Question

For the past 20 years, Ginny has operated her tailoring and alterations business out of a 700-square-foot, commercial office building, at 4000 Central. Last year, Ginny signed a five-year lease with Kelly Real Estate Management, the owner of the building. This year, Kelly decided to convert the building into lofts and is negotiating with all its tenants to surrender their leasehold rights and vacate their space in the building. Kelly has offered Ginny a $60,000 cash payment and the use of a 1,000-square-foot office and workshop in a new location. If Ginny accepts Kelly’s offer, she can use the new office and workshop rent free for 36 months. The fair rental value of this new location is $1,000 per month.

Required:

1. Calculate the amount that Ginny will realize based on the facts given.
2. Describe the tax consequences of this asset disposition. Identify the type of asset and provide an overview.
3. Identify the character of any income/gain.
4. Based on the character of income, discuss the various taxes that may apply.
5. Differentiate between ordinary income and preferential rates and the significance of each.

Answer 1

Amount of money that Ginny will realise:

Cash consideration + fair value of free rentals

$60,000 + $1000*36

= $96,000

Leasehold assets are shown as own assets in the balance sheet and the amount owed for lease rents is shown as liabilities, Hence it'll be shown as Building worth the present value of future lease rentals. Since building is a fixed asset (capital asset) capital gains taxes will accrue on its disposition.

Capital Gains Tax will be payable further the amount of free rentals will be taxed as income from other sources.