Week 4 Assignment

Chapter 8

1. Lento, Inc. owned machinery with a $30,000 initial cost basis. Accumulated book depreciation
with respect to the machinery was $12,000, and accumulated tax depreciation was $19,100.
Lento sold the machinery for $13,000 cash. Lento’s marginal tax rate is 21 percent.

Compute Lento’s book gain or loss on the sale.

$5000 loss

Compute Lento’s tax gain or loss on the sale.

$2100 gain

Compute Lento’s after-tax cash flow from the sale.

$12559

2. Several years ago, PTR purchased business equipment for $50,000. PTR’s accumulated book
depreciation with respect to the equipment is $37,200, and its accumulated tax depreciation is
$41,000.

Compute PTR’s book and tax basis in the equipment.

Book basis=$12800, Tax basis=$9000

Using a 21 percent tax rate, compute PTR’s deferred tax asset or liability (identify which) resulting from
the difference between accumulated book and tax depreciation.

$798 deferred tax liability

Compute PTR’s book and tax gain if it sells the equipment for $14,750.

$1950 book gain, $5750 tax gain

Explain the effect of the sale on the deferred tax asset or liability computed in part (b).

The effect of the sale on the deferred tax asset or liability computed in part (b) would be to
reduce or eliminate the deferred tax liability. As the equipment is sold, the deferred tax liability would
be recognized as a current expense on the income statement. This would reduce the company's net
income for the current period.
3. Firm CS performed consulting services for Company P. The two parties agreed that Company P
would pay for the services by transferring investment securities to Firm CS. At date of transfer,
the securities had a $38,500 FMV. Company P’s tax basis in the securities was $25,000.

How much income must Firm CS recognize on receipt of the securities? What is the character of
this income? What is Firm CS’s tax basis in the securities?
$13500 Income. Ordinary income. $38500
How much income must Company P recognize on disposition of the securities? What is the
character of the income?
Company P must recognize $13,500 of income on disposition of the securities. The
character of the income is ordinary income.
Does disposition of the securities result in a deduction for Company P? If so, what is the amount
of the deduction?
Disposition of the securities does not result in a deduction for Company P. The gain of
$13,500 is already included in the income reported by the company. However, if the
securities would have been sold for a loss, then it would be a deductible loss. The
amount of the deduction would be the difference between the basis and the selling
price of the securities.

4. Company L sold an inventory item to Firm M for $40,000. Company L’s marginal tax rate is 21
percent. In each of the following cases, compute Company L’s after-tax cash flow from the sale:

Firm M’s payment consisted of $10,000 cash and its note for $30,000. The note is payable two
years from the date of sale. Company L’s basis in the inventory item was $15,700.
$4897 now, $30000 after 2 years
Firm M’s payment consisted of $5,000 cash and its note for $35,000. The note is payable two
years from the date of sale. Company L’s basis in the inventory item was $47,000.
$5000 now, $30000 after two years
Firm M’s payment consisted of $40,000 cash. Company L’s basis in the inventory item was
$18,000.
$35380 now
Firm M’s payment consisted of $40,000 cash. Company L’s basis in the inventory item was
$44,000.
$40000 now

5. KNB sold real property to Firm P for $15,000 cash and Firm P’s assumption of the $85,000
mortgage on the property.

What is KNB’s amount realized on the sale?

$100,000
Compute KNB’s after-tax cash flow from the sale if its adjusted basis in the real property is
$40,000 and its marginal tax rate is 35 percent.
$6000 outflow
6. Firm UT sold realty to an unrelated buyer for $40,000 cash plus the buyer’s assumption of a
$166,700 mortgage on the property. UT’s initial cost basis in the realty was $235,000, and
accumulated tax depreciation through date of sale was $184,200.

Compute UT’s gain recognized on the sale.

$155900
Assuming a 21 percent marginal tax rate, compute UT’s after-tax cash flow from the sale.
$7261

7. TPW, a calendar year taxpayer, sold land with a $535,000 tax basis for $750,000 in February. The
purchaser paid $75,000 cash at closing and gave TPW an interest-bearing note for the $675,000
remaining price. In August, TPW received a $55,950 payment from the purchaser consisting of a
$33,750 principal payment and a $22,200 interest payment.

Compute gain realized on the sale.

$215000
Compute gain recognized in the year of sale if TPW elects not to use the installment sale method
of accounting. Compute TPW’s tax basis in the note at the end of the year.
If TPW elects not to use the installment sale method of accounting, the entire gain will
be recognized in the year of sale. The tax basis in the note at the end of the year would
be zero.

Compute gain recognized in the year of sale if TPW uses the installment sale method of
accounting. Compute TPW’s tax basis in the note at the end of the year.
If TPW uses the installment sale method of accounting, the gain recognized in the year
of sale would be calculated as follows:
Gross profit percentage = ($750,000 - $535,000) / $750,000 = 29.33%
Gain recognized in the year of sale = Gross profit percentage x cash received ($75,000) =
$22,000

8. Refer to the facts in the preceding problem and assume that TPW uses the installment sale
method of accounting.

Compute the difference between TPW’s book and tax income resulting from the installment sale
method.

$193000

Is this difference favorable or unfavorable?

This difference is favorable for TPW, as it is able to defer a significant portion of the gain
recognized in the year of sale to future periods, which reduces its current tax liability.

Using a 21 percent tax rate, compute PTR’s deferred tax asset or liability (identify which) resulting
from the book/tax difference.
 $40530 deferred tax liability

9. Refer to the facts in problem 7. In the first year after the year of sale, TPW received payments
totaling $106,900 from the purchaser. The total consisted of $67,500 principal payments and
$39,400 interest payments.

Compute TPW’s gain recognized under the installment sale method.

$31354

Compute TPW’s tax basis in the note at the end of the year.

$621646

10. Compute the difference between TPW’s book and tax income resulting from the installment sale
method.

Is this difference favorable or unfavorable?

This difference is favorable for TPW, as it is able to defer a significant portion of the gain
recognized in the year of sale to future periods, which reduces its current tax liability.

Using a 21 percent tax rate, determine the effect of the difference on the deferred tax asset or
liability generated in the year of sale.

The effect of this difference on the deferred tax asset or liability generated in the year of sale
depends on whether the tax rate remains constant or not. If the tax rate remains constant at
21%, the difference will reduce the deferred tax asset or liability generated in the year of sale.
As the gain recognized in future periods is lower than the gain realized, the company will have
to pay less in taxes in the future.

Tax planning case 1

Firm Z, a corporation with a 21 percent tax rate, has $100,000 to invest in year 0 and two
investment choices. Investment 1 will generate $12,000 taxable cash flow annually for years 1
through 5. In year 5, the firm can sell the investment for $100,000. Investment 2 will not
generate any taxable income or cash flow in years 1 through 5, but in year 5, the firm can sell
Investment 2 for $165,000.

Assuming a 6 percent discount rate, which investment has the greater NPV?

Investment 1 NPV=$17326 - has greater NPV

Investment 2 NPV=$13104

Would your answer change if Firm Z were a noncorporate taxpayer with a 35 percent tax rate
and the gain on sale of Investment 2 were eligible for the 15 percent capital gains rate?
 Investment 1 NPV=$7587

Investment 2 NPV=$16018 – has greater NPV

Chapter 9

1. Company Z exchanged an asset (FMV $16,000) for a new asset (FMV $16,000). Company Z’s tax
basis in the old asset was $9,300.

Compute Company Z’s realized gain, recognized gain, and tax basis in the new asset assuming the
exchange was a taxable transaction.

Realized gain $6700, Recognized gain $6700, tax basis of new asset $16000.

Compute Company Z’s realized gain, recognized gain, and tax basis in the new asset, assuming the
exchange was a nontaxable transaction.

Realized and recognized gain $0, Tax basis of the new asset $9300

Six months after the exchange, Company Z sold the new asset for $16,850 cash. How much gain does
Company Z recognize if the exchange was taxable? How much gain if the exchange was nontaxable?

Gain $850 if taxable.

Gain $7550 if not taxable.

2. Business K exchanged an old asset (FMV $95,000) for a new asset (FMV $95,000). Business K’s
tax basis in the old asset was $107,000.

Compute Business K’s realized loss, recognized loss, and tax basis in the new asset assuming the
exchange was a taxable transaction.

Realized and recognized loss= $12000, tax basis of the new asset $95000

Compute Business K’s realized loss, recognized loss, and tax basis in the new asset, assuming the
exchange was a nontaxable transaction.

Realized and recognized loss $0, tax basis of the new asset $107000

Six months after the exchange, Business K sold the new asset for $100,000 cash. How much gain or loss
does Business K recognize if the exchange was taxable? How much gain or loss if the exchange was
nontaxable?

$5000 gain -if taxable

$7000 loss – if not taxable

 3. Rufus, Inc. and Hardy Company are negotiating a nontaxable exchange of business properties.
Rufus’s property has a $50,000 tax basis and a $77,500 FMV. Hardy’s property has a $60,000 tax
basis and a $90,000 FMV.

Which party to the exchange must pay boot to make the exchange work? How much boot must be paid?

Rufu should pay boot of $12500.

Assuming the boot payment is made, how much gain or loss will Rufus realize and recognize on the
exchange, and what tax basis will Rufus take in the property acquired?

Gain $0, Tax basis $62500

Assuming the boot payment is made, how much gain or loss will Hardy realize and recognize on the
exchange and what tax basis will Hardy take in the property acquired?

Gain $0, tax basis $47500

4. Firm A exchanged an old asset with a $20,000 tax basis for a new asset with a $32,000 FMV.
Under each of the following assumptions, apply the generic rules to compute A’s realized gain,
recognized gain, and tax basis in the new asset.

Old asset and new asset are not qualified property for nontaxable exchange purposes.

Realized gain - $12000

Recognized gain -$12000

Tax basis - $32000

Old asset and new asset are qualified property for nontaxable exchange purposes.

Realized gain - $12000

Recognized gain -$0

Tax basis - $20000

Old asset and new asset are not qualified property for nontaxable exchange purposes. To equalize the
values exchanged, Firm A paid $1,700 cash to the other party.

Realized gain - $10300

Recognized gain -$10300

Tax basis - $21700

Old asset and new asset are qualified property for nontaxable exchange purposes. To equalize the
values exchanged, Firm A paid $1,700 cash to the other party.

Realized gain - $1700

Recognized gain -$1700

Tax basis - $20000

Old asset and new asset are not qualified property for nontaxable exchange purposes. To equalize the
values exchanged, Firm A received $4,500 cash from the other party.

Realized gain - $16500

Recognized gain -$16500

Tax basis - $15500

Old asset and new asset are qualified property for nontaxable exchange purposes. To equalize the
values exchanged, Firm A received $4,500 cash from the other party.

Realized gain - $4500

Recognized gain -$4500

Tax basis - $20000

5. Firm Q exchanged old property with an $80,000 tax basis for new property with a $65,000 FMV.
Under each of the following assumptions, apply the generic rules to compute Q’s realized loss,
recognized loss, and tax basis in the new property.

Old property and new property are not qualified property for nontaxable exchange purposes.

Realized loss - $15000

Recognized loss -$15000

Tax basis - $65000

Old property and new property are qualified property for nontaxable exchange purposes.

Realized loss - $15000

 Recognized loss -$0

Tax basis - $80000

Old property and new property are not qualified property for nontaxable exchange purposes. To
equalize the values exchanged, Firm Q paid $2,000 cash to the other party.

Realized loss - $17000

Recognized loss -$17000

Tax basis - $65000

Old property and new property are qualified property for nontaxable exchange purposes. To equalize
the values exchanged, Firm Q paid $2,000 cash to the other party.

Realized loss - $2000

Recognized loss -$0

Tax basis - $80000

Old property and new property are not qualified property for nontaxable exchange purposes. To
equalize the values exchanged, Firm Q received $8,000 cash from the other party.

Realized loss - $7000

Recognized loss -$7000

Tax basis - $65000

Old property and new property are qualified property for nontaxable exchange purposes. To equalize
the values exchanged, Firm Q received $8,000 cash from the other party.

Realized loss - $8000

Recognized loss -$0

Tax basis - $80000

6. Firm M exchanged an old asset with a $9,100 tax basis and a $21,000 FMV for a new asset worth
$18,500 and $2,500 cash.
If the exchange is nontaxable, compute Firm M’s realized and recognized gain and tax basis in the new
asset.

Realized gain $11900

Recognized gain -$0

Tax basis - $9100

How would your answers change if the new asset were worth only $7,000, and Firm M received $14,000
cash in the exchange?

Realized gain $11900

Recognized gain -$0

Tax basis - $7000

7. This year, Neil, Inc. exchanged a business asset for an investment asset. Both assets had a
$932,000 appraised FMV. Neil’s book basis in the business asset was $604,600, and its tax basis
was $573,000.

Compute Neil’s book gain and tax gain assuming the exchange was a taxable transaction.

Book gain =$327400, Tax gain = 359000

Determine Neil’s book and tax basis of the investment asset acquired in the taxable exchange.

Book and tax basis = $932000

Compute Neil’s book gain and tax gain assuming the exchange was a nontaxable transaction.

Book gain =$327400 and Tax gain =$0

Determine Neil’s book and tax basis of the investment asset acquired in the nontaxable exchange.

Book basis= $604600, Tax basis=573000

8. Refer to the facts in the preceding problem. Three years after the exchange, Neil sold the
investment asset for $1 million cash.

Compute Neil’s book gain and tax gain on sale assuming Neil acquired the investment asset in a taxable
exchange.

Book gain = $68000, tax gain = $68000

Compute Neil’s book gain and tax gain on sale assuming Neil acquired the investment asset in a
nontaxable exchange.

Book gain = $395400, tax gain = $427000

9. CC Company exchanged a depreciable asset with a $17,000 initial cost and a $10,000 adjusted
basis for a new asset priced at $16,000.

Assuming that the assets do not qualify as like-kind property, compute the amount and character of CC’s
recognized gain and its basis in the new asset.

Gain $6000, basis $16000

Assuming that the assets qualify as like-kind property, compute the amount and character of CC’s
recognized gain and its basis in the new asset.

Gain 0, basis $10000

10. XYZ exchanged an old building for a new like-kind building. XYZ’s adjusted basis in the old
building was $13,000 ($30,000 initial cost − $17,000 accumulated depreciation), and its FMV was
$20,000. Because the new building was worth $28,500, XYZ paid $8,500 cash in addition to the
old building.

Compute XYZ’s realized gain, and determine the amount and character of any recognized gain.

Realized gain 7000, recognized gain $0, The realized gain would be deferred and be recognized
when the new building is sold.

Compute XYZ’s basis in its new building.

$13000

Tax Planning case 1

Firm NS owns 90 percent of Corporation T’s outstanding stock. NS also owns business realty that T needs
for use in its business. The FMV of the realty is $4 million, and NS’s adjusted basis is $5.6 million. Both
NS and T are in the 21 percent tax bracket. Discuss the tax implications of each of the following courses
of action, and decide which course you would recommend to NS.

NS could exchange the realty for newly issued shares of T stock worth $4 million.

If NS exchanges the realty for newly issued shares of T stock worth $4 million, it would have a
$1.6 million recognized loss on the exchange. However, since NS owns 90 percent of T's stock, it
 would be considered a related party transaction and the loss would be disallowed. Additionally,
since T is a corporation, it would not be able to use the loss to offset its own income and NS
would not receive any tax benefit.

NS could sell the realty to T for $4 million cash.

If NS sells the realty to T for $4 million cash, it would have a $1.6 million recognized loss on the
sale. However, since T is a corporation, it would not be able to use the loss to offset its own
income and NS would not receive any tax benefit.

NS could lease the realty to T for its annual fair rental value of $600,000.

If NS leases the realty to T for its annual fair rental value of $600,000, it would have an ordinary
income of $600,000 each year. The lease payments would be considered rental income and be
taxed at NS's 21 percent tax bracket. Additionally, T could deduct the rental payments as a
business expense, which would reduce its own taxable income. This would be the most tax
efficient option for NS as it would receive rental income and T would be able to deduct the
rental payments as a business expense.