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 2010.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 2012 note as promised, what is the recognized gain to Pedro in 2012 (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 recognized gain in the year of payment, subtract the adjusted basis from the payment received. In 2010, Pedro received $28,000 cash and 11 notes of $12,000 each, totaling $160,000 ($28,000 + $132,000). The mortgage assumption is not included in the calculation of the payment received. The gross profit is $40,000 ($160,000 - $120,000). The gross profit percentage is 25% ($40,000/$160,000). Therefore, in 2012, when Pat pays the first note of $12,000, Pedro will recognize 25% of $12,000, which is $3,000. However, Pedro can also subtract the interest expense on the installment sale from the amount recognized each year. Since the interest rate was not provided, we cannot calculate the interest expense and will assume it is zero. Therefore, the recognized gain in 2012 is $3,000.

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