Exam Number ________

Class Division ________

This is a three-hour, open book examination; you may use any resource, except for a live, personal consultant.

This examination has 5 pages (including the instruction page). Be sure you have them all.

Do not waste time paraphrasing the Code. An accurate citation will suffice. Common abbreviations, e.g., GI, AR, AB, FMV, etc., may be used.

Read the questions carefully. Answer only with respect to the parties about whom, and the taxable year about which, the questions ask.

All parties are cash method, calendar year taxpayers.

The law applicable to all transactions and situations is the Internal Revenue Code as in effect on the date of this exam. Assume the statute has been in effect in that form since 1916. Ignore all inflation adjustments. Thus, for example, the dependency and personal exemption amounts are each $2000 (as set forth section 151(d)(1)). In computing taxable income, use the tables set forth in section 1 of your IRC.

Good luck!

Stately, plump Buck Mulligan appeared with his employee, Stephen Dedalus, at the entrance of Buck's Tax Advice Service, which Buck founded last year (1993). It was 4:15 p.m. on April 15, 1994, and business had been brisk the last few weeks. Buck suddenly remembered something about this income tax filing thing, and realized that he had 45 minutes to get his 1993 return to the Post Office before it closed. He raced back to his business books and started sorting his receipts and bills in order to determine his tax liability for 1993. He was ready to pay his fair share of taxes.

Buck's records showed the following transactions for 1993:

I. Buck earned $270,000 in cash from his Tax Advice Service.

2. Buck paid Stephen a salary of $25,000.

3. Buck purchased a computer and printer solely for business use for $10,000. The computer qualifies as five-year property under section 168(e)(3)(B)(iv).

4. Buck purchased business supplies consisting of printer paper, diskettes, and office air fresheners (red rose scent) for a total of $5,000.

5. Buck vacuumed the carpets and swept in front of his office himself every other week. If he had hired someone to do it for him, he would have had to pay that person wages of $4,500.

6. Buck did Molly Bloom's return and instead of paying Buck cash, she gave him a rare Warhol lithograph worth $500, for which she had paid $100.

7. Buck took two courses at the local community college, Advanced Tax Methods (cost, $750) and Zen and the Art of Relaxation (cost, $500).

8. After success in the U.S. market, Buck started to think globally: "Why not Brazil, too?" He travelled to Rio to investigate the possibility of opening a Buck's in Brazil. He left New York Monday on a direct flight to Rio and met with potential joint venture partners on Monday, Tuesday, Wednesday, and Thursday. He then concluded, like De Gaulle, that Brazil was not a serious country, abandoned his business plans, and spent the rest of his time playing soccer on the beach. He returned home on Wednesday of the next week. His expenses were: transportation $2,000; meals $1,000 ($100 per day); and lodging $2000 ($200 per day, including the day of departure).

PROBLEM 1 CONTINUED ON NEXT PAGE

9. Buck sold stock in the following transactions:

Purchase Purchase Sale Sale

Stock Date Price Date Price

Micro, Inc. 1/1/80 $6000 3/1/93 $12000

Pan Am 1/31/92 $3000 1/31/93 $1000

ToysRUs 2/5/93 $1000 6/5/93 $5000

10. Buck paid state income taxes of $5000; and real estate taxes on his personal home of $2000.

11. Although Buck had never been married, Buck's girlfriend's cousin, François Grenouille (a naturalized U.S. citizen) lived in Buck's home for the entire year and Buck supplied over 1/2 of François's support. As François was slightly slothful--remunerated employment was just a bourgeois, capitalist construction--he had earned income of $1000 in 1993.

Assume that Buck wants to pay as little in taxes as legally possible.

(A). Calculate Buck's adjusted gross income for 1993.

(B). Calculate Buck's tax liability for 1993, assuming that Buck's adjusted gross income for 1993 was $200,000. Note, this is NOT the correct answer to (A) above. All other facts and figures, however, remain the same.

Note: For purposes of this problem, assume that sections 465, 469, 280A, and 1250 do not apply. If you have never heard of these sections, don't worry.

In 1990, John inherited a house in Miami from his parents. His parents's adjusted basis in the house was $100,000 and the fair market value ("FMV") of the house at the time of death was $250,000 ($100,000 allocable to the land). There was no mortgage on the property at the time of death. John immediately moved into the house, and made it his principal residence. In 1991, Madonna moved next door, and the FMV of the house jumped to $500,000. In 1992, John borrowed $200,000 from the bank and used the funds to add an additional room to the house. The loan was secured by a first mortgage on the house. At the end of 1992, Madonna moved out, and the FMV of John's house (new room and all) declined to $350,000. John paid $20,000 of interest on the first mortgage in 1992.

1. What's John's adjusted basis in his house (including the land)

at the end of 1992?

2. How much interest may John deduct in 1992?

In 1993, John borrows $150,000, which was secured by a second mortgage on the house, and uses the proceeds to buy a red Ferrari. John paid $20,000 of interest on the first mortgage and $15,000 of interest on the second mortgage in 1993.

3. How much interest may John deduct in 1993?

On January 1, 1994, John gets transferred to Cleveland--happy new year, John--and rents out his house starting on Jan 1, 1994. On this date, the FMV of the home is still $350,000 ($100,000 allocable to the land). John rents the house for one year and sells the house (including the land) for $300,000 on Jan 31, 1995. Assume that John's rental activities constitute a trade or business.

4. Calculate the depreciation deduction for the home for 1994. John wants to claim the maximum amount of depreciation legally possible.

5. How much interest may John deduct in 1994?

6. Calculate the gain or loss recognized on the sale of the home in 1995.

7. What is the character of the gain or loss?

Isabel borrowed $100,000 from Bank a few years ago. Assume that the note was unsecured, bore interest equal to the applicable federal rate, and the loan proceeds were used to take a vacation to visit the Prado and Louvre (and a few places in between). She has no money in the bank; and her only asset is a condo--in which she lives--worth $95,000 and an adjusted basis of $50,000. Isabel hits hard times, and she and the Bank negotiate a reduction in the loan principal to $90,000.

1. How much gross income, if any, must Isabel report?

2. After the reduction of the loan principal, what is Isabel's basis in the condominium, assuming no section 108(b)(5) election is made?

3. Assume that the $100,000 loan was recourse and secured by the condo. Isabel decides to get the bank off her back by transferring the condo to the bank in exchange for the bank canceling the $100,000 loan. What are the income tax consequences to Isabel?

4. What is the character of any income reported in 3, above?

5. Same facts as in 3, above, except that the loan is nonrecourse. How much gross income must Isabel report?

Anne borrowed $100,000 from Bank that was used in her business. As she is having a successful year in the stock market, she wants to offset some of her gains. $10,000 of interest accrues each year and is payable in arrears on December 31. She offers to pay and Bank agrees to accept three years of interest--$30,000--on December 31. What are the tax consequences to Anne when Bank accepts her check on December 31 for $30,000?

Tiffany is injured when Brutus runs a red light and hits her with his car. She sues him for $100,000, alleging damages of $20,000 for past medical expenses, $10,000 for future medical expenses, $30,000 for lost wages, and $40,000 for pain and suffering. A jury awards Tiffany $100,000.

1. How much gross income does she have?

2. From a tax policy perspective, is this the right answer? (No more than two sentences!)