Limitations  on Gross Income
i. Recovery of Capital
1. 1001; 1012 [basis of property--cost]
2. Rebates:  rebates are a return of capital spent on a product
3. Note:  RoC is instrumental in determining tort damages.
a. Compensatory damages:  excluded from GI
b. Damages representing lost profit:  included in gross income
4. problems arise in practice whenever you have issues surrounding the timing and recovery of capital
5. there are especially problems with returns from annuities, insurance proceeds, sales of partial interest, or installment sales, all of which often involve a taxpayer’s original capital outlay, raise the issue of which cost recovery system to employ.

ii. Receipts Subject to Claims
1. a taxpayer who receives funds under the “claim of right” of another does not have GI
2. “Claim of Right” doctrine:  when a taxpayer receives funds with:
a. a contingent obligation to repay, either because the sum is disputed or mistakenly paid, &
b. no limitation on the use of the funds exists, those funds are included in the taxpayers’ income in the year they are received (this is basically, if you have a dispute over a sum and you get it in Y1 with no restriction on its use, but the dispute is not settled until Y4, the proper year of report is Y1)

iii. Realization
1. 1001; 1.61-6; 1001-1(a)
2. The realization requirement generally ensures that the inherent gains or losses in the taxpayer’s investment are not taxed until they have been severed from the capital that created them.
3. Severance occurs on a sale, exchange, or other disposition or the property.
4. Annual appreciation is not included in GI until it is realized, and then only in the year in which that gain has been realized through a taxable disposition.
5. Note:  Treasury Regulation §1.1001-1 provides that a taxpayer realizes income when properties exchange are “materially different.”  However, the question of “what is ‘materially different’” arises.  The Court in Cottage Savings stated the test was that properties are materially different if the legal entitlements associated with the property are different in kind or extent.  There needs to be awarness of minor changes things like debt instruments.  This was solved with Reg. §1.1001-3(e).  See more concerning this bright line test on page 89.
6. it is very important to note that amount realized includes any amount canceled or assumed by another party
7.
iv. Imputed Income
1. imputed income is generated in two situations:
a. when taxpayers derive an economic benefit from the ownership and use of their own property (such as the rental value of their home) &
b. when taxpayers derive an economic benefit from performing services for themselves (such as the value of one’s services
2. imputed income is not taxable
3. Commissioner v. Daehler:  real estate agent buys a home and realizes commission and said it was imputed income—idiot
a. Court said that the commission was compensatory.
4. do not feel to bad for the G, they get their shares in other ways; instead of taxing you on the benefit you derive from the rental value of you home, they assess property tax