Sample Answers to Question 2

Exam #6586

The first issue concerns James’ receipt of stock as a gift and the subsequent sale of the stock. A gift is not taxable to the recipient donee nor is it a realizing event to the donor. Thus, neither Debbie or James will be taxed as a result of the gift. This gift falls under the Duberstein “detached and disinterested generosity” analysis. Since it was Debbie’s intent to give James a gift, we can conclude it is a gift.

Under IRC 1015, lifetime gifts typically result in a carryover basis. When this is the case, the donee takes on the donor’s basis. However, when transferred, the fair market value of the stock ($13,500) was below the basis of $15,000. Thus, James has a basis for gain purposes of $15,000 and a loss basis of $13,500. Because no gift tax was paid, there will be no step up of basis under IRC 1015(d). The stock is ultimately sold at a loss, for $10,000. The amount realized is $10,000. The basis is $13,500. Thus, the loss realized is $3,500.

No non-recognition statute applies. Thus, the $3,500 loss will be realized. Because the sale involved property (worthless securities) held for greater than a year (capital asset), the loss will be deducted at capital gain rates. The loss is deductible because it involves the sale of investment property for a loss (IRC 165).

However, because the loss is a capital loss, it may only offset (1) capital gains and (2) ordinary income up to $3,000. Assuming James had no capital gains, he can deduct $3,000 of the loss and carry the excess of $500 forward. The loss will be deducted at the lower capital loss rates.

In the future, James should tell Debbie to sell “loser” stock, realize the entire loss (they lost $1,500 of basis here) and gift the proceeds to James.

The exchange of the manor raises an issue concerning whether the transaction is a like-kind exchange. Because an exchange is a realizing event, James must avail himself to the “like kind exchange” non-recognition provision to avoid realizing a gain on the exchange. The “home sale” provision is inapplic. because the rental property is not the principal residence of James.

The first step is to determine whether a like kind exchange occurred. The fact that the other party to the exchange is a dealer does not affect James. However, the dealer will not be able to avail herself to the like kind exchange provision. Additionally, while a broker helped James locate the property, he is not a broker.

The manor (property 1) was held by James for investment purposes. It is also real estate. Thus, it is the correct type of property for a like kind exchange. The transaction is an exchange and does involve like kind property. The requirements for real estate are quite lenient. Thus, a large vacant rural piece of land is like kind to the rental real estate. Finally, James holds the new property for investment. Thus, the three requirements for a like kind exchange have been met.

Before moving to the “step 2" calculations. It should be noted that James has an adjusted basis of $300,000 in his property, computed as follows: 500,000 (cost basis) – $200,000 depreciation = $300,000.

Step 1

The gain realized on the sale is computed as follows:

Amount realized	$ 250K FMV of prop.
	$ 80K cash
	$ 330,000
Basis	- 300,000
	$ 30K Gain Realized

Step 2 involves computation of the gain recognized. The gain recognized cannot exceed the value of the boot (80K) and cannot be greater than the gain realized. Thus, the gain recognized in the year of the exchange is $30,000.

Finally, we must compute the basis for James.

The basis is computed as follows:

Old basis	300,000
- Cash received	- 80,000
+ Amount recog.	+ 30,000
	250,000

The new basis is $250,000. Because the boot received was cash and not property, the entire $250,000 basis goes to the rental property.

Finally, returning to the $30,000 gain recognized, it will be recognized in 2001. The “non-like kind” portion of the exchange is an exchange of property. For appreciable real estate (rental property), the gain is capital and the loss is ordinary. Thus, James will be taxed at a favorable capital gain rate. Additionally, he can use the gain to offset capital losses stuck in their “basket” (i.e., $500 remaining in part one).

The final issue concerns expenditures made by James on his elderly mom. First of all, because James’ mom is (1) a dependent blood related household member who (2) likely receives at least ½ her support from James and (3) is not earning greater than $2,900, you would think he would be entitled to a personal exemption for her. However, James cannot take a personal exemption for himself or his mother because they are completely phased out as a result of his income.

The true issue involves the dependent care expenditures made on Melanie. There is no deduction for dependent care services retained to enable an individual to work. However, James should consider taking a dependent care credit under IRC 21. The credit covers helpless adults who meet the dependency requirements for personal exemptions under IRC 151.

As discussed above, Melanie is a dependent helpless adult. Thus she is a qualifying individual. Additionally, the expenses are employment related because they enable James to go to work. The nurse takes care of Melanie while James is at work.

Because James’ “AGI” is above the $10,000 threshold, the percentage of credit is phased down from 30% to 20%. With only 1 dependent in his household, the credit is capped at $2,400.

The following is a calculation of the credit:

20% * 2,400 = $480

Thus, James is entitled to a credit of $480 on the tax return for the current taxable year. A credit is taken off the annual tax after the taxable income is multiplied by the tax rate. Thus, James’ tax liability will be reduced by $480.

Exam #6759

There are no tax consequences to James from the receipt of the shares, as he got them as a gift. However, there are tax issues with the sale of the shares, specifically regarding James’ basis. James can’t claim Debbie’s carryover basis of $15,000, because the sale of the shares falls within the narrow exception to § 1015. At the time of the gift, Debbie’s basis was greater than the fair market value of the shares. Because James later sold the shares at a loss, for $10,000, he is only entitled to claim as a basis the fair market value of the shares at the time of the gift – $13,500. As such, James realized a loss on the sale of $3,500. However, this loss is a capital loss, because the shares were transferred in a sale, and the shares of stock are a capital asset. Accordingly, James can only deduct the loss from the sale against any capital gain he has during 2002; he can also carry forward any remaining losses to offset capital gains (both short and long-term) in future years.

James’ second transaction is a like-kind exchange that falls within the purview of § 1031. The section applies because the Manor is property held for investment, and is being exchanged for Blackacre, which James also plans to hold for investment. It doesn’t matter that Blackacre is undeveloped; for § 1031 purposes, all real property, whether developed or not, is “like-kind.” It also doesn’t matter that Patty probably isn’t eligible to use § 1031, because she is a real estate dealer. In the § 1031 analysis, James realized $30,000 of gain ($250,000 value of Blackacre plus $80,000 of boot, less James’ adjusted basis of $300,000 (cost basis less depreciation taken)). The gain recognized in the transfer is $30,000. James’ new basis in Blackacre is $250,000 (his old basis in the Manor, $300,000, less the $80,000 cash he received from Patty, plus the $30,000 of gain recognized in the exchange).

It appears that there are no significant tax consequences to James’ caring for his mother Melanie. While the facts suggest that Melanie is James’ dependent, as she lives with him and he apparently provides more than half of her support (he “provides for most of her needs”); however, James is well over the $288,700 total phase out for personal exemptions for a head of household (and if he’s not considered a head of household, he also exceeds the phase out for an unmarried individual, $255,450). As such, James cannot claim a dependency exemption for Melanie.

It appears that James can claim a credit for a portion of the amount he pays the nurse to care for Melanie, under § 21. To claim the credit, James must establish that he paid the nurse so that he could work. As Melanie is frail and apparently unable to care for herself, and because James is Melanie’s only relative, this test appears to be met (no one else could have cared for her, and she can’t care for herself). Because § 21 applies, James should be able to claim a credit in the amount of $480 (20% of $2,400 of employment-related expenses).

James may also be able to deduct the expenses paid for Melanie as medical expenses under § 213. Without more facts, it’s unclear whether the section applies here. Melanie’s nursing care may be considered long-term care (we don’t have the IRC section that details what qualifies as long-term care). If § 213 applies, James could deduct the amount of medical expenses paid for Melanie, his dependent, to the extent that they exceed 7.5% of his adjusted gross income; because the facts do not provide James’ AGI, there is no way to calculate how much of the $60,000 is in excess of 7.5% of James’ AGI and is thus deductible.

Exam No. 6034

1. Stock Gift

First, gross inc. doesn’t incl. gifts. Gifts are transfers made out of detached, disinterested generosity. Although intent is a question of fact, this situation clearly indicates a gift b/c the facts don’t state that James is an employee of Debbie, or that J performed services for D for which the stock could have been compensation. Lifetime gifts (as this was b/c the donor D was alive when the transfer was made), follow the carry-over basis rule; that is, the donee’s basis is the same as the donor’s (§ 1015) = $15K. However, if the donor’s basis is greater than the FMV of the prop. at the time of the gift, then the donee’s basis = FMV at the time of the gift (and there’s no 1015(d) issue b/c D didn’t pay fed gift tax) -- thus J’s basis in the stock = $13,500. J sold the stock for 10K. Thus the amt realized - basis = - $3,500. Stock is a capital asset and loss on sale of a stock is treated as a cap loss. Cap. losses can only be offset against capital gains except 3K, which can be deducted against ord. income. It appears that J may have had no cap. gains in 2002. Thus, the only part of this loss that he can deduct is $3,000, which he can deduct against ord. income. He can carry over the remaining $500 to deduct against cap. loss in the next year under 1212(b).

2. The Manor

James’ orig. basis in the Manor 500K is adjusted under § 1016 for depreciation deductions. Thus his adj. basis in 2001 is 300K. When J swapped M for BA, he entered into a like-kind exch., non-recognition transaction. This means that, although he realized income, it’s not recognized, and a gain must be both realized and recognized to be taxable income. Most realized gains are recognized, except like-kind exchanges, invol. conversions, and sales of principal residences. This swap constitutes a § 1031 like-kind exch. b/c the Manor is property used for bus. purposes (rentals), not held primarily for sale (J. isn’t a dealer and it doesn’t matter that Patty is, b/c § 1031 transactions are analyzed from the perspective of each party separately). The Manor is not inventory, stocks, or any of the other excluded properties. The properties are used for the same kinds of purpose enough to satisfy the statute, which is liberal for real property. Like-kind looks at nature and character, not grade or quality. It is sufficient that the properties are both properties for business or investment. It doesn’t matter that one is improved and the other vacant (this goes to grade or quality) or that one is urban and the other rural. It also doesn’t matter that Patty is giving $80K w/the swap -- this doesn’t defeat the “solely” lang. in the code. The only limit is that the recog. gain can’t exceed gain realized. James’ basis in the new prop. is