Question

What can Kelly do to avoid the expected higher tax rate on the property sale proceeds of $240,000 cash and a $960,000 note due on September 30, 2024, with a 6% interest rate equal to the federal rate and a cost of $400,000?

A) Kelly could elect to the installment method and report the entire realized gain of $240,000 in 2023.
B) Kelly could defer the tax on the note until it is collected in 2024.
C) Kelly could pay the entire tax amount in 2023 to lock in the current tax rate.
D) Kelly could sell the property at a loss to reduce the taxable gain.

Answer 1

Kelly could minimize taxes by electing the installment method, deferring the tax liability over the period the note payments are received. This would help avoid a large tax bill in the year of sale and match income with cash flow.

Step-by-step explanation:

The student is asking about strategies to minimize taxes on the sale of property where the total consideration consists of both cash and a seller-financed note. The subject of this question falls under the category of tax planning in business transactions. The correct response to this scenario would be:

Kelly could elect the installment method and report the realized gain as she receives the payments. By doing so, Kelly can spread the tax liability over the period in which the note repayments are received, matching income recognition with cash flow. This method may be beneficial if Kelly expects higher tax rates in the future or wants to avoid a large tax bill in the year of sale.

Choosing to defer the tax on the note until it is collected in 2024 might not avoid the higher tax rate if the rates have increased by that time. Paying the entire tax amount in 2023 could lock in the current tax rate, but this would require payment upfront without the benefit of the cash flow from the note. Selling at a loss is not applicable as the question implies a gain on the sale of the property.