James and Kate Sawyer were married on New Year's Eve of 2014. 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 $100,000. After their marriage, Kate left her job in New York and moved into the couple's newly purchased 3,200-squarefoot home in Atlanta. Kate incurred $2,200 of qualified moving expenses. The couple purchased the home on January 3, 2015, by paying $100,000 down and obtaining a $240,000 mortgage for the remainder. The interest rate on this loan was 7 percent and the Sawyers made interest-only payments on the loan through June 30, 2015 (assume they paid exactly one-half of a year's worth of interest on this loan by June 30). On July 1, 2015, because the value of their home had increased to $400,000, the Sawyers were in need of cash, and interest rates had dropped, the Sawyers refinanced their home loan. On the refinancing, they borrowed $370,000 at 6 percent interest. They made interest-only payments on the home loan through the end of the year and they spent $20,000 of the loan proceeds improving their home (assume they paid exactly one-half of a year's worth of interest on this loan by year end).
Kate wanted to try her hand at making it on her own in business, and with James's help, she started 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 $2,100 to have the carpet replaced with a tile floor. She also paid $1,200 to have the room painted with vibrant colors, and $650 to have the room rewired for appropriate lighting. Kate ran an ad in the local newspaper and officially opened her shop on January 24, 2015. By the end of the year, Kate's Beauty Cuts LLC generated $40,000 of net income before considering the home office deduction. The Sawyers incurred the following home-related expenditures during 2015:
• $4,200 of real property taxes.
• $2,000 for homeowner's insurance.
• $2,400 for electricity.
• $1,500 for gas and other utilities.
They determined depreciation expense for their entire house was $8,364.
Also, on March 2, Kate was able to finally sell her one-bedroom Manhattan condominium for $478,000. She purchased the condo, which she had lived in for six years prior to her marriage, for $205,000.
Kate owns a vacation home in Myrtle Beach, South Carolina. She purchased the home several years ago, largely as an investment opportunity. 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 eight 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 six days for a romantic getaway and another three days in order to do some repair and maintenance work on the home. The rental revenues from the home in 2015 were $18,400. The Sawyers incurred the following expenses associated with the home.
• $9,100 of interest expense.
• $3,400 of real property taxes.
• $1,900 for homeowner's insurance.
• $1,200 for electricity.
• $1,600 for gas, other utilities, and landscaping.
• $5,200 for depreciation.
Required:
Determine the Sawyer's taxable income for 2015. Disregard self-employment taxes for Kate. Assume the couple paid $4,400 in state income taxes and files a joint return. The Sawyers would like to use the method for determining deductible home office expenses and the method for allocating expenses to the rental that minimize their overall taxable income for the year.