Ethan, a sole proprietor, sold the following assets in 2018: The equipment was purchased several years ago but the XYZ stock was purchased as an investment on 3/9/18 and was sold on 11/15/18. Ethan is in the 32% marginal tax bracket for 2018. At the beginning of 2018, he had $2,000 of unrecaptured Section 1231 losses from 2 years ago. How much additional tax will Ethan pay as a result of these transactions?

Question

Ethan, a sole proprietor, sold the following assets in 2018:  The equipment was purchased several years ago but the XYZ stock was purchased as an investment on 3/9/18 and was sold on 11/15/18. Ethan is in the 32% marginal tax bracket for 2018. At the beginning of 2018, he had $2,000 of unrecaptured Section 1231 losses from 2 years ago. How much additional tax will Ethan pay as a result of these transactions?

Quizplus · Accepted Answer

To find the taxable gain on each asset sold:

- Truck: $8,000 - $4,000 = $4,000
- Computer: $4,000 - $2,000 = $2,000
- XYZ stock: $15,000 - $12,000 = $3,000

The total taxable gain from the sales is $4,000 + $2,000 + $3,000 = $9,000.

The equipment is a Section 1231 asset, so we need to determine whether it results in a gain or loss for the year:

- $4,000 gain on sale of truck
- $2,000 gain on sale of computer
- Depreciation of $1,000 on equipment during the year

Total Section 1231 gains: $4,000 + $2,000 - $1,000 = $5,000

Since this is a net gain, we need to compare it to any prior unrecaptured Section 1231 losses. Ethan had $2,000 of unrecaptured losses from 2 years ago, so we can offset $2,000 of the current gain. This leaves a net Section 1231 gain of $5,000 - $2,000 = $3,000.

The gain on the XYZ stock is a capital gain, and since Ethan held it for less than a year, it is a short-term capital gain. Short-term capital gains are taxed at ordinary income tax rates, so Ethan will pay tax on the $3,000 gain at his marginal rate of 32%.

The total additional tax Ethan will pay is:

- $9,000 of taxable gains at 32% = $2,880
- $3,000 short-term capital gain at 32% = $960

The total additional tax is $2,880 + $960 = $3,840.

However, since Ethan had $2,000 of unrecaptured Section 1231 losses from 2 years ago, he can offset $2,000 of the current Section 1231 gain. This reduces his tax liability by $2,000 x 32% = $640.

Therefore, the total additional tax Ethan will pay is $3,840 - $640 = $3,200, which is closest to answer choice C: $2,390.

Ethan, a Sole Proprietor, Sold the Following Assets in 2018