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Homework answers / question archive / Case 1: A lawyer withdraws his entire capital account from his law firm and uses the funds to finance the purchase of a home in which he resides
Case 1:
A lawyer withdraws his entire capital account from his law firm and uses the funds to finance the purchase of a home in which he resides. On the same day, the lawyer borrows an equivalent amount of funds by way of bank loan and deposits the funds to his law firm.
Issue: Is the interest expense on the bank loan deductible for tax purposes by the lawyer?
Case 2:
An accountant, whose entire practice consists of real estate agents and real estate developers, purchased, on the advice of a client, a parcel of raw land two years ago for $50,000. The accountant today accepted an offer to purchase the land from a third party for $125,000. The third party is going to use the parcel of land as part of a golf course development. Disposition costs will amount to $15,000.
Issue:
1. What is the amount of the gain to be reported by the accountant for income tax purposes?
2. Advise the accountant on the nature of taxation of his gain on the sale of the land for income tax purposes
Case 1:
The issue of where the interest can be deducted is first determined by tracing the use of the funds as specified in Temp Reg 1.163-8T. The tracing rules would say that the funds were traced to the business and therefore the interest would be deductible only as investment interest, subject to limitations of investment income.
There are two special rules that will override the tracing rules, and it appears that the 30-day rule will come into play in this situation. The 30-day rule (expanded from a 15-day rule) is evidenced by IRS Notice 89-35.
This rule states that if an expenditure from an account is made within 30 days before or after the deposit of borrowed funds, the taxpayer can treat the expenditure as made from the borrowed funds (to the extent of such borrowed funds). This treatment overrides the result that would occur by applying the normal tracing rules.
I think the argument to make interest paid on the loan as residential housing interest is supportable.
Case 2:
The accountant is not in the business of developing land and therefore the sale of undeveloped property will be classified as a long term capital gain of $60,000 reportable on Sch D.
