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Structuring Installment Sales for Tax Purposes

Norman is considering the purchase of some investment land from his neighbor, Robin, a high school math teacher. Robin purchased the land 10 years ago for $6,000. They have agreed on the overall terms of payment of $800 every month for the next three years for a total of $28,800. They have not agreed on how much of each payment is interest and how much is principal. Norman thought that a fair interest rate would be 8 percent, with the rest of each payment allocated to principal. Robin, however, said that he wanted to "give his neighbor a break" and have only 4 percent designated as interest with the rest of each payment allocated to principal.

What difference does it make to Norman and to Robin how much is allocated to interest versus principal if the total of the cash payments will not change?

Which interest rate would be better for Norman?

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Solution Summary

This solution discusses and illustrates the effects on the buyer and seller of varying the terms of an installment agreement.