Tax Exam Final

What are the general rules for deducting business expenses?

What are the general rules for deducting business expenses?

Business expenses must be ordinary, necessary, and reasonable in amount. Expenses must be directly connected to business activities and cannot be lavish or extravagant.

What items are disallowed from business expense deductions?

Personal expenses, expenditures against public policy (like bribes or fines), expenses relating to tax-exempt income, and key employee insurance premiums if the business is the beneficiary.

How are business travel expenses like airfare, lodging, and meals treated for deduction?

Travel expenses are deductible based on the business portion of the trip. Meals are only 50% deductible. Documentation must be maintained to prove business purpose.

What limits the deduction of business interest expenses under the tax law?

Deduction is limited to business interest income + 30% of adjusted taxable income.

What is excluded in adjusted interest income?

Interest income, interest expense, depreciation, amortization, depletion, and net operating loss carryovers. This limitation does not apply to businesses with average annual gross receipts of $26 million or less.

How are casualty losses to business property deducted?

Deductible if property is totally or partially destroyed. Deduction is limited to the lesser of the decrease in tax basis or repair cost, minus insurance proceeds.

How do cash basis taxpayers recognize income and expenses?

Income is recognized when received, and expenses are recognized when paid. This method does not match income and expenses well but is simpler and allows for flexible tax planning.

How are advance payments recognized for income by accrual basis taxpayers?

Income can be recognized using the full inclusion method (at receipt) or the deferral method (deferring until services are provided but not beyond one year of receipt).

What is the economic performance test for the deduction of prepaid expenses under the accrual method?

Deductions for accrued liabilities are allowed only when all events have occurred that establish the fact of the liability, the amount can be determined with reasonable accuracy, and economic performance has occurred (services/goods received or expected within 3.5 months after payment).

What constitutes the tax basis of an asset?

The tax basis of an asset is its initial cost plus all expenses necessary to prepare it for use, including purchase price, sales tax, shipping, and installation costs.

What are the MACRS depreciation conventions and methods?

Uses the 200%, 150%, and straight-line depreciation methods. Conventions include half-year, mid-quarter, and mid-month, which determine when depreciation starts based on when the asset is placed in service.

How is MACRS depreciation calculated for personal and real property in the year of purchase and disposal?

Use the applicable IRS depreciation table, selecting the column matching the asset's recovery period. For personal property, apply either the half-year or mid-quarter convention. For real property, use the mid-month convention and straight-line method.

How is MACRS depreciation calculated for property used both personally and in business?

Depreciate the business-use portion of the property only. If business use is more than 50%, normal MACRS rules apply. If 50% or less, use straight-line depreciation.

What are the depreciation limits for automobiles under MACRS?

The maximum depreciation limits apply to passenger vehicles weighing 6,000 pounds or less. The first-year limit is enhanced if bonus depreciation is claimed.

How do you calculate the gain or loss on the sale of property?

Gain or loss is the difference between the sale proceeds and the asset's adjusted basis (original cost minus accumulated depreciation).

How is the character of gain or loss determined on the sale of business, personal, and investment property?

The character depends on the type of property sold. It can be classified as ordinary if from depreciable property, capital if from an investment, or Section 1231 if it's business property held for more than one year.

What is the §1231 netting process?

Combine all §1231 gains and losses for the year. If the result is a net gain, it is treated as long-term capital gain. If there's a net loss, it is treated as an ordinary loss. If there are prior year §1231 losses, they may recharacterize current year §1231 gains as ordinary gains (look-back rule).

What is the §1231 look-back rule?

If there's a net §1231 gain in the current year and there were net §1231 losses in any of the previous five years, an amount of the current year's net §1231 gain equal to the prior year's net losses is recharacterized as ordinary income.

How is the basis of new property determined in a like-kind exchange involving boot?

The basis of the new property is the original basis of the property given up, adjusted by any boot received or given. If boot is received, gain is recognized up to the amount of boot or the realized gain, whichever is less. The basis of the new property is its FMV minus the deferred gain or plus the deferred loss.

How is gain calculated on an installment sale?

Gain is recognized proportionally as payments are received. Use the gross profit ratio (total gain divided by total contract price) to determine the portion of each installment payment that is taxable gain.

When is gain recognized in a like-kind exchange?

Gain is not recognized unless boot is received. If boot is received, gain is recognized up to the lesser of the total gain realized or the FMV of the boot received.

What is the rule for revenue recognition on installment sales?

Revenue is recognized as payments are received. The portion of each payment that represents profit is calculated based on the ratio of the total profit to the total sale price (gross profit percentage).

What are the eligibility requirements for excluding gain from the sale of a personal residence?

Homeowners can exclude up to $250,000 of gain ($500,000 if married filing jointly) if they owned and used the property as their principal residence for at least 2 out of the 5 years preceding the sale.

How does the exclusion of gain change under hardship circumstances?

If sold due to a change in employment, health, or unforeseen circumstances, the exclusion is prorated based on the actual period of residency divided by 24 months

What is the nonqualified use limitation on the exclusion of gain from the sale of a home?

The exclusion is reduced if there was nonqualified use (periods the property was not the taxpayer's principal residence) after 2008 during the ownership period.

What are the limits on deducting home mortgage interest?

Interest on up to $750,000 of mortgage debt ($375,000 if married filing separately) incurred after December 15, 2017, is deductible. For earlier loans, the limit is $1 million.

How is a residence with minimal rental use taxed?

If rented for fewer than 15 days per year, the rental income is tax-free, and no rental expenses are deductible. Mortgage interest and property taxes remain fully deductible as personal expenses.

What are the tax implications for a residence with significant rental use?

If rented for more than 14 days, rental income must be reported, and expenses must be allocated between rental and personal use. Deductible rental expenses are limited to the amount of rental income.