Question

In year O, Javens Incorporated sold machinery with a fair market value of $400,000 to Chris. The machinery's original basis was $317,000, and Javen's accumulated depreciation on the machinery was $50,000, so its adjusted basis to Javens was $267,000. Chris paid Javens $40,000 immediately (in year 0) and provided a note to Javens indicating that Chris would pay Javens $60,000 a year for

six vears beginning in year 1.
a. What are the amount and character of the gain that Javens will recognize in ear 0?
b. What amount and character of the gain will Javens recognize in years 1 through 6?

Answer 1

In year 0, the immediate gain recognized by Javens Incorporated would reflect a loss of $(227,000) due to the selling price being lower than the adjusted basis. From years 1 through 6, Javens will recognize a gain of $22,166.67 annually. The character of the gain may be either a capital gain or ordinary income, depending on prior use.

Step-by-step explanation:

Calculation of Gain on Sale of Machinery

When Javens Incorporated sold machinery to Chris in year 0, the machinery had a fair value of $400,000, an original basis of $317,000, and an accumulated depreciation of $50,000, resulting in an adjusted basis of $267,000 ($317,000 original basis - $50,000 depreciation). The immediate payment was $40,000 with an additional $60,000 to be paid annually over six years.

a. Gain Recognized in Year 0

Gain on sale can be calculated as follows:

• 
  
• Selling Price (immediate payment): $40,000
• 
  
• Adjusted Basis to Javens: $267,000
• 
  
• Gain Recognized: Selling Price - Adjusted Basis = $40,000 - $267,000 = $(227,000)

In year 0, Javens has a gain of $(227,000), which illustrates a loss instead of a gain, since the selling price is less than the adjusted basis.

b. Gain Recognized in Years 1 through 6

For each of the years 1 through 6, Javens will receive $60,000. Since these payments are part of the original selling price which cumulatively exceeds the adjusted basis, Javens will recognize gains in these years:

• 
  
• Total Note Value: $360,000 ($60,000 × 6 years)
• 
  
• Adjusted Basis to Javens: Already factored in year 0
• 
  
• Total Gain on Sale: Total sale price ($400,000) - Adjusted Basis ($267,000)
• 
  
• Gain Recognized Each Year: $133,000 / 6 = $22,166.67 per year

The character of the gain would typically be capital gain, but it depends on Javens' use of the machinery before the sale. If it was used in a trade or business, it could be subject to recapture as ordinary income to the extent of prior depreciation.

Answer 2

In year 0, Javens will recognize a gain of $133,000 as ordinary income. In years 1 through 6, Javens will recognize $10,000 of ordinary income each year.

Step-by-step explanation:

a. To determine the gain Javens will recognize in year 0, we need to calculate the excess of the fair market value over the adjusted basis. The fair market value of the machinery is $400,000, and the adjusted basis is $267,000. The gain is the difference between these two values, which is $133,000. This gain will be recognized as ordinary income for Javens.

b. In years 1 through 6, Javens will recognize gain for the portion of the note payment that exceeds the accumulated depreciation on the machinery. The accumulated depreciation is $50,000, so the excess payment of $10,000 each year ($60,000 - $50,000) will be recognized as ordinary income for Javens.