Question

Cobra Inc. sold stock for a​ $25,000 loss five years ago. It has been carrying over the capital loss for five​ years, and the loss will expire at the end of this year because Cobra has not had any capital gains. Earlier this year Cobra sold a parcel of land held four years for business use and will recognize a​ $30,000 gain. Cobra is thinking about selling some machinery used in its business for the past three years. During this time technology has dramatically changed so Cobra will recognize a​ $32,000 loss on the sale of the machinery. Cobra is trying to decide whether to sell the machinery at

yearminus−end

or early next year. Cobra is profitable and has a consistent marginal tax rate of​ 35%. When should Cobra sell the​ equipment?

A. current​ year, but arrange an installment sale to spread the loss recognition over the two years

B. early next year

C. Current Year

D. Either the current or next year

Answer 1

Case : When the machine is sold in the current year

The Long Term Capital Loss of $25000 setoff with Long Term Capital gain on sale of land $30000, leads to a Capital Gain of Balance $5000, which would be further exhausted in the current year by the capital loss on sale of Equipment worth $32000. The net Capital Loss would be $270000, on which no tax would have to be paid in the current year. And the Capital Loss can be sold carried forward for further 5 years

Case : When the machine is sold next year

The Long Term Capital Loss of $25000 setoff with Long Term Capital gain on sale of land $30000, leads to a Capital Gain of Balance $5000​. On which a marginall Tax rate of 35% would have to paid ---> ($5000*0.35)=$1750

As the sale would be next year the loss of $32000 can be carried forward for further 5 years

Case: When machine is sold in current year, and the installment is spread over the two years

In this case nil tax liability would be incurred in the current year as well as the balance capital loss of the current year would be carried forward for a period of 5 years , and the capital loss of the next year would be carried forward for further 5 years giving the opportunity to setoff in future 6 years.

This case is the most feasible as the company saves the current year tax and also gets the benefit to carry forward the capital loss for rest 6 years.