Question 1: On January 1 of this year, J.P., a wealthy investment banker, purchased an office building and underlying land (the property) for $500,000, borrowing the entire purchase price from the Last Texas Savings and Loan in two $250,000 mortgages. Both mortgages are nonrecourse and secured only by the property itself. One of the mortgages qualifies as "qualified nonrecourse financing." J.P. is a calendar year taxpayer.
J.P. did not invest any of his own money and did not devote any of his time to managing the office building (he hired a management company).
During this year, the results for J.P.'s building are as follows:
Rental income $200,000
Interest paid $50,000
Operating expenses $486,000
Depreciation $14,000
In addition to the interest paid during the year, J.P. made a $20,000 principal payment on each note (total of $40,000 principal paid). J.P. has $800,000 of salary income from his investment banking job and $80,000 of dividend income from the portfolio investments. J.P.'s depreciation was not accelerated or otherwise subject to any recapture rules.
(a) To what extent may J.P. deduct his net loss from the office building? Provide explanations as to each type of loss limitation (and whether or not they apply).
(b) In Year 2, the property generated $10,000 of net income. J.P. also earned $300,000 of salary income during the year. No principal was paid during the year. Depreciation for the year (included in the net income amount) was $14,000. Analyze the tax treatment of the property income to J.P.
(c) At the beginning of Year 3, when the property was worth $460,000 - exactly equal to the amount of outstanding mortgages - J.P. sold the property. The buyer took the property subject to the mortgages and paid no other consideration. What are the tax consequences of this sale to J.P.?