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 determine the effect of gains and losses on Brandon's tax liability, we must first identify the type of gain or loss. The gains and losses on assets sold should be classified as either §1231 gains/losses or ordinary gains/losses.

- Machinery:

The machinery is a §1231 asset because the asset was held for longer than one year and was used in Brandon's trade or business. The gain on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$30,000 - ($30,000 - $7,000) = $10,000 §1231 gain

- Land:

The land is also a §1231 asset because it was held for longer than one year and was used in Brandon's trade or business. The gain on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$20,000 - $40,000 = ($20,000) §1231 loss

The loss on the land is subject to special treatment under the tax code. If a taxpayer has a net §1231 loss for the year (i.e. more losses than gains), the net loss is treated as an ordinary loss. If there is a net §1231 gain for the year (i.e. more gains than losses), the net gain is treated as a capital gain. In this case, since there is only one §1231 gain and one §1231 loss, the net §1231 gain is $10,000 - $20,000 = ($10,000). Therefore, the net loss is treated as an ordinary loss.

- Building:

The building is also a §1231 asset because it was held for longer than one year and was used in Brandon's trade or business. The loss on this asset is calculated as follows:

Sales Price - Adjusted Basis = Gain/Loss
$0 - ($90,000 - $20,000) = ($70,000) §1231 loss

Therefore, in total, Brandon has a net §1231 loss of ($10,000) + ($70,000) = ($80,000).

Brandon has an additional $5,000 of §1231 losses carried forward from previous years. Therefore, Brandon's total net §1231 losses for tax purposes is ($85,000). This net loss is treated as an ordinary loss and can be used to offset ordinary income.

Brandon also has $0 of ordinary income in the current year ($25,000 - $25,000). Therefore, his taxable income is the same as his ordinary income, which is $0.

Finally, we need to calculate Brandon's tax liability on his ordinary income. Brandon's marginal ordinary income tax rate is 35 percent. Therefore, his tax liability on $0 of ordinary income is also $0.

Therefore, combining the net loss on §1231 assets with the lack of ordinary income, Brandon's tax liability for this year is $0. The only answer choice that matches this 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