On August 31, 2007, Dan Brown sold his land to Trident Inc. for $800,000. Dan has bought the land thirty years ago for $61,598. The terms of the sales contract call for a 20% down payment, a monthly payment of $5000 at 8.5% interest on the first of each month and a final balloon payment of $605,260 on September 1, 2012.
On May 2, 2011, the president of Trident Inc. called Dan and said since the land had devalued, Trident is unable to pay the balloon payment. However, Trident will consider a settlement payment of $200,000 in lieu of the remaining $5000 monthly payments and the final balloon payment.
Dan called you for help. He is potentially suffering a $400,000 loss and would like you to amend his prior tax returns.
As Dan's trusted CPA, how would you advise Dan?
In support of your analysis, you should prepare a brief memo for your files considering all of the following points:
1. Is there a cancellation of debt issue for Trident Inc.?
2. As the sale was on an installment basis, each year, capital gains and interest were reported on Dan's tax returns. Could you amend Dan's prior year tax returns? Please cite your reference.
3. Calculate the original gross profit percent.
4. Using the appended amortization table, prepare a schedule showing how much capital gains have been reported from 2007 to May 1, 2011.
5. Calculate the remaining basis of the installment note as of May 2, 2011.
6. Calculate the gain and loss on the settlement.