Tax 4-6 Analyze a situation to calculate the taxable portion of an installment sale. Flashcards
Calculate Tax of Installment Sale
To calculate the taxable portion of an installment sale, it is necessary to first calculate a _____ profit percentage. This is simply the profit (gain) from the sale divided by the contract price, which is typically the sale price of the asset.
(4-6, 39)
gross profit
If the property is sold subject to a mortgage, the amount of the mortgage assumed by the other party reduces the contract price, but never below zero. This gross profit percentage is then multiplied by the payments received during the year to yield the gain recognized, the amount of gain that is taxable during the year.
Calculate Tax of Installment Sale
If Roger Willis had an adjusted basis of $1,500 in a painting and he sold the painting for $2,000, then his profit would be $500. Dividing the profit by the total contract price yields the gross profit percentage, or ratio. In this case, the gross profit was $500 and the contract price was $2,000. What is the gross profit percentage?
(4-6, 39)
25%
$2,000 Sale Price - $1,500 Basis = $500 Profit * $2,000 Sale Price = 25.00% Gross Profit Ratio
Assume that Roger is to receive a $300 down payment in the year of sale, and $425 per year for four years, beginning in the year of sale. In the year of sale, Roger would have a gain of $181.25 (25% of $725 received).
Calculate Tax of Installment Sale
This gross profit percentage is then multiplied by the _____ received during the year to yield the gain recognized, the amount of gain that is taxable during the year.
(4-6, 39)
payments
Calculate Tax of Installment Sale
For property subject to cost recovery recapture, recaptured income must be reported by the taxpayer in the year of disposition. This rule applies even if a payment is not received in the year of disposition. To compute the gross profit percentage, the recaptured ordinary income is added to the taxpayer’s _____ basis, which is used to calculate the remaining profit on the disposition.
(4-6, 39)
adjusted
Calculate Tax of Installment Sale
If John Rogers had an adjusted basis of $15,000 in manufacturing equipment and he sold the equipment for $60,000, then his profit would be $45,000. Assuming that $5,000 of his gain is to be recaptured as ordinary income, the entire $5,000 must be reported as ordinary income in the year of sale. The $5,000 is added to his $15,000 adjusted basis to determine the gross profit percentage. In this case, the gross profit would be…
(4-6, 40)
$40,000, based on a contract price of $60,000.
Thus, $40,000 divided by $60,000 is equal to a gross profit percentage of 66 2/3%.
This means that 66 2/3% of each payment received is reported as gain in the year in which the payment is collected.
Calculate Tax of Installment Sale
Identify the formula for determining the gross profit percentage on installment sales.
(4-6, 74)
Profit
/ Total contract price
= Gross profit percentage
Calculate Tax of Installment Sale
Module Check
Question 6 of 30
The gross profit percentage in an installment sale is calculated by:
a. dividing the gross profit by the contract price.
b. multiplying the payments received by the contract price.
c. dividing the sale price by the number of payments required to be made under the contract.
d. multiplying the marginal income tax bracket by the payments received.
(LO 4-6)
a. dividing the gross profit by the contract price.
Profit
/ Total contract price
= Gross profit percentage
The gross profit percentage in an installment sale is calculated by dividing the gross profit (the sales price minus the adjusted basis) by the contract price.
Calculate Tax of Installment Sale
Module Check
- Barney Herman had an adjusted basis of $15,000 in an antique automobile that he had purchased as an investment. He sold the auto for $45,000. This year, the buyer made a down payment of $12,000 and made the first of three annual installment payments of $11,000.
What amount, if any, of installment sale income must Barney recognize in the current year?
a. $7,334
b. $7,667
c. $15,333
d. $23,000
(LO 4-6)
c. $15,333
$45,000 Sale Price - $15,000 Basis = $30,000 Profit / $45,000 Sale Price = 66.67% Gross Profit Ratio * $23,000 Payment Received = $15,333 Gain Recognized
Calculate Tax of Installment Sale
Module Check
- Cara Irwin has a basis of $6,000 in a classic Mercedes that she purchased several years ago. This year, she sold the Mercedes to a business associate for $18,000. The buyer made the first of six annual installments of $3,000 this year. What is the amount of gain recognized in the current year?
$1,000
$2,000
$3,000
(LO 4-6)
$2,000
Installment Sale Taxation
$18,000 Sale Price - $6,000 Basis = $12,000 Profit / $18,000 Sale Price = 66.67% Gross Profit Ratio * $3,000 Payment Received = $2,000 Gain Recognized
Calculate Tax of Installment Sale
Module Check
- Helen Stewart purchased an antique cabinet as an investment for $30,000 a few years ago. On January 15 of this year, she sold the cabinet to an art museum for $120,000 in an installment sale. She received a down payment of $12,000 and a note requiring monthly principal payments (to begin in March of this year) of $5,000. What amount of gain must Helen recognize for the current year?
$42,500
$46,500
$50,000
$62,000
(LO 4-6)
$46,500
$120,000 Sale Price - $30,000 Basis = $90,000 Profit / $120,000 Sale Price = 75.00% Gross Profit Ratio * $62,000 Payment Received (see below) = $46,500 Gain Recognized
$12,000 down payment \+ (10 × $5,000) = $12,000 \+ $50,000 = $62,000 (payments received)
Practice Test 2
Calculate Tax of Installment Sale
- This year, Randy Myer sold a classic painting to his neighbor, Norm Dibble, under the following terms:
The price was $22,000, equal to the fair market value.
Randy’s basis in the painting was $5,000.
Starting this year, Norm will pay in five annual installments of $4,000 plus accrued interest.
Norm will make a $2,000 down payment.
Ignoring interest income, what amount of gain will Randy recognize for the current year?
$2,000
$3,000
$4,500
$4,636
(LO 4–6)
$4,636
$22,000 Sale Price - $5,000 Basis = $17,000 Profit / $22,000 Sale Price = 77.27% Gross Profit Ratio * $6,000 Payment Received = $4,636 Gain Recognized
- This year, John Scotch sold a rare painting to his neighbor, Ken Meyer, on the following terms:
The price was $6,000, equal to the fair market value. John’s basis in the painting was $4,000. Ken will pay in six annual installments of $1,000 plus accrued interest. Ken made the first installment payment this year.
Ignoring interest income, what amount of gain will John recognize for the current year?
$333
$667
$1,000
$2,000
$6,000
(LO 4-6)
$333
$6,000 Sale Price - $4,000 Basis = $2,000 Profit / $6,000 Sale Price = 33.33% Gross Profit Ratio * $1,000 Payment Received = $333 Gain Recognized
