Brandon, an individual, began business four years ago and has never sold a §1231 asset. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: $$\begin{array} { | l | r | r | r | }
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r }
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Computers } & 10,000 & 6,000 & ( 2,000 ) \
\hline \text { Building } & 90,000 & 20,000 & ( 2,000 ) \
\hline
\end{array}$$ 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 never sold a §1231 asset. Brandon owned each of the assets for several years. In the current year, Brandon sold the following business assets: $$\begin{array} { | l | r | r | r | } 
\hline { \text { Asset } } & \text { Original Cost } & \begin{array} { r } 
\text { Accumulated } \
\text { Depreciation }
\end{array} & \text { Gain/Loss } \
\hline \text { Machinery } & \$ 30,000 & \$ 7,000 & \$ 10,000 \
\hline \text { Computers } & 10,000 & 6,000 & ( 2,000 ) \
\hline \text { Building } & 90,000 & 20,000 & ( 2,000 ) \
\hline
\end{array}$$ 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

Since Brandon has never sold a §1231 asset, all of the assets are treated as ordinary assets. Therefore, the gain on Machinery is treated as ordinary income: $10,000 - ($30,000 - $7,000) = $7,000. The loss on Computers is also treated as ordinary: ($10,000 - $6,000) - $2,000 = $2,000. However, the loss on Building is a §1231 loss: ($90,000 - $20,000) - $2,000 = $68,000, which is treated as a §1231 loss since it is less than the gains. Therefore, the net gain on §1231 assets is $7,000 - $0 + $0 = $7,000. The net gain on ordinary assets is $7,000 - $2,000 = $5,000. Since the marginal tax rate is 35%, the tax liability on the ordinary gain is $5,000 x 0.35 = $1,750. The tax liability on the §1231 gain is $7,000 x 0.28 = $1,960. Therefore, the total tax liability is $1,750 + $1,960 = $3,710, which is closest to $2,100 in choice B.

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