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 11% when the applicable Federal rate was 7%.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 must use the installment method of recognizing gain because he received a note as part of the consideration.

To calculate the gross profit percentage (the portion of each payment that represents gain), we use the total expected payments on the note:

$64,000 (principal) + ($64,000 × 0.11 × 2 years) (interest) = $86,240

Gross Profit Percentage = ($100,000 – $40,000) ÷ $100,000 = 0.6

Therefore, each payment from the note represents 60% gain and 40% return of capital:

Payment from note = $64,000 × 0.6 = $38,400 gain

Hal received a cash payment of $36,000, which is treated as a return of capital.

He must report gain of $38,400 × 0.5674 (the present value factor for two years at 7%) = $21,821.

Therefore, (D) Unless Hal elects not to use the installment method, Hal must recognize $21,821 gain in the year of sale.

Hal Sold Land Held as an Investment with a Fair