Federal Income Tax 2
Prof Foreman- room 424
Probably multiple choice exam
2 main issues: basis and timing
Review your notes from Tax I and answer the following questions.
1. In year 1, A purchases Blackacre, vacant land, for $100. At the end of year 5, Blackacre is worth $120. In year 10, A transfers the land to B in exchange for $150 in cash and stock worth $20.
(a) When and in what amount does A recognize gain with respect to Blackacre?- $70 in year 10
Look at steps:
-year 1- basis of $100- there is no income, he hasn’t been enriched and does not have income- look at regs section 1011- adjusted basis for determining a gain or a loss- 1012- basis is the cost of the property- 1016 discusses adjustments to basis- that basis may change (depreciation)- depreciation is not an issue here because you cannot depreciate vacant land
-year 5- blackacre is worth $120- doesn’t matter- nothing changes because there is no realization- we could do this, it might make sense from an economic standpoint, but it would be a logistical mess- plus, it seems unfair to tax when you don’t have the money- if property skyrockets, you may need to sell it to pay the taxes
-year 10- he transfers the land for $150 in cash and stock worth $20- tax this- 1001 formula- excess of amount realized over the adjusted basis:
-AR is $170
-AB is $100
-thus, he gains $70-
-you need to also recognize a gain or loss (we will do that later in the semester)- the general rule is that when you realize(c), you recognize it (there are some non-recognition provisions
-(d)- installment sales- we will do this later
1001-1a- if you exchange property, it’s usually for cash- but if you exchange blackacre for something very similar, the rules are different- so when is property different enough? (Cottage Savings case- banks had a portfolio on mortgage loans- bank A would swap portfolios with bank B- they were worth the same- have they swapped something different?- the court ruled that the mortgages are materially different and the banks could do what they wanted and recognize a gain or loss)
(b) What if the consumer price index doubled between year 1 and year 10 due to inflation such that a basket of goods that cost $100 in year 1 now costs $200 in year 10. Should this affect the tax that A owes on her investment in Blackacre?
-under the first example(the code doesn’t work this way, but here’s why it’s criticized)-
Year 1 dollars- bought property for $100- AR is really $85 (half b/c of the CPI)- he really has a loss
Year 10 dollars- he bought for $200 and sold for 170- $30 loss this time
2. Assume T receives a used car instead of cash compensation from his employer. The car has a FMV of $5,000. Because the form of income makes no difference, T has $5,000 of income. T sells the car for $6,000. How much gain?
-this is just to remind us that basis is not just cost basis- the car was compensation and he has a tax cost basis in the $5,000- you get basis when you pay taxes on something- 1.61-2d
3. A owns stock in X Corp that she purchased five years ago for $100 in cash. B owns stock in Y Corp that was purchased two years ago for $200. A and B swap stocks when the X Corp stock is worth $150 and the Y Corp stock is worth $160. What are the tax consequences?
-a- $60 gain- b- $50 loss
Taxable exchange- this is not a like kind exchange because stocks are excluded from like kind exchanges
-A has a basis of $160 and B has a basis of $150- Philly Park- the basis is the fair market value of what they got
4. G owes $200 as the principal amount of a loan that has come due. G has no money to pay off this loan so G transfers shares of M Corp. stock worth $200 to the lender to satisfy the debt. G had received the shares of M Corp. stock from his employer as a bonus 10 years ago when the shares were worth $50. What are the tax consequences to G?
-he recognizes $150 gain on the stock
-this is a §83 issue- he got this as a bonus- he doesn’t have to include it until it’s vested- he included it right away- he has a basis of $50- this is the same as him selling the stock for $200, then giving the bookie the cash- he pays a gain of $150- this is a “deemed sale”
5. D bought stock for $100 and held it until his death this year. The stock was worth $140 upon D’s death and D left this stock to S in his will. The stock is distributed to S eight months after D’s death in accordance with the will and S immediately sells it for $150. What are the tax consequences?
-the stock passes to his son- the son realized $150- the basis is the FMV- he gets stepped up or stepped down basis
D-pays no tax on his gain- S is enriched, but why isn’t this income?- this is in §102- gift by bequest, devise, or inheritance- but he gets the FMV basis
-he hasn’t held it for a year, so it looks like short term capital gain (if it’s long term, it’s 15%)- HOWEVER- 1223- it is considered long term- 1223(9)- when you inherit property, you automatically get long term
6. A makes a gift of Blackacre that A had purchased several years ago for $1,000 to B. At the time of the gift, Blackacre is worth $1,500. B sell
-Realization v. recognition
Realization is usually implied- idea that you have disposed of the property enough that it is fair and safe to tax you- 1001-1a reg-
-a gain or loss realized is when you sever or change something from the property- you usually have to change your investment
Recognition- 1001(c)- if you have really gotten out of your investment and realize it, you recognize that gain or loss (figure it out on your taxes). However, if you can find a non-recognition exception, that exception applies
Ex. sell property to a spouse- I sell a lamp to my wife for $200- I have realized a $100 gain- but it is not recognized because I’m married- more like a gift in this case
Class 2- Recourse and Nonrecourse debt
1. What is T’s basis in Blackacre if T acquires Blackacre the following ways (assume that T is personally liable for all borrowings; i.e., these are recourse loans):
(a) $20,000 in cash.
(b) $20,000 in cash to the seller. Then T takes out a loan from Bank for $20,000 to replenish his cash.- the same answer- $20,000 basis
(c) $10,000 in cash to the seller and $10,000 borrowed from T’s Bank. T gave the Bank a recourse note secured by a mortgage on the property.- basis is still $20,000
(d) $10,000 in cash and $10,000 paid to the seller that T borrowed from T’s Bank on an unsecured basis.
-still $20,000 basis
(e) $10,000 in cash and by assuming an existing $10,000 mortgage encumbering the property.- $20,000
(f) $10,000 in cash to the seller and by giving the seller a note for $10,000.- $20,000
2. Using the facts of 1(c) above, T sells Blackacre to Joe two years later for $25,000. Joe paid T $17,000 in cash and assumed the remainder of T’s liability on Blackacre of $8,000. What is T’s amount realized?- AR is $25,000
DISCHARGE OF INDEBTEDNESS
Review chapter 9, discharge of indebtedness.
3. T purchases a tract of undeveloped land for $2000, paying $500 in cash and borrowing the remaining 1,500 from an unrelated lender with the land as collateral