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Capital gains, depreciation recapture, and losses

Income Taxes

Capital gains, depreciation recapture, and losses

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A capital gain occurs when an asset is sold for more than its original cost basis. The difference between the selling price (market value, MV) and the cost basis (B) is the amount of the capital gain. Currently capital gains realized by corporations are taxed as ordinary income. Note that the IRS rules regarding the taxation of capital assets changes from time to time. Be sure to check with the IRS or a tax advisor when this may be important.

When a capital gain occurs for a depreciable asset, the difference between the cost basis and book value, BV, is taxed as depreciation recapture. This is important because the tax rates for ordinary income such as depreciation recapture and capital gains may be different.

When an asset is sold for more than the book value but less than the basis, the amount over book value is called depreciation recapture and is treated as ordinary income in that year.

Capital gains are rare in engineering economic analysis because the assets of interest typically lose market value over project life.

If a non-depreciable asset is sold at a market value less than its original cost basis, the difference is treated as a capital loss. When calculating income tax, corporations may use capital losses to offset capital gains in the current year or, if necessary, in a limited number of previous years, or, if necessary, carried forward to offset capital gains in a limited number of future years.

More detailed information on capital gain "carry back" and "carry forward" is available from the IRS.

Income Taxes

Capital gains, depreciation recapture, and losses

Question 1

Question 2

Question 3

Return to Capital gains and losses

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Question 1.

A corporation with a federal income tax rate of 34% bought a tract of land for $340,000, strictly as an investment. Three years later the land is sold for $485,000.

What capital gains tax results from the sale of this land?

Choose an answer by clicking on one of the letters below, or click on "Review topic" if needed.

A There is no capital gain. Tax = $0

B The capital gain is not taxed because the asset was held for at least 18 months. Tax = $0

C $49,300

D $164,900

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Question 2.

A corporation with a federal income tax rate of 38% placed a depreciable asset in service at a cost basis of $34,000. After five years of use, the asset is sold for $5,000. At that point the asset's book value is $6,000.

Which statement below correctly gives the federal income tax due as a result of asset disposal?

Choose an answer by clicking on one of the letters below, or click on "Review topic" if needed.

A There is no capital gain or loss, and no depreciation recapture. There is an ordinary income loss of $1,000, which will reduce the corporation's federal income taxes by $380.

B The capital loss of $29,000 has no effect on income taxes.

C The depreciation recapture of $1,000 will increase the corporation's income taxes by $380.

D The capital gain of $6,000 will increase the corporation's income taxes by $2,280.

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Question 3.

A corporation with a federal income tax rate of 34% placed a depreciable asset in service at a cost basis of $10,000. After two years of use, it was sold for $14,000 because the asset was in short supply. When sold, the asset had a book value of $6,400.

Which statement below correctly gives the federal income tax due as a result of asset disposal?

Choose an answer by clicking on one of the letters below, or click on "Review topic" if needed.

A The capital gain of $7,600 is taxed at 20%, resulting in a tax due of $1,520.

B Both the capital gain of $4,000 and the depreciation recapture of $3,600 are taxed at 34%, resulting in a tax due of $2,584.

C The capital loss of $4,000 can be used to offset capital gains the company realizes through disposal of other assets.

D The ordinary income of $14,000 is taxed at 34%, resulting in a tax due of $4,760.

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