In 2009, Sophia sold real estate (adjusted basis of $500,000) for $1,500,000. Under the terms of the sale, she received two notes of $750,000 each, with 9% interest provided. One note is due in 2010 and the other in 2011. She did not elect out of the installment method of recognizing gain. In 2010 and before the first note matures, Sophia gives both notes to her adult children. At this time, the notes are worth a total of $1,400,000. Disregarding the interest element, a tax result of these transactions is:

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Sophia did not elect out of the installment method of recognizing gain, so she will recognize the gain as she receives the payments. When she gave the notes to her children, she was deemed to have received payments for tax purposes. The amount she received was the fair market value of the notes, which was $1,400,000.

To calculate the gain recognized, we first need to find the total gain on the sale. The amount realized is $1,500,000, and the adjusted basis is $500,000, so the total gain is $1,000,000.

Sophia received half of the proceeds in 2009, and the other half was due in 2010 and 2011. When she gave the notes to her children in 2010, she was deemed to have received the second payment. This means she recognized $500,000 of gain in 2010.

When the children eventually sell the notes, they will have to recognize the interest income and any gain on the sale. However, for Sophia's tax purposes, she has now recognized $500,000 of the gain on the sale.

In 2009, Sophia Sold Real Estate (Adjusted Basis of $500,000)