Dagwood has come to you with a pressing problem. In November 2005, he purchased an office building that he has rented out to various businesses. On May 2 of the current year, a fire swept through the building, totally destroying it. To make matters worse, his lifelong accountant was trapped in the building and perished in the fire (along with all of Dagwood's income tax records). The following is all the information Dagwood has available about the building:
Dagwood is sure that he purchased the building in November 2005, because he has a property tax statement indicating that the land was revalued at $30,000 and the building at $300,000 for property tax purposes at that time. The date is further supported by a canceled check dated November 28, 2005, for $550,000, payable to the company from which he had purchased the property. Although he doesn't have the tax records to support any deductions on the property, he's confident that his former accountant took the maximum deductions allowable on the property as it had always produced a loss for income tax purposes.
He recently received a check for $400,000 from his insurance company for the destruction of the building. In the interim, Dagwood has been obtaining estimates of the cost of putting another office building on the property. However, his analysis of the construction costs, combined with the potential rental income generated by the building, indicates that putting another office building on the property would not be profitable in either the short or the long term. He has received an offer to sell the land for $84,000. If he does sell the land, he is considering purchasing an upscale apartment building in another part of town.
Before he proceeds with the sale of the land and the purchase of the apartment building, he needs to know the tax effects of the fire and the sale of the land. Dagwood is afraid that he may have a big tax bill to pay and won't be able to afford the apartment building after he settles up with the IRS.
Read and analyze the following authorities and determine how much gain or loss Dagwood will have to recognize from the fire if he purchases the apartment building:
• Sec. 1033.
• Rev. Rul. 64-237.
• Rev. Rul. 59-361.
• Henry J. Masser, 30 T.C. 741 (1958).