QUESTION 1

Chester King has been a sailor for his entire life.  As he has saved some money, he now wants to go into business for himself.  Chester decides to become the captain of his own tugboat which he will name “American Queen”.  Chester has also always wanted to live in California, so he decides to buy his boat and operate it on the San Francisco Bay.  Chester figures he better talk to an attorney before buying the boat about things like business licenses, insurance.  He also figures it would be a good idea to investigate the market for a tugboat in San Francisco.  So, Chester hires an attorney to do all the legwork for which Chester pays the attorney $15,000 to help set up the business name, the single member LLC paperwork, and a variety of other legal tasks necessary to get his business situated.  Chester also pays a research firm $5,000 to provide him details on the potential market for a tugboat in the SF Bay.  Just as Chester is about to complete the purchase of his tug, the research information shows up in his email with bad news.  The research firm has discovered that there are a limited number of tugboats allowed to operate on the SF Bay and currently all of the licenses are taken and none are for sale.  Disappointed, Chester cancels the purchase of the tugboat and forfeits his deposit of $9,000 to the current owner since it was a non-refundable deposit.  All of the above happened between February and March 2017.  Sad that he cannot work and live in California, Chester has the research firm do a little more work for him (free of charge since they felt so bad for him) to find out whether or not a tugboat operation would be a viable business in New York City on the Hudson river.  This research was much more promising showing that there were several licenses currently for sale.  So, Chester makes the big decision and moves to New York City.  Since he did not really have much stuff in the first place, the move only cost him $3,000 to get to NYC, including making a deposit on a small apartment near the water for $1,000.  Chester immediately went about obtaining a tugboat license for which he had to pay a fee of $50,000 plus a commission to the broker of $5,000.  The license will last for 10 years, at which point he can renew it for an annual cost of $5,000 per year.  Finally, Chester finds a used tugboat in good condition that he purchases, including tax and transfer fees, for $1,995,900.  Before he can operate the tug safely, Chester decides to invest in a state-of-the-art computer and radar system so he can operate at night and in bad weather.  The system cost him another $245,500.  He decides to have the systems installed on the tug in such a way that if he ever sells the tug, he can remove and keep the equipment without damaging the boat.  The installation costs him another $17,500.  Chester needed a new single member LLC (to limit his liability) in NYC so he hired yet another attorney to do that paperwork for him.  The NY attorney cost him $10,000 to get all of the business paperwork in order.

PART A TO QUESTION 1:

1. Explain and calculate all of the impacts on Chester’s 2017 tax return presuming that the tugboat was purchased and placed in service on June 15, 2017. You can assume that Chester will make a profit during 2017.  Show your calculations and explain each one.

2. Using the same information, explain and calculate all of the impacts on Chester’s 2017 tax return presuming that the tugboat is purchased and placed in service on November 12, 2017 (ignore all mid-quarter convention issues). You can assume that Chester will make a profit during 2017.  Show your calculations and explain each one.

PART B TO QUESTION 1:

Chester has spent the last several years running the tugboat operation by himself and is now tired of the late nights and bad weather.  So, he has decided to retire and sell the American Queen to a wealthy overseas investor.  The sales price is agreed as $2,160,000 for the boat.  After some negotiations, Chester agrees to sell the equipment with the boat for a total price of $2,260,000.  Chester had to pay a 5% commission on the total price to the broker who helped arrange the sale.  The sale occurs on November 15, 2020.

1. Calculate and explain your conclusions for the amount and character of the gain or loss on the sale assuming the boat was placed in service on June 15, 2017 (i.e. question 1 above). Show your calculations and explain each one.

2. Calculate and explain your conclusions for the amount and character of the gain or loss on the sale assuming the boat was placed in service on October 12, 2017 (i.e. question 2 above). Show your calculations and explain each one.