Entity & Property Taxation

REG loves to make you reconcile book income to taxable income on Schedule M-1 (M-3 for larger filers): add back the federal income tax expense and non-deductibles (50% of meals, fines, life-insurance premiums where the corporation is the beneficiary), then subtract the dividends-received deduction. Watch the flat 21% rate and the DRD tiers — 50%/65%/100% keyed to ownership (under 20% / 20–80% / 80%+), capped by a taxable-income limit unless the full DRD creates an NOL. Corporate capital losses offset only capital gains (carry back 3, forward 5), and post-2017 NOLs carry forward indefinitely but offset just 80% of taxable income.

The classic trap is mixing up entity types: unlike an S corporation or partnership, a C corp’s losses stay trapped at the entity and never flow to shareholders. Skip the individual rules — no standard deduction and no preferential capital-gains rate (corporate gains hit the same 21%). For charitable contributions, OBBBA now imposes a 1%-of-taxable-income floor (effective for tax years after 2025, gifts below 1% are nondeductible) underneath the long-standing 10%-of-taxable-income ceiling — older banks still teach only the 10% cap.

REG loves the eligibility checklist: a valid S election requires a domestic corporation with no more than 100 shareholders, only individuals, estates, and certain trusts (no C corporations, partnerships, or nonresident aliens), and one class of stock (differing voting rights are fine — not a second class). The classic “tell” quietly slips in an ineligible shareholder or a second class of stock — the answer hinges on the election being terminated or never valid. Timing rule: an election filed by the 15th day of the third month is retroactive to year-start.

The trap is conflating S-corp and partnership basis math. S shareholders do NOT add entity-level debt to stock basis (only direct shareholder loans create debt basis — a mere personal guarantee doesn’t), while partners do increase basis for their share of partnership liabilities. Distinguish too from corporate taxation: an S corp avoids the double taxation that hits C corporations, yet can still owe built-in gains (BIG) tax (21% rate, 5-year recognition period) after a C-to-S conversion. Memory hook: “100, 1 class, 1 country” = shareholder cap, single stock class, domestic requirement.

REG loves the outside-basis ordering rule: a partner’s basis is increased by their share of partnership income before you subtract distributions, and the deduction of losses is limited to basis (then at-risk, then passive). The classic MCQ gives a beginning basis, a distributive share, a cash distribution, and a liability change, then asks for ending basis or the deductible loss. The “tell” is that a partner’s share of partnership liabilities is added to outside basis (§752) — students forget this and understate it. A cash distribution exceeding basis triggers capital gain under §731 (not ordinary income, absent §751 “hot assets”).

The trap is conflating partnership and S-corp rules. Unlike an S corp, partnership liabilities give basis to partners, so debt-funded losses can be deductible; an S shareholder gets debt basis only from direct loans to the corporation, not entity-level debt (a mere guarantee doesn’t count). Contributing appreciated property is generally nontaxable under §721 and yields a carryover (substituted) basis, distinct from the cost basis the basis term describes. Remember: income first, then distributions — order matters.

REG questions rarely ask “what is basis”—they hand you a fact pattern and make you pick the right starting basis first. The tell is how the property was acquired: purchased property takes cost basis, gifted property generally takes the donor’s carryover (transferred) basis, and inherited property takes a fair-market-value basis at the date of death (or the alternate valuation date)—usually a “step-up,” though it can be a step-down. The trap is the dual-basis gift rule: if gift-date FMV is below the donor’s basis, use carryover basis for gain, FMV for loss, and recognize no gain or loss if the sale price lands between them.

Don’t confuse basis with the related concepts. Capital gains is the result once you subtract basis from amount realized. In a like-kind exchange (real property only since 2018), basis carries over so the deferred gain lives inside the replacement property’s lower basis; here boot received decreases basis while gain recognized increases it—don’t let “boot” fool you into raising it. MACRS depreciation reduces basis annually, so a later sale shows a larger gain—the reason depreciation recapture exists. Hook: GIFT = carryover, DEATH = step-up.

REG loves to bury the rate in a netting question: it hands you a mix of transactions and forces the order—short-term nets against short-term, long-term against long-term, then leftover loss in one bucket offsets net gain in the other. The “tell” is a net long-term gain paired with a net short-term loss; the answer hinges on cross-netting before applying the preferential 0/15/20% brackets. Watch the carve-outs: collectibles cap at a 28% maximum, unrecaptured §1250 gain at a 25% maximum, and high earners owe the extra 3.8% net investment income tax. If a net loss results, only $3,000 ($1,500 MFS) deducts against ordinary income; the rest carries forward indefinitely.

The classic trap is treating §1245 depreciation recapture as capital gain—it is ordinary income, never the preferential rate. Don’t confuse character with holding period: replacement property from a like-kind exchange (real property only since 2018; older banks may still show personal-property swaps) tacks on the relinquished property’s holding period, often making a quick resale long-term.

Hook: gains net like with like, then leftover losses cross over.

REG tests this as a table lookup plus convention selection: identify the property class (5-year for autos/computers, 7-year for office furniture and most machinery, 27.5-year residential and 39-year nonresidential real property), then pick the convention. The classic trap is the mid-quarter convention — if more than 40% of personal-property basis is placed in service in the last quarter, you abandon half-year for all such assets that year. Real property always uses mid-month and straight-line, never accelerated. Watch the ordering when §179 expensing and bonus depreciation stack: take §179 first, then bonus, then regular MACRS on the remaining basis (bonus is back to 100% for qualifying property acquired and placed in service after January 19, 2025 under the 2025 OBBBA, permanently — older banks may still show the repealed 40% TCJA phase-down, or a 40% rate that now applies only to pre-January 20, 2025 acquisitions).

Do not confuse MACRS with book depreciation, which uses estimated useful life and subtracts salvage; MACRS ignores salvage entirely and uses statutory periods. Distinguish it from basis — MACRS computes the deduction, but each year’s deduction reduces adjusted basis, which then drives gain on sale and §1245/§1250 recapture.

REG loves the two-line computation: recognized gain = the lesser of realized gain or boot received, where boot is net debt relief plus cash or non-like-kind property received. The classic tell hands you the FMV of new property, cash, and relieved/assumed mortgages, daring you to recognize the whole realized gain — the trap. A realized loss is never recognized here (it’s deferred), so don’t elect §1031 expecting to bank a loss. Watch the substituted-basis follow-up: new basis = old adjusted basis + gain recognized + boot paid − boot received, preserving the deferred gain for a later sale.

Distinguish from the siblings. Capital gains rates don’t apply now — §1031 only defers until a future taxable disposition. Basis here is carryover, not the cost basis a normal purchase gives. Two killers: the 45-day identification / 180-day completion deadlines, and the related-party two-year rule — if either party disposes within two years, the deferred gain is triggered (narrow death/involuntary-conversion exceptions aside). (Some older banks still drill personal-property exchanges, no longer eligible.)