Question

Three years ago you bought a machine for $1,000. You expected to use it for 10 years, and you have been depreciating it over a 10-year life using the straight-line method and an expected salvage value of $0. It is now Time 3, and you are going to sell the machine. What is the tax consequence for each of the possible sales prices below? The ordinary income tax rate is 25%, and the capital gains tax rate is 20%.

1. What is the tax consequence if you sell it for $800?
2. What is the tax consequence if you sell it for $500?
3. What is the tax consequence if you sell it for $700?
4. What is the tax consequence if you sell it for $1,300?

Answer 1

At the end of time 3, 3 years depreciation would have been charged amounting to $300 (100 per year)

Thus, the book value of machien would be $700.

A) If sold for $800, there would be a profit of $100 and captial gain tax of (100*20%) = $20 would have to be paid.

B) If sold for $500, there would be a loss of $200, and tax shield of (200*25%) = $50 would be received.

C) if sold for $700, there would be no profit or loss hence no tax impact.

D) If sold for $1,300 there would be a gain of $600, capital gain tax of (600*20%) = $120 would have to be paid,