Question

There are four ways tax consequences may affect the after-tax net proceeds received from the sale of an asset. Describe the four ways and the tax impact in paragraph and examples in detail.

Answer 1

When the assets are sold the net proceeds are subject to tax in different ways based on the sales value. The following are the four ways of tax impact on the after-tax net proceeds received from the sale of an asset:

1. When the sales value of the asset is equal to the tax book value of the asset: In this case there will be no tax consequences for the net proceeds because; there is no gain or loss from the sale of the asset. For example, the original cost of the asset 50000, tax book value 45000, and sales value 45000. There is no tax liability
2. If the sales value is less than the tax book value of the asset: In this case, there is a loss from the sales. This loss will reduce the total tax liability of the person by considering it as an operating loss. For example, the original cost of the asset 50000, tax book value 45000, sales value 43000. Amount of loss is 2000
3. The third situation for tax consequence is when the sales value is an amount which is more than the tax book value but less than the original cost of the asset. In this case, the amount equal to the book value does not have tax liability. But the amount in excess of book value will be taxed by treating it as an operating profit from sale. For example, the original cost of the asset 50000, tax book value 45000, sales value 47000. The tax liability is for 2000
4. The sales proceeds will have another way of tax liability when the sale is for an amount which is more than the original cost of the asset. The difference between the book value and original cost of the asset will be treated as operating income and will be taxed. The amount in excess of the original cost will be treated as capital gain and will be taxed. But the operating income and capital gain will be taxed in different tax rates. For example, the original cost of the asset 50000, tax book value 45000, sales value 53000. Operating income is 5000. Capital gain is 3000.