Question

James and Kate Sawyer were married on New Year's Eve of 2021. 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 $112,500. 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 $3,450 of moving expenses. The couple purchased the home on January 3, 2022, by paying $100,000 down and obtaining a $400,000 mortgage for the remainder. The interest rate on this loan was 3 percent, and the Sawyers made interest-only payments on the loan through June 30, 2022 (assume they paid exactly one-half of a year's worth of interest on this loan by June 30). On July 1, 2022, 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 3 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 $2,600 to have the carpet replaced with a tile floor. She also paid $1,450 to have the room painted with vibrant colors and $900 to have the room rewired for appropriate lighting. Kate ran an ad in the local newspaper and officially opened her shop on January 24, 2022. By the end of the year, Kate's Beauty Cuts LLC generated $45,000 of net income before considering the home office deduction. The Sawyers incurred the following home-related expenditures during 2022:

$5,450 of real property taxes.

$2,625 for homeowner's insurance.

$3,650 for electricity.

$2,750 for gas and other utilities.

They determined depreciation expense for their entire house was $18,074.

Also, on March 2, Kate was able to finally sell her one-bedroom Manhattan condominium for $490,500. She purchased the condo, which she had lived in for six years prior to her marriage, for $230,000.

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 8 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 6 days for a romantic getaway and another 3 days in order to do some repair and maintenance work on the home. The rental revenues from the home in 2022 were $19,400. The Sawyers incurred the following expenses associated with the home:

$10,070 of interest (assume not limited by acquisition debt limit).

$3,150 of real property taxes.

$2,150 for homeowner's insurance.

$1,450 for electricity.

$1,850 for gas, other utilities, and landscaping.

$5,825 for depreciation.

Required:

Determine the Sawyers' taxable income for 2022. Disregard self-employment taxes and the qualified business income deduction. Assume the couple paid $4,650 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.

Note: Do not round any division. Round other intermediate calculations to the nearest whole dollar amount. Assume 365 days in the current year.

Answer 1

To determine the Sawyers' taxable income for 2022, calculate their income from James' job, Kate's business income, and rental income from their vacation home. Subtract eligible deductions, such as business expenses and a portion of home expenses, from the total income. The resulting taxable income is subject to tax rates.

Step-by-step explanation:

To determine the Sawyers' taxable income for 2022, we need to consider their various sources of income and expenses. First, let's calculate their income from James' job. He earns a salary of $112,500 per year. Next, let's consider Kate's business income. Kate's Beauty Cuts LLC generated $45,000 of net income before considering the home office deduction. Now, let's calculate the rental income from their vacation home. The rental revenues from the home in 2022 were $19,400.

Now let's consider their expenses. For the home-related expenditures, the Sawyers incurred $5,450 of real property taxes, $2,625 for homeowner's insurance, $3,650 for electricity, and $2,750 for gas and other utilities. They also incurred $18,074 for depreciation expense for their entire house. For the vacation home, they incurred $3,150 of real property taxes, $2,150 for homeowner's insurance, $1,450 for electricity, $1,850 for gas, other utilities, and landscaping, and $5,825 for depreciation.

The Sawyers can deduct Kate's business expenses, including the $2,600 for replacing the carpet, $1,450 for painting, and $900 for rewiring the room for appropriate lighting. They can also deduct the portion of their home expenses that is related to the home office. Since the home office is 384 square feet out of a total of 3,200 square feet, they can allocate 12% of their home expenses as home office expenses. This includes real property taxes, homeowner's insurance, electricity, gas, and other utilities. Finally, the Sawyers can also deduct the interest paid on their mortgage and home equity loan.

After calculating all the income and expenses, we can determine the Sawyers' taxable income for 2022 by subtracting the deductions from their total income. The taxable income is then subject to the applicable tax rates to calculate their final tax liability.

Answer 2

Taxable income: $324,900 - $57,062 = $267,838

State income tax deduction: $4,650

Net taxable income: $267,838 - $4,650 = $263,188

How to solve

Here's the determination of the Sawyers' taxable income for 2022:

Income

Kate's Beauty Cuts LLC net income: $45,000

Rental income: $19,400

Gain on sale of NYC condo: $490,500 - $230,000 = $260,500

Deductions

Moving expenses: $3,450

Interest on home mortgage: $12,000 ($400,000 * 3% * 0.5)

Interest on home equity loan: $750 ($50,000 * 3% * 0.5)

Real property taxes: $5,450

Homeowner's insurance: $2,625

Electricity: $3,650

Gas and other utilities: $2,750

Depreciation: $18,074

Rental property expenses:

Interest: $10,070

Real property taxes: $3,150

Homeowner's insurance: $2,150

Electricity: $1,450

Gas, other utilities, and landscaping: $1,850

Depreciation: $5,825

Deductible home office expenses:

Percentage of home used for business: 384 square feet / 3,200 square feet = 12%

Deductible expenses:

Real property taxes: $5,450 * 12% = $654

Homeowner's insurance: $2,625 * 12% = $315

Electricity: $3,650 * 12% = $438

Gas and other utilities: $2,750 * 12% = $330

Taxable income

Income:

Kate's Beauty Cuts LLC net income: $45,000

Rental income: $19,400

Gain on sale of NYC condo: $260,500

Total income: $324,900

Deductions:

Moving expenses: $3,450

Interest on home mortgage: $12,000

Interest on home equity loan: $750

Real property taxes: $5,450 + $3,150 = $8,600

Homeowner's insurance: $2,625 + $2,150 = $4,775

Electricity: $3,650 + $1,450 = $5,100

Gas and other utilities: $2,750 + $1,850 = $4,600

Depreciation: $18,074

Deductible home office expenses: $654 + $315 + $438 + $330 = $1,737

Total deductions: $57,062

Taxable income: $324,900 - $57,062 = $267,838

State income tax deduction: $4,650

Net taxable income: $267,838 - $4,650 = $263,188