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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 courts
a. 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 cases
i. 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

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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=1214842

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2. 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 = 170,599.75
d. Joint 560k - 105062 plus 35% of 171650 (excess of 388350) = 165,139.50
2. 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

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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:

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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:

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(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.
i.

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(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)

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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.

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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)

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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 apportionment
b. 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

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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)

N.B.: Except as otherwise provided... (61): Gross income

o Broadly construed rule
o Narrowly construed exceptions and deductions

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

A. 102(a)

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Tax 8-14-12

B.
C.

D.

E.

F.

G.

H.

Brewer 2012

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.
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.
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).
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.
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.
Part Gift/Part Sale rules, N.B.: wonderful multiple choice questions! (EXAM)
1. 1.1001-1(e)
2. 1.1015-4
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
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

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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.

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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.

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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

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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.

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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)

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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

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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

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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

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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)

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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.

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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

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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

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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

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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
1.
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,

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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 line
b. 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

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iv.

v.

vi.
vii.

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

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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 = $145,600
f. 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)

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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 phaseouts, 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):

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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 midmonth)
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)

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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?

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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 school,
cant pay back, becomes worthless, deduction? Is personal not a transaction
entered into for profit. BUT short term capital loss, limited exception, compromise...
allowed to take nonb but limited
d. 166(e) if security, 165 applies, not 166. Promissory note was not a security for tax
purposes. Can only write off unpaid debt for services rendered if accrual method, not if
had not included in GI under cash method (standard recs).
D. Problems, p. 349
1. Unrelated person, $60k truck, AB 38,400 at time of sale, FMV 40k
a. May he deduct loss on sale? Yes, trade/business. How much? 3,400: (AB 38,400 (lesser
of AB/FMV) Amount realized, 35k)
b. What if personal vehicle? No deduction, even though economic loss
c. What if stolen, never recovered? 38,400 not sale/exchange, no salvage value,
worthless (still lesser of FMV/AB, though), under what section? 165c1 NOT 165e
because disposition in trade/business 165e says WHEN, not if
2. 100 shares of stock, 15k falls in value to 5k.
a. Loss? Not yet, economic loss but no deduction for tax purposes because not
complete/final, no fixed event, disposition, transaction (like gain realized time)
b. Is like the case in the chapter never got money but claimed on taxes, etc, because of
Ponzi scheme: Bernie Madoff: loss now? YES, under 165c2, entered into for profit.
c. Rev Ruling 2009-9 RE-READ, understand when is theft vs. business/profit.
3. Problem #2
a. 100 shares of stock for $15k 3 yrs ago, fell to 5k almost immediately
b. Decline in value in-part attributable to fraud: take drop in value as loss?
i. No, must dispose of first
ii. Counter-argument? Intent to steal, theft when discovered. 165
iii. Here, theft? Probably not, no specific intent to deprive her of property. See Rev
Ruling 2009-9, theft under 165 means taking property specifically.
c. What about (b), different facts when can she take loss? This year found out, take this
year theft deduct when discovered. How much? $25k (remember no reasonable
prospect of recovery requirement)
d. How is loss calculated? Adjusted Basis. Eg: investment minus gain/salvage value, plus
any gain reported on tax returns.
4. Problem #4
a. (a): No, personal residence, no deductions, no loss
b. (b): Whipple case? No difference, No trade/business or profit because hasnt gotten
income from: 165(c)(2), transaction for profit (if not trade/business) higher standard
than 212, why should there be a difference?
c. (c): Didnt offer for sale, probably wouldnt count because not using
d. (d): can now get depreciation, maintenance, and loss by actually renting (165(c)(2))

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Amount? Cost $1.2 mil, FMV $1 mil. $70k of depreciation. AB = 1,130,000 (FMV is
lower!) Use Lesser of FMV vs. (1.165-9, converting from personal use, if FMV lower
than original cost basis, for purposes of determining loss & depreciation, use FMV),
SO: 1 mil basis, 70k dep, 930k new basis, 900 sold, 30k loss.
ii. If sold for 950k, would have 20k gain still use lesser of FMV/AB? Use higher for
gain 1,130,000....
5. Problem #5: worth 300k at death, AB was $100k.
a. Harrys AB is $300k (1014, stepped up basis) by devise, stepped up
b. Harry sells for $250k, 50k loss. Take it? Personal residence, but not his. Piece of
investment property.
c. Problem #6: 166(a) v. 165(c)(2) bad/worthless debt vs. trade/business loss, here, 166
because not entered into for profit. Written, promissory note what is the term? None.
Even though 165 doesnt apply, not in business of lending money, not held for more than
one year. Problem: insolvent/Peter, no income.
i. What prevents Paul from taking deduction? If cash method: no income claimed,
never recd. If accrual and had claimed, then yes...
ii. Read 1.166-1(e)
d. Problem #7:
i. At a minimum, 166 bad debt. Can she also argue 165(c)(1) debt? Trade/business?
Trade or business of being an employee: business bad debt under 166, but Generis
case, TP same argument, failed
e. P. 351, #7: Gloria stock, donated $100k to corporation
i. Can she take deduction, receives nothing for liquidation (165c2)
ii. Is worthless stock under 165g
iii. 267 does not apply bc family-owned corporation, can still be related party to
corporation. Language from 267a1: preceding sentence shall not apply... in case of
distribution in complete liquidation.
iv. Loan - Business bad debt (166a, ordinary loss/deduction dominant motive to
preserve income, status as EE, trade/business as EE) or non-business bad debt
(dominant motive to save family corporation, better argument)?
V. Limitations on Deductions (diff between limits, limitations)
A. 267(a)
1. Losses disallowed.... (p. 617) (b) lists relationships
2. Matching deduction to income
3. Transaction child didnt know had....? Knowingly doesnt matter. Why? Cuts down on
litigations, people cant argue certain relationships, etc. Bright line rule.
4. Defer tax until the next year... manipulation? Brewer example. 267a2 says no...
a. 267a2 mandates that you may deduct in same year as income
b. Wont apply if not related transaction, doesnt require matching all the time, otherwise
manipulating system
c. Attorney, agent, indirect transfer will come back to later... effectively own stock
d. Most of the time really have to search for indirect transfer, facts & circumstances
i.

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5. Income excludable: judgments from lawsuits, personal injury awards, deduct attorneys fees?
Not if excludable doesnt match!
a. Cant include deductions from tax-exempt income
b. Allocate if partial
B. Problems, p. 615
1. D 100 shares of XYZ 30k, sold to granddaughter 20k
a. May he deduct loss realized? Was profit income, but cant deduct loss because she is
related, 267 disallows, 267(b) members of family, b4
b. Irrelevant
c. In-law not related under 267c4. What if she gave to Christina 3 months later? IRS would
say constructively possessed in code? Indirect transfer? Always in-law.
d. Dennis owns 60%, related to corporation, 267b2, what if Christina owned 60%? still no:
indirectly owned under 267c2, loss disallowed either way
e. Had not spoken for years (doesnt matter), sold XYZ to DEF, Christina owns 60% - still
disallowed, knowingly doesnt matter
f. If Dennis sold to corporation owned by Christinas husband? Allowed? Is in-law, no
family re-attribution sells to in-law, she is spouse, not considered related, unless
constructively owned, but then doesnt go again from husband to grandfather, no further
attribution of stock (1 step, not two steps for constructive possession) 267c5!!!!!!!!!!!!!!! By
reason of P1 treated as actually owned but not Ps2-3 constructive relationship.
g. Re-read codes/rules
2. Same facts as #1, C sells stock a year later to unrelated 3P for $15k, what loss if any may
she deduct? 267d1, use HER basis, 20k, sells for 15, 5k loss. (165c2) can she deduct?
didnt SELL to related, got from related. If gift component on ORIGINAL transaction from D,
if part-gift part-sale, apply... her basis would be greater of FMV/his basis, which would be
30k (but here no facts to indicate)
a. What if sold for 35: gain of 15k (AB 20), report? D had 30k basis, disallowed 10k under
267, C is selling for 35, can calculate Ds loss, exclude (267d), amount of previously
disallowed loss. Nonrecognized. Now gain is FIVEk.
b. What if sold for 25: gain of 5k, disallow 10k middle ground, claim 5k loss? Claim
nothing at all? Did he do this question correctly???
i. Brewers example.... What if sold 30? AR 30, AB 20, GR 10, exclude, ZERO.
3. D shareholder 60%, son and sons wife employed, M owns 40%, corp fails to pay salary,
doesnt occur until Feb next year.
a. When can corporation deduct salaries owed to M and wife? No deduction for Michael,
less than 50% owner? But related parties, 267, constructive owner because of father,
constructively owns 100%.
i. For wife, may deduct that year, constructive for Ms husband but not D (re-attribution
thru... see above) [what if they said hang onto money, dont pay me now
manipulation? Depends when reporting, constructive receipt, MATCH the companys
deduction because related parties]
ii. When must M and wife include amounts owing to them? Cash method, not until
recd.... matching.

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b. Eg
i. Corp owned:
A.
25% father
B.
25% son
C.
25% spouse/in-law
D.
25% unrelated
ii. Defer income: Michael actual ownership - 75% (his, dads, wifes)
iii. Dennis 50
iv. Meredit 50
v. Loss disallowed? Only Michaels because only one MORE than 50%
vi. If unrelated party is now granddaughter, no one allowed: Father has son &
granddaughter, son (M) has granddaughter, wife, father, Spouse has her daughter &
husband, granddaughter related to everyone
vii. If unrelated party is now a law partner w/ father:
A.
No double attribution with father and then reattributed to son
B.
Wife at 50, Father/Son at 75, law partner 50
C.
If son was partner in firm as well, would change to 100 for him, change law
partner to 75
c. Exam: visualize, draw pictures
d. Lawyer SS claim half excludable, half not; how much of fees can be deducted? Half
e. 267,265 done.... until now identifying income, deductions (depreciation,
capitalization, etc): now moving into big category: TIMING
VI. Cash method of accounting (Ch. 28, p. 643)
A. Timing
1. Good to know not just if its income but exactly when, what year entitled to deduction
2. Determined based on method of accounting
3. 441: annual accounting year assume all on calendar year for our exam
4. 446:
5. Most all cash or accrual (accrual most for larger businesses)
6. Most important rule: no method accepted unless opinion commissioner clearly reflects
income, all items of GI & expense treated consistently from year to year
7. Why would TP like cash method? Dont have to pay unless in hand
8. Accrual more precise, for when you earn or have a right to income, or have liability
B. How it works
1. Checks, property, other types of non-cash items can be income, taxable
2. These rules dont trump what we know about capitalization versus expenses
3. Individually on cash but LLC on accrual is OK, but cannot have cash method for income and
accrual for expenses & deductions
4. KEY: have to keep in mind w/ methods, figuring out when income is included and when
deductions can happen.
5. Timing of income and deductions if you represented the IRS? Must match, accurate
reflection of income rather accelerate income and defer deductions, TP opposite

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C. Cash receipts & disbursement method:

1. Income when received, can be other forms besides cash; deductions when pay
2. All INCOME items to be included in taxable year in which actually or constructively recd;
Expenses to be deducted in taxable year ACTUALLY made (acceleration income, deferral
deductions)
3. 1.451-1: about including items of income: INCLUSIONS
a. Actually or constructively received
i. Constructive receipt: not actually reduced to possession but constructively recd in
taxable year during which credited to acct, made available draw upon it at any time or
COULD have if notice of intention to withdraw given
ii. NOT if control is subject to substantial limitations or restrictions (stock, etc.)
iii. Examples: just walking away and not cashing, doesnt work, constructive rect
A.
But stock/dividend at the end of the year, paid every year but no receipt until
following year, NOT constructive had to receive the check
b. 1.461-1 DEDUCTIONS: taxable year IN WHICH PAID
i. Write a check and deliver end of Dec, have you paid? Money in still in account, but
no control over it even though could stop payment
ii. Promissory note versus credit card: CC like borrowing money and paying, liability not
to recipient but to CC company. Respect borrowing, allow TP to take into account
basis credit, etc.
iii. The point: could you transfer something for cash? Is it worth something, in your
possession/control without substantial limitations? Giving a promissory notes to
someone means you can be liable for that, but cant go trade it for cash at the bank.
Depends on situation. Ask if its cash equivalent.
A.
Generally: promissory note better from corporation than individual
B.
Unless its a wealthy well-known person could argue
C.
All of this is the CASH EQUIVALENCY DOCTRINE (items)
D.
Difference between that and constructive receipt? 648-650, distance, knowledge,
etc. (check in mail, etc?)
E.
Part of bargained for consideration? IS income, even if not technically cash
equivalent. Painted house, promissory note for $5k, income?
1. FMV of note, present value, when payable, interest, etc. Less, discount. 1.612(d)(4)
2. Q: pay T for note, bargained for consid, T clearly has income, does other get
deduction? Probably not, illustration of rules diff for deduct.
3. Contrary TP argument: deduct now, pay later? Weak, though.
4. Economic Benefit Doctrine, section 4, read Rev Ruling in book: why football player income
but others did not.
5. Also: if cash method TP and attempt to pre-pay items (lease, utilities, interest, etc.) get to
deduct? What rule might get in the way? Capital expenditures: pre-paying clearly paying for
benefit that extends beyond the current year. IRS arg.
a. However: remember 12-month rule, limited amount of relief

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b. SECTION 83, one of the most important sections as business/tax lawyer HAVE to be
aware of:
i. Ex: paying employees in restricted stock
ii. 83(b) governs restricted stock
iii. Revenue procedure from assignment, questions probably on exam
iv. How it works:
A.
EE of Corp., condition granted 1 share of stock, have to pay present value, but
getting stock by virtue of empt
B.
Stock subject to restriction says if stop working for Corp. in next 2 yrs, can buy
stock back for the lower of what paid or FMV.
C.
83 allows to make a choice: file 83(b) election and declare value of what recd in
income, OR not make election and hold onto stock and declare value when it
becomes vested, no longer subject to restriction
D.
How much income when recd stock? ZERO. Make election, report 0 on tax
return. 2 years from now vesting restrictions lapse, sell stock for double money,
$1200, how much income? $600. All capital gains.
E.
Economically owner of stock, 83 codification of economic benefit doctrine. If
didnt make it, sold stock 2 years later, made $600, have $600 income, but is now
ORDINARY income, NOT capital gains. RE-READ REV PROC
D. Section 83: April 1, 2012, Company B $25k to Employee F, substantially non-vested stock
(substantial risk/forfeiture, subject to buy-back option); stay empd thru April 1, 2014 or forfeits
stock back to Co. B
1. Makes election 83(b): $25k by 40% (ordinary rate) - $10k included in income.
a. Why? Because whatever he makes in appreciation will be capital gains rate, not ordinary
income rate
b. Takes in 2012
2. No election: Taxed in vested year as ordinary income, increases to $40 times 40% is $16k
income (2014)
3. 83(a) GI in first year vested; 83(b) can elect to include excess of FMV at time of transfer over
amount paid
4. Basis:
a. Basis w/ 83b election: 25k
b. Basis w/ NO election: 40k
c. Sells for 60k (AR)
i. Election: 35k gain (rate is about 20%) - $7k tax
ii. No election: 20k gain (rate is about 40%) - $4k tax
iii. Economic benefit doctrine codified essentially: vested when its YOURS, but 83(b)
creates exception
d. Results:
i. $10k tax under election plus $7k tax on sale, $17k total paid
ii. $16k tax w/ no election plus $4k tax on sale, $20k total paid
e. Include when value is LOW, sell high, pay less taxes
5. Misc:

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a. If you leave the company before the tax vests, forfeit, but youve already paid taxes on it.
Regulations under 83 dont even get loss. Big risk, but can pay off it staying from
company. In Rev Proc assigned (2012-29).
b. 83(h): general rule company deducts when paid out, but (h) when vests
E. Problems
1. M legal services, sent D $50k bill for services sent in Oct, Nov, Dec. D mailed check on Dec.
31, yr 1 but recd on Jan 2, yr 2.
a. When must M recognize the income? No constructive receipt because payment was not
available to M in year 1 actually or constructively received no, had no access to
check. YEAR 2.
b. Would it make a difference if Ds office less than block from Ms? No: Easily available.
Constructive receipt about turning back on income. Even if a block away, not Ms fault,
dont know when D has the check ready about the recipient w/ KNOWING access to
money. (73-99, could have picked up by Year 1, would HAVE TO KNOW about it.)
2. What if check when to secretary? Rev Rul 76-3, would be constructive receipt because
available, but absent from where check is delivered secretary is his agent, can receive and
cash checks. Money his in Yr 1. (but part b PO Box???? Depends on if sec had access)
3. D called Mike to request statement immediately: WOULD be constructive receipt, could have
drawn upon at any time. (Turning back on $) Services already done, complete, just waiting
on check, D ready to pay, M said no. Exception: original contract, normal course of business
(rent, etc.), but highly unusual because most people want money right away, as soon as
available.
4. D receives bill, cash flow problems, cant pay M until March, Yr 2, gave promissory note. No
cash equivalent because cant take to bank (less likely, at least, no FMV). Only income if had
been bargained-for consideration, value of note would be income. NOT our facts here.
a. Cash equivalent means checks, etc: defined as payment w/ clear FMV value and
transferrable.
b. Cowden, p. 673, unconditional and assignable, frequently transferred
c. Is the promissory note PROPERTY? Could take 83 election? Would be too easy of a
way around cash method. 83 mostly for prop that can increase in value. Reg 1.83-3e:
does not include unsec promise to pay.
5. Developer side: assume deductible under 162 (because 263 may have applied)... when
may D claim deduction in each of problems above?
a. #1: Deductible when paid, so when sent check in Yr 1, money gone (Reg 1.461-1: when
PAID, out of your control at that point.)
b. #2: Same, when check sent, Yr 1
c. #3: Ready to send check but asked him not to... Yr 2 (even though M Yr 1), because
when ACTUALLY paid.
6. (SKIP)
7. #7: escrow account not to be paid until Jan 3 Yr 2. Economic benefit doctrine. Rev Ruling w/
4 different scenarios, including football player. Fixed account SOLELY for him. P. 665.
Included in income because there for him, belongs to him, economic benefit even though not
paid, INCLUDE then.

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a. Close question in THIS case because: facts can lead to either conclusion is either
Luigis or not his YET. Argue IS his: not subject to reach of creditors/payor. (Argument
against?)
b. Reasoning: prevent TP from playing games that keep you from getting cash in hand but
have all the benefits of having the cash (matters if interest-earning?) Unusual but not
unheard of test to see whether economic benefit applies. (Makes difference pd after
services done?)
c. What if this were a deposit? If only deposit, not income (refundable) but here doesnt
look like deposit, not even close, set aside for L.
d. Point: L trying to defer income but take deductions for expenses/work.
8. Later...
9. Accrual method more than ever know diff from inclusion side tests and rules, VERSUS
tests and rules for deduction. Difference. BIG. Economic performance doctrine. Focus on
that for problems Thursday. If unable to get through problems, talk some about assignments
of income, or if have to push those assignments back.... would revise Week 13/14. If cant
get to lifetime exchanges no big deal, no anxiety about getting to materials.
VII. Accrual
A. IRS prefers, better at matching income/expense, more accurate, AND ***because it tends to
accelerate income and defer deductions
1. 1.451-1(a): income includable in GI when all events which fix right of income AND can be
determined with reasonable accuracy. Fixed and determinable
a. If TP has actually paid, have to include. Earliest of... test
b. Either fixed & determinable OR paid.
c. Ac-crash method?! wtf
2. Liability: same requirements PLUS economic performance TPs were attempting to work
the system by creating a contract that made liability
3. Code: 461(h): all events test not earlier than economic performance, but if services and
property are being provided to the TP, then economic performance occurs AS the services
or property are provided.
a. Eg, hire someone to work for you, economic performance occurs as they complete the
work.
b. Or if buy property from someone, economic performance occurs as they transfer the
property to TP. Like other party to K performing K obligations.
c. If TP using property, econ perf occurs as use property (eg every day)
d. ***NB: All Events Test not satisfied w/o economic performance its fixed & determinable
PLUS economic performance for DEDUCTIONS.
e. So: is the liability fixed & det, AND has economic perf occurred? (one exception, very
narrow recurring item exception)
4. Regs under 461: 1.461-4: time when economic performance occurs
a. Recurring item exception (coming back to)
b. 12-month rule (coming back to)

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c. (f) Liability that is contested fixed & determinable? NO. But puts TP in bind, portion of
dispute may be agreed to. Mechanism in (f) says pay over in escrow, meet requirements,
can accrue/take deduction to that extent.
B. Ch. 29 Problems:
1. M 3-month project for D completed Dec. 15, sent bill for $50k for services. D mailed check
Jan. 4, allowed to deduct.
a. When M income? YEAR 1, fixed & det. When D deduct? Same b/c fixed & det. and also
economic performance services completed in Yr 1.
i. For economic performance, look at what is being paid for, not mailing check. (461(h)
arises out of providing of services to TP by another)
ii. If had been cash method, Yr 2 for both.
b. Same facts, D offers to pay immediately but M asks him to wait: no change, still Yr 1 for
both for same reasons in part (a) answer, pmt doesnt matter at all follow fixed & det,
plus econ performance rules.
c. D couldnt pay, gives promissory note. What then?
i. Sufficient doubt about collecting? HIGH HURDLE to clear. So basically wouldnt
change, temporary cash flow problems only.
ii. Because its not a cash method, none of this matters, still Yr 1.
d. Contested:
i. Mike: delay income until dispute over, could pay what agreed upon. If repd M,
consider it fixed & det? No. If thought earned 50k, wouldnt accept check for $40k
D would have to put in escrow. NO accrual. When they settle on $45k, then YES,
accrual of 45, and paid.
ii. D: same time.
2. C sells paintings to P on credit. Doubt as to collectability. 685, Spring City Foundry case
summary: Sup Ct required accrual on sale b/c no doubt regarding collectability existed AT
THE TIME OF SALE. Hmmm....
a. So under that analysis (in that court), best answer is C has to accrue $15k plus the
interest, at least until Dec. 1. THEN as of Dec. 1, true doubt as to collectability
(bankruptcy), claim as a loss?
b. Exception? 448(d)(5), specific services including..., gross receipts, dont exceed $5 mil?
No. But (b) says.... ? (Re-read!)
3. #4 recurring item exception and #8 from Ch. 28, also 12-month rule, READ very
closely the Rev Ruling in book: 2007-3, if can understand why neither rec item or 12month rule applied in 2007-3, will get it.
VIII. Chs. 28 and 29 problems, contd
A. See articles clipped in Evernote Tax category (tagged)
B. 461(h)(3): recurring items exception KNOW FOR EXAM AND APPLY!***
1. If met first two prongs of all events test fixed & determinable, and then economic
performance occurs w/in shorter of
a. Reasonable period after close of year OR (interpreted/applied as 8.5 months, never
argued shorter, kind of redundant)
b. 8.5 months after close of such year

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c. CAN take deduction even though economic performance occurring in next year
d. Nature of expense needs to be recurring, results in proper matching, not material,
constituently treated as recurring item
2. Rev Ruling 2007-3, p. 708 (and Evernote)
a. Situation 1: K for services in Dec 2006, began Jan 15, 2007, paid same day
b. Situation 2: K for insurance, same facts
c. Why didnt recurring item exception apply? Cant just go on bilateral contract, still have to
use all events test, economic performance and all events next year not yet fixed &
determinable just because of a contract. Econ performance test met w/in recurring item
timeline, 8.5 months, but first two NOT met.
d. Example where it DOES apply: 1.461-4(g)(8) Example 8: see 461 PDF tax imposed
under state law, fixed and determinable on Jan. 1, lien attaches as of that date, too, even
though paying over next 18 months. Economic performance occurs when paid. TP can
deduct $6k in 1992, second payment happens w/in 8.5 months of close of 1992, can
also deduct in 1992 $4k exception to general rule of 1993. Qualifies for recurring
item exception. 1.461-4(g)(6).
C. Problem #2, Ch. 29: Accrual method TP sells paintings, C charges interest on open account,
promises to pay $15k, cash flow problems, as of Dec that year, likely cant pay
1. Conclusion: for accrual method TP, doubts as to collection dont allow to not accrue, would
have to be serious/real doubt as to collectability. Some objective manifestation. Facts here
too thin, but best answer is accrue $15k, accrue interest until Dec. 1, then on Dec. 1 TP
might have good argument shouldnt have to accrue.
2. Facts & circumstances question, no bright line.
3. Part (b): what basis, if any, does C have in $15k accounts recvbl resulting? 15k. If accrued
income on account revbl, have basis in it of 15k, but if cash method TP, basis is (if C were
cash method)... 0. Hasnt received any cash. (Interest irrelevant, wont get either way, not
paying. Basis = cost.)
4. Part (c): May P deduct? Short answer, yes. Just as rules dont allow postponing accrual
based on not-real doubt, also accrue deductions until serious doubt, even when no absolute
certainty as to payment.
a. Only perhaps after December when bankruptcy/clear indication of non-payment, more
proper for P not to deduct for INTEREST only, not 15k, business expense.)
b. [Eg, 1.461 regs, 1.461-4(e): in the case of interest (wont ask about on exam!),
economic perf occurs as interest
cost economically accrues.....]
5. Part (d): discharged in bankruptcy, what happens to C? Business deduction under 166 the
next year, LOSS... but if collected as bankruptcy debtor, claim as income later. If had been
cash method, no change, would never had received the cash, no deduction basis zero, so
gain/loss is zero. Loss under 166 keys off of basis. (Eg contrast, cash method TP loans
money, no repayment, bad debt deduction.)
D. Problem #4, CH. 29, p. 680:
1. When may TP deduct property tax? Special one-time tax, recurring item deduction doesnt
apply, not recurring in nature. Deduct in Yr 2 when paid, even though fixed and determinable
in Year 1. Follow general rule of accrual, all items, ONE-TIME tax.

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2. Also: 12-month rule, helps cash method TP paying for things otherwise capitalized, doesnt
apply to bar licensing fees b/c right of indefinite duration. Limitation for rights subject to
renewal (1.263af...5), Factors listed re: renewable, then section (6) coordinates w/ 461 (all
events test), accrual method: rules of paragraph (f) do not affect determination of whether
liability occurs w/in taxable year, including economic performance, IE: 12-month exception to
apply, still meet ALL aspects of all events test, versus recurring item exception only applied
to first 2 parts. 12-month rule may apply but STILL must meet all parts of accrual test: fixed,
determinable, and econ p. (eg, doesnt apply in 2007-3 b/c TP hadnt met all aspects of all
events test.)
3. Read Reg examples, Dec 1 2005, fixed & determinable AND economic performance (1.4614g5 rules re: economic performance)... read ALL examples, showing precise close
reading of statute and regs together to illustrate.
E. Problem #8, CH. 28
1. Hank, cattle business, year-to-year lease, commences Jan. 1 Year 2, pays lump sum of Jan.
5 each year. Each lease 12-month period.
2. When may H deduct in each situation? (cash method TP)... prepayment rule???
a. On Dec 30, Yr 1, H pays Annie $50 to cover lease for Yr 2: Rule #1: deduction when
paid, so YEAR 1. BUT always subject to capitalization rule: extends beyond the year
would have to capitalize. BUT THEN: 12-month exception (1-263(f)) not beyond earlier of
12 months after benefit or end of taxable year. so YEAR 1, paid for benefit that occurred
w/in 12 months. One caveat: subject to renewal? If repd IRS, could argue lease
subject to renewal.
b. On Dec 30, Year 2, H pays Annie $50k to cover lease payment for Year 3.
c. TP like cash method, IRS likes accrual: income when cash, usually get deduction when
pay, worry about capitalization (12.5 months, etc.). Versus accrual: income when fixed &
determinable even with doubt of collection, deduction delayed b/c fixed & determinable
AND economic performance, lots of hoops accelerates income and postpones
deduction. POLICY: think about it, whats the effect.***
3. 1 or 2 multiple choice questions, but at least grasp what learning. Review: done w/ methods
of accounting, yay!
IX. Ch. 34: ASSIGNMENT OF INCOME
A. Not spending much time b/c doesnt come into play often anymore. Why? Later....
B. Fruit of the tree metaphor
1. Meaning: fruit = income, tree = TP
2. Lucas v. Earl: lawyer K w/ wife, pennies earned belong half to him, half to her, before joint
returns and tax rates high (60-70% for high bracket vs. 10% for poor)
a. Simplest tax planning, move money to someone in lower bracket
b. IRS: cant anticipatorily assign away income because power, control over earning income
belongs to TP, must then be taxed. TP is tree, income is fruit. Cant sep.
3. Helvering case: bonds & interest coupons
a. Coupons given away, avoid being taxed at high level, moving to lower level

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b. IRS: cant do that, own the property (the bond), power to dispose of the property is
yours, therefore income from property is also yours, cant assign w/o giving up property
itself. Fruit of the tree.
c. RULE: you cant assign away the fruit and keep the tree.
d. But if giving away the tree as well, fruit is now other persons, they are taxed.
4. PAGE 821!!! TWO RULES***:
a. Income is taxed to person who controls earning of income regardless of who receives.
Eg, cant have salary paid to children, tax them.
b. Income from property is taxed to the person who OWNS the PROPERTY (tree). Eg,
cant have rent check written to child of landlord.
c. If repd IRS, how would you re-characterize? Income to father, gift to son.
5. Eubank case: TP is insurance salesman
a. Income: renewal commissions every time an insured person renews their policy,
salesperson gets another commission (smaller but still there), get as long as policy
outstanding. Right coming to you from policy sold years ago.
b. TP gave renewal commissions away IRS said no, TP said was assignment of
something earned in the past, right had, gave whole thing away. IRS won. Court
emphasized fact that it was a gift, given away, didnt like idea of shifting income by virtue
of a gift, tax earner and gift to donee.
6. Other cases unread:
a. Stranahan: TP sold to son right to receive future divs on stock, irrevocable stock, right to
receive forever, IRS said anticipatory assignment. Court holds YES can, because TP by
selling div gets taxed on proceeds from sale, ordinary income, buyer will report income
as recd on divs down the road. Diff rule b/c not GIFT. Arms-length sale, FMV for right to
dividends.
b. Salvatore...?
7. May v. Commissioner case
a. TP gave rental property away to trust for his kids (co-trustee), rented the property, taking
deductions presumably, rented to trust.
b. IRS said no, court said yes, given away entire tree legitimately, property no longer
belongs to individual. Complete control to other entity. Trust/ee could control, given away
the TREE.
8. Plans 1, 2, 4 in casebook next class Brewers answers, THINK ABOUT: current
events, George Lucas selling Star Wars/Lucas Films for $4 billion. Signed pledge
about giving wealth away w/ Buffett? Stock in LucasFilm: will keep some, but will take
some and give to charity, take deduction, assume zero basis, charity sells: can he do
that? Does assignment of income apply to stop that or not? Next class!!!
C. Does George Lucas have an assignment of income problem?
1. Lucasfilm corporation assume G owns 100%
2. Disney pay $4 billion to G/L (some cash, some stock)
3. G has 100 shares of stock, donate/transfer 10 to Foundation (charity) $400 mill
a. Conceivably deduction of $400 million
b. Instead of $4 bill paid to G, will only get 3.6 billion from Disney, 400 mill to F

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c. Assume ZERO adjusted basis in stock, F is tax-exempt, doesnt pay tax on $400 million
in gain upon sale. (F: Chairman of Board)
i. As long as not contractually obligated to sell shares, no assignment problem?
ii. Did he give them the shares free/clear of control? If so, can assign
iii. Nobody would be paying taxes on $400 million gain b/c F could sell w/o tax, but at
the SAME time, Lucas taking deduction on something hes not claiming as income,
doesnt MATCH. Wait... yes it does: 10 shares to F then to D.
d. Gain = $3.6 B, b/c 3.6 Amt Realized, ZERO Adjusted Basis, $400 mil deduction for FMV,
no tax on $400 mill gain to F, $3.2 Taxable Income doesnt seem right, should have to
claim $4 bil THEN deduct, b/c Disney paying F directly
e. Timeline: gives away stock, gets deduction, sells other stock, income stock went from
Foundation THEN to Disney.
4. Advising Lucas, asking can he assign this income:
a. Rev Ruling 78-197, litigated for years, took same position that getting double advantage,
deduction AND escaping tax on this money
b. But NOW, is OK because legitimate business transactions, IRS lost because every court
said that at TIME of donation, no legal requirement that charity/transferee sell the stock.
(MAY v. COMMISSIONER CASE!)
c. LOI: letter of intent, between Disney/Lucas, not binding agreement: when deal closes,
donate proceeds fruit ripe when assigning, give away no strings, relinquish all control
on the transfer. Happens ALL the time, going public, etc.
5. Without binding contract, many things could happen, treat as separate transactions
D. Common transaction, saving huge taxes because deduction AND skipping tax on big donation
to foundations. So charity basically just a way to avoid paying taxes for rich.
1. Posting answers to problems for plans in casebook chapter/assignment. READ! Key
question: DO YOU HAVE POWER over the income in the future? Have you already
earned it? Or transferred BEFORE fruit was ripe (like Lucas example)?
2. Lucas example is classic problem. Other contexts, pretty rare, b/c tax rates are compressed.
0-35% so most will save is 35%, old times rates up to 70%, incentive.
X. CH. 31, Capital Gain and Loss
A. Basic Rule:
1. Net gains from sale/exchange of assets held for more than 1 year, taxed at a preferential
rate. IE: only long-term capital gains are taxed at lower rate.
2. Short-term gains are taxed as ordinary income.
3. Net LOSS from sale/exchange, limited to $3k per year, IE: capital losses over and above
capital gains are limited to $3k per year.
4. Capital gains, especially long-term, are good. Capital losses suck, dont want.
B. Policy for preferential treatment? 15% is the MAX rate for federal taxes, LTCG
1. Eg, Lucas only paying 15% on income from long term dividends, cap gains
2. Versus 35% on ordinary income. Incentive to invest/save, good to be patient.
3. Bunching of Income effect

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a. Eg, Lucasfilm around since the late 70s, making $100 M per year, 2012 happens,
income skyrockets, $4 B sale. Did appreciation all happen in 2012? No, building up over
time, value of stock going up, but no sale/realization
b. No tax until realization, becomes huge number, so maybe tax at lower rate so it doesnt
overwhelm TP since cant tax in increments over several years w/o sale
c. (What about dividends coming in over time, tax those same rate?)
d. Reagan made all taxes same rate in 1986, simplifying, since then changed back
e. TP want to convert income into capital gains, save money, pay lower rates
C. Code
1. 1221: Capital Assets defined
a. Property held by TP whether or not connected w/ trade or business BUT courts have
taken that definition and confined to ...
i. Hort case: tenant pays landlord to cancel lease is a leasehold property interest?
Yes. TP (landlord), capital gain taxed at lower rate. Court said no not intent of
property, not common law definition, meant property that appreciates, investment
long-term, realized through sale/exchange. Payment from tenant was just a substitute
for ordinary income (lease payments).
ii. Davis case: lottery payments. TPs won lottery, paid installments, collected one
check, sold right to future payments to buyer. Buyer paid less than total value of
stream of lottery payments (TP wanted lump sum). TP tried to say capital gain,
sale/exchange of property: right to payments. Court said NO proceeds are ordinary
income, selling right to those is substitute for OI.
iii. Court: property that appreciates over time under 1221, specifically (footnote 23 in
Davis case, p. 790) accrued over substantial period of time, ameliorate hardship of
taxation of entire gain in one year narrowly interpret 1221a
iv. Does NOT include stock/trade or other property of kind would properly be included
in INVENTORY of TP or held primarily for sale to customers in ordinary course of
TPs trade/business real estate agents, etc.
b. Bynum case, p. 774: farmer
i. Portion of land, subdivided and sold off as residential plots, developed
ii. Said it was property, kind included in 1221a, invested and sold, not in the farm
business, should get capital gain treatment
iii. Court said NO, because even though started owning as farm, land not for sale, at
some point started selling plots, now purpose for holding is for sale to customers,
ordinary course of business
A.
became real estate developer, not farmer, is like inventory fruits & veggies.
Added street, etc. NOT improvements over time, made them marketable over
regular appreciation.
B.
Concurring opinion, made point that normal appreciation that would have
happened w/o improvements: ALLOCATION (p. 779-80) statute doesnt permit,
looks to how holding prop AT TIME OF SALE, tax accordingly. Otherwise serious
administrative difficulties to determine $ of land.
iv. Key: PRIMARILY for sale to customers.

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v. Factors determining whether held primarily for sale to customers

A.
Frequency, substantiality of sales
B.
Improvement made to land
C.
Solicitation advertisement
D.
Utilization of real estate brokers/agents
E.
A is most important, facts/circs analysis, difficult, but illustrates point that capital
assets do NOT include property that is inventory-like, realize income in ordinary
course of business. Normally dont sell land but selling many lots consistently, is
ordinary, not big investment/capital asset.
c. Next week: DROP last reading assignment (lifetime exchanges): be prepared for
Tuesday problems Ch 31, get into 1231, re recapture Ch 32, then finish next
Thursday w/ Ch 33, important stuff... code logic.

XI. MISC:
A. KEY: How much gain/loss is recognized and what is its nature?
B. Casebook: netting out gains, losses, carryovers do NOT need to worry about that, just have
a sense of why can matter, wont have to calculate net capital gains/losses, carryovers & offsets,
etc.
C. DO know 1211(b) $3,000/yr limitation
D. Review the PROBLEMS from each chapter
XII. 1221 defining capital assets
A. Property 1221(a) very particular definition, (a)(1) inventory and primarily for sale to customers
in ordinary course of trade/business
B. (a)(2): used in tr/bus character subject to depreciation OR real property used in tr/bus
1. Nothing about merely for production/collection of income
2. Just trade/business, so no rental properties, etc.
3. Exclusion #3, if creates a painting, work of art, sale of that should not be entitled to capital
gain treatment: is ordinary income just like $ services as lawyer
4. #4 accounts or notes recvble, acquired in ordinary course of tr/bus or services rendered, or
sale of property described in paragraph 1 (eg, if in hardware business, sell saw, sell account
receivable, NOT a capital asset by this exclusion: saw is inventory, primarily for sale to
customers in tr/bus.)
5. 1222: to get capital gain/loss treatment, must have sale or exchange. To get LONG term
treatment, must have held asset for more than a year. (year and a day)
a. Other definitions for short term, long term, etc.
b. But essence is sale/exchange requirement and holding for +1 yr requirement
C. 1211(b): .... plus lower of $3000 or excess of loss over gain (many TP try to time sale of gain
assets w/ loss assets to offset gain w/ losses)
1. If yr w/ all loss and no gain, only up to $3000/yr
2. ... (gain w/ no loss?)
3. Try to match cap gains & losses
4. NB: Arrowsmith doctrine, p. 773: corps liquidated, distributed, creditor didnt get paid, sued
shareholders to pay back liquidating proceeds.

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a. TP argued: capital gain in Yr 1, had to pay back in Yr 2/3 due to creditors lawsuit, took
ordinary loss
b. First was sale/exchange of capital asset, second transaction was payment to corp
because of lawsuit in different year, no sale/exchange
c. Origin of the claim: characterize payment on origin of the claim. Arrowsmith court said
repayment was so tied w/ the liquidation/corporation that still capital, would be unfair to
give ordinary loss treatment when what WOULD have happened is reduced capital gain
b/c pay creditors THEN paying smaller amount to shareholders. Stands for if ORIGIN of
claim is SO RELATED TO prior transaction, characterize that payment/receipt-of-addtl$
same as original.
D. Kenan case, p. 792: old lady dies, leaves trust to niece, age 40 distribute $5 mil (1940)
1. Trustees said trust invested in stocks, bonds, etc., presumably going up in value
2. Distributed stocks & bonds to niece instead of cash
3. TP files tax return taking position that is bequest, non-taxable under 102
4. IRS said no, didnt receive bequest trust said receive 5 mil cash not stocks & bonds
5. Therefore, to extent recd stocks & bonds appreciated in value, capital gain (did she sell? reread case) eg, $3 mil in stocks & bonds became $5 mil = 3 mil gain reald
6. TP: No sale or exchange! GR not generated, no realization event. Plus 102 exclusion for
gifts and bequests.
7. WHO WON? IRS. Why? Court said capital gain, effect of sale/exchange: niece had a right
to $5 mil, satisfied w/ transfer of appreciated property. When transf. property in satisfaction
of obligation/liability = triggers gain! Just as if trust had sold then paid.
8. SALE/EXCHANGE can be broader than commonplace notion of sale/exchange.
a. If had transferred inter vivos different.
b. If bequest of specific asset (Home Depot stock): bequest under 102
i. Why different? If specific bequest, not sure what the value is
ii. If for specific value and get in form of stock, different because of right of claim
E. Problems, Ch. 31
1. Terry and Margaret own car dealership
a. New sedan: no, inventory
b. Van: no, ordinary course of trade/business, subject to depreciation (a)(2)
c. Station wagon: YES, even though personal use, 1221 very broad, just prop
d. Land and building of car dealership: no, real property for trade/business (a)(2)
e. Vacant land purchased for investment: YES, not trade/bus, held for investment (212), no
exclusions apply under 1221
f. Promissory note: no, account receivable, 1221(a)(4), ordinary course of trade/business
because for sale/car
g. Home: YES, no exceptions under statute
h. Painting Margarets mother painted: Not if recd before she died, is gift, basis from
creator (carryover), but second painting received as heir to mothers estate, YES, basis
is FMV of painting (stepped up basis), doesnt depend on mothers (1221a3 re-read,
would not apply in second situation)

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Wedding ring: YES because no applicable exclusion

Stock in dealership: YES, is NOT stock in trade under definition, basically means
inventory, not stock in own business
k. Computer originally for business but now for personal investments: at first (a)(2) would
exclude, but after using for self to track investments, converts to cap asst., not technically
a personal use, held for collection/production of income, depreciation. NB: (1221a1, look
to nature at the time of sale)
2. Basketball contract bought out: NO, K not a capital asset. Gets $400k, ordinary income
because substitute, just like Davis/lottery case (courts have construed property under
1221a very narrowly, kind that depreciates/appreciates over time)
3. Tracts of land, never listed, intending to sell. Is sale of prop under 1221a, but is it excluded
from capital asset treatment? If so, how? Primarily for sale to customers, subdivided, 10
sales (feels like trade/business) answer? Depends. Breaks tie for Brewer, subdivided and
sold 10 parcels, significant, like farm/subdiv. (1237? ignore)
4. KEY: What is it? Does it fall under 1221 definition? Is there an exclusion?
XIII. Ch. 32, Quasi-capital assets, 1231
A. All about helping out TP. Best of both worlds. IF subject to depr (eg, van used in dealership, not
cap asset b/c prop used in tr/bus subj to depr), used in tr/bus, normally sale/exchange not cap
asset, held for + 1 year = ordinary income/loss, 1231 exception
1. 1231 gain = any recognized gain from sale/prop used in tr/bus (also invol conversion)
2. 1231 loss = any recognized loss from sale/exchange/conversion as above
3. HOTCHPOT:
a. If 1231 gains in taxable year EXCEED 1231 losses = long term cap gain/loss
b. If 1231 gains DO NOT EXCEED 1231 losses (tied or less) = ordinary
c. Good thing for TP? If sell used in tr/bus (van), sell at a gain, capital gain treatment (1 yr
holding period requirement)
d. If lose $ on van, get ordinary loss treatment. Win win.
4. PRELIMINARY HOTCHPOT:
a. 1231(a)(4): losses, including not compensated by insurance/otherwise, on destruction,
theft in whole or in part, used in tr/bus OR held for more than 1 year and in connection
tr/bus or transaction entered into for profit (eg rental prop)
b. Cuts TP a break, in the case of involuntary conversion when capital asset, does not
apply, get to claim ordinary loss, IF 1231 LOSSES EXCEED THE GAINS. (so no $3000
limit if you lose the property involuntarily instead of selling/exchange)
c. READ 32 & 33!
i.
j.

Recapture of Depreciation on PERSONAL property 1245:

o Property bought for $100 (original basis)
o Depreciates X over more than one year (when calculating X, take 179 deduction FIRST
and THEN start calculating the depreciation amount.)
o Sold for Y (amount realized)
o THEN:
100 minus X = AB (AB + X should = original basis (unless gift))

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If Y (AR) > $100 (original basis), then Y minus 100 may = capital gains, 1221/1231,
whatever is left of gain realized is ordinary income
o If Y < or = $100, then Y minus AB = ordinary income
o 1245 DOES NOT apply to losses
Problems
1. Purchase price/original basis, $200k (minus $100k 179)
a. Depreciates $61,600 (20 yr 1, 32 yr 2, 9600 yr 3) = $38,400
b. Sold for $175k
c. $25k loss in FMV, but $136,600 over AB (gain realized, ordinary inc)
d. If sold for $210k - $10k regular gain, $171600
o

I.

1231 quasi-capital assets, contd

A. Presumption pro-TP, loss is ordinary, gain is capital. See slides/flow chart:
http://www.cpaexamacademy.com/lessons/regulation-reg/4-0-c-corporation-taxation/4-5-section1231-1245-and-1250-assets/
B. Problems
1. George realizes following gains/losses in 2013. Characterization? Deductible?
a. Parcel of land used in rental business. GR = $150k. Is the land a capital asset? No,
using in his own trade/business, not for investment. 1231 asset? YES, held for +1 yr,
used in trade or business. STAYS IN.
b. Summer cabin, loss of $60k, personal use asset, outside the analysis. Is a capital asset
but NOT 1231, not all losses from cap assets used. (Cap gain on personal use asset is
OK, but cant take ANY loss on personal use asset 262)
c. Uninsured loss, theft of truck owned and used in business +1 yr. Time of theft, AB in
truck $25k, value $30k. Capital asset? NO. 1231 asset? YES, used in trade/business.
Involuntary conversion = not sale/exchange. Fits w/in definition of 1231 invol conversion,
what to do? 1231(a)(4)(C) = preliminary hotchpot
i. decide whether LOSSES exceed GAINS. Not enough facts, use AB $25k, not $30k
FMV, because to determine loss use basis.
ii. Theft loss = $25k. Preliminary hotchpot.
d. Corporate stock, $30k loss capital asset? YES. 1231 apply? NO. Stock is not used in
trade or business, wasnt invol converted. Sale/exchange of cap asset 1221 not in
1231 analysis.
e. $2k loss on sale to sister of computer used in business for more than year. Capital
asset? NO. 1231 asset? YES. +1 yr, used in trade/business.
i. Sale/exchange, not invol conversion, not preliminary hotchpot
ii. Goes into principal hotchpot: NO, because family member/related party sale. 267
disallows the loss, outside the analysis.
f. Preliminary Hotchpot do losses from involuntary conversions exceed gain? YES. What
happens? Becomes ordinary loss - $25k, drops out of the 1231 analysis altogether. TP
favorable, b/c ordinary loss NOT limited.
g. Principal Hotchpot - $150k 1231 gain, any 1231 loss? NO. Next step: NET - $150k gain
minus $0 loss. If 1231 gains exceed the 1231 losses, ALL gains and losses

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characterized as capital gains. They DO here, so $150 cap gain. [NB if losses had
exceeded gains, becomes ordinary loss, still TP-favorable)
i. Net 150k, characterd capital gain, taxed at lowest rate: 1231 analysis
ii. When TP calculates, will also include corporate stock but DONT WORRY ABOUT
THAT FOR EXAM ($120k net cap gain b/c loss on stock, not 1231)
2. G recognizes a $25k gain from collection of insurance proceeds on destruction by
earthquake of land he owned and used in business for 5 yrs. How to characterize gains and
losses? (Other $ from problem 1 STAYS IN.)
a. Involuntary conversion not sale exchange. $25k gain goes in PRELIMINARY Hotchpot.
Losses DO NOT exceed the gains.
b. Do NOT bypass 1231 analysis, promote to principal hotchpot instead.
c. Now: $25k loss, $175k GAIN
i. (Ignore/skip recapture)
ii. NET: do the 1231 gains exceed the losses? STILL YES. Gains and losses
characterized as capital gains/losses. (If loss had exceeded gains, would be ordinary
loss). So: $175k-$25k = $150k capital gain. (-$30k JUST in cap gain calculation, not
1231! - $120 cap gains on tax return.)
3. ***Assume G recognized $45k in 1231 losses from SALE, $15k of 1231 gain from INVOL
CONVERSION. Now gains exceed the losses, promote to principal hotchpot. Losses $45,
ordinary. 2012.
a. 2013 facts from Problem 1 are exactly the same for loss, BUT
b. Now use $30k NET LOSS from last year when computing gain (1231(c) net 1231 loss
within the last 5 years, subject to TAX RECAPTURE, designed to prevent TP from
gaming the system, timing, etc.) Recapture $30k and treated as ordinary income. Now
capital gain is $120k ($150k gain minus $30k recapture) (plus $30k for regular stock loss
from problem 1, net $90k cap gain.)
II. Recapture Depreciation, 1245 & 1250
A. Policy: allowing TP depreciation or 179 write-off, allowing that spurs economic incentive for
buying long-term assets, but artificial type of deduction.
1. Assets can last longer than recovery period, salvage value, etc. Buy an asset w/in these
categories, depreciate, 179 write-off.
2. FLIPSIDE is, if you then sell the property at a gain that isnt economic gain (property didnt
really appreciate), only reason gain is because of write-offs/depreciation, to that extent
recapture and hit w/ ordinary income.
3. 1245 property is depreciable personal property
4. 1250 property is REAL property no real recapture only $ over straight line deduction,
dont use double-declining, etc. (almost exclusively 1245 on exam)
5. Example: 1231 and recapture, look at example! (where???)
B. Problems:
1. $200k coast of boat p. 341 depreciation chart, 5 years.
a. $100k 179 deduction = $100k depreciable basis (1.179-1f) (so 179 THEN dep.)
i. Year 1 depreciation deduction = $20k
ii. $80k AB at the end of Year 1 (no straight line election)

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b. $80 AB at beginning of Year 2, $32k depreciation = $48k AB

c. Year 3: $48k 9,600 yr 2 dep = $38,400
d. Tax break deductions worth over $160k for 1231 asset which was capitalized in matter
of 2.5 years, but boat has much higher value. Tax breaks, not econ loss. Just break for
making investment. If taking those deductions, recapture, ord inc $136,600 (done
outside 1231)
e. AMT Realized: 175, AB: 38.4, GR = 136.6. 1245 says recapture UP TO recomputed
basis = 200. Actual recognition = $25k loss. (lower of gain realized or recomputed
basis) [SEE SLIDES!]
i. $136,600 ordinary income because just computing income, above the line.
ii. If 210 sold, use lower of AR (210) or recomputed (200) 200, now has $10k gain.
Would have been $171,600 w/ 210 but now w/ 200: $161,600 ordinary income
$10k excess gain goes through 1231 analysis. ABOVE THE LINE, then deal
with g/l?
iii. Dont forget to calculate income above the line, not just the net gain/loss, etc.
i.

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