Question

Nicholas bought land from Meredith for $150,000. Nicholas paid $50,000 cash and gave Meredith an 8 percent note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Meredith began having financial difficulties. To accelerate her cash inflows, Meredith agreed to accept $60,000 cash from Nicholas in final payment of the note principal. Which of the following statements is true?

a) Nicholas recognizes a gain of $20,000.
b) Nicholas recognizes a loss of $20,000.
c) The transaction does not impact Nicholas' taxable income.
d) Nicholas can only recognize the gain or loss when the note is fully paid.

Answer 1

Nicholas recognizes a $20,000 gain for tax purposes because he settled the debt for $20,000 less than its book value.

Step-by-step explanation:

Nicholas bought land from Meredith for $150,000, paid $50,000 in cash, and gave an 8 percent note for $100,000 to be paid over five years. When the balance on the note was $80,000, Meredith needed to accelerate her cash inflows due to financial difficulties and agreed to accept $60,000 in final payment of the note principal. The question asks which statement is true regarding the tax implications for Nicholas. Answer (a) Nicholas recognizes a gain of $20,000 is correct. The gain is the difference between the book value of the debt ($80,000) and the amount that Nicholas paid to settle the debt ($60,000).