 Hello and welcome to this session. This is Professor Farhad and this session we're gonna look at deductions and losses and specifically rental or vacations home. In this session, we'll include examples. Once I say I'm including examples, it means at some point in the past, in a prior session, I look at the lecture. So if you want to see the explanation, please look at the previous session and this playlist. This topic is covered in an income tax course, the CPA exam regulation section, as well as the unrolled agent exam. As always, I would like to remind you that I would like to connect with you, my viewers on a personal as well as a professional level. Life is too short, let's go ahead and connect. You can connect with me on LinkedIn. This is my LinkedIn profile. I do post my lectures as well as other related news about CPA and accounting. My Facebook page, you can like my Facebook page and connect with me on my personal Facebook. You wanna make sure you subscribe to my YouTube, like my YouTube, share my YouTube. This is where I house all my lectures and I do have it with our account. I also put my lectures on my website. It's not 100% updated. Let's go ahead and take a look at the first example and see how this works. So we have Adlin. Adlin, who lives in a winter resort area, rented her personal residency for 14 days. That's what she did. While she was visiting Brussels, she was in Europe visiting Brussels and that's what she did. Rent income was $5,000 and related expenses were as follow. She incurred $3,800 of real property taxes, mortgage interest, utilities, insurance, repairs, and depreciation. Determined the effect on Adlin's AGI. Now, here this is, if you get these questions on the exam as a multiple choice or as a problem, this is easy answer. Why it's an easy answer? Because if you know the rules and what are the rules here? Well, if you know that Adlin rented her house less than 15 days, fewer than 15 days. She only rented her house 14 days. There's no really consequences. There is no income to be included and there is no deduction to be taken. What does that mean? That means the income is not included and all these deductions are not taken. Now, not a caveat, just wanna make sure you're aware that this is considered a personal residence and because it's a personal residence, her property taxes and her interests is deducted on schedule A, assuming she's going to itemize deducted on schedule A, but that has nothing to do with her rental property because in this scenario, the rental property is considered strictly personal use. Okay, hopefully this is easy. This is easy questions if you get on the exam or on the CPA exam. The next problem during the year, actually this problem, what I did is I want to look at it on an Excel sheet because we will need to do some computation. So it's very important that we do it on the Excel sheet. This is not a leap year. Now we have Anna in this situation, rented her vacation home for 30 days, used it personally for 20 days. So notice what we have here. Let me just highlight what's important. So she rented it for more than 15 days and she used it for more than 14 days or 10% of the rental days. So and left it vacant for 315 days. So what are we looking at here? So again, let me just look at this. So she rented it more than 30 days and she lived in it more than 14 days or greater than 10% of the rental days. What do we have on our hand? We have what's called personal stack slash rental, basically a hybrid. Now what do we know about hybrid? If the property is considered hybrid use or personal slash rental, then it's treated like a hobby. And how do we treat hobby losses? Basically they are deducted to the extent of income. So the best case scenario you can hope for is zero income. Okay, zero income means you break even. So we have rental income, we have real estate taxes, we have mortgage, we have utilities, repair, so on and so forth. The first thing is they want us to do is compute Anna's net income or loss and the amount she itemized on her tax return using the courts approach. So they want us to do both the rental income as well as the amount deducted on her schedule A. Okay, let me stop inking here. All right, okay, I stop inking. All right, now, first of all, we're gonna start with the court approach. Well, the first thing is we're gonna include is the $7,000 of income. So that's starting with that. She include $7,000 of her income. Now the next thing is we have to do is we have to know which items do we deduct. Now you need to know that the items that are deductible anyway gets deducted first. What items are deductibles anyway? Well, the items that are deductibles anyway are mortgage, interest, and real estate taxes. So here I'm gonna highlight those. So mortgage, interest, and real estate taxes. Now under the court formula, how do we deduct those? How do we deduct those? Well, under court formula, remember, we use the number of days rented, which is 30 days. Let me just change the inking here. We're gonna use number of days rented, which is 30 days divided by the number of days in a year, which is 365, 365, 365 days, okay? So what does that mean? That means we're gonna go ahead. We're gonna go ahead, add up rental, rental, which is a real estate taxes, 2,500, plus mortgage interest, 9,000, and we're gonna multiply this. I'm gonna multiply this by 30, the number of days rented divided by 365, by 365, okay? So this is the formula. And I'm gonna be able to deduct $945. So there we go, 7,000 of income minus 945 gives me 6,055. This is the amount that's remainder to apply against operating expenses and depreciation. Operating expenses here are utilities and repair. The next thing I'm gonna look at is utilities and repairs. Utilities and repairs, I have 2,400 plus 1,000. I'm gonna multiply this by ratio. What ratio do we use for those expenses? Whether it's under the court or the IRS system, we're gonna use the number of days, divided by the number of days used, which is rented and personal, which is 30 divided by 350. Notice the ratio here, 30 divided by 350 is different than the ratio we used here, 30 divided by 365. So the taxes and mortgage interest, they got treated differently under the court's approach. Now, after we deducted utilities, we still have $4,015 remainder. Guess what? Now we're gonna include depreciation. We have depreciation of 7,500. We're gonna take 7,500. Also multiply it by 30 divided by 50. And that's gonna give us 4,050. Guess what? We cannot deduct 4,050 because that's gonna give us a loss. Okay, that's gonna give us loss. This is we have, this is net rental income, which we cannot have income. So what's gonna happen? Because we cannot have net rental income. We're gonna have to plug in 4,015. That's gonna give us a loss. Therefore, this is how we will approach this under the courts, under the court. Now, keep in mind, keep in mind what happened is this. Let's see. Remember, we had in total mortgage in interest, in total mortgage in interest, we had 11,500, which is those two together. We already used up 945. What does that mean? It means on schedule A, we could still deduct 10,555. That's gonna go on schedule A because they want us to know what goes on schedule A. Okay, what can be itemized? That's the amount that's gonna be itemized. So this is the courts approach. Let's look at the IRS approach. Under the IRS approach, income is obviously included $7,000. Taxes and interest. Now, this is where it makes a difference. I'm gonna take my taxes, which is 2,500, plus my interest, 9,000. Those are the items that are deductible. Anyway, gets deducted first. And here I'm gonna multiply them. I'm gonna multiply them by 30 divided by 50. Not 30 divided by 365. Under the IRS approach, I multiply this ratio by 30 divided by 60. Notice here I divided by 30 divided by 365. Here I divided 30 divided by 60. A 30 divided by 50. What I left is $100. And you know, if I take my repairs and utilities multiplied by 30 divided by 50, it's gonna give me more than 100. Therefore, the only thing I can deduct is 100. Therefore, I have zero and I'm done. This is under the IRS approach. So notice under both method, I have net income of zero. But the question is, if you are the taxpayer, which method you would prefer to use? Okay, that's the question. Which method you would prefer to use? And I hope you understand or I hope you can see that you prefer to use this method. Now, why? Why? Because this, because under this method, you were able to use your utilities in depreciation as expenses. Notice you expense utilities in depreciation, okay? And the amount that you did not take in mortgage and interest, what happened is you're gonna take it on your Schedule A. But in this scenario, what happened, you consumed most of your mortgage and interest. And what's left of mortgage and interest? You're gonna have some left, okay? So you're gonna have 11,500 minus, so you're gonna have left in mortgage and interest, 11,500, you're gonna have 11,500 minus 6,900. Whatever that amount is, goes to Schedule A, it's not zero, whatever that amount is, goes to Schedule A, which is 4,600, which is 4,600, goes on Schedule A, okay? But your total deductions are higher under the court's approach, because utilities and repaired, if you don't deduct them, you can't use them. So utilities and repaired, basically only used under the IRS approach, you only used of all of those $100, you did not use this. Now I did not mention, what about the roof? It's a capital expenditure. What is a capital expenditure? It means it's added to the cost of the house, to the basis, and it's taken in depreciation. It means it's accounted for. I did not talk about this, but there it is, okay? So that's that. Now, how would your answer to this problem differ if Anna has rented the house 87 days and has used it for 13? Well, if she rented it for 87 days, that's definitely kind of where we're going toward rental. And when we look at the personal days, it's less than 14. Therefore, now the property is rental. So let me just erase this, erase everything, okay? So here what they want us to do is to change the scenario. Simply put, when we change the scenario, now rental becoming is the primary objective, 87 days, and 13 days. 13 days is less than, not greater, do less than 14, okay? And 87 days is more. And if we take 87 times 10%, that's gonna give us 8.7 days, but we cannot use 8.7 days. We have to use 13 days. We have to compare it to the greater of 14 days or 10% of the rental days. Therefore, it's a primary rental. What do we need to do here? Let me just delete those numbers. Now, what's gonna happen is, we're gonna have to allocate, because 87% how did I come up with 87% versus 13%? Well, it's 87 days plus 13 equal to 100. So 87% of the time it was used for business. I'm sorry, I didn't mean to say now business. Let's make sure we use the proper term rental, 87% for rental and 13% for personal, okay? So now what's gonna happen is, under the rental, they would report 7,000. Mortgage and interest is 11,500. Then we're gonna multiply this by 0.87, 87%. And that's gonna give us 10,055. Utilities and repairs are, utilities and repair are, if we go back up there, it's 3,400 together. And we're gonna multiply this by 0.87. And that's 2,958. Depreciation is 7,500. I'm gonna multiply it by 0.87. And that's gonna give me 6,525. As a result, I have total expenses of 19,480. And my income is only 7,000. Therefore, it gave me a net loss of 12,488. Am I happy or am I sad, as my son would say? Well, I am happy about this because this loss, this loss is the deductible. This loss is deductible, okay? So I'm good with this, I'm okay with that. Now, remember, we have mortgage and interest. Let me go back up here. We have mortgage and interest of, let me delete this, this is becoming two. Okay, I have mortgage and interest, if you notice of 2,509,000. Now on schedule A, I can no longer use my mortgage, whatever, mortgage interest. The mortgage interest is no longer deductible if it's a rental property. For the 2,500, for the 2,500, I already used 87% out of it. Okay, 87%. What's left is, is 13%. If I take 2,500 times 13%, that's gonna give me 325 that I could still deduct on schedule A, on schedule A, okay? Let me go down here. So remember, although I'm so personal, really what's left for person is 1495, but I can only deduct 325 for utilities and repair, 442 I cannot use, 975 of depreciation left, I cannot use. The only thing I could still deduct is the 325 from my taxes, real estate taxes. So this amount is not deductible, only 325 out of it is deductible. Hopefully this example illustrates how rental property work. If you have any questions, any comments, by all means email me. If you're studying for your exam, make sure to study hard, good luck. And if you happen to visit my website, please consider donating.