Steve Drake sells a rental house on January 1, 2015, and receives $120,000 cash

Question

Steve Drake sells a rental house on January 1, 2015, and receives $120,000 cash and a note for $45,000 at 10 percent interest. The purchaser also assumes the mortgage on the property of $35,000. Steve’s original cost for the house was $180,000 and accumulated depreciation was $30,000 on the date of sale. He collects only the $120,000 down payment in the year of sale. a. If Steve elects to recognize the total gain on the property in the year of sale, calculate the taxable gain. $ c. Assuming Steve collects $5,000 (not including interest) of the note principal in the year following the year of sale, calculate the amount of income recognized in the current year under the installment sale method. Round your answer to the nearest dollar. $

Explanation / Answer

a. Taxable gain in the year of sale:

Written down value of the house :

Total consideration received ( inclusive of mortgage assumed) :

Therefore taxable gain in the year of sale : $1,59,500 - $1,50,000 = $ 9,500.

b. Income recognized in the current year by Instalment sales method :

The installment Method of revenue recognition under the revenue principle deals with sales that require periodic payments over a specified time period usually established within a contract called the installment sales contract.Due to conservative practices in business the installment sales method of accounting finds the gross profit percentage associated with the total sale and recognizes this percentage as gross profit as the periodic or installment payments are received. Therefore, the company does not recover the cost of the goods sold or the gross profit until the last payment has been made by the customer.

Calculation of gross profit % as follows:

Current year income recognized calculation under the Installment Sales method ( assuming interest is collected at the end of the current year) :$ 31,125.

N.B $5,000 note principal collected not considered as the same is to be collected following the year of sale and not in the current year.

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