XYZ Company (C Corp) sold a business asset with an $80,000 adjusted tax basis for $100,000 in June of the current year. The purchaser paid $30,000 in cash and gave XYZ a note for the $70,000 balance of the price. In December, XYZ received a $10,000 principal payment on the note and an $4,000 interest payment. Compute XYZ's gain recognized under the installment sale method.

Question

XYZ Company (C Corp) sold a business asset with an $80,000 adjusted tax basis for $100,000 in June of the current year. The purchaser paid $30,000 in cash and gave XYZ a note for the $70,000 balance of the price. In December, XYZ received a $10,000 principal payment on the note and an $4,000 interest payment. Compute XYZ's gain recognized under the installment sale method.

BlackTom AI · Accepted Answer

To tackle this, I’ll lay out the scenario and then evaluate each answer choice before identifying the logic that points to the correct result.
First, determine the gross profit on the sale: selling price (100,000) minus adjusted tax basis (80,000) equals 20,000. This 20,000 is the gross profit that would be allocated over the installment payments.
Option A: 2,000. This would imply that only a very small portion of the gross profit was recognized. Under the installment method, the recognized gain in a given year equals gross profit multiplied by the ratio of cash (and any payments) received during that year to the total contract price. Since some cash was indeed collected this year, 2,000 would require a much smaller collection base (e.g., only 10% of total price) than what actually occurred, making 2,000 inconsistent with the facts.
Option B: 8,000. This aligns with the standard installment method calculation. The payments received during the year total 40,000: 30,000 at the time of sale and 10,000 later in December. The gross profit is 20,000, and 40,000 is 40% of the total contract price (100,000). Multiply 20,000 by 0.40 to get 8,000 of gain recognized in the year. The remaining 12,000 of gross profit would be recognized as other payments are collected in future periods, and any interest received (4,000) is taxed as ordinary interest income, not as part of the installment gain.
Option C: 20,000. This would imply that the entire gross profit is recognized in this year, which cannot be the case under the installment method unless all payments were received in the year and there were no separation of principal and interest. Here, payments occurred in multiple occurrences, and only a portion of the gross profit is recognized this year.
Option D: 40,000. This would exceed the gross profit (20,000) and would also not be consistent with how the installment method allocates profit; you can’t recognize more than the total gross profit from the sale as guitar of the installment mechanism. Moreover, 40,000 represents total cash received this year (including what was received at sale and the December payment) but the gain recognized is limited to the gross profit portion, not the total cash collected.
Additional nuance: the 4,000 interest payment is separate from the gain calculation under the installment method; it is treated as interest income rather than as part of the gain on the sale. The installment gain calculation focuses on the proportion of the gross profit (20,000) that corresponds to the proportion of the contract price collected in the year (40,000 out of 100,000), which yields 8,000.
In summary, evaluating the options against the mechanics of the installment sale method shows that 8,000 correctly reflects the year’s recognized gain based on cash collections relative to the total contract price, with interest recognized separately.

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