Question

Early in the year, Charles, Lane, and Tami form the Harrier Corporation for the express purpose of developing a shopping center. All parties are experienced contractors, and they transfer various business assets to Harrier in exchange for all of its stock. Three months after it is formed, Harrier purchases two cranes from Lane for their fair market value of $400,000 by issuing four annual installment notes of $100,000 each. Because the adjusted basis of the cranes is $550,000, Lane plans to recognize a loss of $150,000 in the year of the sale. Does Lane have any potential income tax problem with this plan?

Answer 1

Yes, Lane will have a potential income tax problem with this plan. This is because as per the books of accounts, on the basis of accounting standards, Lane can recognize the loss on sale of cranes as an impairment loss on asset, and can debit the loss of $150,000 in the profit and loss account in the year of sale. However this loss of $150,000 would not be allowed as a deduction from profit and loss account, as per income tax.

The reason that it will not be allowed as a deduction from profit and loss account for income tax purpose is that in income tax, only depreciation on asset as per income tax is allowed as a deduction from profit and loss account. Capital loss is also allowed to be deducted from capital gain but for calculating the capital loss, cost of acquisition of capital asset is required, which is not given in the question, due to which capital loss cannot be calculated.

Due to the above reason, the loss of $150,000 will not be allowed as deduction from profit and loss account for the purpose of income tax.