James and Kate Sawyer were married on New Year's Eve of 2021. 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 $112,000. After their marriage, Kate left her job in New York and moved into the couple's newly purchased, 3,200-square-foot home in Atlanta. Kate incurred $3,400 of moving expenses. The couple purchased the home on January 3, 2022, by paying $100,000 down and obtaining a $400,000 mortgage for the remainder. The interest rate on this loan was 3 percent, and the Sawyers made interest-only payments on the loan through June 30, 2022 (assume they paid exactly one-half of a year's worth of interest on this loan by June 30). On July 1, 2022, the Sawyers borrowed an additional $50,000, secured by the home, in order to make home improvements (the loan was called a home equity loan by the lender). The interest rate on the loan was 3 percent (assume they paid exactly one-half of a year's worth of interest on this loan by year-end).

Shortly after moving into the new home, Kate started a new business called 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 $2,580 to have the carpet replaced with a tile floor. She also paid $1,440 to have the room painted with vibrant colors and $890 to have the room rewired for appropriate lighting. Kate ran an ad in the local newspaper and officially opened her shop on January 24, 2022. By the end of the year, Kate's Beauty Cuts LLC generated $44,800 of net income before considering the home office deduction. The Sawyers incurred the following home-related expenditures during 2022:

• $5,400 of real property taxes.
• $2,600 for homeowner's insurance.
• $3,600 for electricity.
• $2,700 for gas and other utilities.

They determined depreciation expense for their entire house was $18,048.

Also, on March 2, Kate was able to finally sell her one-bedroom Manhattan condominium for $490,000. She purchased the condo, which she had lived in for six years prior to her marriage, for $229,000.

Kate owns a vacation home in Myrtle Beach, South Carolina. She purchased the home several years ago, largely as an investment. 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 8 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 6 days for a romantic getaway and another 3 days in order to do some repair and maintenance work on the home. The rental revenues from the home in 2022 were $19,360. The Sawyers incurred the following expenses associated with the home:

• $10,060 of interest (assume not limited by acquisition debt limit).
• $3,160 of real property taxes.
• $2,140 for homeowner's insurance.
• $1,440 for electricity.
• $1,840 for gas, other utilities, and landscaping.
• $5,800 for depreciation.

Required:

Determine the Sawyers' taxable income for 2022. Disregard self-employment taxes and the qualified business income deduction. Assume the couple paid $4,640 in state income taxes and files a joint return. For determining deductible home office expenses and allocating expenses to the rental, the Sawyers would like to use the methods that minimize their overall taxable income for the year.

Note: Do not round any division. Round other intermediate calculations to the nearest whole dollar amount. Assume 365 days in the current year.

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1. James and Kate Sawyer were married on New Years Eve of 2021. Before their marriage, Kate lived in New York and worked as a hair stylist for one of the citys 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 couples newly purchased, 3,200-square-foot home in Atlanta. Kate incurred $2,200 of moving expenses. The couple purchased the home on January 3, 2022, by paying $100,000 down and obtaining a $400,000 mortgage for the remainder. The interest rate on this loan was 3 percent, and the Sawyers made interest-only payments on the loan through June 30, 2022 (assume they paid exactly one-half of a years worth of interest on this loan by June 30). On July 1, 2022, the Sawyers borrowed an additional $50,000, secured by the home, in order to make home improvements (the loan was called a home equity loan by the lender). The interest rate on the loan was 3 percent (assume they paid exactly one-half of a years worth of interest on this loan by year-end).

Shortly after moving into the new home, Kate started a new business called Kates Beauty Cuts LLC. She set up shop in a 384-square-foot corner room of the couples 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, 2022. By the end of the year, Kates Beauty Cuts LLC generated $40,000 of net income before considering the home office deduction. The Sawyers incurred the following home-related expenditures during 2022:

• $4,200 of real property taxes.
• $2,000 for homeowners insurance.
• $2,400 for electricity.
• $1,500 for gas and other utilities.

They determined depreciation expense for their entire house for the year was $17,424.

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. 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 8 days that they rented the home to Jamess 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 6 days for a romantic getaway and another 3 days in order to do some repair and maintenance work on the home. The rental revenues from the home in 2022 were $18,400. The Sawyers incurred the following expenses associated with the home:

• $9,100 of interest expense (assume not limited by acquisition debt limit).
• $3,400 of real property taxes.
• $1,900 for homeowners insurance.
• $1,200 for electricity.
• $1,600 for gas, other utilities, and landscaping.
• $5,200 for depreciation.

Required: Determine the Sawyers taxable income for 2022. Disregard self-employment taxes and the qualified business income deduction. Assume the couple paid $4,400 in state income taxes and files a joint return. For determining the deductible home office expenses and allocating expenses to the rental, the Sawyers would like to use the methods that minimize their overall taxable income for the year.

James and Kate have taxable income of $132,810. See the analysis below.

Description	Amount	Explanation
Total income
Jamess Salary	$100,000
Kates Schedule C income before home office deduction	40,000
Home-office deduction (for AGI)	(8,783)	See Note A below for computation. Not limited by income limitation
Rent revenue	18,400
Rental expenses (for AGI)	(12,005)	Used Tax Court method because it generated $382 more in current deductions than IRS method; See Note B below for computation
Gain on sale of principal residence after exclusion	23,000	$478,000 205,000 = $273,000 gain minus 250,000 exclusion
(1) AGI	$160,612
Itemized deductions:
(2) State income taxes	(4,400)
(3) Real property taxes on principal residence	(3,696)	$4,200 504 (deducted as home office expense)
(4) Real property taxes on vacation/rental home	(2,459)	$3,400 941 (deducted as rental expense) ($555 not deductible due to $10,000 limit)
(5) Deductible taxes	(10,000)	(2) + (3) + (4), limited to $10,000 (Sum is $10,555 but limited to $10,000)
(6) Home mortgage interest expense on principal residence	(11,220)	$12,750 1,530 (deducted as home office expense)
(7) Home mortgage interest expense on vacation/rental home	(6,582)	$9,100 2,518 (deducted as rental expense)
(8) Total itemized deductions	(27,802)	(5) + (6) + (7) > $25,900 standard deduction for MFJ
Taxable income	$132,810	(1) + (8)

Note A: Home office deduction computation using the actual expense method:

Home Office Deduction	Type	(A) Amount	(B) Office % (384/3,200 for indirect)	(A) (B) Home office Expense
New flooring	Direct	$2,100	100%	$2,100
New paint for office	Direct	1,200	100%	1,200
New office lighting	Direct	650	100%	650
Real property taxes	Indirect	4,200	12%	504
Home interest expense*	Indirect	12,750	12%	1,530
Utilities	Indirect	3,900	12%	468
Homeowners insurance	Indirect	2,000	12%	240
Depreciation	Indirect	17,424	12%	2,091
Total expenses		$44,224		$8,783

*Total interest expense for the year is computed as follows:

Original loan: $400,000 3% of a year = $6,000.

Original plus additional loan: $450,000 (additional $50,000 is acquisition debt because it was used to improve the home so interest on entire line is fully deductible):

$450,000 3% = $6,750.

Total interest expense = $12,750 ($6,000 from original loan through June 30 + $6,750 interest on original plus additional loan from July 1 through the end of the year).

Note that under the simplified method, the home office expense deduction is $1,500 (300 square feet $5). Under this method, the Sawyers would be able to deduct an additional $1,530 of home interest expense but they would not be able to benefit from the additional $504 of real property taxes that would be potentially deductible but is not because the Sawyers would exceed the $10,000 deduction limit for taxes even without the additional real property tax amount. Nevertheless, the deductions allowed under the simplified method are considerably less than those under the actual expense method.