Assignment - Transactions
In answering the questions, please make sure you have identified the issue, explained the relevant tax code and/or regulations, explained any elements of the law that are necessary, and how the circumstances of the hypothetical given to you either meet or do not meet the elements of that tax law.
Question 1 - Bill pledged 200 shares of FoxCo stock with a basis of $1,000 and a value of $2,500,000 as security for the following: (1) a $2,000,000 loan by KraftBank to BelCo, a corporation in which Bill's son, Steve, was the sole shareholder; and (2) as security for KraftBank's $500,000 loaned to Steve for his contribution to capital of BelCo.
Also, Steve made a guaranty of a $2,000,000 loan by KraftBank to BelCo for a development project known as "Colonials," which is secured by a mortgage on BelCo's development project.
Bill did not guarantee the loan to BelCo, nor did he join in or otherwise guarantee Steve's guarantee. Bill's role was providing the shares as collateral for the above mentioned items only.
Prior to the transaction for which Bill provided collateral, BelCo and Steve had successfully developed a number of projects. Unfortunately, the Colonials Project was not successful. KraftBank forecloses on the Colonial developments and, when it became clear that the bank would not realize more than $1 million on the foreclosure sale of the Colonials, KraftBank also forecloses on the FoxCo stock, which was then worth only $1,000,000, for a total realization of $2,000,000.
Notwithstanding the unpaid balance of $500,000 on Steve's guarantee, KraftBank releases Steve from personal liability, in part because Bill was still wealthy and a good customer of the bank.
Based on the above circumstances, answer the following questions:
a) What are the tax consequences to Bill and Steve after all the foreclosure sales and the liability releases? Fully explain each individual's income recognition and realizations.
b) What is the tax consequences to KraftBank after the foreclosures and releases?
Question 2 - On January 1 of Year 1, Tom individually acquires a food-packaging machine for $1 million, paying $100,000 cash and a $900,000 nonrecourse loan from a third party lender that is secured by the machine. Interest on this loan is at 10% compounded annually. The loan is payable over a 10-year period with annual principal and interest payments of $146,471 per year payable on December 31 of each year.
Upon acquisition, Tom immediately leases the food-packaging machine to Jules Corporation for a term of 10 years with an annual rent of $160,000 payable on December 31 of each year. The lessee will be responsible for all costs of maintaining and insuring the machine.
The food-packaging machine is a five-year property under section 168, but Tom will take no accelerated or bonus deductions under sections 168(k) or 179. Assume for the years in question Tom's effective tax rate is 35%.
Based on these circumstances, answer the following questions:
a) Applying the at-risk rules, what will happen if Tom retains the property through year 10?
b) Does you answer change if the loan was a recourse rather than a nonrecourse loan? How and why?
c) What if, instead of the acquisition of this machine by an individual it was made by a Tom's corporation: Twelve, Inc.?
d) Going back to Tom acquiring the machine individually, what would happen if, at the beginning of Year 7, Jules Corporation goes bankrupt, Tom defaults on the loan, and the mortgagee forecloses on the property?
Question 3 - On January 1, Year 1, Rob invested in a fitness club. He put in $700,000 of his own money and obtained a nonrecourse mortgage from KraftBank for $2.8 million. This loan was secured by the land, building, and equipment purchased for the business. The loan requires interest payments of 8% each year, with principal payable at the end of 15 years. At the time of acquisition, the fair market value of the building was $2.5 million, the land was $500,000 and the equipment was $500,000. Rob hired someone to manage the fitness club and make the appropriate day-to-day decisions for the company, and checked in with this person from time to time to make sure the company was operating smoothly.
In Year 1, the overall income and expenses were as follows:
Fitness Revenue: $520,000
Interest Expense: $224,000
Manager's Salary: $80,450
Taxes: $175,000
Insurance: $26,000
Depreciation: $104,550
Total Expenses $610,000
Based on the above circumstances, answer the following questions:
a) Will Rob be limited in the amount of deductions he can take in Year 1? Explain your answer fully as to why or why not.
b) What would be the deductions Rob could take if Rob also has several investments in real estate (also with someone else managing these properties) and in Year 1 he has the following net income or loss from each of the real estate investments:
Fox Properties: Net loss of ($90,000)
Buffalo Properties: Nest loss of ($60,000)
Wildcat Properties: Net gain of $50,000
(Assume for the above rental properties Rob does not have any carryover losses and he is has no amount at risk in these properties.) Make sure in explaining your answer you address the order in which any deductions can be taken.
c) In Year 11, Rob decides to sell his investment in the fitness club he purchased in Year 1. At the time of sale, Rob's basis in the property (building, land and equipment) is $2,413,700; and has suspended losses attributable to the investment of $300,000. Rob sells his total interest in the fitness club to an unrelated party for $4 million. What is his tax circumstances at the time of sale? d) What if, instead of selling to a third party, Rob gave his interest in the fitness club to his younger brother?