Alley’s automobile dealership, which has an adjusted basis of $400,000, is destroyed by a hurricane in the current year. Alley’s receives $600,000 from its insurance company to cover the loss. Alley’s has begun to rebuild the dealership at an estimated cost of $750,000. Assume that the rebuilding costs at least $750,000.
a. What is the minimum gain Alley’s must recognize on the hurricane damage?
b. Alley’s is organized as a corporation. Because of a slump in the automobile industry, Alley’s has net operating losses totaling $400,000 that it is carrying forward from the previous 5 years. Alley’s expects to have another operating loss in the current year. Write a letter to Alley’s explaining how to account for the involuntary conversion results and why you advise taking those measures.