Test Return #3

[Gretel]

Thanks Bees, this is the best CPE I ever had. I did Test 2 just manually and arrived at the correct answer the correct way, BUT when I put it into ProSeries it took me awhile to figure everything out.

Test 3 beats me. I am off by $50 (have a refund of $5,600) and can't figure out why. I will vote for "none of the above" even though I am pretty sure that this is wrong.

I really liked the interest allocation part. I always was afraid that this will be coming my way one day and I won't know what to do. Can't wait for the answers.

[S T]

Test 1 and Test 2

Test 1 wasn't so hard for me, as I had the "wash sale issue" arrive recently, so I was aware of that

Test 2 - was really hard for me and I stuggled for days, looking up rules and regulations, and finally what I arrived at was the same answer and the same approach as Bees posted. I just don't encounter that many of the EIC and dependent issues in my practice. I also had a very difficult time working the return manually, and then having my software also to arrive at the same figure. Just way "too many" toggle ons/off and checking too many forms to make sure they were either present or calculating correctly, so without working manually, I COULD NOT have relied on the Software to give me the correct answer. I definitely could NOT have charge enough for that return

Now Test 3 - I have several answers, and as Bees stated in prior post - you can arrive at the correct answer with the wrong methodology - so at this point I am not even sure that I have the correct answer.

I think I have 3 issues - which I won't divulge right now, so as not to taint any of the answers that might be posted. Another learning experience and "good unrecorded CPE exercise" and "if" I have been misreporting "all these years" guess I will learn how to make changes for 2009.

So far I have an answer of 5487, 5662 or 5812 which would be none of the above.

Depending on a factor or two I am more confident in either 5487 or 5662, so guess that is how I will cast the poll.

As with most of us, I also will be waiting for the answer and the whys/wherefore's that support what my results are And in the process have and will learn something

And Test 4 ????

Thanks Bees,

Sandy

[Bees Knees]

And the answer is….

Refund = $5,675

Form 1040 Line By Line:

Line 7 = $62,000
Line 8a = $63
Line 10 = $523
Line 17 = $1,761
Line 22 and 37 = $64,347
Line 40 = $10,298
Line 42 = $3,500
Line 43 = $50,549
Line 44 = $8,975
Line 62 = $7,150
Line 69 = $7,500
Line 71 = $14,650
Line 72 and 73a = $5,675

Explanation:

Schedule E Insurance deduction = $525, which is 50% of $1,050, total insurance paid during 2008 for a duplex in which 50% is for personal use and 50% is for rental use. Although a portion of the $1,050 is for months of insurance coverage in 2009, the prepaid expense rules do not apply. TheTaxBook page 8-23 says:

Twelve month rule exception. The prepaid expense rule does not
apply to amounts paid to create certain rights or benefits for the
taxpayer that do not extend beyond the earlier of the following:
• 12 months after the right or benefit begins, or
• The end of the tax year after the tax year in which payment is
made.

Since none of the prepaid insurance for 2009 extends beyond 12 months after the beginning of the period of insurance coverage, the prepaid expense rule does not apply, and all of the payment allocated to the rental portion is deductible.

Mortgage interest reported on Schedule E = $2,713. Mortgage interest reported on Schedule A = $2,692. Total mortgage interest reported on Form 1098 = $5,405. TheTaxBook, page 4-15 says:

Loan repayment ordering rules. When a loan is repaid that has
been allocated to more than one use, treat it as being repaid in
the following order:
1) Personal use.
2) Investment and passive activities (other than
those included in number 3 below).
3) Passive activities in connection with a rental
real estate activity in which the taxpayer
actively participates.
4) Former passive activities.
5) Trade or business use and expenses for
certain low-income housing projects.

The example that follows illustrates how to calculate interest allocated between personal use (the mortgage interest deducted on Schedule A) and rental real estate use (the mortgage interest deducted on Schedule E). The only benefit this type of calculation does for Bart is move some of the deductible mortgage interest from Schedule A to Schedule E, which decreases Bart’s AGI. This increases the deductible medical expenses and miscellaneous itemized deductions due to the 7.5% AGI limitation for medical expenses, and the 2% AGI limitation for miscellaneous itemized deductions.

RE taxes deducted on Schedule E = $441. RE taxes deducted on Schedule A = $441. Total deductible RE taxes = $882, which equals the $1,450 total RE taxes paid by Bart during 2008 for the duplex, minus $568 which was allocated to the seller at closing, thus giving Bart a reduction of his total cost of purchasing the property by that same amount at closing.

Water & Garbage deducted on Schedule E = $445, which is 50% of the total Bart paid for the duplex. The other 50% is a non-deductible personal expense.

Depreciation deductible for 2008 on Schedule E = $2,915. Depreciation comes from two assets: 50% of the building and 100% of the new carpeting for the rental unit. The building depreciation = $1,955 [50% of (192,000 minus $20,000 for land) = $86,000 x 2.273%]. The carpeting depreciation = $960 [($1,599 x 50% special depreciation allowance = $800) + ($799 x 20% = $160)].

Although a rental activity does not qualify to use the Section 179 deduction, there is no such restriction placed on using the 50% Special Depreciation Allowance. Also, the remaining depreciable portion of the carpeting is considered 5 year property. TheTaxBook, page 9-8 under 5-year property says:

Distributive Trades and Services. Includes
assets used in wholesale and retail trade,
and personal and professional services.
Includes Section 1245 assets used in marketing
petroleum and petroleum products. Also
includes personal property used in a rental real
estate activity, such as appliances, carpeting,
furniture, etc. (Announcement 99-82)

Note: The carpeting cannot be treated as a repair because carpeting is not considered Section 1250 real property. The class life for rental real estate carpeting is 5 years, according to the above quoted IRS announcement. Since the old carpeting was 15 years old, the new carpeting increases the life expectancy of the carpeting, which is one of the criteria used to determine whether an asset should be depreciated or treated as a repair. If we were talking about replacing a 10 year old roof, there would be an argument for treating the new roof as not increasing the useful life of the building, which has a 27.5 year class life. According to various court rulings, replacing a 10 year roof on a commercial building could be treated as a repair verses a depreciable asset. Those court rulings do not apply to our scenario because the carpeting is not considered to be a part of the building.

Bart paid $2,016 for tools. Since these tools are used for his W-2 activity and not his rental real estate activity, the Section 179 deduction may be used for the entire cost of tools.

First time homebuyer credit = $7,500, which is the lesser of $7,500 for a new home purchased in 2008, or 10% of the purchase price ($192,000 x 50% for personal portion = $96,000 x 10% = $9,600). The reason why it is not 50% of $7,500 is because the purchase of a rental duplex is actually the purchase of two separate homes. Bart purchased a principal residence for $96,000, and a second home for $96,000 that he uses in a rental activity. If Bart had purchased a single family home and rented out 50% of the square footage of his residence to roommates, his first time homebuyer credit would be limited to $3,750 instead of $7,500.

The fact that taking the first time homebuyer credit for a 2008 purchase increases his tax in future years due to the recapture rule is irrelevant. Bart said he wanted the largest possible refund for his 2008 tax return.

Anyone care to explain why the correct answer should be a different result?

[nalawson]

Thank you Bees,
I got the right answer, but I did not allocate the interest correctly. I just split the amount in half...so now I know how to do that part correctly. I appreciate the time and effort that went into this.
Nancy

[Bees Knees]

...I did not allocate the interest correctly. I just split the amount in half...

Since it is to the taxpayer's advantage to allocate the interest this way, the IRS is not going to care or make an issue out of it if you split the interest in half. In reality, in most cases it makes little difference in tax. In reality, I would charge the client much more to calculate the interest this way each year than any tax savings that would result. Thus, I have never bothered making this special allocation of interest for my own clients. Thus, in reality, $5,662 is the realistic answer when you factor in tax preparation fees as I'm sure most of us would charge more than $13 extra to calculate interest under this method.

[PIGLEE]

My answer was 5,687 (so I voted none of the above) I also split the mtg interest in half. I could not figure out why the detail. The interest would be deductible anyway on schedule A, so why bother. I really need to digest the example in the Tax Book, it did make a 8.00 difference on this return, and 12.00 more in refund. Could be a lot more on a different problem, plus it needs to be right. I also missed (in my mind) the Special Depreciation Deduction, BUT my program got it right, I did not even notice that it had be deducted.

After over 30 years of doing tax returns, I really need these tests. THANK YOU. I have realized that I have gotten a little lazy about research, I know how to do it RIGHT????. NO NOT ALWAYS!!!!!

Thank you so much BEES KNEES? Also so much fun to compete, but only 12 voted, every one else, please join in.

[PIGLEE]

Wow, I just checked and 736 I think viewed, although I viewed several times, to see if I could pick up any hints.

[Gretel]

I knew my answer was wrong but I am proud that I got the mortgage interest allocation right. No nightmares no more.

I figured the house taxes right the first time, then read something into that part that wasn't there and got it wrong.

I also missed Sec. 179 on the tools.

Thanks you so much again. This way I won't get Alzheimer's.

[S T]

Mortgage Interest Calculation

Thanks Bees for that explanation - I did arrive at the $ 5,662 using the 50/50 split on the mortgage interest to Sched A and Sched E.

The only reason I didn't use the method described in TTB on page 4-15 was the example referred to discussed an equity line of credit and mixed use of the funds. In Test 3 - the mortgage was an original loan. Also in reviewing Pub 527 (2008) on page 17 middle column "Duplex" - the example given (if both units approx the same size) you deduct one half on Schedule E and one half on Sched A.

CFS Tax Tools has a worksheet to calculate the appropriate mortgage interest as your example states on 4-15 which I have used on refinances and mixed use equity lines.

I also was not aware of the Special Depreciation Allowance for Rental Units - thought it was the same rule as Sect 179. Therefore the difference on the refund from 5,487 to 5,662.

Sandy

[Larmil]

Special Depreciation Deduction

In order to take the special depreciation deduction you had to ASSUME that the carpet was new.

[Earl]

I also did not get the Special Depreciation as I thought it only applied in the named disaster areas. However, I did get the mortgage interest correct.

[Bees Knees]

Also in reviewing Pub 527 (2008) on page 17 middle column "Duplex" - the example given (if both units approx the same size) you deduct one half on Schedule E and one half on Sched A.

It is true that IRS Pub 527 fails to mention this rule. The example listed on page 17 says:

Example. You own a duplex and live in one
half, renting the other half. Both units are approximately
the same size. Last year, you paid a
total of $10,000 mortgage interest and $2,000
real estate taxes for the entire property. You can
deduct $5,000 mortgage interest and $1,000
real estate taxes on Schedule E, and if you
itemize your deductions, you can deduct the
other $5,000 mortgage interest and $1,000 real
estate taxes on Schedule A.

Nothing is said about allocating principal to the personal use side first, thus increasing the interest on the rental use side. However, IRS Pub 535 page 12 says:

Loan repayment. When you repay any part of
a loan allocated to more than one use, treat it as
being repaid in the following order.
1. Personal use.
2. Investments and passive activities (other
than those included in (3)).
3. Passive activities in connection with a
Rental real estate activity in which you
Actively participate.
4. Former passive activities.
5. Trade or business use and expenses for
certain low-income housing projects.

IRS Pub 535 does not provide an example. Note that the rule is not limited to equity lines of credit. The rule applies to the interest tracing rules in general. We have a case here where one IRS Pub does not know what the other one says. The rental duplex example in Pub 527 where one half is used as a personal residence is an example in my opinion where the rule mentioned in IRS Pub 535 should apply.

[Bees Knees]

In order to take the special depreciation deduction you had to ASSUME that the carpet was new.

The instructions to the problem said:

Bart also replaced the wall to wall carpeting in Gerard’s apartment on 8/15/2008. The old carpeting was 15 years old at the time and needed replacing due to normal use. The total cost of replacing the carpeting was $1,598.95.

In all my years as a professional carpet cleaner, over 50% of which was cleaning carpets for landlords, I never once heard of a case where a landlord replaced old carpeting with used carpeting. Even if there is a rare case in which someone has, they certainly would not have had to pay very much for it, if anything at all. Given the cost, I think the original scenario is obvious it was replaced with new carpeting.

[JG EA]

Schedule E Insurance deduction = $525, ..

Mortgage interest reported on Schedule E = $2,713. Mortgage interest reported on Schedule A = $2,692. Total mortgage interest reported on Form 1098 = $5,405. ..

Anyone care to explain why the correct answer should be a different result?

This is great fun - give us more.

I only differed on the Mortgage interest (which I would not have done because of the confusion for future years tax preparation).

And on the rental insurance (which I should not have done to avoid confusion in future years tax prep). I limited it trying to be precise for this test - here again should have looked it up.

Great exercise.

[Larmil]

Ever hear of "Big Bob's"?

The instructions to the problem said:



In all my years as a professional carpet cleaner, over 50% of which was cleaning carpets for landlords, I never once heard of a case where a landlord replaced old carpeting with used carpeting. Even if there is a rare case in which someone has, they certainly would not have had to pay very much for it, if anything at all. Given the cost, I think the original scenario is obvious it was replaced with new carpeting.

Big Bob's advertises "Plus, we have four-day-old carpet that has only been used at conventions and trade shows."