Reference no: EM131805111

Assignment

Require: Read the following background and case information. Your requirement is to complete the research required to answer your client's question. In doing this you will need to write a research memo to the file like you have been accustomed as well as a letter to your client. Please use the format specified in your textbook on page 4-11 for the client letter and follow the guidelines specified in your book. Up to a 20% penalty will apply for mechanical errors so please proofread your work.

Background

For years the IRS and taxpayers have contested the proper allocation of interest and taxes expenses related to a second (vacation) home. The IRS has insisted that the denominator used to allocate rental vs. personal days should be the total days the property was actually occupied (used) during the year, while taxpayers have followed the decision in Bolton, 694 F2d 556 (1982) allowing the use of 365 days as the denominator. Although the arguments have focused on situations where the rental expenses are limited to rental income under Code Sec. 280A (i.e., personal usage days exceed the greater of 14 days or 10% of the days rented), there are also implications when the Code Sec. 280A limitations are not violated. Specifically, if the property is classified as a "rental property," then interest expense for personal usage days is not deductible because the property cannot be both a rental and a personal residence at the same time. This brings up the question of whether a property owner might be better off to violate the usage limits deliberately so that the personal interest would be deductible (i.e., the vacation home is classified as a second residence).

Client Information

Your client, MilliVanilli, has come to you in November with some questions regarding a vacation rental and you have tasked your intern to develop a spreadsheet for some of the monetary information to help aid in you decision.

The spreadsheet assumes that, near the end of the year, the vacation home owner has rented the property for 260 days and has used the property for personal reasons a total of 26 days. Thus, one more personal day will invoke the Sec. 280A vacation home limitations however; such a scenario will permit the taxpayer to deduct the allocated personal interest as well.

Using the spreadsheet, answer the following questions put forth by your client. Please be sure to address these answers in your research memo to the file as well as in your client letter.

1. The saved version of the spreadsheet currently assumes that the total annual interest expense related to the property is $6,875. Based on this assumption, should your client use the property one additional day for personal reasons?

2. Examine the allocated interest and taxes closely in the "Current Result" columns of the spreadsheet. Notice that even though the Bolton method is used for both interest and taxes, the same fraction does not apply to the two expenditures. Explain this apparent inconsistency. You may want to refer to the discussion of vacation rental homes in Chapter 11 of the text.

The interest expense may go up next year as his ARM is set to begin to adjust. Assuming the interest was to increase next year, what are some planning considerations that Mr. Vanilli should consider when he is determining the number of personal versus rental days next year? (Please note, I do not want concrete calculations, instead I want some general advice regarding deductions, carryovers etc. with support.)

Vacation Rental Home Analysis
Treatment of Interest Expense Deductions
		Current		Proposed
Days of Personal Use of Vacation Home		26		27
Days of Rental Use of Vacation Home		260		260
Total days property was actually used		286		287
Rent Charge per day		60		60
Marginal income tax rate		40.00%		40.00%
Treatment for Federal Tax Purposes		Rental		Personal
		Current Result		Proposed Result
	Inc/Exp	IRS Method	Bolton Method	IRS Method	Bolton Method
Gross Rents ($60 per day)	15,600	15,600	15,600	15,600	15,600
Interest Expense (total)	6,875	(6,250)	(6,250)	(6,228)	(4,897)
Taxes Expense (total)	3,650	(3,318)	(2,600)	(3,307)	(2,600)
Repairs (total)	5,000	(4,545)	(4,545)	(4,545)	(4,545)
Depreciation	4,000	(3,636)	(3,636)	(3,636)	(3,636)
Net Loss		(2,150)	(1,432)	2117	(79)
Deductible Rental Loss		2,150	(1,432)	0	0
Deductible Interest on Schedule A		0	0	(647)	(1,978)
Deductible Taxes on Schedule A		(332)	(1,050)	(343)	(1,050)
Total tax deductions		(2,482)	(2,482)	(990)	(3,028)
Marginal tax rate		40%	40%	40%	40%
Total tax savings - vacation rental		(993)	(993)	(396)	(1,211)