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    Mortgage interest & donations in Japan, basis of accounting

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    Research guestions

    For questions #1 - #3, you should consider yourself as the tax professional. A client has come to you with the situation described. You should then advise the client on how best to proceed. For questions #1 - #3, I anticipate that you should be able to successfully complete the research by referring to relevant IRS publications.
    The correct solution to each of the questions requires more than a one sentence answer. You need to explain to Mr. C what you found in your research and why his course of action is or is not advisable.
    1) Mr. A is a U.S. Government Employee assigned to support the US Navy in Japan. In 2009, Mr. A earned $60,000 and received a $35,000 tax-free housing allowance. Mr. A is single and has no children.
    On January 1, 2009, Mr. A bought a traditional Japanese home on the slopes of Mt. Fuji which he uses as his primary residence. (All relevant figures have been converted from Yen to Dollars.)

    The property cost $500,000.
    Mr. A's expenses associated with the home in 2009 were:
    Mortgage principal: $4,000
    Mortgage interest: $30,000
    Real estate taxes: $0 (would have been $3,000, but Mr. A is exempt under relevant SOFA statutes)
    Utility costs: $2,500

    Mr. A plans to file a Schedule A with his tax return and deduct the $33,000 in mortgage interest and taxes. What do you think about Mr. A's plan?

    2) Coincidentally, Mr. A's close friend Reverend B, bought an identical property on January 1, 2009. The facts regarding Reverend B's property are identical to those for Mr. A's. How would you advise Reverend B in the question of the mortgage interest and property tax deductions on his schedule A?

    3) Mr. C attends Reverend B's church in Japan. He donated $25,000 (again, converted from Yen to Dollars) to the church during 2009. Mr. C plans to file a Schedule A with his tax return and deduct the $25,000 in charitable contributions. What do you think about Mr. C's plan?

    4) Ms. D, an avid New York Yankees fan, was discussing the situation in the American League with her friend Mr. E, who supports the Cleveland Indians.

    Ms. D said -- "As well as having a terrible team last year, I heard that the U. S. Supreme Court had ruled against the Cleveland Indians sometime in the last five years. The Court ruled that they could not use accrual accounting, and that they had to do all their accounting on a cash basis."

    Mr. E, who had taken ACCT 220 with UMUC, did not think that this could be correct. He replied -- "GAAP requires the use of accrual accounting. I don't see how or why the Supreme Court would require otherwise."

    Please help out Ms. D and Mr. E by explaining the facts of the case, the ruling of the court, the reasoning of the court in making its decision, and the relationship of the case to the broader issue of cash versus accrual accounting.

    Note: Ms. D was incorrect about the timing of the case involving the Cleveland Indians. The relevant Supreme Court decision did not occur within the last five years -- but it did occur within the last 10 years.

    For #5 and #6, explain your reasoning based on your research

    5) Peter Nelson is employed full time as an accountant by an insurance company. In his spare time, he operates a secondary business as a self-employed wedding photographer. On January 3, 2009, Peter purchased new video recording equipment for $22,600. During 2009, he used this equipment for personal enjoyment (filming his family members on holidays and during vacations). He also used the equipment for business purposes when a client wanted video coverage of a wedding. Peter did not purchase any other property for business use during the year. Peter kept a careful written record of the time that he used the video recording equipment for either personal or business reasons during 2009. This record substantiates that he used the equipment 59 percent of the time for personal reasons and 41 percent of the time for business reasons. Can Peter elect to expense any of the cost of the video recording equipment under Section 179?

    6) Tim Loker is the five-year-old godson of Mr. and Mrs. Bryant. Tim's parents died in an accident on December 18 of last year. Tim was seriously injured in the accident and remained hospitalized until August 12 of this year. After his discharge from the hospital, Tim moved into the Bryants' home. The Bryants have provided 100 percent of Tim's financial support since the accident and intend to raise him as their own child. Can the Bryants claim Tim as a dependent on this year's tax return?

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    Solution Preview

    Please see attached file for answers.

    Case #1
    First, in order for a taxpayer to be able to deduct the mortgage interest, all the following requirements must be met. These requirements are stated In Publication 936 of the IRS:
    1. Form 1040 must be filed and deductions be itemized on Schedule A
    2. The taxpayer must be legally liable for the mortgage
    3. The mortgage must be a secured debt on a qualified home
    In the case of Mr. A, the mortgage is a secured debt and the house in Mt. Fiji, his primary residence, is considered as a qualified home.

    For the interest to be fully deductible, the total mortgage balances should be $1,000,000 or less. In Mr. A's case, his mortgage balance was less than $1,000,000 at all times during the year, hence the home mortgage interest of $30,000 is fully deductible. Again, to claim this Mr. A has to itemize deductions on Schedule A.

    Lastly, he can't claim the $3,000 real estate taxes since he didn't pay for it. No one can claim deductions for something that was not paid out. In Mr. A's case, the $35,000 tax-free housing allowance he received does not preclude him from deducting the home mortgage ...

    Solution Summary

    Mortgage interests and donations in Japan are examined as a tax professional.