Question I: Sam Seller owns raw land he holds for investment located near Fresno, California. Sam has owned the land for 3 years.
Relevant information regarding the property is as follows:
Land:
Fair Market Value: $5 MM
Adjusted Basis: $3 MM
Debt: None.
Assume Sam sells the land for its fair market value to Bonnie Buyer in an all cash sale.
i. Determine Sam's realized and recognized gain or loss and the character of such gain or loss that applies to any recognized gain or loss. Indicate authority for your views.
ii. Determine Bonnie's basis in the property. Indicate authority for your views.
Question II: Assume the same facts as stated in question 1. However, assume that instead of selling the land in an all-cash sale, on January 1, 20x1 Sam sold the building to Bonnie for $5 MM sales price pursuant to the following terms:
i. $1 MM cash payment to Sam; and
ii. $4 MM nonrecourse note payable by Bonnie to Sam as follows:
• interest rate--accrued and payable at lesser of (i) 3% compounded semi-annually or (ii) the applicable federal rate.
• principal payments due on January 1 of each year, as follows:
--January 1, 20x2: $1 MM
--January 1, 20x3: $2 MM
--January 1, 20x4: $1 MM.
Discuss the tax consequences to Sam as regards the following matters:
i. Amount Realized in year of sale;
ii. Gain Realized in year of sale;
iii. Gain Recognized in year of sale and subsequent years through tax year 20x4; and
iv. Character of gain.
Question III: Assume the same facts presented in question II. What is Bonnie's basis in the property? Discuss.
Question IV: How would your answer to question III change if the $4 MM loan payable from Bonnie to Sam is recourse? Discuss.
Question V: Assume the same facts as initially presented as regards the $4 MM nonrecourse loan. However, instead of a fixed $4 MM principal loan amount, assume the loan is as follows:
i. interest rate--the same as initially described above.
ii. principal payments due on January 1 of each year, as follows:
--January 1, 20x2: $1 MM
--January 1, 20x3: $2 MM
--January 1, 20x4: $1 MM, but only if an appraisal by an agreed upon appraiser issues an opinion that the land is worth at least $5 MM as of December 1, 20x3. If the appraisal indicates the land is worth less than $5 MM on December 1, 20x3, then the remaining $1 MM principal otherwise due on January 1, 20x4 is reduced dollar for dollar up to a $500,000 reduction in principal amount due and payable on 1/1/x4.
In light of these facts, discuss the tax consequences to Sam and Bonnie at the time Sam sold and Bonnie bought the land.
Question VI: Assume that it is 1/2/20x4 and Bonnie has fully paid Sam all amounts due on the $4 MM note. However, Bonnie is now experiencing a significant cash-flow problem and is forced to borrow $3 MM on a nonrecourse basis from XYZ Bank.
Pursuant to the loan agreement, the note bears interest at the applicable federal rate and only interest payments are due on the loan for 10 years, at which time the $3 MM debt is required to be paid off.
Because the bank demanded collateral, Bonnie granted the bank a deed of trust on the land.
After the loan funding Bonnie promptly used $2 MM to pay off other debts. She used the rest of the money to construct improvements on the land at a cost of $1 MM.
Describe the tax consequences of the transaction to Bonnie.
Question VII: Unfortunately for Bonnie, real estate market values plummeted and the land declined in value to a FMV of $2 MM at a point in time when the outstanding balance of the nonrecourse loan remained at $3 MM. Considering her options, Bonnie decided to default on the loan and XYZ Bank promptly foreclosed on the property.
Discuss the tax consequences to Bonnie as a consequence of the foreclosure.