Problem: Mr. Adams is asking if he will be required to pay capital gains taxes. Given is the information regarding his family and his income. Prepare a memo to Mr. Adams explaining what capital gains and losses are, what the requirements are for reporting capital gains and losses, and detailing whether or not he will be required to pay capital gains taxes.
Information:
Information for 2007:
The Adams family consists of the following:
James M. Adams, age 46, SSN 222-22-2345, Computer Consultant
Diane J. Adams, age 44, SSN 333-33-4567, Customer Service Rep
Elaine Adams, age 20, SSN 456-78-9012, daughter and full-time student
Susan Adams, age 19, SSN 567-89-0123, daughter living at home, graduated from high school May 2007, will be attending college in 2007.
Brandon Adams, age 13, SSN 678-90-1234, son in the eighth grade
They live at 505 Pleasant Valley Lane, Chicago, IL 75839.
They do not want to contribute any money to the presidential election campaign.
The Adams will be filing as married filing jointly.
Dependents:
Elaine Adams:
Elaine is a full-time student at an Arizona university. James & Diane pay all her expenses. As a sophomore, James and Diane pay $6,600 for her tuition.
Susan Adams:
Susan is 19 years old and lives with James and Diane who pay all her expenses. She will attend a community college this spring semester.
Brandon Adams:
At 13 years old, Brandon lives at home all year. James & Diane pay all his expenses.
Income
Diane had the following earnings on her W-2:
• wages $38,550 and federal income tax withheld $4,540
• Social Security wages $38,550 and Social Security tax withheld $2,390
• Medicare wages $38,550 and Medicare tax withheld $559
• $2,427 deducted for state income tax
Diane is covered by a 401K plan, and she contributed $1,427 to her 401K.
Their $424 interest income was from Merchants Bank and $1,576 from Downtown Bank ($345 from U.S. Government investments and $1,231 from a CD that was cashed early incurring an early withdrawal penalty of $150).
They also received $3,546 in dividends from Jones Brokerage Company. $452 of the dividends was Qualified Dividends. During the year, James sold 200 shares of Finnigan, Inc.’s stock, which he purchased on 6/1/04 for $2,000 and sold on 8/1/2007 for $2,554.
James received a 1099-R for a total distribution from a pension plan he had with a previous employer. The amount received was $15,000. The taxable amount was $15,000, and $3,000 in federal tax was withheld.
Assets:
Computer Consulting:
James owns a computer consulting business as a sole proprietor and runs from an office in their home. The total square footage of their house is 2,800 and James’s office is 800 square feet. His 2007 revenue was $90,000. On 6/1/02, James purchased a 2002 Audi to use in computer consulting business. Total miles driven in the car for 2007 was 12,000 with 2,000 miles for personal use and 10,000 miles for computer consulting related activity. He paid $342 for parking and tolls while on business activity. There were no commuting miles as he works out of his house.
On June 1, 2007, he purchased a laptop computer for $1,800 that he uses 100% for business and a desktop computer and printer for $1,700 that he uses 85% for business.
Other business expenses for which James has receipts are as follows:
• advertising $530
• insurance $1200
• interest $262
• office expense $1286
• equipment rental $252
• repairs and maintenance $189
• travel and entertainment $4,356
• computer software $3,580
• books and seminars $1,500
• dues and subscriptions $500
• postage $291
• telephone $940
• Internet $480
On 1/1/2007, James sold a computer that he purchased on 6/1/2003. The purchase price was $4,500, and the depreciation allowed was $3,722. He sold the computer for $500. This is section 1245 property.
Investment Properties:
James owns investment property in Owensboro, Kentucky, and Jamessonville, Florida.
The property is Owensboro is a single family home that he rents. He has an active role in the rental of the property. James has the following information:
• rental income $25,200
• advertising $100
• cleaning & maintenance $488
• insurance $1265
• legal $125
• mortgage interest $2,955
• repairs $310
• supplies $385
• taxes $2,004
James purchased the property on 6/1/1995. The cost of the home was $250,000 ($50,000 was the cost of the land), and prior depreciation is $83,000. On 6/1/2000, he had a new roof added for $10,000, and prior depreciation is $3,500. From previous years, there was a $1,000 un-allowed loss.
On 6/1/2000, James purchased a condo in Jamessonville for $310,000. James does not materially participate in the rental of the condo and has a management company oversee the condo operation.
• rental income was $27,375
• advertising $200
• travel $2,050
• cleaning and maintenance $1,200
• insurance $1,655
• management fees $2,400
• mortgage interest $4,444
• supplies $200
• taxes $3,808
Depreciation taken on the condo in prior years was $18,010. From 2003, there was a $2,000 un-allowed loss.
K-1
James’s other investments are reported to him on a K-1. He is a partner in Simms Graphics Inc., which had active income of $12,005 and section 179 expense of $1,500. He is also a shareholder in MAN Computer Design Company, which is an S corporation. He had passive income of $1,555.
401K
James made a contribution of $2,500 to his IRA even though Diane had an employer retirement plan.
Other Data
James had gambling winnings of $5,500 and Diane had $1,600. Their combined losses were $2,750.
James and Diane paid $500,000 (the land was appraised at $120,000) for their home in May, 2005. Real estate taxes on James and Diane’s residence were $3,766, and mortgage interest was $8,018. Utilities for the year totaled $1,800
Cash gifts to church were $1,470, and they contributed clothing and furniture to the Salvation Army with a cost of $4,500 and a fair market value of $1,200.
Healthcare expenses are as follows: $3,900 for self-employed health insurance for James, Diane, Elaine, and Brandon; $1,766 for payments to doctors; $800 for payments to dentists; and $225 for medical aids.