Income Taxation I

Fall 2012

Bogdanski

 

 

OVERALL EXAM INSTRUCTIONS

 

            This examination consists of 36 multiple-choice questions (Questions 1 through 36) and two essay questions (Questions 37 and 38).  An hour and a half (90 minutes) is recommended for the multiple choice questions, and two hours is recommended for the two essay questions (one hour per essay question). 

 

            In determining grades, each multiple choice question will count for 1 point, and each essay question will count for 24 points.  Therefore, you should budget your time according to the allocation just given.  Experience has shown that failure to budget one’s time appropriately can result in a drastic lowering of one’s overall grade on this examination.

 

            For the multiple choice questions, you must submit your answers using SofTest.  You may write the answers to the essay questions either on SofTest or by hand.  If you choose to write the essay answers by hand, you must write them in the bluebook(s) you have been provided, and return the bluebook(s) along with the hard copy of the essay questions.

 

            At the end of the exam, all students must return the hard copy of the essay questions in the envelope in which it came.  However, no credit will be given for anything written on the hard copy of the essay questions.  Only your electronic answer file (and bluebook(s), if any) will be graded.

 

            For the multiple choice questions, choose the best answer to each question posed.  You must choose one, and only one, answer to each question.  Although an incorrect answer earns no credit, there is no penalty for an incorrect answer on the multiple choice questions, so it is in your interest to answer every question, guessing if necessary.

 

            In the essay 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.  In your essays, 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.

 

            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.

 

QUESTION 37

(One hour)

 

            Lara is the chief executive officer of a corporation, XYZ, that operates hospitals.  Lara frequently leaves her office to drive in her own car to XYZ facilities for unannounced visits.  At the hospitals, Lara sometimes eats alone in the cafeterias without disclosing her identity, to check the quality of food and service that is being provided to patients and visitors.  On other occasions, Lara has lunch with other XYZ employees.  XYZ reimburses Lara for her mileage and the cost of meals on these visits.

 

            At the start of year 1, XYZ transfers to Lara as a bonus a parcel of real estate, Blackacre, with a fair market value of $20,000.  The terms of the transfer include a provision that if Lara ceases working for XYZ for any reason before the end of year 3, Blackacre will revert to XYZ.  Lara continues to work for XYZ throughout the three-year period.  At the end of year 3, Blackacre has a fair market value of $26,000.

 

            XYZ also operates a program of lending money to its employees on a short-term basis.  At the beginning of year 2, Lara takes out a $7,500 loan from XYZ under the program.  Near the end of year 2, when the loan has a balance of $7,200 outstanding, XYZ’s board of directors, which includes several of Lara’s close friends, votes to have XYZ forgive the debt “out of affection for our most excellent CEO.”  XYZ’s treasurer’s office returns Lara’s promissory note to her, with the word “cancelled” written across the front.  Under applicable state law, this cancels the debt.

 

            In year 5, Lara donates Blackacre, which she has been holding as an investment, to a national literary society.  Shortly thereafter, the society sells Blackacre to a real estate developer for its then-fair market value, $30,000.

 

            What are the federal income tax consequences to Lara of all the transactions just discussed, with and without any available elections?  Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of Blackacre, at each stage of the transactions.

 

            Explain.

 

(End of Question 37)

 

QUESTION 38

(One hour)

 

            Early in 2012, George, a litigation attorney in a large city on the West Coast, buys a parcel of rural real estate, Greenacre.  George tells his friends that he hopes eventually to retire from law practice and take up a new life as a Christmas tree farmer on Greenacre.  George pays $500,000 for the property.  He also pays $2,000 in fees to a local real estate lawyer who reviewed the purchase documents on George’s behalf.  Additionally, George pays $8,000 in other transaction costs as part of the acquisition.  He borrows $400,000 from a bank to finance the purchase of Greenacre; the rest of the funds come from his sizeable bank account.

 

            When the transaction closes, George immediately begins clearing the land for a farmhouse.  To commence the work, he purchases a bulldozer for $10,000.  The equipment has a “class life,”as described in section 168(e)(1) of the Code, of six years.  George also pays for fuel for the bulldozer, and property taxes and mortgage interest on Greenacre.

 

            Also in 2012, George is approached by a neighbor, Dave, who offers him $40,000 for the water rights attributable to Greenacre.  Since George’s tree farm will not need any water beyond natural occurring rainfall, George agrees to sell Dave all the perpetual water rights he holds as owner of Greenacre.  Dave pays George $20,000 in 2012, and another $20,000, plus one year’s worth of interest at a market rate, in 2013.

 

            What are the federal income tax consequences to George  in 2012 of all the transactions just discussed, with and without any available elections?  Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of George’s property, at each stage of the transactions.

 

            Discuss.

 

(End of examination)

 

Created by: bojack@lclark.edu
Update:  20 Jan 13
Expires:  31 Aug 14