Hal sold land held as an investment with a fair market value of $100,000 for $36,000 cash and a note for $64,000 that was due in two years. The note bore interest of 7% when the applicable Federal rate was 4%. Hal's cost of the land was $40,000. Because of the buyer's good credit record and the high interest rate on the note, Hal thought the fair market value of the note was at least $74,000.

Question

Quizplus · Accepted Answer

Hal can choose to use the installment method for reporting the sale. The gain from the sale is the selling price minus the cost, which is $60,000 ($100,000 - $40,000). Because Hal received $36,000 in cash, only the remaining $64,000 is eligible for installment reporting, and the gain to be recognized each year is the gross profit percentage times the amount received in that year. The gross profit percentage is the selling price minus the cost, divided by the selling price, which is 0.6 ($60,000/$100,000). Therefore, Hal must recognize $38,400 ($64,000 x 0.6) of gain in the first year, and the remaining gain of $21,600 ($60,000 - $38,400) will be recognized in the second year when the note is collected.

Hal Sold Land Held as an Investment with a Fair