Re: Tax Issues Relevant Facts John Smith, Esq. worked on a case for over two years. The jury awarded his client $2,000,000 in damages, of which his fee was $300,000 plus recovery of expenses paid up front in the amount of $25,000. John is also thinking about buying the building that he currently leases his office space in. His current lease is $3,500 per month. John Smith’s business is a separate law practice established as an LLC. Jane Smith sells handcrafted jewelry which earned her $20,000 last year. Jane’s jewelry making equipment is five years old, cost $10,000 and is almost obsolete. Specific Issues 1. John Smith tax issues: a. How is the $300,000 treated for purposes of federal tax income? b. How is the $25,000 …show more content…
Under 26 USC § 121, gains on the sale for married taxpayers filing jointly would be excluded up to $500,000 (or $250,000 each for married filing separately) given the residence was owned and occupied as a principal residence for two out of the last five years. b. 26 USC § 1031 provides for like-kind exchange treatment on property that must qualify by being held either for productive use in a trade or business or for investment. c. Per 26 USC § 183, an activity that has motives of profit is defined as a trade or business. The investment of equipment and time invested for the purpose of making profit would qualify Jane’s jewelry making as a business. This distinction is important, as a business is allowed to deduct items such as travel, tool and home office expenses. d. Per 26 USC § 162, traveling expenses shall be allowed as a deduction while away from home in the pursuit of a trade of business. A portion of the home that is dedicated to the business may also qualify for itemized deductions. e. John would not realize any immediate tax benefits, as 26 USC § 263 provides no current deductions for capital expenditures; these costs must be recovered over the useful life of the acquired property. f. Per 26 USC § 179, vehicle depreciation is not allowed unless vehicle is an SUV over $25,000/6,000 pounds. However, Jane’s travel expenses would be allowed and the
Capital gain or loss that happens to a dwelling that is a taxpayer’s main residence is
Why? The owners capitalized and amortized 50 percent of the purchase price ($12 million) simply because the tax rules allowed it; therefore the
Taxable income includes a deduction for $40,000 of depreciation that exceeds the depreciation allowed for E&P purposes.
f) Yes, Jane can depreciate the vehicle and her jewelry making machine. The equipment can be depreciated with MACRS or
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
Under the Reg. §1.47-3(f) (5) (ii), the transferor of the section 38 property in any taxable year dose not retain a substantial interest in the trade or business directly or indirectly. According to this code, the transferor does not need to make the payment for tax of the interest during the property transaction only if the property can be qualified to “section 38 property” which indicate property (1) with respect to which depreciation is allowable to the taxpayer (2) has an estimated useful life of 3 years or more (3) which is tangible personal property or other tangible property. In this case, the machinery purchased by the individual two years ago can be applied for the “section 38 property” which also means the transferor does not need to pay for the interest happened during the transaction. And because of the gift of stock made by the individual caused a reduction in his interest. Which occurred at a time when the useful lives were just taken into account in computing the credit about the “section 38 property”. Unless his remain interest is a substantial interest, the section 47(b) would no longer be applicable and total
Which of the following is not a required test for the deduction of a business expense?
In 2013 Marianne sold land, building and equipment with a combined basis of $150,000 to an unrelated third party and in return received an installment note of $80,000 per year for five years. Of the $250,000 gain on sale, $150,000 was classified as Section 1245 gain and the remaining $100,000 was Section 1231 gain. In 2013, Marianne had a capital loss carryover of $60,000, $50,000 of which she used to offset her Section 1231 gain; she recognized no Section 1245 gain. The following year she recognized $40,000 of 1245 gain and $10,000 of Section 1231 gain which she promptly offset with the last $10,000 of the capital loss carryover. In 2015, she recognized $50,000 Section 1245 gain and no Section 1231 gain.
Once a gain or loss is recognized, a taxpayer must determine how the recognized gain or loss affects the taxpayer’s tax liability. The character depends on a combination of two factors: purpose or use of the asset and holding period. The purpose or use of the asset is important because the law does not treat all assets equally. The general use categories are: (1) trade or business, (2) for the production of income (rental activities), (3) investment, and (4) personal. Based on these criteria, we can categorize an asset into one of three groups: (1) ordinary, (2) capital, or (3) section 1231. Characterizing the gain or loss is important because all gains and losses are not equal. Ordinary gains and losses are taxed at ordinary income rates, regardless of the holding
Generally, a realized gain from sale of personal residence can be excluded from gross income under Exclusion 121. The amount realized is the selling price of the property less any disposition costs. The adjusted basis is then determined and the amount is subtracted from the realized sum. This will give you the amount of loss or gain from the sale of the property. Since the couple occupied the sold home for at least 2 of the last 5 years they fulfill the requirements for exclusion 121 treatment. The exclusion amount for the couple if filing jointly is $500.000 and the calculation would be as follows:
The log maintained by the couple indicates that the couple used 14 guaranteed personal days. If even 1 out of the 28 days that the couple partially or fully worked on the house is considered a personal day than the 14-day provision is violated. However, if none of those days turn out to be considered personal days then the loss in excess over rental income can be deducted according to section 280A. Section 183(a) permits no allowable deductions for activities not found to be engaged in for profit. However, we found that the Harrell’s activities are found to be engaged in for profit and should therefore be allowed these deductions.
He can deduct the fair market value of the land without recognizing the $40,000 appreciation as income.
c. Does Jane have a business or hobby? Why is this distinction important? According to Code Sec.162 trade and business expenses is for only the expenses that paid or incurred in for business or trade activities. The purpose of this code is to deny deductions for any personal expenses. (http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_162) According to IRC Sec. 183(c) “hobby loss rule
Conclusion: Thanks to the landmark case, Marrita Murphy and Daniel J. Leveille, Appellants v. Internal Revenue Service and United States of America, Appellees, there is now no misunderstanding that awards received for damages to personal and professional reputation and mental suffering are included in gross income and are therefore taxable under 26 U.S.C. § 104(a)(2). This determines that because Murray did not suffer personal physical injuries and since gross income as defined by Code Sec. 61 includes compensatory damages for nonphysical injuries, such as those awarded to Murray, his award is in fact taxable [2007-2 U.S.T.C. ¶50,531, (Jul. 3, 2007)].
In this scenario, the labor cost is to print his shop in order to save some costs, and it incurred by him in the course of carrying on his business, which is consistent with the section DA 1(b) ITA 2007 (DA 1(b) General Permission, 2004). Therefore, the labor cost $1,000 is allowed to deduct.