This second part of the examination consists of two essay questions, each of which will be given equal weight in determining grades. Two hours will be permitted for this part. At the end of the two hours, you must turn in both this set of essay questions and your answers in the original envelope in which this set came.

All answers must be entered in the bluebooks you have been provided (or, for those typing or operating computers, on separate sheets of plain white paper). No credit will be given for anything written on this set of questions.

Pay close attention to the final portion, or "call," of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.

Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion and analysis are often as important as any particular conclusion you reach.

The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

Unless otherwise expressly instructed, assume that all taxpayers described in the questions are individuals, and that they report their income on the cash method and the calendar year for federal income tax purposes. Any references to the "Code" mean the Internal Revenue Code of 1986, as amended.
 
 

Allco is a corporation that owns and operates several businesses. One of these is a 100-mile oil pipeline that Allco built in 1968. Part of Allco's pipeline runs along a state highway. The state owns the land over which this portion of the pipeline (approximately 20 miles) runs; Allco has an easement that allows it to operate the pipeline over the state land. However, Allco's agreement with the state provides that, if the state ever wishes to widen the highway, Allco must move the pipeline, at its own expense.

In 1997, the state informs Allco that it wishes to widen a section of the highway. The widening project requires Allco to move a two-mile section of the pipeline about 30 feet further away from the existing roadway. Allco uses an outside contractor to perform the move, at a cost of $700,000. Allco takes the opportunity of the moving project to replace the existing pipe along this section with a much better grade of pipe. Pipeline relocations are common in Allco's industry and locale, but the scope of the work required for this project is unusual.

Later in 1997, Allco throws a party for executives from the companies that are Allco's customers. It rents passenger vans to take the executives, along with their family members and an equal number of Allco employees and their families, on a day trip to a college football game in another part of the state. (The Allco employees do the driving.) At the game, the Allco party, which numbers about 40 people, watches the action from luxury box seats and dines on good food, beer, wine and soft drinks. Copies of Allco's magazine advertisements are posted throughout the luxury boxes.

At halftime of the game, the president of Allco hands 10 of the guests -- all customer executives -- watches with the Allco logo engraved on their faces. "Take this as a token of our appreciation of, and affection for, all of you," Allco's president tells them in a short speech extolling the quality of Allco's products.

Allco's costs for the outing include the following:

Van rentals           $ 700

Game tickets         2,000

Catering                2,000

Gold watches
(10 @ $500 each)  5,000

Total                  $ 9,700

What are the federal income tax consequences to Allco of each of the transactions just described? Be sure to discuss the amount, timing and character (ordinary or capital) of each item of income, deduction, loss or credit, and the impact (if any) the transactions have on the basis of any of Allco's property.

Discuss.

Ken is an employee of a corporation, Corp. In January 1997, as compensation for his services, company management has Corp transfer to Ken an undeveloped parcel of real property, Blackacre. Corp's basis in Blackacre is $100,000. Under the terms of the transfer, if Ken leaves Corp's employ within 12 months after the transfer, he must transfer Blackacre back to Corp and receive no compensation for it. The fair market value of Blackacre on the date of the 1997 transfer from Corp to Ken is $150,000. Twelve months later, in January 1998, the fair market value has risen to $160,000. Ken remains an employee of Corp throughout 1997 and 1998, and so he gets to keep Blackacre.

In early 1999, Ken takes out an equity loan, using Blackacre as collateral. He borrows $21,000 from a bank, and gives the bank a mortgage on Blackacre. Ken uses the $21,000 to pay for his two dependent children's college education. He continues to hold Blackacre, subject to the mortgage, as an investment. The value of Blackacre, which is still vacant, continues to rise. Ken makes several payments of principal and interest on the bank loan.

In September 2000, Ken enters into a real property exchange agreement with Laura, a professional real estate operator. Under the agreement, Ken transfers Blackacre to Laura, and Laura transfers to Ken a rental house with a fair market value of $145,000. As part of the transaction, Laura assumes the mortgage on Blackacre, which has an outstanding balance of $20,000, and also transfers to Ken $5,000 cash.

What are the federal income tax consequences to Ken of each of the transactions just described (including, but not limited to, the mortgage interest and the amounts spent on the children's education)? Be sure to discuss the amount, timing and character (ordinary or capital) of each item of income, deduction, loss or credit, and the impact of any elections available to Ken. In addition, be sure to discuss Ken's basis in Blackacre at each stage of the transactions, and Ken's basis in the rental house.

Do not discuss Ken's personal exemption, or the dependency exemptions or child credits for his children.

Explain.

Created by: bojack@lclark.edu
Update: 07 Mar 02
Expires: 31 Aug 03