7. Gross profit percentage: Mike sold a 40-acre tract of land for $500,000 on Ja

Question

7. Gross profit percentage: Mike sold a 40-acre tract of land for $500,000 on January 1. The land had an adjusted basis of S300,000. The agreement specified a down payment of $100,000, with the remaining $400,000 sales price to be paid over a five-year-note term at 10% interest. (a) What is the gross profit percentage from the sale? (b) What is the capital gain on the down payment (c) What is the return of capital on the down payment? (d) If Mike received a note payment of $120,000 in the first year, of which $40,000 represented accrued interest, how much of the $120,000 is ordinary income, capital gain and nontaxable return of capital. (8 points)

Explanation / Answer

Calculation of Equated yearly Installments

PVAF(10%,5years)=3.7907

EMI=Amount Pauable/PVAF(10%,5 years)

=$400000/3.7907

=$105521.4

Question a

Gross Profit percentage from the sale

Interest Earned from the Sale =$127592.30

Profit from the Sale is $500000-$300000=$200000

Gross Income=$200000+$127592.30=$327592.30

Net Sale Revenue=$500000

Gross Profit Percentage=Net Income/Sale Value

=$327592.30/$500000

=0.6552

=65.52%

Question b

Capital Gain on Down payment $500000-$300000=$200000

Since the revenue generated during the current year and installments are paid in next years

Question c

The return of Capital on Down payment is $100000 since no amount of Interest is involved in the Down payment totally accounted for capital.

Question d

If Mike received $120000 in 1st Year of which $40000 represents accrued interest.

Ordinary Income is $120000-$40000=$80000

But actually the Principal Involved in first repayment is $65521.40

Hence Capital gain =$80000-$65521.40=$14478.60

Non taxable return of capital in general terms is a distribution of dividend out of capital

and Hence the amount in the Capital gain calculated above is done during start of sale and once again it cannot be Treated as Capital gain.Hence $14478.60 is the non taxable return of Capital.

Calculation of Installments Year Installments Opening principal Outstanding Interest Principal Repayment Closing Principal Balance 0 100000 400000.00 0.00 0.00 400000.00 1 105521.4 400000.00 40000.00 65521.40 334478.60 2 105521.4 334478.60 33447.86 72073.54 262405.06 3 105521.4 262405.06 26240.51 79280.89 183124.17 4 105521.4 183124.17 18312.42 87208.98 95915.18 5 105521.4 95915.18 9591.52 95915.18 0.00 Rounded off

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