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.
 
 

Amy was involved in an auto accident and suffered extensive injuries. She sued the driver of the other car, claiming $500,000 in compensatory damages resulting from the accident. Her claims were comprised of the following:
 

Element of claimed damage	Amount
Medical care for physical injuries	$ 80,000
Professional psychiatric care for psychological injuries	$ 55,000
Physical pain and suffering	$100,000
Emotional distress	$ 65,000
Lost earnings	$200,000
Total of compensatory damages	$500,000

Amy also sought $1,000,000 of punitive damages. Initially, the defendant denied any liability, and claimed in the alternative that some of Amy's physical and psychological problems pre-dated the accident. Two years after she filed suit, however, Amy accepted a $300,000 lump-sum payment from the defendant in settlement of all of her claims. She paid all her medical and psychiatric bills, $135,000, out of the settlement.

Bert purchased real property in a rural area, paying $100,000 cash for it. A large portion of the value of real estate in the area has always depended on access to water. However, at the time Bert purchased the land, his rights to use the water from a nearby river were unclear. A few years after Bert acquired the property, new state laws and regulations clarified his rights, which turned out to be substantial. Under the revised laws, Bert was able to sell his water rights to the owners of neighboring parcels. In 2001, he sold the water rights to a neighbor for $65,000. Bert retained title to his parcel.

Carly owned a business. One of Carly's business associates, Pearl, filed a lawsuit against Carly in 1999, claiming that Carly had sold Pearl the business. In January 2000, the trial judge in the case ordered that the business be placed in the hands of a receiver pending resolution of the lawsuit. The receiver was ordered to hold onto all profits of the business until otherwise instructed by the judge. In 2000, the business turned a profit of $150,000, and the receiver retained all of that amount pursuant to the court order. Early in 2001, the judge entered summary judgment in favor of Carly, and ordered the receiver to turn over to Carly the $150,000 profit, which the receiver promptly did. The summary judgment dismissed Pearl's suit. Pearl filed an appeal, and it is still pending; if the appeal is successful, Carly will have to turn over the business, plus the $150,000 profit, plus interest, to Pearl.

What are the federal income tax consequences to Amy, Bert, and Carly 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 the basis of Bert's property, at each stage of the transactions discussed.

Discuss.
 
 

In 2000, James receives shares of stock from his friend, Debbie, as a birthday present. At the time of the gift, the stock has an adjusted basis of $15,000; its fair market value is $13,500. As Debbie is not wealthy, she neither owes nor pays any federal gift tax on the transfer. In 2002, James sells the stock to a stranger for $10,000 cash.

James also owns an apartment building known as "the Manor." He owns the building free and clear, with no mortgages or other encumbrances. James rents out all of the apartments for fair market rent; he himself lives elsewhere. James's original basis in the building was $500,000. Over the years since he has acquired it, James has properly taken a total of $200,000 of depreciation deductions with respect to the Manor through the end of 2000. He has made no improvements to the Manor. In 2001, James enters into an exchange with Patty, a wealthy real estate dealer whom James located through a broker. In the exchange, James swaps the Manor for Blackacre, a large parcel of vacant real estate, owned by Patty, in a rural area far away from the Manor. At the time of the exchange, the fair market value of Blackacre is $250,000; as part of the exchange, Patty pays James $80,000 cash at the closing. In the exchange, Patty receives only the Manor, with a fair market value of $330,000. James holds Blackacre for investment; Patty plans to renovate and sell the Manor.

James's primary occupation is as a stock broker, a job that results in his having an adjusted gross income well in excess of $300,000 every year. James's frail and elderly mother, Melanie, lives with James, who is her only surviving relative. James provides for most of her needs. In order to enable himself to go to work, James pays to have a nurse come to his home and care for Melanie while he is at the office, at a cost of $70,000 a year.

What are the federal income tax consequences to James 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, at each stage of the transactions discussed, and James's basis in Blackacre.

Explain.

Created by: bojack@lclark.edu
Update: 19 Feb 02
Expires: 31 Aug 03