ii. Normally 3 years, unless
iii. TP under reports by > 25%, then is 6 years
iv. TP does not report or commits fraud, then
indefinite
D. Audits
i. 2-3% audit rate, but  for wealthy
ii. Correspondence: tell TP owes $
1. Has 30 days to respond
2. If don’t, send 90 day letter
iii. Office: bring records to IRS
1. Don’t give more than required
iv. Field: come to you and search records
E. Audit Appeal Process
i. Negotiate settlement price
ii. If can’t, IRS sends RAR. TP can…
1. Concede liab
2. Request admin appeal
iii. If TP does nothing, 90 day “ticket to tax court”
iv. If TP loses, may pay or appeal to COA
I. INTRODUCTION
1.
FIRST STEP W/ TAX PROBLEMS IS…
A. Understand the underlying action / occurrence
B. Tax problems make NO sense divorced from the
underlying action
C. Ask TP “how long has the property been held”
D. Determine:
i. Tax Rate
ii. Tax Liability
2.
WHERE DOES TAX LAW COME FROM?
A. Early Days
i. 16th Amd: “Congress shall have power to lay
taxes from whatever source derived”
ii. Tax Act of 1913: beginning of modern taxation
iii. WW I and II:
1. Expanded tax base
2. W/holding at the source
B. Tax Law Today
i. Congress - pass Tax Code, i.e. system of
taxation
1. Primary purpose - raise revenue
2. Secondary purpose - social and economic
policy
ii. Courts - interpret IRC w/ judicial gloss
1. Tax Court: deficiency cases; most
sophisticated on tax matters
2. Fed. Dist. Court: refund cases; jury trial
3. Appellate Courts:
a. 1st - Court of appeals
b. 2nd - SCOTUS
iii. Executive - Dep’t of Treasury
1. Issue regs, which clarify IRC, and are
binding unless overturned
iv. Admin - IRS
1. Rev. Rulings: fact patterns to provide
guidance
2. Rev. Proc: “line in the sand” litigation
tactic
3. Private Letter Rulings: TP asks question;
binding on specific TP
a. Attach to transaction, so w/draw if
getting negative feedback
3.
HOW DOES TAX LAW WORK?
A. Income Tax
i. Begin w/ total amt of income that will be taxed
ii. Logic
1. Fairness: based on ability to pay; spreads
burden
2. No federal property tax
B. Definitions
i. Income: anything subject to tax
ii. Amt. Realized: amt received in an exchange
iii. Basis: investment in property
iv. Gain: amount realized -- basis
C. SoL
i. Begins when return filed, unless TP gets
extension
4.
ACCOUNTING PRINCIPLES
A. Cash Method
i. Report income year received
B. Accrual Method
i. Report income year have right to receive
5.
TAX LIABILITY FORMULA
A. GI
i. Specific inclusions / exclusions listed in § 61
B. ATL Deductions
i. Listed in § 62, if not, bellow the line
ii. Most T or B types
C. AGI
i. GI minus ATL deductions
D. BTL Deductions
i. Most personal types
ii. § 63 gives standard deduction
iii. § 151 gives personal deduction
E. Taxable Income
i. AGI minus BTL deductions
F. Tax Rate
i. Provided in § 1
ii. Applied to ordinary income
iii. Applies to capital gains
II. GROSS INCOME - § 61
I.
INCOME DEFINED
A. § 61(a): “… all income, from whatever sourced
derived, including but not limited too…”
i. Items that  TP’s net worth
ii. May be realized in any form, whether $,
property, or services. § 1-61-1(a)
a. Services / property income = FMV
iii. Logic: difficulty of measurement should not
obscure fact of payment
B. Rev. Ruling 79-24: barter for services taxable GI
C. Imputed Income
i. Self performing services for self or
family/friends not GI
1
D. Bargain Purchase
i. Purchase for less than FMV
ii. Not taxable, unless compensation for services
iii. Then, FMV -- amt paid = GI. § 1.61(d)(2)(i)
E. Tax Benefit Rule
i. Mistaken assumption regarding tax benefit must
be corrected in 2nd year
II. CASE LAW
A. Glenshaw Glass - punitive TI - “touchstone” - three
prong test
i. Undeniable accession to wealth
ii. Clearly realized by TP (realization event?)
iii. TP has complete dominion (no restriction on
use)
B. Cesarini - treasure trove taxable when discovered
i. 1.61-14(a): clearly realized when reduced to
undisputed possession
C. Old Colony Trust - payment of tax liability is GI
i. Pyramiding required by regs
ii. § 1.61-14
D. McCann - compensation to e’ees in form of trip is
GI
i. § 1.61-2(a): bonus is GI
ii. Test: meaningful business component or 
productivity from e’ee
iii. GI = FMV of trip
E. Roco - qui tam damages GI
III. EFFECTS OF AN OBLIGATION TO REPAY - §
1341
I.
LOANS
A. NOT GI, although no specific code §
B. NO accession to wealth, b/c loan accompanied w/
equal and offsetting liability
i. Repayment not deductible
ii. Lender has no GI when loan repaid
C. Loan test
i. Unconditional obligation to repay
ii. Unconditional intention to secure repayment
D. Factors
i. Presence of debt instrument
ii. Collateral securing purported loan
iii. Interest accruing
iv. Repayments
v. Indicia of enforceable obligation to repay
II. CLAIM OF RIGHT DOCTRINE - § 1341
A. Issue: $ subject to contingent repayment obligation
GI?
B. Rule: If receive $ under claim of right w/out
restriction as to its disposition, must report as GI,
even if may be required to restore its equivalent
C. Ways Around Doctrine
i. Set $ aside and voluntarily don’t use
ii. Forced to not use $
iii. Put $ in separate account
D. § 1341 - if must repay, TP may take either deduction
or tax credit
i. Must be > $ 3K
ii. Deduction is f(x) of TR, so worth what it
saves TP from change in TR
iii. Credit is a $ for $ deduction
III. ILLEGAL INCOME
A. Illegally obtained funds ARE taxable
B. James - embezzled funds includable in GI
C. Rutkin - extorted funds includable in GI
D. Repayment may entitle TP to deduction
i. But … can’t use § 1341, b/c no
“unrestricted right to such item”
E. Innocent Spouse Rule
i. Understatement by one spouse
ii. Other has no reason to know
iii. Equities in favor of some relief
a. Lavish lifestyle?
b. Sophistication?
IV. DEPOSITS
A. § 1.61-8(b): advance rent is GI in year rec’d
regardless of period covered or acc’g method
B. Logic: income, b/c not due to offsetting obligation
V. CASE LAW
A. N.A. Oil
i. “Unfettered control”
ii. W/ § 1341, must use TR from earlier year in
calculating deduction
B. Indianapolis Power & Light Co.
i. $ from bad credit customers; not put in
separate account
ii. Arguments FOR GI - pre-payment for
services
iii. Arguments A/G GI - security deposit
iv. Held: not GI b/c no control and t/f no
complete dominion
C. Wetpac Foods - advance trade discounts
i. NOT GI, b/c must pay back if volume
commitment not met, t/f no accession
ii. Karns held opposite, so have circuit split
iii. But… service sided w/ Westpac
D. Millenbach - Oakland raiders sky boxes case
i. T.C.: Repayment obligation based on
contingency that never arose, t/f NOT GI
ii. A.C: discharge of indebtedness, t/f GI
IV. GAINS DERIVED FROM DEALINGS IN
PROPERTY - §§ 1001, 1011, 1012, & 1016
I.
OVERVIEW
A. TP usually has two “baskets”
i. OI
ii. CGs - includes certain gains from property
B. § 61(a)(3): “GI” includes “gains derived from
dealings in property”
C. § 1001(a): Gain = AR - AB
2
i. § 1001(b): AR = Sum of $ Rec’d + FMV of
Any Other Property Rec’d
ii. § 1011(a): AB = § 1012 Cost Adj. by § 1016
a. §1012: Basis = COST of property
b. § 1016: adjust basis for recovery or
add’l investment in the property, i.e…
1. Expenditures
2. Improvements
3. Deprecation
D. Recovery of Capital Concept
i. Right to recover tax-free your investment b/f
taxed on income from disposition of property
ii. Note: Acquisition debt included in TP’s
basis.
E. Realization Event
i. NO RE while property being held
ii. RE is property being transferred or sold
II. TAX COST BASIS
A. Issue: property given as compensation for services
i. Here, basis = FMV of services rendered
B. § 1.61-2(d)(2)(i): If property given by e’er to e’ee
as compensation for amt less than FMV…
i. GI = Amt paid for property - FMV at time of
transfer
ii. On later sale, basis = amt paid for property +
amt of such difference included in GI
III. LIABILITIES ASSUMED BY PURCHASER
A. Impact on Basis
i. Recourse liab incurred in acquisition are
included in basis of property
B. Impact on AR
i. Recourse liab of seller assumed by purchaser
are included in seller’s AR
IV. BASIS OF PROPERTY ACQUIRED IN TAXABLE
EXCHANGE
A. Rule: cost basis of property acquired = FMV of
property rec’d
i. § 1001: Gain = FMV + $ -- AB
B. Philadelphia Park - prop exchanged for prop
i. Taxed on difference b/t FMV rec’d and FMV
given (this is the gain)
ii. Logic: prevent TP from receiving stepped up
basis w/out paying tax
iii. If can’t valuate prop rec’d, court will assume
= to that of FMV given up
C. Questions to ask in determining tax liability w/ an
exchange of property
i. AR?
ii. AB?
iii. Taxable gain?
iv. Basis taken in new property acquired?
V. REFINANCING (Woodson)
A. Two components
i. Borrow $ to pay old debt to  interest rate
ii. Use $ for other purposes
B. Rule: borrowing NOT RE, so not taxed on gain
i. H/w, if $ spent on remodeling, etc., must
make § 1016 adj. to basis
C. Refinancing a property mortgage does NOT
change tax liability.
V. GIFTS, BEQUESTS, & INHERITANCES - §§ 102,
1041, 1015, 1014
I.
INTRODUCTION
A. §102 - GI does NOT include value of property
acquired by gift, bequest, devise, or inheritance
i. (b) NO exclusion for income generated by
property rec’d by such methods (i.e. rent)
a. Note: property value (apt) still excluded
ii. (c) E’er  e’ee gift is GI, unless substantially
attributed to family relationship
iii. Notes:
a. NO deduction for donor, unless to a
charity
b. Gift is NOT a RE
B. § 1041 - Transfer of Property b/t Spouses
i. Not gain
ii. No loss
iii. Basis transferred
II. GIFT DEFINED
A. Duberstien Test - given from a…
i. Detached / disinterested generosity out of…
ii. Affection, respect, admiration, charity, or like
impulses
iii. Dominant factor is transferor’s intent
B. Compensation v. Gift?
i. § 102(c) - must have family relationship
ii. § 274(b) - disallows deduction for gifts to
individuals > $25
a. Ex: ham’s for X-mas
C. Cases
i. Duberstein - Cadillac for providing business
contacts NOT gift
ii. Olk - casino worker’s tokens NOT gift
a. Test: transferee’s expectation (or that of
a R transferee)?
iii. Wolder - stock rec’d by attn’y in bequeath
NOT gift
a. Test: reason for transfer?
iv. Goodwin - annual congregation-wide payment
to pastor NOT gift
a. Factors:
1. Routine nature
2. Large amt compared to salary
3. Formality involved
4. Declared salary compared to FMV
of services
v. Theme: flavor of compensation?
III. BASIS OF PROPERTY RECEIVED
A. Gift of Appreciated Property (FMV > Basis)
i. § 1015: Donor’s basis  donee (defers tax
liab), w/ exceptions
3
(d) donee’s basis  by payment of gift
tax
B. Gifts of Depreciated Property (FMV < Basis)
i. If FMV < Basis, have exception to § 1015
a. Logic: income shifting o.k., but loss
shifting not o.k.
ii. § 1015 Special Loss Rule
a. If FMV @ DoG < Basis, on later
disposition, Basis = FMV @ DoG
iii. Significance:
a. If property has depreciated below basis,
do NOT gift it.
b. Rather, sell it, and gift the proceeds
c. Donor will at least get loss deduction
C. Bequests / Inheritances
i. § 1014(a): step  or  devisee’s basis to FMV
@ time of decedent’s death
a. Note: only appreciation after decedent’s
death will be taxed
ii. § 1022 changes rule after 2009
a. Lesser of donor’s basis or FMV @ DoD
iii. § 1014(e): Anti-Abuse Provision
a. Transfer to dying person
b. Bequest back w/in one year of death
c. Original owner takes original basis, NOT
FMV @ DoD
a.
IV. PART GIFT / PART SALE
A. Issue: sale of property for < FMV to family / friends
B. Seller / Donor Gain or Loss
i. Recognize gain to extent AR > AB
ii. NO loss recognized if AR > FMV
C. Buyer / Donee Basis
i. Greater of amount paid by buyer / donee or
seller / donor’s basis
D. Issue: NOT $ transaction, but assuming liability.
AR?
i. Except for discharge of indebtedness and
acquisition debt, AR includes liability of
transferor assumed by transferee
VI. SALE OF PRINCIPAL RESIDENCE - § 121
I.
INTRODUCTION
A. Policy: encourage home ownership
B. § 121 - Exclusion of Gain from Sale of PR
i. (a) GI shall NOT include gain from property
sale / exchange IF
a. During 5 years ending on date of sale /
exchange;
b. Property owned / used;
c. As TP’s principal residence;
d. For period aggregating 2 or more years
ii. (b) Exclusion shall NOT exceed
a. $250K for singles
b. $500K for joints, if certain requirements
met (see infra)
B.
C.
D.
E.
F.
G.
H.
TP receives mail
TP does his banking
Car registered/titled
TP is registered to vote
TP has his driver’s license
TP pays state taxes
Time spent at residence (most imp factor. Guinan)
III. OWNERSHIP AND USE REQUIREMENT
A. § 1.121-1(c) - Owning / Using at Different Times
i. O.k., so long as TP satisfies each w/in 5 year
period
ii. Short, temporary absences will be counted as
periods of use
a. Ex: vacations or seasonal absence
b. Not Ex: 1 year sabbatical
B. § 121(d) Special Sympathy Provisions
i. (2) If unmarried indiv disposes of property
after spouse’s death, indiv’s O&U period shall
include that of their deceased spouse
ii. (3) Property Owned by Spouse / Former
a. (A) If indiv receives prop from spouse,
indiv’s O&U period may include that of
spouse
b. (B) Indiv’s PR period continues while
former spouse granted U of prop
pursuant to divorce or separation
iii. (7) Out of Residence Care
a. If TP becomes physically / mentally
incapable of self-care, and
b. Owns and uses prop for 1 yr during 5 yr
period,
c. Prop treated as TP’s PR during period
he resides in a healthcare facility
IV. AMOUNTS EXCLUDABLE
A. (b)(2): Special Rules for Joint Returns - must meet
req. to exclude max of $500K
i. (1) One spouse satisfies O requirement;
ii. (2) Both satisfy U req. (marriage not req);
AND
iii. (3) Neither violates (b)(3)
a. If fail here, other spouse may exclude
max of 250K
iv. Note: MUST be married to use (b)(2)
B. (b)(3): only 1 sale / exchange every two years
C. (c) Safe Harbor Reduced Max Exclusion
i. Use where O&U or (b)(3) would have been
met but for change in…
a. Employment;
b. Health; OR
c. Unforeseen circumstances
ii. Max exclusion reduced by fraction of usual
limit, i.e. the shorter of…
a. (# of months of O&U / 2 years); OR
b. (“” since last exclusion / 2 years)
iii. Note: must be primary reason for sale /
exchange (factors in § 1.121-3(b))
II. PRINCIPAL (NOT PRIMARY) RESIDENCE?
A. Family location
4
VII. ANNUITIES, INSURANCE, & IRAS - §§ 72,
101, 219, & 408
I.
a.
C.
TAX-ADVANTAGED INVESTMENTS
A. Returns are excludable
B. Deferral of tax liability
i. TP can put $ in b/f taxes and end up w/ more $
ii. Interest earned is tax-free
II. ANNUITIES - § 72
A. Defined
i. Series of payments made over time in return
for later payout
ii. Tax free buildup, usually for retirement
iii. Taxed on w/drawal
B. (b)(1) Exclusion Ratio
i. Amt Rec’d as Annuity x (Investment in K /
Expected Return) = Amt Excluded
C. Payout for Indefinite Period (i.e., remainder of life)
i. (c)(3)(A): If payout depends on life
expectancy, use Table V
ii. Mortality Gains and Losses
a. (b)(2): If TP still living after full
investment recovered, further payments
taxable
b. (b)(3): If TP dies b/f fully recovering
investment, unrecovered investment
deductible for last tax year
iii. If payout based on LE of two people, use
longer of two
D. (q) Early W/drawal Penalty
i. 10% penalty for early w/drawals
ii. Exception where pmts…
a. Made after TP turns 59 ½
b. Made after death of the holder
c. Taken b/c of disability
iii. Policy: encourage retirement savings
E. Tax Advantages
i. During pay-in years, premiums are earning
investment income tax-free (inside tax-free
buildup)
ii. Additional tax deferral on payout
III. INSURANCE - § 101
A. Definitions
i. Beneficiary: person who will receive policy’s
proceeds on death of insured
ii. Insured: person whose life measures the policy
iii. Owner: policy purchaser
iv. Key-Man Policy: bought by e’er on e’ee’s life
to protect business if person dies
B. § 101 - Certain Death Benefits
i. (a)(1) Amts rec’d under LI K NOT GI, if paid
by reason of the insured’s death.
ii. (g)(1)(A) Terminal Illness
a. Early pmts made to insured not expected
to live > 24 months NOT GI
iii. (d) Pmts Made After Death (installments)
D.
E.
F.
G.
H.
I.
Post death earnings (interest) on LI
proceeds ARE GI
Three Categories of Insurance
i. Term: no value built up, make bet w/ ins. co.,
if die during term you win (risk only)
a. Can NOT deduct premiums
b. If cancel, get back unearned premiums
only (no inside buildup)
ii. Whole/Ordinary: pure risk and savings
component
a. Fixed premium; renewable year-to-year;
inside tax-free buildup
b. At payout, get Cash Surrender Value, i.e.
Savings + Investment Return - Fee
c. If cash-in early, Gain = Cash Surrender
Value - Total Premiums Paid (unlikely)
iii. Modified: huge savings, tinny risk component
a. Primarily investment, not LI vehicle
b. If savings % too high, plan divided into...
1. LI component
2. Investment component - taxed
annually on inside build-up, no
deferral
Payable to Lender
i. Remaining spouse will NOT have any GI even
though inherits spouse’s portion debt-free
ii. Lender does NOT have any GI since $ used to
pay loan
Consequences of Ending Policy
i. Death - o.k. (see supra)
ii. Cancellation
a. Term: get unused portion of premium
back; NOT GI
b. Whole: get cash surrender value; GI
1. Better tax consequences than
typical investment
Delayed Payouts
i. Logic: beneficiary is minor, should save $ for
college or until mature
Insurable Interest
i. Policy: prevent abuse; must have an interest in
keeping someone alive
a. Ex: close family member or business
partner
How to Obtain Policy
i. Buy it yourself
ii. Have existing policy transferred
iii. Makes difference, b/c tax benefits do NOT
transfer w/ policies
(a)(2) Transfer for Value
i. May exclude only…
a. Price paid; AND
b. Any premiums later paid
ii. Remaining face amt included in GI
iii. Exceptions: transfer for value to…
a. The insured
b. Partner of the insured
c. Partnership in which insured is a partner
d. Corporation in which insured is a SH or
officer
5
e.
Theme: beneficiaries or have insurable
interest
IV. INDIVIDUAL RETIREMENT ACCOUNT (IRA) - §§
219 & 408
A. Introduction
i. Max deductible amt is $5K, except for TP’s
over 50, whereby its $6K. § 219(b)(1)
a. Accounts - § 408(a)
b. Annuities - § 408(b)
ii. Tax free-build up
B. Non-Deductible IRA - no deduction when add $
i. Earn $  taxed  put $ in IRA, inside tax
free BU till retire  payout taxed (§ 72)
ii. Least advantageous: no upfront deduction;
taxed on dispersement
iii. Benefit: Inside tax-free buildup
iv. Penalty for early w/drawal
a. Policy: encourage retirement savings
C. Deductible IRA
i. Earn $  NOT taxed  put $ in IRA, inside
tax free BU till retire  payout taxed (§ 72)
ii. Advantages: upfront deduction; pre-tax $
investment
iii. Taxed on full amt b/c never taxed due to initial
deduction
D. Roth IRA
i. Earn $  taxed  put $ in IRA, inside tax
free BU till retire  payout NOT taxed
ii. Advantage: tax free dispersement; flexible
rules on contribution and w/drawal
E. Deductible vs. Roth IRA
i. NO difference if TR level over time
ii. But, if TR , Roth IRA better
iii. If TR , Deductible IRA better
iv. Important questions
a. Does TP have a spouse?
b. Is TP covered by an e’er plan?
c. How much total income does TP make?
VIII. RELIEF OF INDEBTEDNESS - § 108
I.
INTRODUCTION
A. Under § 61(a)(12), RoI IS GI
B. Views
i. Traditional: RoI provides taxable benefit
ii. Accounting Fix: only taxable where debt was
obligation expected to repay
C. Other Issues
i. Contingent debt: only considered liab if “more
likely than not” will have to repay
ii. Discharge by employer: likely compensation
and t/f GI
iii. Gift: if qualify under § 102 and Duberstein,
NOT GI
D. Provision Map
i. Sympathy
ii. Technical (looks like, but not)
iii. Anti-abuse (sneaky TPs)
iv. Non-interference (leave market alone)
E. Analysis Framework
i. Does TP have RoI income?
ii. Is there an exception allowing exclusion?
II. DOES TP HAVE RoI INCOME?
A. Disputed Debt
i. NO RoI income if amt was never certain
ii. Note: unenforceable debt may still give rise to
RoI income (95% of illegal debts are enforced)
B. Disputed Price Doctrine
i. FMV disputed b/c defects in prop not
discovered until after sale
ii. § 108(e)(5): purchase price reduction NOT GI
C. Yr debt relief occurs is yr it is included
III. IS THERE AN EXCEPTION ALLOWING
EXCLUSION?
A. Sympathy Provisions
i. (a)(1)(A) - Bankruptcy
ii. (a)(1)(B) - Insolvency
a. Not permanent exclusion, only deferral
b. Limited to amount liab > assets
c. Exclusion TP’s basis in prop. (b)(1)
B. Technical
i. (e)(2) - NO GI for item that would have
generated deduction, e.g. business XP
ii. (e)(5) - Purchase Price Reduction
a. Must  TP’s basis
b. Must be b/t same buyer and seller, i.e.
does not apply if 3rd party  debt
C. Non-Interference
i. (a)(1)(D): PPA where debt acquired for
business purpose
a. Where debt relieved by person holding
note, NOT GI
b. Use where (e)(5) would not work b/c
have new parties
D. Anti-Abuse
i. (e)(4): debt acquisition by related party
a. If person related to debtor acquires debt,
treat as acquisition by debtor and t/f GI
b. Also applies to majority SHs and corps
c. Prevents circumventing RoI by a parent
acquiring debt and “gifting” it to child
IV. TWO CATEGORIES OF DEBT
A. Recourse
i. Lender may obtain collateral and other prop
ii. If forgiven, RoI income
B. Non-Recourse
i. Lender may obtain collateral only
ii. Always secured
iii. Collateral fully satisfies debt, so NO GI
V. DECISION TREE
A. Is there a RoI?
i. Gift or sale, then NO
ii. If YES…
B. Does § 108 exclusion apply?
6
i. If NO, its GI
ii. If YES…
a. How much excluded under § 108(a)(3)?
b. What are the tax consequences under §
108(b)(2)(E)?
IX. COMPENSATION FOR PERSONAL INJURY &
SICKNESS - §§ 104, 105, & 106
I.
INTRODUCTION
A. First question - are damages for…
i. Business / property; OR
ii. Personal injury
B. Categories
i. Business/K cases
ii. Property
iii. Personal injury (§ 104) - tort / tort type injury
a. Physical - compensatory and punitive
b. Non-physical
C. Jury instructions
i. Favorable / unfavorable to let know award is
taxable / not-taxable
II. BUSINESS / K / ECONOMIC DAMAGES
A. Ask: “in lieu of what were the damages awarded”
Raytheon
B. Examples
i. Damages b/c of lost salary are in lieu of salary
and t/f GI
ii. “” profits are in lieu of profits and t/f GI
III. PROPERTY DAMAGES
A. Ask for…
i. FMV of destroyed property
ii. Lost profits, if commercial property
iii. Perhaps, rent for temporary workspace
B. Test - Involuntary Disposition
i. If forced to sale b/c property destroyed 
ii. Reinvest $ 
iii. Then … tax deferred
IV. PERSONAL INJURY DAMAGES
A. Physical (must be physical to use § 104)
i. Ex: P&S, lost income, loss of consortium,
medical expenses
ii. § 104(a)(2): GI does NOT include amts rec’d
on account of personal injury or sickness
a. Ex: in car accident, damage to car NOT
w/in § 104
b. Note: “on account of” is judicial gloss
from Schlier latter added to statute
iii. If TP previously deducted medical XP under §
213, NOT excludable. § 104(a)
B. Non-Physical
i. If NO physical injury, ALL damages included
in GI.
ii. Examples
a. ED damages are GI
b.
Sexual harassment damages w/ no
physical injury are GI
c. Damages to auto are GI
iii. Issue: non-physical w/ physical manifestations
a. Test - whether origin of claim lies in
physical injury
V. AWARDS
A. Personal Injury Requirements
i. Tort or tort type
ii. On account of physical injury, i.e. actual
compensation for physical injury
iii. Damage award must bear close nexus to the
injury, otherwise, GI
a. Injury justifies the damages
b. Intended to compensate
c. Causal link
B. Only ask “in lieu of what” in business and property
damage cases
VI. SETTLEMENTS
A. If settlement structured so that all damages allocated
to non-taxable areas, IRS will closely scrutinize
i. What portion of settlement was made at arm’s
length?
ii. Look at pleadings, etc.
VII. PAYMENTS FOR INSURANCE COVERAGE
A. First, determine whether policy is…
i. Self-provided; OR
ii. Employer provided
B. Self-Provided
i. Obviously, NOT GI
ii. NOT deductible, usually
C. Employer-Provided
i. Purchased: NOT GI for e’ees, b/c gov’t wants
to encourage such coverage. § 106(a)
ii. Self-Insured: e’er doesn’t purchase policy, but
tells e’ee will cover their expenses if arise
a. No specific exclusion or grant in § 106
b. NOT GI
VIII. PAYMENTS FOR INSURANCE CLAIMS
A. Self-Provided
i. § 104(a)(3): fully excludes amts from accident
or health insurance plans, unless e’er provided
ii. (a)(1): excludes worker’s comp payments
B. Employer-Provided
i. § 105(a): amts rec’d through e’er provided plan
ARE GI, unless already included in e’ee’s GI
ii. Exceptions
a. (b): amts for medical care
b. (c)(1): permanent loss or loss of use of a
member … or permanent disfigurement
iii. If total amt rec’d > total costs, must include
difference in GI
iv. (h): w/ self-insured, must cover enough e’ees
and not discriminate in favor of highly
compensated
a. Penalty: lose tax-exempt status
7
C. Difference b/t Self & E’er Provided
i. Pmts rec’d for time off ARE included in GI if
e’er provided
ii. But … if self-provided, NOT GI
D. Combination Plans
i. If covered by both self and e’er provided,
allocate $ rec’d accordingly
IX. NON-PHYSICAL INJURY & ATTORNEY’S FEES
A. § 212(1) allows deduction for attn’y fees as PoI
B. § 67 treats as misc. ID subject to 2% floor, thereby
disallowed in determining AMT applicability
i. AMT: prevents aggregation of deductions to
point of paying no or shockingly no tax
ii. TP must compare reg and TMT, pay higher
iii. TP loses deduction and pays higher tax
C. §62(a)(20): fixes problem by making deduction ATL,
but must be discrimination suit
INTRODUCTION TO DEDUCTIONS
I.
DEDUCTION ANALYSIS
A. Do I have expense (outflow)?
B. Is that expense deductible (need specific §)?
i. T or B
ii. PoI
iii. Personal
C. Any general / specific limits?
i. Total amount
ii. Timing
iii. Criminality - bribes, kickbacks, narcotics
D. ATL or BTL?
i. § 62 gives ATL; if not here, BTL
ii. Must apply §§ 67-68 AMT to BTL
II. TAXABLE INCOME - § 63
A. Allows TP to take either…
i. Itemized Deduction
ii. Standard Deduction
B. Calculate, take greater of, and subtract from AGI to
get TI.
III. “HATS” OF TAXPAYER
A. Trade or Business - §§ 162-166 - generally
deductible
B. Production of Income / Investor Persona -§ 212 more limits than T or B
C. Personal / Family Persona - § 262 - generally, NOT
deductible
X. BUSINESS & PROFIT-SEEKING EXPENSES - §§
162, 195, & 212
I.
INTRODUCTION
A. Logic: NI, rather than GI (Sales - COGS), should be
taxed
B. § 162, AKA, the “Work Horse §” Requirements:
i. Ordinary and Necessary
ii. Expense
iii. Paid or incurred during tax year
iv. While carrying on
v. T or B
II. ELEMENTS OF § 162 DEDUCTION
A. Ordinary - occurs normally in T or B
i. Welch - customary or expected during B’s life
ii. Jenkins - two part test:
a. TP’s purpose or motive in pmts;
b. Sufficient nexus b/t pmts and T or B;
iii. Dupont - may be ordinary and occur only once
B. Necessary - appropriate and helpful (lower std)
i. Primarily for SH or B?
ii. Issue: R-ness of salaries in family business
a. Test - independent investor
iii. Note: § 162(e) excluded deduction for
lobbying XP
iv. Logic: autonomy in business decision making
C. Expense - used up or consumed in current tax year
i. If benefit multiple years, must treat as capital
expenditure
D. Pd or incurred during tax year
i. Cash method: deduction recognized on
payment
ii. Accrual “”: “” recognized on obligation to pay
E. Carrying on - “doors are open”
i. Issue: job hunting XP deductible?
a. If new T or B, NO
b. If same T or B, YES - BTL
ii. Allowed 1 year of unemployment and still be
carrying on T or B; or show intent to resume
F. T or B - selling product / services w/ intent to profit
i. Groetzinger - continuity and regularity;
primary purpose is income or profit
ii. Higgins - holding one’s self out as selling
goods / services
a. Not Ex: managing own investments
(hence, § 212 enacted)
iii. § 1.183-2(a): “for profit” factors
III. LOSS OF PROPERTY VALUE - § 165
A. Ex: toxic dump moves in next to business
B. NOT deductible until have RE
C. NOT deductible for personal / family XP
IV. START-UP EXPENSES - § 195
A. May amortize over 180 months (5 years)
i. Policy: help small-businesses survive
B. Deduct up to $5K in first year, reduced by amt
expenses > $50K
C. Remainder amortized over 180 months
V. PRODUCTION OF INCOME - § 212
A. O & N expenses of…
i. Producing or collecting income;
ii. Mgmt, conservation, or mtnc of prop held for
PoI;
iii. Determining, collecting, or refunding any tax
B. Factors
i. Amt of activity
8
ii. Regularity “”
iii. Continuity “”
iv. % of income
C. BTL
D. § 1.212(e) - NO deduction for XP allocable to tax
exempt income
VI. CLOTHING
A. Three part test (Donnelly / Pevsner) - clothing is…
i. Required as condition of employment;
ii. Not adaptable to general usage;
iii. Not so worn
B. Objective, b/c subjective would be inconsistent
XI. TRAVEL EXPENSES - §§ 162(A) & 274
I.
INTRODUCTION
A. Line drawing exercise
B. Recall § 262, i.e. NO deduction for personal, living,
or family expenses
II. COMMUTING
A. § 1.262-1(b)(5): NOT deductible, b/c personal in
nature (personal decision to live far away)
B. Flowers test - to be deductible, travel XP must be …
i. R and necessary;
ii. Incurred while away from home; AND
iii. “” in pursuit of business
C. Hypos:
i. If work two jobs at diff locals, travel b/t
deductible, travel home NOT
ii. If on duty while driving to work, deductible
III. OTHER TRANSPORTATION EXPENSES
A. PPB is residence, travel to see clients deductible. §
162(a)(2)
B. Mixed Business / Personal - § 1.162-2(b)(1)
i. Primary purpose B: B related XP deductible
ii. Primary purpose personal: only XP related to
B deductible, travel NOT
C. § 274(m) - Limitations
i. (1) Luxury water transportation NOT
deductible
ii. (2) travel as education NOT deducible
IV. EXPENSES FOR MEAL & LODGING WHILE
TRAVELING
A. Two Classes
i. § 162 T or B
ii. § 274 B / Entertainment (see supra)
B. § 162(a)(2) - deductible as part of travel XP if…
i. NOT lavish or extravagant under circum;
ii. Away from home;
iii. In pursuit of business
C. § 274(n) - meal deduction limited to 50% of cost
D. Correll Sleep/Rest Rule - must be away from home
long enough so that sleep / rest required
V. “AWAY FROM HOME”
A. “Home” means TP’s principal place of business.
B. Factors:
i. Time spent @ each local;
ii. Business activity generated “”;
iii. Relative TI derived “”;
C. Henderson - no tax home, NO travel XP deduction
D. Temporary Worksites
i. Typically, deductible
ii. § 162(a): NOT temporarily away from home if
period > one year
VI. TRAVEL EXPENSES OF SPOUSE, DEPENDENTS,
ETC.
A. Severe restriction
B. § 274(m)(3) - NOT deductible, UNLESS indiv:
i. Is e’ee of TP;
ii. Serves bona fide business purpose; AND
iii. Could otherwise deduct XP
VII. REIMBURSED EMPLOYEE EXPENSES
A. To deduct ATL, e’er must satisfy § 62(c), i.e…
i. (1) Plan requires e’ee to substantiate XP; OR
ii. (2) NOT allow e’ee to retain excess
reimbursement
B. If unreimbursed or don’t meet § 62(c), BTL
C. Accountable Plans - EXCLUDED from GI
i. Meet above, and additional factor…
ii. B connection: reimbursements, etc. for
deductible B XP only
VIII.
LIMITATIONS ON FOREIGN TRAVEL
A. § 274(h)(1): factors to determine R-ness of meeting,
seminar, or convention held outside U.S.
i. If NOT R, NOT deductible
B. § 274(c): foreign travel limits
IX. RELATIONSHIP TO § 212
A. Issue: XP incurred in § 212 PoI activity NOT rising
to level of T or B.
B. § 274(c) & (d): allow deduction for § 212 XP,
subject to § 162 rules
C. But … § 274(h)(7) denies deduction for § 212 XP
for convention, seminar, or similar meeting.
X. SUBSTANTIATION REQUIREMENT
A. § 274(d): TP must substantiate w/ adequate records
or sufficient evidence.
B. § 1.274-5(c)(3): NOT required for XP < $75
XII. ENTERTAINMENT & BUSINESS MEALS - § 274
I.
INTRODUCTION
A. Necessary “social lubricant”
B. Moss - firm lunches
i. NOT deductible, b/c personal in nature
ii. Economic argument: personal v. B utility
C. Meal XP must satisfy § 274(k)(1)…
i. NOT lavish / extravagant under circum; AND
ii. TP present
II. ENTERTAINMENT EXPENSES
9
A. To deduct, entertainment, amusement, or recreation
XP must satisfy § 162 AND § 274(a)(1)(A)
i. Directly Related Test; OR
ii. Associated w/ Test - follows substantial, BF
business discussion
B. Directly Related (to active conduct of T or B) - strict
- § 1.274-2(c)
i. More than general expectation of deriving
income or B
ii. TP actively engaged in BF business meeting
a. Substantial distractions?
iii. Principal character of entertainment is T or B
iv. XP allocable to TP and others actively
engaged in T or B conduct
C. Associated w/ - loose - clear business purpose
i. XP directly preceded or followed by
substantial and BF B discussion
D. Limitations
i. (a)(1)(B): NO deduction for entertainment
facilities
ii. (a)(3): NO deduction for club dues, unless
used primarily for BP, then only to that extent
iii. (n): may only deduct 50% of XP
E. Note: only FV of ticket deductible; scalper’s fee not
III. BUSINESS MEALS
A. Safe Harbor - § 162(a)(2)
i. Ones meals while away from home on T or B
ARE deductible
B. Rev. Ruling
i. Can NOT deduct portion of meal cost not
exceeding amt would normally spend anyway
IV. SUBSTANTIATION REQUIREMENT - § 274(d)
A. Adequate records or sufficient evidence
corroborating…
i. (A) Amt of XP;
ii. (B) Time and place incurred;
iii. (C) Business purpose;
iv. (D) Business relationship of TP and
entertained
B. Recall < $75 exception
V. ANALYSIS FRAMEWORK
A. Does TP meet § 162?
i. Moss: furtherance of T or B
ii. If personal, stop here
B. Is XP for entertainment?
i. If YES, § 274 triggered
C. Is § 274(a)(1)(A) satisfied?
i. Directly related
ii. Assoc. w/
D. Amt deductible?
i. § 274(n) 50% limit
XIII. CAPITAL EXPENDITURES - § 263
I.
INTRODUCTION
A. § 263 denies deduction for capital expenditures
B. Zinnovich Definition
i. Provide substantial benefit significantly
beyond current tax year; OR
ii. Significantly extend asset’s life
C. Lincoln Savings
i. Anything creating separate / distinct asset
ii. Acquisition costs: part of property’s basis
D. Note: may be entitled to depreciation deduction
under §§ 167 / 168
E. Two Categories
i. Purchased (§ 263)
ii. Self-Constructed (§ 263A)
II. CAPITAL EXPENDITURES (PURCHASED) - § 263
A. (a) NO current deduction for…
i. Cost of new buildings;
ii. Permanent improvements;
iii. Betterments  value of property; OR
iv. Restoration costs for which allowance made
B. § 1.263(a)-1(b) - disallowance applies to
expenditures…
i. Adding value to property;
ii. Substantially prolonging UL of property;
iii. Adapting property to different use;
iv. But … NOT incidental repair and mtnc
C. For these, MUST capitalize
i. Matching income and related XP
ii. Costs become part of basis!
III. SELF-CONSTRUCTED ASSETS - “WIDE NET”
A. Idaho Power - must include ALL costs, i.e…
i. Design Phase
ii. Direct (materials, labor, etc.)
iii. Indirect (admin, OH)
iv. Use of equipment
B. § 263A - Idaho Power, w/ limits - must capitalize…
i. Direct and indirect costs, including certain
interest
ii. Incurred by TP’s who
a. Manuf, construct, or produce real /
tangible personal property; OR
b. Acquire or hold inventory for resale
IV. IMPROVEMENT OR MAINTENANCE / REPAIR?
A. Repairs currently deductible under § 162,
improvements NOT
B. Midland Empire Packing - w/ repair, UL and value
do NOT 
C. Mount Morris
i. Old building, likely repair
ii. Foreseeable, likely improvement
iii. Create something new, likely improvement
iv. Bettered for intended use, improvement
v. O & N, repair
D. Catastrophic Events
i. If made same as b/f, repair
ii. If better, improvement
E. Revenue Ruling 2001-4, p. 305
F. Should changes made due to new building code be
deductible?
V. § 162, NOT § 263 (COMMON MIX-UPS)
10
A. E’ee training XP
B. Advertising XP
C. Attny’s fees NOT relating to acquiring, perfecting,
or defending title
D. Capital XP < $5K
VI. DEPRECIATION PREVIEW - §§ 167 & 168
A. Depreciable Property
i. Will undergo wear and tear;
ii. Become obsolete; OR
iii. Time will render useless
B. § 1016 - adjust basis  when record depreciation
XIII. DEPRECIATION - §§ 167, 168
I.
INTRODUCTION
A. Deduct costs of generating income, i.e. recover of
capital b/f disposition
i. Logic: allocate XP of asset’s use to period
benefited by such
B. Must Determine
i. Is property depreciable?
ii. What is the recovery period?
iii. What depreciation method applies?
iv. What is the applicable convention?
II. DEPRECIABLE PROPERTY
A. § 167 - R allowance for exhaustion, wear and tear
(including obsolescence) of depreciable property…
i. Right asset (suffers wear and tear);
ii. Used either…
a. In T or B; OR
b. For PoI
iii. TP suffers the loss
B. If does NOT decline in value predictably, NOT
depreciable (land, stock, artwork)
C. Note: PR NOT depreciable
III. RECOVERY PERIOD
A. Depreciation recognized over asset’s UL
B. In 1986, Congress passed MACRS
i. De-emphasized UL concept
ii. § 168(i): defines “class life” as mid-point life
in ADR
iii. § 168(e): classifies property by class life…
a. Non-residential real prop = 39.5 years
b. Residential real prop = 27.5 years
c. Race horses, rent to own prop = 3 years
d. Autos, computers, trucks, copiers = 5
years
e. Catch-all (furniture, fixtures, and equip)
= 7 years
IV. DEPRECIATION METHODS
A. Straight Line - simplest
i. Asset’s Cost or Basis / Recovery Period =
Annual Depreciation Allowance
ii. § 168(b)(3): use SL for residential rental and
non-residential real property
B. Accelerated - “front loaded”
i. Declining Balance (150%)
a. 15 and 20 year property used in farming
ii. Double Declining Balance (200%)
a. 3, 5, and 7 year property
b. § 168(b)(1)(B): switch to SL when
becomes more advantageous
C. Conventions - assumption of when property placed
in service
i. Determines when recovery period begins
a. RE = mid-month (15th)
b. Non-RE = mid-year (July 1st)
ii. “Placed in service”, i.e. placed in…
a. Condition or state of readiness
b. Available for assigned function
iii. § 168(d)(3) Anti-Abuse Provision: apply midquarter convention where…
a. Prop PIS during last 3 months of year
b. Prop’s bases > 40% of aggregate bases of
ALL prop PIS that year
V. COMPUTING THE DEPRECIATION DEDUCTION
A. § 168(a): depreciation of tangible property
determined w/…
i. (1) Applicable depreciation method;
ii. (2) “” recover period; AND
iii. (3) “” convention.
B. Steps
i. What is AB?
ii. What is appropriate recovery period?
a. (e)(3) classifies property
b. (c)(1) gives applicable recovery period
iii. What is applicable depreciation method?
a. (b)(1) gives method
b. (d)(1) give convention
iv. What is the depreciation rate?
a. Rev. Proc. 87-57
b. Note: uses unadjusted basis for yr-to-yr
computation
VI. EXPENSING TANGIBLE PERSONAL PROPERTY §§179 & 168(k)
A. § 179: May expense (currently deduct) cost of
depreciable tangible personal prop bought for use in
active conduct of T or B
i. Economic stimulant - get business spending
ii. Limited to 500K
B. § 168(k): allows deduction of ½ cost of asset in first
year,  basis by that amount
C. Issue: is this interference w/ free-market economy
D. Methodology
i. Expense up to § 179 limit
ii. § 168(k) deduct ½ remaining basis,  basis by
that amount
iii. Take regular § 168(a) depreciation deduction
from remaining basis
VII. AMORTIZATION OF INTANGIBLES - § 197
A. Amortization - SL depreciation over UL for
intangibles
B. § 167
11
i. May amortize intangible asset w/ limited UL
w/out regard to salvage value
ii. If can’t estimate UL, may use 15 year catchall
C. §197
i. Allows amortization at 15 year SL rate for
GW, covenants not to compete, etc.
ii. See in sale of business
VIII.
A.
B.
C.
D.
2.
B.
CASES /REVENUE RULINGS
Revenue Ruling 68-232
Simon v. Commissioner
Liddle v. Commissioner
Revenue Ruling 89-25
C.
XIV. LOSSES & BAD DEBTS - §§ 165 & 166
I.
II.
LOSSES - § 165
A. § 165(a): deduction for any uncompensated loss
sustained during tax year not compensated by
insurance or otherwise
B. § 165(c): for indiv, deduction limited too…
i. (1) T or B;
ii. (2) Transaction for profit, not incurred in T or
B;
iii. (3) Casualty or theft losses
C. B or Profit Requirement
i. Separate B / Profit from Personal
1. T or B  ATL
2. Profit  BTL
3. Personal  NO Deduction
ii. Remember, must have RE to deduct loss…
D. When is Loss Sustained?
i. § 1.165-1(b): evidenced by closed / completed
transactions, fixed by identifiable events,
sustained during tax year
1. NOT mere  in value
ii. § 165(g)(1): securities loss allowed when
become worthless, w/ no hope of recovery
1. § 6511(d): provides 7 year SoL, to
prevent arguments over when worthless
E. Amount of the Deduction
i. § 165(b): limited to AB
ii. § 165(a): deduction  by insurance or other
compensation
iii. If R prospect of recovery, NO loss until matter
of reimbursement known w/ R certainty
BAD DEBTS - § 166
A. Introduction
i. § 166: deduction for debts becoming worthless
during tax year for indiv and corps
ii. Dividing Line: B (a) v. Non-B (d)
1. B  deductible a/g OI; wholly or
partially worthless
2. Non-B  deductible as STCL; MUST
be wholly worthless
iii. Accounting method important…
1. Accrual: GI from A/R included on return
for year claiming deduction
D.
E.
F.
III.
Cash: likely, NO BD deduction
a. When debt worthless, can take
deduction
Bona Fide Debt Requirement
i. § 1.166-1(c): D / C relationship based on valid,
enforceable obligation to pay fixed or
determinable sum of $
ii. Required for § 166 applicability
iii. When relationship close, have rebuttable
presumption of gift.
Worthlessness
i. Required for § 166 applicability
ii. Cancelled debt may be gift and NOT worthless
iii. But… cancelled B debt may meet § 162 and be
deductible, regardless of worthlessness
Business v. Non-Business Debts
i. Business Debts
1. (a)(1) Totally worthless  deduct year
became so
2. (a)(2) Partially  deduct amt charged
off during year
ii. (d) Non-Business Debts: debt other than…
1. (2)(A) Created / acquired in TP’s T or B;
2. (2)(B) Debt loss from worthlessness of
which is incurred in TP’s T or B
Amount Deductible = AB
Guarantees
INTERPLAY B/T §§165 & 166
A. Sometimes, may use one but not other, or one is
better
B. Note: so long as BF, personal debts deductible
C. If both apply, §166 followed
XV. CASUALTY LOSSES - § 165
I.
II.
INTRODUCTION
A. Casualty losses diff from life’s ordinary losses and
XP, and sufficiently related to wealth / ability to pay
B. § 165(c)(3) - deduction for uncompensated casualty
and theft losses unconnected w/…
i. T or B; OR
ii. Transaction entered into for profit
C. § 165(h) Casualty Loss Limits
i. (1) Each loss event first subject to $100 nondeductible floor
ii. (2) Net casualty loss allowed only to extend
exceeds 10% of AGI
DEFINITIONAL QUESTIONS
A. Casualty Loss
i. Rev. Ruling 72-592
1. “Fire, storm, or shipwreck” type
2. “Identifiable event of a sudden,
unexpected, and unusual nature”
ii. § 1.165-7(a)(3): NO deduction for loss from
“willful act or N”
iii. Physical damage/ force has been required
B. Theft Losses
12
i. § 1.165-8(d): included, but not limited to,
larceny, embezzlement, and robbery
ii. Must prove theft occurred, mysterious
disappearance NOT enough
III.
IV.
V.
B. § 221: Qualified Education Loan
i. Interest on loans for higher education expense
deductible
ii. Interest on indebtedness owed to person
related to TP NOT deductible
iii. $2.5K max, phased out if modified AGI b/t
$50K and $65K
TIMING OF LOSS
A. Casualty - deductible year sustained. § 165(a)
B. Theft - deductible year discovered. § 165(e)
AMOUNT OF LOSS
A. Casualty
i. § 1.165-7(b)(1): LESSER of:
1.  in value; OR
2. AB
ii. See infra § 165(h) limits
iii. (h)(2)(B): Personal Casualty Gains
1. Treated as CGs
2. But, § 1231 gives special trtmt, so that
generally characterized as ordinary
B. Theft
i. § 1.165-8(c): lesser of basis or value; value
presumed zero
ii. $100 floor applies, but NOT 10% AGI
restriction
IV.
INVESTMENT INTEREST - § 163(d)
A. General Rule - Unless meet T or B, must be
generating income to take deduction.
B. (1) - Max deduction = Net Investment Income (Inv.
Inc. - Inv. XP)
C. (2) - May carry forward indefinitely to match
deduction w/ income.
V.
QUALIFIED RESIDENCE - § 163(h)(3)
A. Test - cooking and bathing facilities?
B. (A) Max deduction of…
i. Interest on $1 million of debt + $100K of
home equity debt
ii. Equity = FMV - Amt Owed from Acquisition
Debt
VI.
TIMING ISSUES / LIMITATIONS - § 461(g)
A. (1) $ method TP may not currently deduct int to
compensate for use / forbearance in future yrs
i. Must amortize
ii. Only interest XP relating to current year
deductible
B. (2) Exception…
i. Qualifying points (pre-paid int) paid in
connection purchase or improvement of, and
secured by, TP’s PR
ii. Huntsman Test: debt must have association /
relation w/ purchase of TP’s residence
INSURANCE COVERAGE
A. § 165(h)(5)(E): must file timely insurance claim to
deduct, if have coverage
B. But, NOT required to obtain insurance to begin w/
XVI. THE INTEREST DEDUCTION - § 163
I.
II.
III.
ANALYSIS FRAMEWORK
A. TP entitled to deduction under § 163?
i. (a): all interest paid or accrued w/in tax year
on indebtedness
B. What limitations apply? (h)(2) disallows deduction
of personal interest other than…
i. (A) Interest paid for T or B;
ii. (B) Investment interest;
iii. (D) Qualified residence interest (PR + 1
other);
iv. (F) Interest on educational loans
C. Any amount limits?
i. T or B
ii. PoI interest: timing
iii. Qualified residence: interest on $1 million of
debt + $100K home equity debt
WHAT IS INTEREST?
A. Rev. Ruling 69-188
i. True debt; payment for forbearance of $
ii. Incidental to legally enforceable obligation
iii. NOT fees related to borrower’s acct
B. T or B interest deductible under § 162, even w/out §
165
DEDUCTION OF PERSONAL INTEREST
A. Policy: eliminate significant savings disincentive
XVII. CAPITAL GAINS - §§ 1(H), 1221(A), 1222
I.
INTRODUCTION
A. Basic Idea - give preferential §1(h) rates to LTCGs
B. Policy - time restriction creates lock-in effect;
attempt at stabilizing market
II.
CURRENT LAW - § 1(h)
A. 28% - primarily collectibles
i. Ex: antiques, rugs, coin collections, etc.
B. 25% - depreciation recapture on RE
i. Buy building 500K  depreciates 50K  sale
for 500K. 50K gain taxed at CG rate, rather
than OI rate.
ii. Note: may have to split rate
C. 15% - everything else
D. NCG = NLTCG -- NSTCL
III.
DEFINITION OF CAPITAL ASSET
A. Property transactions NOT the normal source of
business income
B. §1221(a) - property held by TP (whether or not
connected w/ his T or B ), but does not include …
13
i. (1) Inventory, Stock in Trade, and Property
Held Primarily for Sale in OCOB
ii. (2) Depreciable or Real Property Used in TP’s
T or B
iii. (3) Copyrights, Literary, Musical, or Artistic
Compositions
iv. (4) A/R for Services Rendered or InventoryType Assets Sold
v. (5) Certain U.S. Gov’t Publications (AntiAgnew)
vi. (8) Supplies Used in T or B
IV.
V.
SALE OR EXCHANGE - § 1222
A. Required for § 1222 CG / CL treatment
B. Forms
i. Actual market transaction
ii. Judicially defined (foreclosure)
iii. Defined by statute (§ 165(g))
C. Freeland - Congress intended broad meaning
BYNUM - § 1231(a)(1) JUDICIAL GLOSS
A. Facts: TP divided lots; sold several.
B. Issue: character of gain?
C. Analysis: shifted from T or B to primarily holding
land for sale in OCOB
D. Factors
i. Frequency of sales
ii. Level of improvements
iii. TP’s involvement
iv. Use of RE brokers / agents
VI.
MIXED COMPONENT TRANSACTIONS
A. OI v. CG
i. OI = Ordinary Business Profits
ii. CG = LT Appreciation
B. Where not mutually exclusive, must divide b/t two
C. Substitution Rule - If receive something substituting
OI, taxed as OI
VII.
§ 1(h) FRAMEWORK
A. Identify capital assets sold / exchanged during year
B. Separate LT and ST
C. § 1222 Netting Process
i. NLTCG or L = LTCG - LTCL
ii. NSTCG or L = STCG - STCL
iii. *Provides how much gains get § 1(h)
preferential rates
D. §1222(9) Compute NCG
i. NCG = NLTCG - NSTCL
ii. Leave NSTCG behind, b/c does NOT get
preferential rate
E. Take NCG to § 1(h). Apply too…
i. 28% gains (collectible gains - collectible losses
- NSTCL)
ii. 25% gains
iii. 15% gains
F. Note: Dividends NOT CGs, but taxed at 15% rate
per § 1(h)(11)
I.
INTRODUCTION
A. How do losses work?
i. First: offset gains of their own category (LT or
ST)
ii. Second: if losses from one category > exceed
that category, migrate to § 1(h)…
1. 1st  28%
2. 2nd  25%
3. 3rd  15%
iii. Pro TP Rule
B. § 1211(b): indiv may deduct losses up to amount of
gains, plus $3K, and may carryover indefinitely
II.
BASIC FRAMEWORK
A. Is loss deductible via §§ 162 or 165?
i. If NO, STOP
B. How long was property held?
i. LT
ii. ST
C. § 1222 Netting Process (see supra)
D. Compute NCG (see supra)
E. Take NCG directly to § 1(h); Migrate losses, if any
III.
CARRYOVER
A. If losses > gains, § 1(h) no longer applies, t/f use §
1211
B. Analysis
i. How much total loss?
ii. Entitled to deduction?
iii. How much (see supra)?
iv. Carryover: separate losses b/t LT and ST,
carryover in unchanged character
1. If have both LT and ST, ask which is
majority
2. Why does it matter? Will offset that type
next year, and rather offset LT first
XVIII. CAPITAL LOSSES - § 1211
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