cch federal taxation basic principles chapter 8 deductions: itemized deductions ©2003, cch...
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CCH Federal TaxationBasic Principles
Chapter 8Deductions:
Itemized Deductions
©2003, CCH INCORPORATED4025 W. Peterson Ave.Chicago, IL 60646-6085800 248 3248http://tax.cchgroup.com
CCH Federal Taxation Basic Principles 2 of 23
Chapter 8 Exhibits 1. Medical Expenses
2. Medical Care
3. Medical Transportation and Lodging
4. Medical Insurance Premiums
5. Qualified Residence Defined
6. Qualified Residence Debt—Limitations
7. Qualified Residence Debt—Prorating Interest
8. Prorating Principal Residence Interest—Example
9. Methods of Prorating Principal Residence Interest—Solution
10. Charitable Deductions
11. Charitable Deduction Without Category 3 Election—Example
12. Charitable Deduction With Category 3 Election—Example
Chapter 8, Exhibit Contents
CCH Federal Taxation Basic Principles 3 of 23
Medical Expenses
Deductible medical expenses include medical care, medical transportation and lodging, and health insurance premiums.
Chapter 8, Exhibit 1
CCH Federal Taxation Basic Principles 4 of 23
Medical Care
The diagnosis, cure, mitigation, treatment, or prevention of disease, or
To affect any structure or function of the
body
Chapter 8, Exhibit 2a
CCH Federal Taxation Basic Principles 5 of 23
Inpatient hospital care. Includes meals and lodging. Meals consumed by patients during hospital stays are not subject to the 50% exclusion.
Medicines and drugs. All require a prescription.
Medical Care
Chapter 8, Exhibit 2b
CCH Federal Taxation Basic Principles 6 of 23
Capital expenditures—general. Capital expenditures may qualify for an immediate medical deduction (subject to the 7.5% floor) if prescribed by a physician to alleviate a physical or mental defect or illness. Examples:
Seeing Eye dogs Wheelchairs Eyeglasses
Medical Care
Chapter 8, Exhibit 2c
CCH Federal Taxation Basic Principles 7 of 23
Capital expenditures—home improvements. Qualified expenditures for home improvements and additions may be deductible to the extent that their costs exceed any increase in the fair market value of the existing structure. Examples:
Adding wheelchair ramps Widening doorways to create wheelchair access Adding a swimming pool prescribed by a physician to
alleviate some ailment such as partial paralysis Installing an elevator to provide handicap access
between floors
Medical Care
Chapter 8, Exhibit 2d
CCH Federal Taxation Basic Principles 8 of 23
Medical Transportation and Lodging
Mileage. If mileage was primarily for and essential to medical care, the taxpayer may choose between
the standard mileage allowance of 12 cents per mile (for year 2003), plus parking and tolls, or
actual expenditures.
Chapter 8, Exhibit 3a
CCH Federal Taxation Basic Principles 9 of 23
Medical Transportation and Lodging
Meals during medical-related travel. Meals consumed during medical-related transportation are NOT deductible even if the transportation is primarily for and essential to the rendition of medical care.
Chapter 8, Exhibit 3b
CCH Federal Taxation Basic Principles 10 of 23
Medical Transportation and Lodging
Lodging during travel—nondiscretionary. A medical expense deduction is allowed for lodging (but not meals) while away from home primarily for and essential to medical care. This lodging deduction is limited to amounts that are not lavish or extravagant and cannot exceed $50 per night for each individual. (Code Sec. 213(d)(2).) The deduction may also be claimed for a person who must accompany the individual seeking medical care.
Examples: Lodging during away-from-home travel and Out-of-town lodging incurred by a friend or relative while
the patient is in the hospital
Chapter 8, Exhibit 3c
CCH Federal Taxation Basic Principles 11 of 23
Medical Transportation and Lodging
Lodging during travel—discretionary. If a doctor prescribes an operation or other medical care and the taxpayer chooses, purely for personal considerations, to travel to an out-of-town locality for medical treatment, the lodging is not deductible.
Chapter 8, Exhibit 3d
CCH Federal Taxation Basic Principles 12 of 23
Medical Insurance Premiums
For 2003, self-employed persons may deduct
100% of medical insurance premiums “FOR” AGI
Chapter 8, Exhibit 4
CCH Federal Taxation Basic Principles 13 of 23
Qualified Residence Defined
A principal residence and Any second residence that is for personal use
Unusual principal residences. A qualified principal residence may include a houseboat trailer, airplane, automobile, or mobile home, if it has kitchen and
bathroom facilities.
Chapter 8, Exhibit 5
CCH Federal Taxation Basic Principles 14 of 23
Qualified Residence Debt—Limitations
For acquisition loans, qualified residence debt is the least of the following four amounts: 1. Adjusted purchase price as of the end of the tax year
2. Average loan balance (a lesser amount than the original acquisition loan if a refinancing has occurred)
3. Fair market value of the residence on the date of the acquisition loan
4. $1 million
Chapter 8, Exhibit 6a
CCH Federal Taxation Basic Principles 15 of 23
Qualified Residence Debt—Limitations
For home equity loans, the limitation is the lesser of thefollowing two amounts:
1. Either The lesser of the adjusted purchase price as of the end of the tax year or the fair market value of the house on the date of the home equity loan minus the average balance of the ACQUISITION LOAN
2. $100,000
Chapter 8, Exhibit 6b
CCH Federal Taxation Basic Principles 16 of 23
Qualified Residence Debt—Prorating Interest
Reg. §1.163-10T(d) and (e) provides two methods forprorating interest between qualified and excess debt:
1. The simplified method prorates the combined amount of
interest on the acquisition and home equity loans.
2. The exact method prorates interest on the acquisition loan, then prorates interest on the home equity loan.
Any interest remaining after prorating deductible interest isconsidered nondeductible consumer interest.
Chapter 8, Exhibit 7
CCH Federal Taxation Basic Principles 17 of 23
Prorating Principal Residence Interest – Example
FACTS:
On December 31, 200X, the adjusted purchase price of Roger’s principal residence is $105,000. Roger has two debts secured by the residence. The beginning and ending balances and interest payments on each debt during 200X and the fair market value of the residence on the date each debt was secured are as follows:
Type of Debt Date of Debt
FMV on Date of Debt
01/01/0X Loan
Balance
12/31/0X Loan
Balance
200X Interest
Paid
Acquisition Loan June 1995 $ 95,000 $82,000 $78,000 $8,000
Home Equity Loan May 1999 $140,000 $41,000 $39,000 $4,800
QUESTION: Determine the amount of deductible and nondeductible interest under the simplified and exact methods of Reg. §1.163-10T(d) and (e).
Chapter 8, Exhibit 8
CCH Federal Taxation Basic Principles 18 of 23
Simplified Method of Prorating Interest – Solution(a) Interest paid on acquisition loan $ 8,000
(b) Interest paid on home equity loan 4,800
(c) = (a) + (b) Total interest paid during the tax year 12,800
(d) Adjusted purchase price at end of tax year 105,000
(e) = Lesser of: Average balance of original loan or $1,000,000
Average balance of qualified acquisition loan amount for the tax year. [(82,000 + 78,000) 2]
80,000
(f) = Lesser of: Average balance of home equity loan or $100,000
Average balance of qualified home equity loan amount for the tax year. [(41,000 + 39,000) 2]
40,000
(g) = (e) + (f) Combined average balances 120,000
(h) = [Lesser of (d) or (g)] (g)
Portion of interest paid that is deductible[(Lesser of $105,000 or $120,000) $120,000]
87.5%
(i) = (c) x (h) Deductible interest 11,200
(j) = (c) - (i) Nondeductible personal interest $ 1,600Chapter 8, Exhibit 9a
CCH Federal Taxation Basic Principles 19 of 23
(k) FMV of house on date of acquisition loan $ 95,000
(l) FMV on date of home equity loan 140,000
(m) = Least of: (d) (e) (k), or $1,000,000
Limit on acquisition loan. The least of: (d) = $105,000 adjusted purchase price, (e) = $80,000 average balance of acquisition loan (k) = $95,000 FMV on date of acquisition loan $1,000,000
80,000
(n) = (m) (e) Portion of interest on acquisition loan that is deductible ($80,000 limit $80,000 average loan)
100%
(o) = (a) x (n) Deductible interest on acquisition loan ($8,000 x 100%) 8,000
(p) = Lesser of [Lesser of (d) or (l)] - (e) $100,000
Limit on home equity loan. The lesser of: The lesser of:
(d) = $105,000 adjusted purchase price or
(l) = $140,000 FMV on date of home equity loan minus
(e) = $80,000 average balance of acquisition loan $100,000
25,000
(q) = (p) (f) Portion of interest on home equity loan that is deductible
($25,000 limit $40,000 average loan)
62.5%
(r) = (b) x (q) Deductible interest on home equity loan ($4,800 x 62.5%) 3,000
(s) = (b) – (r) Nondeductible “personal” interest ($4,800 - $3,000) $ 1,800
Exact Method of Prorating Interest – Solution
Chapter 8, Exhibit 9b
CCH Federal Taxation Basic Principles 20 of 23
Charitable DeductionsCategory Charity Property Valuation Deduction Limit
1 Public O.I. Basis 50% AGI
2 Private O.I. Basis Lesser of: 30% AGI, LESS: category 3 contribution value before limitation or 50% AGI, LESS: category 1 and 3 contribution value before limitation
3 Public Long-term Capital Gain
(LTCG)
Fair Market Value (FMV)
Lesser of: 30% AGI or 50% AGI, LESS: category 1 and 2 deductions
Special Category 3 election: Basis 50% AGI, LESS: category 1 and 2 deductions
4 Private Long-term Capital Gain
(LTCG)
Lesser of: Basis FMV
Least value of the following: 20% AGI 30% AGI, LESS: category 3 deductions 50% AGI, LESS: category 1, 2, and 3 deductions
Special treatment for qualified appreciated stock (i.e., stock traded publicly that has appreciated in value)
FMV (no need to use the lower basis)
(Same as above)
Contributions that exceed deduction limitations can be carried forward up to 5 years.
Chapter 8, Exhibit 10
CCH Federal Taxation Basic Principles 21 of 23
Charitable Deduction Without Category 3 Election—Example 1Facts: AGI = $40,000, and the following charitable contributions were made:
Charity Property Amount
Frick Museum (private) Cash $10,000
Church (public) Cash 3,500
Boy Scouts (public) Cash 500
United Way (public) Cash 1,000
State University (public) Stock (held long-term) Basis: $1,000; FMV: $11,000
Determine the amount of charitable deductions without the special category 3 election.
Solution
Category Contribution Valuation Limitation Deduction Carryover
1 $ 5,000 ($1,000 + $3,500 + $500)
50% x $40,000 = $20,000 $5,000 $0
2 $10,000 Lesser of: (30% x $40,000) - $11,000 = $1,000 50% x $40,000 - ($5,000 + $11,000) = $4,000
The lesser amount is 1,000.
1,000 9,000
3 $11,000 Lesser of: 30% x $40,000 = $12,000 50% x $40,000 - ($5,000 +$1,000) = $14,000
The lesser amount is $12,000.
11,000 0
Totals $17,000 $ 9,000Chapter 8, Exhibit 11
CCH Federal Taxation Basic Principles 22 of 23
Charitable Deduction With Category 3 Election—Example 2
Charity
Frick Museum (private)
Church (public)
Boy Scouts (public)
United Way (public)
State University (public)
Property
Cash
Cash
Cash
Cash
Stock (held long-term)
Amount
$10,000
3,500
500
1,000
Basis: $1,000; FMV: $11,000
Facts: AGI = $40,000, and the following charitable contributions were made:
Determine the amount of charitable deductions with the special category 3 election.
Chapter 8, Exhibit 12a
CCH Federal Taxation Basic Principles 23 of 23
Charitable Deduction With Category 3 Election—Example 2
Chapter 8, Exhibit 12b
Category
1
2
3
Contribution Valuation
$5,000 ($1,000 + $3,500 + $500)
$10,000
$1,000 (using basis rather than FMV, with election)
Limitation
50% x $40,000 = $20,000
Lesser of:(30% x $40,000) – $1,000 =
$11,000
50% x $40,000 – ($5,000 + $11,000) = $14,000 The lesser amount is $11,000.
50% x $40,000 – ($5,000 + $10,000) = $5,000
Deduction
$5,000
10,000
1,000
$16,000
Carryover
0
0
0
0
Solution
Totals
Observations:1. A category three election requires recomputing the limitations for categories two and four! 2. The category three election usually is not favorable if the basis of the long-term capital gain property is substantially lower than its FMV.