Sany is considering selling an old machine and replacing it with higher capacity machine. Sany purchased the old machine for $1,000,000 3 years ago. The old asset is being depreciated via the straight-line method to a salvage value of $0 assuming a 5-year useful life.

If Sany can sell the machine for $200,000 today, what are the tax implications from the sale of this old asset? Assume that the tax rate is 40%.

Question

Sany is considering selling an old machine and replacing it with higher capacity machine. Sany purchased the old machine for $1,000,000 3 years ago. The old asset is being depreciated via the straight-line method to a salvage value of $0 assuming a 5-year useful life.

If Sany can sell the machine for $200,000 today, what are the tax implications from the sale of this old asset? Assume that the tax rate is 40%.

BlackTom AI · Accepted Answer

We start by identifying the key numbers for depreciation and book value.
- Cost of old machine: 1,000,000
- Useful life for depreciation: 5 years, salvage value: 0
- Annual depreciation (straight-line): (Cost - Salvage) / Life = (1,000,000 - 0) / 5 = 200,000 per year
- Years elapsed: 3
- Accumulated depreciation after 3 years: 3 × 200,000 = 600,000
- Book value now: Cost - Accumulated depreciation = 1,000,000 - 600,000 = 400,000

Next, compare sale price to book value to determine gain or loss on sale.
- Sale price today: 200,000
- Book value: 400,000
- Loss on sale: Book value - Sale price = 400,000 - 200,000 = 200,000

Tax implications of a loss on sale: a realized loss reduces taxable income, creating a tax shield equal to the loss amount times the tax rate.
- Tax rate: 40%
- Tax shield: 200,000 × 0.40 = 80,000

Now evaluate the given options:
- Option A: tax shield of 80,000 — This matches the calculated tax shield from the 200,000 loss at 40% tax rate, so it is correct.
- Option B: tax shield of 160,000 — This would imply a loss of 400,000 or a higher tax rate, which is not consistent with the numbers (the loss is 200,000 and the rate is 40%).
- Option C: tax liability of 160,000 — A liability would occur if there were a gain rather than a loss; here we have a loss, resulting in a shield, not a liability.
- Option D: tax shield of 320,000 — This would require a loss of 800,000 at 40%, which does not align with the actual loss of 200,000.

Putting it together, the correct implication is a tax shield equal to 80,000, arising from the 200,000 loss on sale times the 40% tax rate.

MSB-250-300-002 Topic 12 Quiz

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