PROBLEM 31 Illustrating Basis for Determining Gain or Loss From the Sole of Securities Which Were Purchased Within Thirty Days after the Sale of Substantially Identical Property Made FACTS: At a Loss Subsequent to 3:55 P. M. of Nov. 23, 1921 Mr. Charles A. Brown on April 6, 1918 purchased three hundred shares of Erie Copper Company stock for $115 per share. He sold the above shares on December 5, 1921, for $45 per share. Ten days later, on December 15, 1921, he purchased two hundred shares of the same stock for $45 per share. On March 16, 1922, he sold one hundred shares of the stock thus reacquired, at $55 per share. Mr. Brown files his income-tax returns on the calendar-year basis. QUESTION: What gains or losses is Mr. Brown to report as a result of the above transactions, and for what years? ANSWER: As Mr. Brown purchased, December 15, 1921, 200 shares of the Erie Copper Company stock which purchase was within 30 days of the sale (made after the passage of the Revenue Act of 1921-3:55 P. M. of November 23, 1921) by him of 300 shares of the same stock, two-thirds of the loss resulting from the sale of such 300 shares is not deductible (see Problem 105). Consequently the deductible loss for 1921 resulting from such sale of 300 shares is only $7,000. (300X$70 $21,000. 1% of $21,000 =$7,000.) For the purpose of computing the profit or loss resulting from the subsequent sale of the whole or any part of the 200 shares purchased on December 15, 1921, such 200 shares are regarded as costing Mr. Brown $115 per share. Therefore upon the sale on March 16, 1922, of 100 shares of this stock, Mr. Brown is considered, for tax purposes, to have suffered a loss, deductible in 1922, of the difference between $115 per share and $55 per share, or $60 per share, amounting in the aggregate to $6,000. REFERENCES: Sec. 202 (d) (3): "Where no deduction is allowed for a loss or a part thereof under the provisions of paragraph (5) of subdivision (a) of section 214 and paragraph (4) of subdivision (a) of section 234, that part of the property acquired with relation to which such loss is disallowed shall for the purposes of this section be treated as taking the place of the property sold or disposed of." 66 Sec. 214 (a) (5): ... No deduction shall be allowed under this paragraph for any loss claimed to have been sustained in any sale or other disposition of shares of stock or securities made after the passage of this Act where it appears that within thirty days before or after the date of such sale or other disposition the taxpayer has acquired (otherwise than by bequest or inheritance) substantially identical property, and the property so acquired is held by the taxpayer for any period after such sale or other disposition. If such acquisition is to the extent of part only of substantially identical property, then only a proportionate part of the loss shall be disallowed; . . ." PROBLEM 32 Illustrating Basis for Determining Gain or Loss When FACTS: Mr. James H. Mason on March 16, 1914 purchased a farm near Cleveland, Ohio for $10,000. He decided to retire from the farming business in July, 1921. He therefore accepted an offer to exchange the farm for a small house in the suburbs of Cleveland together with $15,000 in cash. In January, 1922, Mr. Mason sold the house for $2,500. At the time the house was acquired by Mr. Mason, it had no readily realizable market value. Mr. Mason files his income-tax returns on the calendar-year basis. QUESTIONS: Did Mr. Mason derive a profit from the exchange of the farm for the house plus cash? If so, how much? What was the amount of the profit derived from the sale of the house? For what years are the several profits, if any, to be reported? ANSWERS: The cash received by Mr. Mason from the exchange of his farm in 1921, is to be offset against the cost of said farm, leaving an excess of $5,000 to be reported as taxable income in 1921. The house acquired by Mr. Mason in 1921, as a result of the exchange of the farm is regarded as having cost Mr. Mason nothing; consequently upon the sale of this house in 1922, the entire proceeds from such sale, or $2,500, are to be reported as income for 1922. REFERENCE: Sec. 202 (e): "Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis, shall be taxable to the extent of the excess; . . ." PROBLEM 33 Illustrating Basis for Determining Gain or Loss for the Taxable Year from the Sale of Property Sold under Contract Providing for Payment in Installments FACTS: The Taylor Piano Company sold a player piano to Arthur Robinson for $900 on July 1, 1921, payable in monthly installments of $25. The sales contract provided that title to the piano was conveyed to Mr. Robinson immediately upon the initial payment of $25, but subject to a lien for the unpaid portion of the purchase price. The cost of the piano to the Taylor Piano Company amounted to $300. The Taylor Piano Company received six payments of $25 each on account of this sale, during 1921. The company has been reporting its sales in accordance with the installment method. QUESTION: What taxable income should the Taylor Piano Company report on the above sale for the calendar year 1921? ANSWER: The Taylor Piano Company should report as income the proportion of each installment payment received during 1921, which the gross profit to be realized bears to the gross contract price, viz: $600 gross profit to be realized divided by $900, the gross contract price, equals 66% per cent gross profit. Sixty-six and two-thirds per cent of $25, each installment payment, equals $16.66% which is the portion of profit in each installment. This amount multiplied by six, the total number of installments received during 1921, equals $100, which is the total gross profit received during 1921 to be reported as income. REFERENCES: Sec. 202 (f): "Nothing in this section shall be construed to prevent (in the case of property sold under contract providing for payment in installments) the taxation of that portion of any installment payment representing gain or profit in the year in which such payment is received." Art. 42, Regulations 62: "... The rule prescribed is that in the sale or contract for sale of personal property on the installment plan, whether or not title remains in the vendor until the property is fully paid for, the income to be returned by the vendor will be that proportion of each installment payment which the gross profit to be realized when the property is paid for bears to the gross contract price. . . .” PROBLEM 34 Illustrating Necessity of Inventories to Clearly Reflect Income FACTS: The Advertising Specialty Company, Inc., was organized during 1921. Its business consisted of the manufacture and sale of advertising novelties. During 1921, the company bought a considerable quantity of raw materials to be made into the finished product. While its sales during 1921 were not very large, the profit on these sales was about 500% over cost. The company files its return on the calendar-year basis. In preparing its return it intends to compute net income by deducting from the sales for the period its total costs including all purchases. In other words, it plans to compute its income without taking into consideration the inventory at the close of the year. QUESTION: Will the computation of the income in the manner referred to above be acceptable to the Commissioner? ANSWER: From the very nature of the business, i. e., the manufacturing and selling of goods, in order to clearly reflect the net income it is necessary to take into consideration the inventories at the beginning and end of the taxable period. Consequently the manner of computing the net income planned by the company will not be acceptable to the Commissioner. REFERENCE: Sec. 203: "That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income." Art. 1581, Regulations 62: "Need of Inventories. In order to reflect the net income correctly, inventories at the beginning and end of each year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption, or use in productive processes, together with all finished or partly finished goods. Only merchandise title to which is vested in the taxpayer should be included in the inventory. Accordingly the seller should include in his inventory goods under contract for sale but not yet segregated and applied to the contract and goods out upon consignment, but should |