Question

In year 0, Javens Incorporated sold machinery with a fair market value of $570,000 to Chris. The machinery's original basis was $446,880 and Javens's accumulated depreciation on the machinery was $67,000, so its adjusted basis to Javens was $379,880. Chris paid Javens $57,000 immediately (in year 0) and provided a note to Javens indicating that Chris would pay Javens $85,500 a year for six years beginning in year 1.

Required:
a. What are the amount and character of the gain that Javens will recognize in year 0?
b. What amount and character of the gain will Javens recognize in years 1 through 6?

Answer 1

Javens will recognize a gain of $190,120 in year 0, which is a capital gain from the sale of a capital asset. For years 1 through 6, Javens will recognize part of the gain on an installment basis annually as payments are received from Chris.

Step-by-step explanation:

Recognized Gain for Javens Incorporated in Year 0

The amount and character of the gain Javens will recognize in year 0 is calculated by subtracting the adjusted basis of the machinery from the fair market value. The fair market value is $570,000, and the adjusted basis is the original basis minus accumulated depreciation, which is $446,880 - $67,000 = $379,880. Thus, the recognized gain is $570,000 - $379,880 = $190,120. This gain is a capital gain because it results from the sale of a capital asset.

Recognized Gain for Javens Incorporated in Years 1 through 6

In years 1 through 6, as Chris pays the note in installments of $85,500 per year, Javens will recognize a portion of the gain each year based on the payments received. The total amount Chris will pay over the six years is $513,000 which, when combined with the initial payment of $57,000, equals the fair market value of $570,000. The gain recognized each year will be the portion of each payment that exceeds the adjusted basis allocated to that payment (part of the installment sale rules).