c still take carryover basis. (1.1015-4: part sale/part gift rule gift to son is $150 b/c taking carryover basis: AR $250 AB $100. If paid $200? FATHER: AB 100, AR is 200 100k gain realized, recognized. SON: AR 250, AB is 200 (because amount paid basis is higher than carryover basis) SO, basis of recipient is HIGHER of carryover basis or amount paid. (RULE!)

d. (d) AR is $125 because liability assumed, same as income. 100 carryover basis, but 125 is cost, so choose higher 125. Father: AR 125, AB 100, GR = 25. e. (e) Land worth only $90k when made gift...

i. Son sells land for $90: sons AB is 90 (1015a limited to FMV at time of transfer if lower than original cost), no gain or loss (AB 90 AR 90 GR 0)

ii. Sells land for $80: AB 90 AR 80, 10 loss (talk about whether recognized later)

iii. Sells land for $95: AB 100 AR 95 but NOW is a loss! (WTF) (dont use 1015a calculating loss here, no loss HERE use carryover basis): here, no G or L!! Look at regs: 1.1001... e? If donor makes gift and FMV is lower than donors basis (rarely happens), sell and take the loss BEFORE giving a cash gift. ONLY for loss purposes do we use the lower basis. For gain, use normal 1015 carryover. So look at FMV/sale FIRST to determine whether calculating G or L.

iv. Sells land for $110: NOW it is obviously a gain, use 1015, AB 100 AR 110: 10 G

v. WILL COVER MORE IN REVIEW SESSION

f. (f) Father devises to son, FMV 250 at death: sons tax consequences? Son, no income under 102, AB 250, no carryover, b/c when donor dies stepped up B (1014)

g. (g) What if land FMV of 75k at fathers death: stepped down B (FMV) BUT cant recognize a loss on the value of the land, forget fathers original AB altogether. If son sold for 90, gain is 15 different rule w/ death.

h. (h) If the decedent acquired appreciated property during the 1 year period ending on date of persons death, AND property passed from decedent or spouse of decedent immediately beforehand, no go: closing tax loophole where people give land to terminally ill person to avoid tax consequences of huge gains.

i. Use carryover basis. (in code at 1014(e))

ii. Would have to predict death pretty far out to use loophole now.

VIII. Discharge of Indebtedness, Chapter 9

A. Kirby Lumber, p. 175

1. Bonds issued for est. $12 mil, got $12 mil cash. Later that same year buys back on open market for $137k less.

2. Distinguished from Kerbaugh-Empire because in that case was shrinkage of assets clear rise in assets without liability, is a taxable gain = Freeing of assets.

B. Code: 61(a)(12): income from the discharge of indebtedness

1. COD Income: Cancellation of Debt

2. 108 certain circumstances where income can be excluded, (a)(1): GI doesnt include any amount which, but for this subsection, WOULD be includable by reason of discharge of indebtedness, if...

a. Title 11 (bankruptcy) takes precedent, so doesnt matter if becomes solvent.

b. Insolvent: (d)(1,2,3)

i. No assets, income with no cash

ii. Under Kirby Lumber: no freeing of assets, not richer tax to extent of freeing assets only

c. More...

d. Secured mortgage, non-recourse (subject to property, not personally)

e. Next week review CH. 9, no new reading (yay!), but suggest start Ch. 10, will catch up, Ch. 12 is long.

C. (NB code order of exceptions bankruptcy before insolvency?? If bankruptcy makes you solvent, still no tax?)

D. Tax review, whether donated basis is up/down, how to calculate:

a. If donor gives away prop w/ built-in loss (FMV lower than their AB), think about 1015(a), special rule where basis is FMV to determine loss in subsequent disposition

b. Attempt to understand the logic, what is really income

c. Inheriting from someone YOU gave prop to w/in 1 year, other special rules: anti-abuse: dont comport w/ economic reality, are deviations, there to close loopholes

E. Discharge of indebtedness income (COD) FREEING UP OF ASSETS

1. 61-a-12 is GI & 108: under certain circumstances COD may NOT be GI

a. Depending on context, decide whether something is COD income under 61-a-12 or is it something else, some other type of income. If so, 108 exclusions dont apply.

b. 1.61-12 (regs): services for creditor, cancels doubt, debtor realizes income to extent cancelation is compensation for services, falls under 61-a-1 NOT 12, 108 no good.

2. Also note: difference between non-recourse and recourse debt. 1.1001-2(c) Examples:

a. #8, p. 1738: Cancels $7500 debt for which personally liable: RECOURSE debt. Amount realized is FMV. Amt realized (AR): $6k. COD income is remaining $1500. No transfer or sale involved.

b. #7, p. 1737: NON-Recourse. Purchases cattle for breeding, $20k, $1k cash, 19 note. Basis is 20. E not personally liable, only recourse to cattle. Transfers herd back to original seller, satisfies indebtedness. FMV is $15k, remaining balance is 19. AB is $16500. Debt = 19, basis 16.5 (NON-Recourse): Es AR is 19 (amount of debt, discharged, COD) regardless of FMV (more or less) because NOT personally liable. Realized gain is AR minus FMV: 19-16.5 = $2500.

c. Why does it matter? NO assets have been freed up w/ non-recourse because that money would not have gone to the creditor regardless. Creditor only had right to the security/property (cattle), no cancelation of debt (COD), is ALL amt realized. W/ Recourse debt on the other hand: assets freed and creditor wrote off the balance.

3. Other provisions:

a. 108(e)5, Purchase money debt reduction: If A buys property from B, gives B note for X value, later decided to write off portion of that amount and make it Y value, instead of treating X-Y as As COD income, treat as reduction in purchase price. Basis = Y. Purpose? Administrative convenience: put taxpayer and seller in different position, just making adjustment in amount owed.

b. Also: to have COD income you have to actually have debt. May not be debt, adjustment may not be COD if no debt. Example: legal bills, can be adjusted before owed/paid. Doctor bills, etc. Dont really have debt after first bill.

c. Other Exceptions:

i. 108(e)(2): deductible expense: payment of liability would have given rise to deductions. Even if amount would have been included in income, but you would have taken a deduction for it, excluded. Example: reduction in interest rate, would otherwise have COD income, but interest payments are usually deductible.

4. Problems: Ch. 9, p. 161

a. #1: Lender forgave balance of $5k debt (2k left), is solvent:

i. If local bank: YES, would be COD income of $2k

ii. Employer: (like 102c, cant be a gift), would probably be compensation income (not COD), exclusions dont apply is income either way.

iii. Brother: could be considered a gift, not COD income, 102 would help to exclude.

iv. If insolvent, maybe try to argue is COD and have exception

b. #6: Actor, liabilities exceed FMV of assets = insolvent. Money for commercial, still insolvent, what are tax consequences? Not COD, 61-a-1, compensation for services, 108 insolvency exception ONLY applies if its COD income.

i. If owed producer: not exactly EE/ER, may be independent contractor

ii. Revenue ruling, bifurcated analysis: look at what services are worth

iii. REVISIT THIS PROBLEM!

c. #3: In connection w/ business, S borrowed $50k, lender agrees to accept $25k later in full settlement of note in which still owed $45k. Assume solvent. Is this COD?

i. Yes, $25k for $45 balance = 20 gain, COD. Exclusion? No property for price reduction... does she have cash to pay the tax?? (not sure)

ii. What if her parents purchased her note and forgave her? If she didnt owe them, bifurcate analysis, is a gift. If she did still owe them... ?

d. #5: B borrowed $200k from J when B was insolvent, Judy accepted land as pmt. AB of land was $50k, FMV of $150k. Prior to transaction, Bs liabilities were $200k to J and 50 to others. Also guaranteed $25k for son (50/50 chance). Assets: $75. Liabilities after transaction: $50k, (25k).

i. How much COD income must he report?

A. Land sale: AR on land was $150 (FMV), AB $50, Gain 100.

B. COD:

1. 108 potentially applying (insolvent).

2. How much total COD? $200k discharged (J), gave prop $150fmv (100 gain), FMV of prop amount of debt = $50k COD.

3. 100k gain realized (GI) + 50 COD (GI) = 150, BUT insolvency exception

4. Bill can exclude difference in assets and liabilities: (BEFORE transaction) Land worth 150 + 75 other assets = 225, total debt 250 (J+others) [not+ sons debt (is NOT more likely than not 50/50, not 51/49, merckle case)] SO, insolvency excluded: $25k

C. $150k (gain on land plus 50 difference in COD), minus $25 insolv = $125 (GI)

ii. Non-recourse to Bill, AR = 200, AB = 50, GR 150. What is Judys basis? 150 was FMV of what she received. (Philly Park, basis cant exceed FMV of prop recd), but she was OWED 200, cost is another 50 (loss)... $100 AB?iii. (Brewer posting analyses for this) LEARN THIS!IX. Compensation for Injury and Sickness

A. History

1. Pre-1996, cases all over the map re: whether personal injury or not, and whether punitive damages were excludable.

2. 1996: Amended 104 to apply only to physical injury, physical sickness. Also clarified emotional distress: NOT included except not to exceed medical bills.

3. Raytheon: origin of the claim tax treatment turns on whether origin of claim was a physical injury/sickness. If nature of the claim is compensation, that is INCOME.

B. Rules

1. Prop. Reg 1.104-1(c)(1) & (2): proposing to include language on ACCOUNT of physical injury/sickness. NOT emotional distress. (see Week 5 PDF)

2. Damages includes settlement proceeds. What are the damages in lieu of?

3. Elements of the statute:

a. Physical injury

b. personal?

c. .... except under 213, etc

4. Revenue Ruling 85-97: struck by a bus, damages flowing from personal injury claim ALL excludable, b/c on account of/attributable to physical injury/sickness.

C. Problems:

1. Money for destroyed building:

a. Gain recognized $150K (350k 200k basis) [15%, maybe capital gain]

b. Lost profits = income under 61(a)(2) [35%]

2. Suit settlement, auto accident, 5 categories

a. Tax consequences:

i. Pain and suffering, 500: Yes, is on account of physical injury

ii. Reimbursed medical expenses, 100: 100k but deducted 70 last year under 213, so 30k is excludable, 70 included in GI

iii. Future medical expenses, 50: Yes, excludable

iv. Lost income, 100: If on account of physical injury/sickness, even lost wages still excludable

v. Punitive damages, 150: No, not excludable b/c of proposed reg

b. Proposed reg... (zoned out here: find out answer) IRS would likely overrule.

c. Is loss of consortium excludable? Yes, House Report says this flows from and is on account of personal physical injury. Paid over time is OK even though gaining more money.

3. Martha sexual harassment claims: 500k, owe atty 150k on contingency. Excludable?

a. Domeny, no underlying physical injury, not on account of

b. Proposed reg: include?

c. Observable physical injuries usually required

d. Emotional distress specifically excluded

e. Ulcer: exclude partially, medical expenses

4. Misc:

a. Taxpayer advocate asking for Congress to change the rules, exclude for non-observable symptoms, emotional distress

b. Pre-existing condition doesnt matter (Domeny)

X. CLASS! Deductions (162, just covering the basics)A. Re-read overview for determining individual tax. Gross income (income minus exclusions) minus above-the-line deductions equals adjusted gross income. Business and certain other deductions wont do much with below-the-line deductions, less valuable, dont need to know whether its above or below, just whether its taxable.

1. Deductions now, then:

a. Capital Expenditures/Capitalization

b. Depreciation (should have aha! moment about here, if not... help!)

2. Salaries, business expenses deductible

a. Example: own law firm, salary to paralegal: salary is deductible

b. 212: expenses for the production of income: maintaining rental props, etc.

c. 262: personal living and family expenses, NOT deductible, except as specifically allowed in the code. (Put codes on outline)

d. 263, capital expenditures, later / 167(a)(1) and (2) tie-in

e. Page 1, casebook: self-employed

i. 275k in fees: gross income (61a1)

ii. 10k consulting in exchange for 10k landscaping for mother: yes, 10k

iii. Client owed 30k services, not gross income, not paid yet (if on accrual accounting method, may be different, is on CASH method)

iv. Paid EE $60k in wages: deductible as business expense (162)

v. 20k for maintenance, supplies, utilities, etc generally deductible

vi. Purchased building for 500k: capital asset, amortize/depreciate over 30 years

3. 162 is broadest provision for deductions (used the most, workhorse)

a. Ordinary: p. 246-248, as opposed to extraordinary, can relate to capitalization things that occur regularly. Even if rare, can be counted if not totally unexpected. Ordinary for one business can not be under another.

i. Jenkins v. Commissioner, Conway Twitty: repaid investors for Twitty Burger, deducted as business expense, proximate relation to entertainment business

ii. Unusual, not typical, but allowed because protecting reputation

iii. What about paying fines for intentional crime, shouldnt be able to write it off and get a benefit. Different if negligence arguable on exam?

b. Necessary: works together with ordinary

i. Twitty case two part inquiry of MOTIVE and PROXIMATE relationship

ii. Yacht w/ 1040 flag, didnt lead to clients, diff from horse lady

iii. Lindsay Lohan, hotel bill, expenses associated w/ ent. career: ordinary and necessary? Could depend, what about lavish and extravagant under the circumstances? Reg 1.162-2 and code 162(a)(2): travel expenses, meals and lodging, pursuit of business, only as reasonable, necessary, directly attributable. Deduct SOME expenses but not all? Look at line-by-line.

c. Expenses: salaries, utilities, rent not long-term investment

d. Paid or Incurred: cash or accrual accounting. Ex: EE bonus paid in Jan if cash, deduct in Jan, but accrual may deduct in Dec.

e. During taxable year

f. In carrying on next week

g. A trade or business next week

4. 212: individuals ONLY

a. Ordinary

b. Necessary

c. Expenses same definitions as above

d. Paid or Incurred

e. During taxable year

f. For production or collection of income

g. Management, conservation or maintenance of prop held for production of income: maintenance on rental house example, regardless of whether occd (might also fit under 162, may not be carrying on if no one living there)

h. OR in connection w/ determination, collection, or refund of any tax

i. Brokerage fees

ii. CPA doing taxes

B. 162, Defining and dealing w/ Trade or Business

1. Groetzinger case: gambler. Is gambling trade/business?

a. Used to be standard of dealing w/ 3P

b. Court held that yes, gambler can be trade/business because regular, continuous (legal? may not matter)

c. P. 269: Accept fact that to be engaged... continuity and regularity, primary purpose MUST be for income or profit. Hobby, amusement, diversion does NOT qualify. ***

2. Story case, Smile, Up w/ People

a. Attorney making film: looked at different factors, held WAS trade/business

b. Even though no profit, intent was to profit (2003-2008, audit 3 of those years)

c. Read case for factors used in deciding trade or business or just hobby

i. Frequency

ii. Business-like activities, etc.

3. Benson case (optional)

a. Registered nurse who won the lottery

b. Bought a commercial building, let people use it, free

c. Sorta tried a few businesses, court found hadnt tried enough to claim loss

d. Wouldnt even come under 212... Brewer said?

C. Carrying On Requirement

1. Problem deciding when trade/business begins, what counts, etc: Congress stepped in w/ 195: START UP EXPENDITURES

a. Except as otherwise provided in this section, no deduction shall be allowed for start-up expenditures. (Must be capitalized.)

b. 195(c): paid or incurred in connection with investigating... creating... for profit and for production of income BEFORE THE DAY trade/business begins, in anticip.

i. ALL expenses in advance? C1B: which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A)), would be allowable as a deduction for the taxable year in which paid or incurred. Ex? What you otherwise would have spent, had you been operating a business, you would be able to deduct. These ARE deductible. (Exception, cuts a break.)

ii. So what does 195 do? Without it, would capitalize those expenses (next wk)

iii. (b) If taxpayer elects, allowed deduction for taxable year in which trade or business begins, amt equal to LESSER OF:

A. Amt of start up expenditures

B. OR $5,000 (reduced by amt of which start-up expenditures > $50,000)

C. $53,000 in startup, deduct $2k (phase out, remainder ratably over 15 yrs)

D. No deductions for personal expenses, 262

1. Reg 1.262-1: ex, sell car, buying new, economic loss yes, but cant take tax loss

2. If a gain, ....

3. (9) Expenditures made by a taxpayer in obtaining an education or in furthering his education are not deductible unless they qualify under section 162 and 1.162-5 (relating to trade or business expenses). What if had been silent on education? Classify as a start-up expense, not carrying on trade or business.

a. If ER paying, they would get to deduct, you are carrying on income to you? Probably, most cases yes, paying obligation, like giving cash, freeing assets.

b. Parents can take credits for paying childs expenses, deduction (bonds)

4. Key deductible question: IS THIS A PERSONAL EXPENSE disallowed by 262?

E. Problems, p. 237

1. Placement agency, C hires daughter B who has MBA, less experience than 2 EEs

a. May C deduct bonus he paid B? (Higher than others): 162(a)(1) only reasonable salaries, ordinary and necessary, MBA might make reasonable. IRS: might look at familial relationship, gift, not reasonable. Look at other factors production, placements, qualifications, etc. Comparable to others? RULE = what is reasonable? Vague, circuits will be split, facts & circumstances.

b. What if bonus was deemed excessive? 1.162-7 and -9: Deduct reasonable amount (maybe $10k), the rest is a gift, not deductible. B claims as GI.

c. 1.162(8): 25k paid, only 10 is deductible, 15k disallowed, B claims as GI. Gets to her b/c 15 is dividend out to C reallocation Gift to B. (B still claims as GI?? If happened in audit of Casey, probably will not fix B reporting as income. If repd B, might fix w/ amended return and claim 15k was gift, 102(c) doesnt apply? ER is corp., no gifts btwn ER/EE... WHOA, mind blown.)

2. Financial planner

a. Like Jenkins case, protecting reputation like Twitty. IRS: not ordinary/necessary, no proximate relationship, obligation to pay. What if client potential suit? Might help facts & circumstances, avoiding litigation. If arguing just a gift to client: win? Probably not, tough argument to make.

b. Chauffer service, maybe like horse lady but likely plane/landscaping cases: luxury is not necessary, personal expense, primary purpose/benefit is to him, not to the business. Brewer thinks taxpayer would win. Not out of the realm of reason that a wealthy professional would pay that much to have limo available to visit wealthy clients, may not be extravagant.

3. CFO hunting for new jobs

a. 162 not relevant, not trade or business? Start-up expense, investigations. BUT Brewer says post-Groetzinger, might still be carrying on trade or business, active in continuous. Primuth case (in overview, p. 261) even as EE engaged in trade or business of BEING an employee.

i. Brewer thinks a stretch, but argument there. 1-212(f) no expenses occurred in seeking employment. Left w/ 162: use Primuth, is it deductible?

ii. Revenue Ruling, 75-120, p. 270: IRS changed position from not deductible, saying cant deduct unless get new job. 162-7, primary purpose, etc.

A. NOW: if seeking in same line of work, can deduct regardless of whether you get the job. New trade/bus: not deduct. Corollary to carrying on: like investigation into start-up expense.

B. Ex: Rockefeller couldnt deduct presidential campaign expenses.

4. SKIPPED #4, this is #5: Fast food, $500k franchise, rents space, ads, etc.

a. Deductible? Some start-up expenses but would otherwise be deductible? Mc-something case... If shop already open? Clearly deductible.

b. But its NOT open yet, start-up expenditure: capital, but 195 ordinary? Yes, common? Yes. Training, yes... $14k deduct over the course of 180 months. EXCEPT, if 195 does not include 163(a)+ ( if interest, taxes, etc. (curveball)

c. If the business hasnt started yet, cant take deduction until yr business starts, McFarlane, business hadnt started yet. Problem #6 next class, attys fees, etc. NOT going through Problems, read materials, no notes on Tuesday. Will lecture only, use the time to work on problems before class on Thursday. Cap Exp.

F. 212:

G. Prob. 5, Ch. 12: dealt w/ 1.195, start-up expenditures: tax guy wanted to open burger franchise. Spent 19k. All start-up expenditures, but some exceptions:

1. 5k deducted immediately under 195

2. The rest amortized. If exceeded 50k, dollar amt deduction for over 50. (53 spent, 5 minus 3 deductible = 2k)

3. What about the 500k spent to purchase the franchise? Capital expenditure.

H. Prob. 6, Ch. 12: portfolio of stocks & bonds, is not in a trade/business b/c of Higgins (distinguish), does not systematically, reg, continusously trade for income. (Family office, $100mil, full time to manage one familys money.)

1. Used to be not deductible, period, but now 212 allows deductions for the production/collection of income, maintain prop, etc., where not trade/business so, does this fit w/in 212? 195 does NOT apply.

2. $200 for WSJ subscription deductible (or if IRS, might say not relevant)

3. $25 for book re: bonds 1.212-1e, normally deduction, but because tax free in title, regs say relates to production of income NOT otherwise includable in GI tax-free bonds are NOT includable in Gross Income. (Also 265)

4. $500 for newsletter & investment advice deductible (1.212-1g, fees of investment counsel, etc, are deductible only if production/collection of income or ordinary/necessary)

5. $200 for safe deposit box to hold certificates & papers not deductible, not producing income, reg: cost of storing (1.212-1f), but maybe ord/necessary, storing is re: jewelry, may be personal, not like bond certs

6. $400 to prepare tax return deductible 1.212-1g, 1.212-1l to prepare

7. $250 for lawyer re: tax deductible 1.212-1g

I. Ch. 12 examples, attorney fees:

1. Fees paid to defend trade/bus from IRS, empt discrim, breach of K, personal injury, etc, investigation or lawsuit? YES ordinary, necessary

2. Fees paid to sue broker for bad investment advice? 212 collection/production of income, related even though loss, could argue other side, not nec/ord

3. Fees paid to prepare and implement a Will? For a divorce? Can be tax advice, going over tax consequences when allocating assets, expenses, etc. Will is generally personal, but 212 could be exception? Estate & gift tax advice is deductible. (212 doesnt mention income tax?? Huh?) What if will preparation paid through company? Doesnt feel right. What if relates to shareholder/succession? Maybe.

4. Fees paid to draft a shareholders agreement? Deductible 162 if company, 212 for taxpayer (212). Always ask FIRST: WHO IS MY CLIENT?5. Fees paid to defend an IRS audit? ex: $50k in fees. Deductible? YES. Relates to collection/refund of tax.

6. Bar exam review fees? NO start-up expense. Bar exam fees? Same. Even if 212 applied, what else? Reg 1.212-1f, bar exam fees & other expenses not deductible. What if decided to take bar in Alabama, already practicing expanding? Ordinary and necessary? Yes. Capital expenditure, getting bar admission: long-term benefit, intangible asset. In the code (reg 1.263a-4d5ii Ex: 2, Thursdays reading)7. Annual bar dues? Yes, ordinary and necessary to trade/business under 162. [ANSWERS posted in powerpoint on TWEN]

XI. Chapter 13, Capital Expenditures (SEE FLOWCHART, also posting to TWEN detailed cites to regulations answering Ch. 13 problems)

A. Overview of relevant authorities

1. 161: operating rule re: deduction vs. capitalization

2. 263a: general rule requiring capitalization, betterments, etc. POLICY? Making long-term investment, better to take deductions in expenses over time, better MATCHING, accounting for income annually.

a. Ex: rental income, $100k building, rent for $1k/mo would it make sense to deduct $100k from $12k income and every year afterward include $12k income w/o any expenses? NO. Match it up. Net taxable income.

b. Instead: capitalize the $100k, use it as part of adjusted basis, take depreciation deductions for the building, deduct portions of the cost.

c. Also: deduct maintenance and repair fees: HOA dues, lawn costs, etc.

d. In most cases, deduction is money in pocket now. Benefit of capitalizing? Makes business appear more profitable less expenses.

e. Some will capitalize on financial statements then deduct on taxes. (Idaho case)

f. Vocab: (see slides!)

i. Placed in service

ii. Useful life

iii. Class life

iv. Recovery Period

g. Will come back to vocab in depreciation

3. Tangibles

a. Repairs vs. improvements: question of degree, not kind

i. First: identify the UNIT OF PROPERTY

A. If components are functionally interdependent, constitute single unit of property (like airplane parts) (1.263a-3te1, e3i)

B. Components are functionally interdependent IF placing in service of one component depends on the placing in service of the other component. -3Te3i (locomotive example

ii. If the expense incurred is relatively small compared to the size of the asset (ex: changing filter on truck), vs. replacing entire engine, engine probably capital expense: larger $ compared to unit, more likely capital vs. repair.

b. Ex: Alteration to building purchased: routine maintenance? Or investment, expansion, long-term benefits?

c. Concrete sealant example: 2 different outcomes. One used to keep floor in good condition, other investment/permanent improvement. Depends on circumstances.

d. Improvements/capitalization, 3 terms: (see slides)

i. Betterments

ii. Restorations heavy work

A. Airplane, rev ruling, new skin on plane, etc.

B. Wear & tear over time depreciated, deductions over time until basis is 0, spend $ to get it back up to functioning/performing well: doing things as repairing, but part of a general plan of rehabilitation

C. Unless repair is ordinary, necessary by outside event, like Midland Empire

iii. Adapting property to new & different use

iv. Ex: Midland Empire: concrete liner, fixed intervening problem that came in from outside, didnt make anything better

e. Materials & Supplies: carried on hand, no record of consumption or physical inventories. If bought ahead of time in bulk? Not all used in one year, doesnt matter, go ahead and deduct. (Most common, office supplies)

i. Also, routine maintenance safe harbor (airplan)

4. Intangibles (see also regs)

a. 1.263a-4b: general rule: must capitalize:

i. Paid to acquire or create intangible

ii. Paid to create/enhance separate distinct intangible asset

iii. Paid to create/enhance future benefit (careful w/ this, specifically identified in future IRS guidance)

iv. Exception: 12-month rule, 1.263a-4f1, if wont last beyond taxable year, can immediately deduct, case mentioned in cakebook Freighways administrative convenience for taxpayers (buying licenses, fees, etc.)

5. Cases:

a. Idaho Power: constructing towers

i. Long-term assets? Yes

ii. Depreciation?

iii. Tax payers required to keep financial books same as tax? No, but IRS pissed if accounting one way and different for taxes, esp. where routine item.

b. When deciding whether something is a deduction or a capital expenditure, ask: how are you accounting for it?

c. Midland Empire: curing hams

i. Hanging in basement to cure, oil leak in basement

ii. Would have been shut down if problem not fixed, installed concrete liner

iii. Cap or deductible? Repair, necessary, allowed to deduct.

d. Drive-In

i. Opposite outcome: had to drain land after clearing

ii. Was cap expenditure b/c should have done it before moving in, not allowed to deduct, was fixing problem they should have fixed when they moved in, 161

iii. Thin line, arguable. Theory: Midland was running fine, a little water leak, but intervening event of oil leak created problem that needed to be fixed. Vs. Midland Empire, foreseeable, operating fine, avoiding lawsuit and repairing relationship with business neighbor (farmer), on intervening event (rain doesnt count): notion anticipated!

e. Look at regulations (for next class) attempt to take cases/auth and synthesize, organize into rules that can apply to facts. Also read code. Will post powerpoints on TWEN, start next class going over, guides through regs w/ overview, etc.

B. Regs: know where to find rules re: tangibles/intangibles, etc.

1. 1.162-3T(a)(1,2)

2. 1.162-4T(a)

3. 1.162-11(a)

4. 1.263(a)-1T(a, b, c, d)

5. 1.263(a)-2T(d)(1), (e)(1), (f)(1)

a. Acquired or produced intangibles

i. Acquiring IP, yes creating, no

ii. Yeses:

A. Cash register

B. Land (including perfecting title/defending)

C. Building

D. Construction costs

E. Purchasing a business

6. 1.263(a)-3T(d), (g)(1), (h)(1)

7. 1.263(a)-4(a), (b)(1), (c)(1)(vi, xiv), (d)(1), (2)(i)(A, B), (3), (5), (6)(i), (9)(i), (e)(1)(i), (4), (g)(1), 1.263(a)-4(e)(3)

8. 1.263(a)-4(d)(9)(i) and (ii) [see Evernote]. (9) Defense or perfection of title to intangible property.

a. (i) In general. A taxpayer must capitalize amounts paid to another party to defend or perfect title to intangible property if that other party challenges the taxpayer's title to the intangible property.

b. (ii) Example. Defense of title. R corporation claims to own an exclusive patent on a particular technology. U corporation brings a lawsuit against R, claiming that U is the true owner of the patent and that R stole the technology from U. The sole issue in the suit involves the validity of R's patent. R chooses to settle the suit by paying U $100,000 in exchange for U's release of all future claim to the patent. R's payment to U is an amount paid to defend or perfect title to intangible property under paragraph (d)(9) of this section and must be capitalized.

C. Problems:

1. New roof after inspection, rotting like concrete floor? Could be major component, capitalize, IRS might have strong argument.

2. Painting an improvement or maintenance? Maintenance, IRS weak argument (unless needed when purchased, existing defect). But if done w/ roof part of a general plan of rehabilitation?

3. Remodeling, general plan of rehab, bigger capacity and operation

4. Furniture: purchase, capitalize, but lease, can deduct 1.162-11 IRS would argue substance over form lease for multiple years, doesnt look/smell/act like a lease (ask, economically, what is REALLY going on here? dont just look at the words). Option to purchase: buying intangible.

D. Problems, contd:

1. 1(e), p. 275: lots of office supplies for more than one year wont capitalize, can deduct, because regulation says where not keeping inventory, track of consumption (1.162-3T(2)): incidental materials and supplies, temporary. Storing jet fuel example? Not incidental. But can take deduction when you use it (other section in 162?) would keep a record of consumption, though.

2. 1(f): to design website, advertising consultant, prepare content, radio/newspaper ads. Regs say advertising can be deducted. Long-recognized because cant measure how long benefit, some immediate (1.162-1) Website: creation of intangible good, long-term benefits, software (1.263(a)-4). Answer unclear adv, asset, etc. Argument for tax payer? Redo every year, updating: like membership fees/incidentals?. Consultant did more than just software.

3. 1(g): insurance costs, 12-month yes. What about pre-paid, 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 (re-read, can extend into 2nd year but not as far as 3rd if spread across time, reg language confusing; RE-READ!!!), administrative difficulty

4. 1(h): legal fees, clear cloud on title: NO, capitalize, 1.263(a)-2T(e)(1) + examples. What about if paid to remove lien placed by someone trying to defraud? Intervening event? On the contrary, Mt. Morris defect existing? No, placed after purchase. Could maybe argue cost to defend title. Answer not clear, borderline. Example to consider: -2T(e)(2) Ex. 2 mining operations, ordinance, cant mine, pays atty to argue to invalidate ordinance: that is deductible, not capitalized. Argue its not about the title, but about the use, encumbrance, etc. Why is the ordinance different? Like leak in floor, must defend to keep business operating, not as much about title. Doesnt fall w/in literal language of reg, more like production of income, trade/business. Similar to Conway Twitty case, defending against reputation, ability to produce income.

5. 1(i): 5-yr lease for lot vacant to store, to be used for parking, bonus to asst, 5k in wages to handyman to construct fence. Normally $1k salary, deductible. 5k for handyman... or now are part of acquisition costs / costs to facilitate (263 regs) and capitalized? 50k for the 5-yr lease: paid up front? 12-month rule, capitalize, long-term benefit. Cost to create intangible lasts more than a year: capitalize. (1.162-11(a) and 1-263-4(c)(1)(vi)). Bonus b/c facilitates acquisition of lease (intangible long-term asset) is there an exception for taxpayer? -4(e)(4)(i) + (ii)(A), exception for compensation and overhead costs. Is handyman EE or Ker? Trick question, wages usually EE but more likely indie Ker. Does this remind me of something? Idaho Power: court said had to capitalize construction of towers.6. 2: Second store, consultants same trade/business. Regs used word to describe why deductible: investigatory costs, just thinking about expanding, hasnt done it yet. But once youve IDd and are pursuing expansion: capitalize. -2T(f)(2)(iii) for exception, but notice applicable only to real estate. Compare to -2T(f)(4) ex. 5: lawyer hiring interior design firm for new office, must be capitalized. Taxpayer looking for health club instead totally new business. No deduction b/c new trade/business, would start-up cost w/in 195. Otherwise deductible.7. Ex: looking solely for new location for hardware store, hiring for market study for 2nd store should be investigatory and deductible. But if said paying to buy franchise and lawyer to write up agreement: both capitalized. Acquisition, not investigatory.8. See Brewer powerpoints: distilled capitalization into 3-4 pages, broad outline:a. First ask if have asset, separate and distinct. Does it produce future benefit? Beyond a year? If so, capitalization might apply.b. Second, consider case law examples for general guidance.XII. Chapter 14: Depreciation

I. Will post sample exam(s)

A. Will tell us which party to represent

B. Filing jointly or separately see slide w/ chart

C. Ch. 2 whether bargain purchase or not: argue both sides (1(c))

D. Acing tax Donalson, supplement, good for studying, also do CALI

II. Emotional damages: argue either way, know the rules 104 doesnt exclude pure emot distress damages (gun, nervous disorder, even thought intentional, not excludable, BUT if flows from phys, emot ARE excludable and other things flowing from...) Tough cases: Domeny & 1 other MS flare up, qualified as phys caused by wrongful action, thin skull damages allowed (on the line, dont have to decide merits, already decided by jury); other case heart attack excludable; case complained of insomnia, depression, stomach disorders NOT enough, no visible/physical injury or sickness.

III. James case, loan not income, but Sup Ct said encourages people to steal and not report, so crimes need to be reported/taxed. Claim or right vs. loan: can be argued.

IV. Bargain purchase v. treasure trove no liability w/o cash, goal of taxpayer atty, intent arguable. If operating business buying storage units: business asset when sold? Basis what you paid, allocate price paid among different parcels, like real estate example. When sold = realization event.

I. (FROM JEFF HOLTS NOTES FOR 10-4-12) Thursday Class

a. Debate roundup

i. Tax rates arent important until you consider deductions and credits

ii. Lower tax rate may result in higher taxes if sufficient deductions and credits are eliminated

b. Depreciation

i. Golf Course Example

1. $9M paid for assets; $1M to attorneys, accountants, appraisal, etc.

2. $10M basis in property

3. $1M fees are facilitation fees that must be capitalized

4. What part is depreciable?

a. Pro shop, golf carts, etc. are depreciable

b. Land generally is not, but improvements made to make it a golf course might alter problem

c. Good tax advice: allocate $10M purchase price among various depreciable assets (allocate more to pro shop and restaurant, etc. for more deductions)

5. Lesson: allocate as much as possible (reasonable) to depreciable assets to be able to claim deductions

6. Payments to lawyers, accountants, etc. is income to those parties (one party includes as gross income, the other party capitalizes and writes off over time)

ii. Section 167

1. Tells you that you get a depreciation deduction (see 168 for what it is)

2. Allowed dep. deduction a reasonable allowance for exhaustion, wear and tear (including a reasonable allowance for obsolescence)

a. Of property used in the trade or business; or

b. Of property held for production of income

3. Basis for depreciation is cost (what did you pay for it)

iii. Section 168 (Accelerated cost recovery system)

1. Except as otherwise provided, deduction in 167 for tangible property (real or personal) is available and determined by

a. Applicable depreciation method;

i. 200 percent declining balance switching straight line

ii. straight lineb. Applicable recovery period [will tell us on exam]; and

c. Applicable convention (when deemed placed in service)

2. Straight line applies to

a. Nonresidential real property (office buildings)

b. Residential rental property

c. Property with respect to which TP elects under paragraph 5 to have this paragraph apply (alternative method that TP is unlikely to select)

3. Salvage value is treated as zero.

4. Applicable recovery period tables

5. Applicable convention

a. Except as otherwise provided, applicable convention is the half year convention; means that no matter when we buy or sell the property during the taxable year, we will treat it as being bought or sold in middle of the year

b. Real property; applicable convention is mid-month for:

i. Nonresidential real property

ii. Residential rental property

c. Special rule where substantial property placed in service during last three months of taxable year: will be the mid-quarter convention

6. Definitions of conventions

7. Definitions of residential and nonresidential property

8. Treatments of additions or improvements to property

a. Deduction for improvements computed in same manner as deduction for such property being placed in service at time of improvement

b. Applicable recovery period for such is the later of

i. ???

ii. ???

9. Helpful terms

a. 1245 = personal property

b. 1250 = real property

iv. Section 179

1. May elect to treat cost of any section 179 property as an expense

2. Get an immediate deduction for taxable year in which 179 property placed into service

3. Dollar limits are adjusted for inflation; for 2012, it is now $139,000 (up from $125K); max amount is $560K (up from $500K)

4. What is 179 property?

a. Tangible property to which 168 applies;

b. Which is section 1245 property; and

c. Which is acquired by purchase for use in the active conduct of a trade or business (must be 168 type property, not 212)

5. What is a purchase?

a. Means any acquisition of property

b. Unless

v. Section 168(k) Bonus Depreciation

1. Special rule giving depreciation deduction for property acquired after 12/31/2007 and before 1/1/2013

2. 50 percent of adjusted basis in property

3. for purposes of this section, adjusted basis is reduced by amount of deduction

vi. No depreciation for property acquired and disposed of during same year.

vii. Trucker Problem

1. Trucker buys truck for $150K in 2012

2. Not an ordinary and necessary business expense; must capitalize

3. Basis is $150K

4. Go to 167, 168, and 179.

5. See 179 example

a. 150K basis

b. less first year write off under 179 ($139K) [179 first]

c. less 50% bonus first year depreciation under 168(k) [then bonus depreciation]

i. 150K - $139K = $11K

ii. $11K x 50$ = $5500

d. Normal first year depreciation [apply tables after 179 and 168]

i. Method

ii. Recovery period

iii. Convention

e. Total first year deduction = $139K + $5500 + 1100 = $145,600f. Tax savings

i. $145,600 x 36% tax rate = $50,960

g. Equip cost

i. $150K less all tax deductions = $99,040

Depreciation, contd

I. Problems, p. 307, #1

A. Tract of land: nondepreciable, 1.167(a)-2

B. Fences, concrete sidewalks, driveways: Not like land, DO wear out, depreciable under 1.167(a)-2. Revenue ruling w/ tables: dont worry about recovery period on sidewalks, etc. Table w/ longer-life property, p. 340: sidewalks, roads, landscaping, etc: improvements that wear out, subj to obsolescence.

C. Valuable antique furnishings in public spaces: can wear out, being used in trade/business like violins that were being played.

1. Simmon & Liddle

2. Rule: value doesnt matter, antiques can wear out w/ use, regardless of salvage value.

3. Dissent so you know other side

4. Anything else here that might still apply? Art not being used, on display. What about restoration needed? If in fact being used in trade/business, wears out, could argue the art is wearing out: exterior wall, subject to wear & tear.

5. Regardless of whether TP claims deductions, for purpose of computing gain/loss, depreciates (trade or business only)

D. If true art, maybe not, but being used in trade/business, matching dcor: color could fade. Not necessarily valuable, paid to have them painted for decoration.

II. Problem #2 see casebook supplement! Purchase price $200k. What is her basis? 200k. For purposes of depreciation? Yes. Doesnt matter that borrowed: assumption of debt is same. Equipment is 5-yr property under 168. Taxable income $500k. (Tax shelter, invest in prop, deduct even though borrowing encouraged.)

A. Year 1: depreciation (200k AB) 40k from table 1, 20% (because year, would be taking 40% each year under double declining balance method). Basis for purposes of depreciation stays the same for using THIS TABLE, but actual basis goes down to $160k (1016) in year 2. (Table is unadjusted basis)

1. Year 2: 32%: 64k (or 40% of 160). New AB: $96k. (160-64)

2. Table takes mid-year convention into account (1/2 year) (See table 2 for mid-quarter convention)

3. Year 3: 19.2% per table: $38,400 (168b1B switch to straight line year when it produces larger deduction? No, just follow table, does calculation for us!) new AB: $57,600

4. Table: years 4 & 5 are the same (thats where straight line kicks in, larger deduction) but... JUST USE THE TABLE.

B. Year 7? Everything has depreciated, AB becomes 0 (ZERO) (Remainder happened in Year 6, even though 5-year property, b/c year in Year 1) / If had made improvement to equipment, ex $50k, capitalize and add to basis, depreciate it separately when put in service, new table)

C. If sells on Dec. 31 of Year 3? $96,000 19,200 = 76,800 is AB. Regular formula: 100 AR 76.8 AB = 23 Gain. (WHERE DID THE 19200 come from?? Half of the depreciation amount for that year of Year 3, 38,400) Or could be loss if sold for 50 (76.8 50, 26.8 loss). (RELEARN MIDQUARTER RULE) 168d1, d4

D. 179d1, tangible property, 200k unadjusted basis, did not place in service more than 260, had minumum income.

1. 200k 139k = basis of 61k (Year 1 is 2012)

2. Year 2: Start w/ 61, 20% = result is $12,200, AB $48,800

3. Answer change if Year 1 was 2013? Diff minimum/max amts.

4. Phase out 179 by amount.... (will post on TWEN LATER)

5. 179 is supposed to be for small business, if putting much into service, not small, used to be $2 mil, incentive to spur investment

E. 168k, qualifies b/c between 2012-13, start w/ $200k basis, 139 deduction in Year 1, down to $61k. Take 50% of that AB b/c 168k1A (bonus depreciation) = $30,500. New AB is $30,500. From there, normal depreciation, 5 yr property, 20% off: $6,100 = 24,400 new AB.

1. (Always straight line w/ 179?)

2. Rules 179, THEN bonus, THEN regular

F. How is all of this different from the casebook version? 179 does not apply because of phase-outs, does 168k pose a problem? No, does apply. Even #2 in book wouldnt get 179, but could get 168k, nice write-off first year. 50% rule only applies to 2012 (was 100% last year): Brewer example, buying airplane, write off.

G. RE-READ THESE SECTIONS AND REGS! III. Prob #3, Apt building $1.5 mil, 500k land, 1 mil building. $500k down and balance in installments over the next 20 years. 179 must be trade/business: yes, it is.

A. 179d tangible property? yes, 1245 property? No, not personal. (1250 is real/rental/business property). So, NO 179 does not apply to real property in trade/business. (Also dont get 168k for real property)

B. How much depreciation claim in year of purchase? 500 land is not depreciable, start w/ 1 mil. Basis in land 500, basis in building, 1 mil.

1. 1 mil AB in building, depreciation deduction: (200% declining balance method applies? No, straight line for real estate)

a. Div by 27.5: years to divide, recovery period (p. 346)

b. What about convention that might apply? Use mid-MONTH convention, (March 30), changes math. Table residential, mid-month (table 6):

c. Third column (March), Year 1, first row: 2.879: $28,790 new AB is 971,210

2. The next year? 3rd column, SECOND row: 36,360, new AB is 934,850

3. Under the table: becomes same amount basically each year after 1st, using year in year 1 and then straight line/same rate every year after. (Apply table at disposition but use mid-month)

4. WHEN DO YOU USE MID-MONTH/QUARTER??? 24 denominator.

C. 1 mil for building, land 500k building residential rental prop, 27.5 yrs

1. land nondepreciable, no cals. But 1 mil for building depreciable 167, 168

2. 179 doesnt apply, 168k bonus doesnt apply, just regular depr.

3. Straight line for residential rental real estate, (also straight line for commercl)

4. Year 1: 28,790 according to table, Year 2: 36,360

5. Year 3: assume (not in problem): dispose of prop on Jan. 26 yr 3:

a. Jan 26 is Brewers bday. Sold prop how much depr for yr 3?

b. How much is a month worth? Divide in half: full year is 36,360

i. Divide 36360/12 = 3,030 half of that is 1,515

ii. Real estate use MID-month convention, even though sold at the end of the month, as if had prop for 15 days in Jan.

iii. Another way to get there: take 36,360 x (.5/12) OR 36360 x 1/24 (because 24 units in mid-month) (1,515.13 where 13 cents from?)

iv. Adjusted basis as of Jan. 26 in year 3 = Subtract yrs 1-3 from 1 mil: 933,331.87 (1 mil minus all depreciation)

A. If sold for $1.6 mil, what would gain realized be?

B. Remember to include the land (500k)

C. 1.6 mil (933,331.87 + 500k) = 166,668.13

D. BUT is any of the gain allocated to the land? Did the land APPRECIATE? Might be different answer: allocate some to the building and some to the land. (1.1 mil to building/500 to land, or it could be .7 mil to land, .9 to building)

v. (Always of whatever first and last units are?)

IV. CH. 15 LOSSES

A. Background:

1. Deductible expenses: 162, 112

2. Capitalization: fundamental rule, asset = capitalize

3. Depreciation: over time, recover cost of investment/asset, take into account every year depreciation w/ respect to those assets that wear/tear, subj to depreciation

4. Could hold onto it until worth 0 (salvage value) = AB: 0, OR sell, destroyed, abandon

5. Tax law provides a way to recover rest of cost in those cases, income from disposition, or loss/ bad debts. Opposite of what we started w/: gain, GI, etc.

6. Secret: the REGULATIONS, no shortcut, re-read them! Statutes arent bad, but regulations are clearer. Brewers intro summary to regs will be posted on TWEN.

7. Regs summary is GUIDE, learn on your own for exam (267 on Tuesday, and Ch. 15 probs 267 is pretty easy) REVIEW SESSION Oct 23 at 12:15, practice exam(s)

B. 165(a)

1. See above for language of rule. Also 166, worthless applies to all TP not just indiv.

2. Certain special rules that apply to indiv (business, nonbusiness) must decide if trade/business, investor, vs. corporation/org obviously related to trade/business

3. 165(c)(1): Losses incurred in tr/bus, OR transaction entered into for profit, OR losses from fire, storm, shipwreck, other casualty (reminds of 212, but not exactly same)

a. Significant b/c different from 212:........

b. Dont worry about c3, casualty losses, personal use assets, wont be on exam

c. So WHEN? evidenced by CLOSED and completed transaction fixed by identifiable events, not mere decline in value 1.165-1(b), 1.165-4

i. Claim for reimbursement, reasonable prospect: 1.165-1(d)

ii. If chance get $ back, cant claim until know whether will recover or not

iii. 1.165-1(d): Losses

A. However... loss from automobile completely destroyed by negligence

B. Idea: if asset wrecked, might have insurance claim. Wait until KNOW.

d. Special rules for securities, stocks & bonds

i. Is promissory note a security? Not a security for tax purposes

ii. Securities are something registered, stock market, etc.

iii. But is that a debt? YES, is a debt. Corporation issues bond: is also a debt, but the bonds are securities regulated, etc.

iv. When becomes worthless, treated as sale on last day of taxable year. (*will make a difference for WHEN later when we look at capital gains/losses)

e. Theft: loss incurred when theft is discovered, only when no reasonable prospect for recovery. Rev ruling in Ch. 15, tax consequences. Also casualty: instead of disposition/worthlessness, asset is stolen/destroyed, etc. (still 165c1, 2, not governed by c3 if connected to trade/business, so c3 dont need)

C. Bad debts: 166(a) 1& 2: same format of statute, deduction but limitations for individuals, Nonbusiness or Business

a. Subsection d: deduction for BUSINESS bad debt when partially or wholly worthless. Example:

i. $100 for promissory note: business or nonbusiness? Nonbusiness, unless loan shark and is trade/business would be business debt (pawn shop, etc.)

ii. If debt is because of buying business/services, 166 applies, business debt

b. Must be bona fide debt: not loan to daughter w/ no notes, etc. Look behind debt (even if simple IOU/paper, questionable) family members iffy

c. Debt must go bad, cancelled, written off, etc., or 166 wont apply (similar to 108, where only applies to discharge of indebtedness)

i. Basis, $100

ii. If instead gave note to R, R loaned $100, R finds out B is deadbeat, sells note to S for $90; Rs basis 100, Ss is 90, S loss 90, not 100

iii. What about accrued interest? Was it included in GI? No, if havent had to claim as income, cant deduct. BUT if accrual method tax payer, did include interest before getting it, paid tax, then didnt pay, COULD write it off.

iv. Loan guarantees 166(2); if had to make good on it, is that it? Any other remedies? Right of subrogation, reimbursement (like indemnity??), can pursue other org for that money, so would delay ability to take loss

v. Nonbusiness bad debt, code does favor, loaned out money to daughter for