Question

58. [LO 4] {Planning} On January 1 of year 1, Nick and Rachel Sutton purchased a parcel of undeveloped land as an investment. The purchase price of the land was $150,000. They paid for the property by making a down payment of $50,000 and borrowing $100,000 from the bank at an interest rate of 6 percent per year. At the end of the first year, the Suttons paid $6,000 of interest to the bank. During year 1, the Suttons only source of income was salary. On December 31 of year 2, the Suttons paid $6,000 of interest to the bank and sold the land for $210,000. They used $100,000 of the sale proceeds to pay off the $100,000 loan. The Suttons taxable income in year 2 before considering the land sale and interest expense is $300,000.

Required: Should the Suttons treat the capital gain from the land sale as investment income in year 2 in order to minimize their year 2 tax bill? How much does this cost or save them in year 2? Answer the following (use the 2017 tax rate schedules):

a. What effect, if any, did the interest expense have on their year 1 taxes?

b.How much is the gain on the sale of the land?

c. How much income tax would they pay in year 2 if they treated all of the gain as a capital gain? (ignore any possible net investment income tax (NIIT))

d. How much income tax would they pay if they treated some of the gain as investment income? For this alternative, how much should they treat as investment income? (ignore any possible net investment income tax (NIIT))

e. Which alternative is the best and how much tax does it save?

Please Help!! Thank you so much!!

Answer 1

1)-IN THE YEAR1 THE INTEREST EXPENSES PAID WILL BE DEDUCTED FROM THE GROSS TAXABLE INCOME OF THE SUTTONS AND THE NET AMOUNT WILL BE CHARGEABLE TO TAX.

2)-GAIN ON SALE OF LAND-210000-150000=60000$

3)-SINCE TAX RATE IS NOT GIVEN SO CANT SAY THE EXACT TAX AMOUNT BUT SINCE LAND HAS BEEN SOLD WITHIN A YEAR, IT WILL FALL INTO SHORT TERM CAPITAL GAIN TAX BRACKETS.

4)- IT DEPENDS ON PROPORTIONATE SHARE OF AMOUNT TO BE INVESTED. THE AMOUNT INVESTED OUT OF THE SALE PROCEEDS WILL BE CONSIDERED FOR CAPITAL GAIN TAX EXEMPTION.SO IT IS ADVISABLE TO INVEST THE WHOLE AMOUNT OF 210000 AND GET THE FULL EXEMPTION FROM CAPITAL GAIN TAX.

5)-THE BEST ALTERNATIVE WOULD BE TO INVEST THE SALE PROCEEDS IN LAND OR RESIDENTIAL HOUSE PROPERTY OR IN A SOME GOVERNMENT BOND AND GET THE FULL EXEMPTION FROM CAPITAL GAIN TAX.