Question

Five years ago, Firm SJ purchased land for $118,000 with $10,000 of its own funds and $108,000 borrowed from a commercial bank. The bank holds a recourse mortgage on the land. For each of the following independent transactions, compute SJ’s positive or negative cash flow. Assume that SJ is solvent, any recognized loss is fully deductible, and SJ’s marginal tax rate is 21 percent. (Negative amounts should be indicated by a minus sign.)

Required:

1. SJ sells the land for $51,000 cash and the buyer’s assumption of the $80,000 principal balance of the mortgage.
2. SJ sells the land for $131,000 cash and pays off the $80,000 principal balance of the mortgage.
3. SJ sells the land for $91,000 cash and pays off the $80,000 principal balance of the mortgage

Answer 1

a) SJ sells the land for $51,000 cash and the buyer’s assumption of the $80,000 principal balance of the mortgage

Particular and Explanatin	Amount in dollar
Amount realized on sales( $51,000 + 80,000 )	$131,000
Basis of land(less)	118,000
Gain Recognized on sales	13,000
Tax rate	21% or 0.21
Tax(13,000 x 0.21)	2730
Cash received on sale	51,000
Tax cost	2730
Net cash flow	$48,270

b)SJ sells the land for $131,000 cash and pays off the $80,000 principal balance of the mortgage.

Particular and Explanatin	Amount in dollar
Amount realized on sales( $51,000 + 80,000 )	$131,000
Basis of land(less)	118,000
Gain Recognized on sales	13,000
Tax rate	21% or 0.21
Tax(13,000 x 0.21)	2730
Cash received on sale	131,000
Debt payment	-80,000
Tax cost	2730
Net cash flow	$48,270

c)SJ sells the land for $91,000 cash and pays off the $80,000 principal balance of the mortgage

Particular and Explanatin	Amount in dollar
Amount realized on sales	$91,000
Basis of land(less)	118,000
Gain Recognized on sales	-27,000
Tax rate	21% or 0.21
Tax(13,000 x 0.21)	5,670
Cash received on sale	91,000
Debt payment	-80,000
Tax cost	-5,670
Net cash flow	$8,270

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