Federal Tax Law
On January 3, 2009, Kathy and Frank Willow got married and entered into a contract with Hive Construction Corporation to build a house for $3,000,000 to be used as their main home. Kathy and Frank made a $400,000 down payment and took out a $2,600,000 mortgage to finance the remaining cost of the house with Outside Lender. Kathy and Frank are personally liable for the mortgage loan, which is secured by the home.
On November 10, 2010, when the outstanding principal balance on the mortgage loan was $2,500,000, the FMV of the property fell to $1,750,000 and Kathy and Frank abandoned the property by permanently moving out. They had made interest payments of $130,000 in 2009 and 2010 and paid $50,000 of principal in each year of those years (2009 and 2010) to bring the mortgage balance from $2,600,000 to $2,500,000 just before the date of abandonment. The lender foreclosed on the property and, on December 5, 2010, sold the property to another buyer for $1,750,000. More than one year after the foreclosure, and after heated negotiations, the couple convinced Outside Lender to cancel the remaining debt. So, on December 26, 2011, the lender canceled the remaining debt owing. Kathy and Frank are filing a joint return for 2011.
On December 26 2011, Kathy and Frank had $15,000 in a savings account, household furnishings with an FMV of $17,000, a car with an FMV of $10,000, and $18,000 in credit card debt. The household furnishings originally cost $30,000. The car had been fully paid off (so there was no related outstanding debt) and was originally purchased for $16,000. Kathy and Frank had no adjustments to the cost basis of the car. Kathy and Frank had no other assets. There was alsoa $20,000 potential liability over a house warranty with Hive Construction Corporation (the “Disputed Amount”). However, the Willow’s lawyer opined in a letter that there is only a 10% chance that the Kathy and Frank would have to pay the Disputed Amount.
At the beginning of 2012, Kathy and Frank had $9,000 in their savings account and $15,000 in credit card debt. Kathy and Frank also owned the same car at that time (still with an FMV of $10,000 and basis of $16,000) and the same household furnishings (still with an FMV of $17,000 and a basis of $30,000). Kathy and Frank had no other assets or liabilities at that time, except for the Disputed Amount that remains in dispute.
(a) What are the tax consequences to Kathy and Frank, if any, for each year?
(b) Same as (a) except Hive Construction Corporation financed the purchase of the house for Kathy and Frank and Hive Corporation agreed to reduce the debt to 1,750,000 on December 26 2011 and Kathy and Frank continue to live in the houseand there was no foreclosure in 2010?
(c) Same as (a) except the loan from Outside Lender is nonrecourse?
John and Martha own two pieces of investment property as equal joint tenants. Blackacre has a $90,000 basis and $100,000 FMV, and Greenacre has a $110,000 basis and a $100,000 FMV. They decide to divorce. What tax consequences result under the following scenarios?
(a) They sell the two pieces of property to third parties, split the cash equally, and divorce.
(b) Martha takes Blackacre, John takes Greenacre, they divorce, and they sell both properties to third parties.
(c) Change the facts so that John is the sole owner of both properties, and he transfers Greenacre to Martha as part of the divorce settlement. Should John sell Greenacre instead and transfer the $100,000 in cash to Martha (say, in 5 equal installments)? Would it make a difference if Greenacre’s basis were $20,000? Assume John is in the 35% tax bracket and Martha is in the 28% percent tax bracket.
Assume that Patrick, an unmarried individual who has gross income of $100,000 from his law practice operated as a sole proprietorship, incurs the following items in 2012. These items and the gross income from his law practice are his only income and deductions for the year. What are the tax consequences for each of the items and the net gains or losses for the 2012 tax year?
1. Sale of office equipment for $25,000 he purchased 2 years ago for $30,000 for which he deducted $8,000 of depreciation;
2. Sale of rental real property held for 3 years and actively managed by him with a sales price of $110,000, original cost of $100,000 with straight line depreciation taken of $9,000;
3. A $7,000 loss from a loan to his law school classmate;
4. Loss on sale of land used as additional parking for his law practice purchased 5years ago for $7,000 plus improvements to make it a parking lot of $5,000. The improved land was sold for $7,000;
5. Stock he purchased 4 months ago sold at $10,000 and purchased at $7,000;
6. Bearer bondshe held were stolen. They were purchased for $3,000 but he received $5,000 from the insurance company;
7. Patrick was a famous athlete before law school and still receives annual fee from Grain Mills for having his likeness on certain products for endorsing certain Grain Mills products. However, after several years Grain Mills decides to cancel the contract with Patrick but Gran Mills realizes that there is no clause allowing for the cancellation. They decide to pay him $500,000 and Patrick releases all of his rights under the contract; and
8. Patrickpurchased an office building for investment on 6/13/2011. He purchased it for $100,000 from Sam Seller. The land was worthless at the time of the purchase. He paid $10,000 cash and gave Sam a note back for $90,000 and secured by a mortgage on the property. Patrick holds the property for some months, pays the 8% interest but no principal on the debt. Patrick finds a defect with the building and now the building is only worth $70,000. When Patrick is plenty wealthy, he convinces Sam Sellerto reduce the note to $60,000 on 2/14/2012. The next day, 2/15/2012, he sells the noteto an investment partnership that he is a 15% partner for $95,000. The partnership will pay him the purchase price in two (2) equal installments of $47,500 in 2012 and 2013.
On his 65th birthday, George purchased a single premium contract for $100,000. The contract provides for 15 annual payments of $12,000 to George, commencing on the first anniversary of the purchase.
(a) What is the tax result to George in each year of the contract?
(b) What is the tax result if George dies the day before his 75th anniversary?
Federal Tax Law