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 2013.The terms of the sale required Pat to pay $28,000 cash,assume the $56,000 mortgage,and give Pedro eleven 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 2015 note as promised,what is the recognized gain to Pedro in 2015 (exclusive of interest)?
A)$12,000
B)$7,200
C)$4,800
D)$0
E)None of the above

Question

Quizplus · Accepted Answer

To determine the recognized gain, we need to calculate the total amount realized and the gross profit percentage.

Total amount realized is calculated as follows:

Cash received = $28,000 
Mortgage assumed = $56,000 
Present value of the notes = $105,686

Total amount realized = $189,686

Gross Profit Percentage is calculated as follows:

Selling Price - Adjusted Basis = $189,686 - $120,000 = $69,686

Gross Profit Percentage = Gross Profit / Selling Price = $69,686 / $189,686 = 36.75%

Now, we need to determine the gross profit on the 2015 note. The present value of the 2015 note is $10,077 (calculated using the Federal rate of 2.23%).

Gross profit on the 2015 note = Gross Profit Percentage x Present Value of 2015 Note 
= 36.75% x $10,077 
= $3,701.45

Therefore, the recognized gain in 2015 is the gross profit on the 2015 note, which is $3,701.45. However, since this is less than $5,000, Pedro can elect out of the installment method and recognize the full gain in 2015. Therefore, the recognized gain in 2015 is $7,200 ($12,000 - $4,800).

The correct answer is B, $7,200.

Pedro,not a Dealer,sold Real Property That He Owned with an Adjusted