1. Chapter 14. Home Ownership

2. 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?

3. 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 taxes Describe 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.

4. Tax Consequences of Home Ownership
Determine whether a home is a principal residence, a residence (not principal), or a non-residence for tax purposes.

5. (4) Other definitions and special rules. (A) Qualified residence.
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)).

6. Reg. 1. 121-1. (b) Residence. (1) In general
Reg (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)).

7. Reg
(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.

8. Reg. 1. 121-1. (2) Principal residence
Reg (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)

9. (2) Principal residence. (continue from slide)
Reg
(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.

10. Compute taxable gain on sale of a residence.
Consequences of owning a Home
Compute taxable gain on sale of a residence.
Explain requirements.
Also, forgiveness of mortgage debt.

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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?

19. Sale of Residence
Clyde, a single person, bought his home on for $225,000 and lived there until he sold it on 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.)

23. 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.

24. 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.

25. 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).

26. (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.

27. (C) Period of nonqualified use
(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.

28. IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.
See class discussion handout,
Page 1:
IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.

29. SEC. 61.GROSS INCOME DEFINED.
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:
(1) Compensation for services,
(9) Annuities;
(2) Gross income derived from business;
(10) Income from life insurance and endowment contracts;
(3) Gains derived from dealings in property;
(11) Pensions;
(4) Interest;
(12) Income from discharge of indebtedness;
(5) Rents;
(6) Royalties;
(13) Distributive share of partnership gross income;
(7) Dividends;
(14) Income in respect of a decedent; and
(8) Alimony and separate maintenance payments;
(15) Income from an interest in an estate or trust.

30. 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 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 $ and a “charge off” of $11, MBNA provided the IRS a Form 1099-C, Cancellation of Debt (cancellation of debt of $11,974.65).
Thomas did not include the $11, in income on the Federal income tax return. IRS sent a notice of deficiency that included the $11, in petitioners' income for 2005 and determined a deficiency of $3,892.
What tax rules apply here?

31. 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.

32. (1) Basis reduction. The amount excluded [reduces basis].
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.

33. Tax Consequences of Home Ownership
Determine the amount of allowable interest expense deductions on loans secured by a residence.

34. 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 interest paid or accrued during the taxable year.

35. 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).

36. 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 indebtedness with respect to any qualified residence of the taxpayer, or
(ii) home equity indebtedness with respect to any qualified residence of the taxpayer. ..

37. (B) Acquisition indebtedness.
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).

38. (C) Home equity indebtedness.
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).

39. IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.
See class discussion handout,
Page 1:
IN-12-Chp-14-6-Home-Gain-and-Interest-Code Sec-121-and-163-and-108.

40. Tax Consequences of Home Ownership
Discuss the deductibility of real property taxes.

41. Tax Consequences of Home Ownership
Describe the first-time home buyer credit. See text page 14-16

42. 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.
11/28/2018

43. 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."
11/28/2018

44. 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.
11/28/2018

45. 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.
11/28/2018

46. 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.

48. 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.

49. ACTIVITIES NOT … FOR PROFIT 183(a) GENERAL RULE
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.

50. 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

51. Hobby Expenses
If a profit is realized in 3 out of 5 years (2 out of 7 years for horses) then burden of proof shifts to IRS to prove activity is a hobby
Taxpayer can deduct expenses, even if a net loss results, by showing activity is run in a businesslike manner
If activity is a hobby, the deduction for expenses is limited to hobby income

52. Hobby Expenses Expenses deducted in this order:
Otherwise allowable expenses (mortgage interest, taxes, and casualty losses)
Expenses that do not reduce the tax basis of the assets used in the hobby (advertising, insurance, utilities and maintenance)
Depreciation and amortization
Excess expenses are lost - no carryover

53. Sec. 183 Activities Not. For Profit -1 (b) Deductions Allowable
Sec. 183 Activities Not.. For Profit -1 (b) Deductions Allowable.-- In the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed-- (1) the deductions which would be allowable … without regard to whether or not such activity is engaged in for profit, and

54. Sec. 183 Activities Not … For Profit -2
(b) Deductions Allowable.--
(2) a deduction equal to the amount of the deductions which would be allowable … … only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1).

56. Vacation Homes

58. Residential Rental Property
If rental of real estate is a business, all income is included and all expenses are deductible, even if it creates a loss (subject to passive loss rules)
Expenses include: advertising, cleaning, maintenance, utilities, insurance, taxes, interest, commissions for collection of rent, travel to collect rental income or to manage the property or maintain the property

59. Residential Rental Property
When property is converted from personal to rental property, expenses must be divided between rental and personal use
No depreciation or insurance deduction allowed for personal-use part of year
Mortgage interest and real estate taxes for personal-use can be deducted as itemized deductions

60. Rental of a Vacation Home
If the residence is rented for less than 15 days during the year a de minimis exception applies
No rental income is reported and
No deductions are allowed for expenses other than mortgage interest and property taxes as itemized deductions
See Sec. 280(g)

61. Rental of a Vacation Home
If rental period is greater than 14 days and
If personal use does not exceed the greater of 14 days or 10% of the rental days
All rent is included in income
Expenses are allocated between rental and personal use
All expenses related to the rental use are deductible (even if this creates a loss)
But see passive loss rules. Sec. 469

62. Rental of a Vacation Home
If rental period is greater than 14 days but
Personal use exceeds the greater of 14 days or 10% of the rental days
Rental expenses limited to rental income (no loss)
Nondeductible rental expenses can be carried forward to the future years
Real estate taxes and mortgage interest for personal-use portion allowed as itemized deductions

64. Expenses … Business Use of Home, Rental of Vacation Homes, etc.
Sec. 280A Disallowance of Certain
Expenses … Business Use of Home,
Rental of Vacation Homes, etc.
(a) General Rule.-- Except as otherwise provided in this section, in the case of a taxpayer who is an individual or a S corporation, no deduction otherwise allowable … shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.

65. Sec. 280A Disallowance of Certain Expenses … Business Use of Home, Rental of Vacation Homes, etc. (b) Exceptions for Interest, Taxes, Casualty Losses, Etc.-- Subsection (a) shall not apply to any deduction allowable to the taxpayer without regard to its connection with his trade or business (or with his income-producing activity).

66. Sec. 280A Disallowance… (d) Use as Residence.--
(1) In General.--For purposes of this section, a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of--

67. (d) Use as Residence.-- Sec. 280A Disallowance…
(A) 14 days, or 10 percent of the number of days during such year for which such unit is rented at a fair rental. For purposes of subparagraph (B), a unit shall not be treated as rented at a fair rental for any day for which it is used for personal purposes.

68. Sec. 280A Disallowance… (g) Special Rule for Certain Rental Use.--
Notwithstanding any other provision of this section or section 183, if a dwelling unit is used … by the taxpayer as a residence and
… rented for less than 15 days during the taxable year, then--

69. Sec. 280A Disallowance… (g) Special Rule...-- …
(1) no deduction otherwise allowable … because of the rental use of such dwelling unit shall be allowed, and (2) the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under section 61.

70. (e) Expenses Attributable To Rental. -- (1) In General. --…where
(e) Expenses Attributable To Rental.-- (1) In General.--…where .. an individual or an S corp. uses a dwelling unit for personal purposes on any day .. (whether or not he is treated under this section as using such unit as a residence), the amount deductible.. with respect to expenses attributable to the rental of the unit (or portion thereof) .. shall not exceed an amount which bears the same relationship to such expenses as the number of days during each year that the unit (or portion thereof) is rented at a fair rental bears to the total number of days .. that the unit (or portion thereof) is used.

71. (e) Expenses Attributable To Rental
(e) Expenses Attributable To Rental.-- (2) Exception for Deductions Otherwise Allowable.--This subsection shall not apply with respect to deductions which would be allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was rented.

72. Sue rents her vacation home for 60 days and lives in the home for 30 days. Sue's gross Rental income is $5,000
Expenses for the entire year:
Real estate taxes $2,300
Mortgage interest expense $7,000
Utilities and maintenance $2,400
Depreciation $9,000
How much depreciation will Sue
deduct on her tax return?
a. $1, b. $6, c. $3, d. $1,400

77. Tax Consequences of Home Ownership
Requirements to qualify for home office deductions Compute deduction limits on home office deductions.

79. Tax Shelter Losses Passive Activity Loss
A passive activity is any trade or business in which the taxpayer does not materially participate.
Passive Activity Loss Rules disallow the deduction of passive activity losses from other forms of income

80. Types of Income and Losses
Active: salary and wages of an employee and income earned from a business in which the owner/recipient materially participates
Portfolio: interest and dividends
Passive: tax shelter income, income passed through to limited partners, and income from other businesses in which owner/recipient does not materially participate

81. Passive Activity Loss General Rules for Limitations
Passive activity losses must be netted against passive activity income
Net passive losses are not deductible
Net passive gains are reported with other income

82. Passive Activity Loss Exception for Rental Real Estate
By definition, all rental activities and limited partnership interests are passive
But, taxpayers who materially participate in rental real estate business are allowed to offset any losses against other active or portfolio income

83. Material Participation
Current activity level
500 hours or more participation during year
Participation is substantially all the activity by all persons
At least 100 hours and no one else participates more
At least 100 hours in more than one activity and aggregate of activities exceeds 500 hours

84. Rental Real Estate Relief
Taxpayers can qualify for up to $25,000 deduction for rental real estate losses
Taxpayer must own at least 10% and actively participate in management
Set rents, qualify renters, approve repairs
Deduction phases out for AGIs between $100,000 and $150,000

85. Bud is single & received wages of $140,000 from IBM in 2011
Bud is single & received wages of $140,000 from IBM in Bud is a 50% partner in a partnership engaged in a rental real estate activity w/ $60,000 loss for the partnership. Bud was an active participant in the rental real estate activity. He had no other income.
How much of the partnership rental loss may Bud deduct on his 2011 income tax return? (Sec. 469(i))
a. $0 b. $5,000 c. $15,000 d. $25,000

88. The End