Question

Harold bought land from Jewel for $150,000. Harold paid $50,000 cash and gave Jewel an 8% note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $60,000 cash from Harold in the final payment of the note principal.
a. Harold must recognize $20,000 ($80000-$60,000) of gross income.
b. Harold is not required to recognize gross income but must reduce his cost basis in the land to $130,000.
c. Harold is not required to recognize gross income since he paid the debt before it was due.
d. Jewel must recognize gross income of $20,000 ( $80,000-$60,000) from discharge of the debt.
e. None of these.

Answer 1

Answer: b. Harold is not required to recognize gross income but must reduce his cost basis in the land to $130,000.

Explanation:

When Harold bought the land for $150,000 he acquired a basis of $150,000 in the land. Due to Jewel's cash problems, he managed to pay $20,000 less for the land.

For tax reporting purposes, he need not recognize gross income but he must reflect that he acquired the land for $20,000 less in his basis for the land thereby reducing the basis to $130,000.