Chapter 5, Problem 57P

Ray, 83, is a used car dealer. He lives in a rural community and operates the business out of his home. One room in his 6-room house is used exclusively for his business office. He parks the cars in his front yard, and when customers come along, they sit on the front porch and negotiate a sale price. The income statement for Ray’s auto business is as follows:

If Ray’s home were rental property, the annual depreciation would be $2,900. The utilities and upkeep on the home cost Ray $6,400 for the year. Ray’s mortgage interest for the year is $2,400. When asked about the loan fees, Ray bitterly responds that Jim, the bank loan officer, charges him 10 percent of his gross profit on cars financed through the bank. Ray says, “The money is under the table, and if I don’t shell out the cash, Jim won’t loan the money to my customers to buy my cars. Everybody goes to Jim—he’s got the cash.”

Write a letter to Ray explaining the proper treatment of this information on his tax return.