Final answer:
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:
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- Selling Price (immediate payment): $40,000
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- Adjusted Basis to Javens: $267,000
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- 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:
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- Total Note Value: $360,000 ($60,000 × 6 years)
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- Adjusted Basis to Javens: Already factored in year 0
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- Total Gain on Sale: Total sale price ($400,000) - Adjusted Basis ($267,000)
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- 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.