Chapter 6, Problem 48P

a.

To determine

Calculate Person A’s net rent income or loss and the amounts that Person A can itemize on tax return by using courts approach to allocate property taxes and interest.

Explanation of Solution

Personal/Rental use: “If the residence is rented for 15 days or more during a year and if it is used for personal purposes for more than the greater of (1) 14 days or (2) 10 % of the total days rented then the residence is considered as a personal/rental use residence”.

Calculate net rental income by using courts approach:

Gross income	$7,000
Deduct: Taxes and interest (1)	($945)
Remainder to apply to rental operating expenses and depreciation	$6,055
Utilities and repairs (2)	($2,040)
Remainder	$4,015
Depreciation (limited to remainder)	($4,015)
Net rental income	$0

Table (1)

Note: If a residence is categorized as personal/rental use property, the real estate taxes and mortgage interest should be deducted first and if a positive net income arrives, then expenses, other than depreciation ( like, maintenance, insurance and utilities), that are deductible for rental property are allowed after that. Lastly, if there is a positive result balance, depreciation is allowed.

Working notes:

(1)Calculate the amount of taxes and interest that are deductible:

$\begin{array}{c}\begin{array}{l}\text{Taxes}\text{and}\text{interest}\\ \text{deductible}\end{array}\}\text{=}\left[\left(\begin{array}{l}\text{Real}\text{estate}\text{taxes}\text{+}\\ \text{Interest}\text{on}\text{mortgage}\end{array}\right)\text{×}\text{Time}\text{period}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$2,500+}\text{\$9,000}\right)\\ \text{×}\frac{\text{30}\text{days}}{\text{365}\text{days}}\end{array}\right]\\ \text{=}\text{\$11,500}\text{×}\frac{\text{30}\text{days}}{\text{365}\text{days}}\\ \text{=}\text{\$945}\end{array}$

Note: The courts have allocated real estate taxes and mortgage interest on the basis of 365 days (366 days in a leap year).

(2)Calculate the amount of utilities and repairs:

$\begin{array}{c}\text{Utilities}\text{and}\text{repairs}\text{=}\left[\left(\begin{array}{l}\text{Utilities}\text{expense}\text{+}\\ \text{Repairs}\text{expense}\end{array}\right)\text{×}\text{Time}\text{period}\right]\\ \text{=}\text{\$2,400+\$1,000}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$3,400}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$2,040}\end{array}$

Note: Other expenses like utilities and maintenance and depreciation are allocated on the basis of total number of days used. In this case vacation home is used for 50 days $\left(\text{30}\text{days}\text{+}\text{20}\text{days}\right)$.

(3)Calculate the amount of depreciation expense:

$\begin{array}{c}\text{Depreciation}\text{expense}\text{=}\left[\text{Depreciation}\text{expense}\text{×}\text{Time}\text{period}\right]\\ \text{=}\text{\$7,500}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$4,500}\end{array}$

Note: Other expenses like utilities and maintenance and depreciation are allocated on the basis of total number of days used. In this case vacation home is used for 50 days $\left(\text{30}\text{days}\text{+}\text{20}\text{days}\right)$. Here, the remaining balance is $4,015 therefore, $4,015 is a deducted as depreciation expense instead of $4,500.

b.

To determine

Explain the manner in which the answer in requirement a will change by using IRS method of allocating property taxes and interest.

Explanation of Solution

Calculate net rental income by using IRS approach:

Gross income	$7,000
Deduct: Taxes and interest (4)	($6,900)
Remainder to apply to rental operating expenses and depreciation	$100
Utilities and repairs (limited to remainder)	($100)
Net rental income	$0

Table (2)

Person A is allowed to deduct the remaining taxes and interest of $4,600 $\left(\text{\$11,500}-\text{\$6,900}\right)$ as itemized deductions. Person A is having no net rental income and having an itemized deduction of $4,600 under the IRS approach.

Note: If a residence is categorized as personal/rental use property, the real estate taxes and mortgage interest should be deducted first and if a positive net income arrives, then expenses, other than depreciation ( like, maintenance, insurance and utilities), that are deductible for rental property are allowed after that. Lastly, if there is a positive result balance, depreciation is allowed.

Working notes:

(4)Calculate the amount of taxes and interest that are deductible:

$\begin{array}{c}\begin{array}{l}\text{Taxes}\text{and}\text{interest}\\ \text{deductible}\end{array}\}\text{=}\left[\left(\begin{array}{l}\text{Real}\text{estate}\text{taxes}\text{+}\\ \text{Interest}\text{on}\text{mortgage}\end{array}\right)\text{×}\text{Time}\text{period}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$2,500+}\text{\$9,000}\right)\\ \text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\end{array}\right]\\ \text{=}\text{\$11,500}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$6,900}\end{array}$

Note: According to IFRS real estate taxes and mortgage interest are allocated on the basis of total days used.

(5)Calculate the amount of utilities and repairs:

$\begin{array}{c}\text{Utilities}\text{and}\text{repairs}\text{=}\left[\left(\begin{array}{l}\text{Utilities}\text{expense}\text{+}\\ \text{Repairs}\text{expense}\end{array}\right)\text{×}\text{Time}\text{period}\right]\\ \text{=}\text{\$2,400+\$1,000}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$3,400}\text{×}\frac{\text{30}\text{days}}{\text{50}\text{days}}\\ \text{=}\text{\$2,040}\end{array}$

Note: Other expenses like utilities and maintenance and depreciation are allocated on the basis of total number of days used. In this case vacation home is used for 50 days. Here, the remaining balance is $100 therefore, $100 is a deducted as utilities and repairs instead of $2,040.