Vacation Home Rental Deductions: Example

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En provenance du cours de University of Illinois at Urbana-Champaign

Federal Taxation I: Individuals, Employees, and Sole Proprietors

73 notes

University of Illinois at Urbana-Champaign

Federal Taxation I: Individuals, Employees, and Sole Proprietors

73 notes

Cours 1 sur 5 dans Specialization U.S. Federal Taxation

This course is the first course in a five-course US Federal Tax Specialization. It covers and focuses on the U.S. federal tax system as it relates to individuals, employees, and sole proprietors. Key concepts covered include gross income and items that are statutorily included or excluded in it, personal and business expenses that qualify as tax deductions, and the differing tax treatments for employees versus self-employed taxpayers. Unlike many other introductory courses in tax and as part of this course’s comprehensive wrap-up, learners will be provided with practical and tangible experience reporting both income and expenses on the main individual tax return used in the US, Form 1040. If you have enjoyed this course, consider enrolling in our online graduate Accounting program. The University of Illinois at Urbana-Champaign, consistently ranked as one of the nation's top three accounting programs, now offers a master’s in accounting at a very affordable tuition rate and is completely online. The iMSA is a full Master of Accountancy program and students graduate with an MS that is highly recognized. Try an open course or two, then apply for admission into the credit-bearing version as you may be eligible to take credit-bearing courses during the application process. If you are missing any prerequisites for the full degree, you can complete Coursera courses to demonstrate readiness and strengthen your application for the iMSA. For more information on this exciting iMSA online program, refer to this link: https://www.coursera.org/degrees/imsa

À partir de la leçon

MODULE 5: DEDUCTIONS AND LOSSES: IN GENERAL

In this module, you will learn about deductions, which is the term used in tax to describe an expense that is allowed to reduce a taxpayer’s tax liability. You will discover what adjusted gross income is, why it is important, and how to calculate it. You will also learn the difference in tax treatments for special types of acitivites, such as hobbies and rentals.

Vacation Home Rental Deductions: Example6:53

Rencontrer les enseignants

Matthew Hutchens
Lecturer of Accountancy
Department of Accountancy
Petro Lisowsky, PhD, CPA
Associate Professor of Accountancy
College of Business: Department of Accountancy

Welcome back. So, in the previous video,

we discussed how rental income deductions are calculated and allocated.

In this video, let's work through an example together.

During the year, Michelle rented her vacation home for three months,

so 90 days, and spent one month there, so 30 days.

Gross rental income from the property was $5,000.

Michelle incurred the following expenses: she had mortgage interest expense of $3,000,

real estate taxes of $1,500,

utilities of $800, maintenance of $500, and depreciation of $4,000.

So, let's consider the following questions.

First, is the vacation home subject to limitations

on the amount of the allowed deductions--that is,

personal use/rental use property?

Why or why not?

Here we need to consider two tests.

First, was the property rented for greater than 14 days?

Yes, it was rented for 90 days.

Second, was the property used personally for

more than the greater of 14 days or 10 percent of days rented?

Ten percent of days rented is nine days;

so the greater of 14 or nine, 14.

Was it used personally for more than 14 days?

Yes, it was used personally for 30 days.

So, here we can see that Michele meets these two tests

to be considered a mixed personal and rental use property.

The implication here, from the mixed personal and rental use property,

is that Michelle can take deductions,

but only to the extent there is rental income.

This is similar to hobby,

where we can only deduct hobby expenses up to hobby income.

Next, let's calculate the effect of

the rental income on Michelle's AGI using the Bolton method.

Let's compare that to the IRS method.

At issue in the Bolton approach is the allocation of tier 1 expenses only.

So, here interest and taxes only.

The calculation of gross income,

as well as the tier 2 out-of-pocket expenses

and tier 3 depreciation expenses,

are the same using either of the two methods.

The IRS method looks at interest in taxes on a usage basis--

so, time rented divided by time used--

whereas Bolton looks at interest and taxes ratably--

so, time rented divided by the total time in the year.

So, we first start with gross rental income,

and from it we subtract tier 1 expenses,

but here we allocate them differently under Bolton versus IRS.

Notice that for Bolton, the three-twelfths is the total rental use months--

so, three months divided by total months in the year, 12 months.

For IRS, the three-fourths is the total number of months rented-- so, three months--

divided by the total number of months used--

so, three rental months plus one personal month.

So, here, notice that the subtotal,

the net rental income after allocating tier 1 expenses, is 3,875 under the Bolton method,

but only 1,625 under the IRS method.

Because these subtotals are positive,

we can go on and subtract out tier 2 expenses next.

The tier 2 expenses here are utilities and repairs.

So, here we have to actually use the IRS method,

which is allocated according to total rental time,

so three months, divided by total use time, or four months.

This method is required regardless of

which method was used for tier 1 expense allocation.

Under both scenarios, we have positive net rental income,

after applying tier 2 expenses.

Therefore, we can move on and subtract

tier 3 expenses up to the net rental income subtotal.

Here, depreciation would have been $3,000, or

$4,000 total depreciation times three-fourths.

But like hobbies, the amount of deduction is limited to the amount of income.

Here, depreciation can only offset $2,900 of rental income.

Unlike hobbies, however, the unused losses carried over into

future years indefinitely to offset future rental income.

The deductions up to rental income are for AGI.

Again, note that utilities, repairs, and depreciation under both methods

is the same calculation,

except limited here to $2,900 or $650,

because that's the extent of income remaining under

the Bolton or IRS methods when tier 1 expenses were calculated.

So, at the end of the day,

Michelle had $5,000 of gross rental income,

and now has zero rental income.

That is, she generated $5,000 of for-AGI deductions.

You're probably scratching your head and asking,

why does the Bolton versus IRS method matter here?

Well, what we'll see next is that it matters

when we're figuring out how much in deductions Michelle can take from AGI.

So, finally, does Michelle have any deductions from AGI?

And If so, how much?

So, here the balance of the unused interest in taxes that were not deducted

above against rental income are deductible from AGI.

So, what we have here is that more of the tier 1 deductions

are pushed into being classified as from AGI

under the Bolton method than under the IRS method.

So, the punchline here is that total for- and from-AGI deductions under Bolton,

is $8,375, or a

$5,000 in for-AGI deductions Michelle took against the rental income above,

plus the $3,375 from-AGI deductions here.

Meanwhile, the total for- and from-AGI deductions under the IRS method

is only $6,125, or the same $5,000 for-AGI deductions allocated against rental income,

plus the $1,125 from-AGI deductions here.

So, hopefully this video helped you better understand

the expense calculations and allocations

related to mixed personal and rental use property.

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