Presentation:
Federal Income Taxation
Chapter 20 Capital Losses
Professor Wells
November 17, 2015
1 Prior Related Transaction
Arrowsmith v. Commissioner
p.1147
Taxpayer liquidated a corporation.
Gain reported on stock redemption as capital gain.
Later taxpayer required to pay a judgment against the
corporation.
Payment treated as a capital loss, not as an ordinary and
necessary business expense.
Skelly Oil (page 700) in Note
2 Hypothetical: Sale of Business
FACTS: Seller sales a business for
$5 million in cash and has a basis of
$4 million. Assume only asset is a
§1231 asset that has $300,000 of
depreciation recapture.
1
Sell of Asset for $5 million
$5 million of cash
Seller
Buyer
QUESTION #1: What is the tax
consequence on the sale?
QUESTION #2: Now assume that
there was a defect in the equipment
and Seller must reimburse Buyer
$1.2 million for this undisclosed by
reason of the indemnity clause of
the purchase & sale agreement.
What result?
§1231 Asset
2
Reimbursement of $1.2 million
$1.2 million of cash
Seller
Buyer
3 Prior Related Transaction Supp. p. 94
Merchant National Bank v. Commissioner
Facts: The taxpayer bank held promissory notes for loans that
turned sour and wrote them off completely as ordinary losses in
1941 and 1943. It 1944 it sold the notes for $18,460.
Held: Ordinary income.
4 U.S. v. Skelly Oil
Supp. pp. 95-98
FACTS: Skelly sold natural gas at regulated price and claimed percentage
depletion on those sales of 27.5%. Skelly Oil had to repay a portion of these
proceeds ($505,536.54). Only $366,513.99 had been subject to tax in the
earlier year (i.e., $505,536.54 * 72.5%). Taxpayer claims a 100% deduction
on the $505,536.54 repayment while IRS claims that the repayment should
only give rise to a $366,513.99.
Holding: Deduction limited to only 72.5% of amount of repayment under tax
benefit rule principles, citing Arrowsmith.
5 Corn Products Case
(Overview of Hedging)
p.1150
Oil Commodity Swap
WTI Spot $80 today
±
Interest
Storage Cost
Fee
Corn Future
Corn
Price
A
±
$80
Commodity Swap
Fixed
B
(Derived by Interest, Storage, Fee)
Spot: $3.70 + (.02) storage + (.01) financing+ (.02) fee = Future Price
$3.75
6 Corn Products Case
p.1150
Were purchases and sales of corn
futures contracts capital asset
transactions?
Taxpayer says futures trading was
separate from its manufacturing
operations. And, therefore, capital
gains (and losses) from the futures
contracts.
Sup. Ct. says futures contracts are
equivalent to inventory and,
therefore, ordinary income (and
loss) realized
on disposition.
CBOT
CBOT
1
2
Grain
Elevator
Farmer
7 “Corn Products” Doctrine
Arkansas Best Case
p.1155
Issue: Was corporate stock a capital asset?
Facts: Taxpayer acquired stock in a Dallas bank. The stock was
sold at a loss after the bank became a problem bank (& ordinary
loss?).
Tax Court held the stock purchases during bank's “problem
phase” were made exclusively for business purposes.
Reversed by 8th Cir. and Supreme Court affirmed. Acquisition
purpose not deemed relevant.
8 Sequels to Arkansas Best
p. 641-642
No tax “common law” definition of a capital asset
(assumed after Corn Products case). But, a broad
construction of §1221(a)(1).
Regulatory response: Reg. §1.1221-2 which limits non
capital asset treatment to hedging transactions/ “risk
reduction.”
9 Changes to IRC §1221 (1999)
Exceptions to capital gains definition:
§1221(a)(6) – commodities derivative financial instruments
§1221(a)(7) – hedging transactions (timely identification
required)
§1221(a)(8) – supplies of a type consumed by the taxpayer in
ordinary course of business
(e.g., airlines purchase of fuel).
10