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.
Beyond taking out the loans to purchase the property, 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).
In the first year of operations, the results for J.P. are as follows:
Rental Income: $200,000
Interest Expense: $50,000
Operating Expense: $486,000
Depreciation Expense: $50,000
Net Loss ($386,000)
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) List the primary authorities relied upon in answering parts b-d below:
c) 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.
d) 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.?Question 2
ESSAY ONLY: The annual accounting concept is a key Federal income tax concept. Please explain the annual accounting concept and discuss two (2) areas in which tax law departs from strict adherence to the annual accounting concept. Include supporting citations as you write your response.
OilCo is a corporation that files its federal income tax return on a calendar year basis using the accrual method of accounting.During the year, OilCo entered leases with the federal government to use offshore wells for oil production. The leases provide that OilCo must remove any physical assets that it constructs to run its business should it abandon the wells or upon lease termination. Although the lease itself does not state when it will terminate, the lease may be terminated upon one years notice by either party. Typically, parties maintain these types of lease arrangements for twenty years.OilCo installed platforms and fixtures this year and in its federal income tax return for the year deducted the estimated cost of removing them. OilCo will perform all services incidental to removing the assets.Assume that the costs at issue are fully deductible (the question is not whether they are deductible, but when). Also, assume that the estimated removal cost is a good approximation of the actual costs.(a) List the primary authorities (Code, Regulations, cases, rulings, and procedures only) relied upon in answering parts b & c below:(b) When may OilCo deduct the costs related to the fixtures?(c) Assume that OilCo will pay another person to remove the physical assets when the time comes. How does this change your answer to a (if at all)?
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