Pfau_problemsplanning Version 1

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Apr 3, 2024

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Interpretation 1Amount Interpretation 2Amount Contract Price $ 60,000.00 Contract Price $ 60,000.00 Price $ 51,726.00 Price $ 39,380.00 Interest $ 8,274.00 Interest $ 20,620.00 Price $ 51,726.00 Price $ 39,380.00 Cost of Land $ 10,000.00 Cost of Land $ 10,000.00 Seller Profit $ 41,726.00 Seller Profit $ 29,380.00 1. Julia currently is considering the purchase of some land to be held as an investment. She and the seller have agreed on a contract under which Julia would pay $1,000 per month for 60 months, or $60,000 total. The seller, not in the real estate business, acquired the land several years ago by paying $10,000 in cash. Two alternative interpretations of this transaction are (1) a price of $51,726 with 6 percent interest and (2) a price of $39,380 with 18 percent interest. Which interpretation would you expect each party to prefer? Why? In interpretation one, Julia observes a capital gain of $41,726 alongside an interest income of $8,274. Julia's basis would be $51,726, and she deducts interest of $8,274. This perspective favors the seller as it ensures they do not face high-interest taxation. Under interpretation two, Julia experiences a capital gain of $29,380 alongside an interest income of $20,620. Julia's basis would be $39,380, and she claims an interest deduction of $20,620. This interpretation benefits Julia because she enjoys a more significant interest deduction, consequently reducing the cost of the land.

Year 1 Amount Year 2 Income $ 10,000.00 Income Less: Tax rate 31% Year 1 $ 3,100.00 Less: Tax rate 31% Year Adjusted Income $ 6,900.00 Net Income Add: Return Rate 10% $ 690.00 Total Income $ 7,590.00 Less: Tax Rate 31& on $690.00 $ 213.90 Income $ 7,376.10 Answer a. The taxpayer should choose to receive his money at the end of Year 2, wher b. At what pre- tax rate of return, will the taxpayer be indifferent to taking the Year 1 Amount Income $ 10,000.00 Less: Tax rate 31% Year 1 $ 3,100.00 Adjusted Income $ 6,900.00 Add: Return Rate 10% of $10,00 $ 1,000.00 Total Income $ 7,900.00 Rate of Return 14.49 Answer b. 14.49% c. If the taxpayer’s marginal tax rate increases to 35 percent in Year 2, when s Year 1 Amount Year 2 Income $ 10,000.00 Income Less: Tax rate 31% Year 1 $ 3,100.00 Less: Tax rate 35% Year Adjusted Income $ 6,900.00 Net Income Add: Return Rate 10% $ 690.00 Total Income $ 7,590.00 Less: Tax Rate 35& on $690.00 $ 241.50 Income $ 7,348.50 Answer c. The taxpayer should elect to receive his income at the beginning of the year d. What would the tax rate need to be in Year 2 to make the taxpayer indiffere Year 2 Indefferent Amount Income $ 11,000.00 Adjusted Income at end of Year $ 7,376.10 Rate of Return 32.94 Answer d. 32.94% or 33% 2. Assume that a taxpayer can choose when he is to receive $10,000 of fully taxable income. If the ta will receive exactly $10,000. If he delays receipt of the income until the end of Year 2, the amount wil the end of Year 1, he can invest the proceeds and earn a pre-tax return of 10 percent over the next year a. If the taxpayer faces a marginal tax rate of 31 percent in both Year 1 and Ye income?

Amount Gain/Loss Amount $ 11,000.00 Gain $ 213.90 $ 3,410.00 $ 7,590.00 re he will gain $213.90. e money in Year 1 and Year 2? should he elect to receive the income? Amount Gain/Loss Amount $ 11,000.00 Loss $ 198.50 $ 3,850.00 $ 7,150.00 r to avoid experiencing a loss of $198.50. ent? axpayer receives the income at the end of Year 1, he ll grow to $11,000. If the taxpayer takes the money at r. ear 2, when should he elect to receive the

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10-Year Bond Amount Land Amount Initial Investment $ 10,000.00 Before Tax Value $ 10,000.00 Pre-Tax Return 6% Pre-tax return $ 14,802.44 Marginal Rate 25% Capital Gains $ 4,802.44 Annual After 0.045 Capital Gains Tax $ 960.49 Value After 10 Years $ 15,529.69 Value of Land $ 13,841.95 3. A taxpayer can invest $10,000 in a taxable 10-year bond that yields an annual pretax return of 6 percent or buy land (a capital asset) for $10,000 that is expected to increase at an annual pre-tax rate of 4 percent. The taxpayer expects to hold the bond and the land for 10 years and expects to pay capital gains taxes of 20 percent when the land is sold. The taxpayer’s marginal tax rate on ordinary income is expected to be 25 percent throughout the 10-year period. 3. Preferring the 10-year bond over purchasing the land results in a more favorable investment totaling $15,529.69, compared to the land investment of $13,841.95.

Offer 1 Amount Offer 2 Amount Number of rental days 10 Number of rental days 16 Price per day $ 500.00 Price per day $ 400.00 Potential income $ 5,000.00 Potential income $ 6,400.00 4. Greg Jones lives in Augusta, Georgia and has the opportunity to rent his condominium during the next Masters golf tournament. He has 2 offers— one to rent for 10 days at $500 per day and the other to rent for 16 days at $400 per day. Rental expenses will be negligible. What is your advice to Greg? Answer 4. Greg should lease his condominium for ten days at $500 per day during the Masters golf tournament. According to §280A(g), rental property for less than 15 days does not count toward gross income. This provision allows Greg to reduce his gross income, thereby lowering the taxes he pays, as rental income falls under gross income according to §61.

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