Attack/Short Sheet for Income Tax

GROSS INCOME
Under 61(a), GI means all income from whatever source derived, UNLESS there is an exclusion (Reg 1.61-1(a))
Glenshaw Glass 3 Part Test: (1) Undeniable accession of wealth, (2) Clearly realized, & (3) Complete control
o Accession of Wealth: Not mere return of capital and NOT accompanied by obligation to repay
o Realization Event: an objective, identifiable event MUST take place =something different after the event than before
Recognized, UNLESS otherwise excepted (e.g., transfer to spouse 1041, OR gift ( 1015)
(1) Sale; (2) exchange; (3) foreclosure; (4) transfer deed (in lieu of #3); (5) finding property
GI = Whats in 61(a) and whats included specifically in 71-86, BUT does NOT include whats excluded in 101-139
o No GI if mere return of capital w/ contemporaneously acknowledged obligation to repay (BUT stolen $$ = GI)
Comp. for Services INCLUSION 61(a)(1)/Reg. 1.61-2(d)(1) FMV of property received as comp. is included in GI
Found Property -- INCLUSION
o Finding property is a realization event; GI includes Treasure Trove (Reg 1.61-14(a)) @ time of undisputed
possession (Cessarini) -> Rule: S/L = 3 years; Except: large sum NOT included= 6 years; NO file or fraud = No S/L
o Include propertys FMV (or cash) in GI, and the amount included in GI is your Tax-Cost Basis (BR #3)
COD Income INCLUSION
o Any discharged debt for which TP was liable, OR subject to TPs property is included in GI ( 61(a)(12), UNLESS:
Excluded by 108 (Bankruptcy or Insolvency), OR debt is 1) forgiven, 2) Worked off, or 3) paid non-cash
Discharge of an Obligation by a Third Party INCLUSION (Old Colony Trust Co.)
o Discharge of an obligation by a third party, including anothers payment of the TPs taxes = GI (Reg 1.61-14(a))
Prizes & Awards INCLUSION
o 74 Prizes & Awards are includible in GI
EXCEPTION # 1: Award received (1) in recognition of relig., charitable, scientific, educational, artistic,
literary, or civic achievement are excludible IF: (2) TP selected w/o any action on his part to enter contest;
(3) TP is not required to perform future services as condition of receiving award; and (4) the prize/award is
transferred by the giver of the award to a (a) govt unit OR (b) entity operated exclusively for religious,
charitable, scientific, literary, or educational purposes; or (c) NCAA; or (d) 501(c)(3) non-profit
EXCEPTION # 2: (c) Awards to EE for (1) length of service or (2) safety achievement NOT included in GI
Rents; Royalties; Windfalls; Illegal Income INCLUSION (stolen $$ = GI; not loan, even if you have to pay it back)
Dividends Include in Net Capital Gain
Property Subject to Substantial Risk of Forfeiture may elect either to:
o (1) Include in O.I. Now (in year of receipt)amount included is value at time of receipt minus amount paid if any 83(b)
o (2) Include in O.I. Later (when property vests & is transferable or no longer subject to risk of forfeiture)amount
included is value at time of vesting minus amount paid if any 83(a)
HAIG-SIMMONS INCOME (conceptual tax policy done by economists, not adopted by law)
H/S Income = FMV of Consumption + Net change in Assets
Imputed income is ONLY included in GI under Haig/Simmons; GI is what is consumed
No realization doctr. in H/S Appreciation/depreciation in assets would affect GI each year, even if NOT sold/disposed.
EXCLUSIONS
Under 61(a), GI means all income from whatever source derived, UNLESS there is an exclusion (Reg 1.61-1(a))
Gift 102(a) EXCLUSION
o Transferor intends detached/disinterested generosity (Duberstein) OR comp. for services under 61(a)?
Gifts are excluded from donees GI 102(a) look to 1015 for transferred basis rule
NO gifts in ER/EE relationship (102(c)), but see 132 & 74(c)Exception for certain EE awards
274(b): deduction for gifts to individuals (non-EE) as business exp. limited to $25 per donee/yr.
Part-Gift/Part-Sale All Gain & Basis Sale; Gift -- EXCLUSION
o When property encumbered with a mortgage is gifted, it is a part sale/part gift transaction
o Amount of mortgage is the sale component, the difference between the mortgage and the FMV is the gift component
View this transaction as a sale first, then any excess treated as a gift
For transferor, entire AB allocated to sale; NOT divided btw sale & gift Reg. 1.1001-1(e)(1)
However, if transferee were a charitable organization, the AB would be split btw gift & sale. The
transferor MUST be taxed at disposition because otherwise the taxes would be lost since the
charitable organization does not pay taxes (Reg. 1.1011-2)
o Transferor CANNOT realize a loss on a part sale/part gift transaction (Reg. 1.1001-1(e)(1))
Interest on State & Local Bonds EXCLUSION
o 103 GI does NOT include interest on any State or Local bond
Receipts Related to Physical Injury or Sickness Damages / Workers Comp-- EXCLUSION
o Under 104(a), NO GI for damages (NOT punitive damages) received bc of personal injuries or physical sickness
Emotional distress or Back-Pay is generally NOT treated as a personal injury or physical sickness
UNLESS its linked w/ such injury/sickness, then is excludible from GI (104 Flush language)
 Attack/Short Sheet for Income Tax

Amount paid for medical care attributable to emotional distress is excludible (104 Flush language)
o 104(c) Punitive damages from a civil action are ONLY excludible from GI, IF:
(1) wrongful death action AND (2) state law only provides for punitive damages in wrongful death actions.
o If NOT for a physical injury (e.g., defamation, discrimination), then MUST be included in GI
Discharge from Indebtedness Excluded IF:
o 108 COD income is EXCLUDED from GI, IF: (1) TP is Bankrupt or Insolvent (2) discharge of a purchase price
adjustment (3) the debt qualifies as real property business debt OR (4) its public interest education indebtedness
If Discharge of Indebtedness doesnt meet one of the Exceptions include in GI under 61(a)(12)
Qualified Scholarships EXCLUSION
o 117 Scholarship for (1) Tuition fees and (2) required books for candidate for a degree is excluded from GI
BUT: scholarship amount for (3) room & board and (4) recommended books or (5) comp. for service = GI
Meals & Lodging -- EXCLUSION
o Under 119, IF the meals or lodging are (1) furnished for the convenience of the employer, (2) on employers
business premises, AND (3) (in the case of lodging) the employee is required to accept the lodging as condition of
employment THEN exclude from GI; if NOT, then include in ordinary income (as comp. for services (61(a)(1)
Gain from Sale of Principal Residence EXCLUSION
o 121 TP can exclude from GI ($250K for individual, $500K for MFJ) gain from the sale/exchange of property IF
owned and used by TP as the TPs primary residence for a period of 2 years or more out of 5.
Certain Employee Benefits EXCLUSION
o 132(a) GI shall NOT include any fringe benefit which qualifies as:
(1) qualified EE discount (Basis=propertys FMV), OR no-additional-cost service (ER provides to public)
(2) de minimis fringe (e.g., coffee & donuts)
(3) working condition fringe (e.g., desk, chair, supplies)
Imputed Income EXCLUDED from GI
AMOUNT REALIZED
Gains & Losses from Sales/Exchanges/Dispositions
o 1001(a) (1) Gain = AR -- AB (provided in 1011); Loss = AB AR.
o 1001(b) (2) determination of amount realized
AR = Cash + FMV of property (other than cash) + FMV of services received + Debt Relief (Crane, FP #1)
Fund. Prin. #2 = Liabilities of seller, whether recourse (assumed) or nonrecourse (taken subject
to) by the purchaser, are included in the sellers AR (Crane; Reg. 1.1001-2(a)(1))
TP must include value of Debt relief in amount realized (Crane)
o 1001(c) (3) gain or loss recognized, UNLESS another code provision applies
Realization Event = sale/disposal, exchange, casualty; (realized NOT recognized = gift, inheritance, or charitable deduction

DISCHARGE of INDEBTEDNESS / COD INCOME

When debt is cancelled, your wealth is increased by the amount you keep w/o the attached obligation of repayment = GI
Any discharged debt for which TP was liable, OR subject to property held by TP is included in GI ( 61(a)(12), UNLESS:
o Excluded by 108(a)(1)
(A) Bankruptcy / Title 11
(B) TP is insolvent (liabilities > assets)
o OR the debt is NOT actually discharged, BUT rather is:
Forgiven (as a gift look for requisite generosity)
No gifts in EE/ER relationship 102(c)
Worked off comp. for services for TP (and is included in GI; Reg. 1.61-12(a); 61(a)(1)
Not cancelling the debt, but converted from loan and working it off (comp. for services),
Repaid in a non-cash form (count services performed or property exchanged as GI)
ER makes payment to satisfy (portion) of debt COD Income 61(a)(12)) & comp. for services 61(a)(1)
Contested Liability Doctrine
o If TP, in good faith, disputes the amount of a debt, a subsequent settlement of dispute is treated as amount of debt
cognizable for tax purposes
Identify:
o AR ( 1001(b))
o AB ( 10012 cost basis or other basis rule)
o Gain (61(a)(3) gain counts as GI - (realized 1001(a), and recognized 1001(c))
o GI from COD Income ( 61(a)(12)
o Total GI, including (if any) comp. for services 61(a)(1))
If the FMV of the property goes below the value of the debt, identify whether its recourse OR non-recourse
o Tax consequences to Mgor when debt is recourse BIFURCATE (COD income and Gain)
AB (1012; FP #1)
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FMV (property) If AB > FMV, then amount over FMV is COD income
AR (1001(b)
Under a recourse mortgage, AR is limited to FMV; & remainder (if any) is COD income
Gain (61(a)(3) gain counts as GI - (realized 1001(a), and recognized 1001(c))
GI from COD Income ( 61(a)(12)
o Tax consequences to Mgor when debt is non-recourse (NEVER have COD income w/ N/R debt)
AB (1012; FP #1)
FMV (property)
AR (1001(b)
Under a non-recourse mortgage, AR is NOT limited to FMV (Tufts)
Gain (61(a)(3) gain counts as GI - (realized 1001(a), and recognized 1001(c))
No COD TP cant discharge it b/c it couldnt be collected by Mgee anyway
Kirby Lumber Rule:
o A corporation that buys back a bond at less than its issuing price realizes taxable income
The difference btw the issuing price and the purchase price is taxable income to the corporation
o EXCEPTIONS:
Solvent farmers
Real estate (Qualified real property business exception) Limited to the excess of outstanding principal
over FMV
Mortgage: Can exclude up to $2M from discharge of mortgage for principal residence basis in property
will be reduced by amount but not below 0
Rural or low-income professionals w/ forgiven student loans
Zarin Rule:
o The discharge of indebtedness resulting from a settlement fixing the amount of a disputed debt is NOT = GI
o Accounting mechanisms (like chips) are not property on which TP owes debt
BASIS
Fund. Prin. #1 = Liabilities, whether recourse (assumed) or nonrecourse (taken subject to) or otherwise incurred in the
acquisition of property are included in TPs basis (Crane)
o Debt used to acquire property is included in basis
o BUT debt AFTER land is already owned does NOT count in AB b/c it wasnt used to acquire the property
Reg. 1.61-6(a): When part of a larger propertys sold, split entire property basis based on subs FMV; G/L for each part
Purchase/Sale BASIS RULE # 1
o 1012 - Cost Basis (Basis Rule #1) = Cash + Debt
o Reg. 1.1012-1(a): In general, basis of property = cost. (the amount paid in cash or other property)
Exchange/Barter BASIS RULE # 2
o Property acquired in an exchange (property for property): basis according to Philadelphia Park
1. FMV of acquired property
2. FMV of property given up
3. In rare/extraordinary cases, basis of property given up becomes the basis of property acquired
Tax Cost BASIS RULE # 3
o Tax-Cost Basis: Basis in acquired property is equal to the amount included in GI (propertys FMV)
o Reg 1.61-2(d)(2)(i), Duberstein
Gift BASIS RULE # 4
o If property acquired by gift (detached & disinterested generosity) Transferee takes a transferred basis 1015(a)
o Exceptions to transferred basis rule:
Exception #1 = If the FMV < Basis of property at the time of the gift, and property is subsequently sold for
LESS than that FMV, then the basis is that FMV Prevents trafficking in losses
Exception #2 = If the FMV < Basis of property at the time of the gift, and property is subsequently sold for
an amount between FMV and that basis, then NO gain or loss. Reg. 1.1015-1(a)(2)
o But note gift tax transactions on all of these transactions AND taxes for income tax can vary from gift/estate taxes
o Net Gifts
R.R. 75-72: if at the time of the transfer, the gift is made subject to a condition that the gift tax be paid by the donee or
out of the transferred property, the donor receives consideration for the transfer in the amount of gift tax to be paid by
the donee. Under these circumstances, the value of the gift is measured by the FMV of the property or property right
or interest passing from the donor, MINUS the amount of the gift tax to be paid by the donee.
Gain = Donees Gift Tax Pmt Donors Adj. Basis
Net Gift = Total Gift Amt. Donees Gift Tax Pmt
Part gift/Part sale transaction BASIS RULE # 5 Gifting Property w/ Mortgage OR not arms-length & hidden gift
o Donors basis is allocated to sale component (NEVER sale loss), and NO gain/loss can be recognized on gift ( 267)
o Donee realizes NO gain/loss on the gift AND (Reg. 1.1015-4(a)(1)): Donees basis is the greater of:
 Attack/Short Sheet for Income Tax

(a) amount paid by the Donees

(b) Donors AB in the property
o BUT if one piece of property is treated entirely as a sale and another entirely as a gift Split up the basis.
Property Acquired btw Spouses / Former Spouses Incident to Divorce BASIS RULE # 6
o 1041 - Non-Recognition AND Basis Rule spouse ALWAYS take a transferred basis, even if gift or loss to other
Tax Consequences to Transferor
Non-recognition: No gain OR loss recognized on transfer of property to spouse OR former spouse
IF incident to a divorce (1041(a))
Tax Consequences to Transferee
Transfer treated as a gift (No GI (1041(b)(1) & w/ transferred basis (1041(b)(2) and 1015(e))
Bequest (Personal Prop. in Will) /Devise (Real Prop. in Will) / Inheritance (No Will) BASIS RULE # 7
o Transferee takes a stepped-up (or down) basis 1014
If Community Property, upon the death of one, ALL community property is stepped up (or down)
ADJUSTMENTS TO BASIS
1016(a)(2): Adjusted Basis = Original Basis amount of depreciation allowed + cost of improvements made (if any)
1016(a)(1) Make adjustments to basis for
o (1) Cost of Capital expenditures / improvements; (2) Depreciation deductions allowed; (3) Other receipts or losses
properly chargeable to capital account
o BUT NO Basis adjustments for Interest paid AND NO basis adjustments for paying off debt (assumed itd be paid)
109 and 1019 If improvements to land made by lessee, either: (1) include both in GI & AB, OR (2) include in neither.
o If the improvements by the lessee are excluded from the lessors GI under 109, then the basis of the property is
NOT adjusted for the improvements. (1019)
o However, if the improvements by the lessee are included in the GI of the lessor, then the basis of the property is
adjusted for the improvements (1019)
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DEDUCTIONS
Location of Deductions for Individuals
GI
Less: <Above the Line Deductions (anything listed in 62(a))> B/c ATL ded., TP should pick ACCOUNTABLE PLAN/EE exp. Rmbrmt.
== Adjusted GI (AGI)
Less: <Below the Line/Itemized Deductions OR Standard Deduction> With limitations for itemized/BTL deductions
Less: <Personal Exemptions> With limitations for personal exemptions
== Taxable Income what you apply the tax rate to
o Above the Line Deductions (anything listed in 62(a))
Deductions attributable to a trade or business carried on by the TP, if such trade or business does not consist of the
performance of services by the TP as an employee 62(a)(1); actually authorized by 162(a)
Certain trade & business deductions of EEs - 62(a)(2)(A) Reimbursed expenses of employees
Losses from sale/exchange of trade or business 62(a)(3); authorized by 165(c)(1)
Some Investment Deductions:
Losses from sale/exchange of investment property 62(a)(3); authorized by 165(c)(2)
Deductions attributable to rents & royalties of investment property 62(a)(4); authorized by 165(c)(2)
Alimony/SMP personal deduction that is Above the Line 62(a)(10); deductible under 215

o Below the Line Deductions Subject to PEPs (permanent- 161(d)(3)) and Pease (temporary - 68)
Some Investment Deductions (1) Dep. deductions of property held for production of income; (2) Investment interest,
ONLY to the extent of NET investment income ( 163(d))
Personal Deductions (e.g., QRI (163(h)); personal taxes (164)); charitable contribution (170); Gambling losses but
ONLY to the extent of gambling gains; EXCEPT A/SMP (Above-the-Line)
Itemized Deductions 63(d) = B.T.L Deds + Personal Exemp. ( 151) + if blind or + age <65 (both in 63)
Miscellaneous Itemized ded. (doesnt include 163 or 164) ONLY IF it exceeds 2% of AGI - 67(a)
BUT 68% of TPers take Std Ded. ($12,200 MFJ, or $6,100 single TP) + if blind or + age <65 (both in 63)
Pease Limited if > 250K ind. or 300K MFJ; Phased out if > $372.5K ind. OR $422.5 MFJ -- 68(a)
Personal Exemption ($3,900) all TPers get at least one (if MFJ, get 2, &1 per child); but have PEPs- 151(d)(3)

Type of Is Gain Capital Treatment Is Loss O&N Expenses of Depreciation

Event Included in GI? (if Sold/Exchanged) Deductible? Maintaining Deductions?
Type of Deductible?
Activity

Trade or Yes - 61(a)(3) No - 1221(a)(1), Yes, ATL - 165(c)(1) Deductible, ATL - Deductible, IF depreciable
Business 1001(a), (c) (a)(2), (a)(4), (a)(8) 162(a) property (167(a)(1))

Investment Yes Yes - 1221(a)(1), Yes, ATL - 165(c)(2) Deductible- 212 Deductible, IF depreciable
61(a); 1001(a),(c) BUT Losses limited 165(f) loss from CA Cf. Higgins property (167(a)(2))

Personal Yes Yes - 1221(a)(1), NO - 165(c)(3), NOT Deductible NOT deductible (167(a))
Use 1001(a), (c) BUT Losses limited UNLESS casualty event 262(a)

Trade or Business Expenses DEDUCTION

o Under 162(a), deductions for trade or business expenses are allowable IF they are:
(1) ordinary [usual or customary; defer to the TPs judgment --> Not normally challenged by IRS]
Note: Doesnt mean it happens frequently, but is something thats a customary/expected response.
(2) necessary [appropriate & helpful; defer to the TPs judgment --> Not normally challenged by IRS]
Example of ordinary and necessary expenses:
Rent; Salaries/Wages; Utilities; Maintenance/Repairs; Insurance; Interest; Certain Taxes; Supplies
Advertising Being looked at now, maybe should be a CAPEX and deducted over time
R&D (174) Being looked at now, maybe should be a CAPEX and deducted over time
Federal income tax is NOT deductible, BUT State income tax may be deductible
(3) Expenses MUST be an expense, as opposed to a CAPEX frequently litigated
Expense = benefit realized in the present tax year; CAPEX = benefit beyond present tax year
(4) paid or incurred during the taxable year [accrual and cash basis] AND
(5) in carrying on any trade or business [Compare: 212 says in investing setting.]
Being an employee is considered a trade or business.
o 162(a)(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;
o 162(a)(2) traveling expenses (including meals& lodging IF NOT lavish or extravagant under the circumstances) while away
from home in the pursuit of a trade or business; and
 Attack/Short Sheet for Income Tax

o 162(a)(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the
trade or business, IF TP has NOT or will NOT take title or get equity in the property
Miscellaneous Business Deductions Still need to meet 162 requirements
274 narrowed scope of 162 w/ respect to expenses to business meals, entertainment, gifts, employee awards and travel
o Travel Expenses: deductible IF necessary to carry out business while away from home in pursuit of trade or business
Home/Location of personal residence = regular place of business
o Meals/Lodging: deductible ONLY IF reasonable/appropriate, in pursuit of T/B while away from home overnight
o Meals and Entertainment: 50% of the cost if directly related to or associated with taxpayers trade or business274

Commuting to Place of Employment: nondeductible personal expense (work location is fixed and decision to live beyond
walking distance is personal)BUT may be deductible if temporary = must be direct connection btw expense and carrying out
trade - (1) between residences and temporary deduct if outside metropolitan); (2) between work locations deduct

Uniforms/Clothing Expenses: An employee may deduct unreimbursed expenses that he incurs which otherwise meet the Section
162 requirements
o Deductible ONLY IF required as condition of employment and not suitable for general use

Organizational Dues: Dues paid to organizations directly related to ones business are deductible under 162

Education Expenses: deductible ONLY IF incurred to maintain/improve skill required by current trade or business (Reg 1.162-5)
o Argument that could be capitalized (and deducted over time) b/c it provides a long-term method

Advertising: Ad. exp. are deductible in year in which they are incurred/paid even though benefits extend for several years Dues

Fines Paid to a Government for Violation of Law = 162(f)

Lobbying Expenses = Congress tightened rules on deductions of lobbying expenses; now generally nondeductible
o Except expenses in connection with lobbying local govt bodies & de minimis in-house lobbying expenditures ($2,000)

Salaries or Other Compensation: deductible IF reasonable compensation for services actually rendered
o 162(m) = NO ded. for comp. > $1M to CEO + 4 most highest paid of public corp. UNLESS performance based

Most Other: deductible IF ordinary and necessary (rent, repairs, interest, bad debts)

Special Rules on Realty Deductions

o 1986 Act significantly reduced the opportunity to use real estate as a tax shelter
o Real property = land and buildings only!!!
i. Land is NOT depreciable (Reg. 1.167(a) 2)
ii. Also cannot take dep. deductions on personal use buildings (e.g., home) (Reg. 1.167(a) 2)
o Building has to be used in trade or business activity or investment activity to be depreciable
i. Since buildings are tangible property 168
ii. 167(a) authorizes depreciation deduction
o Because buildings are tangible property, 168 determines how depreciation is calculated
 Attack/Short Sheet for Income Tax

Investment Activity Expenses DEDUCTION

o Under 212(2), expenditures are deductible for the management, conservation, or maintenance of property held for the
production of income.
o Examples of Deductible Investment Activities
1) Expenses for Investing in stocks & bonds
2) Expenses for Investment advisor fees ( 212(1)and 212(2))
3) Expenses for Investment in real estate for rental income (Exp = maintence/repairs, insurance, utilities, interest exp.)
4) Investment Interest Expense (Deductible against Net Investment Income (Investment Income Investment Expense)
o Note: Do NOT expense commissions rather, include commissions in basis.
Reg. 1.263(a) 2(e): Commissions paid in selling securities are an offset against the selling price, UNLESS youre a
dealers in securities then commissions treated as an ordinary/necessary bus. expense
Interest DEDUCTION
o 163(a): A deduction is allowed for interest paid or accrued on indebtedness (for some personal activities-163(h))
Business interest ( 162) and investment interest ( 212) are already deductible
o Interest = the amount paid for the use of money (NOT pmt. for other services the lender performs)
Principal repayment has NO tax consequences for either party
o Interest payment for Lender, interest payment is GI under 61(a)(4); for Lendee, may deduct under 163(a)
Note: NO deduction for interest on loan used to purchase tax-exempt obligations (muni bonds / life insurance annuities)
(265(a)(2)) because its a tax exempt bond.
Note on Zero Coupon Bond: Lender MUST include interest in GI, even if he has NOT received the actual cash
[Matching Principle (since Lendee can deduct interest expense over course of loan]
o Bond interest is includible in GI and deductible ratably over the life of the bond (regardless of if payments are made

o 163(d): Investment Interest Non-Corp., can ONLY deduct investment interest against net investment income
Net investment income = investment income - investment expense
BUT can carry forward the amount of disallowed interest (i.e., excess interest expense)
Note: TP can (1) choose for dividends and LTCG to receive preferential tax treatment and be entitled to NO deduction
for investment interest expense OR (2) can be taxed at ordinary rates for dividends and LTCG and be allowed to reduce
that income by investment interest expense.

o 163(h) ONLY allows deductibility of personal interest in certain situations :

(A) interest paid or accrued on debt for Trade or Business (EXCEPT performing services as an employee),
(B) investment interest (within the meaning of 163(d) [Investment Interest]),
(D) qualified residence interest (within the meaning of 163(h)(3)),
(F) interest allowable for educational loans. [221: Max deduction = $2,500, phased out starting at $50K]
o Qualified Residence Interest Any interest which is paid or accrued during the year on:
Acquisition indebtedness with respect to any qualified residence of the TP
MUST be (1) incurred in acquiring (existing home), constructing (build new), or substantially improving
(renovation - adds value OR increases life or uses *often litigated) any qualified residence of the TP, AND
(2) is secured by such residence (residence is security for loan).
(3) limited to principal amount of $1,000,000 ($500,000 in the case of married filing separately).
AI also includes refinanced debt, up to the value that it was used to pay off the initial AI (i.e. new debt steps
into shoes of old AI for portion used to pay off the old AI). (163(b)(3)(B) Flush)
Home Equity indebtedness with respect to any qualified residence of the TP, means any debt:
(1) that is secured by such residence, AND
(2) is equal to the lower amount of:
o (i) TPs Equity = FMV of Qualified Residence MINUS Acquisition Debt OR
o (ii) $100,000
Note: Home equity indebtedness is max of $100k for MFJ and $50k for single.
Qualified residence means (i) TPs principal residence, and (ii) one other residence of the TP. Principal residence =
where majority of time is spent; other residence = TP can pick one other residence for QRI
Losses DEDUCTION
o 165(a): May deduct certain losses sustained during the taxable year IF not compensated for by insurance
o 165(c): For individuals, limited to:
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, even if not connected w/ trade or business; OR
(3) personal losses arising from fire, storm, shipwreck, or other casualty, or from theft--limited by 165(h)
Allowed ONLY to the extent they exceed 10% of AGI (Section 165(c)(3) & (h))
o NO losses on dispositions of personal assets ( 165(c)) and NO losses from transactions btw Related TPers ( 267)
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Taxes DEDUCTION
o Note: 164 gives a tax deduction in a personal setting BUT still cite to 164(a)(1) for taxes in T/B setting
o 164(a): The following taxes can be deducted for the taxable year they are paid or accrued;
(1) State and local, and foreign, real property taxes
(2) State and local personal property taxes
(3) State and local, and foreign --> (1) income, (2) war profits, and (3) excess profits, taxes
(4) The GST - generation skipping tax ( tax imposed on income distributions)
(5) The environmental tax imposed by 59A
o Note: Under 901 Election to take CREDIT against US taxes owed for foreign income taxes TPers almost always elect
foreign tax credit under 901 (credits reduce taxes dollar for dollar) credit removes difference btw earning income in the US v.
foreign country; the income results in the same taxes
o 164(b)(5): Gives TP the election to deduct State & Local sales tax in lieu of State & local income tax
Expires on Jan. 1, 2014
More beneficial to TPers in states w/o state income tax; also more beneficial to TPers in states where either Income or
Sales Tax is on the extreme ends; disadvantageous to TPers in states where state income and sales tax are average,
because they can only choose to deduct one Argue that both deductions should be allowed (Senator & Hanna)
o Note: NO Deduction for Federal Income Taxes ( 275)

Start-up Expenses (pre-trade or business expenses) -- DEDUCTION Commented [A1]:

o Start-up Expenditures: meet the first 4 rqmts of 162(a) but do NOT get a deduction b/c they are PRE-trade or business expenses 1.Beginning of business Start applying 162
o 195(a): NO deduction allowed for start-up expenditures, UNLESS there is an exception a.TP wants this to be as early as possible
i.When acquiring an existing business, it starts when purchased
Start-up = (1) Investigating the creation/acq. OR (2) creating OR (3) activity in anticipation of becoming an active T/B ii.If creating own business, there is little guidance
o 195(b): Election to deduct [TPs always elect] If TP elects to deduct any start-up expenditures 1.Definitely starts on the day the business opens doors to the
(A) TP may deduct for the taxable year in which the active trade or business begins an the LESSER amount of: public
(i) the amount of start-up expenditures with respect to the active trade or business, OR 2.Maybe a few weeks earlier if open for select customers
earlier
(ii) $5,000 minus amount by which the start-up expenditures exceed $50,000
(B) AND the remainder of such start-up expenditures is deducted ratably over 180-month period beginning with the
month in which the active trade or business begins. Application of 195 to individuals seeking new employment
195 does not apply to individuals seeking new employment.
195(b)(1) ELECTION Rule Example Such deductions must be determined under 162 & 212
Rev. Ruling 75-120 allows deductions for expenses for employees
seeking new employment in the same trade, whether successful or
Expenditures < $5K Immediately deduct all $4K Immediate = $4K not

$5K < Expenditures < $50K Immediately deduct $5K; and deduct the remaining amount $12K Immediate = $5K
over 180 months (SL Dep.) Over 180 mo = $7K

$50K < Expenditures < $55K Immediately deduct $5K LESS the amount Start-up $52K Imm. = $3K [5- (52 50)]
expenditures exceeds $50K; SL remaining over 180 months Over 180 mo = $49K

$55K < Expenditures No immediate deduction; all is deducted over 180 mo (SL) $60K: Immediate = $0;
Over 180 =$60K

Depreciation DEDUCTION
o 167(a): May deduct a reasonable amount for depreciation for the exhaustion, wear & tear, obsolescence OF:
(1) property used in a Trade or Business {business activity], OR
(2) property held for the production of income [investment activity]
o Note: 168 Tells us what amount do deduct for Tangible Property BUT EXCLUDES Land, Inventory, Stocks/Bonds
o Note: 197 - Goodwill & Intangible are amortized (see what life is)
o Under 167(c)(1), Basis for depreciation = cost basis 1011
o Steps To A Depreciation Problem
1. Do 179 Bonus Depreciation (Expense) -- Expensed in the year placed in service
a. Maximum amount of 179 expense is $500k (Dollar-for-dollar cap reduction kicks in at $2MM)
i. (1) Tangible (168), (2) 1245 (depreciable personal) property , (3) used in T/B (e.g.,
equipment/machinery)] that is , (4) purchased AND , (5) placed in service in the taxable year;
b. AND if over $2mm, the $500k shall be reduced by the same amount] if so, AB must first be reduced by 179
before applying 168
c. Note: 1.179-1(f)(1) - Basis is reduced by the amount of 179 expense taken
d. Note: Take the Deduction/Expense on properties w/ longer class life FIRST --> TVM
e. Note: Conceptually based on Cary/Brown theory
2. Determine dep.: (1st 168(k) deduction (50% dep. w/ NO phaseout), THEN 2nd 168 dep.)
 Attack/Short Sheet for Income Tax

3. Then do 167 - deduction allowable for property subject to wear & tear/obsolescence used in a Trade or Business OR
Investment Activity (EXCLUDES personal use property)
(1) Class Life of Property (2) Classification of Property - (168(e)) (3) A.R.P
168(i) & Rev. Proc. 87-56 *Half-Year Convention UNLESS otherwise noted - (168(d)) (168(c) & 168(e)(1)

Class Life < 4 Years 3-Year Property 3 Years

Note: TP can elect to do DDB until SL>DDB (common), or elect SL (168(b))

4 or more < Class Life < 10 5-Year Property 5 Years

Note: TP can elect to do DDB until SL>DDB (common), or elect SL

10 or more <Class Life< 16 7-Year Property 7 Years

Note: TP can elect to do DDB until SL>DDB (common), or elect SL

16 or more<Class Life < 20 10-Year Property 10 Years

Note: TP can elect to do DDB until SL>DDB (common), or elect SL

20or more <Class Life < 25 15-Year Property 15 Years

Note: MUST use 150% Dep. until SL>150%

25or more < Class Life 20-Year Property 20 Years

Note: MUST use 150% Dep. until SL>150%

Residential rental property (>80% rental income - NOT hotel/motel) 27.5 years
Note: MUST use SL and Mid-Month Convention (168(d)(2))

Nonresidential real property 39 years

Note: MUST use SL and Mid-Month Convention (168(d)(2))
**Note on ARP: (1) is given. Use (1) to determine (2), use (2) to determine (3). Then depreciate property over (3).
If TANGIBLE is it a 179-asset (i.e., depreciable tangible personalty acquired for a T/B but NOT an income-producing activity)?
If YES --> Deduct Immediately ABOVE the LINE up to $500K of the cost of the 179 property placed in service
during the taxable year AND Depreciate the rest of the cost, if any. (if TP places MORE than $2 MM of 179 property
in service in the taxable year, the deduction cap is reduced by $1 for each dollar OVER $2 MM)
If NO --> Depreciate following 168
If INTANGIBLE --> is it a 197 -intangible (e.g., goodwill, going concern value, information base, patent, copyright, govt license,
covenant not to compete, franchise, trademark) that was ACQUIRED and USED in connection w/ TB?
If CREATED by TPgenerally DEPRECIATE by applying SL method over the useful life to the TPs basis ( 167)
If ACQUIRED/Used in T/B --> AMORTIZE by applying the SL method over 15 years to the TPs basis ( 197)

Depreciation of Goodwill/Intangibles - DEDUCTION

o 197: TP may use amortization deduction for any amortizable 197 intangible, by amortizing the AB (to determine gain) of such
intangible ratably over the 15-year period beginning with the month in which such intangible was acquired.
Depreciate asset over its USEFUL life Amortize asset over its ARTIFICIAL life
o 197 intangible includes acquired:
(A) goodwill, (B) going concern value,
(C)(i) workforce in place including its composition & Ts & Cs of its employment,
(C) (ii) business books and records, operating systems, or any other information base (including lists or other
information with respect to current or prospective customers),
(C) (iii) any patent, copyright, formula, process, design, pattern, knowhow, format, etc.
(C) (iv) any customer-based intangible; (C) (v) any supplier-based intangible, AND (C) (vi) any other similar item,
(D) any license, permit, or other right granted by a governmental unit
(E) any covenant not to compete entered into in connection with an acquisition (directly or indirectly) of an interest in a
trade or business or substantial portion thereof, and (F) any franchise, trademark, or trade name.
o Amortizable 197 intangible includes intangibles(A) acquired by the TP after the date of the enactment of this section, and
(B) held in connection w/ the conduct of a trade or business OR an income-producing activity (212).
EXCLUDES self-created intangibles.
Samuelson Depreciation
o The difference between the present value of expected cash flows at the start of the taxable period and the present value of
expected cash flows at the end of the taxable period.
 Attack/Short Sheet for Income Tax

Starts off small and gets increasing large; slower than SL Dep.
Take the sum of all the Expected Values at beginning, advance 1 year, recalculate, subtract the difference.

Non-Residential Real Building (39 Years, SL Dep.) - 168(d)(2)(A)

Period/Year (Dep Yrs) Basis (167(c)(1) use 1012 Dep. Ded. ($ , %) Adj. Basis Notes

1 (____) SL (1.00 /39) = % 168 Dep.

*Mid Month Convention *Note: Mid-Month Convention
Jan15 = .9583 / Dec.15 = .04167 for yr. placed in svc. AND sold

2 (____)

3 (____)

4 (____)

5 (____)

Yr. X (__)*** Mid-Month *** Mid-Month IF sold/last year

Residential Rental Building (27.5 Years, SL Dep.) 168(d)(2)(B):80%+ of GI is dwelling units (NOT hotel)
Period/Year (Dep Yrs) Basis (167(c)(1) use 1012 Dep. Ded. ($ , %) Adj. Basis Notes

1 (____) SL (1.00/27.5)= % 168 Dep.

*Mid Month Convention *Note: Mid-Month Convention
Jan15 = .9583 / Dec.15 = .04167 for yr. placed in svc. AND sold

2 (____)

3 (____)

4 (____)

5 (____)

Yr. X (__)*** Mid Month *** Mid-Month IF sold/last year

Equipment OR Other Property (Look @ Dep. Method & ARP)

^^ Change to 150% for 15- and 20-year property ^^
Period/Year (Dep Yrs) Basis (167(c)(1) use 1012 Dep. Ded. ($ , %) Adj. Basis Notes

Do 179 (1) Tangible (2) Depreciable Personal Property (3) Purchased (4) for T/B BEFORE 168 Dep
For 179: if $2 MM + of 179 property in service in year, deduction cap reduced by $1 for each dollar over $2MM (so greater than
$2.5MM gets $0 in 179 depreciation)
Change to 150% for 15- and 20-year property

1 (____) *Mid-Year DDB (1.0/ARP= %) *2 SL-1.0/ X yr=% *Note: Mid-Year (for year placed
150 (1.0/ ARP =%)*1.5 Imm. after pt in Service AND when sold)
**Do DDB or 150% until < SL

2 (____)

3 (____)
 Attack/Short Sheet for Income Tax

4 (____)

Yr. X (__)*** Mid-Year *** Mid-Year IF sold/last year

Capital Expenditures NO DEDUCTION
o 263: No deduction/expense is allowed for(1) Any amount paid out for new buildings OR for permanent improvements or
betterments made to increase the value of any property Its a CAPEX Add it to basis
o Reg. 1.263(a)-1T CAPEX includes:
(1) amount paid for new real OR personal property Acquisition + Sales Tax + Installation + Transportation Costs
(2) Costs incurred for permanent improvements / betterments / construction made to increase the value of any tangible
real or personal property/estate
(3) Repairs = restoring property or making good the exhaustion thereof for which an allowance is/has been made;
(4) Where TP realizes significant benefits beyond the year of expenditure, the expenditure should be capitalized
(e.g., INDOPCO realized synergy benefits well beyond the current year = significant, NOT an incidental, future benefit)
(5) TP expenditure that serves to create OR enhance a separate and distinct asset should be capitalized under 263 (may
be a sufficient condition for capitalization, but it is by no means necessary)
Additionally, Regulations generally require capitalization of:
(6) An amount paid to acquire, create, or enhance an intangible asset;
(7) An amount paid to facilitate an acquisition or creation of an intangible, and
(8) An amount paid to facilitate a restructuring or reorganization of a business entity OR a transaction involving
the acquisition of capital, including stock issuance, borrowing, or recapitalization INDOPCO
o Repairs Reg. 1.162-4
Repairs that do NOT materially add value or prolong life = expense ( 162(a))))
(9) Repairs in the nature of replacement (or updating) that prolong life = CAPEX

Capital Expenditure VS. Expense

o An expense is something that gives you a current benefit (using up the benefit of that payment currently during the course of the
taxable year), as opposed to a capital expenditure (give it basis) that gives you a payment that goes well into the future (benefit
goes well into the future). INDOPCO: significant benis beyond year of expenditure (NOT merely incidental, future benefit)
o 263: If an expenditure will (1) create a separate, distinct asset OR (2) yield benefits extending beyond one year = CAPEX
CAPEX (give it a basis and dep.) = equipment, building, restorative repairs, AND Land = Capex (BUT No Dep. Ded.)
Long-term Improvements are NOT 162 deductible (taken this year), but ARE 263 depreciable (over time)
 Attack/Short Sheet for Income Tax

o Will the CapEx produce taxable income in the TPs business or income-producing activity?
If NO --> asset = personal asset, & cost recovery is postponed UNTIL disposition. Basis assigned and offset against AR.
If YES, is the asset a depreciable asset ( 167) (i.e., a wasting asset or subject to wear and tear)?
If YES, is the asset tangible OR intangible?
o Problems w/ INDOPCO: Distinguishing incidental future benefits (expense) v. significant future benefits (capital expenditure);
There is NO asset resulting from the professional fees, AND no way to depreciate expenditure over time b/c NO asset.
Timing Principles CASH-BASED Methods
446: (a) Taxable income must be computed under the method of accounting on the basis of which the TP regularly computes his
income in keeping his books, UNLESS (b) If no method of accounting has been regularly used by the TP, OR if the method used does
not clearly reflect income, the [government can change it clearly reflect income]
o If TP owns more than one T/B, can use different methods for each T/B
o BUT some provisions force cash method even on TPers who adopted accrual method (i.e. Charitable ded. require pmt. (170(a))

Cash Method (generally used by individuals, small businesses and service-oriented businesses)
This is because it is the easiest method, BUT no requirement that the two match up in the same year
Income GI upon RECEIPT (of (1) cash, (2) property, or (3) services)
o 451(a) include in GI the amount received by the TP
Cash = Bills, coins, checks OR 3rd party CC (Visa) (BUT NOT 2-Party CCs, i.e. Dillards Card)
3rd party CC
o **Gray Area = (1) payment when CC is run/signed, OR (2) delayed until CC bill paid**
Have to be consistent!
Borrowed funds (loan) = payment
o Actual Receipt: actually have it in-hand (e.g., cash (bills/coins & 3rd party CC) or check in hand)
o Constructive Receipt: the date the money was made available to the TP (Reg. 1.45102(a)) Prevents abuse
Maybe no constructive receipt IF date/timing and geographic limitations makes it unavailable (Baxter)
Checks must be delivered to be payment Mailing = Delivery = Paid
Deduction Expense upon PAYMENT ( 461(a))
o Reg. 1.461-1(a)(1) TP using cash method should claim a deduction in the year paid
Deductionpayment is key (Has payment taken place?)
(for Cash/Check) Paid = delivered = mailed
(for 3rd party CC) when CC is run & receipt is signed
No constructive payment CANNOT deduct payment UNTIL it is actually paid and allowed by statute
o Pre-Paid Expenses / Prepayments
Reg. 1.461-1(a) Cash Method: If an expenditure creates an asset having a useful life which extends
substantially beyond the close of the taxable year, that expenditure IS NOT deductible, or MAY be
deductible ONLY in part, for the taxable year in which it was made.
Ex: insurance premiums of $6,000 for 3 years of insurance coverage Use 162(a) five-prong test for exp.
Is it an ordinary and necessary business expense? Yes
Is that an expense OR is it a capital expenditure?
o CAPEX: Insurance is an intangible asset (that will benefit the business for 3 years)
o To be consistent, prepaid insurance should be deductible over the life of the prepaid
period (Boylston Market Assn)
B/C its Capex give it a basis and deduct depreciation on a 3-year basis (if
you take it all in Year 1, thats a mismatch of benefits) = $2,000 deduction / year
BUT Zaninovich and Reg 1.263(a)-(4)(a) 12 Month Rule (Rule of administrative convenience)
IF the asset has a useful life of 12 months or less Deduct the whole expense in the year paid,
even if the expense touches two different years
o Prepaid Interest - 461(g)
If the Cash Method is used, TPers must allocate deductions for prepaid interest to the period to which they
relate by way of capitalization and amortization
 Attack/Short Sheet for Income Tax

Timing Principles ACCRUAL-based Method

Accrual Method
Income GI = All Events Test
o 2 prong test: (1) right to receive income is fixed, and (2) amount can be determined w/ reasonable accuracy
Test is MET when goods are sold on credit, b/c at time of sale, knew amounted owed to you
**The right to receive payment could either be when (1) services are rendered, OR (2) bill is sent out
There is NO clear rule. Most use billing date/Bill is sent out (administratively convenient).
However must be consistent and cannot manipulate
Deduction All Events Test + Economic Performance
o 3 prong test: All Events Test (right to deduct + amt determined) + Economic Performance prong (461(h))
o Economic performance instituted to prevent TPers from taking advantage of the TVM
Matching principle: expense is matched and reported in the same year as the income produced by the expenditure

RECEIPT Advanced Payment for Services Trilogy of SCOTUS cases (Schlude doctrine)
o General rule: accrual TP must include in GI an advance pmt for services upon receipt IF services will be performed
on customer demand (No GI in future , include all at receipt)
o Treated like cash method b/c better reflects GI since income is based on customer demand, not a fixed schedule
IF services NOT rendered at fixed rate (but rather on cust. demand), upon receipt, all included in Yr. 1 GI
If you CANNOT tell court in advance when services will be rendered INCLUDE in GI upon receipt
MUST be able to determine when services will be rendered services for a particular member (not in the
aggregate) in order for the GI to be ratably deferred (American Automobile Association)
Possible Exceptions to Schlude Trilogy:
o Revenue Procedure 2004-34 ONLY real exception to Trilogy cases
Allows a limited amount of deferral for a TP that receives an advanced payment for services; however it
ONLY allows for a 1 year deferral At most Rev. Proc. 2004-34 gives a one year deferral and no more
Include ONLY the portion of the advance payment in Year 1 in proportion to the services rendered
in Year 1. However, all of the remainder of the advanced payment must be included in Year 2,
regardless of when services are going to be rendered
o Artnell v. Commissioner (7th Cir. 1968 After Schlude Trilogy)
General rule (under Schlude): an accrual TP must include in GI in the year of receipt prepaid items for
which services will be performed in a later yr.
Artnell Rule: An accrual method TP can defer inclusion of an advance payment for services if the extent
and time of performance are so certain, and related items properly accounted for with such clarity, that a
system of accounting involving deferral of prepaid income is found clearly to reflect income.
Argument for exception IF Customer services here are NOT provided on customer demand but rather are provided on a
fixed schedule (BUT could have a rainout, etc.) B/c its so certain, you dont have to include it upon receipt, you can
spread out GI as you perform the services (clearly reflects income, b/c its so certain so you can spread it out over time)
Deductions All Events Test for Deductions
o Reg. 1.461-1(a)(2): A liability/deduction is incurred when:
(1) all the events have occurred which establish the fact of the liability(deduction),
(2) the amount of the liability (deduction) can be determined with reasonable accuracy, AND
(3) economic performance has occurred with respect to the liability (deduction) ( 461(h))
o Economic performance occurs when:
461(h)(2)(A) Services or property is provided to the TP which causes the liability [expense] to arise
Services/property provided to TP occurs as TP uses such property.
461(h)(2)(B) when the TP provides property or services which causes the liability [expense]
Services/property provided by TP occurs as TP provides service
461(h)(2)(C) for tort and workers comp economic performance occurs upon pmt
This treats accrual method tax payers like cash method TPs for workers comp and tort payments;
when payment occurs Putting them on the Cash Method
o All Events Test Prong (1)
The right to receive payment could either be when services are rendered, OR when services are billed for
There is NO clear rule. Most use billing date/Bill is sent out (administratively convenient).
However must be consistent and cannot manipulate
Could also analogize to manufacturing. regulation
Reg. 1.446-1(c)(2)(ii)(C) Mfg selling products may account for sales when the TP ships the
goods, when the product is delivered or accepted, or when the title passes to the customer.

o For CASH-based TP DEDUCT at the time of payment

 Attack/Short Sheet for Income Tax

o For ACCRUAL-based TP IF econ performance is split over 2 days (12/31 &1/1), split it equally over 2 days.

ACCRUAL method TP receives Advance Payment for services

General Rule An accrual-method TP MUST include an advance payment for services in income upon receipt based on the
Schlute Doctrine fact that the services will be performed on customer demand SCOTUS ruling
YEAR 1 YEAR 2 YEAR 3 YEAR 4
Gross Income $ $0 $0 $0
*all GI in Yr 1 when received
Deductions
(Taken as Expense < > < > < > < >
incurred) All deductions must meet
the O&N expenses all
events test
Taxable Income = = = =

An Accrual method TP receives Advance Payment for services

First Exception An accrual-method TP can defer inclusion of advance payments for services for, at most, one year. The TP
Rev. Pro. 2004-34 includes in income during the current year ONLY to the extent that services are rendered in the current year.
The remaining income MUST be included in the next year (Year 2). At most, this gives you a one-year
deferral, and no more.
YEAR 1 YEAR 2 YEAR 3 YEAR 4
Gross Income $ ____________________
*include here to the extent $___________ $0 $0
services were rendered in Yr. 1 **remainder here
Deductions
(Taken as Expense < > < > < > < >
incurred) All deductions must meet the
O&N expenses all events
test
Taxable Income = = = =

An Accrual method TP receives Advance Payment for services

Second Exception An accrual-method TP can defer inclusion of advance payments for services IF the extent and time of
Artnell Exception performance are so certain and related items properly accounted for w/ such clarity, that a system of acting
involving deferral of prepaid income is found clearly to reflect income (7 th Cir. decision discussing baseball)
YEAR 1 YEAR 2 YEAR 3 YEAR 4
Gross Income $ __________________ $ ______________ $ _______________ $ _______________
*ratable reflection of GI
Deductions
(Taken as Expense < > < > < > < >
incurred) All deductions must meet
the O&N expenses all
events test
Taxable Income = = = =
 Attack/Short Sheet for Income Tax

CHARACTERIZATION
1245 Gain = Any depreciable PERSONAL property (TANGIBLE - Equipment/Machinery, etc, or self-created INTANGIBLE )
Recognition AND characterization rule (to be consistent and fix what was a flaw in the system)
Qualitative provision matches up the character of the gain/deductionsrecharacterizing the gain to match ordinary ded.s
Requirements = (1) Gain, (2) Depreciable personal prop, (3) Disposed of (sold, exchanged, stolen, condemned, etc.)
1245 & 1250 = most powerful provisions in IRC (1245(d))
o BUT 1245 does NOT apply to (1) gift, (2) transfer upon death, or (3) transfer to corp./partnership
Gift property keeps the recapture taint whenever it is sold, 1245 will apply
Death cuts off the recapture taint
1250 Gain = Any depreciable REAL property =Buildings (extends recapture concept of 1245 to real prop., w/ substantial changes)
Both a Recognition (primary) AND Characterization (secondary) rule
Requirements = (1) Gain, (2) Depreciable real prop, (3) Disposed of, (4) held for less than 1 yr (longer doesnt have effect)
Real property is different from personal property because there is an appreciable rise in the value of real property attributable
to a rise in the general price level over a long period of time BUT Only if dep. exceeds the SL ded. is it recaptured as OI
IF THE BUILDING IS HELD for less than a year, this will apply.
1221(a):Capital Asset = All property is a Capital Asset, EXCEPT: (1) Inventory; (2) Property held in a T/B; (3) Copyright,
music, artistic, literary composition, or letters or memorandum (or similar property); (4) A/R and N/R; (5) Congressional
publication not bought at FV; (6) Business supplies
*The ONLY property that is a CA used in a T/B is (1) collectible (b/c its NON-depreciable personalty); & (2) self-created goodwill

1221(a)(3):[Eisenhower Amendment] A copyright, a literary, musical, or artistic composition,

[Nixon Amendment] a letter or memorandum, or similar property, held by a TP whose personal efforts created such
property, OR in the case of a letter, memorandum, or similar property, a TP for whom such property was prepared or
produced, OR
[Gifts of (3) property] a TP who receives property as a gift, it keeps its classification as a NON-capital asset and the
donee takes a transferred basis.
Note: 3 possibilities: Gain is either LTCG, STCG, or ordinary income.
If gain would be (1) LTCG if sold, amount of deduction is FMV of property.
If gain would be (2) STCG or (3) ordinary income if sold, amount of deduction is limited to basis (low).
Note: Patents = Capital Asset
Note: 1221(b)(3): The TP can elect to treat musical compositions OR copyrights in musical works sold or
exchanged by a TP (who created the music) as a capital asset, notwithstanding (a)(1) and (a)(3).
o Elect this provision for music sold at gain (=capital) but not sold at a loss (=ordinary)

1221(a)(5): A publication of the U.S. govt (including the Congressional Record) received from the US Govt or other
agency for anything less than the sale price offered to the public, AND which is held by (a) a TP who received such
publication, or (b) a TP in whose hands the basis is determined
Note: Anti-abuse provision: the record is NOT a Capital Asset, so if the Congressman sold it, gain would be
ordinary, and the amount of deduction limited to AB.
1222 = S/T & L/T Capital Gains & Losses Defined
Must be a recognized gain. So if you have unrecognized gain (transferred to spouse 1041), do NOT figure out the character.
Only talking about deductible losses (NO personal matters). If loss is NOT deductible (NOT usable by TP) no one cares
about characterization (i.e. loss on sale of personal car; Cf: Stock deductible under 165(c)(2) character of this loss matters
i. Requirements for LTCG or LTCL
1. If gain/loss arises in a transaction involving a C.A. (b) Sold or exchanged, & (c) Held for 1+ year
ii. Requirements for STCG or STCL
1. Capital asset; (b) Sold or exchanged, and (c) Held for one year or less
iii. Holding Period for Capital Assets (Rev. Ruling 66-7) (IRC 1223)
1. Date of acquisition disregarded (excluded from holding period)buy property on 12/31, begin count on 1/1
2. Date of disposition is included in the holding period
iv. Sold or Exchanged To be a capital gain or loss, a capital asset must have been sold or exchanged

1231 = Hotchpot Recharacterization

Almost all gains or losses without the Hotch Pot would be treated as ordinary because they lack the sale/exchange
(conversions) attribute OR capital attribute (business assets)
o This is a pro-TP provision (best of both worlds)
If 1231 applies, then it makes all gains capital gains (long-term since requires +1 yr.)
If 1231 does NOT apply, then it makes all losses ordinary losses (no limit on deductibility)

Equipment/Machinery
Bought for: $__________
Sold for: $ _________
Dep Ded: $ _________
Adj. Basis: $__________
Gain: $_________
Any gain due to Dep?
1245 recapture as O.I.
Requirements
Depreciable personal
property disposed of
(sale/exchange/involuntary or
compulsory conversion)
*does NOT apply to gifts,
transfer @ death
Gain over OB=CG 1231
Gain below OB = OI
Sale or Exchange of
1221 Capital Asset?
--If used in T/B NO
--if InvestmentYES
--if PersonalYES
1231
If any remaining gain after
O.I. recapture check to see
if any goes to 1231 HotchPot
Involuntary Conversion?
Fire, storm, theft OF:
(1) equip used in T/B for 1+ yr
or (2) C.A. held for +1 year
- in connection w/ T/B
- trans. entered for profit If
Ls > GsLs & Gs=OI
Iif Gs Ls Gs & Ls to Iif Gs Ls Gs & Ls to
Main HP
Main HP
Sale/Exchange of equip. held
for 1+ year in T/B
Condemnation of equipment
used in T/B or C.A. held for
more than 1 yr. (a) in
connection w/ T/B or (b) trans.
for profit
Gains and losses from Sub
Cubbyhole #3
Attack/Short Sheet for Income Tax
Building
Bought for: $____________
Sold for: $ ___________
Dep Ded: $ ___________
Adj. Basis: $____________
Gain: $____________
Any gain due to Depreciation?
1250 recapture as O.I.
1 Year or LESS: Lower of:
o Total Dep. Taken or
Gain
MORE than 1 year: Lower
of:
o $0 or Gain (always $0)
Any remaining gain goes to
1231 Main HP
Sale or Exchange of
1221 Capital Asset?
--If used in T/B NO
--if InvestmentYES
--if PersonalYES
1231
If any remaining gain after
O.I. recapture check to see if
any goes to 1231 HotchPot
Involuntary Conversion?
Fire, storm, theft OF:
(1) building used in T/B 1+ yr
or (2) C.A. held for +1 year
- in connection w/ T/B
- trans. entered for profit
If Ls > GsLs & Gs=OI
If Ls > GsLs & Gs=OI
Main HP
Main HP
Sale/Exchange of building held
for 1+ year in T/B
Condemnation of building used
in T/B for more than 1 year
OR C.A. held for 1+ yr. (a) in
connection w/ T/B or (b) trans.
for profit
Gains and losses from Sub
Cubbyhole #2
Modified 1250 LOWER of:
(1) total dep. ded. taken OR (2)
gain
Land Collectible
Bought for: $____________ Bought for:$_______
Sold for: $ ___________ Sold for: $ ________
Dep Ded: $ ___________ Dep Ded:$ ________
Adj. Basis: $____________ Adj. Basis: $_______
Gain: $____________ Gain: $___________
NO 1245 or 1250 b/c NOT NO 1245 or 1250 b/c
depreciable NOT depreciable
Sale or Exchange of Sale or Exchange of
1221 Capital Asset? 1221 Capital Asset?
--If used in T/B NO --used in T/B YES
--if InvestmentYES --if InvestmentYES
--if PersonalYES --if Personal YES
1231 1231
Does gain/loss on disposal of land Does gain/loss on
fit into 1231? disposal of collectible
fit into 1231?
Involuntary Conversion? No main HP b/c NOT
Fire, storm, theft OF: depreciable)
(1) land used in T/B for 1+ yr or (2)
C.A. held for +1 year Involuntary
- in connection w/ T/B Conversion?
- trans. entered for profit Fire, storm, theft OF:
(1) collectible held for
+1 year in connection
Iif Gs Ls Gs & LsMain HP w/ T/B or
(2) collectible held for
Main HP +1 year in trans. entered
Condemned property used in T/B for profit
(IF land in T/B held for more than
one year) If Ls > Gs
Ls & Gs=OI
Land held for 1+ year in connection If Gs Ls
w/ T/B, OR Gs & LsMain HP
Land Investment held for 1+ year
Gains and losses from Sub
Cubbyhole #3 Cubbyhole #1
Collectible CG +
NSTCL + Carry-
forward LTCL
 Attack/Short Sheet for Income Tax

Bad Debts Deduction

Bad Debt Deduction - 166

Relates to both characterization & accounting method
o Characterization Bad debt deduction should be the same character as the GI that its offsetting (ordinary)
o Since character of income was ordinary, the bad debt ded. should be an ordinary ded. (to be consistent)
Two ways bad debt arises
(1) Loan money and the borrower doesnt repay
As long as the lender makes reasonable efforts to get the money back (calling, pursuing, but dont
have to file a lawsuit), & then determines that debt was worthless, TP can take a bad debt ded. under 166
BUT if relative or friends, that loan may be converted into the gift due to generosity of the heart
(really scrutinize here b/c you have to look if the creditor really pressed for repayment AND if
there really was a debt)
o If it was just forgiven converted from debt to gift (has to really be a debt)
o If occurring outside the T/B setting (168(d)) Treat as a STCL
(2) Not being paid for services rendered
Accrual TP recognizes GI (ordinary income) b/c all-events test, BUT then should take ordinary deduction
if after reasonable efforts, determines it is a bad debt (so the #s are consistent & will offset/net to 0)
If assessing whether the TP can take a bad-debt deduction Need to know whether TP is on a cash or accrual method
o Cash
No GI to UNTIL payment (reasons why lawyers/ service providers want to be on cash-based method)
If you never receive the money, then you never include in GI, thus you do NOT get a bad debt deduction
because it was never included in GI to begin with
The key here is RECEIPT
No deduction when you find out debt wont be paid, b/c never included in GI shouldnt get a benefit
when youre already at a zero position
o Accrual
GI in year when 2-prong all events test for receipt is met
Character of this income- Ordinary because it IS NOT GAIN.
BUT bad-debt Deduction allowed when you determine the debt is worthless ONLY for accrual method
thus equalizing the two methods (by offsetting the GI claimed by accrual method TP in Yr. 1)
o Reg 1.166-1(f) Recovery of Bad Debt
If client shows up after bad-debt deduction was taken to pay, then this is considered Recovery of bad debt
 Attack/Short Sheet for Income Tax

b. Cash method include $$$ in GI (upon receipt); Accrual method $$$ of GI (recovery of bad debt)
o Partial Debt deductions 166(a)(2) allows for partial worthless bad debt deduction; Cf. Spring City Foundry