Chapter 14 Tax Consequences of Home Ownership

1. [LO 1] Several years ago, Junior acquired a home that he vacationed in part of the time and rented out part of the time. During the current year Junior:

· Personally stayed in the home for 22 days.

· Rented it to his favorite brother at a discount for 10 days.

· Rented it to his least favorite brother for eight days at the full market rate.

· Rented it to his friend at a discounted rate for four days.

· Rented the home to third parties for 58 days at the market rate.

· Did repair and maintenance work on the home for two days.

· Marketed the property and made it available for rent for 150 days during the year (in addition to the days mentioned above).

How many days of personal use and how many days of rental use did Junior experience on the property during the year?

2. [LO 1] Lauren owns a condominium. In each of the following alternative situations, determine whether the condominium should be treated as a residence or nonresidence for tax purposes?

a. Lauren lives in the condo for 19 days and rents it out for 22 days.

b. Lauren lives in the condo for 8 days and rents it out for 9 days

c. Lauren lives in the condo for 80 days and rents it out for 120 days

d. Lauren lives in the condo for 30 days and rents it out for 320 days.

3. [LO 2] Steve and Stephanie Pratt purchased a home in Spokane, Washington for $400,000. They moved into the home on February 1 of year 1. They lived in the home as their primary residence until June 30 of year 5, when they sold the home for $700,000.

a. What amount of gain on the sale of the home are the Pratts required to include in taxable income?

b. Assume the original facts, except that Steve and Stephanie lived in the home until January 1 of year 3 when they purchased a new home and rented out the original home. They finally sell the original home on June 30 of year 5 for $700,000. Ignoring any issues relating to depreciation taken on the home while it was being rented, what amount of realized gain on the sale of the home are the Pratts required to include in taxable income?

c. Assume the same facts as in (b), except that the Pratts lived in the home until January of year 4 when they purchased a new home and rented out the first home. What amount of realized gain on the sale of the home will the Pratts include in taxable income if they sell the first home on June 30 of year 5 for $700,000?

d. Assume the original facts, except that Stephanie moved in with Steve on March 1 of year 3 and the couple was married on March 1 of year 4. Under state law, the couple jointly owned Steve’s home beginning on the date they were married. On December 1 of year 3, Stephanie sold her home that she lived in before she moved in with Steve. She excluded the entire $50,000 gain on the sale on her individual year 3 tax return. What amount of gain must the couple recognize on the sale in June of year 5?

4. [LO 2] Steve and Stephanie Pratt purchased a home in Spokane, Washington for $400,000. They moved into the home on February 1, of year 1. They lived in the home as their primary residence until November 1 of year 1 when they sold the home for $500,000. The Pratts’ marginal ordinary tax rate is 35 percent

a. Assume that the Pratts sold their home and moved because they don’t like their neighbors. How much gain will the Pratts recognize on their home sale? At what rate, if any, will the gain be taxed?

b. Assume the Pratts sell the home because Stephanie’s employer transfers her to an office in Utah. How much gain will the Pratts recognize on their home sale?

c. Assume the same facts as in (b), except that the Pratts sell their home for $700,000. How much gain will the Pratts recognize on the home sale?

d. Assume the same facts as (b), except that on December 1 of year 0 the Pratts sold their home in Seattle and excluded the $300,000 gain from income on their year 0 tax return. How much gain will the Pratts recognize on the sale of their Spokane home?

5. [LO 2] Steve Pratt, who is single, purchased a home in Spokane, Washington for $400,000. He moved into the home on February 1 of year 1. He lived in the home as his primary residence until June 30 of year 5, when he sold the home for $700,000.

a. What amount of gain will Steve be required to recognize on the sale of the home?

b. Assume the original facts, except that the home is Steve’s vacation home and he vacations there four months each year. Steve does not ever rent the home to others. What gain must Steve recognize on the home sale?

c. Assume the original facts except that Steve married Stephanie on February 1 of year 3 and the couple lived in the home until they sold it in June of year 5. Under state law, Steve owned the home by himself. How much gain must Steve and Stephanie recognize on the sale (assume they file a joint return in year 5).

6. [LO 2] Celia has been married to Daryl for 52 years. The couple has lived in their current home for the last 20 years. On October of year 0, Daryl passed away. Celia sold their home and moved into a condominium. What is the maximum exclusion Celia is entitled to if she sells the home on December 15 of year 1?

7. [LO 2] Sarah (single) purchased a home on January 1, 2008 for $600,000. She eventually sold the home for $800,000. What amount of the $200,000 gain on the sale does Sarah recognize in each of the following alternative situations?

a. Sarah used the home as her principal residence through December 31, 2013. She used the home as a vacation home from January 1, 2014 until she sold it on January 1, 2016.

b. Sarah used the property as a vacation home through December 31, 2013. She then used the home as her principal residence from January 1, 2014 until she sold it on January 1, 2016.

c. Sarah used the home as a vacation home from January 1, 2008 until January 1, 2015. She used the home as her principal residence from January 1, 2015 until she sold it on January 1, 2016.

d. Sarah used the home as a vacation home from January 1, 2008 through December 31, 2009. She used the home as her principal residence from January 1, 2009 until she sold it on January 1, 2014

8. [LO 2] Troy (single) purchased a home in Hopkinton, MA on January 1, 2007 for $300,000. He sold the home on January 1, 2014 for $320,000. How much gain must Troy recognize on his home sale in each of the following alternative situations?

a. Troy rented the home out from January 1, 2007 through November 30, 2008. He lived in the home as his principal residence from December 1, 2008 through the date of sale. Assume accumulated depreciation on the home at the time of sale was $7,000.

b. Troy lived in the home as his principal residence from January 1, 2007 through December 31, 2009. He rented the home from January 1, 2010 through the date of the sale. Assume accumulated depreciation on the home at the time of sale was $2,000.

c. Troy lived in the home as his principal residence from January 1, 2007 through December 31, 2012. He rented out the home from January 1, 2013through the date of the sale. Assume accumulated depreciation on the home at the time of sale was $0.

d. Troy rented the home from January 1, 2007 through December 31, 2010. He lived in the home as his principal residence from January 1, 2011 through December 31, 2011. He rented out the home from January 1, 2012 through December 31, 2012 and he lived in the home as his principal residence from January 1, 2013, through the date of the sale. Assume accumulated depreciation on the home at the time of sale was $0.

9. [LO 3] Javier and Anita Sanchez purchased a home on January 1, 2014 for, $500,000 by paying $200,000 down and borrowing the remaining $300,000 with a 7 percent loan secured by the home. The loan requires interest-only payments for the first five years. The Sanchezes would itemize deductions even if they did not have any deductible interest. The Sanchezes’ marginal tax rate is 30 percent.

a. What is the after-tax cost of the interest expense to the Sanchezes in 2014?

b. Assume the original facts, except that the Sanchezes rent a home and pay $21,000 in rent during the year. What is the after-tax cost of their rental payments in 2014?

c. Assuming the interest expense is their only itemized deduction for the year and that Javier and Anita file a joint return, have great eyesight, and are under 60 years of age, what is the after-tax cost of their 2014 interest expense?

10. [LO 3] Javier and Anita Sanchez purchased a home on January 1 of year 1 for $500,000 by paying $50,000 down and borrowing the remaining $450,000 with a 7 percent loan secured by the home. The loan requires interest-only payments for the first five years. The Sanchezes would itemize deductions even if they did not have any deductible interest.

a. Assume the Sanchezes also took out a second loan (on the same day as the first loan) secured by the home for $80,000 to fund expenses unrelated to the home. The interest rate on the second loan is 8 percent. The Sanchezes make interest-only payments on the loan in year 1. What is the maximum amount of their deductible interest expense (on both loans combined) in year 1?

b. Assume the original facts and that the Sanchezes take out a second loan (on the same day as the first loan) secured by the home in the amount of $50,000 to fund expenses unrelated to the home. The interest rate on the second loan is 8 percent. The Sanchezes make interest-only payments during the year. What is the maximum amount of their deductible interest expense (on both loans combined) in year 1?

11. [LO 3] Javier and Anita Sanchez purchased a home on January 1, year 1 for $500,000 by paying $200,000 down and borrowing the remaining $300,000 with a 7 percent loan secured by the home. The loan requires interest-only payments for the first five years. The Sanchezes would itemize deductions even if they did not have any deductible interest. On January 1, the Sanchezes also borrowed money on a second loan secured by the home for $75,000. The interest rate on the loan is 8 percent and the Sanchezes make interest-only payments in year 1 on the second loan.

a. Assuming the Sanchezes use the second loan to landscape the yard to their home, what is the maximum amount of interest expense (on both loans combined) they are allowed to deduct year 1?

b. Assume the original facts and that the Sanchezes use the $75,000 loan proceeds for an extended family vacation. What is the maximum amount of interest expense (on both loans combined) they are allowed to deduct in year 1?

c. Assume the original facts, except that the Sanchezes borrow $120,000 on the second loan and they use the proceeds for an extended family vacation and other personal expenses. What is the maximum amount of interest expense (on both loans combined) they are allowed to deduct in year 1?

12. [LO 3] Lewis and Laurie are married and jointly own a home valued at $240,000. They recently paid off the mortgage on their home. In need of cash for personal purposes unrelated to the home, the couple borrowed money from the local credit union. How much interest may the couple deduct in each of the following alternative situations (assume they itemize deductions no matter the amount of interest)?

a. The couple borrows $40,000 and the loan is secured by their home. They use the loan proceeds for purposes unrelated to the home. The couple pays $1,600 interest on the loan during the year and the couple files a joint return.

b. The couple borrows $10,000 unsecured from the credit union. The couple pays $900 interest on the loan during the year and the couple files a joint return.

c. The couple borrows $110,000 and the loan is secured by their home. The couple pays $5,200 interest on the loan during the year and the couple files a joint return.

d. The couple borrows $110,000 and the loan is secured by their home. The couple pays $5,200 interest on the loan during the year and the couple files separate tax returns. Determine the interest deductible by Lewis only.

13. [LO 3] On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.5 million by paying $200,000 down and borrowing the remaining $1.3 million with a 7 percent loan secured by the home.

a. What is the amount of the interest expense the Franklins may deduct in year 1?

b. Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $300,000 secured by the home at a 7 percent rate. They make interest-only payments on the loan during the year. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

c. Assume the same facts as in (b), except that the Franklins borrow $80,000 secured by their home. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

14. [LO 3] In year 0, Eva took out a $50,000 home-equity loan from her local credit union. At the time she took out the loan, her home was valued at $350,000. At the time of the loan, Eva’s original mortgage on the home was $265,000. At the end of year 1, her original mortgage is $260,000. Unfortunately for Eva, during year 1, the value of her home dropped to $280,000. Consequently, as of the end of year 1, Eva’s home secured $310,000 of home-related debt but her home is only valued at $280,000. Assuming Eva paid $15,000 of interest on the original mortgage and $3,500 of interest on the home-equity loan during the year, how much qualified residence interest can Eva deduct in year 1?

15. [LO 3] On January 1 of year 1, Jason and Jill Marsh acquired a home for $500,000 by paying $400,000 down and borrowing $100,000 with a 7 percent loan secured by the home. On January 1, of year 2, the Marshes needed cash so they refinanced the original loan by taking out a new $250,000 7 percent loan. With the $250,000 proceeds from the new loan, the Marshes paid off the original $100,000 loan and used the remaining $150,000 to fund their son’s college education.

a. What amount of interest expense on the refinanced loan may the Marshes deduct in year 2?

b. Assume the original facts except that the Marshes use the $150,000 cash from the refinancing to add two rooms and a garage to their home. What amount of interest expense on the refinanced loan may the Marshes deduct in year 2?

16. [LO 3] {Planning} On January 1, year 1 Brandon and Alisa Roy purchased a home for $1.5 million by paying $500,000 down and borrowing the remaining $1 million with a 7 percent loan secured by the home. Later the same day, the Roys took out a second loan, secured by the home, in the amount of $300,000.

a. Assuming the interest rate on the second loan is 8 percent. What is the maximum amount of the interest expense the Roys may deduct on these two loans (combined) in year 1?

b. Assuming the interest rate on the second loan is 6 percent, what is the maximum amount of interest expense the Roys may deduct on these two loans (combined) in year 1?

17. [LO 3] {Research} Jennifer has been living in her current principal residence for three years. Six months ago Jennifer decided that she would like to purchase a second home near a beach so she can vacation there for part of the year. Despite her best efforts, Jennifer has been unable to find what she is looking for. Consequently, Jennifer recently decided to change plans. She purchased a parcel of land for $200,000 with the intention of building her second home on the property. To acquire the land, she borrowed $200,000 secured by the land. Jennifer would like to know whether the interest she pays on the loan before construction on the house is completed is deductible as mortgage interest.

a. How should Jennifer treat the interest if she has begun construction on the home and plans to live in the home in 12 months from the time construction began?

b. How should Jennifer treat the interest if she hasn’t begun construction on the home, but plans to live in the home in 15 months?

c. How should Jennifer treat the interest if she has begun construction on the home but doesn’t plan to live in the home for 37 months from the time construction began?

18. [LO 3] {Planning} Rajiv and Laurie Amin are recent college graduates looking to purchase a new home. They are purchasing a $200,000 home by paying $20,000 down and borrowing the other $180,000 with a 30-year loan secured by the home. The Amins have the option of (1) paying no discount points on the loan and paying interest at 8 percent or (2) paying one discount point on the loan and paying interest of 7.5 percent. Both loans require the Amins to make interest-only payments for the first five years. Unless otherwise stated, the Amins itemize deductions irrespective of the amount of interest expense. The Amins are in the 25 percent marginal ordinary income tax bracket.

a. Assuming the Amins do not itemize deductions, what is the break-even point for paying the point to get a lower interest rate?

b. Assuming the Amins do itemize deductions, what is the break-even point for paying the point to get a lower interest rate?

c. Assume the original facts except that the amount of the loan is $300,000. What is the break-even point for the Amins for paying the point to get a lower interest rate?

d. Assume the original facts except that the $180,000 loan is a refinance instead of an original loan. What is the break-even point for paying the point to get a lower interest rate?

e. Assume the original facts except that the amount of the loan is $300,000 and the loan is a refinance and not an original loan. What is the break-even point for paying the point to get a lower interest rate?

19. [LO 4] In year 1, Peter and Shaline Johnsen moved into a home in a new subdivision. Theirs was one of the first homes in the subdivision. In year 1, they paid $1,500 in real property taxes on the home to the state government, $500 to the developer of the subdivision for an assessment to pay for the sidewalks, and $900 for real property taxes on land they hold as an investment. What amount of property taxes are the Johnsens allowed to deduct assuming their itemized deductions exceed the standard deduction amount before considering any property tax deductions?

20. [LO 4] Jesse Brimhall is single. In 2014, his itemized deductions were $4,000 before considering any real property taxes he paid during the year. Jesse’s adjusted gross income was $70,000 (also before considering any property tax deductions). In 2014, he paid real property taxes of $3,000 on property 1 and $1,200 of real property taxes on property 2.

a. If property 1 is Jesse’s primary residence and property 2 is his vacation home (he does not rent it out at all), what is his taxable income after taking property taxes into account?

b. If property 1 is Jesse’s business building (he owns the property) and property 2 is his primary residence, what is his taxable income after taking property taxes into account?

c. If property 1 is Jesse’s primary residence and property 2 is a parcel of land he holds for investment, what is his taxable income after taking property taxes into account?

21. [LO 4] Craig and Karen Conder purchased a new home on May 1 of year 1 for $200,000. At the time of the purchase, it was estimated that the real property tax rate for the year would be one percent of the property’s value. How much in property taxes on the new home are the Conders allowed to deduct under each of the following circumstances (the Conders’ itemized deductions exceed the standard deduction before considering property taxes)?

a. The property tax estimate proves to be accurate. The seller and the Conders paid their share of the tax. The full property tax bill is paid to the taxing jurisdiction by the end of the year.

b. The actual property tax bill turns out to be 1.05 percent of the property’s value. The Conder’s paid their share of the estimated tax bill and the entire difference between the one percent estimate and the 1.05 percent actual tax bill and the seller paid the rest. The full property tax bill is paid to the taxing jurisdiction by the end of the year.

c. The actual property tax bill turns out to be .95 percent of the property’s value. The seller paid taxes based on their share of the one percent estimate and the Conders paid the difference between what the seller paid and the amount of the final tax bill. The full property tax bill is paid to the taxing jurisdiction by the end of the year.