Tuesday, February 28, 2012

Gain Exclusion from Personal Residence

Permanent Exclusion of Gain on the Sale of a Principal Residence- § 121 and § 1034

Exclusion rather than non-recognition provision. The new § 121 lets you exclude up to $250,000 on gain from the sale of their primary personal residence. Up to $500,000 with married couples filing jointly. You can’t get this more than once every two years. Taxpayer must own and occupy the residence for at least 2 out of 5 years before the exchange. No unqualified use like renting. The 2 years of ownership and use do not have to happen at the same time.

Ownership+ Use Requirement is vital to these problems. To Determine Time: IRS Balances in a Totality of the Circumstances Test:

  • Place of employment
  • Where do family members live
  • The address on tax returns, drivers license, auto registration
  • Mailing address for bills
  • Location of bank accounts
  • Location or religious organizations or religious clubs
There are key exceptions: §121 (c)(2) – If taxpayer has to sell his property due to a change in employment, health reasons, or unforeseen circumstances. The once every 2 years rule does not apply. Take the ceiling amount, for example 250k and multiply by a fraction (shorter of the time the property was owned, time property was used, time since last § 121) AMOUNT OF EXCLUSION    DISPUTED HEAVILY

Fact and Circumstances Test: Safe Harbor Provisions- Middle Ground between having bright line rule and blurry act and circumstances tests.

Definitely EMPLOYMENT related if:

  1. Someone has change in place of employment while owning a residence. The need place of employment is at least 50 miles away. Or If the person did not have a job and finds a job.
  2. Not requirement, you just need to show. Makes it easier to prove in court.
No safe harbor for HEALTH REASONS. Easy standard to meet.
What it means to move for health reasons is that the primary reason for sale is to obtain, provide, or facilitate the diagnosis, cure, or treatment of disease illness or injury or you are doing this for someone else. If your doctor tells you to move basically.  Merely beneficial to health does not qualify. Although it does not need to be necessary to cure your disease. T. Reg. § 1121-3(d)91)

UNFORSEEN CIRCUMSTANCES: Involuntary Conversion, Natural or manmade disasters, Terrorism or war, Death, Unemployment, employment status that causes taxpayer unable to pay living costs, Divorce, Multiple Births

What is the Cash Conversion Cycle?

The cash conversion cycle (CCC) is the length of time between a company's purchase of inventory from a supplier and the receipt of cash from accounts receivable in connection with the company undertaking a discrete unit of its operations.

The cash conversion cycle (CCC) cannot be directly observed in the firm’s cash flow statements; rather the raw cash flow will be influenced by variables not entertained by the cash conversion cycle, such as various investment and financing activities concurrently undertaken by the company. Generally, this is the time required for a business to turn purchases into cash receipts from customers through its accounts receivables.

Most importantly, the CCC is the total days a company's cash remains locked up within the operations of it business units. In practice, this equation can show how effective the management of a corporation is.

Why is advertising not considered an asset?

Why is advertising not considered an asset?

Under accounting standards, for an expenditure by a company to be recognized as an asset on the balance sheet it needs to pass several tests:


  1. It is very probable that future economic benefits will flow to the company from the asset
  2. These future economic benefits can be measured reliably
Proving economic benefits from an activity that is only promoting your products is not easy to justify. Therefore advertising expenditure is simply expensed out and not treated as an asset. However, if the advertising is directed at creating a new separate and distinct asset, then the costs may be capitalized into this new assets cost.

Monday, February 27, 2012

What is an accounting expired cost?

What is an accounting expired cost?

Businesses acquire assets in the course of ordinary affairs to consume or use up in order to generate revenue which leads to profits.

Therefore, assets represent un-expired cost before their ultimate consumption by a business. As soon as part or an entire asset is depleted, completely used, or expires it is no longer an asset and converts into expired cost or expenditure and reported as an expense on the accounting income statement. Thus, it is generally said in accounting terms that this is an expired cost.

Thursday, February 23, 2012

What are Short Term Investments?

What are short-term investments on an accounting balance sheet?

Short-terms investments are generally very liquid marketable equity securities and/or debt. These will all be classified as a current asset on an accounting balance sheet by a corporate accountant.

If there interest paid on the bonds being held differs from the current market rate for comparable debt, the bond premiums and discounts are not recorded on the balance sheet because their short-term nature causes these amounts to be negligible. This is because the bonds are not held long enough for this to be a factor for the company.

However, the cost of equity investments is required to include commissions as part of the balance sheet. The FASB has rules requiring the lower cost or market cost rule to be applied to equity securities, which can be marked down to market cost and back up, but never above actual cost. The cost of commissions is an integral part to the over cost of equity securities.

Wednesday, February 22, 2012

Interpretation Inclusionary Tax Benefit Rule by IRS

Inclusionary Tax Benefit Rule

What happens when taxpayer has a tax benefit that is based on an incorrect assumption and later finds out that assumption is fundamentally inconsistent with the taxpayers current tax position?

The Tax Benefit Rule is often a completed transaction that will reopen unexpectedly in a subsequent tax year, rendering the initial reporting by the taxpayer improper.

The policy behind making an adjustment is recognizing and seeking to avoid the possible distortions of income. Courts and the Internal Revenue Service require  the taxpayer to recognize the repayment as income in the current tax year to fix the anomaly

The basic purpose of the tax benefit rule is to achieve rough transactional parity in tax, and to protect the Government and the taxpayer from the adverse effects of reporting a transaction on the basis of assumptions that an event in a subsequent year proves to have been erroneous.

Tuesday, February 21, 2012

Interest-free Gift Loans and § 7872

Interest-free Gift Loans and § 7872 of the Internal Revenue Code

In the case of a “gift loan” –  § 7872(f)(3)  - it defined as a loan bearing a below-market rate of interest when the foregoing of interest is in the nature of a gift – the statute in the IRC creates a deemed interest payment from the borrower to the lender.


  1. The amount of deemed interest payment by the IRS is the difference between interest at the “applicable federal rate” (AFR) and the actual interest charged.
  2. The deemed interest income is taxable to the lender.
  3. The deemed interest payment is deductible by the borrower, subject to the interest expense deductions under § 163.
  4. There is a De minimis exception of § 7872 (c)(2), $10,000 Max
  5. § 7872(d)(1) Deemed interest is limited to the borrowers net investment income for the year.
The whole interest payment is deductible. Interest payment doesn't exceed the loan amount (Only under 100,000).

The Internal Revenue Service will closely examine these transactions under a tax audit, especially if the connection between the parties is a very close. The overall  effect of § 7872 will be to put that lender and the borrower in the same position as if the gift loan had never been made. The deduction qualifies as investment income deduction for lender as well. 

Friday, February 17, 2012

Limitations on Charitable Deductions and Carryovers - § 170

Limitations on Charitable Deductions and Carryovers under § 170(b)a.

§ 170(b) imposes quantifiable limits on how much can be deducted based on AGI. You can deduct charitable deductions in excess of 50% of your AGI on income tax returns. If giving the charitable deduction to a private organization, you can only deduct 30%:


  1. 50 % total limit § 170(1)(1)(g)
  2. 30% limit to private organizations
  3. 30 % limit to appreciated property
  4. 20% limit to appreciated property to private organization IRS Reg. 1.170A-1 (c)(1)
These limits are applied sequentially by the IRS which means that the total of all gifts is first compared with the overall 50 percent limit on charitable contribution deductions. If it exceeds that limit, the deductions disallowed are considered to come from the least-favored category according to the Internal Revenue Code.

Any amounts that are disallowed by these IRS rules may be CARRIED OVER by the taxpayer and deducted in up to five subsequent tax years, pursuant to the rules of § 170(d). The charitable gifts retain their character in the carryover year according to the IRS regulations 


Sunday, February 12, 2012

Section 1245 Property- Depreciable Property Used In Business

What is Section 1245 Property- Depreciable Property Used In Business?

A gain on the disposition of §1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. The gain treated as ordinary income is the lesser of:

  1. The depreciation allowed or allowable on the property. 
  2. The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property taking into account depreciation.)
Extent gain results from artificial depreciation deductions, § 1245 applies. The extent the gain results because the taxpayer sells the property for more than he paid for it, § 1245 does not apply

This is all taxed at the Capital Gains Rate. Any gain recognized that is more than the part that is ordinary income from depreciation is §1231 gain.

Tuesday, February 7, 2012

Cost Recovery Schedules Depreciation

§168 of the Internal Revenue Code provides various cost recovery schedules. Under the accelerated cost recovery system” ACRS, the cost recovery of an asset depends on three things:

  1. The total amount of cost to be recovered
  2. The number of years over which the cost is to be recovered
  3. The rate at which the cost is to be recovered over those years

The total amount of cost to be recovered  by the taxpayer is the total expected decline in value while the asset is used in the taxpayer’s business, as measured by the different between the original cost and the salvage value. 

The Internal Revenue Service (IRS) allows that the depreciation of an asset is $0 under § 168(b)(4).

Sunday, February 5, 2012

Installment Sales Section 453


1.  Installment Sales - § 453
a.     § 453(a)- Gain from an installment sale is ordinarily reported on the installed method, which is defined by § 453(c) as “a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit… bears to the total contract price.” Gross profit is the gain realized on the disposition and the contract price is the amount realized.
b.     The goal is to determine the amount of income recognized for a particular taxable year:
                                              i.   Installment Sale Equation § 453(c) = (income recognized)/ payments received in the year = (Gross Profit)/ (Contract Price)
                                            ii.     Income Recognized = Payment Received  * (Gross Profit)/ (Contract Price)
                                          iii.     PRODUCES AMOUNT INCLUDED IN INCOME
                                            iv.     The idea behind the installment method is to treat every principal payment as a microsm of the entire transaction.
c.     Payment is the most disputed, what is consideration. Consideration v. Promise to Pay
                                               i.     Does not include a buyers promise to pay. What about third parties? Include a third party obligation as part of payment. Include it as fair market value.
                                            ii.     EXCEPTIONS:
1.     Readily tradable- If it is liquid and there is an established market, include it as payment received even if it is a debt instrument
2.     Also, if it is secured by cash or a cash equivalent
                                            iii.     These are all rules about principal payments. The tax consequences of interests are different. You must allocate basis among the assets with more complicated payments.
d.     CONTINGENT INSTALLMENT SALES: 
                                              i.     There are also big issues with contingent sales in this area of the law. For example, a percentage of profits the seller is entitled too.
                                             ii.     If we don't know the whole contract price, can’t calculate gross profit. However, congress is clear that in § 453 (j)(2) they wanted them to have installment treatment, regulations about how the installment can work when you don't know the full contract price.
1.     Transaction in which there is a maximum possible price
a.     Treat the maximum as the contract price, if you get less, you re-compute the formula and take a loss deduction for the amount you overpaid.
b.     You can make a deduction if you over paid. TAX BENEFIT RULE
2.     Transaction in which there is no max price, but the period of time over which the payments will come in is known.
a.     Pro-rate the taxpayers basis over the known period of years in the contract.
b.     Then subtract the gain from the basis
3.     Transactions in which we don't know either of the first two things. No max selling price or max time period
a.     IRS might think that it is not a real sale contract. Disguised interest payments, royalties, or rent. Convince the IRS that it is a sale. The IRS will look skeptically upon this.
b.     If they scrutinize all the pertinent facts, they will pretend that the contract is 15 years long and pro-rate the basis over that period of time. You can argue with the IRS over this Then there can be an offset.
e.     INTEREST PAYMENTS received will be included in the gross income of the seller as ordinary income under  § 61(a)(4), and interest paid may be deductible by the buyer under § 163
f.      What about payments that trickle in over time that were not in the original sales contract. Does this apply to involuntary installment sales? There is policy reasons for allowing unintended sales to allow this:
                                               i.     Taxpayers don’t pay realize any gain
                                             ii.     Liquidity problem, might not have enough money to pay the tax on the entire amount.
g.     Amended Agreements: Not clear in § 453 if the buyer agrees to pay in full, and then in amendment is allowed to make some of the payments late. If the amendment is made before the sale closes, then the installment rules should apply.  There was never a contractual right to have the money from the sale, then the installment sale rules can apply.
                                              i.     The installment sale rules don't apply if the parties amend the contract after the seller has fully performed and has an unconditional right to payment. NOT INSTALLMENT SALE
                                            ii.     Doctrine of constructive receipt. Congress does not allow people to avoid tax by turning their back on payments.
h.     There is a lot of fighting over this because Congress has a choice how to tax installment sales, they could have completed them as complete for tax purposes in the first year of the installment sale. However, they thought that was to harsh and allow people to recognize payments gradually.
i.      Limits on Installment Method
                                               i.     You can't do it for stocks on securities market
                                             ii.     Cant do it from dealers on property
                                            iii.     No inventory
                                            iv.     Not for sales of depreciable property to affiliated entities.
j.      Installment Method is elective and can be used in connection with § 1031.  Remember that 1031 like kind exchanges are not elective though and you must conduct the transaction in that manner if you qualify.

Wednesday, February 1, 2012

When is gain taxed by the IRS?

What is a realization event?

There is no tax on the gain until the occurrence of a “realization event”, such as a cash dividend or other types of payouts considered by the IRS.  Although the cash dividend does not make the owner any richer, it serves as the trigger for taxing the enrichment that the tax system had previously ignored.

This is mainly justified by the tax policy of Administrative ease for the Internal Revenue Service's enforcement of tax law.

Popular Accounting Problems

The information on this site is for informational purposes only and should not be used as a substitute for the professional advice of an accountant, tax advisor, attorney, or other professional.