Federal Tax Week 3 You Decide Essay

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1. John Smith's tax issues: Issue a) How is the $300,000 treated for purposes of federal tax income? Applicable Law & Analysis: From the information that was provided, the income was derived from the business and this gross income is taxable pursuant to Code§1.61-3(a). He is subject to self-employment tax, since the total amount of income that will come through to his personal tax income of half of the self-employment tax liability. Conclusion: John will have to pay self-employment tax, which is the gross income that obtained in business in the amount of $300,000. He will actually have to pay "income" and "self-employment" tax on the "net" earnings from his business... not the entire $300K because presumably he has…show more content…
< this is good. Conclusion: In summary, the only tax advantage of selling the old house is that a larger deduction of mortgage interest on the new home. Paying off a mortgage associated with a primary residence has no impact on calculation of gain or loss, it simply reduces the otherwise deductible mortgage interest. You should have mentioned that under IRC 163 the $1M principal balance limitation to fully deducting interest and that they can deduct interest on their primary residence and one other residence. Issue b) Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John's case? Applicable Law & Analysis: The 1301 1031 tax exchange refers to the exchange of real property that is “like-kind” (Reg.§1.1031(a)-1(b). John and Jane are looking to but an expensive home, this would not apply. Code§1031(b) states that no gain or loss shall be allowed and a gain would be applicable in this case. By adding money in the exchange or boot as it is referred to, they would most likely have a recognize a gain and pay tax on that gain. Conclusion: In summary, John and Jane would not be able to use 1031 tax exchange to purchase the new more expensive home. Due to the gain of buying an expensive house, it would not be considered “like-kind”. The additional money that is paid to acquire this
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