A firm is selling an existing asset for $5,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is ________.
A) $0 tax liability
B) $1,320 tax liability
C) $1,160 tax liability
D) $2,000 tax benefit

Question

Quizplus · Accepted Answer

The tax effect is calculated based on the difference between the sale price and the book value of the asset, taking into account depreciation. Under MACRS for a five-year recovery period, the asset would be fully depreciated over its life. However, after four years, it would not yet be fully depreciated. The cumulative depreciation percentage for four years under MACRS for a 5-year property is approximately 88%. Thus, the depreciated value is $10,000 * 88% = $8,800. The book value then is $10,000 - $8,800 = $1,200. Selling the asset for $5,000 results in a gain of $5,000 - $1,200 = $3,800. The tax on this gain at 40% is $3,800 * 40% = $1,520. However, the correct calculation involves the specific MACRS depreciation percentages and might involve more precise figures not provided in the question. Given the options, the closest to the expected calculation based on the provided information and typical tax implications would be a tax liability, but the exact number provided in the choices might not directly align with the explanation due to a lack of specific depreciation percentages or a possible typo in the question's choices. The principle, however, involves calculating the gain and applying the tax rate to find the tax liability.

A Firm Is Selling an Existing Asset for $5,000