Your clients are Mr. and Mrs. Nittany, cash basis taxpayers who file a joint Form 1040. Six years ago, Mr. Nittany sold investment land with a basis of $562,250 to Pitt LLC for $865,000. The LLC gave Mr. Nittany a note for the entire sale price. The land was collateral for the note, and Mr. Nittany used the installment sale method to recognize his taxable long-term capital gain on sale. Early this year, Pitt LLC defaulted on the note and Mr. Nittany repossessed the land. On the date he regained title, the principal of his Pitt LLC note was $644,000. Mr. Nittany is hoping to find another buyer for the land by the end of the year.
In March, Mrs. Nittany sold a residential rent property that she had owned and managed for several years. The property generated net losses for the last two years, and Mrs. Nittany has a $28,750 suspended ordinary passive activity loss with respect to the rent property that carried into this year. Her current year operating loss through date of sale is $4,293. The Nittanys own no interests in passive activities other than this property, and they are not eligible for any Section 469(i) offset because their AGI is well in excess of $150,000.
Mrs. Nittanyâ€™s original cost of the realty (land and building) was $338,200, and accumulated straight-line depreciation through date of sale was $41,920 making her adjusted basis $296,280. The sale included the furnishing (appliances, furniture, rugs, etc.). Mrs. Nittanyâ€™s original cost of the furnishings was $21,400, and accumulated MACRS depreciation through date of sale was $15,000, making the furnitureâ€™s adjusted basis $6,400. She sold the property to an unrelated purchaser for $400,000 lump-sum contract price ($385,000 allocated to the realty and $15,000 allocated to the furnishings) and received an $80,000 cash down payment and the purchaserâ€™s interest bearing note for $320,000. Mrs. Nittany will not receive her first principal payment on the note until 2017.
Ten years ago, the Nittanys purchased a small farm in Centre County for $618,000. The property consisted of a 75-year-old, four-bedroom farmhouse and two barns located on 113 acres of woods and pasture land. The Nittanys live in the farmhouse and use the barns only for personal storage. They originally planned to buy a herd of dairy cattle, sheep, and perhaps some chickens, and try their hand at farming, but they never purchased any livestock or actually engaged in any farming activity. Six years ago, the Nittanys paid $176,000 for a 46-acre tract of pasture land adjacent to their property. They knew that property values in Centre County were increasing dramatically so that the land was an excellent long-term investment. They also wanted to own the land to prevent any type of development that would spoil their mountain views, invade their privacy, and disrupt the peace and quiet of their rural home.
Although the Nittanys love their farm, they are growing older and want to move closer to their children and grandchildren. A developer has approached them about buying the entire 159 acres. He plans to demolish the farmhouse and barns, subdivide the land into one-acre lots, and sell the lots to various local builders. He has offered the Nittanys $1.4 million cash.
Identify the tax issues suggested by these facts and formulate your research questions accordingly. Please show the IRC source, regulations and any court cases for each paragraph.