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CHAPTER 18 Accounting Periods and Methods i
Comprehensive
Volume 2022
General Editors
James C. Young David M. Maloney
Ph.D., CPA Ph.D., CPA
Annette Nellen Mark B. Persellin Andrew D. Cuccia

J.D., CPA, CGMA Ph.D., CPA, CFP® Ph.D., CPA
Contributing Authors
James H. Boyd Steven C. Dilley Annette Nellen Toby Stock

Ph.D., CPA J.D., Ph.D., CPA J.D., CPA, CGMA Ph.D., CPA
Arizona State University Michigan State University San Jose State University Ohio University
Bradrick M. Cripe William H. Hoffman, Jr. Mark B. Persellin James C. Young
Ph.D., CPA J.D., Ph.D., CPA Ph.D., CPA, CFP® Ph.D., CPA
Northern Illinois University University of Houston St. Mary’s University Northern Illinois University
D. Larry Crumbley Sharon S. Lassar William A. Raabe Kristina Zvinakis
Ph.D., CPA Ph.D., CPA Ph.D., CPA Ph.D.
Texas A&M University - University of Denver Madison, Wisconsin The University of Texas
Corpus Christi at Austin
David M. Maloney
Andrew D. Cuccia Ph.D., CPA
Ph.D., CPA University of Virginia
University of Oklahoma
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Preface
Committed To Educational Success

S outh-Western Federal Taxation (SWFT) is the
most trusted and best-selling series in college
taxation. We are focused exclusively on providing the
In revising the 2022 Edition, we focused on:
• Accessibility. Clarity. Substance. The authors
most useful, comprehensive, and up-to-date tax texts, and editors made this their focus as they revised
online study aids, tax preparation tools, and research the 2022 edition. Coverage has been streamlined
tools to help instructors and students succeed in their to make it more accessible to students, and dif-
tax courses and beyond. ficult concepts have been clarified, all without
SWFT is a comprehensive package of teaching and losing the substance that makes up the South-
learning materials, significantly enhanced with each edi- Western Federal Taxation series.
tion to meet instructor and student needs and to add • Developing professional skills. SWFT excels
overall value to learning taxation. in bringing students to a professional level
The SWFT Comprehensive Volume, 2022 Edition in their tax knowledge and skills, to prepare
provides a dynamic learning experience inside and them for immediate success in their careers.
outside of the classroom. Built with the most important We include development of written and verbal
and relevant resources and tools, our complete learning communication skills, the use of tax preparation
system provides multiple options for students to achieve and tax research software, orientation toward
success. success on the CPA Exam, exposure to tax policy
In addition, the SWFT Comprehensive Volume, 2022 and tax law development, consideration of the
Edition provides accessible, comprehensive, and authori- time value of money in the tax planning process,
tative coverage of the relevant tax code and regulations and experience with advanced spreadsheet
as they pertain to the individual and business taxpayer, applications and data analytics.
as well as coverage of all major developments in Federal
income taxation. • CengageNOWv2 as a complete learning
system. Cengage Learning understands that
digital learning solutions are central to the class-
room. Through sustained research, we continually
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plan, video lectures, auto-graded homework, auto-
graded tests, and a full eBook with features and
advantages that address common challenges.
Learning Tools and Features to Help Students Make the Connection
FULL-COLOR DESIGN: We understand that students struggle with learning difficult tax law concepts and
applying them to real-world scenarios. The 2022 edition uses color to bring the text to life, capture student attention,
and present the tax law in an understandable and logical format.
Property Transactions:
13
C H A P T E R
Determination of Gain or Loss,

Basis Considerations, and
❏❏ Selected content is streamlined Nontaxable Exchanges
to guide students in focusing on L E A R N I N G O B J E C T I V E S : After completing Chapter 13, you should be able to:
LO.1
Perform the computation of realized gain or loss on
LO.6
Apply the nonrecognition provisions and basis
property dispositions. determination rules for like-kind exchanges.
the most important rules and LO.2

Distinguish between realized and recognized gain
or loss.
Illustrate how basis is determined for various methods
LO.7
Explain the nonrecognition provisions available on
the involuntary conversion of property.
Describe the provision for the permanent exclusion
THE BIG PICTURE ISTOCKPHOTO.COM/MICHAEL COURTNEY
concepts for the CPA Exam while Sale or Gift of inherited houSe and other ProPerty tranSactionS
LO.3 LO.8
of asset acquisition. of gain on the sale of a personal residence.
Describe various loss disallowance provisions. Apply various tax planning opportunities related to
LO.4 LO.9
selected property transactions.
Alice owns a house that she inherited from her grandmother, Paula, seven months ago. Paula lived in the house
still providing in-depth coverage of

Explain the rationale for nonrecognition (postpone-
LO.5
ment) of gain or loss in certain property transactions. for over 50 years. Alice has many fond memories associated with the house, because she spent many summer
vacations there. This has caused her to delay making a decision regarding what she is going to do with the house.
Based on the estate tax return, the fair market value of the house at the date of Paula’s death was
topics. CHAPTER OUTLINE

13-1 Determination of Gain or Loss, 13-2 13-5 Involuntary Conversions—§ 1033, 13-29
$475,000. According to Paula’s attorney, she paid $275,000 for the house. The real estate market for resi-
dential housing currently is robust in the city in which the house is located. So based on a recent appraisal,
the house is worth $800,000. Alice is considering two options. The first is to give the house to her son,
13-1a Realized Gain or Loss, 13-3 13-5a Involuntary Conversion Defined, 13-31
13-1b Recognized Gain or Loss, 13-8 13-5b Computing the Amount Realized, 13-31
Michael. Michael, his wife Sandra, and their daughter Peggy would live in the house. The second option is
13-1c Nonrecognition of Gain or Loss, 13-8 13-5c Replacement Property, 13-32 to sell the house. Projected selling expenses would be about 7 percent of the selling price.
13-5d Time Limitation on Replacement, 13-33
13-2 Basis Considerations, 13-9 Alice would also like to know the tax consequences of selling her boat, which she purchased for $22,000
13-5e Nonrecognition of Gain, 13-34
13-2a Determination of Cost Basis, 13-9 13-5f Reporting Considerations, 13-35 four months ago. She has been using it exclusively for personal use but is disappointed with its layout and
13-2b Gift Basis, 13-12
13-2c Inherited Property, 13-14 13-6 Sale of a Residence—§121, 13-35 capacity. Because it is a new model, there is significant demand for the boat, and based on listings in her
13-2d Disallowed Losses, 13-16 13-6a Principal Residence, 13-36 area, she anticipates that she can sell it for $20,000 to $23,000.
13-2e Property Converted from Personal Use to Business or 13-6b Requirements for Exclusion Treatment, 13-36
Income-Producing Use, 13-19 13-6c Calculating the Exclusion, 13-38 While you are talking, Alice mentions that earlier this year, she sold some Green Corporation stock at a
13-2f Summary of Basis Adjustments, 13-20 13-6d Exceptions to the Two-Year Rules, 13-39 loss. A few days later, after hearing Green Corporation’s quarterly earnings report, she decided to buy back
13-3 Nontaxable Exchanges, 13-22 13-7 Tax Planning, 13-41 the shares. You ask her to provide additional information to determine the tax effects of these transactions.
13-7a Cost Identification and Documentation Considerations,
13-4 Like-Kind Exchanges—§ 1031, 13-22 13-41
Alice also has owned a building (adjusted basis $50,000) that was used in her business. The building
13-4a Like-Kind Property, 13-23 13-7b Selection of Property for Making Gifts, 13-41 was recently destroyed by a fire, but fortunately, it was fully insured. The insurance company paid Alice
13-4b Exchange Requirement, 13-24 13-7c Selection of Property to Pass at Death, 13-42
13-4c Boot, 13-25
$100,000 to compensate her for the loss. Now she is looking to acquire suitable replacement property for
13-2 PART 4 Property Transactions CHAPTER 13 Property Transactions: Determination of Gain or Loss, Basis Considerations, and Nontaxable Exchanges 13-3 13-7d Disallowed Losses, 13-42
13-4d Basis and Holding Period of Property 13-7e Like-Kind Exchanges, 13-43 her business. If possible, she would like to claim a casualty loss, but certainly does not want to recognize
Received, 13-26 13-7f Involuntary Conversions, 13-43
13-1a Realized Gain or Loss 13-4e Reporting Considerations, 13-29 13-7g Sale of a Principal Residence, 13-44
any taxable gain from this event as she needs the funds for replacement property.
FRAMEWORK 1040 Tax Formula for Individuals Alice has come to you for advice regarding the tax consequences of these various transactions. Alice’s objec-
Realization Events tives are to minimize the recognition of any realized gain and to maximize the recognition of any realized loss.
Realization events include the sale or other disposition of property (i.e., transactions in
which taxpayers change, in a meaningful way, their ownership interest in an asset). A Read the chapter and formulate your response.
This chapter covers Income (broadly defined) ........................................................................................................ $ xx,xxx
the boldfaced portions Less: Exclusions ..................................................................................................................... (x,xxx) sale is the most common realization event involving property. The term other disposition
of the Tax Formula for Gross income ....................................................................................................................... $xx,xxx is defined broadly in the tax law and includes a wide variety of realization events includ-
Individuals that was ing exchanges, barter transactions, trade-ins, condemnations, and bond retirements.
FORM 1040 (p. 1)
introduced in Concept This term also applies when the taxpayer identifies a change in property (or property
7 Capital gain or (loss). Attach Schedule D if required. If not required, check here ▶
rights) even if they do not receive anything on the “disposition” (e.g., a casualty, theft, 13-1
Summary 3.1 on p. 3-3.
Below those portions FORM 1040 (Schedule 1)
the expiration of an option, or certain assets becoming worthless).
are the sections of Identifying a specific economic event (e.g., a sale) is a key factor in determining whether
3 Business income or (loss). Attach Schedule C . . . . . . . . . . . . .
Form 1040 where the a disposition has occurred.1 A change in the value of the property is not sufficient.2
4 Other gains or (losses). Attach Form 4797 . . . . . . . . . . . . . .
results are reported.
Less: Deductions for adjusted gross income ..................................................................... (x,xxx) Lori owns Tan Corporation stock that she bought for $3,000. The stock has appreciated in value and
is now worth $5,000. Lori has no realized gain because a change in value is not an identifiable event
EXAMPLE
Adjusted gross income ........................................................................................................... $ xx,xxx
Less: The greater of total itemized deductions or the standard deduction ............................. (x,xxx)
for tax purposes. Here, Lori has an unrealized gain of $2,000 ($5,000 2 $3,000). 1
The same is true if the stock had declined in value to $1,000. Because there was no identifiable
Personal and dependency exemptions* ......................................................................... (x,xxx) event, there is no realized loss. Here, Lori would have an unrealized loss of $2,000 ($1,000 2 $3,000).
Deduction for qualified business income** .................................................................... (x,xxx)
Taxable income ...................................................................................................................... $ xx,xxx Computation of Realized Gain or Loss
Tax on taxable income (see Tax Tables or Tax Rate Schedules) ............................................... $ x,xxx Realized gain or loss is the difference between the amount realized from the sale or
Less: Tax credits (including income taxes withheld and prepaid) ............................................. (xxx) other disposition of property and the property’s adjusted basis on the disposition date.
Tax due (or refund) ................................................................................................................. $ xxx If the amount realized exceeds the property’s adjusted basis, the result is a realized gain .
On the other hand, if the property’s adjusted basis exceeds the amount realized, the
* Exemption deductions are not allowed from 2018 through 2025.
** Only applies from 2018 through 2025.
result is a realized loss .3
Carl sells Swan Corporation stock with an adjusted basis of $3,000 for $5,400. Carl’s realized gain
is $2,400 ($5,400 2 $3,000). If Carl had sold the stock for $1,750, he would have had a realized loss
EXAMPLE
T
his chapter and Chapter 14 explain the income tax consequences of property
of $1,250 ($1,750 2 $3,000). 2
transactions (the sale or other disposition of property).
Concept Summary 13.1 summarizes this calculation. The various terms used in Con-
• Is there a realized gain or loss? cept Summary 13.1 are discussed on the following pages.
• If so, is the gain or loss recognized?
• If the gain or loss is recognized, is it ordinary or capital? Concept Summary 13.1
• What is the basis of any replacement property that is acquired?
Realized Gain or Loss
This chapter discusses the determination of realized and recognized gain or loss and
the basis of property. Chapter 14 covers the classification of the recognized gain or loss Realized Gain
as ordinary or capital. +
is
nt
ou =
LO.1 13-1 DETERMINATION OF GAIN OR LOSS If a
m
Perform the computation

of realized gain or loss on As discussed in Chapter 4, taxpayers do not recognize gross income until there has Amount Realized Adjusted Basis
property dispositions. been a realization. “Realization events” include the sale or other disposition of property. Money received Cost (or other basis) on date of acquisition
+ Fair market value of any other property received + Capital improvements and additions
Property includes both tangible assets (property having a physical existence, like land, a –
+ Debt relief (debt given up less any debt assumed) – Cost recovery/depreciation and other
building, or equipment) and intangible assets (like investments and goodwill). Tangible assets – Selling expenses capital recoveries
include both real property (e.g., land or a building) and personal property (e.g., equipment, = Amount realized = Adjusted basis
furniture, or a car). These property types do not change from taxpayer to taxpayer. However,
how that property is used (e.g., for business, investment, or personal purposes) can vary by If a
taxpayer. How property dispositions are taxed depends on the type of property involved. mo =
un
13-4 PART 4 t is
Property Transactions CHAPTER 13 Property Transactions: Determination of Gain or Loss, Basis Considerations, and Nontaxable Exchanges 13-5
Realization events related to property involve a significant change in ownership – Realized Loss
rights, and once a realization event has occurred, a realized gain or loss must be deter-
Amount Realized
mined. Many, but not all, realized gains and losses also are recognized (i.e., included in Ridge sells an office building and the associated land on October 1, 2021. Under the terms of the
The amount realized from a sale or other disposition of property is a measure of the eco- EXAMPLE
the determination of taxable income) at the time of the realization event. So realization sales contract, Ridge is to receive $600,000 in cash. The purchaser is to assume Ridge’s mortgage
is an accounting concept, and recognition is a tax concept. These matters are discussed 1
Reg. § 1.1001–1(c)(1). 3
§ 1001(a) and Reg. § 1.1001–1(a).
nomic value received for property given up. In general, it is the sum of any money received of $300,000 on the property. To assist the purchaser, Ridge agrees to pay $15,000 of the pur- 6
in more depth in this section. 2
Lynch v. Turrish, 1 USTC ¶18, 3 AFTR 2986, 38 S.Ct. 537 (USSC, 1918).
(which includes any debt relief) plus the fair market value of other property received.4 chaser’s closing costs (a “closing cost credit”). The broker’s commission on the sale is $45,000.
Debt relief includes any liability (e.g., a mortgage) assumed by the buyer when the The amount realized by Ridge is calculated as follows:
property is sold. Debt relief also occurs if property is sold subject to the mortgage (i.e.,
the seller remains liable for the debt even though the buyer will be making the pay- Selling price:
ments). In addition, debt relief is not limited by the fair market value of the property.5 Cash $600,000
Mortgage assumed by purchaser 300,000 $900,000
Less:
Amount Realized
❏❏ Examples are clearly labeled and

Broker’s commission $ 45,000
Juan sells a machine used in his landscaping business to Peter for $20,000 cash plus four acres of Closing cost credit provided by Ridge 15,000 (60,000)
EXAMPLE property that Peter owns in a nearby town with a fair market value of $36,000. Juan’s amount real- Amount realized $840,000
3 ized on this sale is $56,000 ($20,000 cash 1 $36,000 land).
directly follow concepts to assist with EXAMPLE

Barry owns property on which there is a mortgage of $20,000. He sells the property to Cole for
$50,000 cash and Cole’s agreement to assume the mortgage. Barry’s amount realized from the sale
Adjusted Basis
The adjusted basis of property disposed of is the property’s original basis adjusted to
the date of disposition.9 Original basis is the cost or other basis of the property on the
student application. An average of 4 is $70,000 ($50,000 cash 1 $20,000 debt relief ).
In a property transaction, the fair market value of property received is the price determined
date acquired by the taxpayer. Capital additions increase and capital recoveries decrease
the original basis.10 As a result, adjusted basis is determined as follows:
Cost (or other adjusted basis) on date of acquisition
over 40 examples in each chapter by a willing seller and a willing buyer when neither is compelled to sell or buy and both
have reasonable knowledge of relevant facts.6 All of the relevant factors must be considered,7
and if the fair market value of the property received cannot be determined, the value of the
property given up by the taxpayer is assumed to be equivalent and may be used.8
1 Capital additions
2 Capital recoveries
5 Adjusted basis on date of disposition
use realistic situations to illustrate

A taxpayer’s original basis also includes any liability incurred to acquire the property.
Return to the facts of Example 3. There are several ways one can determine the fair market value
EXAMPLE Veronica purchased a residence for $250,000. Whether Veronica uses $250,000 from her personal
of the land Juan is receiving.
assets to pay for the residence or uses $50,000 from her personal assets and borrows the remaining
EXAMPLE
the complexities of the tax law and

5 • An appraiser can be paid to provide an appraisal of the land. $200,000, her basis in the residence is $250,000. It does not matter whether Veronica borrows from 7
• City or county property tax assessment information may also be helpful; the city or county the seller (via a land contract) or from a local bank or any other lender (via a mortgage).
assessor determines the fair market value of property so that property taxes are levied
appropriately. Many assets are acquired without purchasing them (e.g., via gift or inheritance). We’ll
allow students to integrate chapter • If the exchange is between a willing buyer and seller, determining the fair market value of
Juan’s landscaping machine could answer the question (i.e., given the facts of the case, it
should be worth $56,000).
discuss how to determine basis for these assets later in the chapter.
Capital Additions
concepts with illustrations and

Capital additions include the cost of improvements made to the property that lengthen its
useful life or increase its production capacity or efficiency. These costs are different from
In calculating the amount realized, selling expenses (e.g., advertising, commissions, repair and maintenance expenses, which are neither capitalized nor added to the original
and legal fees) relating to the sale are deducted. As a result, the amount realized is the basis (refer to text Section 6-3i). As a result, repair and maintenance expenses are deductible
net amount the taxpayer received directly or indirectly, in the form of cash or anything
examples.
in the current taxable year if they are related to business or income-producing property.
else of value, from the disposition of the property. Any liability on property that is assumed by the buyer also is included in the buyer’s
The calculation of the amount realized may appear to be one of the least complex areas original basis of the property. The same rule applies if property is acquired subject to a
associated with property transactions. However, because numerous positive and negative liability. Amortization of the discount on bonds increases the adjusted basis of the bonds.11
adjustments may be required, this calculation can be complex and confusing. In addition,
determining the fair market value of the items received by the taxpayer can be difficult. The Capital Recoveries
following example provides insight into various items that can affect the amount realized. Capital recoveries decrease the adjusted basis of property.
4
§ 1001(b) and Reg. § 1.1001–1(b). The amount realized also includes any of property subject to a mortgage, the Federal income tax consequences in
Depreciation and Cost Recovery The original basis of depreciable property is
real property taxes treated as imposed on the seller that are actually paid calculating the amount realized are the same.
by the buyer. The reason for including these taxes in the amount realized 6
Comm. v. Marshman, 60–2 USTC ¶9484, 5 AFTR 2d 1528, 279 F.2d 27
reduced by any cost recovery or depreciation allowed while the property is held by the
is that by paying the taxes, the purchaser is, in effect, paying an additional (CA–6) and Reg. §§ 1.737–1(b), 20.2031–1(b), and 25.2512–3(a). taxpayer. The amount subtracted annually from the original basis is the greater of the
amount to the seller of the property. Refer to text Section 10-2b for a dis- 7
O’Malley v. Ames, 52–1 USTC ¶9361, 42 AFTR 19, 197 F.2d 256 (CA–8) allowed or allowable cost recovery or depreciation.12
cussion of this subject. and Alan Baer Revocable Trust v. U.S., 2010–1 USTC ¶60,590, 105 AFTR
5
Crane v. Comm., 47–1 USTC ¶9217, 35 AFTR 776, 67 S.Ct. 1047 and Comm. v. 2d 2010–1544. 9
§ 1011(a) and Reg. § 1.1011–1. 12
§ 1016(a)(2) and Reg. § 1.1016–3(a)(1)(i). In most cases, these amounts are
Tufts, 83–1 USTC ¶9328, 51 AFTR 2d 83–1132, 103 S.Ct. 1826. Although a legal 8
U.S. v. Davis, 62–2 USTC ¶9509, 9 AFTR 2d 1625, 82 S.Ct. 1190. 10 the same (refer to text Section 8-1c).
§ 1016(a) and Reg. § 1.1016–1.
distinction exists between the direct assumption of a mortgage and the taking 11
See text Section 14-3b for a discussion of bond discount and the related
amortization.
vi
COMPUTATIONAL EXERCISES: Students need to learn to apply the rules and concepts covered in
each chapter to truly understand them. These exercises, many of which mirror text examples, allow students to practice
and apply what they are learning.
❏❏ Found in the end-of-chapter sections of the textbook
❏❏ CengageNOWv2 provides algorithmic versions of these problems

13-50 PART 4 Property Transactions
26. LO.1 Melba purchases land from Adrian. Melba gives Adrian $225,000 in cash and
agrees to pay Adrian an additional $400,000 one year later plus interest at 5%.
a. What is Melba’s adjusted basis for the land at the acquisition date?
b. What is Melba’s adjusted basis for the land one year later?
27. LO.1 On July 1, 2021, Katrina purchased tax-exempt bonds (face value of $75,000)
for $82,000. The bonds mature in five years, and the annual interest rate is 3%.
a. How much interest income and/or interest expense must Katrina report in 2021,
assuming that straight-line amortization is appropriate?
b. What is Katrina’s adjusted basis for the bonds on January 1, 2022?
28. LO.3 Luciana, a nonshareholder, purchases a condominium from her employer
for $85,000. The fair market value of the condominium is $120,000. What is
Luciana’s basis inCHAPTER
the condominium andDetermination
13 Property Transactions: the amountof Gain orof
Loss,any income as
Basis Considerations, and a resultExchanges
Nontaxable of 13-67
this purchase?Randall treats the transaction as a like-kind exchange. Even though the original office
Research AND Data29.Analytics the 45-day rule.Problems:

building identified was not acquired, Randall concludes that in substance, he has satisfied
LO.3 Sebastian purchases two pieces of equipment for $100,000. Appraisals of the
He identified the acquired office building as soon as the negotiations
equipment indicate that the fair market value of the first piece of equipment is
ceased on his first choice. Should the IRS accept Randall’s attempt to comply? Explain.
$72,000 and that of the second piece of equipment is $108,000. What is Sebastian’s
Use internet
basis students
in these tax resources to address the following questions. Look for reliable web-
two assets?
❏❏ Research Problems provide sites andwith
blogs ofvital
the IRSpractice in an increasingly
and other government agencies, media demanded skill area.
outlets, businesses,
Some of these end-of-chapter items
30. LO.3 Juliana ask students
tax professionals,
purchased landtothink
academics, analyze
three tanks, andtax
years agodata,
politicalfor helpingShe
outlets.
$50,000. them made to aunder-
gift of the
stand the application of this information
land to Tom,
Research in
hervarious
Problem brother,
4. How are scenarios.
intransactions
the current These essential
year,
using bitcoin when
(or features
the
another fair cur-
virtual prepare
market value
Communications
students for professionalwas
tax$70,000. Notreated
environments.
rency) Federal
undergift taxlaw?
U.S. tax is paid on IRS
Locate the theguidance
transfer. Tom
on this subsequently
question. Some sells
the property background on bitcoin can be found at bitcoin .org/en/faq. In addition, locate the
for $63,000.
American Institute of CPAs Comment Letters on virtual currency (issued in May 2018
a. What isand Tom’s basis
February inAfter
2020). thereading
land?theseWhat is hisprovide
materials, realized gain or
a one-page losssum-
written on the sale?
b. Assumemary instead
for yourthat the land has a fair market value of $45,000 on the date of
instructor.
Becker Professional Education REVIEW QUESTIONS: the gift,

land, and
and that
Research
by size
what
Tom5. sold
Problem
of income
How do
is his(AGI)?
theU.S.
land
Go togain
realized the IRS
for $43,000.
individuals
ortaxloss
generate Now
statistics
on the
what Does
their income?
website
sale?
is Tom’s
it varybasis in the
Communications
End-of-chapter CPA Review
(irs.gov/statistics), Data Analytics
Questions from Becker PREPARE STUDENTS FOR and SUCCESS. Students
download a recent review
tax year’s key
information concepts
on “sources using
of income.” proven
Compare the questions from Becker
31. LO.4 Lisa sells business
following
Professional Education —one of the industry’s most
® property
types of income with
by size an
of AGI: (1)adjusted
effective tools to prepare for the CPA Exam. wages, (2) basis of
capital gain $130,000
distributions,to her son,
(3) sales of capital assets, and (4) sales of property other than capital assets. Clus-
Alfred, for its fair market value of $100,000.
ter the data into no more than six AGI categories. Present your findings in a visual
a. What is(e.g.,
Lisa’s realized
bar chart), and recognized
and summarize your findingsgain or loss?
in a one-page memo to your instructor.
b. What is Alfred’s recognized gain or loss if he subsequently sells the property
for $138,000? For $80,000?
❏❏ Located in select Becker CPA Review Questions
32. LO.4 Arianna’s personal residence has an adjusted basis of $230,000 and a fair
end-of-chapter sections market value of $210,000. Arianna converts the personal residence to rental
property. 1.What
Jasmin purchased 100 shares of Pinkstey Corporation (publicly traded company)
is Arianna’s gain basis? What is her loss basis?
on January 1 of year 1 for $5,000. The FMV of the shares at the end of year 1 was
❏❏ Tagged by concept in 33. LO.4 Peyton$6,000.
sellsOnanJanuary
office1 building
of year 4, Pinkstey
and the Corporation
associateddeclared
landa 2-for-1
on May stock1split
of the current
CengageNOWv2 when the fair market value of the stock was $65 per share. On January 1 of year 5,
year. Under the terms of the sales contract, Peyton is to receive $1,600,000 in
Jasmin sold all of her Pinkstey Corporation stock when the fair market value was
cash. The purchaser isWhich
$40 per share. to assume Peyton’s
of the following mortgage
statements is true? of $950,000 on the property.
❏❏ Questions similar to what To enable the
a. purchaser
Jasmin reportsto$6,500
obtain adequate
in gross income forfinancing, Peyton
the 2-for-1 stock split inis to4.pay the $9,000
year
students would actually in points charged by basis
b. Jasmin’s the inlender. TheCorporation
the Pinkstey broker’sstock
commission on 4the
at the end of year sale
is $65 per is $75,000.
find on the CPA Exam What is Peyton’sshare.
amount realized?
c. Jasmin has no taxable income for the Pinkstey Corporation stock in year 4.
34. LO.6, 9 Vijay owns land (adjusted basis of $40,000) that he uses in his business. He
d. Jasminthe
exchanges ownsland
100 shares in Pinkstey in
and $20,000 Corporation
cash forstock at the end parcel
a different of year 4.of land worth
$50,000. May Vijay avoid like-kind exchange treatment to recognize
2. Alice gifted stock to her son, Bob, in year 5. Alice bought the stock in yearhis realized loss
1 for
$8,300. The value of the stock on the date of gift was $6,400. Bob sold the stock in
of $10,000? Explain.
year 7 for $15,800. What is Bob’s recognized gain or loss on the sale in year 7?
35. LO.6 In June a. 2021,
$0 Sue exchanges a sport-utility vehicle
c. $9,400 gain (adjusted basis of $16,000;
b. $7,500
fair market gain of $19,500) for cashd.of $15,800
value $2,000gain
and a pickup truck (fair mar-
ket value3.ofJerry
$17,500).
inherits anBoth vehicles
asset from his uncle,are
whoheld for the
purchased business
asset five use. Sue he
days before believes that
her basis fordied.
theWhich
truckof is
the$17,500.
following statements is correct? Why or why not? As part of your
Is Sue correct?
response, compute
a. If JerrySue's realized
sells the gain
asset a few daysor loss
after (andit,any
receiving recognized
any gain gain
or loss on the sale or loss) on
vii
the exchange. will be short term.
b. Jerry’s basis in the asset is the carryover basis from his uncle.
c. Jerry’s basis is the FMV on the alternate valuation date or date it is distributed
to him.
Editorial review has deemed that any suppressed content does not materially affect the overall
d. learning
Jerry’sexperience.
basis is Cengage
the FMVLearning
on his reserves the right
uncle’s datetoof
remove additional content at any time if subsequent rights restrictions require it.
death.
See how the SWFT series helps students understand the big picture
and the relevancy behind what they are learning.
THE BIG PICTURE Joseph Mucira/pixabay THE BIG PICTURE: Tax Solutions for the
EffEct of a for-Profit BusinEss on a tax-ExEmPt Entity
Real World. Taxation comes alive at the start of each
Hopeful, Inc., is a tax-exempt organization under § 501(c)(3) that provides temporary lodging and psycho-
logical services for abused women and children. Its annual operating budget is $12 million. More than two
chapter as The Big Picture examples provide a glimpse
decades ago, Jennifer Abbott was a recipient of the services provided by Hopeful. Now Hopeful’s adminis-
trator has been notified by the attorney for Jennifer’s estate that her will transfers to Hopeful her shares in
the outstanding stock of Taste Good Ice Cream, a chain of 40 gourmet ice cream shops located in Virginia,
into the lives, families, careers, and tax situations of
North Carolina, and South Carolina. The business has been in existence for eight years and has produced
substantially higher profits each year. typical filers. Students will follow a family, individual, or
Hopeful’s board is considering the following options regarding the bequest from Jennifer and has hired
you to provide an analysis of the tax consequences of each option.
• Sell the stock of Taste Good Ice Cream, and add the net proceeds to Hopeful’s endowment.
other taxpayer throughout the chapter, to discover how
• Continue to conduct the Taste Good Ice Cream business as a division of Hopeful.
• Continue to conduct the business as a wholly owned subsidiary of Hopeful.
the concepts they are learning apply in the real world.
With the second and the third options, the existing Taste Good management team will remain in place.
After-tax profits not needed to expand the ice cream shop chain will be transferred to Hopeful, to be used
Finally, to solidify student comprehension, each
chapter concludes with a Refocus on the Big
in carrying out its exempt mission.
Read the chapter and formulate your response.
Picture summary and tax planning scenario. These

scenarios re-emphasize the concepts and topics
from the chapter and allow students to confirm their
understanding of the material.
23-1
19240_ch23_hr_002-033.indd 1 2/2/21 7:26 PM
FRAMEWORK 1040:
Fitting It All Together.
This chapter-opening feature 11-2 PART 3 Deductions and Credits
demonstrates how individual FRAMEWORK 1040 Tax Formula for Individuals
income tax topics fit together, This chapter covers Income (broadly defined)....................................................................................................... $ xx,xxx Use this chapter-opening
the boldfaced portions
using the Income Tax Formula of the Tax Formula
for Individuals that
Less: Exclusions ................................................................................................................... (x,xxx)
Gross income ...................................................................................................................... $ xx,xxx Framework 1040, which
shows the topics as they
for Individuals as the framework. was introduced in
Concept Summary 3.1
FORM 1040 (p. 1)
7 Capital gain or (loss). Attach Schedule D if required, If not required, check here
appear in the individual
on p. 3-3. Below those
The framework helps students portions are the
sections of Form 1040
FORM 1040 (Schedule 1)
3 Business income or (loss). Attach Schedule C . . . . . . . . . . . . .

tax formula, to
organize their understanding of where the results are
reported.
4
5
Other gains or (losses). Attach Form 4797 . . . . . . . . . . . . . .
Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E
understand where on
Form 1040 these chapter
the chapters and topics to see Less: Deductions for adjusted gross income .................................................................... (x,xxx)
Adjusted gross income.......................................................................................................... $ xx,xxx
topics appear.
how they relate to the basic Less: The greater of total itemized deductions or the standard deduction .................... (x,xxx)
FORM 1040 (p. 1)
tax formula and then identify 12 Standard deduction or itemized deductions (from Schedule A) . . . . . . . . .
where these items are reported Personal and dependency exemptions* ....................................................................... (x,xxx)
Deduction for qualified business income** .................................................................. (x,xxx)
Taxable income .................................................................................................................... $ xx,xxx
on Form 1040. Framework 1040 Tax on taxable income (see Tax Tables or Tax Rate Schedules) ............................................. $ x,xxx
Less: Tax credits (including income taxes withheld and prepaid) .......................................... (xxx)
helps students navigate topics by Tax due (or refund) ............................................................................................................... $ xxx
*Exemption deductions are not allowed from 2018 through 2025.
explaining how tax concepts are **Only applies from 2018 through 2025.
organized.
A
s discussed in Chapter 6, a tax deduction for an expense or a loss is not allowed
unless specifically permitted by Congress. For example, losses can be recog-
nized and deducted in the case of certain unprofitable investments only because
the Code allows them. These losses can arise from the operation of an activity or on its
sale. For most individual taxpayers, deductible investor losses come within the scope
of § 165(c)(2) relating to transactions entered into for profit.1 But what happens if the
investment is mostly motivated by the tax loss it generates? Or what if the investment
generates expenses that offset ordinary income and it later is expected to produce
appreciation taxed at capital gain rates? This chapter addresses these tax minimization
strategies and the rules put in place to restrict their use.
LO.1 11-1 THE TAX SHELTER PROBLEM

Explain the tax shelter
problem and the reasons for Before Congress passed laws to reduce their effectiveness, tax shelters provided a
the at-risk and passive activity popular way to avoid or defer taxes, since they could generate deductions and other
loss limitations. benefits to offset income from other sources. Because of the tax avoidance potential of
many tax shelters, they were attractive to wealthy taxpayers in high-income tax brackets.
Many tax shelters merely provided an opportunity for “investors” to obtain tax deduc-
tions and credits (and some had no profit motive).
1
If the losses are incurred in connection with a trade or business, § 165(c)(1)
applies.
11015_ch11_hr_002-039.indd 2 25-02-2021 7:04:34 PM
viii
FINANCIAL DISCLOSURE
8-6 PART 3 Deductions and Credits
INSIGHTS: Tax professionals need to FINANCIAL DISCLOSURE INSIGHTS Tax and Book Depreciation
A common book-tax difference relates to recovery deductions represent a means by which the taxing
understand how taxes affect the financial the depreciation amounts that are reported for GAAP and jurisdiction infuses the business with cash flow created by the
Federal income tax purposes. Typically, tax depreciation reduction in the year’s tax liabilities.
statements. Financial Disclosure Insights, deductions are accelerated; that is, they are claimed in earlier For instance, recently, about one-quarter of General Elec-
reporting periods than is the case for financial accounting tric’s deferred tax liabilities related to depreciation differences.
appearing throughout the text, use current purposes. Ford’s depreciation differences amounted to about one-third
Almost every tax law change since 1980 has included of its deferred tax liabilities. And for the trucking firm Ryder
information about existing taxpayers to depreciation provisions that accelerate the related deductions Systems, depreciation differences accounted for virtually all
of the deferred tax liabilities.
relative to the expenses allowed under GAAP. Accelerated cost
highlight book-tax reporting differences,
effective tax rates, and trends in reporting Taxpayers may elect the straight-line method to compute cost recovery allowances
conventions.
11-18 PART 3 Deductions and Credits for each of these classes of property. Certain property is not eligible for accelerated cost
recovery and must be depreciated under an alternative depreciation system (ADS). Both
participates or has worked for more than 750 hours in these real property trades or
businesses during the year.26 Services performed by an employee are not treated as the straight-line election and ADS are discussed later in the chapter.
being related to a real property trade or business unless the employee performing the Cost recovery for personalty generally incorporates the half-year convention ; that
services owns more than a 5 percent interest in the employer. In addition, a closely held is, cost recovery in the year the asset is placed in service, as well as the year it is
C corporation may also qualify for the passive activity loss relief if more than 50 percent removed from service, is based on the assumption that the asset was used for exactly
of its gross receipts for the year are derived from real property trades or businesses in one half of the year, allowing a half-year of cost recovery.CHAPTER
7
For example, 27theThe Federal Gift and Estate Taxes
regular
which it materially participates. MACRS recovery period for property with a life of three years begins in the middle of
50
Example 46 illustrates a an
the year lifetime
asset is version of theand
placed in service direct
ends skip event.
three years later, In thisfourth
in the situation,
taxable
the GSTT is imposedyear.
ETHICS & EQUITY:
In practical
upon Elenaterms,
when thisthe
means
giftthat
is an asset’sto
made cost is actuallybecause
Rodrigo, recovered the
over gift
4, 6,
ETHICS & EQUITY Punching the Time Clock at Year-End 8, 11, 16, or 21 years.
skips over the generation of Rodrigo’s parents. Many tax issues
As the end of the tax year approaches, Julie, a
The GSTT rate is the highest
• On weekends, she and Ralph will visit the same units to
do not
rate underhave just
the gift andoneestate tax correct
schedulesanswer.
(i.e., 40 percent).
The GSTT base is reduced by the same
MACRS Personalty; exemption
Half-Year equivalent amount that is available
Convention
successful full-time real estate developer and investor, recog-
nizes that her income tax situation for the year could be bleak.
further evaluate the operations.
• Also on the weekends, while they are doingagainst their rou- the Federal estate
Ethics & Equity features
51
and gift tax (see Exhibit 27.1). For a donor who is will spark
married, the
Kareem acquires a 5-year class asset on April 10, 2021, for $30,000. Kareem’s cost recovery deduction
Unless she and her spouse, Ralph, are able to generate more
hours of participation in one of her real estate rental activities,
election
tine household shopping, they will be on the lookout
other rental properties to buy. Julie plans to countThe
E X to
for A Msplit
P L Ethe gift
for(ascritical
2021under asthinking
§ 2513)
is computed can double and
follows: the amount invite
both tax base also is reduced by the annual gift tax exclusion and the charitable
GSTT exemption.52
of theclassroom
3 MACRS cost recovery [$30,000 3 0.20 (Exhibit 8.3)] $6,000
they will not reach the material participation threshold. Conse-
quently, the tax losses from the venture will not be deductible.
her and Ralph’s weekend hours toward the tally of total
participation. and marital deductions. The discussion,
GSTT does not enticing
apply to gifts students to evaluate
made for political, medical,
To ensure deductibility, Julie suggests the following plan: and educational purposes,
Julie contends that the law clearly allows the efforts theirif the owncorrespondingvalue system.
gift tax exemption Suggested
applies. A credit is
• She will document the time she spends “thinking” about of one’s spouse to count for purposes of theallowed material for certain state-level
Assume the sameGSTTfacts aspaid.
in Example 3. Kareem sells the asset on March 5, 2023. Kareem’s cost recov-
her rental activities. EXAMPLE
Generations
participation tests. Likewise, nothing in the tax law requires answers
are assigned
ery deduction by birth
for 2023 to
is $2,880 Ethics
or marriage.
[$30,000 &
3 0.192For Equity
other
(Exhibit scenarios
8.3) 3 parties,
]. 1
2 a generation is
• During the week, Ralph will visit the apartment building taxpayers to be efficient in their hours of participation. How 4
25 years long. The GSTT computation is made on a schedule that is part of Form 706 or
to oversee (in a management role) the operations of the
rentals.
do you react? appear in
709 (i.e., the estate or gift tax return to which it relates).
the Solutions Manual.
Mid-Quarter Convention
The half-year convention is based on the simplifying presumption that assets gener-
Real Estate Rental Activities with Active Participation Mother Anna (age 60) and sonacquired
ally are barry (age 40)even
at an are pace
in two successive
throughout theGSTT generations.
tax year. Father Carl
However, Congress was
The second exception to the passive activity loss limits is more significant(age 60)it and
in that is daughter Denny
concerned(age 15)taxpayers
that are in two successive
might defeat thatgenerations.
presumption by placing large amounts of
EXAMPLE
deduct E’Toin (ageproperty
not restricted to real estate professionals. This exception allows individuals toSpouses
up to $25,000 of losses from real estate rental activities against active and portfolio
60) andin Fantasia
service toward
(agethe
58)end
areofinthethe
taxable
same year (and by doing
generation.
year’s depreciation on those large end-of-year acquisitions).
so, receive
Spouses a half-
Gerardo 47
(age 60) and Hermosa (age 20) are in the same generation.
income each year.27 The potential annual $25,000 deduction is reduced by 50 percent
of the taxpayer’s AGI in excess of $100,000. As a result, the entire deduction isUnrelated
phased individuals Ishu (age 60) and Jiva (age 50) are in the same generation. Unrelated
individuals
out at $150,000 of AGI. If married individuals file separately, the $25,000 deduction is Kong (age 60) and Lian (age 12) are two generations apart.
reduced to zero unless they lived apart for the entire year. In this case, 7the loss amount
§ 168(d)(4)(A).
TAX PLANNING: Chapters include is $12,500 each and the phaseout begins at $50,000 of AGI.28
To qualify for the $25,000 exception, a taxpayer must meet both of the following
a separate section• Actively

calling
requirements:29
attention 27-5 TAX pLANNING
participate in the real estate rental activity, and
LO.10
to how taxpayers can• Own 10use the law to
percent or more (in value) of all interests in the activity during
taxable year (or shorter period during which the taxpayer held an interest
the entire
27-5a The Federal Gift Tax
in the
reach financial and other goals. Tax
activity).
For gifts that generate a tax, consideration must be given to the present value to the
The difference between active participation and material participationdonor is that the
of the gift taxes paid. Because the donor loses the use of these funds, the estate taxes.
planning applications andthreshold
active participation suggestions
can be satisfied without regular, continuous, and substan-
expected
taxpayer interval between a gift (the imposition of the gift tax) and death (the imposi-
11015_ch08_hr_002-047.indd 6 02-03-2021 6:33:03 PM
tial involvement in operations. The active participation standard is met if the
appear throughout each
participates chapter.
in making management decisions in a significant and bonation of the estate tax) may make the gift less attractive from an economic standpoint.
fide sense.
Approving new tenants, deciding on rental terms, and approving capital
Onorthe
repair
plus side, however, are the estate tax savings that result from any gift tax paid.
expenditures meet this test.
Because these funds are no longer in the gross estate of the donor (except for certain
26 28
gifts within three years of death), the estate tax thereon is avoided.
§ 469(c)(7)(B) and Reg. § 1.469–9. In Frank Aragona Trust, 142 T.C. 165 In general, AGI for purposes of the phaseout is calculated without regard to
(2014), the Tax Court found that a trust also could qualify for the real estate IRA deductions, Social Security benefits, interest deductions onGifts possess distinct advantages over transfers made at death. First, and often most
education
27
professional rule.
29
important, income from the property is generally shifted to the donee. If the donee is in a
loans, and net losses from passive activities. See § 469(i)(3)(F).
§ 469(i). § 469(i)(6).
lower bracket than the donor, the family unit will save on income taxes. Second, the proper
spacing of gifts can further cut down the Federal gift tax by maximizing the number of
annual exclusions available. Third, many states impose some type of tax at death, but only
a relatively few impose a gift tax. Thus, a gift may completely avoid a state transfer tax.
In minimizing gift tax liability in lifetime asset transfers, the optimum use of the annual
11015_ch11_hr_002-039.indd 18
CHAPTER 3 Computing exclusion the Taxcan have3-23 significant results. Because a new annual exclusion is available each year,
25-02-2021 7:05:13 PM
spacing gifts over multiple years increases the amount that can be transferred free of gift tax.
GLOBAL TAX ISSUES Tracking Down Tax Dollars
Global Tax Issues: The
Non-U.S. persons who earn income within the The position of the IRS is that theStarting in 2013,
current ITIN Cora makes gifts in the amount of the annual exclusion to each of her five grand-
procedure lobal Tax Issues feature gives
G
children. EXAMPLE
United States may need to file a Federal income tax return, brings in revenue that otherwise would not be Taking into account the changes in the amount of the annual exclusion allowed, Cora will
forthcoming.
but they may not have a Social Security number for filing pur- Some undocumented workers want have transferred
to comply with the $650,000
law insight into the ways in which
through 2021 with no Federal gift tax consequences. 48
poses. If not, they can use a nine-digit Individual Tax Identi- and pay the income taxes they owe. This practice should not
fication Number (ITIN) instead. The IRS issues ITINs upon the be discouraged, as the tax law applies with equal force to legal
Years taxation is affected by international
Amount of Exclusion
submission of an application and proof of identification (e.g., and illegal residents of the United States.
a driver’s license). As the IRS does not require an applicant to However, ITINs have been criticized 2018–2021 concerns and illustrates the effects
for their use by ille- $15,000 (annual exclusion) 3 5 (number of
show that he or she is in the United States legally, the ITINs are gal immigrants and undocumented workers. A recent report donees) 3 4 (number of years) $300,000
freely available to undocumented persons (i.e., illegal immi- 2013–2017
found that individuals who are not authorized of various events on tax liabilities
to work in the $14,000 (annual exclusion) 3 5 (number of
grants). The use of an ITIN also can enable the holder to carry
out other financial transactions (e.g., establish a bank account,
United States were paid $4.2 billion in refundable tax credits,
such as the child tax credit, because they were able to file tax
across the globe.
donees) 3 5 (number of years) 350,000
secure a credit card, and obtain a loan). returns using an ITIN.

50 52
§ 2612(c)(1). § 2652(a)(2).
51
§ 2631(c).
through tax professionals who have been accepted into the electronic filing program
by the IRS. Such parties often hold themselves out to the general public as “authorized
IRS e-file providers.”
For direct e-filing, a taxpayer uses a personal computer, laptop, phone, or tablet,
employing tax preparation software with the capability of conveying the information
11015_ch27_hr_002-041.indd 25
online to an electronic return transmitter. A taxpayer then can use the free smartphone
app “IRS2Go” to check the status of a refund.
Through an arrangement with the IRS, designated software providers offer free
e-filing services. These services are available only to lower-income taxpayers. A list
of these “Free-File” providers and their eligibility requirements can be obtained at
irs.gov/filing/e-file-options.
ix
All e-filing taxpayers and tax return preparers must attest to the returns they file. For
most taxpayers, this attesting can be done through an electronic return signature using
a personal identification number.
E-filing has two major advantages. First, compliance with the format required by the
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xi
xii PREFACE
EXTENSIVELY REVISED. DEFINITIVELY UP TO DATE.

Each year the South-Western Federal Taxation Chapter 1
series is updated with thousands of changes to each
•• Removed Exhibit 1.4 (on IRS audit types), but
text. Some of these changes result from the feedback
retained text discussion.
we receive from instructors and students in the form
of reviews, focus groups, web surveys, and personal •• Expanded judicial concepts to also include judicial
e-mail correspondence to our authors and team mem- doctrines and added new text and example on the
bers. Other changes come from our careful analysis substance over form doctrine.
of the evolving tax environment. We make sure that •• Updated end-of-chapter materials as needed.
every tax law change relevant to the introductory
taxation course was considered, summarized, and
fully integrated into the revision of text and sup-
Chapter 2
plementary materials. •• Minor changes made to various exhibits and
The South-Western Federal Taxation authors concept summaries.
have made every effort to keep all materials up to date •• Updated references and citations throughout the
and accurate. All chapters contain the following general chapter.
changes for the 2022 edition. •• Expanded Internal Revenue Bulletin coverage to
include IRS Notices.
•• Updated materials to reflect changes made by
Congress through legislative action (including the •• Changed references to RIA Checkpoint to Thom-
tax provisions contained in the CARES Act, the son Reuters Checkpoint.
Consolidated Appropriations Act of 2021, and the •• Updated end-of-chapter materials as needed.
American Rescue Plan Act of 2021).
•• Streamlined chapter content (where applicable) Chapter 3
to clarify material and make it easier for students
•• Updated chapter materials to reflect changes
to understand.
to Form 1040 and related schedules; updated
•• Revised numerous materials as the result of exhibit summarizing when Form 1040 Schedules 1
changes caused by indexing of statutory amounts. through 3 are used.
•• Revised Problem Materials, Computational •• Updated explanation and examples of the child
Exercises, and CPA Exam problems. tax credit to reflect 2021 changes made by the
•• Updated Chapter Outlines to provide an overview American Rescue Plan Act of 2021.
of the material and to make it easier to locate •• Updated chapter materials to reflect 2021 inflation
specific topics. adjustments.
•• Revised Financial Disclosure Insights and Global
•• Updated material on virtual currency (including
Tax Issues as to current developments. revised question on page 1 of Form 1040).
In addition, the following materials are available online. •• Updated exhibit summarizing the 0, 15, and 20%
breakpoints for the alternative tax on net capital
•• An appendix that helps instructors broaden and gains.
customize coverage of important tax provisions •• Revised and clarified materials (including end-of-
of the Affordable Care Act. (Instructor Companion chapter materials) as needed.
Website at www.cengage.com/login)
•• An appendix that covers depreciation and
the Accelerated Cost Recovery System (ACRS). Chapter 4
(Instructor Companion Website at •• The discussion of Income Received by an Agent
www.cengage.com/login) was moved to text Section 4-2 with the discussion
•• An appendix that has comprehensive tax of the timing of income recognition.
return problems for the 2020 tax filing year •• Updated Global Tax Issues feature entitled
(Appendix F). (Instructor Companion Website “From ‘All Sources’ Is a Broad Definition” for the
at www.cengage.com/login) number of recent expatriations.
PREFACE xiii
•• Added Ethics & Equity feature on the expansion •• Replaced summary of a Fortune article on execu-
of unemployment benefits during the COVID-19 tive compensation with summary of a Wall Street
pandemic. Journal article (text Section 6-4c).
•• Noted the 2020 unemployment compensation •• Revised and updated end-of-chapter materials
exclusion added by the American Rescue Plan Act as needed (including changes needed to reflect
of 2021. revised inflation-adjusted items).
• • Added two examples illustrating the •• Modified items in tax form and tax computation
relationship of the all-events test to problems to be more reflective of current income
financial reporting. levels.
• • Added example of potential income shifting
to a taxpayer not subject to the kiddie tax to
highlight the general benefits of income shift- Chapter 7
ing and the impact of the kiddie tax on this •• Cited a recent Tax Court decision that
benefit. provides a comprehensive overview
• • Deleted former homework Problem 55 that of the law related to worthless securities
required completion of Worksheet 1, Figur- [MCM Investment Management, LLC
ing Your Taxable Benefits, from IRS Publica- (T.C.Memo. 2019–158)].
tion 915. •• Updated text to include discussion of COVID-19
casualties (and the ability to deduct these in the
year prior to the loss).
Chapter 5
•• Added a new example (Example 27) demonstrat-
•• Modified Learning Objective 1 to address the
ing how to amortize research and experimentation
definition of exclusions and that they are
expenditures incurred in taxable years beginning
distinguishable from items that are
after December 31, 2021.
not income.
•• Noted (in footnote 37) the retroactive delay of the
•• Combined the learning objective on cancellation
excess business loss provision by the CARES Act
of debt with the learning objective related to other
(revised effective date is taxable years beginning
exclusions.
after December 31, 2020).
•• Renamed text Section 5-1 as “Income Exclusions.”
•• Modified the net operating loss materials to reflect
•• Moved material on corporate distributions from changes made by the CARES Act.
text Section 5-11 to new text Section 5-1b, to
•• Added new part to Problem 40 to allow students
illustrate an example of something received that
to compute the appropriate deduction for research
is not income.
and experimentation expenditures incurred in
•• Moved and renamed former text Section 5-16 taxable years beginning after December 31, 2021;
as text Section 5-14 to improve flow of chapter also added a related question to the text bank and
materials. modified an essay question.
•• The discussion of corporate payments called •• Updated remainder of chapter materials as
“dividends” (but not considered dividends for tax needed (including various inflation-adjusted
purposes) was moved to Chapter 4 (as part of amounts).
gross income discussion).
•• Updated text, examples, and end-of-chapter
materials as needed, including 2021 inflation Chapter 8
adjustments. •• Updated chapter materials to reflect inflation
adjustments to § 179 (including SUVs) and luxury
automobiles.
Chapter 6 •• Updated Form 4562 and Schedule C (Form 1040)
•• Revised and updated chapter materials as needed; to 2020 forms.
clarified chapter materials when necessary. •• Updated and revised remainder of text and end-
•• Updated text for inflation-adjusted items. of-chapter materials as needed.
xiv PREFACE
Chapter 9 Chapter 13
•• Updated text and end-of-chapter materials for •• Revised introductory discussion of realized gains
revised standard mileage amounts; updated and losses (text Section 13-1a).
materials on retirement plans. •• Expanded the discussion of basis when a liability
•• Deleted coverage of § 222 (repealed as part of is involved, adding Example 7.
Consolidated Appropriations Act of 2021). •• Reduced the discussion of basis computations,
•• Revised and clarified materials based on feedback deleting former Example 11.
from adopters.
Chapter 14
Chapter 10
•• Updated Exhibit 14.1 summarizing 2021 and 2020
•• Revised and clarified text as needed, including break points for the 0%/15%/20% alternative tax
2021 change to medical expense AGI floor (now rates on net capital gains and qualified dividend
permanently set at 7.5% of AGI). income.
•• Added brief comment on CARES Act cash chari- •• Updated text and end-of-chapter materials for
table contribution for non-itemizers (a for AGI 2021 inflation adjustments to Tax Rate Schedules
deduction). and alternative tax rate brackets (for net capital
•• Updated text for annual inflation adjustments. gains).
•• Updated end-of-chapter materials as needed. • • Enhanced text materials, Concept Summary
14.6, and Concept Summary 14.8 to show
integration with the capital gain materials
Chapter 11 more clearly.
•• Made minor changes to Learning Objectives 2
and 4.
•• Updated chapter materials to reflect inflation Chapter 15
adjustments. •• Updated chapter materials to reflect 2021 infla-
•• Added new research problem on virtual currency tion adjustments to QBI deduction threshold
investing and software tools to help track the nec- limits.
essary information for tax reporting. • • Updated example illustrating the completion
•• Updated end-of-chapter materials as needed. of 2020 Form 8995-A and Schedule A (Form
8995-A).
•• Revised and clarified materials based on feedback
from adopters.
Chapter 12
•• Updated end-of-chapter materials as needed
•• Updated for changes to various individual credits
(including revisions for inflation adjustments to
by the American Rescue Plan Act of 2021.
QBI deduction threshold limits and completion of
•• Reorganized presentation of credits to show those 2020 Form 8995).
available to businesses, to individuals, and to both
types of taxpayers.
•• Updated Ethics & Equity scenarios to reflect cur-
rent tax law considerations.
Chapter 16
•• Removed discussion of conditions for granting
•• Added a problem on the AMT.
approval to change an accounting period.
•• Updated problems, improved readability.
• • Replaced a research problem with one involv-
•• Added an exhibit summarizing various energy ing a sole proprietor and the constructive
credits (Exhibit 12.4). receipt doctrine (and added a communications
•• Updated Affordable Care Act materials. requirement).
PREFACE xv
Chapter 17 •• Added new “formula” version of Excel spread-

sheet for current distributions in Problems 24
•• Updated and revised text and end-of-chapter
and 25.
materials as needed.
•• Noted the changes to the excessive executive •• Replaced calculation spreadsheets to correct typo
compensation rule made by the American Rescue in Problems 24 and 25.
Plan Act of 2021. •• Expanded response to part (b) of Problem 28.
•• Added a new research problem focused on the •• Added new “formula” version of Excel spreadsheet
CARES Act. for liquidating distributions in Problem 29.
•• Added calculation spreadsheets support-
Chapter 18 ing answers in Problem 29.
•• Switched Learning Objectives 2 and 3 to allow
for better understanding of the relevance of stock Chapter 22
basis. •• Revised Learning Objectives 1, 9, and 10.
•• Switched text Sections 18-1e and 18-1f to enhance
•• Changed titles for text Sections 22-3a, 22-3d,
student comprehension.
and 22-3e.
•• Reversed the order of discussion of assign-
ing basis in § 351 transactions and the effect of •• Revised Exhibit 22.1 comparing business
liabilities transferred to a corporation on stock entities.
and asset bases. •• Revised introductory material in text Section 22-1.
•• Added a test bank problem on § 1202. •• Updated statistics about S corporations and part-
nerships/LLCs.
Chapter 19 •• Deleted Exhibit 22.5.
•• Revised and updated chapter materials as •• Revised material in text Sections 22-3f and 22-3g.
needed; clarified chapter materials when •• Placed Discussion Questions, Computational
necessary. Exercises, and Problems in chronological learning
•• Updated end-of-chapter materials as needed. objective order.
•• Added two new research problems, one involving
data analytics.
Chapter 20
• • Revised and updated chapter materials as
needed; clarified chapter materials when Chapter 23
necessary. •• Revised Learning Objective 5.
•• Retitled text Sections 20-5b and 20-5c. •• Revised titles of text Sections 23-2c, 23-7a, and
•• Updated end-of-chapter materials as needed. 23-7c.
•• Added and replaced several new items. •• Updated statistics about the nonprofit sector of
•• Replaced Research Problem 2. the economy, for private foundations, and for the
UBIT.
•• Updated statistics about the tax on university
Chapter 21 endowments and the applications for exempt
status.
•• Added Concept Summary 21.4 entitled “Compar-
ing a Partner’s Tax Basis and Capital Account.” •• Added material about the UBIT “silo” rule.
•• Show reporting of guaranteed payments split •• Deleted some material from the discussion of
between those for services versus use of capital as debt-financed UBTI.
changed by the IRS on Schedule K-1.
xvi PREFACE
•• Added material concerning the loss of exempt Chapter 26

status due to a failure to file Form 990.
•• Made minor revisions to Learning Objectives 2
•• Updated end-of-chapter materials as needed, and 6.
including revising Research Problem 6 and adding •• Added text Section 26-3f (“Ethics in the Tax Prac-
new Research Problem 7 (communications and tice”).
data analytics).
•• Updated and expanded statistics about the IRS
•• Added new Research Problem 7 (communications workforce and budget, tax filings, offers in com-
and data analytics). promise, penalties, and audit rates and results.
•• Updated and reorganized the material on
informants.
Chapter 24 •• Updated the Ethics & Equity item about
•• Added information on the MTC’s project to self-assessment.
update its Statement of Information Concern-
•• Expanded materials about the unauthorized
ing Practices of Multistate Tax Commission and
practice of law.
Signatory States Under Public Law 86–272, for
changes in business practices primarily due to •• Added a research problem about the timely filing
technology. of tax returns.
Chapter 25 Chapter 27
•• Revised Learning Objectives 3 and 5. •• Revised Learning Objectives 1, 2, 5, 8, and 9.
•• Replaced a Global Tax Issues feature •• Updated statistics about estate and gift tax returns
(“COVID-19 and Permanent Residency”). filed.
•• Rearranged and revised material in text
•• Revised the discussion of tax treaties
Section 27-2a.
(text Section 25-2).
•• Revised material in Concept Summary 27-3.
•• Updated and added statistics about the global
economy, worldwide tax rates, treaty withholding •• Revised introductory material in text Section 27-3.
rates, advance pricing agreements, FTC deferrals, •• Revised and rearranged material concerning life
and CFCs. insurance in the gross estate.
• • Revised Concept Summary 25.4 (which now •• Updated information about estate and gift tax
illustrates the components of Subpart F treaties with other countries.
income). •• Replaced a research problem with a new data
•• Deleted text Section 25-5b (“Creating a analytics problem.
Cross-Border Entity”). •• Revised titles for text Section 27-1b.
•• Revised and expanded the discussion of Global •• Updated statistics about the net worth of U.S.
Intangible Low-Taxed Income (GILTI). households.
•• Added a number of new examples to illustrate •• Expanded the list of requirements for using a buy-
text materials. sell agreement.
•• Revised the discussion of the § 1014(e) rule.
•• Revised Research Problem 6, which asks
students to explore and report on OECD •• Expanded material in text Section 27-3b.
base erosion and profit shifting (BEPS) •• Added material on charitable gifts using donor-
developments. advised funds.
PREFACE xvii
Chapter 28 •• Augmented explanation in Example 4.

•• Revised Learning Objective 1 and added a new •• Revised the Ethics & Equity items
learning objective. on pet-assistance trusts and choice
of trustee.
•• Revised title of text Section 28-1.
•• Added a new text Section 28-5 entitled
•• Expanded statistics about Forms 1041 filed.
“Grantor Trusts.”
•• Updated tax amounts in Exhibit 28.3.
•• Replaced a research problem with a new data
•• Added information about entity tax rates for net analytics and communications problem.
long-term capital gains.
TAX LAW OUTLOOK

From your SWFT Series Editors:
Legislation related to the COVID-19 pandemic was a vehicle for tax changes in 2020. And, a variety of tax
changes were incorporated into the American Rescue Plan Act of 2021 (enacted in March 2021). The Biden
administration and 117th Congress began to discuss a wide variety of tax law changes, including changes
to the Tax Cuts and Jobs Act of 2017 (TCJA). Still others are expected in the Biden administration’s Build
Back Better plan (with legislation likely to be discussed and possibly enacted before the end of the 117th
Congress).
Taxpayers and their advisers will need to evaluate how these changes will affect their short- and long-
term planning (adjusting those plans appropriately). The SWFT editors will be monitoring these activities and
provide updates to adopters as needed.
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“Not before so many people,” said her husband with emotion.
“Suppose he were to refuse my hand?”
Marion sighed: but her hopeful nature whispered that the New-Year’s
Eve was not yet ended. And now a clock of silvery tone chimed and
struck the hour of midnight. The guests were conducted to supper:
unseen harps, and sweet voices, gave a slow farewell to the old
year, as they were seating themselves at the upper end of the hall,
and then burst forth into a joyful welcome to the new, as the villagers
entered and took their places at the lower range of tables; this again
died away, and a sweet strain arose, of the softest prayer, for peace
and happiness to all! Marion looked round with emotion.
It was a lovely scene, that huge banquet-hall, with its gay wreaths of
holly and flowers. The bright assemblage of guests; the happy faces
of the villagers below; the beautiful hostess, seated in an antique
chair at the upper end, with the banners of her ancient race, trophies
of ages long gone by, waving behind her; the lovely figure of Peace
below, almost shrouded in the dark leaves, and forming a striking
contrast to those warlike emblems: all these afforded a sight which,
once beheld, would not be easily forgotten.
After each guest had paid sufficient homage to the choice viands
before them, Edith took up a cup of curious workmanship; her face
was radiant with kindness and love as she looked on those around
her.
“This cup has been possessed, for many a century, by my
ancestors,” she said; “preserved for ages as a venerated relic:
doubtless many a toast has been pledged in it—many a friendly
welcome expressed; but I believe no more cordial and sincere one
than that with which I greet you all this night. I would fain express the
usual wish of a new-year of all imaginable happiness and prosperity,
but as such have never visited this earth, we know it would be vain;
and I therefore wish you the greatest of all blessings—that which
cheers and supports us in the sorrows of life, and heightens beyond
measure its pleasures and enjoyments,—love and harmony in your
hearts and homes! There may be some among us estranged from
friends and kindred, grieving over the fault, (for few, let us hope, in a
Christian land, can live unmoved in enmity one with another,) and yet
hanging back, in mistaken pride or want of moral courage, from the
few conciliatory words which would, in most cases, suffice for a
perfect reconciliation. The old year is now passing away—may it
bear with it all anger, all animosity! May those few healing words be
spoken,—and Peace, and Love, and Charity be with us all!”
Edith’s voice trembled with emotion, but she did not perceive the
agitation of many of her guests, for her eyes were fixed, as if in a
dream, on the lower end of the hall. There was a movement of
surprise among those seated there: she made her way, she knew
not how, through them all. Yes, it was Percy!—One look, expressing
a thousand emotions, and their hands were clasped in each other!
For an instant her lovely head was bowed before him, while a few
large, heavy tears, fell on the flowers at her feet! But she soon
mastered her emotion, and, with a face radiant with joy, led him
through the crowd of sympathising faces to her mother’s side. In the
short silence which ensued, the bells of the village church were
plainly heard ringing-in the new-born year! When had they ever
sounded so sweetly before?
And now a joyous strain again burst forth, and all returned to the
ball-room. Again the young, the beautiful, the gay, joined in the
dance; and never feet flew more lightly than theirs. But there were
those who felt a deeper joy; the serene, the heavenly one of
Reconciliation!
And Percy and Edith once more stood side by side,—united, happy!
And Marion told her wondering friend how Percy (who was an old
college friend of her husband’s) had come to see them that morning,
and in their quiet home had confessed that he was drawn to them by
the desire of obtaining news of her, round whom his deep true love
still lingered with so much regret. She had tried to persuade him to
accompany them that night, but still he doubted—still feared. Yet he
now confessed to Edith how, when they were gone, he had longed to
see her face again, how he had concealed himself in the crowd, and
how he had been moved, by what she had just said, to rush forward
from the recess where he stood unobserved, that he might be the
first to own the gentle Magic of those words!
And many others had felt them too! Marion was leaning on her
father’s arm—her eyes cast down and tearful in their joyfulness, as
he spoke to her in a low tone of the invalid whom she must see on
the morrow.
And all hearts were touched and softened, and rich and poor felt
drawn closer together! And they thought of the voice that had said,
—“Love one another as I have loved you,”—and of the divine
lessons of peacefulness and long-suffering which some had
forgotten! And many blessed to the end of their days the Magic
Words spoken by the Peacemaker[A] on that New-year’s Night.
MAGIC WORDS.
Magic words! magic words!
From holy impulse they are born,
The seeming chance of circumstance,
God’s utterance to hearts forlorn;
Where’er they fall reject them not,
Nor think their mission is in vain;
’Twixt loving hearts, whom coldness parts,
Let not the dreary silence reign.
Magic words! what are they?
Things the truest soul will say!

Ah! dear as to the dying flow’r,
The starry dews that balm infuse,
And whisper of the fallen show’r!
Sweet as the bubbling desert spring
To one who wanders o’er the sands,
Are those chance words, that sow like birds
The flowering seeds of happier lands!
Magic words! what are they?
Things the simplest tongue may say!

O let them live on ev’ry lip,
A source of bliss, of holiest kiss,
And bond of fairest fellowship.
And evermore at this blest time,
Tho’ winter’s snows o’erspread the scene,
One magic call, to bind us all,
Shall be old Christmas’ evergreen!
Magic words! are not they
Offerings meet for Christmas Day?
London:—Printed by G. Barclay, Castle St. Leicester Sq.
FOOTNOTE:
[A] Edith, in the Anglo-Saxon language, signifies
Peacemaker.
TRANSCRIBER’S NOTES:
Obvious typographical errors have been corrected.
Inconsistencies in hyphenation have been
standardized.
Archaic or variant spelling has been retained.
*** END OF THE PROJECT GUTENBERG EBOOK MAGIC
WORDS: A TALE FOR CHRISTMAS TIME ***
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