Chapter 8 - Property Dispositions

Chapter8

QuestionsandProblemsforDiscussion

1. a. Section1231asset.

b. Capitalasset.

c. Section1231asset.

d. Capitalasset.

e. Noncapitalasset.

f. Capitalasset.

g. Capitalasset.

h. Section1231asset.

2. Inasaleofproperty,theamountrealizedconsistsofcashoracashequivalent(purchasers
note).Inanexchangeofproperty,theamountrealizedincludesnoncashassets.

3. Ifataxpayerisrelievedofadebtonthedispositionofanasset(i.e.,thepurchaserassumesthe
sellersdebt),thereliefofdebtisanamountrealized.Ifthetaxpayerreceivesservicesin
exchangefortheasset,thefairmarketvalueoftheservicesisanamountrealized.

4. Ifataxpayerhaslossesthatcouldbedeductedagainstgainrecognizedonaninstallmentsale,
thetaxpayermightelectoutoftheinstallmentsalemethod.Alternatively,ifthetaxpayers
marginalrateintheyearofsaleisconsiderablylowerthantheprojectedmarginalrateinfuture
years,thetaxpayermightprefertorecognizetheentiregainintheyearofsale.

5. Thecharacterizationofgainorlossfortaxpurposeshasnoeffectonthecomputationofnet
incomeperbooks.

6. Afirmstaxbasisinanassetincludesanyportionoftheassetscostthatthefirmborrowedfrom
anotherpartytopurchasetheasset,eveniftheassetisthecollateralforthedebt.Afirmsequity
inanassetequalsthefairmarketvalueoftheassetlessanycreditorclaimsontheasset.

7. CorporationAgenerateditsgoodwillthroughitsownbusinessoperations.Suchinternally
createdgoodwillisnotadepreciableoramortizablebusinessassetand,therefore,isacapital
assetbydefault.CorporationZacquireditsgoodwillbypurchase,therebyestablishingan
amortizablecostbasisinthisbusinessasset.Amortizablegoodwillmeetsthedefinitionofa
Section1231asset.

8. Mrs.Carlysgainonsalewillbecapitalgainonlyifthelandisacapitalassetinherhands.
WhetherthelandisacapitalassetdependsonhowMrs.Carlyhasheldthelandsinceshe
acquirediteightyearsago.Ifsheheldthelandasinventoryinarealestatebusiness,thelandis
notacapitalasset,andhergainonsalewillbeordinaryincome.Ifsheheldthelandasan
investment,thelandisacapitalasset,andhergainonsalewillbecapital.Theaccountant
cannotanswerthequestionwithoutfurtherinformationfromMrs.Carly.

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9. a. FirmOPbearstheentireriskofa$125,000lossbecauseitmustrepay$550,000tothe
creditorregardlessofanydecreaseinthevalueoftheland.

b. Inthiscase,FirmOPbearstheriskoflossforits$50,000equityintheland,andthe
commercialcreditorbearstheriskoflossforthe$75,000excessofthe$550,000debtover
the$475,000valueoftheland.

10. Whilethesalemaynotbeanarmslengthtransactionbecauseoftheclosepersonalrelationship
betweenMr.KandMr.P,friendsarenotdefinedasrelatedpartiesfortaxpurposes.
Consequently,Mr.Kmayrecognizehisrealizedlossonthesale.

11. Bothcorporateandnoncorporate(individual)taxpayersprefercapitalgainstoordinaryincome
becausecapitallossesaredeductiblewithoutlimittotheextentofcapitalgainsbutare
nondeductibleagainstordinaryincome.Individualshaveasecondreasontoprefercapitalgains:
thepreferentialtaxratesonsuchgains.

12. UndertheSection1250partialrecapturerule,onlythatportionofgainequaltotheexcessof
acceleratedoverstraightlinedepreciationisrecapturedasordinaryincomeonthesaleor
exchangeofdepreciablerealty.UnderMACRS,realtymustbedepreciatedunderthestraight
linemethodsonoexcessaccelerateddepreciationispossible.

13. Iftheinsurancereimbursementexceedstheadjustedbasisinpropertydestroyedbycasualtyor
theft,theownerofthepropertyrealizesagainontheinvoluntarydisposition.

14. FirmFisadequatelyprotectedonlyifassetAsmarket/replacementvaluedoesnotexceed
$75,000.TheadjustedbasisofanassetdoesnotreflectthevalueoftheassettoFirmF.

ApplicationProblems

1. a. Amountrealizedonsale $13,000
Costbasis $30,000
Accumulatedbookdepreciation (12,000)
Adjustedbookbasis (18,000)
Bookloss $(5,000)

b. Amountrealizedonsale $13,000
Costbasis $30,000
Accumulatedtaxdepreciation (19,100)
Adjustedtaxbasis (10,900)
Taxgain $2,100

c. Cashreceivedonsale $13,000
Taxcost(30%$2,100taxgain) (630)
Aftertaxcashflow $12,370

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2. a. $50,000cost$37,200acc.bookdepr.=$12,800bookbasis
$50,000cost$41,000acc.bookdepr.=$9,000taxbasis

b. $41,000taxdepr.$37,200bookdepr.=$3,800excesstaxdepreciation
$3,800favorabledifference35%=$1,330deferredtaxliability

c. $14,750amountrealized$12,800bookbasis=$1,950bookgain
$14,750amountrealized$9,000taxbasis=$5,750taxgain

d. The$3,800excessoftaxgainoverbookgainisanunfavorabledifferenceandareversalof
thefavorabledifferencerepresentedbytheexcesstaxdepreciationthroughdateofsale.
Therefore,thisbooktaxdifferenceresultsina$1,330reductioninthedeferredtaxliability
computedinb.

3. a. FirmCSmustrecognize$38,500ordinaryincomeonthereceiptofthesecuritiesas
paymentforservicesrendered.CSsbasisinthesecuritiesis$38,500.

b. CompanyPmustrecognize$13,500capitalgainonthetransferofthesecurities($38,500
valueofconsultingservicespurchased$25,000basis).

c. AssumingthatCompanyPcandeducttheconsultingexpense,thefactthattheexpense
waspaidwithanoncashassetisirrelevant.Theamountofthedeductionis$38,500.

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4. a. Amountrealizedonsale $40,000
Basisininventory (15,700)
Gainrealizedonsale $24,300
.35
Taxcost $8,505
Cashreceivedonsale $10,000
Taxcost (8,505)
Aftertaxcashflowfromsale $(1,495
)

b. Amountrealizedonsale $40,000
Basisininventory (47,000)
Lossrealizedonsale $(7,000)
.35
Taxsavingsfromlossdeduction $2,450
Cashreceivedonsale $5,000
Taxsavings 2,450
Aftertaxcashflowfromsale $7,450

c. Amountrealizedonsale $40,000
Basisininventory (18,000)
Gainrealizedonsale $22,000
.35
Taxcost $7,700
Cashreceivedonsale $40,000
Taxcost (7,700)
Aftertaxcashflowfromsale $32,300

d. Amountrealizedonsale $40,000
Basisininventory (44,000)
Lossrealizedonsale $(4,000)
.35
Taxsavingsfromlossdeduction $1,400
Cashreceivedonsale $40,000
Taxsavings 1,400
Aftertaxcashflowfromsale $41,400

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5. a. $100,000($15,000cash+$85,000reliefofdebt)

b. KNBsrealizedgainonsaleis$60,000($100,000amountrealized$40,000adjusted
basis),andthetaxcostofthetransactionis$20,400($60,000gain34%).Therefore,
KNBsaftertaxcashflowisnegative:$15,000cashreceived$20,400taxcost=$(5,400).

6. a. Amountrealizedonsale:
Cash $40,000
Reliefofmortgage 166,700
$206,700
Cost $235,000
Acc.depr. (184,200)
Adjustedbasis (50,800)
Gainrecognized 155,900

b. Cashreceived $40,000
Taxcost($155,900gain35%) (54,565)
Aftertaxcashflowfromsale $(14,565)

7. a. Amountrealizedonsale:
Cash $75,000
Purchasersnote 675,000
$750,000
Adjustedbasis (535,000)
Gainrealizedonsale $215,000

b. $215,000gainrecognized.TPWstaxbasisinthenoteattheendofyearequalsthenotes
$641,250facevalue($675,000originalfacevalue$33,750Augustprincipalpayment).

c. $215,000gainrealized$750,000contractprice=28.67%grossprofitpercentage.

Cashreceivedinyearofsale:
Cashatclosing $75,000
Augustprincipalpayment 33,750
$108,750
.2867
Gainrecognized $31,179

Facevalueofnoteatendofyear $641,250
Deferredgain:
Realizedgain $215,000
Recognizedgain (31,179)
(183,821)
TPWstaxbasisinnote $457,429

8. a. Bookgain $215,000
Taxgain (31,179)
Book/taxdifference $183,821

b. Theexcessofbookgainovertaxgainisafavorabledifference.

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c. $183,82135%=$64,338deferredtaxliability

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9. a. $67,500principalpayment28.67%=$19,352gainrecognized

b. Facevalueofnoteatendofyear:
$641,250$67,500payment $573,750
Deferredgain:
Realizedgain $215,000
Recognizedgain:
$31,179+$19,352 (50,531)
(164,469)
TPWstaxbasisinnote $409,281

10. a. Taxgain $19,352

Bookgain 0
Book/taxdifference $19,352

b. Theexcessoftaxgainoverbookgainisanunfavorablefavorabledifference.

c. $19,35235%=$6,773reductionindeferredtaxliability

11. a. Amountrealizedonsale:
Cash $15,000
Purchasersnote 80,000
$95,000
Adjustedbasis (61,000)
Realizedgain $34,000
$34,000realizedgain $95,000contractprice=35.79%grossprofitpercentage
2004recognizedgain: $15,000cash 35.79%=$5,369
2005recognizedgain: $8,000cash 35.79%=$2,863

b. Atdateofpledge,Aldosbasisintheinstallmentnoteis$35,958($56,000principal
$20,042deferredgain[56,000 35.79%]).Thepledgeistreatedasadispositionofthenote
for$56,000cash,whichtriggersrecognitionoftheentire$20,042deferredgainin2007.

12. a. Amountrealizedonsale:
Cash $15,000
Purchasersnote 80,000
$95,000
Adjustedbasis (100,000)
Realizedandrecognizedlossin2004 $(5,000)

Theinstallmentsalemethoddoesnotapplytorealizedlosses

b. Becausetheinstallmentsalemethoddoesnotapplyinthiscase,Aldosbasisinthe
installmentnoteequalsthenotesprincipalbalance.Thepledgeofthenoteascollateralhas
notaxconsequences.

13. a. $60,000amountrealized$45,250basis=$14,750gainrecognized.

b. $60,000amountrealized$45,250basis=$14,750gainrecognized.Thefactthatseller
andbuyerarerelatedpartiesisirrelevant.

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c. $38,000amountrealized$45,250basis=$7,250lossrecognized.

d. $38,000amountrealized$45,250basis=$7,250lossrealized,butnolossisrecognized
becausesellerandbuyerarerelatedparties.

14. a. PPRhasa$110,000costbasisintheland.
b. BecausePPRandSiloarerelatedparties,Silos$35,000realizedlossonsaleoftheland
wasdisallowed.PPRcanusethislosswhenitsellsthelandasfollows.
(1)PPRs$10,000realizedlossonsale=$10,000recognizedloss.
(2)PPRs$6,000realizedgainonsale$6,000lossfromSilo=0recognizedgain.
(3)PPRs$40,000realizedgainonsale$35,000lossfromSilo=$5,000recognizedgain.

15. a. Theinventoryassetandthereceivableattributabletothesaleofinventorywerenoncapital
assets.Thus,FirmJrecognizeda$7,000ordinarygainonsaleofinventoryanda$2,000
ordinarylossonsaleofthereceivable.
b. Iftheassetwasacapitalasset,thereceivableattributabletoitssalewasalsoacapital
asset.Thus,FirmJrecognizeda$7,000capitalgainonsaleoftheassetanda$2,000
capitallossonsaleofthereceivable.
16. a. ThefactsstronglysuggestthatFirmRDconvertedthelandintoinventoryheldforsaleto
customersintheregularcourseofbusiness.Inthiscase,RDs$532,000gainis
characterizedasordinarygain.
b. Inthiscase,thefactssuggestthatFirmRDheldthelandasaninvestmentratherthanasa
businessasset,sothe$532,000gainischaracterizedascapitalgain.

17. a. $13,000amountrealized$11,900basis=$1,100ordinaryincomefromsaleofinventory
b. $13,000amountrealizedzerobasis=$13,000ordinaryincomeonsaleofanoncapital
asset
c. $13,000amountrealized$14,250basis=$1,250ordinarylossonsaleofanoncapital
asset

18. a. $6,000amountrealizedzerobasis=$6,000ordinaryincomeonsaleofacreativeassetby
thecreator
b. $10,000amountrealized$6,000costbasis=$4,000ordinaryincomeonsaleofinventory
c. $45,000amountrealized$10,000costbasis=$35,000capitalgainonsaleofacapital
asset(nondepreciablebusinesspersonalty)

19. a. Koilstaxableincomeis$732,400($718,400ordinaryincome+$45,000capitalgain
$31,000capitallosses).
b. Koilstaxableincomeis$735,400($718,400ordinaryincome+$17,000ordinarygain+
$22,300capitalgain$22,300allowablecapitalloss).The$35,700capitallossinexcessof
capitalgainisnondeductiblethisyear.
c. Koilstaxableincomeis$709,600($718,400ordinaryincome+$9,000capitalgain$9,000
capitalloss$8,800ordinaryloss).The$7,100capitallossinexcessofcapitalgainis
nondeductiblethisyear.

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20. a. PRSstaxableincomeis$300,000($300,000consultingincome+$36,000capitalgain
$36,000allowablecapitalloss).The$13,000capitallossinexcessofcapitalgainis
nondeductibleinthecurrentyear.
b. PRSstaxableincomeis$287,000($300,000consultingincome+$36,000ordinarygain
$49,000ordinaryloss).
c. PRSstaxableincomeis$336,000($300,000consultingincome+$36,000ordinarygain).
The$49,000capitallossisnondeductibleinthecurrentyear.
d. PRSstaxableincomeis$287,000($300,000consultingincome+$36,000capitalgain
$49,000ordinaryloss).

21. a. Zenohasa$27,400nondeductiblenetcapitallossin2007.Itcancarrythelossbackthree
yearstodeductagainstnetcapitalgaininthoseyears.Zenocandeduct$4,120capitalloss
carrybackagainst2005capitalgainand$13,600capitallosscarrybackagainst2006capital
gaintogeneratea$6,025taxrefund($17,72034%).
b. Zenoscapitallosscarryforwardis$9,680($27,400$17,720).

22. a. Book Tax

Operatingincome $427,300 $427,300
Capitalloss (13,590) ND
Income $413,710 427,300
b. The$13,590excessoftaxoverbookincomeisanunfavorabledifferenceresultingina
$4,621deferredtaxasset($13,59034%)
c. BecauseKZhada$11,900netSection1231gaintreatedascapitalgain,itcandeduct
$11,900ofitscapitallosscarryforwardfromitsfirstyear.
Book Tax
Operatingincome $500,800 $500,800
Section1231gain 19,300 19,300
Section1231loss (7,400) (7,400)
CLcarryforward (11,900)
Income $512,700 $500,800
d. The$11,900excessofbookovertaxincomeisafavorabledifferenceresultingina$4,046
reduction($11,90034%)inthedeferredtaxassetthatoriginatedintheprioryear.
Therefore,thedeferredtaxassetattheendoftheyearis$575.

23. a. $10,000$12,685adjustedbasis=$2,685Section1231loss
b. $13,000$12,685adjustedbasis=$315recapturedordinaryincome
c. $17,500$12,685adjustedbasis=$4,815recapturedordinaryincome
d. $22,500$12,685adjustedbasis=$7,315recapturedordinaryincomeand$2,500Section
1231gain

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24 a. Zeronstaxableincomeis$88,200($87,200serviceincome+$1,000ordinaryincome+
$2,400Section1231gain$2,400capitalloss).The$4,600capitallossinexcessofSection
1231gainisnondeductibleinthecurrentyear.
b. Zeronstaxableincomeis$80,600($87,200serviceincome$6,600Section1231loss).
The$1,700capitallossisnondeductibleinthecurrentyear.
c. Zeronstaxableincomeis$93,810($87,200serviceincome+$3,900ordinaryincome+
$1,510Section1231gain+$1,200capitalgain).
d. Zeronstaxableincomeis$80,900($87,200serviceincome$10,300Section1231loss+
$4,000capitalgain).
e. Zeronstaxableincomeis$88,900($87,200serviceincome+$2,800Section1231gain+
$5,200capitalgain$6,300capitalloss).

25. QIOsgainsandlossesfromassetssalesarecomputedandcharacterizedasfollows.
Amount Adjusted Realized Ordinary Section1231
Realized Basis Gain/(Loss) Gain Gain/(Loss)
Computerequipment $4,500 $3,800 $700 $700
Constructionequipment 50,000 53,300 (3,300) $(3,300)
Furniture 4,750 4,500 250 250
Transportationequipment 55,000 57,200 (2,200) ___ (2,200)
$950 $(5,500)
QIOstaxableincomeiscomputedasfollows.
Netincomefromoperations $192,400
Ordinaryincomefromassetsales 950
DeductibleSection1231loss (5,500)
Taxableincome $187,850

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26. a. Sigmasgainsandlossesfromsalesofbusinessassetsarecomputedandcharacterizedas
follows.
Amount Adjusted Realized Ordinary Section1231
Realized Basis Gain/(Loss) Gain Gain/(Loss)
Productionequipment $30,000 $17,000 $13,000 $13,000
Businessland 180,000 165,000 15,000 $15,000
Businessbuilding 210,000 141,700 68,300 11,660* 56,640
$24,660 $71,640
*20percentrecaptureof$58,300accumulateddepreciation
Sigmastaxableincomeiscomputedasfollows.
Netincomefromoperations $612,000
Ordinaryincomefromsalesofbusinessassets 24,660
Section1231gain(treatedascapitalgain) 71,640
Saleofmarketablesecurities:
Amountrealized $64,000
Basis (144,000)
Realizedloss $(80,000)
DeductiblelosslimitedtoSection1231gain (71,640)
Taxableincome $636,660

b. Sigmastaxableincomeiscomputedasfollows.
Netincomefromoperations $612,000
Ordinaryincomefromsalesofbusinessassets 24,660
Section1231gain 71,640
Saleofmarketablesecurities:
Amountrealized $150,000
Basis (144,000)
Capitalgain 6,000
Taxableincome $714,300

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27. a. EzTechsgainsandlossesfromsalesofbusinessassetsarecomputedandcharacterized
asfollows.
Amount Adjusted Realized Ordinary Section1231
Realized Basis Gain/(Loss) Gain Gain/(Loss)
Machinery $70,000 $57,840 $12,160 $12,160
Officeequipment 57,500 37,530 19,970 12,470 $7,500
Warehouse 125,000 141,880 (16,880) 0 (16,880)
$24,630 $(9,380)

EzTechsnetcapitallossfromthesaleofitsinvestmentassetsiscomputedasfollows:
Amount Adjusted Capital
Realized Basis Gain/(Loss)
Investmentsecurities $83,100 $72,700 $10,400
Investmentland 328,000 350,000 (22,000)
(11,600)

EzTechstaxableincomeiscomputedasfollows.
Netincomefromoperations $994,300
Ordinarygainfromsalesofbusinessassets 24,630
Section1231loss (9,380)
Taxableincome $1,009,550
b. IfEzTechslandwasaSection1231assetinsteadofacapitalasset,the$22,000loss
recognizedonsalewouldincreasethecorporationsSection1231lossto$31,380,and
EzTechstaxableincomeiscomputedasfollows.
Netincomefromoperations $994,300
Ordinarygainfromsalesofbusinessassets 24,630
Section1231loss (31,380)
Capitalgainfromsaleofinvestmentsecurities 10,400
Taxableincome $997,950

28. a. CorporationQhas$6,400nonrecapturedSection1231lossesfrom2005and2006.
Therefore,theentire$4,000Section1231gainrecognizedin2007isrecapturedasordinary
income.
b. In2008,CorporationQrecognizeda$14,700netSection1231gain.Itmustrecapture
$2,400($6,400Section1231lossesfrom2005and2006$4,000recapturedin2007)of
thisgainasordinaryincome.The$12,300remaininggainistreatedascapitalgain.

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29. a. Amountrealizedonsale:
Cash $80,000
Reliefofdebt 225,000
$305,000
Adjustedbasis:
Cost $315,000
Accumulateddepreciation (92,300)
(222,700)
Realizedandrecognizedgain $82,300
b. Lynnmustrecognize$16,460gain(20%$82,300recognizedgain)asordinaryincome
underthe20percentrecapturerule.The$65,840remaininggainisSection1231gain.
c. IfLynnisanoncorporatebusiness,the20percentrecaptureruleisinapplicable.Because
Lynnclaimedonlystraightlinedepreciationonthewarehouse,theentire$82,300gainis
Section1231gain.

30. a. Amountrealizedonsale $450,000

Adjustedbasis:
Cost $1,000,000
Accumulateddepreciation (814,000)
(186,000)
Realizedgain $264,000
Ordinaryincome(excessof$814,000accelerated
over$625,000straightlinedepreciation) $189,000
Section1231gain 75,000
Recognizedgain $264,000
b. IfFirmPisacorporation,itmustrecaptureanadditionalamountofordinaryincome.
Ordinaryincome(excessof$814,000accelerated
over$625,000straightlinedepreciation) $189,000
20percentadditionalrecapture(20%$75,000) 15,000
Section1231gain 60,000
Recognizedgain $264,000

31. Amountrealizedonsaleofpurchasedgoodwill $250,000

Adjustedbasis($200,000cost$74,000amortization) (126,000)
Gainrealized $124,000

Ordinaryincome(recapturedamortization) $74,000
Section1231gain 50,000
Recognizedgain $124,000

32. a. $7,000amountrealized$5,000adjustedbasis=$2,000recapturedordinaryincome
b. $1,000amountrealized$5,000adjustedbasis=$4,000Section1231loss
c. $5,000adjustedbasis=$5,000ordinaryabandonmentloss

33. FirmLcandeductits$22,800adjustedbasisinthedemolishedwallsasanordinary
abandonmentloss.

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34. a. Thestockistreatedassoldonthelastdayoftheyearforanamountrealizedofzero.
Consequently,the$82,700lossisacapitalloss.
b. Thestockistreatedassoldonthelastdayoftheyearforanamountrealizedofzero.
Consequently,the$82,700lossisacapitalloss.
c. Barloisthecorporatetaxpayerswhollyownedoperatingsubsidiaryandthereforeisan
affiliatedcorporation.Consequently,the$82,700lossisanordinaryloss.

35. a. Lylerecognizesa$25,000Section1231gain($100,000FMV$75,000adjustedtaxbasis)
onforeclosureoftherealestate.
b. Lylerecognizesa$25,000Section1231gain($100,000FMV$75,000adjustedtaxbasis)
onforeclosureoftherealestateand$20,000ordinarycancellationofdebtincome.

36. Lylerecognizesa$45,000Section1231gain($120,000reliefofnonrecoursedebt$75,000
adjustedtaxbasis).

37. a. Amountrealizedonsale(cash+debtrelief) $113,000

Basisofland (100,000)
Gainrecognizedonsale $13,000
Taxrate .35
Tax $4,550
Cashreceivedonsale $33,000
Taxcost (4,550)
Netcashflow $28,450

b. Amountrealizedonsale $113,000
Basisofland (100,000)
Gainrecognizedonsale $13,000
Taxrate .35
Tax $4,550
Cashreceivedonsale $113,000
Debtrepayment (80,000)
Taxcost (4,550)
Netcashflow $28,450

c. Amountrealizedonsale $82,000
Basisofland (100,000)
Lossrecognizedonsale $(18,000)
Taxrate .35
Taxsavingsfromlossdeduction $6,300
Cashreceivedonsale $82,000
Debtrepayment (80,000)
Taxsavings 6,300
Netcashflow $8,300

d. Amountrealizedonsale(valueofland) $64,000
Basisofland (100,000)
Lossrecognizedonsale $(36,000)
Cancellationofdebtincome 16,000
Netloss $(20,000)

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Taxrate .35
Taxsavingsfromlossdeduction $7,000
Netcashflow(taxsavings) $7,000

e. Amountrealizedonsale(valueofland) $64,000
Basisofland (100,000)
Lossrecognizedonsale $(36,000)
Taxrate .35
Taxsavingsfromlossdeduction $12,600

Cashpaymenttosettledebt $(16,000)
Taxsavings 12,600
Netcashflow $(3,400)

38. Amountrealizedonsale(reliefofnonrecoursedebt) $300,000

Adjustedbasisofrealproperty (195,000)
Gainrecognizedonsurrenderofrealproperty $105,000
Taxrate .25
Taxongain $26,250
Thesurrenderofpropertyresultsin$26,250negativecashflow,whichisFirmRstaxcostofthe
transaction.

39. a. CompanyJcandeducta$39,000ordinarycasualtyloss($450,000insurance
reimbursement$489,000adjustedbasis).
b. CompanyJcandeducta$489,000ordinarycasualtyloss.

40. Balisnetbookincomebeforetax $605,800

Excessofbookovertaxdepreciation 25,600
Bookgainonequipmentsale $(23,000)
Taxgainonequipmentsale 38,000
15,000
Nondeductiblelossonsaletorelatedparty 23,550
ZEJstaxableincome $669,950
The$75,000gainrealizedonthesecuritiessaletoarelatedpartyistaxableanddoesnotcause
abook/taxdifference.

41. St.Georgesnetbookincomebeforetax $711,800

Installmentsalegain(50.12%$62,000) 31,074
Deductionfordisallowedlossofrelatedseller (12,700)
Excessofbookcasualtylossovertaxcasualtyloss 7,600
St.Georgestaxableincome $737,774

42. Ms.Drecognizedthefollowinggainsonthesaleofherbusinessassets.
Amount Adjusted Ordinary Capital
Realized Basis Gain Gain
Inventory $145,000 $125,000 $20,000
Otherbalancesheetassets 63,700 63,700 0
Goodwill/goingconcernvalue 91,300 0 ______ $91,300

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$300,000 $20,000 $91,300

Hernetcashflowiscomputedasfollows.
Salesproceeds $300,000
Taxonordinarygain($20,000 35%) (7,000)
Taxoncapitalgain($91,300 15%) (13,695)
Netcashflow $279,305

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IssueRecognitionProblems

1. DoesDSCompanyplantodisposeofanyotherSection1231assetsataloss?Willthe$85,000
Section1231gainonthesaleoftheofficebuildingbethecompanysnetSection1231gainfor
theyear?

2. Arethe20,000sharesofMXPstockworthlesssothatFirmLDcanrecognizea$160,000capital
loss?Whatfactsandcircumstancesdetermineifsecuritiesareworthless?Doesthebankruptcy
ofacompanycreateapresumptionthatitssecuritiesareworthless?

3. DoesFirmLrecognizeanylossonthedeclineinvalueoftheindustrialequipment?Howdoes
thefirmaccountforthe$10,000insuranceproceeds?

4. CanCompanyLRdeductanyunrecoveredbasisintheleaseholdimprovementsthatwere
destroyed?Doesithaveanordinaryabandonmentlossforanyunrecoveredbasisinthe
leaseholdimprovements?

5. WhatisthecharacterofCorporationMs$12,700realizedgainonthesaleofthenote?

6. Ifacorporatecapitallossandnetoperatinglosscanbecarriedbacktothesametaxableyear,
whichlossisdeductedfirst?

7. Isthebasisofproperty(forpurposesofdetermininggainorlossrealizedonsale)reducedby
actualdepreciationdeductedorthecorrectdepreciationthattheownershouldhavededucted?
CanWDamenditstaxreturnsforthelast12yearstoreflectthecorrectdepreciation
deductions?

8. DoesCorporationADhaveanysubstantiationorindependentevidencethatthevalueofthe
deskonthedateofsaletoMr.Cwasonly$35,000?IsADsmarginaltaxratemoreorlessthan
Mr.Cspreferentialtaxrateoncapitalgains?

9. Doesthe$100,000paymentreceivedbyMr.Vforhispromisenottocompeterepresentordinary
incomeorcapitalgain?Doesthe$100,000paymentrepresentselfemploymentincome?Can
Mr.Vrecognizethe$100,000incomeoverthefouryearperiodofthecovenantnottocompete?

10. CanCorporationTJdeducttheunrecoveredbasisinitsorganizationalcostsandgoodwillonits
finaltaxreturn?CanTJclaimanordinaryabandonmentlossfortheunrecoveredbasisinthe
organizationalcostsandgoodwill?

11. CanFirmGHclaimanordinaryabandonmentlossforits$290,000basisintheLSRstock?
IstheLSRstockconsideredworthless(triggeringa$290,000capitallosstoGH)eventhoughit
isstilltradingonapublicmarket?

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 Chapter 8 - Property Dispositions
ResearchProblems

1. ThiscaseisbasedonthefactsinGeorgeStotis,TCMemo1996431.Inthatcase,theTax
Courtruledthatcashpaidbybuildingownertoatenantinexchangeforthetenantleasehold
rightswasanamountrealizedbythetenantonsaleofthoserights.Theamountrealizedalso
includedthefairrentalvalueofadwellingunitprovidedfreeofchargebythebuildingownerto
thetenant.InRev.Rul.7285,19721CB234,theIRSruledthataleaseholdinrealproperty
usedinatradeorbusinessisaSection1231asset.Consequently,gainrecognizedonsaleof
suchleaseholdrightsisSection1231gain.(SeealsoLtr.Rul.200045019,Nov.13,2000).
AssumingthatGeorgehasazerobasisinhisleaseholdrightsin129Main,hewillrecognize
Section1231gainequaltotheamountrealizedonsaleoftherightstoKramer.Theamount
realizedwillequalthe$50,000cashpaymentplusthe$1,300monthlyfairrentalvalueofthe
newofficespace.Georgewillrecognize$50,000gainonreceiptofthecashand$1,300gain
eachmonthoverthe36monthperiodthatheoccupiesthenewofficespaceonarentfreebasis.

2. GrahamInc.realizeda$302,750gainonsaleoftheland($865,000amountrealized$562,250
basis),anditsgrossprofitpercentagefortheinstallmentsalemethodwas35percent($302,750
$865,000saleprice).Ithasreceived$221,000cashsincethesale($865,000originalnote
principal$644,000currentprincipalbalance)andrecognized$77,350gain(35%$221,000
cashreceived).Grahamsadjustedtaxbasisinthenoteitselfwas$418,600($644,000current
principalbalance$225,400deferredgain).Grahamalsohada$40,800taxbasisinthe
accruedinterestreceivableonthenote.
Reg.Sec.1.10381(a)requiresataxpayerwhorepossessesrealpropertyinsatisfactionof
aninstallmentobligationmustrecognizegainequaltotheexcessofcashreceivedpriortothe
repossessionoverthegainrecognizedundertheinstallmentsalemethod.However,Reg.Sec.
1.10381(c)limitstheamountofgainrecognizedtothetaxpayersoriginalgainrealizedonthe
salelessthegainrecognizedundertheinstallmentsalemethod.Reg.Sec.1.10381(d)specifies
thatthecharacterofthegainisthesameasthecharacteroftheoriginalgainonsale.
Grahamscashreceived $221,000
Gainrecognizedunderinstallmentsalemethod (77,350)
Excesscashovergain $143,650
Gainrealizedonsale $302,750
Gainrecognizedunderinstallmentsalemethod (77,350)
Limitationongainrecognition $225,400
Therefore,Grahammustrecognize$143,650capitalgainonrepossessionoftheland.Reg.
Sec.1.10381(g)(1)providesthatGrahamsbasisinthelandequalstheadjustedtaxbasisofall
indebtednessofthepurchasertothesellerplusanygainrecognizedonrepossession.Thus,
Grahamstaxbasisintherepossessedlandis$603,050($418,600basisofnote+$40,800
basisofinterestreceivable+$143,650gainrecognizedonrepossession).

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 Chapter 8 - Property Dispositions

3. ThiscaseisbasedonthefactsinWilliamT.Gladden,112TC209(1999).Inthiscase,theIRS
arguedthatfederalwaterrightswerenotcapitalassets,andthattheamountrealizedonthe
taxpayerssaleoftherightswasordinaryincome.Thetaxpayerarguedthatthewaterrights
wereacapitalasset,andthatthesaleoftherightsresultedincapitalgain.Thetaxpayeralso
maintainedthatthecostbasisofthelandtowhichtherightsrelatedcouldbeallocatedtothe
rightstooffsettheamountrealizedonsale.TheTaxCourtagreedthatthewaterrightswere
capitalassetsbecausetheydidnotfitwithinanyofthedefinitionalexceptionslistedinSection
1221.However,thecourtheldthatthetaxpayercouldnotallocateanyoftheircostbasisinthe
landtothewaterrights.
ThetaxpayersappealedtheTaxCourtsdecisiononthebasisallocationissuetotheNinth
CircuitinGladdenv.Commissioner,262F.3d851(CA9,2001).Theappellatecourtheldthatif
thetaxpayerspaidanypremiumonpurchaseofthelandbasedonarealisticexpectationthat
waterrightswouldattachtothelandinthefuture,theycouldallocateaportionoftheircostbasis
equaltosuchpremiumtothewaterrights.Therefore,ifBigSkyePartnershipcanprovethat
someportionofits$695,500originalcostofthelandreflectedthevalueoftheexpectationof
futurewaterrights,thepartnershipcanallocatethisamountofbasistothewaterrightsand
computeitscapitalgainonsaleaccordingly.IfBigSkyecannotproveitscase,itmustrecognize
a$175,000capitalgainonthesaleofthewaterrights.

4. Section267(a)(1)disallowsadeductionforalossrealizedonthesaleofpropertybetween
relatedpartiesasdefinedinsubsection(b).Section267(b)(10)specifiesthatacorporationanda
partnershiparerelatedpartiesifthesamepersonsownmorethan50percentofthevalueofthe
corporationsoutstandingstockandmorethan50percentofthecapitalorprofitsofthe
partnership.Section267(c)(2)and(e)(3)providethatanindividualisconsideredtoownany
corporatestockorpartnershipinterestownedbyafamilymember.Finally,Section267(c)(4)
statesthatanindividualsfamilyincludessiblingsandchildren.
ForSection267purposes,AnnOlsenowns1,057shares(hersharesplusherbrothers
shares)of2,000BPLsharesoutstanding.Annalsoownsa57percentcapitalandprofitsinterest
(herinterestplusherdaughtersinterest)inKaierPartnership.Therefore,BPLandKaierare
relatedparties,andBPLcouldnotrecognizeitslossrealizedonthesaleoflandtoKaier.

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 Chapter 8 - Property Dispositions

TaxPlanningCases

1. a. Investment1:
Initial AnnualIncome/ TaxCost NetCash Present
Year Investment CashFlow at35% Flow Valueat6%
0 $(100,000) $(100,000) $(100,000)
1 $12,000 $4,200 7,800 7,355
2 12,000 4,200 7,800 6,942
3 12,000 4,200 7,800 6,552
4 12,000 4,200 7,800 6,178
5 100,000 12,000 4,200 107,800 80,527
NPV $7,554

Investment2:
Initial Gainon TaxCost NetCash Present
Year Investment Sale at35% Flow Valueat6%
0 $(100,000) $(100,000) $(100,000)
5 165,000 $65,000 $22,750 142,250 106,261
NPV $6,261
FirmZshouldmakeInvestment1becauseithasthegreaterNPV.

b. Investment1hasthesame$7,554NPVtothenoncorporatetaxpayer.
Investment2:
Initial Gainon TaxCost NetCash Present
Year Investment Sale at15% Flow Valueat6%
0 $(100,000) $(100,000) $(100,000)
5 165,000 $65,000 $9,750 155,250 115,972
NPV $15,972
Becauseofthepreferentialrateoncapitalgain,Investment2hasagreaterNPVthan
Investment1,andFirmZshouldmakeInvestment2.

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 Chapter 8 - Property Dispositions

2. Mr.RHsdevelopmentoptionwillgenerate$1,318,500aftertaxcashflow.
Salesproceeds(90lotssoldfor$20,000each) $1,800,000
Basis($935,000cost+$275,000improvements) (1,210,000)
Ordinarygainonsaleofinventory $590,000
Taxrate .35
Tax $206,500
Cashproceeds $1,800,000
Costofimprovements (275,000)
Taxcost (206,500)
Aftertaxcashflow $1,318,500

Mr.RHssaleoftheundevelopedlandwillgenerate$1,307,000aftertaxcashflow.
Salesproceeds $1,350,000
Basis (935,000)
Capitalgainonsaleofinvestmentland $415,000
Taxrate .15
Tax $62,250
Cashproceeds $1,350,000
Taxcost (62,250)
Aftertaxcashflow $1,287,750
Therefore,Mr.RHshoulddevelopthelandtomaximizeaftertaxcashflow.

3. CorporationYs2007taxrateis34percent.Assumingcontinuedgrowth,itsfutureincomewill
betaxedataratenolessthan34percent.Bysellingthesecondcapitalassetthisyear,the
corporationwillpayonly$340taxonthe$21,000realizedgain(34%$1,000netcapitalgain)
insteadof$7,140(34%$21,000).Consequently,the$20,000capitallossisworth$6,800.If
CorporationYcarriesthecapitallossback,itstaxrefundwillbeonly$3,240.
Reductionin2004taxableincome $19,000
Marginaltaxrate .15
$2,850
Reductionin2005taxableincome $1,000
Marginaltaxrate .39
390
3,240
Consequently,CorporationYwillmaximizethevalueofthecapitallossbysellingthesecond
capitalassetin2007.

4. IfOlnousestheinstallmentsalemethodtorecognizegain,itcandeduct$14,190ofthecapital
losscarryforwardtoreduceitscurrentyear(year0)capitalgaintozero.TheNPVofthetaxcost
ofthe$127,710deferredgainis$33,786.
Annualtaxcostinyears19($14,19035%) $4,967
Discountfactorfor9periodannuity 6.802
NPVoffuturetaxcosts $33,786

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 Chapter 8 - Property Dispositions
IfOlnoelectsoutoftheinstallmentsalemethodandrecognizestheentire$141,900capitalgain
thisyear,itcandeducttheentire$52,100capitallosscarryforwardtoreduceitstaxablegainto
$89,800.The35percenttaxonthisgainwouldbeonly$31,430.Consequently,Olnoshouldelect
outoftheinstallmentsalemethodtominimizeitstaxcost.

822