During the 1984 Olympics Frank and Irma rented their home in Hollywood, California and enjoyed a three-week vacation at their condo in Malibu, California. By 2000, they decided to retire to the Palm Springs area. They sold their home and purchased a 4,000 square foot home in La Quinta, California as well as an apartment building in Palm Desert, California for $4,500,000 (i.e., land - $500,000 & Building - $4,000,000). They knew summers would be very warm in La Quinta, so they kept their condo in Malibu for personal use in July & August. They are in the 22% Federal Income Tax bracket. Excel would be an excellent format to answer all three parts of this Project. No Memorandum to File or Client Letters are required for this project.

Part 1

Frank & Irma can rent their personal residence for 16 days during the Stagecoach and Coachella Valley Music Festival. They can rent their home for $3,000/day. They want to maximize their Schedule A deductions (i.e., Mortgage Interest & Real Property taxes) and minimize any potential taxable income resulting from renting the property. They remember during the 1984 Olympics that they didnt have to report any income.

Frank & Irma have the following sources of income before considering the apartment income:

Pensions $ 80,000

Dividend Income 30,000

Interest Income 15,000

Required:

1. Compute the potential tax consequences for renting out their personal residence for 16 days next spring (i.e., Schedule A items and Schedule E items).

2. What advice would you give them regarding the renting of their personal residence for Stagecoach & the Coachella Valley Music Festival? Prepare calculations to support your advice.

Part 2

Frank & Irma have a condo on the beach in Malibu which they use during July & August (i.e., 60 days) and rent out for 90 days at its fair rental value. Round to the nearest percentage (i.e., 29.65% = 30%). A summary of the rental activity is listed below:

Income (i.e., 90 days @ $400/night) $ 24,000

Expenses:

HOA Dues (monthly) $ 2,500

Insurance (monthly) 2,000

Interest Expense (monthly) 10,000

R & M 1,500

Real Estate Taxes (annual) 4,000

Utilities 3,000

Depreciation (annual) 8,500

Total <31,500>

Net Income $ <7,500>

Required:

1. Calculate the Schedule E net rental income and the Schedule A - Itemized Deductions using the IRS Method.

2. Calculate the Schedule E net rental income and the Schedule A - Itemized Deductions using the Court method.

3. Which method should Frank and Irma use to report the rental income and itemized deductions on their Federal Income Tax return? Why?

Part 3

Frank and Irma purchased the 20-unit apartment building for $4,500,000 (i.e., $500,000 for the land and $4,000,000 for the building). The income and expenses from the apartment building are as follows:

Income (i.e., 20 units @ $1,500/month) $ 360,000

Expenses:

Depreciation ($4 million @ 2.56%) $ 102,000

Insurance 50,000

Interest Expense ($2 million @ 3%) 60,000

R & M 10,000

Real Estate Taxes 67,500

Utilities 75,000

Manager 12,000

Total <376,500>

Net Income $ <16,500>

The apartment manager collects the rents each month, inspects the property on a regular basis and handles tenant complaints. The apartment manager talks to Frank and Irma regarding the tenant complaints and discusses the potential repairs and maintenance that is required. The manager then arranges for the services contracts with outside vendors. Frank & Irma make the monthly deposits of tenant rent checks at their local bank and pay for all apartment expenditures from an apartment checking account that they control.

Required:

1. Compute Frank & Irmas modified adjusted gross income.

2. Under the Passive Activity Loss rules, how much of this loss can Frank & Irma claim on their Federal Income Tax return?

3. What is their adjusted gross income after considering the Passive Activity Loss rules?

4. What is the difference between active participation in a rental property and material participation in a rental property?

5. What recommendations would you make to Frank & Irma regarding the future management of these apartments? Would they be able to deduct a greater portion of the loss?