Many Individuals Have Property That Increases In Value Over

Many individuals have property that increases in value over

Many individuals have property that increases in value over time. Examples are homes, stocks and bonds, and artwork. Explain why the increase in these items, from year to year, is not considered gross income. What do you think would happen if these increases were required to be included in gross income? (Consider actions of taxpayers and administrative issues the IRS might face.) Consider discussing the tax concept of income, administrative convenience, and wherewithal to pay in your responses.

The increase in value on property is not considered gross income because it is not realized income. According to the tax principles, income is only recognized when it is realized through a sale or other transaction that converts the increase in value into cash or property. The IRS and tax laws distinguish between unrealized gains—such as the appreciated value of stocks or property—and realized gains, which are taxable upon sale. Including unrealized appreciation as taxable income would significantly complicate tax administration and enforcement, creating difficulties in valuation and valuation disputes, as well as increasing administrative burden on tax authorities such as the IRS.

From an administrative convenience perspective, tracking the precise value increase for each taxpayer annually would impose a substantial burden on the IRS. Valuations of assets like artwork or stocks can fluctuate daily, and establishing a consistent, fair valuation process would require extensive resources. Additionally, including unrealized gains in gross income could lead to taxpayer disputes over valuations, as taxpayers might contest the IRS assessments, increasing the likelihood of audits and legal challenges.

The concept of wherewithal to pay also plays a critical role. Taxes are typically imposed when individuals have the ability to pay, usually at the point of realization, such as when they sell an asset and convert appreciation into cash. If unrealized gains were taxed annually, taxpayers would be forced to pay taxes on increases they have not yet liquidated, potentially creating liquidity issues for some individuals, especially if they are unable to sell assets or do not want to dispose of them for tax reasons.

If unrealized gains were included in gross income, it would fundamentally alter the tax system, incentivizing taxpayers to delay sales to avoid taxes or to engage in complex tax planning strategies to defer gains. Moreover, tax authorities would need sophisticated valuation techniques and may face difficulties in accurately assessing individual asset values annually. This could reduce compliance and increase enforcement costs, ultimately making the system less efficient and more intrusive.

In conclusion, the current system of excluding unrealized gains from gross income aligns with principles of administrative ease, fairness, and economic practicality. Including unrealized appreciation would complicate tax administration, potentially cause disputes, and unfairly burden taxpayers with taxes on income they have not yet realized or access to. Therefore, the distinction between realized and unrealized gains remains pivotal in the U.S. tax system, balancing revenue needs with administrative feasibility and taxpayer fairness.

Paper For Above instruction

The Capital Asset Pricing Model (CAPM) is a fundamental concept in finance that establishes a framework for understanding the relationship between risk and expected return on investments. Developed independently by William Sharpe, John Lintner, and Jan Mossin in the 1960s, CAPM helps investors and financial analysts evaluate the expected return on an investment given its inherent risk relative to the overall market (Sharpe, 1964; Lintner, 1965; Mossin, 1966). The model provides a formula that quantifies the expected return of a security or portfolio based on its systematic risk, represented by beta, and the risk-free rate, thereby guiding investment decisions and capital allocation.

At its core, the CAPM formula is expressed as:

Expected Return = Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)

This equation calculates the return that investors should expect to receive, given the risk profile of the investment. The risk-free rate, typically represented by government treasury bonds, reflects the return on a virtually riskless investment. Beta measures the sensitivity of the security's returns to fluctuations in the overall market; a beta greater than one indicates higher volatility and risk, while a beta less than one suggests lower volatility. The market return is the average return of the market portfolio, representing the overall market's performance.

The utility of CAPM lies in its simplicity and practical application in assessing asset prices, portfolio diversification, and cost of capital calculations. By quantifying the risk premium associated with systematic risk, CAPM informs investors whether a security offers an adequate expected return relative to its risk, helping prevent overinvestment in overly risky assets or underinvestment in promising opportunities (Fama & French, 2004). It also serves as a benchmark for evaluating the performance of investment portfolios, enabling fund managers to compare actual returns with expected returns based on their risk exposure, thus aiding in performance assessment and strategic decision-making.

One of the key advantages of CAPM is its emphasis on diversification and the assumption that investors hold diversified portfolios. This assumption eliminates unsystematic risk—the type of risk associated with individual assets—that can be mitigated through diversification. Consequently, the model focuses solely on systematic risk, which cannot be diversified away, reflecting true market risk. This focus allows investors to assess the required rate of return based on how much market risk they are exposed to, aiding in asset valuation and capital budgeting (Bodie, Kane, & Marcus, 2014).

Another benefit of CAPM is its straightforward computation, which makes it accessible and easy to stress-test under different scenarios. It enables investors and firms to estimate the expected return on new projects or securities, considering the inherent market risk associated with those investments. Furthermore, CAPM's reliance on beta allows for adjustments in cost of capital to reflect changing market conditions or specific risk factors, making it a flexible tool in financial analysis.

Despite its widespread use, CAPM has limitations. Critics argue that the assumptions underpinning the model—such as perfect markets, rational investors, and homogenous expectations—do not fully reflect real-world complexities. Empirical studies also show that actual returns can deviate from CAPM predictions due to factors like bubbles, market inefficiencies, and behavioral biases (Fama & French, 2004). Nonetheless, CAPM remains a cornerstone of modern financial theory because of its clarity, ease of application, and the valuable insights it offers into the relationship between risk and expected return.

References

• Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments (10th ed.). McGraw-Hill Education.
• Fama, E. F., & French, K. R. (2004). The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives, 18(3), 25-46.
• Lintner, J. (1965). The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets. The Review of Economics and Statistics, 47(1), 13-37.
• Mossin, J. (1966). Equilibrium in a Capital Asset Market. Econometrica, 34(4), 768-783.
• Sharpe, W. F. (1964). Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk. The Journal of Finance, 19(3), 425-442.
• Zucchi, K. (n.d.). The Advantages And Disadvantages Of The CAPM Model. Investopedia.