Question

Consider the following two scenarios. The taxpayer sells the property acquired in April 2019 for $800,000 (rental real estate, 27.5 year depreciation) on December 31, 2019 or December 31, 2020 for $1,000,000. Assume the taxpayer is in the 37 percent tax bracket.

Scenario 1. Sale on 12/31/19

Scenario 2. Sale on 12/31/20

1. What is the gain on sale? Show calculations.

2. What kind of gain is this? Ordinary, Capital, or Section 1231? Explain why

3. Based on your answers above, calculate the tax owed on the gain.

Answer 1

PART – 1)

Depreciation from Apr 2019 to Dec 2019 = $800,000*2.576%

                                                                   = $20,608

Thus,

Book value on 31^st Dec, 2019 = $800,000 – $20,608

                                                 = $779,392

Gain = $1,000,000 – $770,392

         = $220,608

It is classified as short term capital gain because the asset is sold before completing one year.

PART – 2)

Book value on 31^st Dec, 2020 = $800,000 – $20,608 – ($800,000*3.636%)

                                                 = $800,000 – $20,608 – $29,088

                                                 = $750,304

Gain = $1,000,000 – $750,304

         = $249,696

It is classified as long term gain because the asset is sold almost after 2 years i.e. after the completion of one year.

PART – 3)

Tax owed in scenario 1 = Gain*tax rate

                                      = $220,608*37%

                                      = $81,624.96

                                      = $81,625 (approx.)

Tax owed in scenario 2 = (Sale price – Cost)*20% rate of capital gain + [Capital gain – (Sale price – Cost)]*37%

= [($10,000,000 – $800,000)*20%] + [$249,696 – ($10,000,000 – $800,000)]*37%

= ($200,000*20%) + ($49,696*37%)

= $40,000 + $18,387.52

= $58,387.52

= $58,388 (approx.)