Federal Income Tax Outline – Page 2 – Gifts and Inheritances

Exclusions of Gifts and Inheritances – 102

102(a) – Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance

Employee Gifts – 102(c), 274(b)

Generally all “gifts” from employer to employee must be counted as gross income


  • “Extraordinary transfers to the natural objects of an employer’s bounty…if the employee can show that the transfer was not made in recognition of the employee’s employment.”
  • Certain traditional retirement gifts (Section 132(e))
  • Certain employee achievement awards (Section 74(c))


Commissioner v. Duberstein (1960)

Duberstein was given a Cadillac by the president of another company after Duberstein provided him with names of potential customers; this qualified as a gift

Lyeth v. Hoey (1938)

The beneficiary challenged the will and received money after a settlement; this money is not gross income because he received it based on his status as a beneficiary

Wolder v. Commissioner (1974)

Wolder’s client bequeathed stock to him in return for providing legal services; “A transfer in the form of a bequest was the method that the parties chose to compensate Mr. Wolder for his legal services, and that transfer is therefore subject to taxation”


Employee Benefits – 132, 119

132(a)(1)&(2) – Certain Fringe Benefits
Nondiscrimination rule 132(j)(1) – may be made available tax-free to officers, owners, or highly compensated employees only if the benefits are also provided on substantially equal terms to other employees

  • If a classification of fringes is discriminatory, highly compensated employees have gross income, but the exclusion still applies to those employees who receive the benefit and are not highly compensated


132(c) – Qualified employee discount

  • Property: Gross Profit Percentage: Aggregate sales price/Aggregate cost
  • Services: An employee discount is not taxed as long as it is less than 20% or

Review beginning of Chapter 4 for summary of 132(a) fringe benefits


119 – Meals or lodging furnished for the convenience of the employer

Section 119 grants an exclusion from gross income of lodging furnished to an employee if three conditions are met:

  1. The lodging is on the business premises of the employer
  2. The employee is “required to accept such lodging as a condition of his employment
  3. The lodging is furnished for the convenience of the employer
  • 119 does not recognize sole proprietorship
  • 119 does recognize a partnership



Herbert G. Hatt

President of a funeral home and lived there; the funeral business requires someone to be in attendance 24 hours a day, the business phone also rang in his apartment; excludable from GI


Prizes and Awards – 74


Section 74(c) – an award may qualify if it relates to length of service or to safety – must be at least 4 years

  • Must be in the form of tangible personal, be awarded as part of a meaningful ceremony, and not be mere disguised compensation


Allen McDonell –sales manager went with his wife on a trip to Hawaii; he was a chaperone and the business sent him; not gross income

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Federal Tax Outline – Page 3
This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.


Federal Income Tax Outline – Page 3 Property Gains, Life Insurance

Gain from Dealings in Property – Chapter 6


1001 – Amount Realized

1012 – Basis = cost (most basic)

1014 – Estate tax basis (decedent)

1015 – Gift tax basis

1041 – Transfers of property between spouses


Philadelphia Park Amusement Co. v. United States

Cost basis is the fair market value of the property received; if we cannot determine with reasonable certainty the value for the property, it is fair to   assume the properties are equal in an arms-length transaction

Taft v. Bowers

Donee assumes the donor’s basis in property acquired by gift (1015)

Crane v. Commissioner

1041; husband and wife same entity

Commissioner v. Tufts

Nonrecourse mortgage treated the same as a true loan


Life Insurance Proceeds and Annuities – Chapter 7


Life Insurance Proceeds – Section 101

101(d): Instead of taking proceeds, you leave it with the insurance company who makes payments to you with interest.

  • Must understand the difference between insurance proceeds and annuities in how these are taxed

101(g): Terminally or chronically ill do not pay tax on proceeds from insurance policies

  • However, there are limitations for chronically ill; there are none for terminally


Annuities – 72

72(b): Exclusion Ratio = Investment Contract/Total Expected Return

–        The exclusion rate is EXCLUDED from gross income

–        The remaining is INCLUDED in gross income

Page 159 for example


Discharge of Indebtedness – Chapter 8


61(a)(12) – Discharge of Indebtedness (Included in Gross Income)

108 – Can exclude or defer

108(b) – not a total freebie, just a deferral

Debt discharge amount: The amount of discharged debt which is excluded from gross income by virtue of the bill’s provision is to be applied to reduce certain tax attributes.

The debt discharge amount is applied to reduce the taxpayer’s tax attributes in the following order:

  1. Net operating losses and carryovers;
  2. Carryovers of the [general business credit]
  3. The Section 53 alternative minimum tax credit
  4. Capital losses and carryovers;
  5. The basis of the taxpayer’s assets (both depreciable and nondepreciable);
  6. Carryovers of passive activity losses or credits;
  7. Carryovers of the foreign tax credit

A business loss can be put back 2 years or forward 20 years

Debt discharge outside of bankruptcy

  • The amount of debt discharge is excluded from gross income up to the amount by which the taxpayer is insolvent


Damages and Related Receipts – Chapter 9

Sections 104 – 106

Punitive damages are taxable ALL the time

All exclusions under 104 and 105(b) are restricted by an “except” clause:

  • Except in the case of amounts attributable to (and not in excess of) deductions allowed under Section 213 (relating to medical, etc., expenses) for any prior taxable year
  • Example:
    • Year 1 – took $500 deduction for medical expenses
    • Year 2 – got reimbursed $500 by employer (must count as Gross income)

If a reimbursement is made in the same year the expense is incurred, the exclusion applies. This is because there has been no deduction with respect to that amount in any “prior taxable year.”


Goodwill is an asset that is includable in income

  • If the plaintiff generates goodwill, his basis is 0
  • You can purchase goodwill and the basis would be the amount allocated to goodwill at the time of the purchase.


Federal Tax Outline – Page 2

Federal Tax Outline – Page 4


This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.

Federal Income Tax Outline – Page 4 Divorce & Other Exclusions

Settlement and Divorce – Chapter 10

71 (income rule); 215 (deduction rule)

You cannot take a 215 deduction unless the other spouse counts it as income under 71



  • Payments that qualify as alimony or separate maintenance are gross income to the payee spouse under Section 71(a) and deductible by the payor spouse under Section 215(a).
  • Must meet five requirements:
    • Four listed in 71(b)(1) and the payment is not for child support.
  • Transfers of property, incident to divorce, will be treated as a gift and the transferee will receive the property at the transferor’s basis


Alimony Recapture

  • Purpose: To prevent property settlements from being categorized as alimony
  • If the alimony is front-end loaded, it looks like a property division (settlement)

3 years is the most that you will have to worry about. The alimony will be recaptured in Year 3.

Steps for Recapture

  1. 71(f)(4) – Year 2
  2. 71(f)(3) – Year 1
  • Exception to Recapture – 71(f)(5) – death in 3 years

Alimony Trusts

  • Income of alimony trusts is excluded from the payor’s gross income (no deduction) and is taxable to the payee.
  • The payee is treated as the beneficiary
  • Example of why you would use an alimony trust: Payor husband is a gambler and may lose all of his money.



Young v. Commissioner

The code uses the language “incident to divorce” if it (1) occurs within 1 year after the date on which the marriage ceases (the regulations extend a safe harbor to transfers made within six years of divorce), or (2) is related to the cessation of the marriage


Other Exclusions – Chapter 11


Gain from the Sale of a Principal Residence – 121

  • A taxpayer can exclude up to $250,000 ($500k if married filing jointly) of gain realized on the sale or exchange of a principal residence.
  • Cannot take this exclusion more frequently than once every two years and the taxpayer must have owned the residence and occupied it as a principal residence for at least two of the five years prior to the sale or exchange.
  • Also, cannot include a loss from sale of personal residence:


Amount Realized = 200
Adjusted Basis = 500

Loss Realized = <300>

Loss Recognized = 0

  • 121(d)(3) – Property owned by spouse or former spouse; (see drawing in Evernote)
  • 121(d)(11) – Decedent; If the decedent used it for 20 months, the beneficiary is deemed to used it for that time period


Items not deductible

  • 262 – Personal, living, and family expenses (generally, no deduction)

Assignment of Income – Chapter 12


Lucas v. Earl

“The fruit must be attributed to the tree from which it grew;” husband attorney had a written agreement with his wife

Commissioner v. Giannini

Board of director who had an agreement to be paid 5% but then after the first payment he said he would not accept any further compensation and said “do something worthwhile with the money.” Further compensation NOT income. He did not direct the disposition of the money

Blair v. Commissioner

G -> Will -> Trust; income for life to Blair. Blair was to get the income for life but he assigned a portion of all of his future unearned income from the trust to his children.


Executor/Administrator of an estate working for free:

  • The requisite intention to serve on a gratuitous basis will ordinarily be deemed to have been adequately manifested if the executor or administrator of an estate supplies one or more of the decedent’s principal legatees or devisees, or of those principally entitled to distribution of decedent’s intestate estate, within 6 months after his initial appointment as such fiduciary, with a formal waiver of any right to compensation for his services.


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Federal Tax Outline – Page 5


This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.

Federal Income Tax Outline – Page 5 Individual Deductions

Deductions for Individuals Only


Adjusted Gross Income – Section 62

Allowable “above the line” – described in section 62

Deductible “below the line” – outside section 62

Section 67 – 2% floor on miscellaneous itemized deductions

85% is the maximum amount of Social Security benefits that can be taxed


Moving Expenses – 62(a)(15), 217

Two requirements to qualify for a deduction:

1. Distance – 217(c)(1)

2. Time – 217(c)(2)

(Meals are not deductible)

Extraordinary Medical Expenses – 213

  • 213(a) allows a deduction for uncompensated expenses for medical care of an individual, the individual’s spouse or a dependent, to the extent the expenses exceed 7.5 percent of AGI (floor)
  • 213(d)(1)(A) – medical care means amounts paid “for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body”
  • They do not include costs to improve the taxpayer’s general health and appearance.
  • 213 – travel to medical facility – 50% of meals, 100% of hotels – reasonable estimate
  • Deductible medical expenses Don mentioned:
    • Birth control pills, vasectomy
    • Excludes: cosmetic surgery


Raymond Gerard v. Commissioner

Daughter had cystic fibrosis. Doctor recommended a central A/C unit and they installed one. The $1300 was an expenditure for medical care within the scope of 213. However, 263 states, “No deduction shall be allowed for permanent improvements made to increase the value of any property.”  If a taxpayer can show that the increase in value is less than the expenditure, the difference is deductible. Here, the unit increased the value of the home by $800. $1300 – $800 = $500 medical deduction

Revenue Ruling 2002-19

Expenses for weight-loss program for a specific disease or ailment diagnosed by a physician – cost of participation in the weight-loss program is paid for medical care and is deductible under 213 (fees to join the program and attend periodic meetings); diet food items are not deductible

You would rather have a 162 deduction instead of 213

Where it is questionable whether an expense is a business or medical expense, the Service indicates the expenses may be deduction under Section 163 if the following three elements are present:

1. The nature of the taxpayer’s work clearly requires that he incur a particular expense to satisfactorily perform such work,

2. the goods or services purchased by such expense are clearly not required or used, other than incidentally, in the conduct of the individual’s personal activities, and

3. The Code and Regulations are otherwise silent as to the treatment of such expense

Qualified Tuition and Related Expenses – 25, 62(a)(18), 222

  • Ceiling limitation on deduction – $4,000 for a taxpayer with less than $65,000 AGI


Personal and Dependency Exemptions – 151

  • A husband and wife filing a joint tax return constitute two taxpayers and are allowed two personal exemptions

 Qualifying Child – 4 requirements

  1. Child of the taxpayer – son or daughter, stepson, and stepdaughter; adopted or foster children are treated the same as blood children
  2. Same principal place of abode as the taxpayer for more than one-half of the year (exception: special circumstances)
  3. Age requirement – under the age of 19 at the close of the calendar year or is a student who has not attained age 24 at the end of the calendar year
  4. The dependent must not have provided over one-half of such individual’s own support (a scholarship does not qualify as support)

 Qualifying Relative

  1. Must not be a qualifying child
  2. Must bear one of the relationships listed under Section 152(d)(2)
  3. The dependent may not have gross income in excess of the exemption amount for the year involved
  4. The taxpayer must provide over one-half of the support for the dependent

A dependent must be a citizen or national of the United States or a resident of a country contiguous to the United States (exception for adopted children)

Multiple Support Agreement (MSA)

  • Generally, you have to pay over 50% of the support to claim a dependent
  • 152(d)(3) when no one person provides over 50% (if one person is over 50% then no MSA)
  • MSA – Multiple Support Agreement – when you have multiple family members paying for expenses
  • Must be greater than 10%.
  • Must have been able to otherwise claim the dependent. (The friendly neighbor cannot claim unless they could otherwise claim the dependent)

The Standard Deduction – 63

  • You should elect to itemize if it is greater than the standard deduction
  • MFS (Married Filing Separately) If one itemizes, then the other has to itemize


Federal Tax Outline – Page 4

Federal Tax Outline – Page 6


This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.

Federal Income Tax Outline – Page 6 Capital Gains and Losses

Capital Gains and Losses – Chapter 21

“Capital” is usually dependent upon:

1. Whether it arises in a transaction involving a “capital asset”

2. Whether the capital asset has been the subject of a “sale or exchange”

3. How long the taxpayer has “held” the asset
*There are some statutes that may artificially accord capital gain or loss treatment to some transactions which do not actually involve the sale or exchange of a capital asset.
Section 1222

(1) Short-term capital gain – gain from the sale or exchange of a capital asset held for not more than 1 year

(2) Short-term capital loss – loss from the sale or exchange of a capital asset held for not more than 1 year

(3) Long-term capital gain – held for more than 1 year

(4) Long-term capital loss – held for more than 1 year
(5)-(8) Netting of short-term losses against short-term gains and long-term losses against long-term gains

STCG – STCL = Net short-term capital gain or loss (1222(5) and (6))

LTCG – LTCL = Net long-term capital gain or loss (1222(7) and (8))
Review numbers on page 691

Net gains can arise in three situations:

1. A net short-term gain in excess of a net long-term loss (taxed at ordinary income)

2. A net long-term gain in excess of a net short-term loss (net capital gain Section 1222(11))

3. A combination of a net short-term gain and a net long-term gain
Collectible LTCG rate = 28%

If there is a “net capital gain,” Section 1(h) comes into play.


Corporation v. Individual – Treatment of Capital Gains

  • Corporations compute and net their capital gains like noncorporate taxpayers but no preferential tax treatment is provided to corporations.
  • Gains – noncorporate taxpayer has the advantage because of the preferential rate
  • Losses – noncorporate taxpayer can offset ordinary income up to $3,000; corporations can only deduct losses from the extent of their gains
    • However, Corporations – for carryover it is ALWAYS a short-term capital loss regardless of its origin (back three years, forward five years)
    • Individuals can only carry forward losses


The Mechanics of Capital Losses

Section 165 – primary code section that determines whether a loss is deductible

  • Capital losses are generally deductible only from or against capital gains.
  • Any capital loss balance remaining is carried forward into succeeding taxable years (retaining either LT or ST capital loss)


Restrictions on capital losses offsetting ordinary income

  • 1211(b) limitation – capital losses are deductible only to the extent of capital gains plus, if such losses exceed such gains, an amount of ordinary income not to exceed the lower of $3,000 ($1,500 married individual filing separately) or the excess of such losses over such gains.
  • 1212(b) Carryover– Capital losses not utilized in the year incurred are carried over into subsequent taxable years and treated as LT or ST losses, depending on their original character.
    • If the sum under 1211(b) does not exceed $3,000 of excess losses over gains, there is no “net capital loss,” no carryover, and no need to use 1212(b)

Make the 1212(b)(2) computation first, before computing carryover losses under Section 1212(b)(1)

The amount of the carryover will be the amount of the net short-term and net long-term capital losses reduced by the $3,000 amount that wiped out ordinary income. The character of the loss (ST or LT) remains the same.


1212(b)(2) Constructive ST Capital Gain – If the taxpayer has both net ST and net LT capital losses, the net ST capital loss is used first and then the net LT capital loss to eliminate the 1211(b) $3,000 deduction from ordinary income.



LT Gain          $400          ST gain          $400

LT Loss          $2,400       ST loss          $2,000

Net LT Loss    (2,000)      Net ST loss     (1,600)



LT gain          $400          ST gain          $3,400

LT Loss          $2,400       ST loss          $2,000

Net LT Loss     (2,000)     Net ST Gain     1,400


1212(b)(1)(B) – There is a $600 excess of the $2,000 net LT capital loss. This is treated as a LT capital loss in the succeeding year.


Capital Losses are reborn indefinitely in succeeding taxable years until finally utilized or until their demise at the taxpayer’s death.


Federal Tax Outline – Page 5

Federal Tax Outline – Page 7


This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.

Federal Income Tax Outline – Page 7 Capital Asset

The Meaning of “Capital Asset”



Mauldin v. Commissioner

Helpful facts to determine whether property is a “capital asset” – 1. The purpose(s) for which the property was acquired – sale or investment; 2. Continuity and frequncey of sales as opposed to isolated transactions; 3. Ppurpose for which it was sold (most important)

Malat v. Riddell

Section 1221(1) denies capital gain treatment to profits reaped from the sale of “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;” Primarily means “of first importance” or “principally.”


The Holding Period


Revenue Ruling 66-7

Calculating a time period; “From” or “after” – excludes the day thus designated and the last day of the prescribed period is included; calendar months and factions thereof, rather than with reference to days; capital assets – the holding period begins to run on the day following the date of acquisition

Statutorily Created Capital Gain and Loss

Section 1231 Recharacterization – Page 751 – Unquestionably the most significant recharacterization


Involuntary conversion

1231(c) – Lookback Recapture Rule:

  • If you have a gain, and if in the prior five years you have taken a deduction(s) through 1231
  • Gain Recognized may be different than Gain Realized


$10,000 loss in Year 1. In Year 2 you take a $7,000 gain. That $7,000 gain would be treated as ordinary income and then there would be $3,000 left in the “filter.” Year 3 you have $5,000 gain, $3,000 would be ordinary income and $2,000 would be LTCG



1239 – Related Taxpayers – Gain recognized to the transferor is treated as ordinary income

Corporation owned by A. A sells a $100,000 piece of machinery to the corporation (1231 property). Had an Adjusted Basis of $20,000; therefore, A has a GRealized of $80,000 and GRecognized of $80,000. If the corporation is going to take a business deduction, they would be offsetting ordinary income. Therefore, any gain recognized to the transferor shall be treated as ordinary income.

  • Does not matter if the transferee takes the deduction or not – it is subject to depreciation
  • This is given capital treatment.


Federal Tax Outline – Page 6


This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.

Joyner v. Adams, 87 N.C. App. 570 (1987)

Case Name: Joyner v. Adams
Plaintiff: Joyners (husband and wife)
Defendant: J.R. Adams (substitute lessee/developer)
Citation: 87 N.C. App. 570 (1987)
Key Facts: Joyner leased a property to an investment company to develop it (“base lease”). The original investment company was not able to complete this, so Adams assumed the lessee/developer position. The lease obligated Adams to have subdivided “all of the undeveloped land…and have it developed and eligible for the execution of a “lot lease” by September 30, 1980 (recomputation provision). By that date, Adams had executed separate lot leases and built buildings on all but one lot. However, that lot was subdivided, graded, and had installed water and sewer lines, etc.

Joyner filed a complaint seeking to recover the rent which it would have received had the last lot be developed.

Adams said that from his experience and the local real estate market, a lot is considered “developed” when water and sewer lines are installed and the lot is otherwise ready for the construction of a building.

Procedural Posture: The trial awarded judgment for plaintiff based on the rule that ambiguity in contract terms must be construed most strongly against the party which drafted the contract.

Judgment: Remanded because in order for the court to use the rule below “the form of expression in words was actually chosen by one party rather than by the other” in order to apply the rule.

Rule: Ambiguity in contract terms must be construed most strongly against the party which drafted the contract (typically used in adhesion contracts). The court stated that the plaintiff can prevail only if the trial court concludes that the defendant knew or at least had reason to know of the meaning he intended while the plaintiff did not know (or have reason to know) of the meaning the defendant intended. This would mean that there was no meeting of the minds on the term “developed.” Where both parties have knowledge of the other parties understanding, then there is no meeting of the minds. Therefore, the first step is to figure out if one party has knowledge of the term when the other party doesn’t.

Page County Appliance Center v. Honeywell, 347 N.W.2d 171 (Iowa 1984)

Case Name: Page County Appliance Center, Inc. v. Honeywell, Inc.
Plaintiff: Page County Appliance Center, Inc.
Defendants: Honeywell, Inc. and ITT Electronic Travel Services, Inc.
Citation: 347 N.W.2d 171 (Iowa 1984)


Key Facts: Page County Appliance Center sued for nuisance and tortious interference with business relations. Since 1953, Appliance Center has owned and operated an appliance store. Before 1980, they had no reception trouble with their display televisions. In Jan. 1980, many of the appliance center’s customers complained that their TVs were bad. This was traced back to one of  ITT’s computers because it was leaking radiation. The computer was manufactured, installed, and maintained by Honeywell. Honeywell engineers made many unsuccessful trips to fix the computer.

Nuisance is defined as a substantial and unreasonable interference with the use or enjoyment of land. Appliance Center alleged a private nuisance which is “an actionable interference with a person’s interest in the private use and enjoyment of his or her property.” Nuisance per accidens – “in fact” – a lawful activity conducted in such a manner as to be a nuisance.

Issue: Whether the defendants are liable for a nuisance claim when they were conducting lawful business activities which caused reception trouble for Appliance Center’s TVs.

Procedural History: The plaintiff was awarded compensatory and punitive damages. Appliance Center asked only for injunctive relief but was also awarded $71,000 in compensatory damages and $150,000 in exemplary damages. The trial court awarded ITT full indemnity against Honeywell. Both defendants appeal from the judgment in favor of Appliance Center. In addition, Honeywell appeals from the judgment awarding ITT indemnity.

Rule: In reviewing a nuisance claim against a lawful trade or industry, a jury must consider the reasonableness of the defendant conducting the trade or industry in the existing manner and place. The existence of a nuisance is not affected by the intention of its creator not to injure anyone.

Judgment: Reversed and remanded for a new trial. New instructions included:
1. Further define the unreasonableness concept
2. Nothing informed the jury that a defendant’s conduct must be a “substantial factor” in bringing about the alleged harm
3. Whether Appliance Center was devoting its premises to an unusually sensitive use


Noone v. Price, 298 S.E.2d 218 (W. Va. 1982)

Case Name: Noone v. Price
Plaintiffs/Appellants: Mr. and Mrs. William H. Noone
Defendant/Appellee: Mrs. Marion T. Price
Citation: 298 S.E.2d 218 (W. Va. 1982)

Key Facts:
Part of the Noones’ house was subsiding. The Noones believed this was caused by Price’s negligence in maintaining her retaining wall. Price’s home was located directly below the Noones at the foot of the hill. Price’s home was built in 1912 and the stone wall was built sometime between 1912 and 1919 while the Noones’ home was built after that in 1928. Price purchased her home in 1955 and the Noones purchased their home in 1960.

Price denied that the wall on her property provided support to the slope or that the condition of her wall caused the slipping and damage to the Noones’ property.

Issue: Whether the defendant is strictly liable or negligent when the plaintiffs’ home subsided because the defendant did not maintain a retaining wall on her property which was built before the plaintiffs’ home.

Procedural History: The circuit court awarded summary judgment to the defendant.

General Rule: A landowner is entitled to lateral support in the adjacent land for his soil.

Rule: A landowner may be negligent in failing to provide against the risk of harm to his neighbor’s structures even if he does not realize that any harm will occur.

Holding: Because the retaining wall was built before the plaintiffs’ home; it is only responsible for supporting the land in its natural condition.

Judgment: If the plaintiffs can recover, they must do so by proving that the disrepair of the retaining wall would have led to the subsidence of their land in its natural condition.

Friendswood Development Co. v. Smith-Southwest Industries, Inc.

Case Name: Friendswood Development Co. v. Smith-Southwest Industries, Inc.
Plaintiff/Appellee:  Smith-Southwest Industries and other landowners
Defendants/Appellant: Friendswood Development Company and Exxon Corporation (parent company)
576 S.W.2d 21 (Tex. 1978)

Key Facts: Smith-Southwest Industries alleged that Friendswood Development Co. pumped large amounts of subsurface waters from its own property which resulted in the subsidence of the plaintiff’s land. They alleged that the wells were negligently spaced too close together and too near the common boundary of lands owned by the plaintiffs and that the defendant produced the wells with knowledge that this could cause subsidence and flooding of the plaintiff’s land. Furthermore, the plaintiffs allege that the defendant’s continued use for the withdrawal and sale of large amounts of fresh water constitutes a continuing nuisance and permanent loss and damage to their property.

General Rule: A landowners has a duty not to use his property so as not to injure others. However, this court has held that this general rule does not apply to withdrawals of underground water because that right is absolute and not subject to the “reasonable use” rule.

Plaintiffs contend that the “reasonable use” doctrine should apply to ground water the same.

Issue: Whether Friendswood Development Co. is liable for nuisance and negligence when it pumped large amounts of subsurface waters from its own property causing subsidence of the plaintiff’s land.

Holding: Friendswood Development Co. is not liable for nuisance and negligence (following the English rule and Restatement of Torts).

Rule: For future subsidence cases, a landowner who withdraws ground water and is negligent, willfully wasteful, or tries to cause malicious injury, and is the proximate cause of subsidence to other landowners, will be liable for negligence.

Judgment: The plaintiffs cannot recover on this future rule because, in property, the parties should be able to rely on the law which existed at the time of their actions

Dissenting: Although, according to Texas law, a landowner has an absolute right to pump water; the plaintiffs also have an absolute right to the lateral support for his land.
I would hold that an owner of land may assert an action against one who destroys the later of subjacent support to his land when:

  1. He engages in conduct knowing that it will cause damages to another’s land by loss or destruction of the subjacent support
  2. The plaintiff proves negligence; or
  3. The plaintiff proves a nuisance

Also, it is unfair to treat the parties unequally by recognizing that they possess an action, but denying them the remedy.