Question;27. LO.4 Kay, who is not a dealer, sold an apartment house to Polly during 2013. The closing statement for the sale is as follows:Total selling price $ 190,000Add: Polly?s share of property taxes (6 months) paid by Kay 3,000Less: Kay?s 8% mortgage assumed by Polly $55,000Polly?s refundable binder (?earnest money?) paid in 2013 1,000Polly?s 8% installment note given to Kay 99,000Kay?s real estate commissions and attorney?s fees 8,000 (163,000)Cash paid to Kay at closing $ 30,000Cash due from Polly = $30,000 + $8,000 expenses $ 38,000During 2013, Kay collected $9,000 in principal on the installment note and $2,000 in interest.Her basis in the property was $110,000 [$125,000? $15,000 (depreciation)]. TheFederal rate is 6%.a. Compute the following:1.Total gain.2.Contract price.3.Payments received in the year of sale.Recognized gain in the year of sale and the character of such gain. (Hint: Think carefully about the manner in which the property taxes are handled before you begin your computations.)b. Same as (a)(2) and (3), except that Kay?s basis in the property was $35,000.28. LO.4 On June 30, 2013, Kelly sold property for $240,000 cash and a $960,000 note due on September 30, 2014. The note will also pay 6% interest, which is slighty higher than the Federal rate. Kelly?s cost of the property was $400,000. She is concerned that Congress may increase the tax rate that will apply when the note is collected. Kelly?s after-tax rate of return on investments is 6%.a. What can Kelly do to avoid the expected higher tax rate?b. Assuming that Kelly?s marginal combined Federal and state tax rate is 25% in 2013, how much would the tax rates need to increase to make the option identified in (a) advisable?29. LO.4 On December 30, 2012, Maud sold land to her son, Charles, for $50,000 cash and a 7% installment note for $350,000, payable over 10 years. Maud?s cost of the land was $150,000. In October 2014, after Charles had paid $60,000 on the principal of the note, he received an offer to sell the land for $500,000 cash. What advice can you provide Charles that will minimize the present value of the tax liability for Maud and him?30. LO.4 George sold land to an unrelated party in 2012. His basis in the land was $45,000, and the selling price was $120,000: $30,000 payable at closing and $30,000 (plus 10% interest) due January 1, 2013, 2014, and 2015. What would be the tax consequences of the following? [Treat each part independently and assume that (1) George did not elect out of the installment method and (2) the installment obligations have values equal to their face amounts. Ignore interest in your calculations.]a. In 2013, George borrowed $40,000 from the bank. The loan was partially secured by the installment notes, but George was personally liable for the loan.b. In 2013, George gave to his daughter the right to collect all future payments on the installment obligations.c. On December 31, 2013, George received the payment due on January 1, 2014. OnDecember 15, 2014, George died, and the remaining installment obligation was transferred to his estate. The estate collected the amount due on January 1, 2015.31. LO.5 The Wren Construction Company reports its income by the completed contract method. At the end of 2013, the company completed a contract to construct a building at a total cost of $800,000. The contract price was $1.2 million, and the customer paidWren $900,000. However, the customer refused to accept the work and would not pay anything else on the contract because he claimed that the roof did not meet specifications.Wren?s engineers estimated that it would cost $140,000 to bring the roof up to the customer?s standards. In 2014, the dispute was settled in the customer?s favor, the roof was improved at a cost of $150,000, and the customer accepted the building and paid the remaining $300,000.a. What would be the effects of the above on Wren?s taxable income for 2013 and 2014?b. Same as (a), except that Wren had $1,100,000 of accumulated costs under the contract at the end of 2013.32. LO.5 Rust Company is a real estate construction company with average annual gross receipts of $4 million. Rust uses the completed contract method, and the contracts require 18 months to complete.a. Which of the following costs would be allocated to construction in progress by Rust?1. The payroll taxes on direct labor.2.The current services pension costs for employees whose wages are included in direct labor.3.Accelerated depreciation on equipment used on contracts.4.Freight charges on materials assigned to contracts.5.The past service costs for employees whose wages are included in direct labor.6.Bidding expenses for contracts awarded.b. Assume that Rust generally builds commercial buildings under contracts with the owners and reports the income using the completed contract method. The company is considering building a series of similar stores for a retail chain. The gross profit margin would be a low percentage, but the company?s gross receipts would triple.Write a letter to your client, Rust Company, explaining the tax accounting implications of entering into these contracts. Rust?s mailing address is P.O. Box 1000, Harrisonburg,VA 22807.33. LO.5 On March 31, 2011, Big Boats Company entered into a contract with VacationsUnlimited to produce a state-of-the-art cruise ship, to be completed within three years.Big Boats estimated the total cost of building the ship at $300 million. The contract price was $400 million. The ship was completed on February 15, 2014.a. What tax accounting method must Big Boats use for the contract? Why?b. Using the financial data provided relating to the contract?s performance, complete the following schedule:DateTotal CostsIncurred to DateTotal Percentage of ContractCompletedCurrent-YearRevenue AccruedCurrent-YearCosts Deductible12/31/11 $ 90 million ______ ______ ______12/31/12 150 million ______ ______ ______12/31/13 270 million ______ ______ ______12/31/14 360 million N/A ______ ______c. What are the consequences of the total cost of $360 million exceeding the estimated total cost of $300 million?34. LO.5 Ostrich Company makes gasoline storage tanks. Everything produced is under contract (that is, the company does not produce until it gets a contract for a product).Ostrich makes three basic models. However, the tanks must be adapted to each individual customer?s location and needs (e.g., the location of the valves and the quality of the materials and insulation). Discuss the following issues relative to Ostrich?s operations:a. An examining IRS agent contends that each of the company?s contracts is to produce a ?unique product.? What difference does it make whether the product is unique or a ?shelf item??b. Producing one of the tanks takes over one year from start to completion, and the total price is in excess of $1 million. What costs must be capitalized for this contract that are not subject to capitalization for a contract with a shorter duration and lower cost?c. What must Ostrich do with the costs of bidding on contracts?d. Ostrich frequently makes several cost estimates for a contract, using various estimates of materials costs. These costs fluctuate almost daily. Assuming that Ostrich must use the percentage of completion method to report the income from the contract, what will be the consequence if the company uses the highest estimate of a contract?s costs and the actual cost is closer to the lowest estimated cost?35. LO.5, 6 Swallow Company is a large real estate construction company that has made aSubchapter S election. The company reports its income using the percentage of completion method. In 2014, the company completed a contract at a total cost of $4.8 million.The contract price was $7.2 million. At the end of 2013, the year the contract was begun,Swallow estimated that the total cost of the contract would be $5.4 million. Total accumulated cost on the contract at the end of 2013 was $1.8 million. The relevant tax rate is 35%, and the relevant Federal interest rate is 5%. Assume that all income tax returns were filed and taxes were paid on March 15 following the end of the calendar tax year.a. Compute the gross profit on the contract for 2013 and 2014.b. Compute the lookback interest due or receivable with the 2014 tax return.c. Before bidding on a contract, Swallow generally makes three estimates of total contract costs: (1) optimistic, (2) pessimistic, and (3) most likely (based on a blending of optimistic and pessimistic assumptions). The company has asked you to write a letter explaining which of these estimates should be used for percentage of completion purposes. In writing your letter, you should consider the fact that Swallow is incorporated and has made an S corporation election. Therefore, the income and deductions flow through to the shareholders who are all individuals in the 35% marginal tax bracket. The relevant Federal interest rate is 8%. Swallow?s mailing address is 400Front Avenue, Ashland, OR 97520.
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