Presentation:
Federal Income Taxation
Chapter 6 Return of Capital and Timing
Professors Wells
September 16, 2015
Fairfield Plaza, Inc. v. Commissioner p.314
FACTS: Land purchased in 1955 of the whole tract was $110,941.12. In
addition, petitioner spent a net of $29,584.64 for engineering, grading,
and other miscellaneous items which are to be capitalized.
1.  In 1957 Taxpayer sold eastern tract for $100,000 to Big Bear.
2.  In 1958, Taxpayer sold 30% of western tract for $150,000 to
Paisley.
Reg. §1.61-6(a): “When a part of a larger property is sold, the cost or other basis of the
entire property shall be equitably apportioned among the several parts, and the gain
realized or loss sustained on the part of the entire property sold is the difference between
the selling price and the cost or other basis allocated to such part.”
Held: 40% of basis allocated to Paisley parcel due to the facts
indicating that its frontage on main through street added value to
that portion of the tract.
2 Rev. Rul. 70-510
p.317
FACTS: The taxpayer received a payment from the Federal
Government for a ‘‘flowage deed’’ whereby the Government was
granted the perpetual right, under certain conditions, to flood designated
portions of the taxpayer’s property. The taxpayer retained title to the
land and had full use thereof except when flooded.
1.  Payment was less than its basis in the land & improvements.
2.  Flowage easement represented 20% of the fee value.
Held: “The amount received shall be applied by the taxpayer against
the cost or other basis of the properties to which the easement
appertains in determining gain or loss from the subsequent sale or other
disposition of the properties.”
3 Inaja Land Co.
Supp. pp. 54-55
Open Transaction Treatment?
Consideration received for an easement in land. The amount
received was less than the tax basis for the property. How
allocate tax basis to the amount received?
Exclude entire proceeds received and reduce basis by that
amount received?
Note: Burnet v. Logan case (p.733) re basis recovery first before
any gain recognition.
& see Reg. §1.1001-1(a).
4 Annuities
Level Payment Contract
p.325
Annuitant can have a contract providing for the receipt of
level payments for:
a) A specified term (e.g., ten years)
b) One life or several lives
c) One life plus a specified term.
An annuity recipient is in a similar position to the lender in a
level payment mortgage loan.
Amounts “realized” periodically, i.e., in pieces.
5 Annuity Income Taxation –
Timing Options
p.325
Tax policy choices for determining the timing for the inclusion of
annuity income:
1) As the value accrues within the contract? Cf., amounts credited
to a bank account or a mutual fund account or OID concepts. Tax
shelter benefit with an annuity?
2) Only as amounts are paid under the annuity contract either (i)
before or (ii) after the annuity starting date.
6 Distributions made Before the
Annuity Starting Date
p.325
1)  Pre-starting date annuity contract withdrawals are sourced
first from accumulated income. Code §72(e)(2)(B).
2) Loans are also treated as withdrawals (& sourced from
income?). Code §72(e)(4)(A).
3) A penalty tax of 10 percent (of the distribution) is applicable
for pre-age 59 1/2 distributions. Code §72(q).
7 Annuities, cont.
Current Method - §72(b)
p.326
1)  Determine the total income tax basis.
2) Determine the expected return - i.e., the payment amount times
the anticipated number of payments (how determine?).
3) This ratio is applied to each payment when received. The
formula is:
(i) total basis/expected payment times
(ii) each payment equals
(iii) amount excluded from gross income.
continued
8 Annuity Income Calculation
for Term Contract
p.325
Purchase for $100,000 of a single premium annuity. Assume15
payments of $12,000.
§72 exclusion computation: 100,000 (investment in contract)
180,000 (12,000 per year x 15 yrs)
Equals: 55.55% times $12,000 (= $6,667).
Equals: 6,667 to be excluded and 5,333 to be
included in gross income (12,000 less 6,667).
continued
9 Problem cont. - Life Contract
Anticipated 15 Year Life
p.325
Death occurs before reaching life expectancy (e.g, after only 9
payments).
The tax basis recovered was $60,003 – ($6,667 times the 9
payments made). The unrecovered basis in the contract is
$39,997 of the $100,000.
Deduction of this amount on final income tax return is
permitted (if expiration of contract at death). §72(b)(3).
10 Annuities, cont.
Impact of Death
p.325
What is the impact of death?
Termination of the annuity contract - if based on life
expectancy. If tax basis is not recovered? Deduction on
annuitant’s last return for unrecovered basis. §72(b)(3).
If tax basis is recovered prior to death?
All subsequent proceeds are includible in gross income. Code
§72(b)(2).
What happens at death with a “term” annuity contract?
11