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.
 
 

Craig is a self-employed individual who makes useful and highly decorative items such as keychains, mousepads, potholders, and trinkets for automobile dashboards. He also makes and sells ornate tiles for use in kitchens, bathrooms, and fireplaces.

In November 1998, Craig sells several cases of his items to Mary, one of his regular customers. The goods have a basis to Craig of $2,000; the sale price in the sale to Mary is $5,000. Mary offers to pay Craig in cash upon delivery of the goods. However, at Craig's suggestion, the contract of sale that they sign contains the following terms: Mary will place half the purchase price, or $2,500, in escrow immediately upon delivery. Craig will have the right to withdraw funds from the escrow at any time, commencing immediately upon Mary's depositing of the funds. Before withdrawing the funds, however, Craig would be required to give notice to the escrow holder and to Mary. The remainder of the purchase price, $2,500, will be due and payable in January 1999. Although these terms are unusual to Mary, they are typical of transactions that Craig has entered into in the past.

Craig ships the goods in November 1998. Mary pays $2,500 cash into the escrow account upon her receipt of the goods, also in November 1998. In January 1999, Craig closes out the escrow and withdraws the $2,500 that Mary had deposited there. Also in January 1999, Mary pays Craig the other $2,500 of the purchase price, in cash.

In February 1999, Craig and another professional artisan exchange several cases of finished goods. Craig's basis in the goods he transfers in the exchange is $14,000, and their fair market value is $30,000. In the exchange, Craig receives several cases of items, also with a fair market value of $30,000.

Craig maintains an inventory of his goods in the back room of his shop, which he rents from a commercial landlord. Each year, Craig pays $6,000 rent for the storage space. He also pays $300 a year for insurance against fire, theft or destruction of the inventory.

What are the federal income tax consequences to Craig of each of the transactions just described? Be sure to discuss the amount, timing and character (ordinary or capital) of each item of income, gain, deduction, loss or credit, and Craig's basis in his various items of property, at each stage of the transactions.

Discuss.

In 1998, Janet, a wealthy microbiologist, borrows $800,000 on a nonrecourse basis, and uses the loan along with $200,000 of her own savings to purchase Blackacre, a partially occupied apartment complex in a declining area of town. The total purchase price of Blackacre is $1,000,000. Other than her home, Blackacre is the first real estate Janet has ever owned.

Shortly after buying Blackacre, Janet decides to have portions of the interior of the building painted. In the course of the painting, the workers also repair a few broken handrails. Janet also has the carpeting replaced in the complex's common areas, and has part of the structure rewired. The total cost of the paint, handrail, carpeting, and electrical work is $30,000. For 1998, her first year of owning the property, the deductions that Janet is properly allowed with respect to Blackacre under sections 162, 163 and 167 of the Code exceed the gross income from Blackacre by $10,000.

Janet is also a "silent partner" in a restaurant. The restaurant is operated by one of Janet's friends, and Janet never works there. Janet's share of the restaurant's profit for 1998 is $3,000.

After a few years, Janet has properly taken $130,000 of depreciation deductions with respect to Blackacre, and she has also paid off some of the principal on her mortgage. Then Janet sells Blackacre to Betty. Betty agrees to pay Janet $360,000 cash, and to assume the nonrecourse mortgage, now with a principal balance of $740,000. The transaction closes as agreed. Janet pays a real estate broker a $50,000 commission in connection with the sale.

What are the federal income tax consequences to Janet of each of the transactions just described? Be sure to discuss the amount, timing and character (ordinary or capital) of each item of income, gain, deduction, loss or credit, and Janet's basis in her property, at each stage of the transactions.

Explain.

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