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TAX OUTLINE Summary Preview of Review, for next week 5 major categories - Units 1.

. Income 61, 71, 74 (inclusions), 101-132 (exclusions) 2. Expenditures deductions (151,162-280F, 465-469) 3. Gains 1(h), 1001-1250 4. Tax Accounting 441-461, 111, 1341 5. Assignment of income judge-made law (1(g))

All Taxes are calculated by taking the TAX BASE MULTIPLIED by the TAX RATE at the moment of INCIDENCE. Different Tax Bases: 1. Income tax (includes capital gains) 2. Property tax (wealth tax) 3. Consumption/expenditure tax (X tax): a tax as you spend money a. Equation: Income minus savings equals consumption b. Pro: it does not disincentive gaining of income c. Con: i. It applies to those who borrow money ii. Transitioning from income to consumption is difficult 4. Transfer tax: a. Includes: i. Gift and estate taxes ii. Sales tax iii. Sin tax 5. Existence tax: head tax or poll tax (per capita everybody pays a fee for existing) 6. Employment tax: a subset of income but not an income tax a. There are no deductions allowed (FICA) b. The problem with taxing employment is it discourages employment Tax Policies: Fairness Policy: o Horizontal equity: similarly placed people should be treated the same This is violated many times (e.g., the mortgage deduction interest rate favors someone who owns a house and they pay less than someone who rents) o Vertical equity: people who make more money should pay more tax Income tax is based on the ability to pay Rich people should pay more and poor people should pay less Administrability/Simplicity: the law should be simple and fairly administrable (if not people will not pay their taxes) Economics: you want a system that promotes, not hinders, economic growth Sources of Federal Income tax law: 1. Constitution: a. Art. 1, 8, cl. 1: i. Congress shall have the power to law and collect taxes ii. All taxes shall be uniform throughout the United States 1

TAX OUTLINE b. Art. 1, 9, cl. 4: No capitation, or other direct tax shall be laid, unless in proportion to the census c. Art. 1, 2, cl. 3: i. Direct taxes shall be apportioned among the several states according to their respective numbers. ii. Example: 1 in 10 people live in California. Therefore one tenth of the revenue has to come from California. iii. A direct tax is a tax that you cannot avoid as a person. Property taxes have been interpreted as a direct tax (even though you can avoid owning property). An income tax has also been interpreted as being a direct tax. iv. An indirect tax is a tax you can avoid. v. 16th amend. allows congress to levy income taxes without apportionment among the several states based on census results (this overturned the Pollock case which said income tax was a direct tax) 2. U.S.C. 26 (I.R.C.) 3. Treasury Regulations: a. Legislative Rules b. Interpretive Analysis 4. Treasury Revenue Rulings/Procedures/Notices/Announcements/Advice a. Guidance from the IRS b. This is related to situations they become aware of and give you guidance c. These are the applications of the law as the Treasury sees it Basics of Tax Procedure: 1. IRS audit: a. Small chance of winning. b. If you cant settle with the agent then proceed to the next level 2. 30 Day Letter: a. IRS appeals (there is a 41% chance you will get a better deal than what the agent would tell you) b. If you do not accept then 90 day letter 3. 90 Day Letter: a. You have a choice b. Dont pay and sue in tax court (there is no jury and the judge and the prosecution are tax lawyers so it is hard to win) c. OR d. Pay and sue in district court (here you have a jury so best chance of winning) e. OR f. Pay and sue in U.S. Court of Claims (no jury but the judge and prosecutor may not be tax lawyers) 4. All appeals go to U.S. Court of Appeals (Golsen Rule: case law in your circuit is binding only in your circuit) 5. SCOTUS: only takes 3 cases per year Gross Income: Two Types: o Specifically included income by statute 61(a) 2

TAX OUTLINE (1): Compensation for services, including fees, commissions, fringe benefits, and similar items; o Someone pays you to put an ad on the side of your car. This is probably includible because you are performing a service of allowing advertising and receiving compensation. (2): Gross income derived from business; (3): Gains derived rom dealings in property; (4): Interest; o You open up a savings account and the bank gives you an iPod. When you give money to a bank you are loaning money to the bank. In return the bank gives you interest. An iPod looks like a prepayment of interests. (It is not a give because any commercial angle means it is not a gift) (5): Rents; (6): Royalties; (7): Dividends; (8): Alimony and separate maintenance payments (12): Income from discharge of indebtedness 74: gross income includes amounts received as prizes and awards Exceptions: If you pay money to play a game and then get a prize Exclusions: o 74(b): gross income does not include amounts received as prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement, but only if 1. Recipient selected without any action on his part to enter the contest or proceeding; 2. The recipient is not required to render substantial future services as a condition of receiving; AND 3. The prize/award is transferred by the payor to a governmental unit or organization pursuant to a designation made by the recipient (can not touch the winners hand) o 74(c)employee achievement awards Must meet definition in 274(j): An item of tangible personal property transferred to employee for length of service OR safety It must be awarded as part of a meaningful presentation The amount of the gift cannot exceed the amount allowable in 274(j)(3) The limitation is 400 dollars if there is no plan for giving out the awards The limitation is 1600 dollars if there is a plan to give out the award o Includible per theory: Income or gains not specifically included by statute Any value received that you do not pay for with already taxed dollars o Mail-In-Rebates are already taxed dollars spent 3

TAX OUTLINE Glenshaw Glass: o Income from whatever source derived o Any accretion to wealth is assumed taxable income o Holding: punitive damages are income Cesarini Case: o Treasury trove counts from the year it is reduced to undisputed possession o Holding: treasure trove is income With gambling: you are only taxed on winnings over what you spent (so keep count of the money you spend gambling) Treasury Regulation 161.14: Others paying your taxes = taxable income Illegal gains = taxable income Treasure trove (baseball) = taxable income Frequent Flyer Miles: o The miles your employer lets you keep are worth something o You did not pay for the miles with tax dollars o The IRS said it is too hard to regulate and not includible income Mobile Phones: o IRS is going after the companies o Also hard to regulate If you are travelling for an interview = not includible Mode of analysis: Any kind of wealth accretion is includable (this is too broad e.g., phones, frequent flyer miles) It is basically everything but a few exceptions so make fairness arguments: o Illiquid o Hard to value o To hard to administer If it is income, then find a statute to show the item does not need to be included in income Exclusions from income: o 102: value of property acquired by gift, bequest, devise, or inheritance for income purposes What is a gift? Elements: o Disinterested generosity o Donative intent o Cant be commercial in any way 102(c): An employer can never give a gift to an employee (there are other exclusions instead but not considered a gift) Duberstein case: o X refers business to Y; afterwards Y transfers property (a Cadillac) to X o Court says it was not a gift Stanton case: o A company gives money to a resigning president o Court says it is a gift 4

TAX OUTLINE Takeaway: If there is any sort of commercial element tied to the gift, even if it happened in the past, it will never be considered a gift. What is bequest, devise, or inheritance? Lyeth case: o There was a dispute over who was going to inherit the property. Ultimately a settlement was made over who would get what. Does this settlement count as income? o Holding: it was still considered a bequest, inheritance, or devise because you received property because somebody died Wolder case: o A lawyer renders services to a woman for the rest of her life. As a result she leaves him her estate. o Holding: It was like a delayed payment. This guy was not one who would normally receive anything through inheritance. He was a service provider o ***NOTE*** IRS has the ability to re-characterize the rules/transactions if the economic substance is not in accord with the legal form 61(a)(13): gains derived from dealings in property are income o Realization requirement: you only have to pay taxes on the gains when there is a dealing aka realization event ( 1001) o Realization event: sale of asset, exchange for other property, gift but not taxable on the gain, abandonment of the property, transfer in satisfaction of a debt or claim o How to calculate a gain ( 1001): Gain = Amount Realized Adjusted Basis Loss = Adjusted Basis Amount Realized The intention is to tax the appreciation on the value of property o Initial Basis in Property: 3 ways 1. 1012the purchase price of the property (when property is exchanged it is FMV at the time of exchange) 2. 1014basis of property inherited is the FMV of the property at the date of death (this is good because all of the appreciation in the deceased life goes untaxed) 3. 1015basis of gifted property is the donors basis Unless the FMV of the gift is less than donors basis at the date of the gift, then wait until the donee disposes of the property. If the donee sells for more than donors basis, then donors basis is your basis; If the donee sells for less than FMV at date of gift, use fair market value at date of gift; If donee sells at price between two figures, then no gain or loss o What happens when you borrow money and buy property with it? Crane case: if you borrow money and invest it then that debt is included in your basis (e.g., you put 20k down on a house and take out an 80k mortgage to acquire property. Basis = 100k) Subsequent secured debt (home equity) not included in basis, unless proceeds actually invested in the property What happens when the property is sold? 5

TAX OUTLINE Tufts case: any nonrecourse mortgage relieved of is included in amount realized (e.g., because you are relieved of 80kk debt and someone takes that loan from youeven if it is only worth 50kyou realize 80k) Tax law attempts to tax property income (you keep the property in these transactions). The property can earn income for you: Interests from debts; Rent payments for the use of tangible property; Royalty payment from intangible property; and Dividends and distributions of profits from a corporation. Discharge of Indebtedness (DOI): o Basic Theory: if a debt is forgiven (discharged) or paid by someone else, you have had an increase in wealth Wealth/equity/net worth = assets minus liabilities So if liabilities go down, you have an increase in wealth o Loan Proceed Approachif you never get the proceeds regarding a debt, then there is no DOI when the debt is forgiven. If you are not given anything of value when you take out the loan then it is not DOI when the debt is forgiven. o Short sale: value of the house is less than the debt There are 3 parties (bank, borrower, and buyer) 2 transactions occur: 1st the sale of the house by the owner to the buyer for less than the loan amount 2nd the buyer pays the bank and then the bank forgives the debt owed by the borrower The AR is a loss o No loss allowed on the short sale of the house o There is a gain under the short sale (the discharge of debt) o EXCEPTION 108(a)(1)(E): if it is a short sale of a principle residence before the end of 2012 then the DOI is excluded. This only applies to acquisition debt, if you take an out additional equity, then that probably will not be excluded. o Zarin case and the Contest Liability Doctrine: Casino loaned Zarin 3.5 million in chips he could not pay back so they settled for .5 million in debt. IRS said he received 3.5 million in wealth and DOI of 3 million Zarin said he only received .5 million and he paid it off (basically arguing that the chips were ultimately worth the .5 million) Court sided with Zarin (***NOTE*** only works when the asset received has no determinable value) Exclusions: o 108(a)DOI excluded if taxpayer is in Title 11 bankruptcy or insolvent BUT, amount excluded must reduce taxpayers tax attributes (certain credits and basis in other taxpayer property) 108(b)(2) o 108(a)(1)(E)if DOI is qualified principle residence debt then that amount is not includible in your incomesee above o 108(e)(5)purchase price adjustment If you buy a car for 25k. The car is not the year you wanted so the dealer reduces debt by 5k. Theoretically, there is a 5k DOI. 6

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TAX OUTLINE Under this exception not includible if it an adjustment to the price the borrower paid originally 108(f)school loan forgiveness If you borrow money for school and there is a provision in the loan for legal aid/peace corps loan forgiveness it would normally be DOI If the provision is in the loan agreement then under this exception not includible It is the same if someone gives you a loan to pay off your original loan and has a forgiveness provision but ultimately works the same way ***NOTE***if G gives you a check to pay back debtsas of nowthat is still DOI 108(h)if you get DOI and you still own the property then you have to reduce the basis by how much DOI is forgiven (this is the same as reducing tax attributes) Non-statutory Gift Loans: a loan from your parents that you could not pay back and parents forgive it is not includible because it could have been a gift 101(a)life insurance Amounts paid under life insurance paid by reason of the death of the insured Death of the insured is key here Payments that come from investments do not fit this exception. Only direct payments from a life insurance policy. 106(a)health insurance If your employer pays part of your premiums on your behalf, that amount would normally fall under 61 as income. This exception excludes employer provided health or accident benefits 105(b) & (c)health insurance (b) payments from the insurance company to the employee or the doctor is an exclusion If you receive a payment from you insurance company because of your employment it is not includible. 104(a)(3)also the same if you pay for your own health insurance 104(a)(2)damages Generally, damages are included in income. Statutes create exceptions for certain damages Glenshaw: punitive damages are includible in income Damages for lost income/profit is includible Damage to property (including insurance pay backs) is the AR Use the AR AB to figure the amount of income Damages on account of personal physical injuries or physical sickness is excluded from income Emotional Distress (ED) is included in income In a case where physical injury (PI) and emotional distress come from the PI, only the PI compensation is excluded from income In a case where ED gives rise to physical injury, still only the PI compensation is excluded If there is a settlement and it does not bifurcate between PI and ED, hire an objective finder of fact to determine what part is being paid for the PI 117scholarships Only qualified scholarships are excluded Elements: 1. An individual 7

TAX OUTLINE 2. Who is a candidate for degree 3. At an educational institution (most institutions are included) The money must be used for tuition and expenses (fees, books, and supplies required for instruction) (c) no exclusion for any part received for teaching 127an exclusion for education your employer pays for 119employer-provided meals and lodging Elements: 1. The meals and lodging have to be provided for the convenience of the employer 2. On the business premise o Meals are furnished on the business premise o The employee is required to accept such lodging on the business premises of his employer as a condition of his employment Meals and lodging can include your spouse and dependent 107exclusion for ministers of the gospel The rental value of the home furnished to him as part of compensation is excluded The rental allowance paid to him as part of his compensation to the extent used to provide a home and it does not exceed FMV of the home 121sale of a principle residence An exclusion for the gain from the sale of a property owned and used as a principle residence by the taxpayer Principle residence: the taxpayers primary place of residence for 2 of the past 5 years preceding the sale. Limited to 250k for an individual and 500k if married and filing jointly (and both used it as a principle residence) Limited to one sale for every 2 years You can receive a pro rata exclusion if forced to move without meeting the 2 year requirement and it is due to unforeseen circumstances 132fringe benefits 1. No additional cost service: No foregone revenue (this is the key element) It is offered to customers in ordinary cost of business You have to work in the line of business This is designed for flight attendants who receive free flights Example: If Delta owned Amtrak then an employee for one cannot get a free ride on the other Includes spouses and dependents 132(h) 2. Qualified employee discount: In the case of property, the gross profit percentage of the price at which the property is being offered by the employer to customers, OR In the case of services, 20 percent of the price at which the services are being offered by the employer to customers Includes spouses and dependents 132(h) 3. Working condition fringe: You may exclude any cost if you could have deducted it as a business expense Additionally, ABA or CA BAR dues 8

TAX OUTLINE If your employer pays these fees on your behalf then you can exclude Reimbursement for travel costs Example: A CEO with bodyguards 4. De minimis fringe: Any property or service that is small (use of a copy machine) Has to be periodical and not regular Cash and a Credit Card are never de minimis 5. Qualified transportation fringe: An employer can give you up to $230 a month in combined carpool/metro/parking pass that is excluded 132(j)nondiscrimination policyif the benefit is only given to the highly compensated in 1 and 2, then you must include in income o Divorce: The termination of a marriage in a competent court ***NOTE***the issue here is not the money coming in the door (this is always includible); this is a question of can you deduct the amount of money you have to send out the door Alimony: (payment is deductible; receiving is includible) 71(a)alimony is income o 215alimony payments are deductions (above the line) 71(b)what is alimony o Requirements: It has to be paid in cash/check It has to be per divorce or separation contract The divorce or separation contract has to call it alimony If separated/divorced under decree, you cannot be living in the same house Exception: there is a policy to encourage reconciliation so if there is a separation contract and no divorce you are allowed to be in the same household There can be no liability to pay after death of the recipient Property Settlements (incident to divorce) 1041 No income event for the transferor or transferee Basis of the property transfers (preserving the gain) Child Support 71(c)child support not includible or deductible because it is considered a personal expense

UNIT II: DEDUCTIONS


Expenditures get treated 1 of 3 ways: o 1. It is deductiblesatisfies statute and reduces TI by the amount of the payment o 2. We ignore itit is not deductible like personal expenditures o 3. The expenditure becomes the basis of propertycapital expenditure ( 1012) Not as good as deducting; but better than ignoring it (assuming you can use the basis at some point) You will be able to depreciate the basis (deduct it over a period of time) If you get to add the expenditure to the basis of property, then you will decrease the gain and the tax when you eventually sell the propertyCapitalize ***NOTE***If something is deductible, then you have to categorize where to take the deduction 9

TAX OUTLINE o If the deduction is taken by an employer, self-employed, or limited partnership, then it is above the line (not limited) o If the deduction is by an employee then it is itemized 162: Business Deductionsdeduct or capitalize? o 5 Requirements for a deduction: 1. Ordinary (dual meaning) The expense is not weird or bizarrea customary expense in that particular business Not capitalan expenditure that goes into the basis of property Hypos: o Deduction allowedmoney for reputation of a country music singer o No deductionpaying a priest to bless a construction site o Deduction allowedlegal expense in operating an illegal business o Deduction allowedlegal expenses arising out of business o Deduction allowedinterest on business loans o No deductionpurchasing business clothes 2. Necessaryappropriate and helpful (a very low standard) 3. The expense was paid/incurred during the tax year Not a capital expense 4. Carrying on The 4 stages of business: o 1. Investigate 195 These expenditures are capital (investigatory and start-up) because you are not carrying on a trade or business You can elect to deduct them when the business begins (Hoose: when you get your first customer) When business begins you can deduct 5k OR the 1195 investigatory costs (the lesser of the two) The remainder of expenses are deducted ratably over 180 months (15 years) For examples of investigatory costs see 195(c) o 2. Establish/Acquirecapitalize o 3. Start-up 195 These expenditures are treated like investigatory costs and capitalized similarly IF prior to operation o 4. Operation 162 deductible 5. Trade or businessnot personal ( 262no deductions for personal expenses except as otherwise provided) what is a business? o Regular, continuous, and substantial activity engaged in by taxpayer for profit o 183(d) presumptionif your income from an activity exceeds the deductions of that activity for 3 of the past 5 years, then it is a business If it is not a business it is a hobby.

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TAX OUTLINE o 183 allows deductions for expenses related to hobbies, but maximum amount deductible is limited to the amount of income from the hobby o Specific Business deductions under 162 162(a)(1)reasonable salaries/allowances Has to meet the 5 part test above PLUS be reasonable compared to others (what would be reasonable pay to a reasonable 3rd party) For owners of a corporation: o Salary deductible o Dividend NOT deductible Exacto Springs: reasonable salaries are deductible so you are able to make the distinction between a salary and a dividend 162(m)executive compensation deductible up to 1 million. EXCEPTION for performance-based pay (contingent on performance) So traditionally, executive pay is 1 million plus stock options and bonuses based on performance 280(G)parachute payments: payments made to executives of companies that were acquired 162(a)(2)travel while away from home on business (not lavish) Has to meet the 5 part test above Meals and Lodging: o To deduct meals you have to stay overnight away from home o 274 limits deduction on meals to 50% o these costs cannot be reimbursed (otherwise working condition fringe) o Rosespan: Traveling salesman who lived out of his car could not deduct meals and lodging because he did not have a home and therefore, was not away from home. o Andrews: if you have 2 homes and 2 businesses you can deduct only one of the homes Transportation/travel costs: purpose to distinguish travel from commutingRev. Reg. 99-7 (you have to have a business home) o 1. Commuting is nondeductible and personal o 2. Temporary worksite outside of metro are is deductible (classic business trip) o 3. If you have a regular work location away from home, you can deduct going from home to a temporary site Temporaryless than 1 year Business to businessdeductible o 4. If your residence is your principle place of business, then you can deduct all travel expenses (very favorable) o 5. You can deduct actual costs or mileage Business/personal combo tripdeductible o Capitalize: Generally, if expenditures have benefit in the future then you do not deduct; instead, capitalize them so you have basis in property Meets 4 of the 5 requirements, but it is related to property with long useful life If the costs only benefit the current year then no capitalization 11

TAX OUTLINE When is capitalization required? Indopco, Inc. v. Commissioner: o If expenditure has significant benefit in future years, then capitalization might be required Intellectual Property o Rev. Reg. 1.263(a)-4: Acquiree of IPcapitalize the cost o Creating IP ( 174): Separate and distinct IP (262(A)(h)): Capitalize Any kind of IP you can sellcapitalize The creation costs that go into the IPcapitalize Exceptions: o If shelf life of the IP is less than 12 months, then you can deductIndopco o Individual that writes, photographs, and artists you can deduct o If expenditure is research or experimental, then you can deduct (this is realistically how a lot of stuff is not capitalized)you can also get a credit Enhancing existing IP ( 174): Enhancing separate and distinct IPcapitalize (you can sell this IP) Enhancing indistinct IP (IP you cannot sell e.g., trade secrets, good will, reputation, advertising) deduct Facilitate the acquisition/creation of IPcapitalize Exceptions you can deduct: o Employee time (in relation to this) o Overhead o De Minimis costs IP example: You create a brochure for your good will and reputation: If you are creating good will (new firm), then capital expense If the firm is not new and you are just enhancing your good will or reputation, then deduct Rules for tangiblesProposed Rev. Reg. 1.263(a)-2, 3 o Mere repair and de minimis can be deducted o Repairingno increase to value, use, or life o Anything thing beyond that is capital Rules for Mergers and Acquisitions (M&A)Rev. Reg. 1.263(a)-5 o Any costs that facilitates the acquisition/dispositioncapital o Exceptions: If you are a corporate employer and some of your corporate employees are facilitating an acquisition, then you can deduct this costs (key here is already being an employee) Deduct overhead the employees are using 12

TAX OUTLINE Deduct De Minimis costs under 5k o Note: at some point of time the employees time is facilitating the acquisition and therefore capital. This starts when you decide which business you are going to acquire (Key here it is not until you decide on a particular target do you have to capitalize). 212: Money spent on investment/production of income is deductible Stockwhen you buy stock, the fee you pay to the broker is not deductible. Instead, the fee gets added to the basis of the stock you are buying Employment-related expenditures: o Employment is considered a business; therefore, employment related expenditures would be a deduction o If you are looking for a job in your field then those costs deductible (on the other hand, if you are switching to a new field of employment, then those costs are not deductible). Example: A catcher for the Chicago Cubs paid his father to train him to be a major league catcher. He was not a catcher yet. He deferred payment to his father until he became a catcher. Court allowed the deduction because he deferred the payment until he was in the business. (Note: if you can defer payment until you are in the field, then do it) o ABA dues, subscriptions, etc. are deductible o Daycare, maids, nice clothes are too personal and not deductible (EXCEPTION: required uniforms are deductible if they are not adaptable to general wear) o These deductions are considered miscellaneous itemized You only get to deduct what exceeds 2% of your AGI 274 Entertainment-related expenditures: o These expenses can only be deducted if related to a bona fide business discussion/purpose (a receipt with a note on the back of what was discussed) o You may only deduct 50% of the meals or entertainment o No facilities 274(a)(1)(B) Gym, or leasing a sky box No leasing the cost of entertainment facilities o No club dues 274(a)(3) This includes things like country clubs o Tickets are limited to face value 274(l) 280(A)Home Office o You may deduct expenses related to your home office (tax depreciation on your house, electricity bills, etc.) o Can only deduct on portion exclusively used for either: Principal place of business OR A place to normally meet patients, clients, or customers in normal course of business OR A separate structure, if used in connection with the business (no exclusivity requirement for this one) o Can deduct expenses associated with the portion used to store samples/inventory, IF the dwelling is the sole fixed location of the business (even if not exclusively used for this portion) o If you qualify you must prorate your home, by square footage, expenditures and deduct them 13

TAX OUTLINE Rev. Reg. 1.162-5: EducationDeductible if: o 1. Maintains or improves skills required in your business (NOT obtaining minimum requirements or to qualify for a new business) o OR o 2. Required by employer or law to retain your employment status (Hillmaintaining a teacher certificate) o If the education qualifies you for something new, then not deductible even if you dont use it o Dont forget the 2% floor if you are an employee o Examples: MBA if you had the exact same job before and after the MBA LLM in tax when you were a tax lawyer before and after NOT LLM in tax when you were antitrust lawyer before 165Business Losses o Businesses can deduct losses that occur in trade/business o Loss incurred on any transaction entered into for profit but not business o Losses that arise from casualty Depreciation/Amortization: o Depreciation results from capitalization. What happens to that basis in property? 1. For non-depreciable assets, wait until a realization event happens, then offset the gain on the AR by the basis. OR 2. You amortize (a intangible asset) or depreciate (a tangible asset) the basis. This is deducting a portion of the basis each tax year, part in the year the expenditure was made and the remainder over a number of subsequent tax years o Do you use 1 or 2? The default rule is that you wait until the realization event. You can only amortize the basis if a specific statute authorizes it: The property has to be used for business or held for production of income. 1. 167tangible propertyThe asset has to suffer wear and tear. o 1. Eligible if used and trade/business or held for investment o AND o 2. Suffers wear and tear (physically deteriorates; it doesnt matter if the property decreases in value.) o An example of no wear and tear is art in a business office or diamonds 2. 197intangible property o 1. The following, if NOT self-created (if instead acquired by purchase from someone else) [generally, if you created the intangible property, you can deduct it instead of amortizing it] good will, going concern, workforce, customer list patent, copyrights, films, recordings, books BUT ONLY IF acquired as part of an overall business o 2. Plus the following, whether self-created or acquired; license, covenant not to compete, franchise, trademark, trade o period of 15 years; ratable method; monthly convention o If property is depreciable/amortizable, how much is the annual depreciation/amortization deduction: Tangible property 168 14

TAX OUTLINE methodaccelerated (TABLE) OR ratable (for realty) o accelerated methoddeduct more in early year; used for personal movable property recovery perioddepends on asset class o number of years: 3, 5, 7 (default if you cant find out what it is in the statute), 10, 15, 20, 27.5, 39 o See 168(c), (e) for particular assets conventionhalf year OR mid-month (first and last year) o Personal property: half a year in the year placed in service, then half a year in year of retirement o Real Property: mid-month (If obtained in February then take a 10.5/12 deduction) Intangible property 197: 15 years, ratable, monthly convention o Special Rules: 168(k)Bonus depreciation (2011 only)try this first! 2011 onlywill be allowed to deduct, in year incurred, 100% of amounts otherwise capitalized AmountBasically tangible property (not IP) with a recovery period less than 20 years Limitsproperty has to be used at least 50% in business o Basis is zero o Can elect out o 280F still applies 179special deduction for small business You can ELECT to deduct, in year incurred, amounts that would otherwise be capitalized Amount (d): tangible, personal property used in business Limits: cannot deduct more than 500k for 2011 (back to 125k for 2012) o Limit is reduced for each dollar of assets placed in service in amount over 2 million (2011) o Limit to income from business prior to considering the deduction (i.e., cant create a loss) o The basis is reduced by amount of the 179 deduction; the remaining basis can still be depreciated 280Flimits on passenger automobilesthis applies to 168, 179 deductions Limits depreciation deduction for passenger autos (less than 6000 lbs) to $2,560 in the first year With 168 bonus depreciation the limit goes up to $10,560 for the first year 179(b)(5) for big SUVs to 25k in the first year. 280Flimits on listed property Generally, depreciated deduction limited to percentage of use of asset for businessSharp If listed property is used 50% or less in business, then you must use ratable and not accelerated depreciation for it You cannot take 179, 168(k) deduction for listed property that is used 50% or less in business Listed property=autos, cell phones, computers, and planes 15

TAX OUTLINE There is a recapture if business use later falls below 50% 212deductions for production of income o (3)costs for determination of tax (legal and accounting fees for tax advice) are deductible o (2)management, conservation, maintenance are deductible This is investment advice (not the actual transactions) Defending a property from a lawsuitcapital Defending a prenuptial agreementpersonal o (1)if you are suing to collect money that will be taxable to you, then it should be deductible (attorney fees, court costs, etc.) Collecting alimony or income is deductible Defending a prenuptial agreement from suit NOT deductible (personal or capital) Obtaining personal injury judgment NOT deductible (because income is excluded under 104(a)(2)) 163interests o Sounds broad, but there are limits o General rule, NOT deductible if personal o What is personal? Everything BUT Business interest Investment interest Qualified residence interest or QRI For two types of debts o Acquisition Debt on qualified residencedebt secured by residence and used to acquire, construct, improve residence Limits: Includes a re-financing but only to the extent of acquisition debt balance prior to re-financing Limited to 1 million in principle. o Home equity Debt on a qualified residencesecured by residence, and not qualifying as acquisition debt Limited to the lesser of: Amount by which FMV of house exceeds acquisition debt OR 100k o If you have no principal residence, then you can deduct interest on only 1 house 164taxesthe following are deductible: o State, local, foreign real property tax o State, local personal property taxes o State, local, foreign, income taxes o 2011 only, can elect to deduct state sales tax as opposed to state income tax 465At Risk Limitation (do this before you get to 469) o For an individual, if section applies to activity, then loss from the activity limited to amount at risk o Activityany business or investment undertaking, that is separate and distinct o Lossdeductible expenses exceeding gross income from activity for tax year o At risk(b) 16

TAX OUTLINE Increased by money, AB of property contributed to activity, plus recourse (in general) debt incurred on activity Reduced once a loss is allowed to be deducted by these rules o This statute still allows the loss to the extent you are at risk, so limited tax shelters but did not close them down completely 469passive activity limitationto close the rest of the tax shelter 465 left behind o For individuals, no passive activity loss is allowed o Passive activitya discernable/distinct business you are NOT materially participating in (rentals are generally passive) A rental property, OR an activity in which you do not materially participate in Rental is always a passive activity Not a rental if substantial services also performed (e.g., hotel; then go back to material participation test. Not a passive activity if a real estate rental and one half of your service hours (and more than 750 hours total) performed in real property businesses during the year Material participationregular, continuous and substantial participation More than 500 hours OR more hours than anyone else o This statute disallowed loss to be carried forward to future years. o Passive losses are allowed to offset other passive income; NOT active income or portfolio income until activity becomes active or is disposed of o ***NOTE*** Classify every business activity as passive or active o Small exception: Allows 25k net loss deduction from real estate (even if passive) Your income is under certain levels and you actively participate in the real estate activity 217moving deductionsabove the line o (a)deduction for moving expenses for start of work as an employee OR selfemployed at new principal place of work (can be new job, transfer, or change) o (b)moving expenses are reasonable expenses for: Moving household goods/personal effects from former to new residence Plus traveling and lodging to move (but not meals), for residents of the household o (c)TWO tests that must be satisfied: Distance testno deduction UNLESS: New workplace is at least 50 miles farther from former residence than was a former workplace, OR If no old workplace, then new workplace is at least 50 miles from former residence Deduction for unreimbursed costs only Time testno deduction UNLESS: Full-time employee in new location for 39 weeks in 12 months following arrival, OR Full-time employee or full-time self-employed, for 78 weeks out of the 24 months following the move (39 of the 78 weeks falling in first 12 month period) o (d)gives you a break on the time tests if you have to move again due to death, disability, or involuntary separation from your job (fired, transferred)

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TAX OUTLINE If you havent met the 39 week test at the end of the tax year, you can still deduct expenses so long as you expect to meet the test If you later fail the test, you must bring deductions back into income 213medical o deduction for UNREIMBURSED expenses incurred for medical care, to the extent expenses exceed 7.5% of AGI (an itemized deduction) o What is medical care? Drugs must be prescription Diagnosis, cure, etc. of diseases Affect any structure/function of the body Long-term care Insurance o See slide 18 of tax classes 15 & 16 for examples of winners and losers 151Personal Exemptionsa Free Deduction o You get a free deduction for you, a spouse, and each additional dependent o Dependentqualified child or qualified relative (test under both) Qualifying Child: 1. 2. Has to live with taxpayer for at least half of the year (same principle abode) 3. Has to be younger than the taxpayer and not obtained 19 at the close of the year or (24 for a student) 4. Person does not provide over one half of their own support 5. Cant file a joint return as a spouse Qualifying Relative: 1. Bears a relationship to the taxpayer (child, descendant, father, mother, ancestor of father or mother/step-father or step-mother, aunts/uncles, inlaws AND living in the same principle abode as the taxpayer 2. The gross income of the individual has to be less than the exemption 3. Taxpayer must provide half of the support for the year 4. The person is not a qualifying child o There needs to be a SSN for each dependent o Amount is 3.7k for 2011 o Phase outYou must take of 2 percent of the deduction for each 2.5k you make over 150k married 63Standard Deduction o If you do not elect to itemize, then your taxable income is just gross income minus the standard deduction and the 151 personal exemptions o Treasury provides he amount every year (5.8k for singles; 11.6k for married) o Using the standard deduction does not eliminate the above the line deductions o So what is a miscellaneous itemized deduction? Everything not listed in 67(b) 165(c)(3)Personal-Use Casualties (make sure these are not part of the capital gains step 5 procedure. Key here is PERSONAL USE)condemnation doesnt count o If there is a loss (no insurance proceeds) after netting all the casualties together, then there is a deduction allowed. o Knock $100 off of each casualty. Net with casualty gains. Then, if there is a net loss, there is a 10% floor. Deduction allowed only after it exceeds 10% of income. o Limit: the value cannot exceed the value right before the destruction or theft. 18

TAX OUTLINE o ***NOTE*** If there is a gain after the netting process, then all personal casualties are capital. Add in at step 6. o Example: Ms new car is stolen in 06; its basis was 20.1k and M received 8k in insurance proceeds; it was worth 18k when stolen. Ms AGI for 06 is 100k. Personal casualty deduction? AR=8k; AB=20.1k; Realized loss is 12.1k Knock off .1k so 12k 10% floor means only 2k 1033Involuntary Conversion Gain (do this before the step 5 capital gains process) o If property is destroyed and converted into money (insurance payout), the gain recognized on the conversion is limited if you purchase, within a certain time window, a replacement property similar or related to the destroyed property o The recognized gain is limited to the amount realized that exceeds the cost of the replacement property o Involuntary conversiontheft, seizure, condemnation or threat thereof etc. o Time window2 years from the end of the year of conversion (3 if condemnation) elective o Replacement propertysimilar endeavor or function (bowling and pool hall are not similar; BUT gas station and warehouse are) o The basis in the replacement property is the cost of the replacement property nonrecognized gain o If after insurance payout there is still a loss, then the loss is a 1231 loss o ***NOTE***if it is short term then it is ordinary income 1031Like Kind Exchange o No gain or loss recognized if 4 requirements met: 1. Exchange 2. Property given up business or investment property 3. Property received to be held for business/investment 4. Properties given up and received of a like kind o Exchange means trade one property for another (not cash); you have 45 days to identify the new property and 180 days to receive the property in return. Can also do reverse (find and acquire before you give up property) Can also do 3-corner (3 parties involved) o Property not eligible: Inventory Stock, bonds, notes, securities, financial instruments Interest in a partnership o The exchange has to be real estate for real estate or non-real estate for non-real estate o Personalitylike kind only if assets are of same general asset class (computer for printer is like kind, truck for plane is not; also hard for IP to qualify) o Pretty much any realty for realty will qualify if not foreign. Even if business realty traded for investment realty (but not personal-use realty) o Bootpartial exchangeif there is a trade with like kind and non-like kind, then you must recognize gain (but not the loss) to extent of the value of non-like kind property received o Basisbasis of property given up money received + recognized gain (usually it is a transferred basis) o The holding period is carried over from the old asset 19

TAX OUTLINE o If you transfer like-kind and a non like kind the basis of the non-like kind is the date you acquired it 170Charityabove the line deductions o You must get nothing back; also must own what you give away o Can be in cash or property (generally, FMV of the property is the deduction) Exception: 1. When a charity takes your property and immediately sells it, your deduction is limited to the sales proceeds for what the charity actually ends up receiving 2. To take a deduction the property has to work and if over $500,then you need a special receipt 3. You cannot deduct a contribution until it is actually paid o No deduction for services performed for charity (but costs are allowed) o Must have receipts/substantiation o When property given to charity, no realization event for the donor (i.e., no gain). You must reduce the amount of the deduction by the amount of ordinary gain inherent in the property donated. o Limits: Generally, cannot deduct more than 50% of AGI in total charitable contributions (Katrina ruleonly for 2005 the limit is lifted for contributions made after Katrina) No more than 30% of AGI for cash to private charities Cannot give more than 30% AGI in contributions of LTCG property to public charities Cannot give more than 20% of AGI in contributions of LTCG property to private foundations

ALTERNATIVE MINIMUM TAX:

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TAX OUTLINE

CREDITS:
24child creditfor every qualifying child you get a 1k credit (there is a phase out in (b) of the statute) 32Earned income credita credit as a percentage of earnedworkingincome in the year (phase out in statute) 42low income housing creditencourages people to invest in low income housing projects (for corporations) 45New markets tax creditinvesting in a project in a particular zip code, then it qualifies for a certain percentage of the project

UNIT III: RULES FOR GAINS AND LOSSES FROM DISPOSITION OF PROPERTY
Tax Rates: o 0% for regular capital gain, if the taxpayer is below the 25% income bracket o 15% regular capital gains rate o 25% rate due to depreciation on business realty o 28% rate on collectibles If the taxpayer has an overall capital loss, then no more than 3k of that loss can be deducted against ordinary income. This can be carried over in future tax years. The 7 step procedure: o 1. Identify all includible/allowable gains or losses. (Do not forget this because it will be a point or two on the exam) Take a look at all property transactions that happen during the year to determine if includible gain or loss. If the income is not includible in income, then do not worry about including it here. 21

TAX OUTLINE The AR = cash + FMV of property received + relief of liability secured by property We only determine gain/loss upon a realization event When is a gain includible? All gains on property are recognized unless statutes says otherwise 1001(c) Examples of non-includible gains: o 121gain on the sale principal residence o 102gifts (for transferor/giver) o 1041transfer pursuant to divorce o 1031, 1033 o 1043if you work for the G and you place it into a blind trust When is a loss allowable as a deduction? Like general rules on deductions, you must find a statute to authorize deduction for a loss computed under 1001. Examples: o 165(c)(1)allows deduction for business losses o 165(c)(2)allows deduction for losses on transactions entered into for profit o 165(f)allows deduction for capital losses, but as limited by 1211 (3k per year) o 165(c)(3)No personal use losses allowed o 2. Determine whether each asset disposed of was a capital asset per 1221 Not all assets are capital. Business related stuff is considered ordinary income. You cannot convert ordinary income to capital gains; so a lease cancellation cant be converted to capital income. Hudson says a settlement of a purchased judgment is still ordinary. Another example, sale of the right to receive lottery proceeds. If asset is listed in 1221(a)(1)-(8), then it is not a capital asset (kicked out of the process) (1)inventory held primarily for sale to customer (2)depreciable property used in trade or business, OR real property used in trade or business (leasing an apartment building; collecting rent) o Anything you use in your business is not a capital asset including: rents, copy machine, houses, cars, etc. (3)copyrights except music ( 1221(b)(3)) (4)accounts receivable arising from business o This is unpaid bills (if you sell it you have a basis of 0; if the client had paid you it would have been ordinary income) (5)government publications (6)commodities derivativesordinary income (7)hedging transactions, if clearly identifiedordinary income (8)suppliesstaplers, paperclips, etc. Summarygenerally, investment gains and losses are includible; but personal gains are includible, but personal losses are generally not deductible and thus not considered part of the capital netting process. This is a taxpayer incentive capital if a gain, ordinary if a loss. o 3. Determine whether the gain/loss is from a sale or exchange per 1222 22

TAX OUTLINE Sale or exchange is usually the same as a realization event Examples: foreclosure, abandonment, transfer subject to nonrecourse mortgage, transfer in satisfaction of a claim BUT A CASUALTY OR INVOLUNTARY CONVESION IS NOT A SALE OR EXCHANGE (stolen, burned down, shipwrecked, destruction or theft) o 4. Determine which assets are long/short term (1 year focal point)these get bumped down to step 6 Long term is more than 1 year 1 year exactly is considered short term Rev. Rule 66-7day of acquisition excluded; day of disposition included Acquire property by gift, then take over the holding period of the donor Acquiring property by inheritance is automatically long term Categorize as Short Term Capital Gain/Loss (STCG/L) or Long Term Capital Gain/Loss (LTCG/L) o 5. Deal with assets used in business per 1231 Disposition of assets used in business If net gaincapitalall of these gains and losses are treated as long term gains and losses If net lossordinary There are 2 pots here: a sub-pot and a main pot Sub-potnet conversion gains and losses (dont forget to see if 1033 applies first) o What goes in the sub-pot? Involuntary conversion of LT business assets AND Involuntary conversion of LT capital gains (non-personal) o If there is a loss, then the sub-pot items would be ordinary o If there is a gain, then sub-pot moves to main pot Main potnet 1231 sale gains with the conversion gain, if any o What goes in the main pot: Property used in the trade or business that is depreciable OR Real property held more than 1 year that is not inventory or a copyright, etc. AND If there is a net gain from the sub-pot You net all the 1231 gains and losses to see if there is an overall 1231 gain or loss If an overall gain, then all 1231 items are long term capitaladd to the capital gains netting process in step 6 If an overall loss, then all 1231 items are ordinary 1250gain due to depreciation on sale of business real estate is still a 1231 gain, but it is taxed at 25% assuming that the gain becomes a capital gain under the netting process (the 1250 gain will always be the lessor of the gain or the depreciation). 1245gain due to depreciation on personal property (non-real property) is treated as ordinary income and is NOT 1231 gain o 179special deduction for small business 23

TAX OUTLINE o 168(k)bonus depreciation (2011 only) o 197intangible property o 6. Then net gains and losses per 1222(5)-(11) to determine if an overall capital gain or loss First, you net the STCL against the STCG Next, you net the LTCL against the LTCG Then, you net the short term result against the long term result One of three results: 1. Net capital gaintaxed at a lower rate 2. Overall capital losslimited by the 3k 3. Net short term capital gainwhich is treated as ordinary income General rule, when netting the losses against the gains use the higher percent gains at first (this is taxpayer favorable) o 7. Final resultnet capital gain or overall capital loss o Special Rules that apply to step 1-4: 165(g)worthless securities (sale/exchange)if you hold stock in a company and the company goes bankrupt, you are allowed to use it as a loss even though no realization event 166(d)nonbusiness bad debts (STCL)if you loan your in-laws money, in the year it becomes clear they cannot pay you, it becomes a loss (if not a business the loss is automatically short term) 1234 & 1234(A)optionsstock options that you lose (because you did not purchase quick enough) can give rise to capital gain/loss 1235patentsif you create a patent and sell it, you can get capital gain treatment sometimes 1236securities dealerssecurities dealers can get capital treatment on stock for their own account as long as they designate it upfront to their account 12375 sale rulethe first 5 sales of subdivided real estate gets capital treatment 1239if you sell property to a related person there is no capital treatment 1253sale of franchiseselling a franchise is ordinary not capital

UNIT IV TAX ACCOUNTING:


The taxpayer would prefer to defer income inclusion and accelerate taking deductions to minimize tax liability in the current year Two major areas: o 1. Accounting periodsmust compute taxable income annually Taxable year for individuals is the calendar year 441(g) 4 problems: 1. Income bunching: working project takes 3 years, but you get paid in the last year. So your income is really high in the last year and not high in the first two. It will be taxed at the highest rate as opposed to a lower rate all three years. There is no solution for this problem currently. 2. Losses: If you work on a project for 3 years and have expenses on all the years until you are paid. You are allowed to carry forward the net loss to offset the final income. Only business losses can be carried forward in this manner.

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TAX OUTLINE 3. Contingent income 1341: You receive a bonus, but must pay it back if you leave the firm before a certain date. o Claim of right doctrine: include the income in the year you answer yes to the following: Received funds? Treated as your own funds? Recognized no offsetting obligation (you did not establish that you owed the money back)? o 2 options if you have to pay it back: (if it exceeds 3k) Deduct the payment in the year of repayment OR Take a tax credit by an amount your previous liability would have gone down if you had not included it in that year. 4. Expenditures that were deducted being returned to you: o If money is being returned to you, and you took a deduction when you gave the money away previously, then you must take the money back into income, if the money reduced your tax liability Phelan o You pay the tax rate applicable in the year you bring the income back o Remember if your take the standard deduction, do not forget that you did not use the state tax deduction so if you have to bring it back in you do not have to include it (has to decrease your tax liability). o 2. Accounting methodsdetermining which year to include income, take deductions 451gross income included when received, unless method of accounting says otherwise Cash method: o Treas. Reg. 1.451-1(a)include income in tax year of receipt of cash or cash equivalent (if you win a car on a game show on 12/31/61; but pick it up in January of next year, you include it in income in 1962Hornung) o If financial instruments can be easily be turned into cash, then include upon receipt (Mere obligation from a customer [IOU] not cash equivalentWilliams. Converting an obligation to cash means you must include itCowden. Checks are considered a cash equivalent.) Accrual method: still generally defaults to inclusion in year of receipt o Must include in the tax year in which: Right to receive income becomes fixed The amount of the income is determinable NO PERFORMANCE ASPECT o Exceptions: 456auto clubs, magazine, dues paying members can be included ratably over 3 years Schludedance studioif you cant tell when or if performance will take place, then include upon receipt of cash (the customer paid but did not take the lessons) 25

TAX OUTLINE Artnellallowed to defer prepaid baseball tickets estimate of performance certain 461deductible in the year which is proper under your method of accounting Cash method used by individuals for personal items. o Generally, deduct in tax year expenditure paid (i.e., when check is put in the mail, OR credit card charged) o Generally, cannot pre-pay future expenditures and deduct now. (g) Cannot deduct pre-payments of interest on my mortgage (g)(2) points are deductible when paid o Dont forget you still have to capitalize certain purchases Accrual Method used by individuals for business items o To take a deduction still must satisfy the all events test 1. Liability must be fixed 2. Amount of liability must be determinable, AND 3. Economic performance, if any, underlying liability must have taken place (h) General dynamicsdeduct in 2005 estimate of employee health care costs for 2005 services, not paid until 2006 Liability fixedyes Amount determinableno! Wont know for sure amount until employees submit reimbursement requests Economic performanceyes (service provided) They lost the case because they could not tell the IRS how much they were actually going to owe the deduction was taken in 2006 o What about taxes, like property taxescan I deduct prior to payment? Liability for 2006 property taxstatement sent out in late 2005 (but payment wont happen until 2006) Liability fixedyes Amount determinableyes Economic performancemaybe (government services) Andersonyou should be able to deduct in 2005 (but can elect to do it in 2006) If you can get the county to do several years in advance should lead to the same result BUT the IRS can ignore this action, and basically allow you to deduct only one year at a time o 1.461-5recurring item exceptioncan deduct small, recurring items so long as performance happens within 8.5 months of current year end 446rules (a)use the method you use for your books (b)if no method, must use method that clearly reflects income (c)can use following methods: o Cash method o Accrual method 26

TAX OUTLINE o Any other method o Combination of foregoing methods (d)you can use a different method for each business, plus different method for business and personal If you receive prepayment for services (not rent or interest) or IP, then you have to pro-rate for the first year and the rest gets included the next year

UNIT V ASSIGNMENT OF INCOME:


In general, each U.S. individual is a separate tax unit (exception is married filing joint return) This is not statutory; instead, case law dictates this section 1(g)kiddie taxunearned income of minor, under 18, taxed at the higher of (1) tax rate as if child included it, OR (2) tax rate as if it had been included in income of custodial parent. It does not matter where the kid got the property from 2 basic types of income, for shifting purposes o Labor/serviceswages, judgments/settlementscannot shift this income Banks: attorneys fees are income (except damages for personal injuries 104(a)(2)) Try to use 162, 212 to deduct lawyers fees 62(a)(20)makes some of these lawsuits (specific federal discrimination cases) above the line deductions to avoid AMT add-back problems Eubanks: deferred working payments still cannot be given away Giannini: if you can order someone else (employer) to make the payment on your behalf, then you do not have to include it Rev. Reg. 66-167 and 74-581: You can perform uncompensated service for a relative, even though it has the effect of shifting income o Income from property Includes ordinary income produced by property (dividends, interests, rents, and royalties) Includes gains from disposition of property (potentially capital) You can give away gain from the disposition of propertyif shifted to a child under 18, then Generally you cannot shift ordinary income arising from property (interests, dividends, rents, etc.) You cannot carve out a part of the property and assign it In other words, you can give away property (tree) but you cannot give away income (fruit) Horst: you cannot assign just the right to receive the interest on the bond to your daughterstill taxed to you. You could have given her the entire bond. Blair: assignment of entire income right in trust is valid, because income is the entire right of the taxpayer Stranahan: you can sell a carved out right; you just cant give it away Salvatore: gave gas station to son, when deal already signed to sell them invalid. Here the executor contract had already been established. She did not transfer all the stations to the kids, only half of the interest to the kids. 27

TAX OUTLINE Had she assigned all the interest before the contract was signed would have been valid. Gift of transfer of cows pregnant with calvesvalid Gift transfer of farmland with grown cropsinvalid IPif you create a copyright (even though it is your services and efforts) you should still be able to transfer the IP according to Hoose

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