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Law Outlines Federal Income Tax (Duke Zelenak) Outlines

Property Transactions Outline

Updated Property Transactions Notes

Federal Income Tax (Duke Zelenak) Outlines

Federal Income Tax (Duke Zelenak)

Approximately 51 pages

Federal Income Taxation outline for Professor Zelenak from Duke Law...

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Property Transactions

The realization doctrine

  1. Income tax generally does not tax an increase in the value of a taxpayer’s asset, as long as the taxpayer merely continues to hold the asset.

    1. Cash dividends can be taxed.

    2. Stock dividends should not be treated as income within the meaning of the Sixteenth Amendment, and that they are a form of unrealized appreciation (Macomber)

Manipulation of the realization rules

  1. Substance of a sale without realization of gain

    1. “Short sale against the box”: a taxpayer borrows and sells shares identical to the shares the taxpayer holds. By holding two precisely offsetting positions, the taxpayer is insulated from economic fluctuations in the value of the stock

      1. Section 1259 requires a taxpayer to recognize gain (but not loss) upon entering into a constructive sale of any appreciated position in stock, a partnership interest or certain debt instruments as if such position were sold, assigned or otherwise terminated at its fair market value on the date of the constructive sale

      2. A taxpayer is treated as making a constructive sale of an appreciated position when the taxpayer does one of the following: (1) enters into a short sale of the same property, (2) enters into an offsetting notional principal contract with respect to the same property, or (3) enters into a futures or forward contract to deliver the same property

      3. An appreciated financial position is defined as any position with respect to any stock, debt instrument, or partnership interest, if there would be gain upon a taxable disposition of the position for its fair market value

    2. Collar: In a collar, a taxpayer commits to an option requiring him to sell a financial position at a fixed price (the “call strike price”) and has the right to have his position purchased at a lower fixed price (the “put strike price”)

      1. In the absence of regulations, it appears that no collar, no matter how tight, can trigger a constructive sale.

  2. Substance of continued ownership with realization of loss

    1. According to Reg. §1.1001-1(a), an exchange of your asset for another asset will qualify as a realization event so long as the exchanged assets differ materially either in kind or in extent (Cottage Savings Association).

    2. §1091 (wash sale rule) if a taxpayer realizes a loss on the sale of stock, no loss deduction is allowed if the taxpayer purchases substantially identical stock within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date. (it only applies to loss, not gains)

      1. For gains, if you use the wash sale way to step up basis in a year with lower capital gain tax rate, the plan may succeed, although it is conceivable that the IRS would challenge it under the sham transaction doctrine.

    3. Section 267(a)(1) disallows any loss deduction on a sale or exchange of property between certain related parties, including a parent and a child.

      1. For gain recognized by a subsequent sale of the property by the related party, reduced gain realized by disallowed loss up to the point you wipe out the whole gain.

      2. For loss recognized by a subsequent sale of the property by the related party, no adjustment can be made

    4. Problems p273

      1. Problem 1 p273

        1. Cannot deduct loss

        2. Start from $1000, adjust according to the price difference, therefore 1000+25=1025 (because you put another 25 into the stock), also see regulation of 1091(d) for examples.

      2. Problem 2

        1. Cannot deduct loss

        2. then the basis of original shares: start with 1200, then adjust 1200-40=1160 (you take out 40 from the original stock)

      3. Problem 3

        1. Father basis 150, FMV 100, sells to daughter 100

        2. cannot deduct loss

        3. daughter’s gain selling 160k: usually gain reduced by disallowed loss. Usual gain =160k-100k=60k, reduced by disallowed loss: 60k- 50k=10k

        4. selling 140k: usual gain 40k, reduced by disallowed loss up to the point you wipe out the whole gain, gain=0

        5. selling 90k: 10k loss for daughter, no adjustment for the disallowed loss.

    5. Stocks are capital assets (as defined in §1221), and under §1211(b) an individual may deduct capital losses only against capital gains and a piddling $3000 of non-capital gain income

Nonrecognition

  1. In some situations, Congress has decided that immediate tax recognition of particular realization events would be unwise. Accordingly, the Code specifies several types of “nonrecognition transactions” – transactions in which gain or loss is realized by the taxpayer engaging in the transaction, but will not be recognized for tax purposes (at least not at that time)

    1. The rationale for allowing deferral of the reckoning of gains and losses is that the taxpayer has maintained a substantially continuous investment, only slightly altered in form

  2. Like kind exchange: Section 1031 allows taxpayers to defer taxation of gains on property that is exchanged for other property that is of “like kind” with the transferred property.

    1. Section 1031(a)(1) No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment

    2. The provision is limited to property that is used in a business or held for investment. This leaves out property held for personal use.

    3. A further limitation on scope is provided by §1031(a)(2), which precludes applicability of this non-recognition rule to several categories of property, among which are stocks, bonds, and notes; partnership interests; and inventory property

    4. Essentially, the scope of the section is limited to tangible property (including real estate) held for use in a business or for investment

    5. “Like-kind” refers to the “nature and character” of the property, and not to its “grade or quality.” Two properties are like kind as long as they are in the same asset class set forth in the regulations.

    6. The IRS acknowledges that a properly structured three-party...

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