Question

Sara owns 160 acres of farmland worth $800,000. She inherited the land from her father 30 years ago when it was worth $200,000. Her married son would like to buy the land, but has limited funds. He proposes buying the land on a contract for deed, paying $50,000 down and the balance over 20 years at 4% interest. Assume that if Sara sold the land for cash, her tax rate on the gain would be 23.8%, but if she sold it on a contract her rate would be 15% on the gain and 28% on the interest income on each payment. Advise Sara on how much tax she would have to pay under each option (selling for cash or on the contract, also assume Sara could earn 4% interest if she sold for cash and invested the money)

Answer 1

The question is about calculating and comparing capital gains taxes and interest income taxes for two different methods of selling farmland: a cash sale and a contract for deed. The capital gains tax rate and interest income tax rates differ between the two options, affecting the total tax paid.

Step-by-step explanation:

The student's question focuses on the financial implications of selling farmland, taking into consideration capital gain taxes and interest over a period of time. Calculating the taxes involves understanding the initial value of the land, the current value, the proposed sale terms, the tax rates that would apply to selling for cash versus a contract, and the investment returns from alternative investments.

For the cash sale option, Sara would pay a capital gains tax of 23.8% on the increased value of the land, which has risen from $200,000 to $800,000 over 30 years. As for the contract for deed option, she would pay a lower capital gains tax rate of 15% on the gain but would also need to pay 28% on any interest income received.

To further illustrate, let's provide a brief calculation for the capital gains tax in both scenarios. For cash sale: The capital gain is $600,000 ($800,000 - $200,000). At a tax rate of 23.8%, she would owe $142,800 in taxes. For the contract for deed: The capital gain remains the same, but at a 15% tax rate, she would owe $90,000 in taxes on the gain plus additional taxes on the interest income earned over the 20 years.

The actual tax calculation for the contract for deed would require an amortization schedule to detail the principal and interest portions of each payment over the 20 years. However, without the full payment breakdown, we can't complete that calculation here.

Answer 2

Check the following calculations

Step-by-step explanation:

Sara with selling option

Selling Price = 800000

acquisition cost = 200000

Capital gain = 600000

• Intersest earned on 800000 @ 4% for 20 Years = 800000 * CVF @ 4% 20 Years

800000* 1.464 = 1171200 - 800000 = 371200

• Tax on interest Income = 371200 * 28% = 103936

• Tax on capital Gain = 600000*23.8% = 142800

• Total Tax on selling of land = 103936 + 142800 = 246736

• On the contract

Capital gain = 600000

Intersest earned on 750000@4% for 20 Years = 750000 * CVF@4% 20 Years

750000* 1.464 = 1098000 - 750000 = 348000

• Tax on interest Income = 348000 * 28% = 97440

• Tax on capital gain = 600000*15%= 90000

total Tax on contract = 97400+ 90000 = 187440

Saving of tax on contracting = tax on sale - tax on contract = 246736 - 187440 = 59296