Tax depreciation shelters a portion of annual operating income from taxation. However, the amount of cumulative...

Tax depreciation shelters a portion of annual operating income from taxation. However, the amount of cumulative tax depreciation is taxed when the property is sold. Suppose that your taxes due on sale will be $35,000 greater than if the property had not been depreciated. If the sale were to occur five years from now, determine the present value of the tax on depreciation recapture in the year of sale assuming a discount rate of 9.5%.
A) $31,963
B) $22,233
C) $55,098
D) $134,390

Given the following information, calculate the straight-line depreciation rate for the second year: cost recovery period: 27½ years, date of purchase: June 12th.
A) 1.67%
B) 3.63%
C) 1.97%
D) 20.0%

Suppose that you are able to generate an annual depreciation deduction of $20,000 that would otherwise have been taxed at a 30% rate each year for seven years. Suppose that your taxes due on sale in year 7 will be $32,000 greater than if the property had not been depreciated. Determine the net benefit of depreciation assuming a discount rate of 6.5%.
A) $53,499
B) $32,907
C) $20,592
D) $12,315

Expert Solution

1.PV of tax on depreciation recapture in the year of sale (year 5)=PVIFA(9.5%,5years)*$35,000=3.839709*$35000=$134,390.

YEAR	PV of [email protected]% Annual discounting

1	0.913242009
2	0.834010967
3	0.761653851
4	0.695574293
5	0.635227665
	3.839708787

2. Yearly straight line depreciation from year 2 onwards=100%/cost recovery period=100%/27.5=3.63%

3. PV of tax savings on depreciation of 20,000 per 7 year is given :-

Year	yearly depreciation	Tax Savings @30%	PV of [email protected]% discounting	PV of tax savings
1	20,000	$ 6,000.00	0.938967136	$ 5,633.80
2	20,000	$ 6,000.00	0.881659283	$ 5,289.96
3	20,000	$ 6,000.00	0.827849092	$ 4,967.09
4	20,000	$ 6,000.00	0.777323091	$ 4,663.94
5	20,000	$ 6,000.00	0.729880837	$ 4,379.29
6	20,000	$ 6,000.00	0.685334119	$ 4,112.00
7	20,000	$ 6,000.00	0.643506215	$ 3,861.04
				$ 32,907.12

PV of additional tax due on sale ,$32,000 in 7th year=$32000*PVIF(6.5%,5)=$32,000*0.643506215=$20,592.20

Net benefit of depreciation=$32,907.12-$20,592.20=$12,315.

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