Question

Steven sells land at a cost of $100,000 for $350,000 on August 14, 2017. The land was originally purchased on February 2, 1983. The buyer has offered to pay $100,000 down and pay the balance next year plus interest of 5%.

A. If Steven's after-tax rate of return on his investments is normally 6%, determine whether he would be better off receiving installment payments or cash. Assume his income tax rate 28% for ordinary income and 15% for long-term capital gains.

B. How much gain does Steven report in year 2 (assuming Steven uses the installment method)

Answer 1

		Sale value of land on 14 /08/2017	$350,000
		Purchase cost of land on 2/02/1983	$100,000
		Offer from Buyer
		downpayment	$100,000
		Balance with 5% interest next year	$262,500
		( 250000+ 5%*250000)
	A.	IF installment offer accepted
			Amount		Time	PVF@ 6%	Present Value
		Downpayment recived	$100,000		0	1	$100,000
		Incremental Income
		Interest Income	$12,500
		( 250000*5%)
		Tax @28%	$3,500
		Net interest income after tax	$9,000		1	0.94	$8,491
		Instalment Received after 1year	$250,000		1	0.94	$235,849
							$344,340
		IF received Cash offer accepted then received $350000 today
		Hence it's better to revived cash today
	B.	Comutation of gain
		Sale value	$350,000
		cost	$100,000
		gain	$250,000
		capital gain tax @ 15%	$37,500
		Net gain on sale of property	$212,500
		Interest income earned in next year	$12,500