Lakhasly

The issue was the amount of income taxpayers must realize when they sell property.Initially, the IRS was convinced that Congress's all-inclusive definition of income required taxpayers to include all sale proceeds in gross income.Taxpayers, on the other hand, argued that a portion of proceeds from a sale represented a return of the cost or capital investment in the underlying property (called tax basis).

The issue was the amount of income taxpayers must realize when they sell property. Initially, the IRS was convinced that Congress’s all-inclusive definition of income required taxpayers to include all sale proceeds in gross income. Taxpayers, on the other hand, argued that a portion of proceeds from a sale represented a return of the cost or capital investment in the underlying property (called tax basis). The courts determined that when receiving a payment for property, taxpayers are allowed to recover the cost of the property tax free. Consequently, when taxpayers sell property, they are allowed to reduce the sale proceeds by their unrecovered investment in the property to determine the realized gain from the sale. When the tax basis exceeds the sale proceeds, the return of capital principle generally applies to the extent of the sale proceeds. The excess of basis over sale proceeds is generally not considered to be a return of capital, but rather a loss that is deductible only if specifically authorized by the tax code.