Use the following scenario to complete the memo and letter activities for this l
ID: 2415056 • Letter: U
Question
Use the following scenario to complete the memo and letter activities for this lesson. During our annual tax preparation meeting on February 5th, Suzanne indicates that everything is going well and that she and her husband Johnny have moved out of their home. When pressed for more information Suzanne says that they exchanged their house for a condo. Suzanne states that there were no papers or real estate agents or attorneys involved at all. They just traded places with another couple who is now residing in the house. Additional Background: • Suzanne and Johnny purchased their house in 2001 for $174,900 • Suzanne and Johnny’s current mortgage on the house is $138,000 • Interest paid on that mortgage in the current year is $7,450 • Real estate tax on the house for the current year is $5,100 • Current Fair Market Value of the house is $259,000 • Current Fair Market Value of the condo is $350,000 • Real estate tax on the condo for the current year is $6,000 TASK: Research the tax laws that apply to the above facts and circumstances. Determine what really happened and what the tax ramifications may be. Identify the issues that must be addressed to provide the FIRM’s client with the best possible result from this transaction. Consider what consultation should be obtained to ensure that the client is compliant and protected. State your assumptions, propose your recommendations as to how the FIRM should proceed and provide your resources to support this position.
Explanation / Answer
We can use 1031 exchange here and defer the capital gains tax on ($84,100), till the sale of condo in the future. For that we should file the form 8824.
Since the property that Suzzane selling has a mortgage on it, the relief of the mortgage will be considered boot to Suzzanne and Johnny. So to make sure that they don't have to pay taxes on that boot. We must ask them to pay take higher mortgage on the Condo when compared to the house or we must encourage them to invest their own money to make up the difference in the purchase price.
Mortgage on your property surrendered 138,000
Any cash received in the exchange -91,000
Boot w/o considering Additional Mortgage or amount invested in new propoerty (sum of above) 47,000
In order to avoid tax we must encorage them to invest $47,000 in the new property or take a mortgage of ($138,000+$47,000 = $185,000)