Tim sells land to Brad for $90,000. Tim originally purchased the land for $50,000. Brad agrees to pay Tim six annual installments of $15,000 each. In year three, Brad makes his third installment of $15,000. How much taxable gain will Tim have in year three?

Question

Quizplus · Accepted Answer

To find the taxable gain, we need to first calculate the total profit Tim will make from the sale of the land.

Profit = Sale Price - Original Cost
Profit = $90,000 - $50,000
Profit = $40,000

Tim will recognize a portion of this profit each year as Brad makes his installment payments. We can calculate the taxable gain using the following formula:

Taxable Gain = Profit x (Payment Received / Total Sale Price)

For year three, we know that Brad has made three installment payments of $15,000 each, so he has paid a total of $45,000 so far.

Total Sale Price = $90,000
Payment Received = $45,000

Taxable Gain = $40,000 x ($45,000 / $90,000)
Taxable Gain = $20,000 x 0.5
Taxable Gain = $10,000

However, Tim already recognized some of this profit in years one and two, so we need to subtract the taxable gains he already recognized.

In year one, Tim recognized a taxable gain of $10,000. 
In year two, Tim recognized a taxable gain of $6,667.

Total Taxable Gain Recognized = $10,000 + $6,667
Total Taxable Gain Recognized = $16,667

Therefore, the taxable gain that Tim will recognize in year three is:

Taxable Gain = $10,000 - $16,667
Taxable Gain = -$6,667

This means that Tim will actually have a loss in year three since the taxable gain from years one and two was greater than the installment payment received in year three. The correct answer is therefore B.

Tim Sells Land to Brad for $90,000