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, this set of essay questions and your answers to them will be collected. 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.
 
 

Rosie, born in 1950, lives alone in a mansion, which she calls Bigacre. Her adjusted basis in the property is $500,000. Throughout 1996, the fair market value of the property is $1,000,000.

Bigacre is encumbered by a mortgage, which secures a loan that Rosie took out years after acquiring the property; she used the proceeds of the loan to purchase additions to her large collection of antique art and glassware. Throughout 1996, the outstanding principal balance on the loan is $300,000. Rosie pays $27,000 of interest on this loan during 1996.

On November 1, 1996, Rosie buys a new condominium, which she calls Thriftacre, for $600,000 cash. On November 15, 1996, she moves herself and her belongings out of Bigacre and into Thriftacre. On December 18, 1996, she signs a contract to sell Bigacre to a stranger, Barney, for $700,000 cash, plus Barney's assumption of her $300,000 loan secured by Bigacre. The sale of Bigacre closes on January 2, 1997.

Rosie dies in September 1997. A substantial amount of federal estate tax is paid by her estate. At her death, Thriftacre's fair market value is $650,000. Rosie leaves all her property to her father, Frank, born in 1926, who lives in a distant city. Frank immediately puts Thriftacre up for sale. In December 1997, Frank sells Thriftacre to a stranger, Patrice, for $658,000 cash. Frank pays his attorney $5,000 for advice in connection with the sale of Thriftacre.

What are the federal income tax consequences to Rosie and Frank 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. In addition, be sure to discuss the basis of the items of real property held by each taxpayer at each stage of the transactions, including Frank's and Rosie's bases in Thriftacre.

Explain.

Irene, a retired schoolteacher, makes her living by playing the stock and bond markets. She spends an average of 40 hours a week studying various investments, trading securities, and collecting interest and dividends on the securities she holds. These investments are her only source of income. Her dividend and interest income for 1996 is $80,000.

Throughout 1996, Irene employs a "buy and hold" strategy. Confident that the markets will continue to rise, she buys many stocks and bonds, but she does not sell any, during the year. In January 1996, Irene buys $250,000 worth of stocks that she believes will grow in value in the short term. Of the purchase price, $50,000 is her own cash from one of her investment accounts; $200,000 is the proceeds of a loan that she procures from her stock broker. The $200,000 loan is secured by her stock and bond portfolios. Irene pays $20,000 of interest on the loan during 1996.

Irene performs all her investment activity from her home, a beachside cottage that she rents for $1,000 a month. Irene has a room in the cottage that she uses exclusively as the office for her securities trading. It is there that she studies current and prospective investments, places orders with her broker over the telephone, and keeps records of her extensive accounts. The office takes up 20 percent of the cottage's floor space.

In November 1996, Irene takes a trip to Tennessee to inspect the premises of two of the manufacturing corporations whose stock she owns. Her investment in each of these companies is quite substantial. While in Tennessee, Irene also sees the sights. She visits the Jack Daniel distillery, to see how her late husband's favorite whiskey is made; the Grand Old Opry, a country music palace in Nashville; and Graceland, the home of her idol, the late singer Elvis Presley. Her total expenses for the trip are $400 for air fare, $600 for lodging, and $200 for meals. Irene dines alone. She keeps meticulous records of all of her activities and expenses during the trip.

In 1997, Irene decides to try a different type of investment. She buys an annuity contract from an insurance company for a single $300,000 premium. The contract provides that commencing immediately, she will receive from the insurance company $30,000 a year for the rest of her life. At the point at which scheduled payments begin, Irene's life expectancy as determined under IRS tables is 15 years. The first $30,000 is in fact paid to her in 1997.

What are the federal income tax consequences to Irene 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.

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