Decisions – top of page 2 of textbook, Chapter 14. • Will they pay taxes on gain from sale of current home? • Will interest expense on new home be fully deductible? • Should they pay points to get a lower interest rate on the home loan? • What will be the after-tax cost of the loan payments? • Is interest expense on a home-equity loan deductible if loan proceeds are used for personal expenses? • May they deduct interest on loan to buy vacation home? • If they rent out the vacation home for part of the year, how do they account for the related income and expenses for tax purposes? • Are losses from rental of the second home deductible? • Will they deduct expenses relating to Jasmine’s home?
Tax Consequences of Home Ownership • Determine whether a home is a principal residence, a residence (not principal), or a non-residence for tax purposes. • Compute taxable gain on sale of a residence.Explain requirements for excluding gain on the sale. • Determine the amount of allowable interest expense deductions on loans secured by a residence. • Discuss the deductibility of real property taxesDescribe the first-time home buyer credit. • Explain the tax issues and consequences associated with rental use of the home, including determining the deductibility of residential rental real estate losses. • Requirements to qualify for home office deductions Compute deduction limits on home office deductions.
Tax Consequences of Home Ownership Determine whether a home is a principal residence, a residence (not principal), or a non-residence for tax purposes.
(4) Other definitions and special rules. For purposes of this subsection (A) Qualified residence. (i) In general. The term “qualified residence” means (I) the principal residence (within the meaning of section 121) of the taxpayer, and (II) 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1)).
Reg. 1.121-1. (b) Residence. (1) In general. Whether property is used by the taxpayer as the taxpayer's residence depends upon all the facts and circumstances. A property used by the taxpayer as the taxpayer's residence may include a houseboat, a house trailer, or the house or apartment that the taxpayer is entitled to occupy as a tenant-stockholder in a cooperative housing corporation (as those terms are defined in section 216(b)(1) and (2)).
Reg. 1.121-1 (b) Residence. (1) In general. Whether property is used by the taxpayer as the taxpayer's residence depends upon all the facts and circumstances. …. Property used by the taxpayer as the taxpayer's residence does not include personal property that is not a fixture under local law.
Reg. 1.121-1. (2) Principal residence.In the case of a taxpayer using more than one property as a residence, whether property is used by the taxpayer as the taxpayer's principal residence depends upon all the facts and circumstances. If a taxpayer alternates between 2 properties, using each as a residence for successive periods of time, the property that the taxpayer uses a majority of the time during the year ordinarily will be considered the taxpayer's principal residence. In addition to the taxpayer's use of the property, relevant factors in determining a taxpayer's principal residence, include, but are not limited to (next slide)
Reg. 1.121-1 (2) Principal residence. (continue from slide) (i) The taxpayer's place of employment; (ii) The principal place of abode of the taxpayer's family members; (iii) The address listed on the taxpayer's federal and state tax returns, driver's license, automobile registration, and voter registration card; (iv) The taxpayer's mailing address for bills and correspondence; (v) The location of the taxpayer's banks; and (vi) The location of religious organizations and recreational clubs with which the taxpayer is affiliated.
Consequences of owning a Home Compute taxable gain on sale of a residence. Explain requirements. Also, forgiveness of mortgage debt.
Sale of Principal Residence • An individual who has owned and occupied a home as a principal residence for at least 2 of the 5 years before the sale can exclude up to $250,000 of gain ($500,000 for qualified married taxpayers filing a joint return) • The full exclusion can only be used once every 2 years
Sale of Principal Residence • Married taxpayers filing jointly can exclude up to $500,000 of gain if • Either spouse owned the home for at least 2 of previous 5 years, and • Both spouses used the home as a principal residence for at least 2 of previous 5 years, and • Neither spouse is ineligible for the exclusion because of the once-every-2-year limit • Amount realized on sale is reduced by selling expenses such as advertising, broker’s commissions, and legal fees
Sale of Principal Residence • Partial exclusion available if failure to meet two-year time period requirement is due to • A change in place of employment • Health (moving into nursing home) • Other unforeseen circumstances including divorce, death of spouse or co-owner, unemployment, disasters, and involuntary conversion of residence
Sale of Principal Residence • Partial exclusion is calculated by taking dividing the number of qualifying months by 24 and then multiplying this fraction by $250,000 ($500,000 if qualifying jointly) • The number of qualifying months is the shorter of • The use and ownership during the 5 preceding years or • The period of time that has passed since the taxpayer last claimed the exclusion
Sale of Principal Residence • A principal residence does not lose that status if temporarily rented during the period of time it is for sale • The exclusion does not apply to any gain attributable to depreciation claimed for rental or business use of the residence • The 25% rate for unrecaptured Section 1250 gain applies to gain up to the previous depreciation deductions
Sale of Residence Clyde, a single person, purchased his home in 1995 for $225,000 and lived there until he sold it for $700,000. He paid commissions of $40,000 on the sale. What is Clyde’s taxable gain?
Sale of Residence Clyde, a single person, bought his home on 1-1-11 for $225,000 and lived there until he sold it on 12-1-11 for $700,000. He paid commissions of $40,000 on the sale. (Clyde sold the home because he was required to enter an assisted living center.) What is Clyde’s taxable gain? (He qualifies for partial exclusion because the sale was not voluntary.)
SEC. 121.Exclusion of Gain From Sale of Principal Residence. (a) Exclusion. Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more.
SEC. 121.Exclusion of Gain From Sale of Principal Residence. (b) Limitations. (1) In general. The amount of gain excluded from gross income under subsection (a) with respect to any sale or exchange shall not exceed $250,000.
SEC. 121.Exclusion of Gain…Principal Residence. (2) Special rules for joint returns. In the case of a husband and wife who make a joint return for the taxable year of the sale or exchange of the property (A) $500,000 limitation for certain joint returns. Paragraph (1) shall be applied by substituting “$500,000” for “$250,000” if (i) either spouse meets the ownership requirements of subsection (a) with respect to such property; (ii) both spouses meet the use requirements of subsection (a) with respect to such property; and (iii) neither spouse is ineligible for the benefits of subsection (a) with respect to such property by reason of paragraph (3).
(C) Period of nonqualified use.. (i) In general.The term “period of nonqualified use” means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used as the principal residence of the taxpayer or taxpayer's spouse or former spouse.
(C) Period of nonqualified use. For purposes of this paragraph … (ii) Exceptions. The term "period of nonqualified use" does not include (I) any portion of the 5-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer's spouse, (II) any period (not to exceed an aggregate period of 10 years) during which the taxpayer or the taxpayer's spouse is serving on qualified official extended duty … (III) any other period of temporary absence (not to exceed an aggregate period of 2 years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the Secretary.
See class discussion handout, Page 1: IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.
Discharge of debt on property SEC. 61.GROSS INCOME DEFINED. • General Definition. Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
Discharge of debt-Thomas F. Liotti Thomas was an attorney in New York, who was admitted to practice before the Tax Court. He had a credit card account with MBNA since 1985. In 2004 and 2005 Thomas sent letters to MBNA debating the amount he rightfully owed. There are no responses from MBNA. In 2005, MBNA accepted his payment of $5,200 to settle his account. His next credit card statement reflects a finance charge adjustment of $244.47 and a “charge off” of $11,974.65. MBNA provided the IRS a Form 1099-C, Cancellation of Debt (cancellation of debt of $11,974.65). Thomas did not include the $11,974.65 in income on the Federal income tax return. IRS sent a notice of deficiency that included the $11,974.65 in petitioners' income for 2005 and determined a deficiency of $3,892. What tax rules apply here?
Sec. 108. Income from Discharge of Indebtedness. (a) Exclusion from Gross Income. (1) In general. Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge …of indebtedness of the taxpayer if— (A) the discharge occurs in a title 11 case, (B) the discharge occurs when the taxpayer is insolvent, (C) the indebtedness discharged is qualified farm indebtedness, (D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or (E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013.
108(h) Special Rules ..Principal Residence Indebtedness. (1) Basis reduction. The amount excluded [reduces basis]. (2) …qualified principal residence indebtedness" means acquisition indebtedness [section 163(h)(3)(B)], ... (3) …Subsection (a)(1)(E) shall not apply…if the discharge is on account of services performed for the lender ... (4) Ordering rule. If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount of the loan (immediately before such discharge) which is not qualified principal residence indebtedness. (5) Principal residence. For purposes of this subsection, the term "principal residence" has the same meaning as when used in section 121.
Tax Consequences of Home Ownership Determine the amount of allowable interest expense deductions on loans secured by a residence.
SEC. 163.INTEREST. (a) General Rule. There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. ……….Most of the section omitted here… (h) Disallowance of Deduction for Personal Interest. (1) In general. In the case of a taxpayer other than a corporation, no deduction shall be allowed …for personal interestpaid or accrued during the taxable year.
SEC. 163.INTEREST. (2) Personal interest. …“personal interest” means any interest allowable as a deduction under this chapter other than (A) interest paid or accrued on indebtedness ..allocable to a trade or business (other than trade or business … as an employee), (B) any investment interest (within the meaning of subsection (d)), (C) any interest which is taken into account under section 469 in computing income or loss from a passive activity…, (D) any qualified residence interest(within the meaning of paragraph (3), (E) any interest payable under section 6601 on any unpaid portion of the tax imposed by section 2001 for the period during which an extension of time for payment of such tax is in effect under section 6163, and (F) any interest allowable as a deduction under section 221 (relating to interest on educational loans).
SEC. 163.INTEREST. (3) Qualified residence interest. For purposes of this subsection— (A) In general. The term “qualified residence interest” means any interest which is paid or accrued during the taxable year on (i)acquisition indebtednesswith respect to any qualified residence of the taxpayer, or (ii)home equity indebtedness with respect to any qualified residence of the taxpayer...
SEC. 163.INTEREST. (B) Acquisition indebtedness. (i) In general. The term “acquisition indebtedness” … (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (II) is secured by such residence. Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness. (ii) $1,000,000 limitation. The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).
SEC. 163.INTEREST. (C) Home equity indebtedness. (i) In general. The term “home equity indebtedness” means any indebtedness (other than acquisition indebtedness) secured by a qualified residence to the extent the aggregate amount of such indebtedness does not exceed (I) the fair market value of such qualified residence, reduced by (II) the amount of acquisition indebtedness with respect to such residence. (ii) Limitation. The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).
See class discussion handout, Page 1: IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.
Tax Consequences of Home Ownership Discuss the deductibility of real property taxes.
Tax Consequences of Home Ownership Describe the first-time home buyer credit. See text page 14-16
First-Time Homebuyer Credit, Woods, Jr., 137 TC No. 12 The Tax Court has found that a taxpayer who took possession of a home under a contract for deed was entitled to the first-time homebuyer credit even though he had not yet occupied the home. Although the taxpayer would not obtain legal title until he made his final payment due under the contract, he assumed all the benefits and burdens of ownership when he entered into the contract.
First-Time Homebuyer Credit, Woods, Jr., 137 TC No. 12 Sec. 36(c)(3)(B) provides that "a residence which is constructed by the taxpayer shall be treated as purchased by the taxpayer on the date the taxpayer first occupies such residence." The Tax Court held that the taxpayer’s renovations were enough to establish occupancy. The court noted, without ruling conclusively on the matter, that in the future questions may arise concerning the distinction between a taxpayer who "purchases" and "renovates" and a taxpayer who "constructs."
First-Time Homebuyer Credit, Woods, Jr., 137 TC No. 12 The taxpayer claimed the Sec. 36 credit, which provides a refundable tax credit for a first-time homebuyer of a principal residence. At the time the taxpayer entered into a contract for his house, the first-time homebuyer credit reached $7,500 and was repayable in installments. The IRS determined that the taxpayer was not entitled to the homebuyer credit because the taxpayer did not have equitable or legal title to the property when he claimed the credit. Additionally, the house was not the taxpayer's principal residence because he had not yet occupied it, according to the IRS.
Homebuyer Credit, Woods, Jr., 137 TC No. 12 Court’s analysis. Holding first that state (Texas) property law controlled the taxpayer’s property interest, the court found that a contract for deed effected a change of ownership and gave the taxpayer equitable ownership of the home, even where the seller retained bare legal title, which was more in the nature of a security to guarantee payment. Second, the court held that Code Sec. 36 required a "prospective" analysis to determine whether the taxpayer occupied the home as his principal residence. The taxpayer’s intent to occupy the home as his principal residence after completing renovations was enough to establish occupancy.
Tax Consequences of Home Ownership Explain the tax issues and consequences associated with rental use of the home, including determining the deductibility of residential rental real estate losses.
Hobby expense are summarized because there is a lot of similarity between the hobby loss rules and the limits on deduction of losses from rental of vacation homes.
ACTIVITIES NOT … FOR PROFIT 183(a) GENERAL RULE. --In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.
Hobby Expenses. • Activities that earn income and incur expenses but do not meet the requirements to be a business or investment are hobbies • Regulations list factors to consider in determining if activity is a hobby including: • Manner in which activity carried on • Expertise of taxpayer and/or consultants • Time and effort spend in activity • Actual profits earned in one or more years • Elements of pleasure or recreation