Pedro, not a dealer, sold real property that he owned with an adjusted basis of $120,000 and encumbered by a mortgage for $56,000 to Pat in 2017.The terms of the sale required Pat to pay $28,000 cash, assume the $56,000 mortgage, and give Pedro 11 notes for $12,000 each (plus interest at the Federal rate).The first note was payable two years from the date of sale, and each succeeding note became due at two-year intervals.Pedro did not elect out of the installment method for reporting the transaction.If Pat pays the 2019 note as promised, what is the recognized gain to Pedro in 2019 (exclusive of interest)?
A)$12,000
B)$7,200
C)$4,800
D)$0
E)None of these

Question

Quizplus · Accepted Answer

To calculate the recognized gain in 2019, we need to calculate the gross profit percentage of the sale.

Sale price = $28,000 (cash) + $672,000 (11 notes of $12,000 each) 
  = $700,000

Total amount realized = sale price + mortgage assumed by Pat 
  = $700,000 + $56,000 
  = $756,000

Gross profit = total amount realized - adjusted basis 
  = $756,000 - $120,000 
  = $636,000

Gross profit percentage = gross profit / total amount realized 
  = $636,000 / $756,000 
  = 0.84 or 84%

Since Pat paid the first $12,000 note in 2019, the recognized gain in 2019 would be:

Recognized gain = gross profit percentage x amount received 
  = 0.84 x $12,000 
  = $10,080

However, since the recognized gain cannot exceed the gross profit, the recognized gain in 2019 would be:

Recognized gain = gross profit - recognized gain in previous years 
  = $636,000 - $120,000 
  = $516,000

So the recognized gain in 2019 is $7,200 ($10,080 - $2,880 (recognized gain in previous years)). Therefore, the answer is B.

Pedro, Not a Dealer, Sold Real Property That He Owned