Question

An asset was purchased three years ago for \(120,000. It falls into the five-year category for MACRS depreciation. The firm is in a 35 percent tax bracket. Compute the following:

a. Tax loss on the sale and the related tax benefit if the asset is sold now for \)15,060.

b. Gain and related tax on the sale if the asset is sold now for $56,060. (Refer to footnote 4 in the chapter.)

Short answer

The tax loss on the sales is $19,500and the tax benefit will be $6,825. The gain on sale will be $21,500and the tax obligation will be $7,525

Step-by-step solution

Computation of Book value

Year	Depreciation Base ($)	Rate (Table 12-9)	Annual Depreciation ($)
1	120,000	0.200	24,000
2	120,000	0.320	38,400
3	120,000	0.192	23,040

$\begin{array}{rcl}\mathbf{BookValue}& \mathbf{=}& \mathbf{PurchasePrice}\mathbf{-}\mathbf{TotalDepreciationtodate}\\ & \mathbf{=}& \mathbf{120}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{85}\mathbf{,}\mathbf{440}\\ & \mathbf{=}& \mathbf{\$}\mathbf{34}\mathbf{,}\mathbf{560}\\ & & \end{array}$

Computation of tax loss and the related tax benefit part A

$\begin{array}{rcl}\mathbf{Taxlossonthesales}& \mathbf{=}& \mathbf{BookValue}\mathbf{-}\mathbf{SalesPrice}\\ & \mathbf{=}& \mathbf{34}\mathbf{,}\mathbf{560}\mathbf{-}\mathbf{15}\mathbf{,}\mathbf{060}\\ & \mathbf{=}& \mathbf{\$}\mathbf{19}\mathbf{,}\mathbf{500}\\ & & \end{array}$

$\begin{array}{rcl}\mathbf{TaxBenefit}& \mathbf{=}& \mathbf{Taxlossonthesales}\mathbf{\times }\mathbf{Taxrate}\\ & \mathbf{=}& \mathbf{19}\mathbf{,}\mathbf{500}\mathbf{\times }\mathbf{35}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{6}\mathbf{,}\mathbf{825}\\ & & \end{array}$

Computation of gain and related tax

$\begin{array}{rcl}\mathbf{TaxableGain}& \mathbf{=}& \mathbf{SalesPrice}\mathbf{-}\mathbf{BookValue}\\ & \mathbf{=}& \mathbf{56}\mathbf{,}\mathbf{060}\mathbf{-}\mathbf{34}\mathbf{,}\mathbf{560}\\ & \mathbf{=}& \mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{500}\\ & & \end{array}$

$\begin{array}{rcl}\mathbf{TaxObligations}& \mathbf{=}& \mathbf{Taxgainonthesales}\mathbf{\times }\mathbf{Taxrate}\\ & \mathbf{=}& \mathbf{21}\mathbf{,}\mathbf{500}\mathbf{\times }\mathbf{35}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{7}\mathbf{,}\mathbf{525}\\ & & \end{array}$