Sara owns 160 acres of farmland worth $800,000. She inherited the land from her

Question

Sara owns 160 acres of farmland worth $800,000. She inherited the land from her father 30 years ago when it was worth $200,000. Her married son would like to buy the land, but has limited funds. He proposes buying the land on a contract for deed, paying $50,000 down and the balance over 20 years at 4% interest. Assume that if Sara sold the land for cash, her tax rate on the gain would be 23.8%, but if she sold it on a contract her rate would be 15% on the gain and 28% on the interest income on each payment. Advise Sara on how much tax she would have to pay under each option (selling for cash or on the contract, also assume Sara could earn 4% interest if she sold for cash and invested the money)

Explanation / Answer

Sara with selling option

Selling Price =                800000

acquisition cost =            200000

Capital gain =                  600000

Intersest earned on 800000@4% for 20 Years = 800000 * CVF@4% 20 Years

                                                                      800000* 1.464 = 1171200 - 800000 = 371200

Tax on interest Income = 371200 * 28% = 103936

Tax on capital Gain = 600000*23.8% = 142800

Total Tax on selling of land = 103936 + 142800 = 246736

On the contract

Capital gain =                  600000

Intersest earned on 750000@4% for 20 Years = 750000 * CVF@4% 20 Years

                                                                      750000* 1.464 = 1098000 - 750000 = 348000

Tax on interest Income = 348000 * 28% = 97440

Tax on capital gain = 600000*15%= 90000

total Tax on contract = 97400+ 90000 = 187440

Saving of tax on contracting = tax on sale - tax on contract = 246736 - 187440 = 59296

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