Week 4 – You Decide

John Smith tax issues:

a. How is the $300,000 treated for purposes of Federal tax income?

The $300,000 that John received for services rendered from the court case is considered earned income for the year. The $300,000 is earned income for John Smith and will be reported as gross income either on Schedule C of the individual return or as gross income on the LLC return. “US code defines gross income in 26 U.S.C § 61 states except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items.” …show more content…

I would have to say in this case that it would be better to sell the existing home without paying off the balance and then purchasing the new home. If the current home was paid off then they couldn’t deduct the mortgage interest. If the current home was paid off and they didn’t immediately purchase a new home then they would be losing the opportunity to deduct the interest during the time between paying off the current home and purchasing the new home. The one thing that Jane needs to keep in mind is that mortgage interest can be deducted up to $1,000,000 for couples filing together and $500,000 for single filers.

b. Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John's case?

A 1031 exchange is a great way for a tax payer to reduce his/her taxable income. There are a lot of rules when it comes to performing a 1031 exchange. The basic concept is an investor can sell a real estate investment, take the initial investment and the capital gains and purchase another real estate investment within a certain amount of time and not have to pay taxes on the capital gains. The only problem that Jane and John have is that “to qualify for Section 1031 of the Internal Revenue Code, the properties exchanged must be held for productive use in a