Chapter 17 1 Tax Consequences of Personal Activities McGraw-Hill Education McGraw-Hill/Irwin Copyright 2015 by McGraw-Hill Education. All rights reserved. 2007 The McGraw-Hill Companies, Inc., All Rights
17-2 Objectives Identify personal receipts that are taxable income Describe the tax consequences of divorce settlements Identify personal expenses and losses that result in itemized deductions Describe the tax treatment of revenues and expenses from a hobby Compute the itemized deduction for home mortgage interest Describe the preferential treatment of gain from the sale of a personal residence Identify itemized deductions that are limited or disallowed for AMT purposes
17-3 Gross Income Section 61 states that gross income means all income from whatever source derived even income from personal activities 17-4 Gratuitous Receipts Prizes and awards are included in gross income Scholarships are excluded to
extent spent on: Tuition, books, fees, equipment required by institution Gifts, inheritances, and life insurance death benefits are excluded from gross income 17-5 Legal Settlements and Government Payments Legal settlements are included in gross income unless compensation for physical injury or illness Workers compensation is excluded
Unemployment compensation is included Need-based payments such as welfare and food stamps are excluded Social Security: 85%, 50%, or 0% included in gross income depending on income level 17-6 Application Problem 1 Marcy Tucker received the following items. Determine to what extent each item is included in gross income. $25,000 cash gift from her parents
$500 cash award from the local Chamber of Commerce for her winning entry in a contest to name a new public park $8,000 alimony from her former husband $100,000 cash inheritance from her grandfather 17-7 Divorce Property settlements are nontaxable Transferred property takes a carryover basis
Alimony is taxable to the recipient, deductible above-the line by the payer Child support is neither taxable nor deductible 17-8 Divorce Example Ted and Alice divorced on July 1. In the property settlement, Ted transferred one-half ownership of their home (FMV $250,000) to Alice. Ted will pay $450 per month alimony and $800 per month child support Tax consequences to Ted? No deduction for property transfer or payment of child support. Ted has a $2,700 ($450 x 6 months) above-the-line deduction for
payment of alimony Tax consequences to Alice? No income from the receipt of property or child support. Alice recognizes $2,700 ordinary income from receipt of alimony 17-9 Personal Use Assets and Personal Expenses Personal use assets Personal use assets may not be depreciated Gains on sale are capital gain Losses on sale are not deductible
No deduction is allowed for personal, living, or family expenses except for: Medical expenses Certain taxes Home mortgage interest Charitable contributions 17-10
Personal Expenses - Medical Taxpayers may deduct the excess of unreimbursed expenses over 10% of AGI as an itemized deduction 10% decreased to 7.5% for taxpayer age 65 or older Qualifying medical expenses include:
Clinics, hospitals, long-term care facilities Medical aids (e.g., hearing aids, crutches) Prescription drugs Medical insurance premiums Doctors, dentists, chiropractors 17-11 Medical Expenses Example Sam, age 42, incurred the following unreimbursed expenses
Health insurance premiums Prescription drugs Hospital bills Doctor bills Wheelchair Diet food and pills, non Rx $2,200 600 2,000 900
100 250 If Sams AGI is $55,000, compute his medical expense deduction $5,800 ($55,000 x 10%) = $300 17-12 Personal Expenses - Taxes Individuals are allowed an itemized deduction for: Real or personal property taxes paid on nonbusiness assets Either state and local sales taxes or state and local
income taxes Costs of tax compliance (e.g. tax preparation fees) are miscellaneous itemized deductions 17-13 Personal Expenses Charitable Contributions General limit Itemized deduction limited to 50% of AGI for cash donation (less for capital assets) Carryover excess as an itemized deduction for 5 years Deduction amount LT capital assets = FMV of property
Other property = lesser of FMV or basis 17-14 Charitable Contribution Example Mrs. Bain gave the following to charity this year Antiques (owned 15 years; cost $50,000; FMV $125,000) Painting (owned 9 months; cost $25,000; FMV $27,000) Compute Mrs. Bains itemized deduction for charitable contributions before AGI limitation $125,000 (FMV of antiques) + $25,000 (basis of painting) = $150,000 deduction
17-15 Tax Subsidies for Education EE Savings Bonds Deduction for qualified tuition and fees Deduction for interest on qualified education loans American Opportunity Credit Lifetime Learning Credit Qualified tuition programs Coverdell education savings accounts 17-16 Casualty Losses
Casualty and theft losses Loss equals lesser of adjusted basis or decline in FMV of property resulting from casualty or theft Loss reduced by insurance reimbursement Loss in excess of $100 floor per casualty is deductible Deduction limited to excess of aggregate losses over 10% AGI 17-17
Hobby and Gambling Losses Activity not entered into for profit (hobby) Revenue included in gross income Expenses are miscellaneous itemized deductions limited to revenue from hobby If the activity generates a profit in 3 of 5 years, IRS presumes it is a business and losses are deductible Gambling losses Itemized deduction but not miscellaneous Limited to gambling winnings 17-18
Home Mortgage Interest Qualified residence interest is itemized deduction Interest on acquisition debt up to $1 million Interest on home equity debt up to $100,000 Deduction for mortgage on principal residence and one other personal residence 17-19 Vacation Home Rental Residence is subject to vacation home rules if owners days of personal use exceed greater of 14 days or 10% of rental days
Expenses attributable to rental days are deductible to extent of rental revenues Vacation home rental cant generate a net loss deductible against other income Nondeductible loss carries forward 17-20 Gain on Sale of Principal Residence $250,000 exclusion of gain on sale of home Owner must have used the home as a principal residence for two years out of five years ending on date of sale Exclusion doubled to $500,000 for MFJ Exclusion applies to only one sale in a two-year period
Owners who sell a home but dont satisfy above requirements may be eligible for reduced exclusion if sale was necessitated by: Change of employment Health reasons Unforeseen circumstances 17-21 Itemized Deductions as AMT Adjustments Medical deductions are allowed only to the extent they exceed 10% AGI Deductions for state and local taxes are disallowed
Miscellaneous itemized deductions are disallowed Interest on home equity debt is disallowed 17-22
