Mary and Charles have owned a beach cottage on the New Jersey shore for several
ID: 2446082 • Letter: M
Question
Mary and Charles have owned a beach cottage on the New Jersey shore for several years and have always used it as a family retreat. When they acquired the property, they had no intentions of renting it. Because family circumstances have changed, they are considering using the cottage for only two weeks a year and renting it for the remainder of the year. Their AGI approximates $80,000 per year, and they are in the 32% tax bracket (combined Federal and state). Interest and real estate taxes total $8,000 per year and are expected to continue at this level in the foreseeable future. If Mary and Charles rent the property, their incremental revenue and expenses are projected to be:
If the cottage is converted to rental property, they plan to be actively involved in key rental and maintenance decisions. Given the tax effects of converting the property to rental use, would the cash flow from renting the property be enough to meet the $12,000 annual mortgage payment?
This (would not/would) qualify for the real estate rental exception, which allows taxpayers to deduct up to $ ------ per year against (passive/active and portfolio) income. Mary and Charles would have a $------ incremental tax deduction related to renting the property and a tax benefit of $-------- . Therefore, the net cash flow (before mortgage payments) of $---------- from renting the cottage (would be/would not be) sufficient to cover the $12,000 mortgage payment.
Rent income $22,000 Rental commissions (4,000) Maintenance expenses (9,000) Depreciation expense (10,000)Explanation / Answer
Answer:
Mary and Charles would have a $5,000 deductible loss; with the total deductible loss of $13,000 ($4,000+8,000 interest and real estate taxes). The interest and real estate taxes would still be deductible if Mary and Charles did not convert the cottage to rental cottage. Although, there is a positive activity in the rental cottage, the cash flow from renting the cottage would not be sufficient to cover the $12,000 mortgage payment.
Particulars Amount ($) Rent Income 22000 Tax benefit from loss deduction ($5,000x32%) 1600 Less: Rental commissions 4000 Less:Maintenance expenses 9000 Net positive cash flow before mortgage payments 10600