In 2011, 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 2012 and the other in 2013. She did not elect out of the installment method of recognizing gain. In 2012 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:

Question

Quizplus · Accepted Answer

Sophia sold real estate for $1,500,000 and had an adjusted basis of $500,000, resulting in a gain of $1,000,000. She did not elect out of the installment method of recognizing gain, meaning that the gain will be recognized as payments are received. When she gives the notes to her children with a total value of $1,400,000, she is treated as having received cash equal to the notes' fair market value ($1,400,000) and recognizes the gain associated with that amount. The amount of gain that she recognizes is equal to the proportion of the total gain associated with the notes' fair market value ($1,400,000) divided by the total sale price ($1,500,000), which is $1,000,000 x ($1,400,000/$1,500,000) = $933,333. Therefore, the answer is C.

In 2011, Sophia Sold Real Estate (Adjusted Basis of $500,000)