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  • Okay. We ended up last, in our last session looking at the Social Security benefits and

  • the taxability of those. So what I want to do is just kind of go over that calculation,

  • the handwritten one that I sent you and we went over so you can understand how that works

  • and then we're going to go ahead and finish up the chapter. We'll finish up the chapter.

  • Basically as I indicate with this calculation, if you have modified AGI that is less than

  • the lower limit, and there's two limits based on if you are married filing jointly or single

  • head of household or widower. As long as it's here, it's not going to be taxable, so anything

  • under these lower limits is not going to be taxable. Anything between it's going to be

  • the taxable portion of the Social Security is going to be the lesser of 50% of the Social

  • Security benefits or 50% of the excess of the modified AGI over that lower limit, okay.

  • If your modified AGI is more than the upper limit, meaning it doesn't fall in between

  • but it falls above the upper limit, then your taxable Social Security benefits are going

  • to be the lesser of 85% of your Social Security benefits or the sum of 85% of the excess over

  • the upper limit or -- and the lesser of 50% of your Social Security benefits at 6,000.

  • So basically what you do is you say, okay, what's the smaller of 50% of my Social Security

  • benefits or 6,000, and I take the smaller of that, and then I'm going to add it to 85%

  • of the excess over the upper limit, and then I'm going to take that sum and then I'm going

  • to compare it to 85% of my Social Security benefits and then the lesser of the two is

  • going to be the portion of my Social Security benefits that are taxable.

  • So as I said, hopefully you have some time to go through that calculation and, therefore,

  • you can see the -- to me the calculation, that is a little easier than the worksheet.

  • But either way, you'll get the same answer. If it's easy for you to follow the worksheet

  • and go through the calculations, you'll be fine. If you're using a tax software, there's

  • one that comes with our textbook, or any one of the ones you purchase, it will go through

  • that calculation for you and let you know the amount of your Social Security benefits

  • that will be taxable. Okay. Let's continue on with the chapter.

  • Next, unemployment compensation. And we know unemployment rates are up. The important thing

  • to remember if you're receiving unemployment, it's going to be taxable. And they don't always

  • withhold taxes from your unemployment compensation. So just be aware if you're receiving unemployment

  • and you're not getting taxes withheld, it's going to be taxable to you and it's going

  • to cause you to have to pay tax on the amount that you receive. I don't -- I believe -- I

  • want to say the State of Kansas may offer you to withhold it versus the State of Missouri,

  • but just inquire. If you're receiving unemployment compensation, be it in Missouri or Kansas,

  • inquire whether they withhold tax on it for you, or you just may choose not to and just

  • be aware it's taxable. Next we want to look at employee fringe benefits.

  • Basically as employees we get certain benefits from working at certain places. It's a fringe.

  • It's a benefit for working there. And basically they say all these employee fringe benefits

  • are included in income except for these ones that we're going to discuss that are specifically

  • excluded, and they're on -- we start those on Page 2-21.

  • Okay. And so employer-provided spending accounts. These are -- this is money that's set aside

  • for dependent care accounts, which you can set aside $5,000, taken out pre-tax to cover

  • child care or aging parent care or medical flex spending accounts that help cover medical

  • expenses. So basically these accounts you can use for medical and for child care. They

  • take out pre-tax, so you get the benefit of it not being taxed, and because the employer

  • runs these plans for you, you do not have to pay any income or any, you know, for that

  • benefit. So excellent options there. Also, this is going to happen mainly in maybe

  • a big city where they encourage you to maybe take the subway. But if an employer provides

  • a spending account for public transportation, there's monthly limits that's gonna apply

  • and it's to cover the public transportation to work and for parking. So if all the requirements

  • are met, then it's going to be a tax-free reduction. So like I said, normally that's

  • going to happen in big major cities, New York, Chicago, where parking sometimes is an issue

  • if you work in downtown. So they're going to try to encourage you to catch the subway.

  • Next is group term life insurance. If -- a lot of employers do this offer, employers

  • can pay up to 50,000 for employers tax-free for group term life insurance. The thing about

  • that insurance, it cannot favor officers, shareholders, or highly paid. It has to be

  • offered to everyone, across the board. Okay. And then they have what they call no

  • additional cost services. These are provided at no additional cost to the employee. And

  • it's only allowed if it's in the employee's major line of business, major line of business.

  • An example of these, if I work for an airline, the perfect example is we know people who

  • work for airlines have the option of maybe flying standby and being able to fly for free.

  • It doesn't cost you any money. It doesn't cost the employer any money to have that vacant

  • seat filled by you, so in that case, it's not taxable. Now, the thing about it, it has

  • to be in the employee's major line of business. Let's say I work for a corporation who owns

  • a hotel chain and they own an airline. If I work for the airline, even though the corporation

  • may give me a discount at the hotel and for airfare, the airfare is the only one that's

  • not taxable to me because that's in my line of work. I work for the airline piece. But

  • for the benefits that I take for the hotel, if I get free rooms or whatever, then that

  • is going to be included in my income. So it's only for the line of business in which I work

  • in. So keep that in mind. It's going to be only for the line of business that you work

  • in. Okay. Qualified employee discounts. We know

  • if you work at certain places, you can get a discount and as long as these discounts

  • are provided on a non-discriminatory basis and then there's certain limits to them, they

  • said these particular discounts are not going to be tax-free. If they're on real estate

  • or investment property, so if you're getting a discount on real estate or investment property,

  • that's not tax-free. You're going to have to include that in income. If the discount

  • exceeds gross mark-up of merchandise, basically if because they're selling it to you they're

  • selling it at a loss, that's not going to be excluded from your income. That's not going

  • to be tax-tree. You have to include that. If the discount exceeds 20% of customer price,

  • basically the exclusion is limited to 20% of the customer price. So if it's more than

  • that, that portion is going to have to be included in income. And once again, if it's

  • out of the employee's line of business, back to me at the hotel, if I'm getting a discount

  • and I work for the airline portion of it, it's going to be -- it's out of my line of

  • business. An example, I used to work for the Kansas City Royals, we had an option of getting

  • the Royals tickets, you know, for free. No problem going to a Royals game, I worked for

  • the Royals. If for some reason the same owners of the Royals owned the Chiefs and which,

  • you know, that's kind of a gray area because we're still in -- well, one is professional

  • baseball versus professional football. It would be probably challenged that my tickets

  • or free tickets to the Chiefs may have to be included in my income. It's not the same

  • line of work. I think you could argue that, you know, professional sports is professional

  • sports and maybe if we threw in a hotel or something, then we would begin to say, okay,

  • that portion is not in my same line of business. So just know you have some gray areas there

  • and that you could -- that would be up for discussion.

  • Okay. Also they have a working condition, another one, excluded -- these working conditions

  • benefits are excluded to the extent that the cost of the property or services would be

  • a deductible expense, meaning if this was something I'm going to get a deduction for

  • anyway, if it's a deductible expense anyway, therefore, it's not going to be included in

  • my income. The example is if your employer pays for your professional dues, if you belong

  • to the AICPA or you belong to a professional organization and your employer pays the dues

  • on your behalf and that is a deduction anyway. So, therefore, since it is a deductible expense,

  • my employer pays it for me, I wouldn't have to include it in my income, and that's because

  • it's already a deductible expense. Okay. These de minimis fringe benefits. These

  • are like little small ones, so small that we don't necessarily account for them. The

  • de minimis fringe benefits are excluded from income if they're too small to account for.

  • If they're -- if it's too tedious to try to track them, you know, they are not going to

  • be included in our income. Also, subsidized lunch room, if you have a lunch room on your

  • -- at your employer and it's subsidized, as long as it's on or near the business, and

  • that the revenue from the operations exceeds the cost, meaning they're operating at a profit

  • and that anybody can use it, it's on a nondiscriminatory basis, that subsidized lunch room, the benefits

  • you get from that is not going to be included in your income, so.

  • Okay. Tuition reductions that are given by educational institutions. For instance, here

  • at Johnson County we get particularly tuition reduction. So those tuition reductions are

  • excluded from income if it's for undergraduate and if it's available to all employees, all

  • say full-time employees, meaning it also is available to spouses and dependents, then

  • that benefit of taking classes at a tuition deduction or at no cost is not included in

  • income. For graduate level education not to be included, the employee has to be at an

  • institution that is teaching in research. So that's the way graduate level can be excluded.

  • Athletic facilities, we have an athletic facility, a lot of companies have athletic facilities

  • on campus or on their -- on the job site. That cost is excluded if the cost to operate

  • the facility is used primarily for employees. So if it's used primarily for employees, it's

  • not an outside place, then it -- that cost of using that facility for free would not

  • be included in your income.

  • And then a lot of times companies offer a -- offer to provide some retirement planning,

  • you know. They may have a company come on-site and give some free advice on retirement planning.

  • If it's provided, value is going to be excluded from gross income, now, that's just a retirement

  • planning piece. If you have the ability to for free go get your taxes done or some type

  • of accounting fees or accounting services or legal and brokerage services, those don't

  • apply. Only retirement planning services. So tax prep, you have to include that value

  • in your income. Any accounting services, you -- if you're getting those for free and your

  • job is providing them, then you're going to have to include the value of those in your

  • income and you're going to have to include the value of those in your income.

  • Okay. That brings us to the end of Chapter 2 that dealt with gross income and exclusions.

  • We dealt with a lot of things that we looked at. First, what was included in income, and

  • the IRS, remember, they say everything is included, not unless it's specifically excluded.

  • Then we begin to look at specific items that were not included, that were partially taxable,

  • and so we begin to look at specific items like that. So that is Chapter 2 that dealt

  • with gross income and exclusions. Okay. We want to go ahead and move on to Chapter

  • 3, which is going to deal with business expenses and retirement plans. This session is going

  • to deal with the beginning part of that, which is this, your business expenses. So in your

  • packet that I sent you, you should have a handout that in this particular one we're

  • not going to do it by PowerPoint, but it's all by notes. We have notes that you're going

  • to be writing and filling out on a handout that I sent you that says Chapter 2, business

  • expenses and retirement. So let me get a blank one and we will get started.

  • Okay. So that is the handout that you should have for Chapter 3. And so we have a lot of

  • notes for this chapter. There's a lot to cover in here. And we're going to basically cover

  • it all this way. So there's no PowerPoint that goes with this chapter. But it's going

  • to be all done by notes. We want to start with our rental income. We want to start with

  • rental income. Rental income is going to be taxable, okay. Rental income is taxable. Okay.

  • It's going to be taxable on Schedule E, okay. And then it's possible that it's going to

  • be treated as a business and possibly be taxable on Schedule C, meaning if there is some cleaning

  • and maid service being provided on this rental property. And probably what we're distinguishing

  • between is rental property that people live in versus hotels, hotels and bed and breakfasts

  • where there's cleaning and maintenance services are coming in, then that's more of a business

  • and Schedule C to where if it's rental, strictly rental property with someone, you rent out

  • a piece of property, then that's going to be Schedule E. So that's the difference there.

  • With Schedule C, this is going to be subject to self-employment tax. Okay. That's going

  • to be subject to self-employment tax. So that's your distinction between those two, okay.

  • And so we want to start off on Page 3-2 where they talk about vacation homes. Basically

  • vacation homes can be both personal and rental use. As we know, if I have a vacation home

  • up in Colorado where I ski, I am probably not going to just leave it vacant if I can

  • when I'm not there, I would like to have it rented out, okay. So when we have vacation

  • homes that are both personal and rental, the use of that property, then what we're going

  • to need to do is allocate the expenses. We're not going to be able to take the, you know,

  • just deduct the whole thing, because you gotta remember there's some personal piece in there,

  • okay. So the way they separate it out, if you begin

  • to look on Page 3-2, there is rental that is -- there's going to be considered primarily

  • personal. So we have rental that's considered primarily personal. Then we have rental that

  • is considered primarily rental, meaning when we look at it, that's really personal. And

  • when we look at it, that's really rental, primarily rental use, with not much, if any,

  • personal. And then we have the rental that is personal and rental. So it has dual use.

  • Okay. So let's look at what qualifies for these

  • items. How does a home qualify as primarily personal use and then how is it taxed or how

  • is it treated? Okay. So when we're talking about property that is primarily personal

  • use, it's going to be rented for less than 15 days. So it's going to be rented for less

  • than 15 days. So 10, 12, but less than 15 days is it's going to be rented. Not equal

  • to. Less than. Okay. So if that's the case, it's going to be treated as personal. Treated

  • as personal. Okay. And then the rental income for that particular property is not taxable.

  • It's not taxable. Okay. So the mortgage interest and taxes on that

  • particular property are going to be deductible on Schedule A. So we're going to be able to

  • take those deductions. And any other expenses are not deductible because they're personal,

  • because we deemed it not to be rental property. So even though I can't deduct any of the other

  • expenses, guess what? The income is not taxable. The perfect example of this is we just went

  • through the inauguration and I had an opportunity to go to the inauguration and there was lots

  • of advertisements regarding people renting out their personal homes for the inauguration

  • week or weekend or whatever the case may be. I had the opportunity to get a hotel room,

  • so I didn't have to do that, but you think about it. And some of them were renting them

  • for huge amounts of money. So if let's say that I decided to rent out my home for the

  • weekend at a rate of $5,000, well, I rented it for less than 15 days, so that's going

  • to be considered personal. None of that income is taxable to me. None of that income is taxable

  • to me. So keep that in mind when it's primarily for personal, as long as it's less than 15

  • days, income is not taxable. Now, any expenses they incurred, you know,

  • to get it ready for rent or whatever the case may, be that's not deductible. But they can

  • still deduct their mortgage interest and taxes. So that's a perfect example of personal property

  • that I did get some rental income on that I don't have to, you know, claim on my tax

  • return. Okay. What qualifies property as primarily

  • rental use? What qualifies property as primarily rental use? And this is when it's rented for

  • greater than or equal to 15 days, okay. So I got that in. I rented it more than 15 days,

  • or equal to that. And -- there's an "and" in this -- and the personal use does not exceed.

  • So there's a personal use does not exceed, okay, the greater of either 14 days or 10% of the rental days.

  • Okay. So we have to look at the personal days and the rental days. So if I've rented my

  • property for more than or equal to 15 days, and the personal use days does not exceed

  • either the greater of 14 or 10% of the rental days, or 10% of the rental days.

  • So long as that happens, then this is going to be considered primarily rental use property,

  • okay. When it's primary rental use property, I want to allocate the expenses between rental

  • and personal. They're still not going to let you take those personal expenses. Okay. And

  • then I'm going to do that allocation based on the rental days divided by the total days

  • used, okay. So I'm going to take the rental days, the number of days that I actually rent

  • it, I'm going to divide it by the total days used, and that's going to equal my rental

  • percentage. And then I'm going to take the expenses and

  • I'm going to multiply them by this rental percentage. And that's going to equal the

  • deductions I'm going to be able to take. Okay. And then for the personal piece, the

  • personal days divided by the total days used, that equals my personal percentage. And then,

  • in that case, the personal part is not going to be deductible. Okay.

  • The good thing about when it's primarily rental use, if I go through my Schedule E and I report

  • my income minus my expenses and it ends up with a rental loss, that rental loss is allowed,

  • I can deduct a rental loss. So a rental loss is allowed on my Schedule E.

  • Okay. So that is the benefit of your primarily rental use property, is that if it's primarily

  • rental, you end up with a loss, then it's a deductible loss. You can take the loss.

  • So that's the good thing about that one. So primarily personal, I have income, I don't

  • have to report. Primarily rental, I can deduct the personal percentage of my expenses and

  • if I end up with a loss, then that loss is fully deductible.

  • Okay. Next is what if we have property that we consider a rental-personal split, or a

  • dual use, meaning I've used it a little bit of both? So what qualifies a piece of property

  • for that? Qualifies a piece of property for that? The way that one works, if it's rented

  • for less -- greater than or equal to 15 days and the personal use -- the personal use exceeds. Remember, in the

  • other one we said that greater than or equal to 15 days and the personal use does not exceed.

  • So now we're at "and the personal use exceeds." So and the personal use exceeds the greater

  • of or of 14 days or 10% of the rental days. Okay. So if you go through that calculation

  • and that applies, my personal use exceeds the greater of those, then that -- in that

  • case it's going to be a rental/personal split, okay. And so what you're going to do is you're

  • going to -- the allocated -- you want to allocate the expenses between the rental and the personal.

  • You want to allocate the expenses between the -- just like we did before, you want to

  • make that allocation. Now, the thing that to note and remember that

  • there's no loss allowed. So if I go through the calculations, I got my income, these are

  • all my expenses and I end up with a loss, I can't take that loss. The only thing I can

  • do is deduct expenses in the following order up to income. So basically up to where I have

  • a net income of zero, meaning I'm going to -- if my expenses, if my income is $5,000,

  • I can only take $5,000 of expenses. Okay. But they're going to make me take them in

  • this order. I'm going to first have to deduct taxes and interest. So I'm going to do that

  • first. Taxes and interest. That mortgage interest and taxes, I deduct those first. Now, if after

  • I deduct those and I end up with a loss, then that's okay. Now, these can create a loss.

  • Okay. Create a loss. They're allowed to create a loss. So, for instance, if my income was

  • 5,000, if my taxes and interest equal 6,000, which makes me have a $1,000 loss, I can take

  • it. Now, I'm not going to get any utilities or

  • depreciation, because I've already consumed all my income. Now, utilities and maintenance

  • would be deducted next. And then any depreciation, okay. Now, on this personal/rental split,

  • that personal percentage of mortgage and interest -- so mortgage interest -- I'm sorry, and

  • taxes, they can go to Schedule A. They are deductible on Schedule A.

  • Okay. When it was primarily rental, that personal percentage I didn't get to do anything with

  • that. But in this case, the personal percentage is going to get to go on Schedule A.

  • So let's review this one. This is deemed or determined to be a rental/personal split based

  • on that the rented days are greater than or equal to 15 days and my personal days exceed

  • the greater of 14 days or 10% of the rental. So what I'm going to do is allocate still

  • between my rental and my personal portion. If I come up with a loss, I cannot take that

  • loss. No loss is allowed. I can only take expenses up to my income. I take my expenses

  • in this order. I deduct my taxes and interest from the rental property. If I still have

  • income left I'm going to deduct my utilities and maintenance. And if I still have income

  • left, I'll deduct depreciation. You have to do it in this order. The personal percentages

  • then of your mortgage interest and taxes are going to be deductible on Schedule A, so you

  • don't -- you don't lose those. You do not lose those.

  • Okay. Now, an interesting thing is this alternative allocation method. There's an IRS method and

  • then there is a tax court method, okay. On Page 3-4, it should be noted that the U.S.

  • Tax Court has allowed taxpayers to use 365 days for the allocation of interest and taxes

  • instead of what I spoke of here. Here I said take your rental days, divided by the total

  • days used, okay. This is considered the IRS way of doing it. If we take -- to get my rental

  • percentage, if I take the rental days and I divide by the total days used, okay. The

  • alternative approach would be take -- would be to take the rental days and divide them by 365, the whole year, and

  • get the rental percentage. So the question is, why is that a big deal? And this is for

  • my interest and taxes allocation. This is -- you know, so that I can deduct or allocate

  • my personal versus my rental. So the question is, why is that a big deal? What's the big

  • deal? Why does it matter? When we do this we come up with a smaller percentage than

  • if we did it the rental days divided by the total days, the total days used, okay. Because

  • we may have some vacant days. If it's not used every day, we're going to have some vacant

  • days. You're going to come up with a smaller percentage. We like this because what happens

  • is that when I come up with this smaller percentage, okay, then I'm going to have a smaller amount

  • deducted on my Schedule E, okay. So basically when I go through this process, this is a

  • small amount, which lets me take more here, so that if this is smaller, then it's going

  • to allow me to deduct larger utilities and a maintenance amount and maybe get some of

  • that depreciation, okay. If I use the IRS approach, this number is

  • going to be larger, so I'm going to -- I'm going to consume all of this with my taxes

  • and interest, so that means I lose this. The thing about it is, you're going to get

  • the taxes and interest. Either they're going to be on Schedule E or they're going to be

  • on Schedule A. So what this does is it pushes more of those to Schedule E -- I mean, I'm

  • sorry, Schedule A. And what it does, I get a smaller deduction on Schedule E and it pushes

  • more of those expenses, basically moves more of your taxes and interest to Schedule A.

  • Okay. It moves more of those to Schedule A. So that's a bigger benefit. So that's a bigger

  • benefit. So of course the IRS wants you to use their

  • method. We want you to use -- we would like to use the tax court method. We would like

  • to use the tax court method. And on Page 3-4, the last little sentence, it tells us that

  • there's controversy between the tax court decision and the IRS. It hasn't been resolved,

  • okay. So people routinely go take the tax court method and it's held up in court. The

  • IRS would like for us to take the IRS method. But of course we want to get more of those

  • expenses deducted on Schedule A, and that frees up me to be able to end up deducting

  • my other one. So just a real brief review before we move on to the next subject. Rental

  • is taxable either on Schedule E or C. If your home is deemed primarily personal use, meaning

  • I rented it less than 15 days, then it's going to be treated as personal use, or personal,

  • and I'm not going to have to report any rental income and I deduct the mortgage interest

  • and taxes on Schedule A. And that's like a second home, you can take mortgage and interest

  • on a second home. If it's deemed primarily rental use, meaning I rented it more than

  • or equal to 15 days and my personal use did not exceed the greater of 14 days or 10% of

  • the rental, I need to allocate my expenses between rental and personal, either based

  • off the IRS or the tax court method, and the rental portion is going to be on Schedule

  • E. The personal portion I don't end up getting because this is not deemed -- once it's deemed

  • primarily the rental, this is not a second home for me; this is rental property. So I

  • can only deduct that interest and taxes on Schedule A for a second home. So this is not

  • a second home. So that personal use basically is lost. I'm going to lose that. And the good

  • thing about this is, though, I can end up deducting a rental loss on Schedule E because

  • it's a business and they're going to let me take that loss.

  • Okay. Next, if we deem the property to be a rental/personal split. If we deem it to

  • be a rental/personal split, that means I rented it for more than or equal to 15 days, and

  • the personal use exceeds greater of 14 days or 10% of the rental, and I'm going to still

  • allocate between rental and personal, once again using the tax court method or the IRS

  • method. And the one thing here is that there's no loss allowed. So if you have more expenses

  • than income, you deduct your expenses in this order, first deducting taxes and interest,

  • utilities and maintenance, and then depreciation, up until the income that you have. The personal

  • portion of your mortgage and interest, because now this is deemed as a second home, then

  • is going to be deductible on Schedule A. It's going to be deductible on Schedule A.

  • So that is your rental property. That's your rental property.

  • Okay. Let's move on. Still kind of dealing with this is passive activity losses. And

  • they call them PALS. Passive activity losses. We pick that up at the bottom of Page 3-4,

  • okay. So the question is, we initially talked about passive versus active income versus

  • portfolio income. So when we're looking at passive losses, we're going to be concerned

  • about our passive income. We want to be concerned about our passive income. Passive activity

  • losses, basically we're dealing with passive losses, is what we're looking at, okay. Passive

  • losses may not be used to offset active income. So basically I can't use a passive loss to

  • offset my salary. Salary is considered active income. So I cannot use a passive loss to

  • offset my salary because it is active income. Okay. So the question is, what is basically

  • a passive loss? These are ventures that a taxpayer is involved in, but they're not actively.

  • So a taxpayer is not -- they may just be an investor, they're not actively involved. So

  • they have a passive role. So if that venture generates a loss, that's considered a passive

  • loss. Okay. Losses, passive losses can only offset passive

  • income. Okay. So if I have a passive loss, I have to be able to have a passive income

  • in order to get it to offset it, okay. Any excess losses, because I don't have enough

  • income to take all my losses, any excess losses are carried forward. So any excess losses

  • are carried forward or I can deduct them when I sell the investment, because maybe it never

  • generates any income. So I will just hold on to those losses until I sell the investment.

  • Okay. So that's a brief overview of passive losses. They do -- they are a lot more detailed

  • than that, but I just kind of want to briefly cover them.

  • Now, on Page 3-7, they talk about real estate rental, which we just talked about rental

  • activity. They consider the rental of real estate a passive activity. Okay. So we just

  • talked about rental and, you know, the deductions of losses, so they consider real estate rental

  • a passive activity. So the question is, now do I have to follow these passive loss rules?

  • Well, there's some special rules for rental. There's some special rules for rental and

  • then they even determine what's considered a trade or business, meaning I'm in the business.

  • That's what I do. I rent out real estate, that's all I do. Or is it truly a passive

  • activity for me? Is it truly passive activity for me? If you look at the bottom of Page

  • 3-7, taxpayers who are heavily involved in estate or rental activities, they may be able

  • to qualify theirs as a trade or a business rather than as a passive activity. So if you

  • are heavily involved and that's your business, that's what you do, then you're saying, well,

  • that's not a passive activity for me, I'm actively. So that income and losses from that

  • activity won't have to meet these passive loss limitations.

  • In order for you to say that you're actively involved and that they're not passive, so

  • in order for you to say -- let's put this in parentheses, that they're not passive,

  • then you want to meet those requirements that's on Page 3-7. And it says that more than 50%

  • of the individual's personal service during the tax year is performed in the real property

  • trade or business. So more than 50% of what you do is in this trade or business.

  • And then number 2, that the individual performs more than 750 hours of service in the real

  • property trade or business in which he or she claims material participation. So the

  • taxpayer must materially participate in the activity. To satisfy that, it has to be more

  • than 50%. And then the individual performs more than 750 hours, okay.

  • So that's very important. Income from passive investments, so in that case it's not passive,

  • I can take it as a trade or a business. It's not an issue, I get to take the deduction.

  • Any loss, it's not considered passive, okay. For real estate, just real briefly, for real

  • estate property that's considered passive, they have allowed you to take a deduction.

  • You may deduct up to 25,000 of losses against other income. So even though they're going

  • to deem it to be passive, they do allow you to take a $25,000 loss.

  • Now, if you are a high income taxpayer, you may lose some of that loss. You may lose some

  • of that loss. So keep that in mind. And then, once again, like I said, if it's not passive,

  • then there's no loss limitations and just long as you meet those requirements, you should

  • be well okay. Okay. So if the real estate is -- the real

  • estate rental equals a trade or a business, meaning it's not passive and you've met those

  • rules, then you have no loss limitations and it's not considered passive. So you just want

  • to make sure you follow those rules that's on Page 3-7.

  • Okay. Let's move on to your bad debts. Move on to your bad debts that's on Page 3-8. Your

  • bad debts. Okay. For instance, if we're talking businesses

  • and we're talking bad debts, these are the situations we're probably kind of talking

  • about is when you have uncollectible accounts receivables, okay. So if we have uncollectible

  • accounts receivable, then we have a deduction, our deduction is going to be limited to what

  • we previously included in income. What we previously included in income. And the example

  • is, it's just let's say that I have a sale and let's say I have, I don't know, $50,000

  • worth of income versus sales and I report that, and of those $50,000 worth of sales,

  • I have 20,000 that's our accounts receivable. I report the 50,000 and I show the 20,000

  • as accounts receivable. If 3,000 of those accounts receivable become uncollectible,

  • because I've reported the income piece to it, then I can deduct it. Now, if you are

  • a cash basis taxpayer, okay, if you are a cash basis taxpayer, meaning that you're not

  • going to report your income until you receive it, so even though you have an account receivable,

  • you never report it until you receive it as income. So, therefore, since it never was

  • reported as income, it is not a bad debt; you cannot take a bad debt. So cash basis

  • taxpayer are not allowed the bad debt. And that's because it was never included in income

  • if you are a cash basis taxpayer, because cash basis, they're going to report their

  • income when they receive it, not when it's earned. Okay.

  • And so with these bad debts, you want to -- you can take the deduction. You want to use the

  • specific charge-off method to do so, as you take these bad debts. Okay. And so

  • basically you want to deduct them as they become partially or completely worthless.

  • Okay. So basically it gives you a benefit that,

  • you know, I had this income, I reported my income, I never got it. It's not fair because

  • I paid taxes on it. So, therefore, you can take a bad debt deduction for those uncollectible

  • accounts receivable just as long as you've included them in your income. Okay.

  • So now if we have the business versus the non-business portion of that, the business

  • versus the non-business portion of that. The business, okay, the business portion of that

  • is any debt from a trade or business, okay. And so when we're talking about a debt from

  • a trade or business, similar to what we were talking about up here, this is a ordinary

  • deduction. It's an ordinary deduction. And you can take it against ordinary income. So it gets to offset -- this

  • bad debt, it's going to get to offset ordinary income and basically is going to appear on

  • Schedule C. It's going to appear on Schedule C, okay.

  • So what we'll do is in our next session we'll start with our non-business bad debts and

  • talk about those, and then we will probably have enough time to finish up Chapter 3. So

  • we will look at business -- continue to look at business expenses, and then we will look

  • at retirements, if we have some time. So that's the end of this session. Make sure

  • you're looking through Chapter 3. We finished up 2, so you need to make sure you do your

  • multiple choice questions for Chapter 2 and get those sent to me. So that's it until our

  • next session. (Music.)

Okay. We ended up last, in our last session looking at the Social Security benefits and

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