Brandon, an individual, began business four years ago and has sold §1231 assets with $5,000 of losses within the last 5 years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: $$\begin{array} { | l | r | r | r | }
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r }
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Land } & 40,000 & 0 & 20,000 \
\hline \text { Building } & 90,000 & 20,000 & ( 5,000 ) \
\hline
\end{array}$$ Assuming Brandon's marginal ordinary income tax rate is 35 percent, what effect do the gains and losses have on Brandon's tax liability?

Question

Brandon, an individual, began business four years ago and has sold §1231 assets with $5,000 of losses within the last 5 years. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: $$\begin{array} { | l | r | r | r | } 
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r } 
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Land } & 40,000 & 0 & 20,000 \
\hline \text { Building } & 90,000 & 20,000 & ( 5,000 ) \
\hline
\end{array}$$ Assuming Brandon's marginal ordinary income tax rate is 35 percent, what effect do the gains and losses have on Brandon's tax liability?

Quizplus · Accepted Answer

To start, we need to calculate the total gains and losses for the year. The gain/loss column already has the values we need. The machinery was sold at a gain of $10,000, the land was sold at a gain of $20,000, and the building was sold at a loss of $5,000.

Total gains: $10,000 + $20,000 = $30,000
Total losses: $5,000

Since the total gains exceed the total losses, we have a net §1231 gain of $25,000.

Next, we need to determine whether the net gain is treated as ordinary income or §1231 gain. To do this, we look at the gains and losses over the last five years. Brandon has had $5,000 of net §1231 losses within the last five years, so the current year's net gain of $25,000 is treated as long-term capital gain, a type of §1231 gain.

Now we can calculate the tax liability. The §1231 gain is taxed at a maximum rate of 20 percent, and the ordinary income is taxed at a maximum rate of 35 percent.

§1231 gain: $25,000 × 20% = $5,000 
Ordinary income: ($10,000 - $7,000) + ($20,000 - $0) + ($90,000 - $20,000 - $5,000) = $48,000 × 35% = $16,800

Total tax liability: $5,000 + $16,800 = $21,800

However, since the building was sold at a loss, there is an additional ordinary loss of $5,000.

Revised total ordinary income: $48,000 - $5,000 = $43,000 
Revised total tax liability: ($10,000 - $7,000) + ($20,000 - $0) + ($90,000 - $20,000) + ($5,000) = $88,000 × 35% = $30,800

Therefore, the answer is C: $13,000 §1231 gain, $12,000 ordinary income, and $6,150 tax liability.

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