D.

Sale or Exchange Requirement 1222

1. Generally
a. 1222 says "Sale or exchange", while 1001(a) says sale or other disposition.
i. Abandonment is a disposition, but is it sale or exchange?
2. Middleton
E. Holding Period - 1223
1. Computing the holding period
a. Important because we figure out when a year has been included.
b. Day of acquisition excluded.
c. General rule of transfer:
i. When the benefits and burdens of ownership have moved, or (?)
when deed is transferred.
d. Tacking is allowed when there's an exchanged basis (where the later
owner's basis is determined in relation to the earlier owner's basis).
i. Ex: 1031, 1033
ii. Also with transferred basis such as gifts.
a. For tacking purposes, gift/sale exchanges are not
distinguished from gifts.
2. Tacked and Split Holding Period
a. Generally
i. See problem
b. Citizen's National Bank of Waco
F. Section 1231 - Property used in a trade or businesss
1. Generally
a. This was made in FMV.
b. Property used in a trade or business is not a capital asset. 1221(a)(2)
c. 1231 was written for this. M. says it would make more sense to just make this
a capital asset.
d. Mechanics
i. Is it sec. 1231(b) property
ii. Is it the right transaction?
a. Must be: sale or exchange, compulsory conversion,
involuntary conversion.
iii. If it meets i and ii, then you net all the 1231 transaction; if there's a
gain it's all considered capital assets (cap. gain or loss) (then this is
netted against all the other capital assets), if there's a loss none of it is
considered a capital asset (ordinary gain/loss).
a. Two part netting process:
i. In the case of involuntary conversion, if you come
out and net all your involuntary conversions and they
come out a loss, then 1231 doesn't apply to them
1231(a)(4)(C).
ii. Then all others are netted. 1231(a)(1)-(3).
b. BUT WAIT: Recapture 1231(c)
 i. If you had section 1231 losses that were taken as
ordinary losses, we'll carry that forward for 5 years to
turn capital gains into ordinary gains to the extent of
the losses
2. International Shoe Machine Corp.
G. Assignment of Income
1. Generally
a. This covers when people try to take what would be an ordinary gain and turn
it into a capital, just as Eisenhower turned his ordinary gain on the profit from
his book into a capital gain by selling the copyright.
b. You buy assets for two reasons: because it "spits off utility while you have it"
and it gives you further utility when you sell it (by appreciating in value).
i. For example, if you buy Microsoft stocks you get dividend income and
then you want to sell it for more.
c. If all you have to do is receive income, it's ordinary income. If you have to do
some work, it's capital income.
i. Payment for personal services are ordinary income.
ii. Remember that a capital asset can "spit off" ordinary income.
iii. If you've already done the work and now you just have to sit back
and get the income, then it's ordinary income if transferred.
2. Lattera
a. The one where the taxpayer won the lottery and sold his right to receive
payments to a third party. The taxpayer tried to convert ordinary gain into
capital gain.
b. The lottery ticket: is it a capital asset?
i. Horizontal carve out is one in which the person who owns the income
is giving it to someone else over time. p. 518
ii. A vertical carve-out is one in hiwhc a complete disposition of the
property is made.
a. M. says neither one of these are very helpful.
iii. The court says this is more like a property that produces income,
and since it's like interest payments its ordinary income.
c. Since it would have been ordinary income had they received it normally, then
it can't be converted.
H. Recapture of Depreciation
1. General Principles
a. Recaptures the difference between the adjusted basis and the amount
realized (I think).
b. 1245 property-depreciable property which is personal property, or property
subject to amortization.
2. Installment Sales
I. Sale of Business
J. Section 1237 - Statutory Immunity for Subdivided Real Property
7-7
● a
○ CA: He's abandoned the property (this works for tax purposes), but this may
not work for property law. This is a disposition under 1001 (take the amount
realized - adjusted basis) he has 100,000 ordinary loss. But is it a capital loss? It
is capital. But is it a sale or exchange under 1222? Probably not, but this means
one can convert capital into an ordinary loss. Look at whether he can reclaim it.
Thus, a capital asset can have an ordinary loss.
● b
○ CA: The difference between a deed in leui and a foreclosure is that the latter is a
suit against the owner, but a deed in leua is where where you deed the property
back to the lender to pay off obligation. You get the same end result in both
cases. If there were a foreclosure it would be a sale, if it is a deed in leau, then
it would be in exchange. It meets 1222 in either case, so it's a capital loss. He
doe snot get any of the foreclosure sale, so did he realize anything? He would
realize the debt relief but not the 75,000. So he gets a smaller capital loss than
he wanted. He has 100,000 long term capital loss.
7-8
● a
○ CA: Aug. 28 is short term, the others are long term. First in first out rule wouldn't
apply because we know the dates. Basis is divided between them.
● b
○ CA:
7-9
● a
○ CA: The transfer happened on June 2, because that's when benefits and burdens
are transferred (possession is the main thing to look at here). Since a short term
loss is better (but M. seems to be saying it isn't, too), they're trying to speed up
when the holding period ends. It's a short term capital loss.
7-10
● a. CA: An option is just a K to buy, and you don't have ownership until you actually buy.
The gain is short term.
● b. CA: What's the difference between stock rights and stock options? Is a right just like
an option for our purposes? I think so, it's similar in mechanics to the above question.
The possible difference is that when you exercise a right it might transfer the same
day, whereas the option doesn't get you the stuff until a bit later. But M. Doesn't know.
Sometimes it depends on the time of the day.
7-11
● CA: He must (not just can) tack the time that his parents held it, because there's a
transferred basis for gifts. But it's personal rather than business, and personal losses (of
capital?) is not deductible (263).
7-12
 ● CA: You can and should partition, you probably have to.
7-13
● CA: not a transferred basis, he gets it at its fair market value. So no tacking, it seems.
1223(9) says that inherited property is considered to be held for a year, even if decedent
didn't. So inherited property not only gets a stepped up basis, but it gets automatic long
term capital gain treatment.
7-14
● CA: None of these are 1221 capital assets - they're all used in a trade or business, so
1231 must be applied. Theft, tornado is an involuntary conversion; lab equipment is sold
at a loss. Now we go into netting. Remember two step process - involuntary conversions
netted against each other is applied and there's a gain. That means that they're added
in with everything else (if there was a loss, this wouldn't be true). Net result is a gain,
this means all three transactions are treated as long term capital transactions. She has a
500$ long term capital gain. This means its taxed at the lower rates of capital gains.
7-15
● CA:
○ there are ten transactions
■ Machine A - not a 1221 capital asset, but a 1231 asset. It was sold, so
there's a 13,000 gain.
■ Car in flood. The car is not a capital asset, because it was used in her
trade or business, and it fits in 1231(b). It passes transaction, but is an
involuntary conversion. So we have a -6,000 going into the first part
netting process.
■ Sale of machine b. -1,000
■ Typewriter - involuntary conversion, goes into prewash
■ Tape recorder - not a capital asset, used in trade or business. not a
1231(b) poperty under 1231 because it's not used for more than a year.
It's a business non-capital loss. Not subject to capital treatment.
■ machine c - not a capital asset, used in her business. held for less than a
year, so not in 1231. This is 4,000 business non-capital gain (ordinary).
■ ibm stock. this is a capital asset. It's the typical capital asset - property
held for investment not in trade or business. -2000 lt captial loss.
■ the yacht - used for personal purposes. is a capital asset, it's property not
excluded. It is a capital asset, because it is property. it has to be a 162 or
212 loss in order to.. (take it as a capital loss)? Since it's neither, it's non-
deductible personal loss. 263. Had it been held for production of income it
would be a long term capital loss.
■ machine d is used in trade or business, but it fits in 1231, but fails on the
transaction requirement. abandonment of property subject to liability is
a sale or echange, but this doesn't apply if there's no liability. -10,000
business non-capital loss.
■ not a capital asset because it's held for profit. Is it a 1231 asset? yes, it
fits proeprty requirement. It fits the transaction req as compulary. But it's
not involuntary, so it doesn't go in the prewash.
 ○ Netting process
■ Involuntary conversion: 1,000 loss. (a)(4)(c) says if it's a net loss it's
excluded from 1231. Then where to they go? They are an ordinary loss.
They're business non-capital gain and loss.
■ Then all others that fall in 1231. 1231(a)(1)-(3). There's a 9,000 net gain.
1231 says in this case these are long term capital transactions.
■ Next, there's a net 7,000 ltcg - 0 stcl = 7,000 ltcg.
■ Now you have 9,000 in ordinary income.
■ 165(c)(i) says you have 16,500 business losses. Don't have to worry if it's
a casualty, becuase it's not a business loss.
■ At the end of the day, the ltcg is taxed at a different rate. She has 0
AGI. She has a 7500 net operating loss deduction. She does not have
negative income.
7-16
● a
○ MA:
■ Year 1. Since this is property used in a trade or business, it doesn't fit
under 1221. It does fit within 1231, and it's not an involuntary conversion,
so it can be taken as a long term capital loss.
○ CA: It is an event of recognition: sale or other recogition under 1001. The truck is
not a capital asset; it's used within her trade or business. It is a 1231 asset. She
has a 40,000 ordinary loss (because it's a loss). It has to be otherwise allowable,
it's a section 162(a) ordinary loss.
● b
○ MA:
■ Year 2. Ordinarily this would be a long term capital gain under 1231,
but 1231(c) says that if in the preceding 5 years, 1231 losses exceeded
gains, and in the current year gains exceed losses, then all or part of the
gain must be characterized as ordinary to the extent that they recapture
ordinary income. So I think that 40,000 is considered ordinary gain and
10,000 is considered capital gain
○ CA: Same thing, you net it for a 50,000 ltcg (because it's a gain). But you have
40,000 of ordinary loss in your bucket, and you have to recapture that by turning
what would otherwise be a capital into ordinary gain to the extent you took a
capital loss earlier.
● c
○ MA: Then all of it would be considered ordinary gin
○ CA: Well, then you haven't used up the loss yet.
● d
○ CA: then 30,000 in year 2 would be considered ordinary gain, and 10,000 in year
three would also be ordinary gain. The remaining 15,000 would be capital gain.
7-17
● a
○ MA: I think these are more like property rights, because even though there will
 be income earned from them, it won't just be income: it's a right to do something
with the asset.
○ CA: Not capital gain, because copyrights in the had of a copyright holder is not a
capital asset, and it can't be converted.
● b
○ MA: I think these are more like property rights. An argument could be made that
the tv rights are rights to earn income, whereas the right to prevent a broadcast is
not income. Or an argument could be made that since all rights revert back, it's a
horizontal disposition, and should be considered capital gain.
○ CA: The rights to make the movie is a capital asset, but the right to be producer
is ordinary income. Whenever you see services being paid it's ordinary income.
The movie right looks like a capital asset in that you have to do something with
it, but it doesn't look like a capital asset in that it reverts in two years. M. says he
has no idea what the right to prevent the film from airing is, whether it's a capital
asset or whether it's going to be treated as ordinary income.
● c
○ MA: it means that he has not given away all that he has (it's horizontal rather
than vertical disposition).
○ CA: The effect of the reversion is to make it all income now, but if the reversion
happens, it's (a loss?). M. says the answers after this are unclear as to what's
actually correct.
● d
○ MA: I'm not sure...
○ CA: The rights to produce a musical is the same thing as tv rights: it's a capital
asset because it requires you to do work. Whats the effect of paying 5,000 up
front and 55,000 upon the first performance? the 55,000 is just delayed ordinary
income, the 5,000 is capital. Probably, M. says reasonable minds can differ.
Arguably it all could be ordinary income. If there was 60,000 up front for the
musical right, it will be more like the tv rights and it would be more likely to be a
capital income.
● e
○ MA: It looks more like a right to receive income, and this can't be converted from
an ordinary gain into a capital gain.
○ CA: This would be ordinary because she doesn't have to do anything but receive
the income. Look at whether one has to do something more than receive income.
If not it looks like dividends, which are ordinary income.
● f
○ MA: I don't think he's eligible for capital gain, it looks like he's being paid for
services.
○ CA: Personal services are ordinary income. It does not become a capital asset
when sold. The answer: No.
● g
○ MA: I think so, film rights aren't just a right to receive income, they're a right to do
something with an asset. I think this is capital gains.
 ○ CA: It doesn't matter who the purchaser is. The film rights are capital assets if
it hasn't been made yet, because there's still work to do; but if it's already been
made, it's just transferred ordinary income. Does it make a difference if that's
what Martin does for a living? If it's part of his trade or business, then it might
fit the stock and trade exception in the statute. M. says he doesn't know if this
changes the judicial analysis. If these rights make their way back to the original
author, then the author wouldn't be able to treat it as a capital asset. 1223(a)(3)
● h
○ MA: I think so, since again, it's something more than the right to receive income
○ CA: See end of (g).
● i
○ MA: Yes.
○ CA: M. says he has no idea what the right to prevent the film from airing is,
whether it's a capital asset or whether it's going to be treated as ordinary income.