Income Taxation I

Fall 2015

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. 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)

 

            Tiana, an executive at an insurance company, also owns the Tower, an apartment building in which Tiana rents units to tenants. Tiana’s adjusted basis in the Tower is $300,000. Its fair market value is $600,000, but it is encumbered by a mortgage securing a loan with a current outstanding balance of $150,000, so that Tiana’s “equity” in the Tower is $450,000.

 

            Tiana enters into a real estate exchange agreement with a real estate professional, Uri. Under the agreement, Tiana transfers the Tower to Uri; in the transaction, Uri assumes the mortgage and transfers to Tiana Blueacre, a parcel of undeveloped land that Uri and his family have been using for camping and other personal recreation for many years. At the time of the exchange, Blueacre has a fair market value of $450,000; Blueacre is not subject to any mortgages or other liabilities. Shortly after the transaction closes, Tiana spends $5,000 to have a section of Blueacre cleared for possible future construction of a horse stable and paddock.

 

            Tiana owns some stock in the corporation for which she works. All of the stock of the company, including Tiana’s, is listed for trading on a major national stock exchange. Tiana owns 1,000 shares of the stock, and her aggregate adjusted basis in the shares, which she purchased all at once several years ago, is $20,000. Tiana sells 100 shares to her friend, Val, for a sale price of $5,000. Pursuant to the sale agreement, Val makes a cash down payment to Tiana of $2,500 and transfers to Tiana a promissory note calling for payment of the other $2,500, plus interest at a market rate, to Tiana a year after the sale closes. The fair market value of Val’s promissory note is $2,400.

 

            Tiana’s elderly mother, Mae, lives in a distant city with Tiana’s sister, Sally. Tiana sends Mae a check each month to help pay Mae’s substantial medical, food, and clothing expenses. Mae’s gross income is about $3,500 a year.

 

            What are the federal income tax consequences to Tiana of each of the transactions and events 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 Tiana’s property, at each stage of the transactions.

 

            Discuss.

 

(End of Question 37)

QUESTION 38

(One hour)

 

            Xio is a key employee of a large corporation, CCC. In 2015, in addition to paying Xio his normal salary, CCC transfers to Xio (1) a stock bonus, (2) a stock option, and (3) a parking pass at a garage near CCC headquarters.

 

            In the stock bonus transaction, CCC transfers to Xio 5,000 shares of CCC stock. At the time of the transfer, CCC shares are trading on an established national stock exchange for $4 per share. As a condition of receiving the stock bonus, however, Xio agrees not to sell the stock for 18 months. This restriction makes the stock less valuable to Xio than if it were freely transferable, but Xio still gladly accepts the bonus and holds onto the stock.

 

            The stock option, which is not an “incentive stock option,” allows Xio to purchase up to 10,000 additional shares of CCC stock, at any time over the next two years, at a price of $4.25 per share. The option is immediately vested – that is, Xio need not perform any future services to keep it. Unlike CCC stock, the option, although inherently valuable, cannot be traded on any public market.

 

            In 2016, Xio partially exercises the option, purchasing 1,000 shares for $4.25 a share. At the time, CCC shares are trading at $6.25 per share. Xio retains the shares as a long-range investment.

 

            The parking pass is good for 12 months. Normally, the operator of the garage charges $200 a month for a pass of the type that CCC transfers to Xio. That is the going rate in the area.

 

            Xio owns his principal residence. It is subject to a mortgage securing the loan that Xio took out a few years ago to buy the residence. The outstanding balance of the mortgage loan is $400,000, on which Xio pays principal and interest every month.

 

            Xio also owns a vacation home, which he and his family and friends use exclusively for personal purposes. Xio bought the vacation home for cash, but he recently subjected it to a  mortgage securing a home equity loan. Xio used the proceeds of the loan to take a lengthy vacation, and to pay off his son’s personal auto loan and credit card debt. The outstanding balance of the equity loan is $150,000, on which Xio pays principal and interest every month.

 

            What are the federal income tax consequences to Xio of each of the transactions and events 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 Xio’s property, at each stage of the transactions.

 

            Explain.

 

(End of examination)

 

Created by: bojack@lclark.edu
Update:  19 Jan 16
Expires:  31 Aug 16