Web Baker

Research 5-73

Web Baker was hired by the Berry Corporation to serve as CEO. The corporation agreed to buy his home at fair market value in case the company fired him. The corporation unsatisfied with Baker’s performance fired him and bought the residence for $350,000. Berry sold the residence for $270,000 and had selling expenses of $12,000. How should the corporation treat the $92,000 loss?

In the Azar Nut Co. v. CIR case, the company incurred a loss when it bought from an employee due to an agreement in the employee’s contract. The court rejected the company’s attempt to report the loss as ordinary income. Azar’s decided to hire a Vice President of the corporation under the conditions that the company agreed to purchase his residence at fair market value upon termination. However, after a couple of years the corporation fired the Vice President and bought his resident for $285,000. Azar listed the house and did not sell the residence for two years. The company realized $185,000 incurring a loss of $111,366. The Azar Nut Company deducted the loss as ordinary income on its 1984 tax return. The Commissioner would not allow the deduction and characterized the loss as a capital loss. The court held the company had incurred a capital loss and limited Azar’s deduction to the extent of its capital gains.

Section 165(a) of IRC says taxpayers are allowed to deduct "any loss sustained during the taxable year and not compensated for by insurance or otherwise," unless it was incurred as a capital asset. When a capital asset is incurred the taxpayer only can deduct the loss to the extent of its capital gains. Section 1221 accepts capital assets but the property must be used in trade or business. As a result, the Berry Corporation will report the $92,000 loss as a capital loss because the residence was incurred as a capital asset. The residence was not purchased for business purposes because it did not play a role in the corporation business operations. The residence...