1. Julia currently is considering the purchase of some land to be held as an investment. She and the seller have agreed on a contract under which Julia would pay $1,000 per month for 60 months, or $60,000 total. The seller, not in the real estate business, acquired the land several years ago by paying $10,000 in cash. Two alternative interpretations of this transaction are (1) a price of $51,726 with 6 percent interest and (2) a price of $39,380 with 18 percent interest. Which interpretation would you expect each party to prefer? Why?
2. Assume that a taxpayer can choose when he is to receive $10,000 of fully taxable income. If the taxpayer receives the income at the end of Year 1, he will receive exactly $10,000. If he delays receipt of the income until the end of Year 2, the amount will grow to $11,000. If the taxpayer takes the money at the end of Year 1, he can invest the proceeds and earn a pre- tax return of 10 percent over the next year.
a. If the taxpayer faces a marginal tax rate of 31 percent in both Year 1 and Year 2, when should he elect to receive the income?
b. At what pre- tax rate of return, will the taxpayer be indifferent to taking the money in Year 1 and Year 2?
c. If the taxpayer's marginal tax rate increases to 35 percent in Year 2, when should he elect to receive the income?
d. What would the tax rate need to be in Year 2 to make the taxpayer indifferent?