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 2015. 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 2017 note as promised, what is the recognized gain to Pedro in 2017 (exclusive of interest)?
A)$12,000
B)$7,200
C)$4,800
D)$0
E)None of the above

Question

Quizplus · Accepted Answer

To calculate the gain recognized in a sale made using the installment method, we need to use the following formula:

Gain = (Total Payments Received / Selling Price) x Total Gain

The selling price is the sum of all the notes plus the cash payment:

Selling Price = $28,000 + ($12,000 x 11) = $160,000

The total gain is the sales price minus the adjusted basis:

Total Gain = $160,000 - $120,000 = $40,000

Since Pedro did not elect out of the installment method, the gain is recognized as payments are received. So far, Pat has paid one note of $12,000, leaving ten notes of $12,000 each.

The total payments received so far are:

$28,000 (cash) + $12,000 (first note) = $40,000

Using the formula above:

Gain = ($40,000 / $160,000) x $40,000 = $10,000

Therefore, the recognized gain in 2017 (if Pat pays the note as promised) would be the gain attributable to the 2017 note, which is:

($12,000 / $160,000) x $10,000 = $7200

Option B is correct.

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