James and Kate Sawyer were married on New Year’s Eve of 2019. Before their marriage, Kate lived in New York and worked as a hair stylist for one of the city’s top salons. James lives in Atlanta, where he works for a public accounting firm earning an annual salary of $105,000. After their marriage, Kate left her job in New York and moved into the couple’s newly purchased, 3,200-square-foot home in Atlanta. Kate incurred $2,700 of moving expenses. The couple purchased the home on January 3, 2020, by paying $100,000 down and obtaining a $400,000 mortgage for the remainder. The interest rate on this loan was 7 percent, and the Sawyers made interest-only payments on the loan through December 31, 2020 (assume they paid exactly one year’s worth of interest on this loan by December 31). On July 1, 2020, the Sawyers borrowed an additional $50,000, secured by the home, in order to make home improvements (the loan was called a “home equity loan” by the lender). The interest rate on the loan was 7 percent (assume they paid exactly one-half of a year’s worth of interest on this loan by year-end).
Shortly after moving into the new home, Kate started a new business called Kate’s Beauty Cuts LLC. She set up shop in a 384-square-foot corner room of the couple’s home and began to get it ready for business. The room conveniently had a door to the outside, providing customers direct access to the shop. Kate paid $2,300 to have the carpet replaced with a tile floor. She also paid $1,300 to have the room painted with vibrant colors and $750 to have the room rewired for appropriate lighting. Kate ran an ad in the local newspaper and officially opened her shop on January 24, 2020. By the end of the year, Kate’s Beauty Cuts LLC generated $42,000 of net income before considering the home office deduction. The Sawyers incurred the following home-related expenditures during 2020:
$4,700 of real property taxes.
$2,250 for homeowner’s insurance.
$2,900 for electricity.
$2,000 for gas and other utilities.
They determined depreciation expense for their entire house was $17,684.
Also, on March 2, Kate was able to finally sell her one-bedroom Manhattan condominium for $483,000. She purchased the condo, which she had lived in for six years prior to her marriage, for $215,000.
Kate owns a vacation home in Myrtle Beach, South Carolina. She purchased the home several years ago, largely as an investment. To help cover the expenses of maintaining the home, James and Kate decided to rent the home out. They rented the home for a total of 106 days at fair market value (this included eight days that they rented the home to James’s brother Jack). In addition to the 106 days, Kate allowed a good friend and customer, Clair, to stay in the home for half-price for two days. James and Kate stayed in the home for six days for a romantic getaway and another three days in order to do some repair and maintenance work on the home. The rental revenues from the home in 2020 were $18,500. The Sawyers incurred the following expenses associated with the home.
$9,200 of interest (assume not limited by acquisition debt limit).
$3,500 of real property taxes.
$2,000 for homeowner’s insurance.
$1,300 for electricity.
$1,700 for gas, other utilities, and landscaping.
$5,450 for depreciation.
Required:
Determine the Sawyers’ taxable income for 2020. Disregard self-employment taxes and the qualified business income deduction. Assume the couple paid $4,500 in state income taxes and files a joint return. For determining deductible home office expenses and allocating expenses to the rental, the Sawyers would like to use the methods that minimize their overall taxable income for the year.
Assume 366 days in the current year.
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James and Kate Sawyer were married on New Year’s Eve of 2019. Before their marriage, Kate lived in New York and worked as a hair stylist for one of the city’s top salons. James lives in Atlanta, where he works for a public accounting firm earning an annual salary of $105,000. After their marriage, Kate left her job in New York and moved into the couple’s newly purchased, 3,200-square-foot home in Atlanta. Kate incurred $2,700 of moving expenses. The couple...
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