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The following named issues of Liberty Bonds must, therefore, be considered for income tax purposes:

First Liberty Loan Converted 4% Bonds of 1932-1947
First Liberty Loan Converted 474% Bonds of 1932-1947
First Liberty Loan Second Converted 4/4% Bonds of 1932-

1947
Second Liberty Loan 4% Bonds of 1927-1942
Second Liberty Loan Converted 474% Bonds of 1927-1942
Third Liberty Loan 474% Bonds of 1928
Fourth Liberty Loan 444% Bonds of 1933-1938

While the above issues of Liberty Bonds must be considered for income tax purposes, the interest on such bonds is to be included in gross income only in the event it is subject to the surtax. The interest on the bonds is subject to the surtax only when the principal amount of holdings exceed the limitations. This will be further discussed under the subject of "exempt income".

To determine the interest on any class of obligations received during the taxable period where the books are kept on a cash basis, add to the amount of all coupons and registered bond interest falling due within the taxable period the amount of accrued interest received on sales of obligations between interest payment dates, and deduct from the sum the accrued interest paid on purchases of obligations between interest payment dates. This rule applies where books are kept on a cash basis whether or not the coupons falling due within the taxable period are actually cashed. If the books are kept on an accrual basis and the return is filed upon this basis, the taxpayer should report the actual amount of interest accrued on the obligations owned during the taxable period.

Partnership Income. (a) Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year, or, if his net income for such taxable year is computed upon the basis of a period different from that upon the basis of which the net income of the partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the taxable year upon the basis of which the partner's net income is computed.

(Section 218—1924 Act) It has been previously pointed out in this discussion that partnerships are required to file returns, but they are not taxable. The partners are, however, taxed as individuals. The distributive share of the net income of the partnership which a partner is required to include in his individual return is his proportionate share of the net income of the partnership. It does not make any difference whether or not a partner withdraws his share of the net profits, he must report it as income in the year in which it was earned.

If the taxable year of the partnership covers the same period as the taxable year of the individual partners, each partner should report as income his distributive share of the total net income of the partnership for that period. If the taxable year of the partnership covers a different period from the taxable year of the individual partner, he should report as income his distributive share of the total net income of the partnership for any accounting period of the partnership ending within the taxable year upon which the individual files his return.

To illustrate these provisions, let us assume that J. H. Hunter and E. L. Vinson are partners in the firm of Hunter and Vinson. The partnership keeps its books on the basis of a fiscal year ending on June 30 and files its income tax return on the same basis. J. H. Hunter files his individual return on the basis of a calendar year ending on December 31. E. L. Vinson keeps a personal set of books and files his individual return on the basis of a fiscal year ending on June 30. The partnership, in filing its return, should report each partner's share of the distributive profits for the year ending on June 30. J. H. Hunter, in making his individual return, should report his distributive share of the net income of the partnership for the period from July 1 of the previous year to June 30 which is the date within the taxable year of the partner on which the accounting period of the partnership ends. In addition to the partnership income J. H. Hunter should report his income from all other sources for the calendar year ending on December 31. E. L. Vinson should file an individual return for the fiscal year ending on June 30. Since his taxable year is the same as the taxable year of the partnership, he should report as income his distributive share of the total net income of the partnership for that period.

Amounts earned and distributed to a partner by a partnership after the end of its taxable year and before the end of his corresponding taxable year should be accounted for both by the partnership and by the partners in their returns for their next succeeding taxable years. Where the result of partnership operation is a net loss, the loss will be divisible by the partners in the same proportion as net income would have been divisible, unless the partnership agreement provides for the division of a loss in a manner different from the division of a gain.

Rents and Royalties. Income from rent or royalty must be included in gross income. Income arising from the rent of property whether tangible or intangible is taxable. If property or crops are received in lieu of cash rent, the value of the property or crops received should be reported as income just as if the rent had been received in cash. In determining the net income received from rent or royalty, the taxpayer is permitted to

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deduct depreciation, obsolescence, depletion, repairs, interest, taxes, fire insurance, fuel, light, labor and other necessary expenses of this character. Thus, if a taxpayer received income in the form of rent on residential property, he would report the difference between the amount received and the sum of the expenses applicable to the upkeep of the property. In determining the depreciation, the original cost of the property should be used as a basis unless it was acquired prior to March 1, 1913 in which case the fair market value on that date should be used.

If tenants construct buildings or improvements upon leased property, the title to which goes to the owner of the property at the termination of the lease, the value of such improvements must be reported as income by the owner. Interest and taxes paid by a tenant on behalf of the landlord are income to the landlord when paid and must be included as income in his return. Ordinarily, repairs made by the tenant are not considered income for the landlord, but expenses of the tenant. The value of the use of property by the owner need not be counted as income to the owner nor may it be deducted as rent paid.

The income derived from royalty received for the use of or the privilege of using patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, etc., should be included in gross income for it represents taxable income to the individual receiving it.

Profit from Sale of Real Estate, Stocks, Bonds, etc. Gains or profits derived from the sale or exchange of property including real estate, stocks, bonds, etc., must be included in gross income. In determining the gain derived from the sale of property, it is necessary to take into consideration the date and method of acquirement—that is, it is necessary to know whether or not the property was acquired before or after March 1, 1913 and whether it was acquired by purchase, gift or inheritance. The reason it is necessary to know the date the property was acquired is because any income accrued prior to March 1, 1913 is not taxable and need not be included in gross income. If property is acquired by gift, it is also necessary to know whether it was acquired before or after December 31, 1920.

In determining the gain or loss resulting from the sale of property which was purchased after February 28, 1913 the cost of such property is the proper basis. The cost will include, in addition to the original purchase price, all expenses incurred in connection with its purchase such as commission fees, charges for converting of the title and similar outlays. It also includes expenses incurred in connection with the holding of the property, such as interest and taxes, if the property is not used for the purpose of earning an income and provided such interest and taxes have not been claimed as a deduction from income. For instance, a real estate company may purchase a subdivision near a city and hold it for five years before opening it for sale. The carrying

charges during the five years may be considered as an addition to cost. The cost will also include any amounts spent for improvements on the property.

Proper adjustment should be made in computing the gain or loss from sale of property for any item of loss, exhaustion, depreciation, obsolescence, amortization or depletion sustained and allowable as a deduction in computing net income. The amount of the depreciation previously charged off by the taxpayer shall be deemed to be the true depreciation sustained unless shown by clear and convincing evidence to be incorrect.

To illustrate the foregoing discussion, let us assume that A. R. Samms purchased a house and lot on January 1, 1920 for $16,500.00, paying cash. The purchase price included a real estate agent's commission of 1% but did not include expenses incident to title and transfer charges which amounted to $100.00. Following the purchase of this property, Mr. Samms leased it, on the same day, to a tenant on an annual rental basis of $1,500.00. In filing his income tax returns for the years intervening between the date of the purchase of this property and December 31, 1923, Mr. Samms claimed a depreciation of 4% on the house which is valued at $12,000.00. On January 1, 1923 Mr. Samms erected a garage on the property costing $1,000.00. The rate of depreciation on the garage is estimated to be the same as on the house. If, on January 1, 1924, the property was sold for $24,000.00, what amount should Mr. Samms report as his gain on the transaction?

To determine the proper basis to be used in the computation of the gain resulting from the sale of this property, it is necessary to compute the total cost of the property. The purchase price was $16,500.00 which included the real estate agent's commission. To this should be added the title and transfer charges of $100.00 and the cost of the garage which amounted to $1,000.00, making a total cost of $17,600.00. From this sum should be deducted the amount of the depreciation charged off and deducted on Mr. Samms' income tax returns for the years intervening between January 1, 1920 and December 31, 1923.

The depreciation on the house which was valued at $12,000.00 for four years at 4% amounted to $1,920.00. The depreciation on the garage for one year at 4% amounted to $40.00. The total depreciation of $1,960.00 should be deducted from the cost of the property making a value of $15,640.00 which is the proper value to use as a basis for the computation of the gain resulting from the sale of the property on July 1, 1924. Since the selling price was $24,000.00 the gain, therefore, amounted to $8.360.00 and this sum should be reported by Mr. Samms as taxable income.

Where a tract of land is purchased and divided into lots for the purpose of resale, the cost of the land should be apportioned to the individual lots. Consequently, at the time of the sale of each lot the profit arising therefrom is regarded as realized for income tax purposes.

The proper basis to use in determining the amount of gain or loss resulting from the sale of property acquired by purchase, gift, or inheritance before March 1, 1913 or after February 28, 1913 is explained in the following section of the Revenue Act:

(a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that

(1) If the property should have been included in the last inventory, the basis shall be the last inventory value thereof;

(2) If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift. If the facts necessary to determine such basis are unknown to the donee, the Commissioner shall, if possible, obtain such facts from such donor or last preceding owner, or any other person cognizant thereof. If the Commissioner finds it impossible to obtain such facts, the basis shall be the fair market value of such property as found by the Commissioner as of the date or approximate date at which, according to the best information that the Commissioner is able to obtain, such property was acquired by such donor or last preceding owner;

(3) If the property was acquired after December 31, 1920, by a transfer in trust (other than by a transfer trust by bequest or devise) basis shall be the same as it would be in the hands of the grantor, increased in the amount of gain or decreased in the amount of loss recognized to the grantor upon such transfer under the law applicable to the year in which the transfer was made. The provisions of this paragraph shall not apply to the acquisition of such property interests as are specified in subdivision (c) or (e) of section 402 of the Revenue Act of 1921 or in subdivision (c), id), or (f) of section 302 of this Act;

(4) If the property was acquired by gift or transfer in trust on or before December 31, 1920, the basis shall be the fair market value of such property at the time of such acquisition;

(5) If the property was acquired by bequest, devise, or inheritance, the basis shall be the fair market value of such property at the time of such acquisition. The provisions of this paragraph shall apply to the acquisition of such property interests as are specified in subdivision (c) or (e) of section 402 of the Revenue Act of 1921, or in subdivision (c), (d), or (f) of section 302 of this Act;

(6) If the property was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the property so acquired consisted in part of the type of property permitted by paragraph (1), (2), (3), or (4) of subdivision (b) of section 203 to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it;

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