Tax: Lilly Outline 2

Tax I

Professor Lilly

Casebook Outline


Part Two: Identification of Income Subject to Taxation


Chapter 2: Gross Income: The Scope of Section 61


  1. Introduction to Income
    1. Internal Revenue Code: Section 61
    2. Taxable income is gross income less certain authorized deductions
    3. Gross income is all income from whatever source derived.
    4. What is income?
  2. Equivocal Receipt of Financial Benefit—Internal Revenue Code: Section 61; Regulations: Sections 1.61-1, -2(a)(1), -2(d)(1), -14(a)
    1. Cesarini v. United States

                                                              i.       Is money found in a piano taxable income?

                                                            ii.      Yes, it is. 

    1. Old Colony Trust Co. v. Commissioner

                                                              i.      Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?

                                                            ii.      Yes.

    1. Commissioner v. Glenshaw Glass Co.

                                                              i.      Whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income under s. 22(a) of the Internal Revenue Code of 1939.

                                                            ii.      Punitive damages are considered gross income.

                                                          iii.      Undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion are includable in gross income.

    1. Charley v. Commissioner

                                                              i.      The Charleys challenged the tax court’s determination that travel credits accumulated by Philip Charley in the course of his employment with Truesdail laboratories constituted gross income subject to taxation.

                                                            ii.      Travel credits accumulated and retained by an employee n the course of his employment constitute gross income subject to taxation.

                                                          iii.      Travel credits converted to cash are considered taxable income.

    1. Unlawful, as well as lawful gains are comprehended within the term “gross income.”
  1. Income Without Receipt of Cash or Property
    1. Internal Revenue Code: Section 61
    2. Regulations: Sections 1.61-2(a)(1), -2(d)(1)
    3. Helvering v. Independent Life Ins. Co.

                                                              i.      Must a taxpayer include in gross income the rental value of a building owned and occupied by the taxpayer?

                                                            ii.      No.  The rental value of the building used by the owner does not constitute income within the meaning of the Sixteenth Amendment.

    1. Revenue Ruling 79-24

                                                              i.      If services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income.

    1. Dean v. Commissioner

                                                              i.      Dean and his wife were the sole shareholders of a corporation that held title to their family residence, which they occupied without paying any rent to the corporation.

                                                            ii.      The court held that the fair rental value of the premises occupied by a taxpayer without payment of rent constitutes income which must be included in such taxpayer’s gross income. 


Chapter 3:  The Exclusion of Gifts and Inheritances


  1. Rules of Inclusion and Exclusion
    1. Internal Revenue Code: Section 102(a) and (b) first sentence
    2. Regulations: Sections 1.102-1(a), (b)
    3. Gross income includes the receipt of any financial benefit which is:

                                                              i.      Not a mere return of capital, and

                                                            ii.      Not accompanied by a contemporaneously acknowledged obligation to repay, and

                                                          iii.      Not excluded by any statutory provision.

    1. Exclusions—Definition

                                                              i.      An exclusion from gross income means that the item is simply not included in gross income, so that it never enters the computation of taxable income.

                                                            ii.      The court construes §61 broadly and they construe exclusions narrowly.

  1. Gifts
    1. The Income Tax Meaning of a Gift

                                                              i.      Internal Revenue Code: Section 102(a)

                                                            ii.      Section 102 excludes from the gross income of the recipient the value of cash or property received by gift or inheritance, regardless of amount.

                                                          iii.      Commissioner v. Duberstein

1.      Duberstein received a Cadillac in return for providing a business associate with some favorable business contacts.

2.      In order to be a gift under Section 102, amounts received must have been given with a detached and disinterested generosity.

                                                          iv.      Stanton v. United States

1.      Stanton received $20,000 when he retired from a church corporation.

2.      Same rule as in Duberstein

    1. Employee Gifts

                                                              i.      Internal Revenue Code: Sections 102(c); 274(b).  See Sections 74(c); 132(e); 274(j)

                                                            ii.      Proposed Regulations: Section 1.102-1(f)

                                                          iii.      The exclusion of §102 does not extend to any transfer made by an employer to an employee (§102(c)(1)).  These amounts are considered compensation, not gifts.

  1. Bequests, Devises, and Inheritances
    1. Internal Revenue Code: Section 102(a), (b) first sentence, (c).
    2. Regulations: Section 1.102-1(a), (b).
    3. Lyeth v. Hoey

                                                              i.      Lyeth’s grandmother died leaving the bulk of her inheritance to a church.  Lyeth contested the will and a compromise was made whereby Lyeth and other heirs would split the inheritance between themselves and the church.  The IRS then taxed the money arguing that the money had befallen Lyeth via a contract, and not by inheritance.

                                                            ii.      Money received from the compromise of a will contest is received through inheritance and is exempt from income tax.

    1. Wolder v. Commissioner

                                                              i.      Whether an attorney contracting to and performing lifetime legal services for a client receives income when the client, pursuant to the contract, bequeaths a substantial sum to the attorney in lieu of the payment of fees during the client’s lifetime.

                                                            ii.      Where a bequest is made by contract to satisfy and obligation, its receipt is income, taxable under §61 of the Internal Revenue Code of 1954, and not excludable under §102.


Chapter 4: Employee Benefits


  1. Exclusions for Fringe Benefits
    1. Internal Revenue Code: Section 132 (omit (j)(2) and (5), (m), and (n)).  See Sections 61(a)(1); 79; 83; 112; 125.
    2. Regulations: Sections 1.61-1(a), -21(a)(1) and (2), (b)(1) and (2).
    3. If an employee benefit is not specifically excluded from gross income, its value must be included within gross income under §61.
    4. Section 132(a)(1): No-Additional-Cost Services
    5. Section 132(a)(2): Qualified Employee Discounts
    6. Section 132(a)(3): Working Condition Fringe
    7. Section 132(a)(4): De Minimis Fringes

                                                              i.      Any property or service whose value is so small as to make required accounting for it unreasonable or administratively impracticable is excluded as a fringe benefit.

    1. Section 132(a)(5): Qualified Transportation Fringe
    2. Section 132(a)(6): Qualified Moving Expenses Reimbursement
    3. Section 132(j)(4): Athletic Facilities

                                                              i.      Employees may exclude from gross income the value of the use of any on-premises athletic facility.

  1. Exclusions for Meals and Lodging
    1. Internal Revenue Code: Sections 107; 119(a). See Section 119(d).
    2. Regulations: Section 1.119-1
    3. Herbert G. Hatt

                                                              i.      Hatt, president and majority stockholder of a funeral home corporation, who lived in an apartment located in the building used for the funeral home, used the apartment 24-hours a day to conduct the funeral business.

                                                            ii.      The value of lodging furnished to an employee may be excluded from gross income if the lodging is on the business premises of the employer, the employee is required to accept such lodging as a condition of his employment, and the lodging is furnished for the convenience of the employer.

  1. Do-It-Yourself Averaging
    1. Internal Revenue Code: See Section 409A
    2. Revenue Ruling 60-31



Chapter 6: Gain From Dealings in Property

  1. Factors in the Determination of Gain
    1. Internal Revenue Code: Sections 1001(a), (b) first sentence, (c); 1011(a); 1012
    2. Regulations: Section 1.001-1(a)
    3. Amount realized

                                                              i.      The amount of money received and the fair market value of property (other than money) received on disposition.

  1. Determination of Basis
    1. Cost as Basis

                                                              i.      Internal Revenue code: Sections 109; 1011(a); 1012; 1016(a)(1); 1019.

                                                            ii.      Regulations: Sections 1.61-2(d)(2)(i); 1.1012-1(a)

                                                          iii.      Philadelphia Park Amusement Co. v. United States

1.      Philadelphia Park Amusement Co deeded its interest in a bridge to the city iin exchange for a ten-year extension of a franchise.

2.      Where a taxable exchange of property occurs, gain or loss should be recognized in establishing the basis for the property on the date of the transfer.

3.      §1016a

a.       Improvements to property result in an increase in the basis of the property.  See Reg. §1.1016-2

    1. Property Acquired by Gift

                                                              i.      Internal Revenue Code: Section 1015(a).  See Sections 1015(d)(1)(A), (4) and (6).

                                                            ii.      Regulations: Section 1.1015-1(a)

                                                          iii.      Taft v. Bowers

1.      Taft was given shares of appreciated stock and contended her basis was the appreciated value of the stock.

2.      The donee receives the basis of the donor in gift property.

                                                          iv.      Farid-Es-Sultaneh v. Commissioner

1.      Farid-Es-Sultaneh received stock from a premarital settlement agreement in exchange for the release of dower rights.

2.      No gift occurs for the purpose of computing the donee’s basis in property received in exchange for a promise to marry and the release of marital rights.

    1. Property Acquired Between Spouses or Incident to Divorce

                                                              i.      Internal Revenue Code: Section 1041(a) and (b)

                                                            ii.      Regulations: Section 1.1041-1T(a) and (d)

    1. Property Acquired From a Decedent

                                                              i.      Internal Revenue Code: Sections 1014(a), (b)(1) and (6), (e)

                                                            ii.      Regulations: Sections 1.1014-3(a); 20.2031-1(b)

  1. The Amount Realized
    1. Internal Revenue Code: Section 100(b)
    2. Regulations: Section 1.1001-1(a), -2(a), (b), (c) Examples (1) and (2)
    3. International Freighting Corporation, Inc. v. Commissioner
    4. Crane v. Commissioner

                                                              i.      Mrs. Crane owned an apartment building that was subject to a non-recourse mortgage.  Over the years, she claimed depreciation deductions.  She sold it to a buyer subject to the debt.  Mrs. Crane claimed that her only gain was her equity in the building.  She argued that her amount realized could not include the mortgage assumed because she did not benefit from the buyer’s taking the property subject to the debt.  The Supreme Court held that her amount realized included the amount of the non-recourse mortgage.  In that case the fair market value of the property exceeded the amount of the non-recourse debt, and the Supreme Court observed that it did not rule on the result that would obtain if the property’s fair market value were less than the debt encumbering the property.

                                                            ii.      When the amount of the mortgage is less than the fair market value of the property, the seller’s amount realized included the debt assumed, regardless of the nature of the mortgage as recourse or non-recourse.

    1. Commissioner v. Tufts

                                                              i.      Tufts contended that the assumption of a mortgage which exceeded the fair market value of the property by the purchaser was not a taxable event.

                                                            ii.      The assumption of a non-recourse mortgage constitutes a taxable gain to the mortgager even if the mortgage exceeds the fair market value of the property.


Chapter 8: Discharge of Indebtedness



  1. Internal Revenue Code: Sections 61(a)(12), 102(a), and 108(a)
    1. United States v. Kirby Lumber Co.

                                                              i.      Kirby Lumber issued bonds at par value and then later repurchased some of them in the open market below par.  The IRS contended that the difference between the issuing price and the repurchase price was a taxable gain to Kirby Lumber.

                                                            ii.      The retirement of debt by a corporation for less than face value represents a realized increase in net worth to the corporation and is therefore taxable gain.


Chapter 7:  Life Insurance Proceeds and Annuities



  1. Life Insurance Proceeds
    1. Internal Revenue Code: Sections 101(a), (c), (d), and (g)
    2. Regulations: Sections 1.101(a)(1), (b)(1), -4(a)(1)(i), (b)(1), (c).
    3. Section 101(a) excluded from gross income amounts received under a life insurance contract, whether in a lump sum or in a series of payments, by reason of the death of the insured.
  2. Annuity Payments
    1. Internal Revenue Code: Sections 72(a), (b), (c)
    2. Regulations: Section 1.72-4(a), -9(Table V)


Chapter 9:  Damages and Related Receipts


  1. Introduction
  2. Damages in General
    1. Raytheon Production Corporation v. Commissioner

                                                              i.      Taxpayer settled a lawsuit under the federal anti-trust laws against R.C.A.  The issue was whether the settlement was required to be included in the taxpayer’s gross income.  Raytheon is arguing that the settlement is excludable from its gross income.

                                                            ii.      Damages for violation of the anti-trust acts are treated as income where they represent compensation for lost profits.

  1. Damages and Other Recoveries for Personal Injuries
    1. Internal Revenue Code: Sections 104(a); 105(a)-(c) and (e); 106(a)
    2. Regulations: Sections 1.104-1(a), (c), (d); 1.105-1(a); 1.106-1

                                                              i.      Section 104(a)(2)

                                                            ii.      Section 106(a)

                                                          iii.      Section 104(a)(1)

                                                          iv.      Section 104(a)(3)

                                                            v.      Sections 104(a)(4) and 104(a)(5)

                                                          vi.      Section 105(a)

                                                        vii.      Section 105(b)

                                                      viii.      Section 105(c)


Chapter 10:  Separation and Divorce


  1. Alimony and Separate Maintenance Payments
    1. Direct Payments

                                                              i.      Internal Revenue Code: Section 71 (omit (c)(2) and (3), (f))); 215(a) and (b); 7701(a)(17)

                                                            ii.      Regulations: Section 1.71-1T(a) and (b) (omit Q 6, 7, 11, and 12)

    1. Indirect Payments

                                                              i.      Internal Revenue Code: Section 71(b)(1)(a)

                                                            ii.      Regulations: Section 1.71-1T(b)(Q6 and 7)

                                                          iii.      I.T. 4001

  1. Property Settlements
    1. Internal Revenue Code: Section 1041; See Section 1015(e)
    2. Regulations: Section 1.1041-1T(b)
  2. Other Tax Aspects of Divorce
    1. Child Support

                                                              i.      Internal Revenue Code: Section 71(b)(1)(D), (c)

                                                            ii.      Regulations: See Section 1.71-1T(c)

    1. Alimony Payments Made by a Third Party

                                                              i.      Internal Revenue Code: Sections 215; 682. See Sections 72; 1041.


Chapter 11:  Other Exclusions From Gross Income


  1. Gain From the Sale of a Principle Residence
    1. Internal Revenue Code: Sections 121 (omit (d)(4) and (5), (e))
    2. Regulations: Section 1.121-1(a), (b)(1), (2) and (4) Example 1, (c)(1), (d), -2(a)(1)-(4) Example 2, -3(b), (c)(1)-(4) Example 1, (d)(1)-(3) Example 1, (e)(1) and (2), (f), (g)(1)-(2) Example 1.
  2. Income Earned Abroad
    1. Internal Revenue Code:  See Section 911
  3. Exclusions and Other Tax Benefits Related to the Costs of Higher Education
    1. Internal Revenue Code: Sections 25A; 135; 529; 530.  See Sections 72(e)(2)(B), (8)(B), (9); 108(f); 117; 127; 132(c)(3); 221; 222.
  4. Federal Taxes and State Activities
    1. Internal Revenue Code: Sections 103: 115; 141(a) and (e).  See Sections 141; 142; 148; 149




Chapter 12: Assignment of Income


  1. Introduction
    1. Internal Revenue Code:  Sections 1(a) through (e), (h); 6013(a).  See Sections 1(g); 63; 66; 73.
  2. Income From Services
    1. Lucas v. Earl

                                                              i.      The Earls entered into a contract whereby they agreed that whatever each acquired in any way during their marriage would be received and owned by them as joint tenants.  Hence, Mr. Earl claimed that he should be taxed for only half of his income.

                                                            ii.      The court held that a statute can tax salaries to those who earned them and can provide that a tax cannot be escaped by anticipatory arrangements or contracts which prevent salary from vesting even for a second in the person who earned it. 

    1. Commissioner v. Giannini

                                                              i.      Although Gianniini had refused to accept compensation for his services to the Bancitaly Corporation which then, at Giannini’s suggestion, donated the money as the corporation saw fit, nevertheless the Commissioner argued that the donated funds had been “realized” as income to Giannini.

                                                            ii.      The court held that when a taxpayer, by anticipatory assignment, makes a gift of the interest or compensation which he is entitled to receive at a future date in return for his present services, he nevertheless thereby realizes taxable income just as surely as if he had first collected the income and then himself paid it directly to the donee.

                                                          iii.      Ruling in favor of Giannini.  Giannini never received the money, he merely suggested it be used for another purpose.

  1. Income From Property
    1. Helvering v. Horst

                                                              i.      Shortly before their due date, Horst detached negotiable interest coupons from negotiable bonds and gave them to his son who in the same year collected them at maturity.

                                                            ii.      The court held that for income tax purposes the power to dispose of income is equivalent to ownership of it, and the exercise of that power to transfer payment of the income to another is the equivalent of realization of the income. 




Chapter 14: Business Deductions



  1. Introduction
    1. Internal Revenue Code:  See Sections 1; 63

                                                              i.      A taxpayer has no constitutional right to a deduction.

                                                            ii.      A taxpayer must find a statutory provision that specifically allows the deduction claimed.

  1. The Anatomy of the Business Deduction Workhorse:  Section 162
    1. “Ordinary and Necessary”

                                                              i.      Internal Revenue Code: Section 162(a)

                                                            ii.      Regulations Section 1.162-1(a)

                                                          iii.      Welch v. Helvering

1.      A grain commission agent repaid the debts of the bankrupt corporation he used to work for. 

2.      The court held that in order to be deductible, an expense must be “ordinary” in the business area practiced by the taxpayer.  Ordinary means that it would be accepted practice in a given segment of the business world.  The repayment of the debts in the case at hand is not considered ordinary.

    1. “Expenses”

                                                              i.      Internal Revenue Code: Sections 162(a); 263(a)

                                                            ii.      Regulations: Sections 1.162-4; 1.263(a)-2 through (c)(1), (d)(1), (e)(1)(i), (2), (3), (4)(i), -5(a), (b)(1).

                                                          iii.      Midland Empire Packing Co, v. Commissioner

                                                          iv.      INDOPCO, INC. v. Commissioner

1.      INDOPCo sought to deduct, as a business expense, costs and fees associated with its friendly takeover by another corporation.

2.      The court held that costs and fees associated with a corporate acquisition are not deductible as “ordinary and necessary” business expenses under §162(a).

3.      The burden of proving deductibility of an item rests with the taxpayer.

    1. “Carrying On” Business

                                                              i.      Internal Revenue Code:  Sections 161(a); 195; 262

                                                            ii.      Regulations: Section 1.195-1(a)

                                                          iii.      Morton Frank v. Commissioner

1.      Frank and his wife incurred traveling, telephone, and legal expenses in investigating opportunities throughout the country in order to purchase a newspaper.  Frank sought to deduct the expenses from his gross income as ordinary and necessary business expenses.

2.      The court held that the expenses of investigating and looking for a new business and trips preparatory to entering a business are not deductible as ordinary and necessary business expenses incurred in carrying on a business.

3.      Distinguish Frank from: situations where the taxpayer has proceeded beyond an initial investigation stage and has entered a transactional stage, or situations where if Frank had been in a trade or business and he was seeking to expand that business or some branch of it.

  1. Specific Business Deduction
    1. “Reasonable” Salaries

                                                              i.      Internal Revenue Code: Section 162(a)(1).  See Sections 162(m); 280G.

                                                            ii.      Regulations: Section 1.162-7, -8, -9

                                                          iii.      Exacto Spring Corporation v. Commissioner

1.      Exacto paid its president a high salary and deducted the salary from their income. 

                                                          iv.      Harolds Club v. Commissioner

1.      Pursuant to an employment agreement, the owners of a casino paid a large percentage of their profits to their father as salary for his services as manager.

2.      An unreasonably large salary expense that has not been determined by a free bargain between the employer and employee may not be deducted by the employer.

    1. Travel “Away From Home”

                                                              i.      Internal Revenue Code: Section 162(a)(2), 162(a) second to last sentence; 274(n)(1).  See Sections 162(h); 274(c), (h) and (m)(1) and (3)

                                                            ii.      Regulations: Section 1.162-2 (omit-2(c))

                                                          iii.      Generally

1.      §162(a) allows a deduction for all the ordinary ad necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

2.      §262 however provides that no deduction is allowed for personal, living, or family expenses.

                                                          iv.      Rosenspan v. United States

1.      Rosenspan was a traveling salesman with no permanent home.  Rosenspan attempted to deduct as traveling expenses the costs of his meals and lodging.

2.      The court held that §162 permits a deduction for traveling expenses if and only if such expenses are: (1) “reasonable and necessary” (2) incurred in connection with business pursuits, and (3) incurred “while away from home.”

3.      Rosenspan had no home to be away from, therefore he does not meet the criteria for §162.

                                                            v.      Andrews v. Commissioner

1.      Andrews maintained a home in Massachusetts and Florida because he had businesses in both states.  Andrews sought to deduct expenses incurred in association with visits he took to his second home.

2.      A person owning a second home in which to reside while on business may deduct costs associated therewith.

  1. Miscellaneous Business Deductions
    1. Introduction

                                                              i.      Internal Revenue Code: Sections 162(a); 274(a), (d), (e), (k), (l) and (n).

                                                            ii.      Regulations: See Sections 1.162-20(a)(2); 1.274-2(a)(1), (c), (d).

                                                          iii.      Business Meals and Entertainment

                                                          iv.      Uniforms

1.      Deductions for uniforms are allowed only if:

a.       The uniforms are specifically required as a condition of employment; and

b.      The uniforms are not of a type adaptable to general or continued usage to the extent that they take the place of ordinary clothing.

                                                            v.      Advertising

1.      Generally advertising expenses of a business are deductible in the year in which they are incurred or paid even though the benefits may extend over several years.

                                                          vi.      Dues

1.      Dues paid to organizatons directly related to one’s business are deductible under §162.

                                                        vii.      Lobbying Expenses

1.      Such expenses are now non-deductible.

    1. Business Losses

                                                              i.      Internal Revenue Code: Sections 165(c)(1); 280B

  1. Depreciation
    1. Introduction

                                                              i.      Internal Revenue Code: Sections 167(a), (c); 168(a), (b), (c), (e)(1) and (2), (f)(1) and (5), (g)(1), (2), and (7), (i)(1); 1016(a)(2).  See Section 62(a)(1) and (4); 168(d); 263(a); 263A

                                                            ii.      Regulations: Sections 1.162-4; 1.167(a)-1(a), -10; 1.167(b)-0(a), -1(a), -2(a)

                                                          iii.      Prerequisites for Deduction

1.      Depreciation is restricted to:

a.       Property used in a trade or business; or

b.      Property held for the production of income

                                                          iv.      The Useful Life Concept

1.      Only property which has an identifiable useful life to the taxpayer can qualify for deduction.

2.      Salvage value:  Acquisition value minus the cost recovered

                                                            v.      Depreciation Methods

1.      Straight-line method

a.       The cost or other basis of the property, less its estimated salvage value, is deducted in equal annual installments over the period of its estimated useful life.

2.      Declining balance method

a.       A uniform rate is applied to the unrecovered basis of the asset.

                                                          vi.      The Relationship of Depreciation to Basis

1.      When a taxpayer claims depreciation on property, the deduction is attended by a commensurate reduction in the basis for the property.

                                                        vii.      The Accelerated Cost Recovery System


  1. The Carryover and Carryback Devices
    1. Internal Revenue Code: See Section 172
    2. Statutory provisions permit operating losses in one year to be utilized in a redetermination of tax liability for another year.
    3. A provision permits an operating loss in one year generally to be carried back and treated as a business deduction in one or two preceding taxable years.
    4. To the extent that income in the preceding years will not absorb the loss, it is carried forward and treated as a business deduction in one or more of twenty succeeding taxable years.


p. 425 reference reading


Chapter 17:  Restrictions on Deductions


  1. Introduction
  2. Deductions Limited to Amount at Risk
    1. Internal Revenue Code: Section 465(a), (b), (d), (e)(1)
  3. Activities Not Engaged in For Profit
    1. Internal Revenue Code: Section 183(a)-(d)
    2. Regulations: Section 1.183-2(a) and (b)
  4. N/A
  5. Passive Activity Limitations
    1. Internal Revenue Code: Section 469(a), (b), (c)(1), (2) and (7), (d), (e)(1), (f), (g), (h)(1) and (2), (i)(1)—(3)(A) and (6), (j)(1), (l)(1).
    2. Regulations: Sections 1.469-4(a), (c), (e), and (f)(1), -5T(a), (b)(2)(ii), (iii), (c), (d).
    3. Introduction

                                                              i.      §469 disallows the deduction of passive activity losses and the usage of passive activity credits.

    1. Taxpayers Subject to the Limitations

                                                              i.      The passive activity rules apply to individuals, estates and trusts, closely-held C corporations, and personal service corporations (for definitions see p. 521). 

    1. Definition of an “Activity”

                                                              i.      A passive activity is any business or profit seeking activity in which the taxpayer-owner does not materially participate.

    1. Definition of a “Passive” Activity

                                                              i.      A passive activity is any activity that involves the conduct of a trade or business or a transaction entered into for profit in which the taxpayer does not materially participate.

    1. Passive Activity Losses and Credits
    2. Exceptions to Disallowance
    3. Release of Suspended Losses and Credits




Chapter 21: Capital Gains and Losses


  1. Introduction
  2. The Mechanics of Capital Gains
    1. Internal Revenue Code: Sections 1(c), (h) (omit (h)(2), (5)(B), (6), (8), (9), (10), (11)) and (i);  1222.  See Sections 1(a)-(e); 1201(a); 1202(a)-(e); 1221(a)(1)-(4).
    2. Noncorporate taxpayers
  3. The Mechanics of Capital Losses
    1. Internal Revenue Code: Section 1211(b); 1212(b)(1), (2)(A)(i); 1222(10).  See Sections 165(c) and (f); 1211(a); 1212(a); 1221(a); 1221(a)(1)-(4); 1222
    2. Noncorporate taxpayers
    3. The Section 1211(b) Limitation

                                                              i.      Capital losses are deductible only to the extent of capital gains plus, if such losses exceed such gains, an amount of ordinary income not to exceed the lower of $3,000 ($1,500 in the case of a married individual filing a separate return) or the excess of such losses over gains.

    1. The Section 1212(b) Carryover

                                                              i.      Capital losses not utilized in the year incurred are carried over into subsequent taxable years and treated as long-term or short-term losses, depending upon their original character.

    1. Corporations

                                                              i.      Losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges.

    1. The Meaning of “Capital Asset”

                                                              i.      The Statutory Definition

1.      Internal Revenue Code: Section 1221(a)(1)-(4).  See Sections 1221(a)(5)-(8), (b)

2.      Maudlin v. Commissioner

a.       Having bought certain land for use in a proposed cattle business, Maudlin found such a venture unsuitable and proceeded to dispose of the lots in bits and pieces at various times over a 28-year period.

b.      The court held that where the primary use or purpose of an asset as changed, the primary purpose at the time of sale determines the nature of the asset for tax purposes.