McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 1 Chapter 17 Tax Consequences of Personal Activities McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

17-2Objectives 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 the 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 payments are excluded Unemployment compensation payments are 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 this year. 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

17-7Divorce 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 What are the tax consequences to Ted? Ted has no deduction for the property transfer or payment of child support. He has a $2,700 ($450 x 6 months) above-the-line deduction for payment of alimony What are the tax consequences to Alice? Alice has no income from the receipt of property or child support. She recognizes $2,700 ordinary income from the 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 generally capital gain Losses on sale are not deductible No deduction is allowed for personal, living, or family expenses except for: Medical expenses Local, state, and foreign income tax payments 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$2,200 Prescription drugs600 Hospital bills2,000 Doctor bills900 Wheelchair100 Diet food and pills, non Rx250 If Sam’s 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. Bain’s itemized deduction for charitable contributions before considering any 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 Coverdell education savings accounts Qualified tuition programs

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 is included in gross income Expenses are miscellaneous itemized deductions limited to the amount of revenue from hobby If the activity generates a profit in 3 of 5 years, the 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 an itemized deduction Interest on acquisition debt up to $1 million Interest on home equity debt up to $100,000 Deduction is available for mortgage on principal residence and one other personal residence

17-19 Vacation Home Rental Residence is subject to vacation home rules if the owner’s days of personal use exceed the greater of 14 days or 10% of rental days Expenses attributable to rental days are deductible to the extent of rental revenues Vacation home rental can’t 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 the 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 don’t satisfy the above requirements may be eligible for a reduced exclusion if the 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

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