Capacidad de Producción

Crane v. Commissioner

• Taxpayer inherited an apartment building subject to a non-recourse mortgage equal to the value of the property. She calculated her basis as equal to the total value of the property, without reduction for the mortgage. Taxpayer sold the mortgaged property, receiving both cash and a release of liability from the mortgage indebtedness.

1. Basis = value of mortgage balance + cash

2. Amount realized = cash received from buyer + outstanding value of mortgage 3. Recourse and non-recourse debts are treated alike

• Significance of Crane:

a. If the property is eligible for depreciation deductions, including the borrowed amount in basis enables a taxpayer to recover costs that she has not yet paid or assumed directly. (you are able to deduct what you have yet paid for).

b. If the money for buying the property is borrowed through a non-recourse mortgage it may be possible for her to recover through depreciation acquisition costs for which she may never have to put up her own money.

c. Although the amount of the outstanding debt will be included in the taxpayer’s amount realized upon an eventual sale (offsetting the earlier deprecation deductions), the taxpayer enjoys the time value of the depreciation deductions.

• Rule: a taxpayer who sells property encumbered by a non-recourse mortgage (the amount of

the mortgage being less than the property’s value), must include the unpaid balance of the mortgage in the AR upon sale.

• Crane case with #s:

• FMV of property is $250,000

• Taxpayer $25,000 of depreciation deductions over 6-year period and then sells the property for $255,000.

• Taxpayer argues that gain is only $5,000 ($255,000 - $25,000/AR - original basis) • IRS argues that the gain is actually $30,000 ($255,000 - $225,000/AR-adjusted basis)

AB= $250,000-$25,000.

• In Crane she had no basis because it was all deducted via depreciation.

Commissioner v. Tufts

• Rule: a taxpayer who sells property encumbered by a non-recourse mortgage (whether the

amount of the mortgage is more or less than the property’s value), must include the unpaid balance of the mortgage in the AR upon sale. Thus, the fact that the amount of the loan exceeds the fair market value of the property becomes irrelevant. Non-recourse mortgage (debt relief) is included as the AR for the seller and the basis for the buyer.

• General partnership (GP) secured non-recourse loan for $1.85 million for apt. building; GP eventually contributed $44,000 in capital and took $440,000 in debt deductions, leaving an AB of approx. $1.45 million. GP sold building. FMV did not exceed $1.4 million (building lost value). GP took a $55,000 loss (AB/$1.45 million – FMV of property).

• IRS says partners had no loss, but rather a gain which should have been approx. $400,000 ($1.85million/AR - $1.45 million/AB). IRS said AR includes the loan.

Reconciliation of Tufts and Estate of Franklin

• If the value of the security exceeds debt initially (Tufts – note: GP went into deal legitimately despite the fact that later the value of the property decreased and the debt exceeded the FMV of the property), the debt will be included in the basis and likewise included in the AR upon foreclosure. On the other hand, where the amount of the mortgage exceeds the FMV of the property securing it when the debt was first incurred (Estate of Franklin – sham from day 1), the mortgage is not included in the basis and thus will not be included in the amount realized upon disposition, generally foreclosure.

Tufts Type Scenario Estate of Franklin Type Scenario

Initial FMV $100,000 $100,000

Debt (mortgage) $90,000 $1,000,000

Equity $10,000 None (deductions taken on

depreciation of inflated debt erase any equity paid in initially)

Basis Debt included Debt not included

XI.

Marriage Penalty and Alimony

• Bonuses – usually arise when one income earner makes substantially less than the other is a married couple.

• Penalties – arise when there is roughly equivalent income. Hypothetical:

Applicable Tax rate schedule (this is a flat tax)

Income level Tax

Up to $40,000 0

> $40,000 30% of income in excess of $40,000

Family #1 Family #2

Husband has income of $40,000 Husband and wife are lawyers and earn $60,000 each Wife has income of $80,000 Tax will be $24,000

Tax will be $24,000 If this family gets divorced, then their tax liability goes down. Then they each only pay $6,000. So, in effect their tax liability is cut in half.

Issues

• As long as you have joint returns that allow you to combine income and be considered one entity and have progressive rates it is impossible to have a system without a penalty. • Marriage penalty also exists in the following:

1. Standard deduction as well. Two individuals filing separately get a standard deduction of $3,000 each for a total of $6,000 in deductions. Whereas if these 2 individuals got married there standard deduction would either be one $5,000 on a joint return or two $2,500 deductions on a married, but filing separate return for a total of $5,000 in deductions.

2. Earned income tax credit. Innocent Spouses

• § 6013(e) – old rule, now moved to § 6015

• § 6015

(a) – The innocent spouse may seek relief from joint and several liability (b) – if:

(A) a joint return has been made,

(B) there is an understatement of tax due to erroneous items (under inclusion or over deduction);

(C) the innocent spouse, dispute signing the return, does not know or does not have reason to know of the understatement (very hard to prove);

(D) taking into account all facts and circumstances it would be inequitable to hold the innocent spouse liable for the deficiency; AND

(E) the innocent spouse makes use of this § within 2 years of IRS beginning the audit

- Then the innocent spouse should be relieved of liability to the extent attributable to such understatement

• (c) – Allows taxpayers to separate their liability so the government can only go after the party whose financial circumstances generated the liability. In the case of deductions which are shared between spouses, it is extremely difficult to determine who’s deduction was whose. Deductions are not separated on the return, but only if/when audited.

• (f) – if you can’t get relief under (b) or (c), (f) is a catchall provision for basic equitable relief • These provisions are in reality very pro-women

Revenue Ruling 76-255

• Whether a couple is married for the purposes of taxation is determined at the close of the tax year

• An individual shall be considered as married even though living apart from the individual’s spouse unless legally separated under a decree of divorce or separate maintenance

• When a couple gets a legal divorce at the end of the tax year and then is remarried in the beginning of the following tax year in an effort to file separately, the IRS shall construe the divorce as a sham transaction, designed only to manipulate your federal income taxes. For tax purposes they will still be considered married. The true nature of a transaction must be considered in light of the plain intent and purpose of the statute. Such transaction should not be given any effect if it merely serves the purpose of tax avoidance. This rule abandons the state law and creates a federal definition of divorce for tax purposes.

B. § 71 – Alimony and separate maintenance payments • Recipient Æ must include the amount received in income.

• Payor Æ permitted to deduct the cost of alimony under §215, so long as the payments (71(b),(c) 1. Are is cash

2. Received under a divorce or separation instrument (in writing) 3. The parities don’t live in the same household

4. There is no liability for any payment after death of the payee 5. The payments don’t constitute child support

§ 215

• Payor can make a deduction for alimony paid during the taxable year as defined in § 71(b) • Note: this would be subject to the 2% floor of § 67

Child Support – § 71

• Child support is not deductible

• (c) – amounts payable for the support of children of the payor spouse (child support) are not alimony and are not included in the receiving spouse’s income

• (b)(1)(B) – to be child support, it must be designated in the divorce or separation instrument and is not allowable as a deduction under § 215