Essentials of Federal Taxation 3rd Edition Spilker Solutions Manual 1

Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.
Essentials of Federal Taxation 3rd

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Chapter 6
Individual for AGI Deductions
SOLUTIONS MANUAL
Discussion Questions
1. [LO 1] It has been suggested that tax policy favors deductions for AGI compared to itemized
deductions. Describe two ways in which deductions for AGI are treated more favorably than
itemized deductions.
Itemized deductions must exceed the standard deduction before taxpayers receive any tax benefit
from the deductions (this is equivalent to an overall floor limit). In contrast, business deductions
that are deductible for AGI (above the line) reduce taxable income without being subject to an
overall floor limit. Also, itemized deductions are subject to many mechanical limitations including
ceilings, floors, and phase-outs whereas business deductions are generally not subject to these
limits (there are limits on certain specific deductions, but this will be described in greater detail in
chapter9).
2. [LO 1] How is a business activity distinguished from an investment activity? Why is this
distinction important for the purpose of calculating federal income taxes?
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Education.
Both business and investment activities are motivated primarily by profit intent, but they can be
distinguished by the level of profit-seeking activity. A business activity is commonly described as a
sustained, continuous, high level of profit-seeking activity, whereas investment activities don’t
require a high level of involvement. The distinction can be important for the location of
deductions, because business deductions are claimed above the line (for AGI on Schedule C) while
investment deductions are generally itemized or from AGI deductions (with the exception of rent
and royalty expenses which are deductible for AGI on Schedule E).
3. [LO 2] Describe how a business element is reflected in the requirements to deduct moving
expenses and how Congress limited this deduction to substantial moves.
A business element is reflected in both the distance test and time test associated with the move. To
satisfy the distance test, the distance from the taxpayer’s old residence to the new place of work
(business element) must be at least 50 miles more than the distance from the old residence to the
old place of work (business element). The time test for a moving expense deduction requires the
taxpayer to be employed full time 39 of the first 52 weeks (or self-employed for 78 of the first 104
weeks) after the move (obviously reflecting a business element).
4. [LO 2] What types of losses may potentially be characterized as passive losses?
Losses from limited partnerships, and from rental activities, including rental real estate, are
generally considered passive losses. In addition, losses from any other activity involving the
conduct of a trade or business in which the taxpayer does not materially participate are also
treated as passive losses. Material participation is defined as “regular, continuous, and
substantial.”
5. [LO 2] What are the implications of treating losses as passive?
Passive losses may not be used to offset portfolio income or active income. Passive losses can only
be used to offset passive income. Passes losses that are limited will be suspended until taxpayers
have passive income or until the activity producing the passive loss is sold.
6. [LO 2] What tests are applied to determine if losses should be characterized as passive?
In general, losses are from trade or business activities are passive unless individuals are material
participants in the activity. Regulations provide seven separate tests for material participation,
and individuals can be classified as material participants by meeting any one of the seven tests.
The seven tests are as follows:
1. The individual participates in the activity more than 500 hours during the year.
2. The individual’s activity constitutes substantially all of the participation in such activity by
the individuals including non-owners.
3. The individual participates more than 100 hours during the year, and the individual’s
participation is not less than any other individual’s participation in the activity.
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4. The activity qualifies as a “significant participation activity” (more than 100 hours spent
during the year) and the aggregate of all “significant participation activities” is greater
than 500 hours for the year.
5. The individual materially participated in the activity for any five of the preceding 10 taxable
years.
6. The individual materially participated for any three preceding years in any personal service
activity (personal services in health, law, accounting, architecture, etc.)
7. Taking into account all the facts and circumstances, the individual participates on a
regular, continuous, and substantial basis during the year.
7. [LO 2] {Planning} All else being equal, would a taxpayer with passive losses rather have wage
income or passive income?
A taxpayer in this situation would prefer passive income because the taxpayer’s passive losses
could be applied currently against the passive income to reduce the amount of tax paid currently.
If the taxpayer had received wage income, the passive losses would have been suspended, and the
tax benefits associated with the passive losses would be deferred.
8. [LO 2] {Planning} Is it possible for a taxpayer to receive rental income that is not subject to
taxation? Explain.
Yes. A taxpayer (owner) who lives in a home for at least 15 days and rents it out for 14 days or
less (residence with minimal rental use) is not required to include the gross receipts in rental
income but is not allowed to deduct any expenses related to the rental.
9. [LO 2] Halle just acquired a vacation home. She plans on spending several months each year
vacationing in the home and on renting the property for the rest of the year. She is projecting tax
losses on the rental portion of the property for the year. She is not too concerned about the losses
because she is confident she will be able to use the losses to offset her income from other sources.
Is her confidence misplaced? Explain.
Because Halle will be living in the home for several months, the home will be considered a
residence with significant rental use. Consequently, she may deduct expenses to obtain tenants
(direct rental expenses such as advertising and realtor commissions) and mortgage interest and
real property taxes allocated to the rental use of the home. To the extent that these expenses
exceed gross rental income she may deduct the loss (the passive loss rules do not apply). However,
the remaining expenses allocated to the rental use of the home may only be deducted to the extent
of the net rental income after deducting the direct rental expenses and rental mortgage interest and
real property taxes allocated to the property. This limitation reduces her ability to deduct a rental
loss from the home.
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10. [LO 2] {Planning} A taxpayer stays in a second home for the entire month of September. He would
like the home to fall into the residence with significant rental use category for tax purposes. What
is the maximum number of days he can rent out the home and have it qualify?
To qualify for the residence with significant rental use category, the taxpayer must have used the
home for personal purposes more than the greater of (1) 14 days or (2) 10% of the total days it is
rented out during the tax year and rented the house for more than 14 days. In this situation, the
taxpayer used the second home for personal purposes for 30 days (the entire month of September).
To qualify, the 30 days of personal use must be greater than 10% of the number of days the
property is rented out. If the taxpayer rents the property out for 300 days, the number of personal
use days will be exactly 10% of the number of rental days, and the property would not qualify as
residence. However, if the taxpayer rents out the property for 299 days, the 30 days of personal
use will be greater than 10% of the number of rental days, so the property would qualify as a
residence with significant rental use. So, the maximum number of days the taxpayer can rent out
the home and have it qualify as a residence with significant rental use is 299 days. Anything more
than that and the property would be considered a nonresidence with rental use.
11. [LO 2] Compare and contrast the IRS method and the Tax Court method for allocating expenses
between personal use and rental use for vacation homes. Include the Tax Court’s justification for
departing from the IRS method in your answer.
The IRS method of allocating deductions between personal and rental use allocates the deductions
based on a fraction with the number of days the property was used for rental property in the
numerator and the number of days the property was used for any reason during the year in the
denominator. Each expense relating to the home is multiplied by this fraction to determine the
amount allocable to rental use. Subject to the gross rental income limitation, tier 1 expenses are
deducted first, followed by tier 2 expenses, and then tier 3 expenses.
The Tax Court and the IRS method of allocating deductions are identical except for the allocation
of the tier 1 expenses of interest and real property taxes. Under the Tax Court approach, interest
and taxes are allocated to rental use based on the fraction of days that the property was rented
over the number of days in the year (not the number of days the property was used for any purpose
during the year). The Tax Court justifies this approach by pointing out that interest expense and
property taxes accrue over the entire year regardless of the level of personal or rental use. The
Tax Court method is generally taxpayer favorable because it tends to allocate less interest and real
property taxes to the rental use which allows more tier 2 and tier 3 expenses to be deducted when
the gross income limitation applies. The taxpayer does not lose deductions for the interest and
property taxes allocated to personal use and not to the rental activity because these expenses are
deductible anyway as itemized deductions.
12. [LO 2] In what circumstances is the IRS method for allocating expenses between personal use and
rental use for second homes more beneficial to a taxpayer than the Tax Court method?
The IRS method is generally more beneficial than the Tax Court method when the property is
considered to be a nonresidence with rental use. When the property is not a residence, the interest
allocated to personal use is not deductible. Thus, under these circumstances, the taxpayer is better
off by allocating as little interest as possible to personal use. The IRS method accomplishes this by
allocating interest (a tier 1 expense) to rental use by dividing the total rental days by the total days
used and allocating the remainder to personal use. The Tax Court method would allocate less
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interest to rental use because the denominator is the number of days in the year, rather than total
days used.
13. [LO 2] Under what circumstances would a taxpayer who generates a loss from renting a home that
is not a residence be able to fully deduct the loss? What potential limitations apply?
By definition, a rental activity is considered to be a passive activity. Because they are passive
losses, losses from rental property are generally not allowed to offset other ordinary or investment
type income.
However, the loss from a rental activity may be deductible under two circumstances. First, a
taxpayer who is an active participant in the rental activity may be allowed to deduct up to $25,000
of the rental loss against other types of income (subject to phase-out beginning at $100,000 AGI).
Second, the taxpayer may offset the passive loss from the rental activity against other sources of
passive income.
14. [LO 2] Describe the circumstances in which a taxpayer acquires a home and rents it out and is not
allowed to deduct a portion of the interest expense on the loan the taxpayer used to acquire the
home.
When a rental home is not a residence, the interest allocable to any personal-use days is
nondeductible.
15. [LO 2] Is it possible for a rental property to generate a positive annual cash flow and at the same
time produce a loss for tax purposes? Explain.
Yes. A taxpayer is able to have a positive cash flow and at the same time produce a loss for tax
purposes. This outcome is possible due to depreciation expense that is deductible for tax purposes
but does not require an annual cash outflow. A rental property could provide a positive cash flow
(gross receipts greater than cash expense for the year) but generate a tax loss when depreciation
expense is deducted.
16. [LO 2] How are the tax issues associated with home offices and vacation homes used as rentals
similar? How are the tax issues or requirements dissimilar?
The tax issues facing renters of second homes are similar in a lot of ways with tax issues facing
taxpayers qualifying for home office deductions. Both taxpayers with home offices and taxpayers
with vacation homes are allowed to deduct business or rental expenses not associated with the use
of the home as for AGI deductions without income limitations. Taxpayers with home offices
allocate expenses of the entire home between personal use of the home and business use of the
home. In a similar way, renters of second homes generally allocate expenses of the second home
between personal use of the home and rental use of the home. Taxpayers with home offices and
vacation homes may deduct mortgage interest and real property taxes allocated to the business or
rental use of the home as for AGI deductions without income limitations. Further, the non
mortgage interest and non real property tax expenses allocated to business use of the home and
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rental use of a residence with significant rental use may be limited by the income generated by the
property (after deducting business and rental expenses unrelated to the home and after deducting
mortgage interest and real property taxes allocated to the business or rental use of the home).
Disallowed expenses are carried over and treated as incurred in the next year.
The treatment of home offices and vacation homes are also dissimilar. By definition, a home office
is located in the taxpayer’s “home” and the home office must be used exclusively for business
purposes. In contrast, the tax consequences of owning a second home depend on the extent to
which the property is used for personal and for rental purposes. Personal use of a rental property
is allowed. This is not the case for home offices.
17. [LO 2] Are employees or self-employed taxpayers more likely to qualify for the home office
deduction? Explain.
Self-employed taxpayers are more likely to qualify for the home office deduction. Both must meet
the requirement of using the home office as either (1) the principal place of business for any of the
taxpayer’s trade or businesses or (2) as a place to meet with patients, clients, or customers in the
normal course of business. However, an employee must meet the additional requirement of using
the home office for the convenience of the employer. Thus, self-employed taxpayers are more likely
to qualify for the home office deduction.
18. [LO 2] Compare and contrast the manner in which employees and employers report home office
deductions on their tax returns.
Both employees and employers will determine the amount of their eligible home office expenses in
the same manner. However, each is subject to different limitations and reports the deduction in
different places on the tax return. An employer reports his home office deduction on Schedule C of
his 1040 and is limited to his Schedule C net income before deducting the home office expense.
Thus, an employer’s home office deduction is a for AGI deduction.
An employee will report his home office expenses as unreimbursed employee business expenses
that are itemized deductions subject to the 2% of AGI floor. Thus, an employee’s home office
deduction is a from AGI deduction.
19. [LO 2] For taxpayers qualifying for home office deductions, what are considered to be indirect
expenses of maintaining the home? How are these expenses allocated to personal and home office
use?
Indirect expenses are expenses incurred in maintaining and using the home. Indirect expenses
include insurance, utilities, interest, real property taxes, general repairs, and depreciation on the
home as if it were used entirely for business purposes. Only indirect expenses allocated to the
home office space, however, are deductible. If the rooms in the home are roughly of equal size, the
taxpayer may allocate the indirect expenses to the business portion of the home based on the
number of rooms. Alternatively, the taxpayer may allocate indirect expenses based on the amount
of the space or square footage of the business-use room relative to the total square footage in the
home.
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20. [LO 2] What limitations exist for self-employed taxpayers in deducting home office expenses, and
how does the taxpayer determine which deductions are deductible and which are not in situations
when the overall amount of the home office deduction is limited?
The total home office deductions other than mortgage interest and real property taxes allocated to
business use of the home allowable for the taxpayer in any given year is limited to a taxpayer’s
Schedule C net income (without any home office expense deductions) minus mortgage interest and
real property taxes allocated to business use of the home. Thus, home office deductions other than
mortgage interest and real property taxes cannot either create or increase a loss on the taxpayer’s
Schedule C. Amounts that are not deducted in the current year are carried over and deducted in
the next year subject to the same Schedule C limitation.
The sequence of deductions for the home office follows the exact same sequence of deductions for
homes with significant personal use and significant rental use. Tier 1-type expenses that would be
deductible as itemized deductions (interest and taxes) are deducted first (and deducted in full
regardless of income). Tier 2-type expenses are deducted second, and Tier 3-type expense
(depreciation) is deducted last.
21. [LO 3] What are the primary tax differences between traditional IRAs and Roth IRAs?
Traditional IRA contributions are deductible and distributions when received are taxable. Roth
IRA contributions are not deductible and distributions when received are not taxable.
22. [LO 3] Describe the circumstances in which it would be more favorable for a taxpayer to
contribute to a traditional IRA rather than a Roth IRA and vice versa.
In general, a traditional IRA will typically provide a better after-tax rate of return when tax rates are
expected to decline in the future. A Roth IRA will generally provide a better after-tax rate of return
when tax rates are expected to increase in the future. If the tax rates are expected to remain the same,
the after-tax rate of return will be the same for both types of IRAs.
23. [LO 3] What are the requirements for a taxpayer to make a deductible contribution to a traditional
IRA? Why do the tax laws impose these restrictions?
To make a deductible contribution to a traditional IRA the taxpayer must (1) not be a participant in
an employer sponsored retirement plan or (2) if they are participating in an employee sponsored
retirement plan, they must have income below a certain threshold. IRAs are meant to help persons
that are unable to participate in an employer sponsored program or that have relatively low levels
of income.
24. [LO 3] What is the limitation on a deductible IRA contribution for 2014?
For those not already participating in an employer sponsored retirement plan, deductible
contributions to an IRA are limited to $5,500 a year or earned income if it is less. Taxpayers who
have reached the age of 50 are able to contribute an additional $1,000. A taxpayer already
participating in an employer sponsored program may also make deductible contributions of the
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same amount if her AGI falls below a certain threshold. The $5,500 (or $6,500) deductible amount
is phased out for taxpayers whose AGI exceeds the threshold amount.
25. [LO 3] Compare the minimum distribution requirements for traditional IRAs to those of Roth
IRAs.
In regards to traditional IRAs, taxpayers are subject to the same minimum distribution
requirements as traditional 401(k) plans. They must begin receiving distribution by the later of
April 1 of the year after the year in which the taxpayer turns 70 ½ or when she retires. The
minimum amount of the distribution is determined by using a table provided by the IRS and is
based upon the taxpayer’s age and account balance.
Taxpayer’s are not ever required to make minimum distributions from Roth IRAs.
26. [LO 3] How are qualified distributions from Roth IRAs taxed? How are nonqualified distributions
taxed?
Qualifying distributions from a Roth IRA are not taxable. Nonqualified distributions are taxed and
penalized to the extent that they are made from the earnings of the IRA. Contributions to a Roth
IRA are from after-tax dollars (non-deductible) and can always be recovered tax free. Nonqualified
distributions are considered to first come from contributions and then earnings.
27. [LO 3] Explain when a taxpayer will be subject to the 10 percent penalty when receiving
distributions from a Roth IRA.
Only nonqualified distributions made from the earnings of a Roth IRA are subject to ordinary taxes
and a 10% penalty. Nonqualified distributions are any distributions if the taxpayer has not had the
Roth IRA account open for at least five years.1 If the Roth account has been open for five years, all
distributions other than distributions (1) made on or after the date the taxpayer reaches 59 ½ years
of age, (2) made to a beneficiary (or to the estate of the taxpayer) on or after the death of the
taxpayer, (3) attributable to the taxpayer being disabled, or (4) used to pay qualified acquisition
costs for first-time homebuyers (limited to $10,000) are considered to be disqualified distributions.
28. [LO 3] Is a taxpayer who contributed to a traditional IRA able to transfer or “roll over” the money
into a Roth IRA? If yes, explain the tax consequences of the transfer.
Taxpayers are able to roll over (transfer) funds from a traditional IRA to a Roth IRA. The entire
amount taken from the traditional IRA is taxed at ordinary rates but is not subject to the 10%
penalty so long as the taxpayer contributes the full amount taken out of the traditional IRA to a
Roth IRA.
29. [LO 3] Assume a taxpayer makes a nondeductible contribution to a traditional IRA. How does the
taxpayer determine the taxability of distributions from the IRA on reaching retirement?
1
The five year period starts on January 1 of the year in which the contribution was made and ends on the last day of
the fifth taxable year.
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When a taxpayer receives a partial distribution from an IRA containing both deductible and
nondeductible contributions, the nontaxable portion of the distribution is determined by
multiplying the ratio of the nondeductible contribution over the entire balance in the account
(nondeductible contributions / entire account balance) by the amount of the distribution.
30. [LO 3] When a taxpayer takes a nonqualified distribution from a Roth IRA,
is the entire amount of the distribution treated as taxable income?
Only the portion of a nonqualified distribution attributable to the earnings from contributions is
taxable (this portion is also penalized at a 10% rate). Distributions are considered to come first
from contributions and then from earnings.
31. [LO 3] Explain why Congress allows self-employed taxpayers to deduct the cost of health
insurance above the line (for AGI) when employees can only itemize this cost as a medical
expense. Would a self-employed taxpayer ever prefer to claim health insurance premiums as an
itemized deductions rather than a deduction for AGI? Explain.
This deduction provides a measure of equity between employees and the self-employed. The cost of
health insurance is essentially a personal expense. However, employees typically aren’t required
to pay insurance premiums because their employers pay the premiums for them as a form of
compensation. The employer is allowed to deduct the premium as a compensation expense, and the
employee is allowed to exclude from taxable income the value of the premiums paid on his behalf.
Thus, from the employee’s perspective, this arrangement has the same effect as if (1) the employer
pays the employee cash compensation in the amount of the premium and (2) the employee pays the
premium and deducts the expense for AGI (completely offsetting the compensation income). In
contrast to employees, self-employed taxpayers pay their own health insurance costs, because they
don’t have an employer to pay these costs for them. Absent a rule to the contrary, self-employed
taxpayers would deduct their medical expenses as itemized deductions subject to strict limitations,
because the cost of the health insurance is a personal expense rather than a business expense. To
treat employees and self-employed taxpayers similarly, Congress allows self-employed taxpayers to
deduct personal health insurance premiums as for AGI rather than itemized deductions. Thus, self-
employed taxpayers are able to (1) receive business income and (2) use the business income to pay
their health insurance premiums and deduct the premiums as a for AGI deduction (completely
offsetting the business income they used to pay the premium). Given the preferential treatment of
for AGI deductions relative to itemized deductions, a self-employed taxpayer should never prefer to
claim health insurance premiums as an itemized deduction rather than a deduction for AGI.
32. [LO 3] Explain why Congress allows self-employed taxpayers to deduct the employer portion of
their self-employment tax.
To put self-employed individuals on somewhat equal footing with other employers that are allowed
to deduct the employer’s share of the social security tax. Hence, self-employed taxpayers are
allowed to deduct the employer portion of the self-employment tax.
33. [LO 3] {Research} Using the Internal Revenue Code, describe two deductions for AGI
that are not discussed in this chapter?
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§62 is the quickest way to identify deductions for AGI, but several can also be identified from the
front of form 1040. Examples include the performing artist deduction, deductions of business
expenses for state and local officials, reforestation expenses, and remitted jury duty pay.
34. [LO 3] Explain why Congress allows taxpayers to deduct interest forfeited as a penalty on the
premature withdrawal from a certificate of deposit.
The full amount of the interest income is included in gross income, and this deduction reduces the
net interest income to the amount actually received by the individual.
35. [LO 3] Describe the mechanical limitation on the deduction for interest on qualified educational
loans.
The maximum deduction for interest expense on qualified education loans is the amount of interest
expense paid up to $2,500. However, the deduction is reduced (phased-out) for taxpayers
depending on the taxpayer’s filing status and modified AGI. Specifically, the deduction for interest
on educational loans is subject to proportional phase-out over a range of $15,000 ($30,000 for
married filing jointly). The range begins for taxpayers at $65,000 of modified AGI ($130,000 for
MFJ) and ends at $80,000 of modified AGI ($160,000 for married filing jointly). Modified AGI for
this purpose is AGI before deducting interest expense on the qualified education loans and before
deducting qualified education expenses. Married individuals who file separately are not allowed to
deduct this expense under any circumstance.
Problems
36. [LO 1] {Tax Forms} Betty operates a beauty salon as a sole proprietorship. Betty also owns and
rents an apartment building. This year Betty had the following income and expenses. Determine
Betty’s AGI and complete page 1 of Form 1040 for Betty. You may assume that Betty will owe
$2,502 in self-employment tax on her salon income.
Interest income $ 11,255

Salon sales and revenue 86,360
Salaries paid to beauticians 45,250
Beauty salon supplies 23,400
Alimony paid to her ex-husband, Rocky 6,000
Rental revenue from apartment building 31,220
Depreciation on apartment building 12,900
Real estate taxes paid on apartment building 11,100
Real estate taxes paid on personal residence 6,241
Contributions to charity 4,237
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The beauty parlor salaries and expenses are deductible on Schedule C as business expenses and
the depreciation and real estate taxes for the apartment building are deductible for AGI as
rental/royalty related deductions. The interest income is included in AGI, and the alimony expense
is deductible for AGI. Note that this solution assumes that the apartment building amounts
represent Betty’s interest and not the total. The residential real estate taxes and the charitable
contributions are itemized deductions.
Interest income $ 11,255
Salon revenue $ 86,360
Less: Salaries - 45,250
Supplies - 23,400
Operating income from salon 17,710
Apartment building revenue $ 31,220
Less: Depreciation - 12,900
Taxes on apartment building - 11,100
Apartment building income 7,220
Less: Employer share of self-employment taxes* -1,251
Alimony deduction -6,000
AGI $ 28,934
*Betty would owe $2,502 in self-employment tax ($17,710 salon income x 92.35% x 15.3% = $2,502).
Of the $2,502, $1,251 ($17,710 x 92.35% x 7.65%) would be deductible as a for AGI deduction.
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37. [LO 2] Larry recently invested $20,000 (tax basis) in purchasing a limited partnership interest in
which he will have no management rights in the company. His at-risk amount is also $20,000. In
addition, Larry’s share of the limited partnership loss for the year is $2,000, his share of income
from a different limited partnership was $1,000, and he had $3,000 of dividend income from the
stock he owns. How much of Larry’s $2,000 loss from the limited partnership can he deduct in the
current year?
Before considering his $2,000 loss, Larry’s tax basis is $20,000 and his at-risk amount is $20,000.
Therefore the basis and at-risk hurdles do not apply. However, Larry still may not deduct $1,000
of the $2,000 loss because he only has $1,000 of passive income for the year. Therefore, Larry has
a $1,000 passive activity loss carryover.
38. [LO 2] Rubio recently invested $20,000 (tax basis) in purchasing a limited partnership interest in
which he will have no management rights in the company. His at-risk amount is $15,000. In
addition, Rubio’s share of the limited partnership loss for the year is $22,000, his share of income
from a different limited partnership was $5,000, and he had $40,000 in wage income and $10,000
in long-term capital gains.
a. How much of Rubio’s $22,000 loss can he deduct considering only the tax basis
limitation?
b. How much of the loss from part a. can Rubio deduct under the at-risk limitations?
c. How much of Rubio’s $22,000 loss from the limited partnership can he deduct in the
current year considering all limitations?
a. Rubio’s initial tax basis in the limited partnership is $20,000. Rubio’s $22,000 loss
reduces his tax basis to zero leaving him with a $2,000 loss carryover because of the tax
basis loss limitation.
b. Rubio’s initial at-risk amount in the limited partnership is $15,000. Rubio’s $22,000 loss
reduces his at-risk amount to zero leaving him with a $5,000 at-risk carryover ($20,000
loss allowed under the tax basis limitation less the $15,000 amount Rubio has at risk).
c. After applying the tax basis and at-risk limitations, Rubio can potentially deduct $15,000
of loss. However, because Rubio is a limited partner this loss is considered a passive
loss. Therefore, Rubio may only deduct this loss in the current year to the extent he has
passive income. Because Rubio has only passive income of $5,000 (from another limited
partnership), he may only deduct $5,000 of the $15,000 loss leaving him with a $10,000
passive activity loss that can be carried forward indefinitely.
39. [LO 2] Anwar owns a rental home and is involved in maintaining it and approving renters. During
the year he has a net loss of $8,000 from renting the home. His other sources of income during the
year were a salary of $111,000 and $34,000 of long-term capital gains. How much of Anwar’s
$8,000 rental loss can he deduct currently if he has no sources of passive income?
Because Anwar meets the definition of an “active participant” and has adjusted gross income of
less than $150,000, before considering his rental loss, he may deduct $2,500 of the loss against his
other income. His $2,500 deduction is computed as follows:
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Description Amount Explanation

(1) Maximum deduction available before $25,000
phase-out
(2) Phase-out of maximum deduction $22,500 [($145,000 AGI –
100,000) x .5]
(3) Maximum deduction in current year $2,500 (1) – (2)
(4) Rental loss in current year $8,000
(5) Rental loss deductible in current year $2,500 Lesser of (3) or (4)
Passive loss carry forward $5,500 (3) – (4)
40. [LO 2] Dillon rented his personal residence at Lake Tahoe for 14 days while he was vacationing in
Ireland. He resided in the home for the remainder of the year. Rental income from the property was
$6,500. Expenses associated with use of the home for the entire year were as follows:
Real property taxes $ 3,100

Mortgage interest 12,000
Repairs 1,500
Insurance 1,500
Utilities 3,900
Depreciation 13,000
a. What effect does the rental have on Dillon’s AGI?

b. What effect does the rental have on Dillon’s itemized deductions?
a. Since Dillon resided in his home for at least 15 days during the year and rented the home for
fewer than 15 days, he excludes the rental income from taxable income and does not deduct
the associated rental expenses. So, the rental has no effect on Dillon’s AGI.
b. He will be allowed to deduct the real property taxes of $3,100 and mortgage interest of $12,000
as itemized deductions
Use the following facts to answer problems 41 and 42.
Natalie owns a condominium near Cocoa Beach in Florida. This year, she incurs the following
expenses in connection with her condo:
Insurance $1,000
Advertising expense 500
Property taxes 900
Repairs & maintenance 650
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Utilities 950
Depreciation 8,500
During the year, Natalie rented out the condo for 75 days, receiving $10,000 of gross income. She
personally used the condo for 35 days during her vacation. Assume there are 365 days in the year.
41. [LO 2] Assume Natalie uses the IRS method of allocating expenses to rental use of the property.
a. What is the total amount of for AGI (rental) deductions Natalie may deduct in the current year
related to the condo?
b. What is the total amount of itemized deductions Natalie may deduct in the current year related
to the condo?
c. If Natalie’s basis in the condo at the beginning of the year was $150,000, what is her basis in the
condo at the end of the year?
d. Assume that gross rental revenue was $1,000 (rather than $10,000), what amount of for AGI
deductions may Natalie deduct in the current year related to the condo?
Note that the home falls into the residence with significant rental use category.
a. $10,000, calculated as follows:
Gross rental income $10,000
Tier 1 expenses:
Advertising expense = $500
Mortgage interest = (75/110) × $3,500=$2,386
Property taxes= (75/110) × $900=$614
Less: total Tier 1 expenses (3,500)
Balance $6,500
Tier 2 expenses:
Insurance = (75/110) × $1,000=$682
Repairs & Maintenance = (75/110) × $650=$443
Utilities= (75/110) × $950=$648
Balance $4,727
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Tier 3 expenses:
Depreciation (75/110) × $8,500= $5,795, but the

deduction is limited to the remaining income
(4,727)
Balance $0
Total “For AGI” deductions ($3,500 + $1,773 + $4,727) $10,000
b. Natalie may deduct the personal-use portion of the mortgage interest and property taxes since
they are deductible without regard to rental income. Her deductions for these items are
computed as follows:
Mortgage interest [(35/110) × $3,500] $1,114
Real property taxes [(35/110) × $900] 286
Total “from AGI” deductions $1,400
c. $145,273, calculated as follows:
Beginning basis $150,000
Less: depreciation actually deducted (4,727)
Adjusted basis $145,273
d. $3,500. Even though it creates a loss ($2,000 - $3,500), Natalie is allowed to deduct all of the
advertising expense and the portion of the mortgage interest expense and real property taxes
allocated to the rental use of the home as for AGI deductions (these deductions are not limited to
rental revenue). The loss is not subject to the passive loss rule limitations.
42. [LO 2] Assume Natalie uses the Tax Court method of allocating expenses to rental use of the
property.
a. What is the total amount of for AGI (rental) deductions Natalie may deduct in the
current year related to the condo?
b. What is the total amount of itemized deductions Natalie may deduct in the current year
related to the condo?
c. If Natalie’s basis in the condo at the beginning of the year was $150,000, what is her
basis in the condo at the end of the year?
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d. Assume that gross rental revenue was $2,000 (rather than $10,000), what amount of for
AGI deductions may Natalie deduct in the current year related to the condo?
Note that the home falls into the residence with significant rental use category.

Tier 1 expenses:
Advertising expense = $500
Mortgage interest = (75/365) × $3,500=$719
Property taxes= (75/365) × $900=$185
Less: total Tier 1 expenses
(1,404)
Balance $8,596
Tier 2 expenses:
Insurance = (75/110) × $1,000=$682
Repairs & Maintenance = (75/110) × $650=$443
Utilities= (75/110) × $950=$648
Balance $6,823
Tier 3 expenses:
Depreciation (75/110) × $8,500= $5,795 (5,795)
Balance—net income from rental of condo $1,028
Total “For AGI” deductions ($1,404 + $1,773 + $5,795) $8,972
b. Natalie may deduct the personal-use portion of the mortgage interest and property
taxes since they are deductible without regard to rental income. Her deductions for
these items are computed as follows:
Mortgage interest [(290/365) × $3,500] $2,781

Real property taxes [(290/365) × $900] $715
Total "from AGI" deductions $3,496
c. $144,205, calculated as follows:
Beginning basis $150,000

Less: depreciation actually deducted (5,795)
Adjusted basis $144,205
d. $2,000. Natalie is allowed to deduct all $1,404 of the advertising expense and the
portion of the mortgage interest expense and real property taxes allocated to the
rental use of the home as for AGI deductions (these deductions would not be limited
to rental revenue even if it created a loss). Natalie is also able to deduct $596 of
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the tier two expenses. In total, she will deduct $2,000 of rental related expenses—
leaving her with $0 net income from the property.
Use the following facts to answer problems 43-45.

Alexa owns a condominium near Cocoa Beach in Florida. This year, she incurs the following
expenses in connection with her condo:
Insurance $2,000
Property taxes 2,000
Repairs & maintenance 1,400
Utilities 2,500
Depreciation 14,500
During the year, Alexa rented out the condo for 100 days. She did not use the condo at all for
personal purposes during the year. Alexa’s AGI from all sources other than the rental property is
$200,000. Unless otherwise specified, Alexa has no sources of passive income.
43. [LO 2] Assume Alexa receives $30,000 in gross rental receipts.
a. What effect do the expenses associated with the property have on her AGI?
b. What effect do the expenses associated with the property have on her itemized deductions?
a. Expenses reduce AGI by $28,900. Alexa’s property is treated as a nonresidence with

rental use property because she rented it for 100 days and did not use it all for
personal purposes. The rental deductions are fully deductible for AGI. Thus, the
expenses reduce Alexa’s AGI by $28,900 and the gross rental income increases the
AGI by $30,000. Overall, Alexa’s AGI will be increased by the rental net income of
$1,100, calculated as follows:

Expenses:
Insurance (2,000)
Mortgage interest (6,500)
Property taxes (2,000)
Repairs & maintenance (1,400)
Utilities (2,500)
Depreciation (14,500)
Less: total expenses (28,900)
Balance—net rental income $1,100
b. Because Alexa did not use the rental property for personal purposes, all expenses
associated with the property were allocated to rental use and were deducted for AGI.
Thus, the expenses associated with the property have no effect on her itemized
deductions.
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44. [LO 2] Assuming Alexa receives $20,000 in gross rental receipts, answer the following questions:
a. What effect does the rental activity have on her AGI for the year?
b. Assuming that Alexa’s AGI from other sources is $90,000, what effect does the rental activity
have on Alexa’s AGI? Alexa makes all decisions with respect to the property.
c. Assuming that Alexa’s AGI from other sources is $120,000, what effect does the rental activity
have on Alexa’s AGI? Alexa makes all decisions with respect to the property.
d. Assume that Alexa’s AGI from other sources is $200,000. This consists of $150,000 salary,
$10,000 of dividends, and $25,000 of long-term capital gain, and net rental income from another
rental property in the amount of $15,000. What effect does the Cocoa Beach Condo rental
activity have on Alexa’s AGI?
Note that the property is a nonresidence with rental use property.
a. Alexa’s AGI will be reduced by $0, calculated as follows:

Expenses:
Insurance (2,000)
Mortgage interest (6,500)
Property taxes (2,000)
Repairs & maintenance (1,400)
Utilities (2,500)
Depreciation (14,500)
Balance—net rental loss ($8,900)
By definition, a rental activity [unless it is a residence with significant rental use (a

vacation home rental)], is considered to be a passive activity. Consequently, losses from
rental property are not allowed to offset other ordinary or investment type income. As a
result, Alexa will include $20,000 of rental income in gross income. She will also get to
deduct $20,000 of expenses related to the rental property. The remaining $8,900 of
expenses (the rental loss) is not deductible this year because (1) the rental activity is a
passive activity, (2) Alexa has no passive income from other sources, and (3) Alexa’s AGI
is above the phase-out range ($100,000 - $150,000) so she is not allowed to deduct any
of the loss under the rental real estate exception to the passive loss rules. She may,
however, carry the loss forward to future years in which she has passive income to offset.
b. Reduction of $8,900.
Under a rental real estate exception, a taxpayer who is an “active” participant in the
rental activity may be allowed to deduct up to $25,000 of the rental loss against other
types of income. To be considered an active participant, the taxpayer must (1) own at
least 10% of the rental property and (2) participate in the process of making management
decisions such as approving new tenants, deciding on rental terms, and approving
repairs and capital expenditures. Since Alexa owns 100% of the property, and she makes
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all decisions with respect to the property, she is an active participant in the rental
activity. Thus, she meets the rental real estate exception, and, because her AGI is below
$100,000 she is eligible to deduct up to $25,000 of the loss against other types of income.
In this case, she may deduct the entire $8,900 loss as an ordinary deduction in the
current year.
c. Reduction of $8,900.
Under a rental real estate exception, a taxpayer who is an “active” participant in the
rental activity may be allowed to deduct up to $25,000 of the rental loss against other
types of income. To be considered an active participant, the taxpayer must (1) own at
least 10% of the rental property and (2) participate in the process of making management
decisions such as approving new tenants, deciding on rental terms, and approving
repairs and capital expenditures. The $25,000 maximum exception amount is phased out
by 50 cents for every dollar the taxpayer’s adjusted gross income exceeds $100,000.
Consequently, the entire $25,000 is phased-out when the taxpayer’s adjusted gross
income reaches $150,000.
Since, Alexa owns 100% of the property, and she makes all decisions with respect to the
property, she is an active participant in the rental activity. Thus, she meets the rental
real estate exception, and she may potentially deduct the rental loss as an ordinary
deduction in the current year. However, because her AGI exceeds $100,000, part of the
exception amount is phased out as follows:
Phase-out = [AGI - $100,000] × $.50

= [$120,000 - $100,000] × $.50
= $10,000
Exception amount = $25,000 (maximum) - $10,000 (phase-out) = $15,000
Since Alexa’s rental loss of $8,900 is less than the exception amount of $15,000, she can
deduct the entire $8,900 as an ordinary deduction in the current year.
d. The rental activity reduces her AGI by $8,900. (All transactions described in the
problem increase her AGI by $191,100.)
Since Alexa has passive income (the rental income from another property), she can
deduct the loss against this passive income. Thus, her net passive income is $6,100
($15,000 rental income - $8,900 rental loss). In summary, she will include $150,000
salary, $10,000 dividends, $25,000 LTCG, and $35,000 rental income ($15,000 +
$20,000) in gross income. She will also be able to deduct all of the expenses related to
the rental property ($28,900) from the income in arriving at AGI. The $8,900 loss from
the rental property reduces her AGI by $8,900.
45. [LO 2] {Planning Assume that in addition to renting the condo for 100 days, Alexa uses the condo
for eight days of personal use. Also assume that Alexa receives $30,000 of gross rental receipts.
Answer the following questions:
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a. What is the total amount of for AGI deductions relating to the condo that Alexa may deduct in
the current year? Assume she uses the IRS method of allocating expenses between rental and
personal days.
b. What is the total amount of from AGI deductions relating to the condo that Alexa may deduct in
the current year? Assume she uses the IRS method of allocating expenses between rental and
personal days.
c. Would Alexa be better or worse off after taxes if she uses the Tax Court method of allocating
expenses?
a. $26,760.
Since Alexa used the condo personally for 8 days, she must allocate the expenses between
personal use and rental use days. As illustrated below, the portion attributable to the
rental days are deductible as “for AGI” deductions.

Expenses:
Insurance [100/108] × $2,000 (1,852)
Mortgage interest [100/108] × $6,500 (6,019)
Property taxes [100/108] × $2,000 (1,852)
Repairs & maintenance [100/108] × $1,400 (1,296)
Utilities [100/108] × $2,500 (2,315)
Depreciation [100/108] × $14,500 (13,426)
Balance—net rental income $3,240
Total “for AGI” deductions $26,760
b. Alexa may deduct the personal-use portion of property taxes since they are deductible
without regard to rental income. However, she is not allowed to deduct the mortgage
interest related to personal-use days because the property no longer qualifies as a
personal residence. Her deduction for the property taxes is calculated as follows:
Real property taxes = (8/108) × $2,000 = $148. Note that Alexa would be able to
deduct the taxes whether she itemized or not (as an increase to her basic standard
deduction).
c. The Tax Court method is less favorable in this circumstance because it allocates less
interest expense to the rental activity and more to personal use. The interest expense
allocated to personal use, however, does not qualify for an interest deduction because the
taxpayer does not meet the minimum amount of personal use required for the deduction.
By using the Tax Court method, any mortgage interest allocated to the personal-use days
generates no tax benefit. Also, since this is primarily rental property, the taxpayer may
deduct expenses in excess of income from the property. So, the taxpayer may not be as
concerned about allocating more taxes to the rental property because doing so does not
limit the taxpayer’s ability to deduct other expenses, as it might with mixed-use property.
Note however, that a loss may not be immediately deductible due to the passive activity
rules.
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46. [LO 2] {Forms} Brooke owns a sole proprietorship in which she works as a management
consultant. She maintains an office in her home where she meets with clients, prepares
bills, and performs other work-related tasks. The home office is 300 square feet and the
entire house is 4,500 square feet. Brooke incurred the following home-related expenses
during the year. Unless indicated otherwise, assume Brooke uses the actual expense
method to compute home office expenses.
Real property taxes $ 3,600

Interest on home mortgage 14,000
Operating expenses of home 5,000
Depreciation 12,000
Repairs to home theater room 1,000
a. What amount of each of these expenses is allocated to the home office?

The expenses are allocated to the home office as follows:
Expense Amount Type Allocated to home office

6.667% of indirect (300/4,500
sq. ft)
Real property taxes $3,600 Indirect $240
Interest on home mortgage 14,000 Indirect 933
Operating expenses of home 5,000 Indirect 333
Depreciation 12,000 Indirect 800
Repairs to home theater 1,000 Unrelated 0
room
Total expenses $35,600 $2,306
b. What are the total amounts of tier 1, tier 2, and tier 3 expenses allocated to the home
office?
• Tier 1 expenses: $1,173 ($240 real property + $933 interest on home mortgage).
• Tier 2 expenses: $333 (operating expenses of the home)
• Tier 3 expense: $800 depreciation.
c. If Brooke reported $2,000 of Schedule C income before the home office expense
deduction, what is the amount of her home office expense deduction and what home office
expenses, if any, would she carry over to next year?
$2,000 home office expense in total and $306 depreciation expense carryover to next year.
She would subtract all $1,173 of the tier 1 expenses and all $333 of the tier 2 expenses from
her $2,000 of Schedule C income. This leaves $494 ($2,000 - $1,173 – 333) of net income
before depreciation (tier 3 expense). Because the home office expense deduction can reduce
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net income to $0 but not below, Brook may deduct $494 of depreciation expense and carry
the remaining $306 over to next year.
d. Assuming Brooke reported $2,000 of Schedule C income before the home office expense
deduction, complete Form 8829 for Brooks home office expense deduction. Also assume the
value of the home is $500,000 and the adjusted basis of the home (exclusive of land) is
$468,019.
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e. Assume that Brooke uses the simplified method for computing home office expenses. If
Brooke reported $2,000 of Schedule C net income before the home office expense deduction,
what is the amount of her home office expense deduction and what home office expenses, if any,
would she carry over to next year?
Home office expense deduction is $1,500 (300 square feet × $5.00 per square foot) with zero
carryover. The gross income limit does not apply here because the Schedule C net income before
the home office expense deduction ($2,000) exceeds the home office expenses of $1,500. Note
that taxpayers cannot carryforward expenses calculated using the simplified method to the next
year even when the gross income limits the amount of the home office expense deduction.
Use the following facts to answer problems 47 – 48.

Rita owns a sole proprietorship in which she works as a management consultant. She
maintains an office in her home (500 square feet) where she meets with clients, prepares
bills, and performs other work-related tasks. Her business expenses, other than home office
expenses, total $5,600. The following home-related expenses have been allocated to her
home office under the actual expense method for calculating home office expenses.
Real property taxes $1,600

Interest on home mortgage 5,100
Operating expenses of home 800
Depreciation 1,600
Also, assume that not counting the sole proprietorship, Rita’s AGI is $60,000.
47. [LO 2] {Tax planning} Assume Rita’s consulting business generated $15,000 in gross
income.
a. What is Rita’s home office deduction for the current year? (Answer for both the actual
expense method and the simplified method).
b. What would Rita’s home office deduction for the current year be if her business
generated $10,000 of gross income instead of $15,000? (Answer for both the actual
expense method and the simplified method).
c. Given the original facts, what is Rita’s AGI for the year?
d. Given the original facts, what types and amounts of expenses will she carry over to
next year?
a. Rita’s home office deduction is $9,100 using the actual expense method calculated as
follows:
Gross Income $15,000

Less: business expenses (5,600)
Balance $9,400
Less: Tier 1 expenses (interest $5,100 + $1,600
taxes) (6,700)
Balance after tier 1 expenses $2,700
Less Tier 2 expenses (operating expenses) (800)
Balance after tier 2 expenses 1,900
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Education.
Less Tier 3 expenses (depreciation) (1,600)

Net income from business $300
Rita is allowed to deduct all expenses allocated to the home office ($6,700 interest and taxes
+ 800 home operating expenses + depreciation 1,600).
Under the optional method, Rita’s home office deduction would have been limited to $1,500 (300
square feet × $5 application rate). However, she also would have been able to deduct all of the
$6,700 for interest and taxes as itemized deductions. This would have provided her with $1,500
+ $6,700 = $8,200 of deductions, but this is still less than the $9,100 in deductions under the
actual method
b. Under the actual expense method, she would deduct $6,700 for the home office expense
deduction.

Balance $4,400
taxes) (6,700)
Loss after tier 1 expenses ($2,300)
Less Tier 2 expenses (operating expenses) 0
Loss after tier 2 expenses ($2,300)
Less Tier 3 expenses (depreciation) 0
Net loss from business ($2,300)
Rita is allowed to deduct only the mortgage interest and real property taxes allocated to the
business use of the home. The remaining expenses (tier 2 and tier 3) are suspended and
carried over to next year.
Under the simplified method, Rita would be limited to a home office expense deduction of
$1,500 (300 square feet x $5 application rate), but she would have $6,700 more for itemized
deductions for mortgage interest and taxes.
c. Rita’s AGI is $60,300 for the year. This is her AGI without the sole proprietorship plus
the net income from the business ($60,000 + $300).
d. None. Because Rita is allowed to deduct all of the expenses this year, she does not carry
any over to next year.
48. [LO 2] Assume Rita’s consulting business generated $13,000 in gross income for the
current year. Further, assume Rita uses the actual expense method for computing her
home office expense deduction.
a. What is Rita’s home office deduction for the current year?
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b. What is Rita’s AGI for the year?

c. Assume the original facts, except that Rita is an employee, and not self-employed (she
uses the home office for the convenience of the employer). Consequently, she does not
receive any gross income from the (sole proprietorship) business and she does not incur
any business expenses unrelated to the home office. Finally, her AGI is $60,000
consisting of salary from her work as an employee. What effect do her home office
expenses have on her itemized deductions?
d. Assuming the original facts, what types and amounts of expenses will she carry over to
next year?

Balance $7,400
taxes) (6,700)
Balance after tier 1 expenses $700
Less: Tier 2 expenses (operating expenses $800
before limit) (700)
Balance after tier 2 expenses 0
Less Tier 3 expenses (depreciation $1,600 before
limit) (0)
Net income from business $0
Rita is allowed to deduct a total of $7,400 in home office expenses ($6,700 in interest and
taxes and $700 of home operating expenses).
b. $60,000. This is the $60,000 of AGI without the sole proprietorship plus $0 net income
from the home business.
c. Because the home office deduction is deductible from AGI for employees, Rita’s AGI is
unchanged by her home office expenses. Employees who may deduct home office expenses
do so as itemized deductions subject to the 2% AGI floor. Thus, Rita’s $9,100 of home office
expenses are reduced by $1,200 ($60,000 × 2%) and she may deduct $7,900 as an itemized
deduction.
d. Rita will carry over $100 of tier 2 expenses (operating expenses) and $1,600 of tier 3
expenses (depreciation expense) to next year.
49. [LO 2] {Research } Boodeesh is contemplating running a consulting business out of her home. She
has a large garage apartment in her backyard that would be perfect for her business. Given that the
garage apartment is separate from her house (about 30 feet behind her house) would the office be
considered part of her home for purposes of the home office rules?
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Yes, the garage apartment is likely to be considered a part of the home as it would be considered
appurtenant to Boodeesh’s dwelling unit. IRC Sec. 280A(f)(1) defines a dwelling unit to include a
house, apartment, condominium, mobile home, boat, or similar property, and all structures or
other property appurtenant to such dwelling unit. See Charles Scott, 84 TC 683 (1985) for a
discussion of when a structure is appurtenant to a dwelling unit.
50. [LO 3] Clem is married and is a skilled carpenter. Clem’s wife, Wanda, works part-time as a
substitute grade school teacher. Determine the amount of Clem’s expenses that are deductible for
AGI this year (if any) under the following independent circumstances:
a. Clem is self-employed and this year he incurred $525 for tools and supplies related to his job.
Since neither were covered by a qualified health plan, Wanda paid health insurance premiums of
$3,600 to provide coverage for herself and Clem (not through an exchange).
b. Clem and Wanda own a garage downtown that they rent to a local business for storage. This year
they incurred $1,250 in utilities and depreciation of $780.
c. Clem paid self-employment tax of $15,300 (the employer portion is $7,650) and Wanda had $3,000
of Social Security taxes withheld from her pay.
d. Clem paid $45 to rent a safe deposit box to store his coin collection. Clem has collected coins
intermittently since he was a boy and he expects to sell his collection when he retires.
a. $4,125 – The tools and supplies and the health insurance are deductible for AGI.
b. $2,040 – The utilities and depreciation are deductible for AGI (rental activity).
c. $7,650 –The employer portion of the self-employment tax is deductible for AGI, but
the Social Security tax is not deductible.
d. $0 – The safe deposit fee is an itemized deduction (it appears that Clem is investing
in rare coins rather than a dealer in coins – a business).
51. [LO 3] Clyde currently commutes 55 miles to work in the city. He is considering a new
assignment in the suburbs on the other side of the city that would increase his commute
considerably. He would like to accept the assignment, but he thinks it might require that he move
to the other side of the city. Assume that Clyde is employed for 39 of the next 52 weeks.
Determine if Clyde’s move qualifies for a moving expense deduction and calculate the amount (if
any) under the following circumstances:
a. Clyde estimates that unless he moves across town, his new commute would be
almost 70 miles. He also estimates the costs of a move as follows:
Lodging while searching for an apartment $ 125
Transportation – auto (100 miles @ 23.5 cents/mile, rounded) 24
Mover’s fee (furniture and possessions) 1,500
Meals while en route 35
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b. Same as (a.) above, except Clyde estimates that unless he moves across town, his
new commute would be almost 115 miles.
c. Same as (a.) above, except Clyde’s new commute would be almost 150 miles and the
mover’s intend to impose a $450 surcharge on the moving fee for the additional
distance.
a. Zero. Clyde would not qualify for a moving expense deduction. To qualify for a
moving expense deduction the new commute from Clyde’s current residence would
need to be a minimum of 105 miles. That is, his commute from his old residence to
the new job must be more than 50 miles longer than his current commute
b. Clyde now qualifies for a moving expense deduction (assuming he is employed for 39
of the next 52 weeks). Estimated costs of $1,524 (mover’s fee of $1,500 + $24 of
mileage) are deductible for AGI. This excludes the cost for lodging while searching
for an apartment and the meals en route.
c. Clyde qualifies for a moving expense deduction (assuming he is employed for 39 of the
next 52 weeks). Estimated costs of moving increase to $1,974, and this total is deductible
for AGI.
52. [LO 3] Smithers is a self-employed individual who earns $30,000 per year in self-employment
income. Smithers pays $2,200 in annual health insurance premiums (not through an exchange) for
his own medical care. In each of the following situations, determine the amount of the deductible
health insurance premium for Smithers.
a. Smithers is single, and the self-employment income is his only source of income.
b. Smithers is single, but besides being self-employed, Smithers is also employed part-time by SF
Power Corporation. This year Smithers elected not to participate in SF’s health plan.
c. Smithers is self-employed, and he is also married. Smithers’ spouse, Samantha, is employed full-
time by SF Power Corporation and is covered by SF’s health plan. Smithers is not eligible to
participate in SF’s health plan.
d. Smithers is self-employed, and he is also married. Smithers’ spouse, Samantha, is employed full-
time by SF Power Corporation and is covered by SF’s health plan. Smithers elected not to
participate in SF’s health plan.
a. Smithers can deduct $2,200 either as a deduction for AGI or claim $2,200 as an itemized medical
expense.
b. Smithers can claim only $2,200 as an itemized medical expense. Even though he is self-employed,
he is not eligible to deduct the health insurance premiums as a for AGI deduction because he is
eligible to participate in his employer’s plan (even though he did not actually participate).
c. Smithers can deduct $2,200 either as a deduction for AGI or claim $2,200 as an itemized medical
expense.
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Education.
d. Smithers can claim only $2,200 as an itemized medical expense. Even though he is self-employed,
he is not eligible to deduct the health insurance premiums as a for AGI deduction because he is
eligible to participate in his spouse’s employer’s plan (even though he did not actually participate
in her plan).
53. [LO 3] Hardaway earned $100,000 of compensation this year. He also paid (or had paid for him)
$3,000 of health insurance (not through an exchange). What is Hardaway’s AGI in each of the
following situations (ignore the effects of Social Security and self-employment taxes)?
a. Hardaway is an employee, and his employer paid Hardaway’s $3,000 of health insurance for him
as a nontaxable fringe benefit. Consequently, Hardaway received $97,000 of taxable compensation
and $3,000 of nontaxable compensation.
b. Hardaway is a self-employed taxpayer, and he paid $3,000 of health insurance himself. He is not
eligible to participate in an employer-sponsored plan.
a. Hardaway’s AGI is $97,000, consisting of the $97,000 of taxable compensation he received from
his employer.
b. Hardaway’s AGI is $97,000 (the same as in part a), consisting of $100,000 of taxable earnings
minus $3,000 for AGI deduction for the health insurance.
54. [LO 3] John (age 51 and single) has earned income of $3,000. He has $30,000 of unearned (capital
gain) income.
a. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA
contribution John can make in 2014?
b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA

contribution John can make in 2014?
c. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA
contribution John can make in 2014 if he has earned income of $10,000?
a. $3,000. Deductible contributions to an IRA account are limited to the lesser of $5,500 or earned
income. If the individual is at least 50 years old by the end of the year, he/she may make a
contribution of up to the lesser of $6,500 or earned income. In this case, John’s deductible
contribution is the lesser of (1) his earned income of $3,000 or (2) the maximum deductible
amount of $6,500. So his deductible contribution is $3,000.
b. $3,000. Taxpayers who are participants in an employer sponsored retirement plan are allowed to
make deductible contributions to an IRA account as long as they meet certain AGI restrictions.
In 2014, the deductibility of IRA contributions is phased-out proportionally for AGI between
$60,000 and $70,000. John’s AGI of $33,000 (3,000 earned income + 30,000 capital gain) falls
below the $60,000 AGI phase-out threshold. Thus, John is allowed to make a contribution equal
to the lesser of $6,500 or earned income (The $6,500 = $5,500 standard limit + $1,000 catch-up
contribution for taxpayers age 50 and over). So, he is allowed to deduct $3,000.
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Education.
c. $6,500. Deductible contributions are limited to the lesser of $5,500 or earned income. The
$5,500 limit is increased to $6,500 for taxpayers who have reached the age of 50 by the end of
the year (taxpayers age 50 or older at the end of the year are allowed to make an additional
$1,000 catch up contribution). Thus, John may make a total deductible contribution equal to the
lesser of $6,500 (5,500 + 1,000) or earned income ($10,000). So, he is allowed to deduct
$6,500.
55. [LO 3] William is a single writer (age 35) who recently decided that he needs to save more for
retirement. His 2014 AGI is $64,000 (all earned income).
a. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA
contribution William can make in 2014?
b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA
contribution William can make in 2014?
c. Assuming the same facts as in b. except his AGI is $75,000, what is the maximum deductible
IRA contribution William can make in 2014?
a. $5,500. Because William is not covered by an employer provided retirement plan, his deductible
contribution is not limited by AGI. Also, because he is under 50 years of age at the end of the year,
his maximum deductible IRA contribution for the year is $5,500.
b. $3,300. Because William is under 50 years of age at the end of the year, his maximum deductible
contribution (before phase-out) is $5,500. However, because he is covered by an employer
sponsored plan as a single taxpayer, William’s maximum deductible contribution is phased out
proportionally for AGI between $60,000 and $70,000. William’s AGI of $64,000 is 40% of the way
through the $10,000 phase-out range [($64,000 - $60,000)/$70,000 - $60,000)] so he is not allowed
to deduct 40% of the $5,500 maximum deductible contribution. But he is allowed to deduct 60% of
his maximum deductible contribution of $5,500 which is $3,300.
c. The maximum deductible IRA contribution that William can contribute in 2014 is $0. Because he
is covered by an employer provided plan, the maximum deductible contribution for unmarried
taxpayers phases out between $60,000 and $70,000. Because William’s AGI exceeds $70,000, he
cannot make a deductible IRA contribution.
56. [LO 3] In 2014, Susan (44 years old) is a highly successful architect and is covered by an
employee-sponsored plan. Her husband, Dan (47 years old), however, is a Ph.D. student and is
unemployed. Compute the maximum deductible IRA contribution for each spouse in the following
alternative situations.
a. Susan’s salary and the couple’s AGI is $200,000. The couple files a joint tax return.
b. Susan’s salary and the couple’s AGI is $120,000. The couple files a joint tax return.
c. Susan’s salary and the couple’s AGI is $80,000. The couple files a joint tax return.
d. Susan’s salary and her AGI is $80,000. Dan reports $5,000 of AGI (earned income). The couple
files separate tax returns.
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Education.
a. Susan’s maximum deductible contribution is $0. Dan’s maximum deductible contribution is

also $0. Susan’s maximum deductible contribution is $0 because she is an active participant
in an employer’s retirement plan and the AGI on the couple’s joint return exceeds $116,000,
so her deductible contribution is entirely phased out. Dan’s maximum deductible contribution
is also $0 even though he is not an active participant in an employer’s plan. Because Susan is
an active participant and the couple’s AGI exceeds $191,000 Dan’s deductible contribution is
fully phased out.
b. Susan’s maximum deductible contribution is $0. Because she is an active participant in an
employer’s plan and the couple’s AGI exceeds $116,000 her deductible contribution is entirely
phased out. Dan’s maximum deductible contribution is $5,500. This is the lesser of (1)
$5,500 or (2) $114,500, which is the couple’s earned income ($120,000) minus Susan’s
deductible contribution ($5,500). Dan is able to contribute $5,500 even though he doesn’t
have any earned income because the couple has earned income and the couple’s AGI is less
than $181,000.
c. Susan’s maximum deductible contribution is $5,500, and Dan’s maximum deductible
contribution is $5,500. Even though Susan is an active participant in an employer’s
retirement plan she is able to make a deductible contribution because the couple’s AGI is less
than $96,000. Dan is able to make a $5,500 deductible contribution which is the lesser of (1)
$5,500 or (2) $74,500 ($80,000 minus $5,500) which is the couple’s earned income minus
Susan’s deductible contribution.
d. Susan’s maximum deductible contribution is $0 because she is filing separately and her AGI
exceeds $10,000. Dan is able to make a $2,750 deductible contribution. His maximum
deductible contribution before phase out is $5,500. Because he is filing a separate return, his
maximum contribution phases out proportionally between $0 and $10,000 of AGI. Here his
$5,000 AGI is 50% of the way through the phase out range so he loses 50% of his otherwise
deductible contribution.
57. [LO 3] {Forms } In 2014, Rashaun (62 years old) retired and planned on immediately receiving
distributions (making withdrawals) from his traditional IRA account. The current balance of his
IRA account is $160,000. Over the years, Rashaun has contributed $40,000 to the IRA. Of his
$40,000 contributions, $30,000 was nondeductible and $10,000 was deductible.
a. If Rashaun currently withdraws $20,000 from the IRA, how much tax will he be required to pay
on the withdrawal if his marginal tax rate is 20 percent?
b. If Rashaun currently withdraws $70,000 from the IRA, how much tax will he be required to pay
on the withdrawal if his marginal tax rate is 30 percent?
c. Using the information provided in part b, complete Form 8606, Part I to report the taxable portion
of the $70,000 distribution (withdrawal). Use 2013 forms if 2014 forms are unavailable.
a. Because Rashaun has made both deductible and nondeductible contributions to his IRA, he
needs to allocate the distribution between taxable amounts and amounts that are a return of his
nondeductible contribution. To do this, he first has to determine the ratio of nondeductible
contributions to the value of the IRA at the time of the distribution. In this case the ratio is
$30,000/$160,000 or 18.75%. Consequently, $3,750 (20,000 × 18.75%) is not taxable and the
remaining $16,250 is taxed at Rashaun’s marginal tax rate of 20%. Thus, Rashaun must pay
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Education.
$3,250 in taxes and the overall amount he receives after taxes is $16,750 [3,750 + (16,250 × (1-
.2)].
b. Again, because Rashaun has made both deductible and nondeductible contributions, he needs to
allocate the distribution between taxable amounts and amounts that are a return of his
nondeductible contributions. His ratio of nondeductible contributions to the value of the IRA is
30,000/160,000 or 18.75%. Consequently, $13,125 (70,000 × 18.75%) is not taxable and the
remaining $56,875 (70,000 – 13,125) is taxed at his marginal tax rate of 30% for taxes of $17,063
($56,875 × 30%). After taxes Rashaun receives $52,937 [13,125 + (56,875 – 17,063]).
c.
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Education.
58. [LO 3] Brooklyn has been contributing to a traditional IRA for seven years
(all deductible contributions) and has a total of $30,000 in the account. In 2014, she is 39 years old
and has decided that she wants to get a new car. She withdraws $20,000 from the IRA to help pay
for the car. She is currently in the 25 percent marginal tax bracket. What amount of the withdrawal,
after tax considerations, will Brooklyn have available to purchase the car?
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Education.
Brooklyn will be taxed at 25% on the $20,000 withdrawal. Consequently, she will pay $5,000 in
taxes (20,000 × 25%). In addition, she must pay a 10% early distribution penalty on the $20,000
withdrawal ($20,000 × 10% = $2,000 penalty). This leaves her with $13,000 after taxes ($20,000
– 5,000 taxes – 2,000 penalties) to purchase the car.
59. [LO 3] Jackson and Ashley Turner (both 45 years old) are married and want to contribute to a Roth
IRA for Ashley. In 2014, their AGI is $170,000. Jackson and Ashley each earned half of the
income.
a. How much can Ashley contribute to her Roth IRA if they file a joint return?
b. How much can Ashley contribute if she files a separate return?
a. Individuals are allowed to contribute to a Roth IRA as long as their AGI falls below certain
threshold limits. The AGI threshold limits for married individuals filing jointly is between $181,000
and $191,000. Because Jackson and Ashley’s AGI is below these threshold limits, Ashley can
contribute $5,500, the maximum contribution for taxpayers under age 50 at the end of the year.
b. The AGI threshold limits for married individuals filing separately is between $0 and $10,000.
Thus, if they filed separately, Ashley would not be able to contribute to a Roth IRA.
60. [LO 3] Harriet and Harry Combs (both 37 years old) are married and both want to contribute to a
Roth IRA. In 2014, their AGI is $50,000. Harriet earned $46,000 and Harry earned $4,000.
a. How much can Harriet contribute to her Roth IRA if they file a joint return?
b. How much can Harriet contribute if she files a separate return?
c. How much can Harry contribute to his Roth IRA if they file separately?
a. Individuals are allowed to contribute to a Roth IRA as long as their AGI falls below certain
threshold limits. The AGI threshold limits for married individuals filing jointly is between
$181,000 and $191,000. Because Harriet and Harry’s AGI is below these threshold limits, Harriet
can contribute $5,500, the maximum contribution for taxpayers under age 50 at the end of the year.
b. The AGI threshold limits for married individuals filing separately is between $0 and $10,000.
Thus, if Harriet files separately, she would not be allowed to contribute to Roth IRA because her
AGI is $46,000.
c. $3,300 ($5,500 × 60%). Since Harry’s AGI is 40% of the way between $0 and $10,000 [($4,000
– 0)/(10,000 – 0)], Harry is only allowed to contribute 60% (100% - 40% disallowed percentage)
of the $5,500 maximum contribution for tax payers under 50 years of age at year end.
61. [LO 3] George (age 42 at year-end) has been contributing to a traditional IRA for years (all
deductible contributions) and his IRA is now worth $25,000. He is planning on transferring (or
rolling over) the entire balance into a Roth IRA account. George’s marginal tax rate is 25 percent.
a. What are the tax consequences to George if he takes $25,000 out of the traditional IRA and puts
the entire amount into a Roth IRA?
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Education.
b. What are the tax consequences to George if he takes $25,000 out of the traditional IRA, pays the
taxes due from the IRA distribution, and contributes the remaining distribution to the Roth IRA?
c. What are the tax consequences to George if he takes $25,000 out of the traditional IRA, keeps
$10,000 to pay taxes and to make a down payment on a new car, and contributes the remaining
distribution to the Roth IRA?
a. George will have to pay taxes of $6,250 (25% × 25,000) for taking the $25,000 out of the IRA.
However, he will not have to pay the 10% penalty tax because he deposited the entire $25,000 (the
entire amount of the withdrawal) into a Roth IRA.
b. George will have to pay taxes of $6,250 for taking the $25,000 out of the IRA. After taxes, this
leaves $18,750 ($25,000 – 6,250) for George to contribute to the Roth IRA. However, because he
doesn’t contribute (roll over) $25,000 (the full amount that was withdrawn from the traditional
IRA), he will also have to pay the 10% penalty tax on the $6,250 that he did not contribute or roll
over. Therefore, he will have to pay a penalty of $625 ($6,250 x 10%). In total he will pay taxes
of $6,875 ($6,250 + 625) on the transaction.
c. George will have to pay taxes of $6,250 for taking the $25,000 out of the IRA. After taxes, this
leaves him with $18,750 ($25,000 – 6,250). Because George only contributes $15,000 to the Roth
IRA he must pay a 10% penalty tax on the $10,000 that he took out of the traditional IRA and did
not contribute or roll over to a Roth IRA. Consequently, he pays a $1,000 penalty ($10,000 ×
10%). In total, George must pay $7,250 ($1,000 penalty + $6,250 tax) in taxes on the distribution.
62. [LO 3] Jimmer has contributed $15,000 to his Roth IRA and the balance in the account is $18,000.
In the current year, Jimmer withdrew $17,000 from the Roth IRA to pay for a new car. If Jimmer’s
marginal ordinary income tax rate is 25 percent, what amount of tax and penalty, if any, is Jimmer
required to pay on the withdrawal in each of the following alternative situations?
a. Jimmer opened the Roth account 44 months before he withdrew the $17,000 and Jimmer is 62
years of age.
b. Jimmer opened the Roth account 44 months before he withdrew the $17,000 and Jimmer is age
53.
c. Jimmer opened the Roth account 76 months before he withdrew the $17,000 and Jimmer is age
62.
d. Jimmer opened the Roth account 76 months before he withdrew the $17,000 and Jimmer is age
53.
a. $500 tax and $200 penalty. Because the Roth account has not been open for five years at the
time of the distribution), this is a nonqualified distribution. Because Jimmer contributed $15,000,
he is allowed to receive $15,000 in distributions from the account without paying tax or penalty.
However, because it is a nonqualified distribution, he must pay tax ($2,000 x 25%) and penalty
($2,000 × 10%) on the $2,000 earnings that Jimmer received in the distribution.
b. $500 tax and $200 penalty. Because the Roth account has not been open for five years (and
Jimmer has not reached age 59 ½ by the time of the distribution), this is a nonqualified
distribution. Because Jimmer contributed $15,000, he is allowed to receive $15,000 in
distributions from the account without paying tax or penalty. However, because it is a
nonqualified distribution, he must pay tax ($2,000 × 25%) and penalty ($2,000 × 10%) on the
$2,000 earnings that Jimmer received in the distribution.
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Education.
c. $0 tax and $0 penalty. Because this is a qualified distribution (distribution is after Jimmer has
attained 59 ½ years of age and the Roth account has been open for more than five years) the
distribution is not subject to tax or penalty.
d. $500 tax and $200 penalty. Because Jimmer has not reached age 59 ½ by the time of the
distribution, this is a nonqualified distribution. Because Jimmer contributed $15,000, he is
allowed to receive $15,000 in distributions from the account without paying tax or penalty.
However, because it is a nonqualified distribution, he must pay tax ($2,000 × 25%) and penalty
($2,000 × 10%) on the $2,000 earnings that Jimmer received in the distribution.
63. [LO 3] Over the past three years, Sherry has contributed a total of $12,000 to a Roth IRA account
($4,000 a year). The current value of the Roth IRA is $16,300. In the current year, Sherry
withdraws $14,000 of the account balance to purchase a car. Assuming Sherry is in a 25 percent
marginal tax bracket, how much of the $14,000 withdrawal will she retain after taxes to fund her
car purchase?
Because Sherry has made a withdrawal from her Roth IRA within five years of opening it, she has
received a nonqualified distribution. Nonqualified distributions are non taxable to the extent they
are attributable to contributions; the earnings made on such contributions are taxed as ordinary
income and subject to a 10% penalty. In this instance, Sherry has withdrawn $2,000 of earnings
(14,000 withdrawal – 12,000 contributions) and will pay taxes of $500 (25% × 2,000) and a
penalty of $200 (10% × 2,000). Of the $14,000 withdrawn, Sherry will retain after-taxes $13,300
($14,000 withdrawal – 500 taxes – 200 penalty).
64. [LO 3] Seven years ago, Halle (currently age 41) contributed $4,000 to a Roth IRA account. The
current value of the Roth IRA is $9,000. In the current year Halle withdraws $8,000 of the account
balance to use as a down payment on her first home. Assuming Halle is in a 25 percent marginal
tax bracket, how much of the $8,000 withdrawal will she retain after taxes to fund her house down
payment?
All $8,000. Because Halle has had her Roth IRA open for at least five years and she used the
distribution proceeds as a down payment on her first home, the entire distribution is considered a
qualified distribution and is not taxable.
65. [LO 3] {Research } Sarah was contemplating making a contribution to her traditional individual
retirement account for 2014. She determined that she would contribute $5,000 to her IRA and she
deducted $5,000 for the contribution when she completed and filed her 2014 tax return on February
15, 2015. Two months later, on April 15, Sarah realized that she had not yet actually contributed
the funds to her IRA. On April 15, she went to the post office and mailed a $5,000 check to the
bank holding her IRA. The bank received the payment on April 18. In which year is Sarah’s $5,000
contribution deductible?
Sarah is allowed to deduct $5,000 in 2014.
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Education.
According to Rev. Rul. 84-18, an individual may deduct a contribution to an IRA (under §219)
even though the contribution is made after the individual’s tax return is filed, as long as the
contribution is made before the due date of the return.
The next issue is whether Sarah’s contribution was made by the due date of her return.
According to IRS Letter Ruling 8536085, June 14, 1985, contributions mailed by a taxpayer on or
before the tax return deadline are considered as though they were timely made.
66. [LO 3] Lionel is an unmarried law student at State University Law School, a qualified educational
institution. This year Lionel borrowed $24,000 from Counti Bank and paid interest of $1,440.
Lionel used the loan proceeds to pay his law school tuition. Calculate the amounts Lionel can
deduct for interest on higher education loans under the following circumstances (assume the 2013
rules apply for purposes of the qualified education expense deduction):
a. The maximum interest deduction is the amount paid up to $2,500. The deduction is phased
out as AGI exceeds $65,000 (before applying the interest deduction). Consequently, because
his AGI is below the trigger amount for the phase-out, Lionel can deduct $1,440, which is
the lesser of (1) $2,500 or (2) $1,440 (the amount of interest expense he paid). Lionel paid
$24,000 of qualified educational expenses. Because his modified AGI ($50,000 - $1,440
deduction for interest on higher education loan = $48,560) is less than the trigger for the
deduction for qualified education expense phase-out ($65,000), Lionel can deduct $4,000 for
qualified education expenses, which is the lesser of (1) $4,000 or (2) $24,000 (qualified
education expenses paid).
b. Lionel can deduct $576 of qualified educational interest expense computed as follows:

(1) Modified AGI $74,000
(2) Amount of interest paid up to $2,500 1,440 Lesser of amount paid or
$2,500
(3) Phase-out (reduction) percentage 60% [(1) – 65,000] / 15,000, limited
to 100 percent
(4) Phase-out amount (reduction in 864 (2) x (3)
maximum)
Deductible interest expense $576 (2) – (4)
Since Lionel’s modified AGI (($74,000 - $576 deduction for interest on higher education
loan = $73,424) exceeds $65,000 but is less than or equal to $80,000, Lionel can also
deduct $2,000 of qualified education expenses, which is the lesser of (1) $2,000 or (2)
$24,000 (qualified education expenses paid).
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Education.
c. Lionel is not allowed to deduct any qualified educational interest expense computed as
follows:

(1) Modified AGI $90,000
(2) Amount of interest paid up to $2,500 1,440 Lesser of amount paid or $2,500
(3) Phase-out (reduction) percentage 100% [(1) – 65,000] / 15,000, limited
to 100 percent
(4) Phase-out amount (reduction in 1,440 (2) x (3)
maximum)
Deductible interest expense $0 (2) – (4)
Lionel is also not allowed to deduct any qualified education expenses because his modified
AGI ($90,000) exceeds $80,000.
67. [LO 3] This year Jack intends to file a married-joint return with two dependents. Jack received
$162,500 of salary, and paid $5,000 of interest on loans used to pay qualified tuition costs for his
dependent daughter, Deb. This year Jack has also paid qualified moving expenses of $4,300 and
$24,000 of alimony.
a. What is Jack’s adjusted gross income? Assume that Jack will opt to treat tax items in a
manner to minimize his AGI.
b. Suppose that Jack also reported income of $8,800 from a half share of profits from a
partnership. What AGI would Jack report under these circumstances? Again, assume that
Jack will opt to treat tax items in a manner to minimize his AGI.
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Education.
a. AGI is $132,050. Jack’s modified AGI calculated without adjustment for

educational interest expense is 134,200. He is allowed to deduct part of his student
loan interest because his modified AGI is not above $160,000. Jack’s maximum
deduction before the phase-out is $2,500 (the amount of interest paid up to $2,500).
The maximum deduction of $2,500 is phased-out ratably over a $30,000 range
beginning with modified AGI over $130,000. Consequently, Jack’s education
interest expense deduction is $2,150 = ($2,500 - $2,500 * [($134,200-
130,000)/30,000]).Jack’s AGI is computed as follows;
Salary and gross income $ 162,500
Less: Alimony - 24,000
Moving Expense Deduction - 4,300
Modified AGI $ 134,200
Student Loan Interest Deduction - 2,150
AGI $ 132,050
b. AGI is $141,583. Jack’s modified AGI calculated without adjustment for educational
interest expense is 143,000. He is allowed to deduct part of his student loan interest
because his modified AGI is not above $160,000. Jack’s maximum deduction before
the phase-out is $2,500 (the amount of interest paid up to $2,500). The maximum
deduction of $2,500 is phased-out ratably over a $30,000 range beginning with
modified AGI over $130,000. Consequently, Jack’s education interest expense
deduction is $1,417 = ($2,500 - $2,500 * [($143,000-130,000)/30,000]).
Jack’s AGI is computed as follows:
Salary $ 162,500
Partnership income + 8,800
Less: Alimony - 24,000
Moving Expense Deduction - 4,300
Modified AGI $ 143,000
Student Loan Interest Deduction - 1,417
AGI $ 141,583
Comprehensive Problems
68. Read the following letter and help Shady Slim with his tax situation. Please assume that gross
income is $172,900 for purposes of this problem.
December 31, 2014
To the friendly student tax preparer:
Hi, it’s Shady Slim again. I’m told that you need some more information from me in order to complete
my tax return. I’m an open book! I’ll tell you whatever I think you need to know.
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Education.
I had to move this year after getting my job at Roca Cola. We moved on February 3 of this year, and I
worked my job at Roca Cola for the rest of the year. I still live in the same state, but I moved 500 miles
away from my old house. I left a little bit early to go on a house-hunting trip that cost me a total of $450. I
hired a moving company to move our stuff at a cost of $2,300. Junior and I got a hotel room along the
way that cost us $42 (I love Super 8!). We spent $35 on meals on the way to our new home. Oh yeah, I
took Junior to a movie on the way and that cost $20.
Can you believe I’m still paying off my student loans, even after 15 years? I paid a total of $900 in
interest on my old student loans this year.
Since Roca Coca (my employer) never started a retirement plan, I decided I should probably start saving
for my golden years. I contributed $3,000 to what the bank referred to as a regular IRA (or was it a
REM?). Oh yeah. I also did a little investing this year. I bought a limited partnership interest in Duds,
Ltd. for $10,000. I thought it was going to be a real winner, but this year they took a bath. My portion of
the loss was $8,000. Well, at least I did not actually do any work for Duds, and I get the tax deduction -
right?
That should be all the information you need right now. Please calculate my adjusted gross income and
complete page 1 of Form 1040. You’re still doing this for free, right?
Adjusted gross income is $167,440, computed as follows:
Gross Income $ 172,900

Less:
Duds, Ltd Loss Deduction $ 0
Moving Expenses:
Mileage (500 x 23.5¢) 118
Moving company 2,300
Lodging 42
IRA Deduction 3,000 - 5,460

AGI $ 167,440
Notes:
1. Duds, Ltd. Loss is not deductible because it is a passive activity for Shady.
2. House-hunting trip, meals, and movie are not deductible moving expenses.
3. Student loan interest is not deductible because AGI exceeds the threshold amount of income.
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Education.
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Education.
69. Jeremy and Alyssa Johnson have been married for five years and do not have any children. Jeremy
was married previously and has one child from the prior marriage. He is self-employed and
operates his own computer repair store. For the first two months of this year, Alyssa worked for
Staples, Inc. as an employee. In March, Alyssa accepted a new job with Super Toys, Inc. (ST)
where she worked for the remainder of the year. This year the Johnsons received $255,000 of
gross income. Determine the Johnson’s AGI given the following information (assume the 2013
rules apply for purposes of the qualified education expense deduction):
a. Expenses associated with Jeremy’s store include $40,000 in salary (and employment taxes)
to employees, $45,000 of supplies, and $18,000 in rent and other administrative expenses.
b. Alyssa contributed $5,000 to a regular IRA. She did not participate in an employer-provided
retirement plan. Jeremy currently is not saving for his retirement.
c. The Johnsons own a piece of investment real estate. They paid $500 of real property taxes
on the property and they incurred $200 of expenses in travel costs to see the property and to
evaluate other similar potential investment properties.
d. The Johnsons own a rental home. They incurred $8,500 of expenses associated with the
property.
e. The Johnson’s home was only five miles from the Staples store where Alyssa worked in
January and February. The ST store was 60 miles from their home, so the Johnsons decided
to move to make the commute easier for Alyssa. The Johnson’s new home was only ten
miles from the ST store. However, it was 50 miles from their former residence. The
Johnsons paid a moving company $2,000 to move their possessions to the new location.
They also drove the 50 miles to their new residence. They stopped along the way for lunch
and spent $60 eating at Denny’s. None of the moving expenses were reimbursed by ST.
f. Jeremy paid $4,500 for health insurance coverage for himself (not through an exchange).
Alyssa was covered by health plans provided by her employer, but Jeremy is not eligible for
the plan until next year.
g. Jeremy paid $2,500 in self-employment taxes ($1,250 represents the employer portion of the
self-employment taxes).
h. Jeremy paid $5,000 in alimony and $3,000 in child support from his prior marriage.
i. Alyssa paid $3,100 of tuition and fees to attend night classes at a local university. The
Johnsons would like to deduct as much of this expenditure as possible rather than claim a
credit.
Answer: $122,638, computed as follows:
Johnson’s AGI
Gross income $255,000
6-43
Education.
a Ordinary and 103,000 Ordinary expenses associated with Jeremy’s business

necessary business
expenses
b Unreimbursed - Unreimbursed employee business expenses are deductible
employment expenses from AGI not for AGI
c Real property taxes - Taxes and investment expenses are deductible from AGI
and investment not for AGI.
expenses.
d Rental expenses 8,500 Rental expenses are deductible for AGI even though they
are technically investment or “production of income
expenses.”
e Moving expenses 2,012 Her old residence to new place of employment is more
than 50 miles farther than her old residence to her old
place of employment (60 – 5 = 55). The location of her
new residence is irrelevant. The Johnsons are allowed to
deduct costs of moving ($2,000 movers including 23.5
cents a mile for driving themselves (50 x 23.5¢ =$12,
rounded). Meals are an indirect cost of moving and are
not deductible.
f Self-employed health 4,500 Jeremy may deduct all the costs of his health insurance
insurance because he is not eligible for ST’s health plan.
g Self-employment 1,250 The employer portion of self-employment taxes are
taxes allowed as for AGI deduction
h Alimony 5,000 Alimony allowed as for AGI deduction
i IRA Deduction 5,000 Fully deductible since Alyssa did not participate in an
employer retirement plan.
i Education expenses 3,100 See Note A below
Total for AGI 132,362
deductions
AGI $122,638 AGI
Note A: Qualifying education expenses are deductible up to a maximum of $4,000. Since the Johnson’s
modified AGI of $125,738 (AGI without deducting education expenses) does not exceed $130,000, the
Johnsons are allowed to deduct the lesser of their actual qualified expenditures of $3,100 or $4,000.
6-44
Education.
70. Joe and Jessie are married and have one dependent child, Lizzie. Lizzie is currently in college at
State University. Joe works as a design engineer for a manufacturing firm while Jessie runs a craft
business from their home. Jessie’s craft business consists of making craft items for sale at craft
shows that are held periodically at various locations. Jessie spends considerable time and effort on
her craft business and it has been consistently profitable over the years. Joe and Jessie pay interest
on a personal loan to pay for Lizzie’s college expenses (balance of $35,000).
Based on their estimates, determine Joe and Jessie’s AGI and complete page 1 of Form 1040.
Assume the 2013 rules apply for purposes of the qualified education expense deduction and that
the employer portion of the self-employment tax on Jessie’s income is $808. Joe and Jessie have
summarized the income and expenses they expect to report this year as follows:
Income:
Joe’s salary $ 119,100
Jessie’s craft sales 18,400
Interest from certificate of deposit 1,650
Interest from Treasury bond funds 727
Interest from municipal bond funds 920
Income from renting out their personal residence
for 10 days during a local golf tournament 800
Expenditures:
Social Security tax withheld from Joe’s wages 7,482
Cost of Jessie’s craft supplies 4,260
Postage for mailing crafts 145
Travel and lodging for craft shows 2,230
Meals during craft shows 670
Self-employment tax on Jessie’s craft income 1,615
College tuition paid for Lizzie 5,780
Interest on loans to pay Lizzie’s tuition 3,200
Lizzie’s room and board at college 12,620
Cleaning fees and advertising expense associated
with renting their residence during local golf
tournament 600
6-45
Education.
Salary $ 119,100
Interest (taxable) + 2,377
Craft revenue $ 18,400
less cost of goods - 4,260
less travel & postage - 2,375
less 50 percent of meals - 335
Income from craft business + 11,430
Total Income $ 132,907
Less Employer portion of SE taxes - 808
Modified AGI (for student loan interest deduction) $ 132,099
Student loan interest deduction - 2,325
Modified AGI (for qualified education expenses) $129,774
Tuition deduction - 4,000
AGI $ 125,774
Joe and Jessie’s maximum deduction for the educational interest deduction before the phase-out is
$2,500 (the amount of interest paid ($3,200) up to $2,500). Joe and Jessie’s modified AGI of
$132,099 (for the student loan interest deduction) is above the phase-out trigger for student loan
interest in 2014, $130,000 for MJ. Hence, the maximum deduction for the educational loan
interest ($2,500) is reduced by the excess AGI over the threshold ($132,099-$130,000) divided by
the phase-out range ($2,099/30,000) or 7 percent. Thus, their deduction for student loan interest is
$2,325 ($2,500 – $175 [7 percent of $2,500]). Their modified AGI of $129,774 (for the qualified
education expense deduction) is less than the $130,000 phase-out trigger. Thus, they may deduct
the lesser of the $5,780 tuition they paid for Lizzie or $4,000 (the maximum deduction allowed)
The $800 income from renting their residence for 10 days is excluded from gross income (and the
related $600 of expenses are not deductible) because the home is considered their residences, and
the rental days did not exceed 14 days.
6-46
Education.
6-47
Education.

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Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.

Essentials of Federal Taxation 3rd

Test Bank: https://testbankpack.com/p/test-bank-for-

Solution Manual: https://testbankpack.com/p/solution-

5. [LO 2] What are the implications of treating losses as passive?

Interest income $ 11,255

Description Amount Explanation

Real property taxes $ 3,100

a. What effect does the rental have on Dillon’s AGI?

Use the following facts to answer problems 41 and 42.

a. $10,000, calculated as follows:

Gross rental income $10,000

Advertising expense = $500

Mortgage interest = (75/110) × $3,500=$2,386

Property taxes= (75/110) × $900=$614

Less: total Tier 1 expenses (3,500)

Insurance = (75/110) × $1,000=$682

Repairs & Maintenance = (75/110) × $650=$443

Utilities= (75/110) × $950=$648

Less: total Tier 2 expenses (1,773)

Depreciation (75/110) × $8,500= $5,795, but the

Total “For AGI” deductions ($3,500 + $1,773 + $4,727) $10,000

Mortgage interest [(35/110) × $3,500] $1,114

Real property taxes [(35/110) × $900] 286

Total “from AGI” deductions $1,400

c. $145,273, calculated as follows:

Beginning basis $150,000

Less: depreciation actually deducted (4,727)

Adjusted basis $145,273

a. $8,972, calculated as follows:

Gross rental income $10,000

Mortgage interest [(290/365) × $3,500] $2,781

c. $144,205, calculated as follows:

Beginning basis $150,000

Use the following facts to answer problems 43-45.

43. [LO 2] Assume Alexa receives $30,000 in gross rental receipts.

a. Expenses reduce AGI by $28,900. Alexa’s property is treated as a nonresidence with

Gross rental income $30,000

Note that the property is a nonresidence with rental use property.

a. Alexa’s AGI will be reduced by $0, calculated as follows:

Gross rental income $20,000

By definition, a rental activity [unless it is a residence with significant rental use (a

Phase-out = [AGI - $100,000] × $.50

Exception amount = $25,000 (maximum) - $10,000 (phase-out) = $15,000

Gross rental income $30,000

Real property taxes $ 3,600

a. What amount of each of these expenses is allocated to the home office?

Expense Amount Type Allocated to home office

• Tier 2 expenses: $333 (operating expenses of the home)

• Tier 3 expense: $800 depreciation.

Use the following facts to answer problems 47 – 48.

Real property taxes $1,600

Gross Income $15,000

Less Tier 3 expenses (depreciation) (1,600)

Gross Income $10,000

b. What is Rita’s AGI for the year?

a. $7,400, calculated as follows:

Gross Income $13,000

b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA

a. Susan’s maximum deductible contribution is $0. Dan’s maximum deductible contribution is

Sarah is allowed to deduct $5,000 in 2014.

Description Amount Explanation

Description Amount Explanation

a. AGI is $132,050. Jack’s modified AGI calculated without adjustment for