Brandon, an individual, began business four years ago and has sold §1231 assets with $5,950 of losses within the last five years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: Assuming Brandon's marginal ordinary income tax rate is 32 percent, what effect do the gains and losses have on Brandon's tax liability? Use dividends and capital gains tax rates for reference.

Question

Brandon, an individual, began business four years ago and has sold §1231 assets with $5,950 of losses within the last five years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets:  Assuming Brandon's marginal ordinary income tax rate is 32 percent, what effect do the gains and losses have on Brandon's tax liability? Use dividends and capital gains tax rates for reference.

Quizplus · Accepted Answer

First, we need to calculate Brandon's net §1231 gains and losses in the last five years, since this will determine whether the current gains will be treated as ordinary income or capital gains (subject to lower tax rates). Brandon has $5,950 of net §1231 losses, which means that any current §1231 gains will be treated as ordinary income.

Next, we calculate Brandon's gains and losses for the current year:

Gain on building: $225,000 sale price - $180,000 adjusted basis = $45,000 long-term capital gain
Loss on equipment: $20,000 sale price - $25,000 adjusted basis = $5,000 loss
Gain on land: $120,000 sale price - $100,000 adjusted basis = $20,000 long-term capital gain

The net result is $60,000 in total gains and $5,000 in total losses, for a net gain of $55,000. Since this includes $20,000 in §1231 gains, which will be treated as ordinary income due to Brandon's prior losses, we have:

§1231 gain = $20,000 ordinary income
Long-term capital gain = $45,000

We can now calculate Brandon's tax liability. The ordinary income will be subject to his marginal ordinary income tax rate of 32 percent, while the long-term capital gain will be subject to the lower capital gains tax rate of 15 percent.

§1231 gain:
$20,000 x 0.32 = $6,400

Long-term capital gain:
$45,000 x 0.15 = $6,750

Total tax liability:
$6,400 + $6,750 = $13,150

However, we need to factor in the $5,000 of net losses from the current year, which can be used to offset other income. This means we only need to pay taxes on $50,000 in net gains, resulting in a final tax liability of:

($20,000 + $50,000) x 0.32 + $6,750 = $14,850 ordinary income, $1,600 §1231 gain, $4,992 tax liability.

Therefore, choice C is correct.

Brandon, an Individual, Began Business Four Years Ago and Has