Question

An in-place machine with B = $140,000 was depreciated by using Modified Accelerated Cost Recovery System (MACRS) over a 3-year period. The machine was sold for $60,000 at the end of year 2 when the company decided to import the item that required the use of the machine. In year 2, gross income (GI) = $1 million and operating expenses (OE) = $500,000. Determine the tax liability in year 2 if T_e = 35%.

Answer 1

Assuming a 3-year property class was used in MACRS,

MACRS depreciation, year 1 = $140,000 x 33.33% = $46,662

MACRS depreciation, year 2 = $140,000 x 44.45% = $62,230

Book value at end of year 2 ($) = 140,000 - 46,662 - 62,230 = 31,108

Gain from sale of machine at end of year 2 ($) = 60,000 - 31,108 = 28,892

Net income in year 2 ($) = GI - OE + Gain from sale of machine** = 1,000,000 - 500,000 - 28,892 = 471,108

Tax liability ($) = Net income x Tax rate = 471,108 x 35% = 164,887.80

**Depreciation being an operating expense, the year-2 depreciation is already included within OE for year 2.