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Tax Issues for Jane Smith - Mortgages and Income

Jane Smith
I think that the fees would be better used for paying off our house and buying a new, bigger house that I've had my eye on. Does it make better tax sense for us to pay off the mortgage, sell the house, and buy a new house, or should we just use the money to buy the new house after selling the old house?

Also, I sell handcrafted jewelry which earned me $20,000 last year. Do my business activities constitute a trade or business for federal income tax purposes? Or, is this just a hobby? Should I establish a separate trade or business to get tax benefits on these earnings? Does it make any difference that I use my car primarily for transporting my jewelry to different shops around town? Finally, I think I can earn more money if John were willing to invest $15,000 for new jewelry making equipment since my original equipment, which cost $10,000 five years ago, is almost obsolete. Does this make sense from a tax perspective?

Jane Smith tax issues:
a. What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for Federal income tax purposes?
b. Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John's case?
c. Does Jane have a business or hobby? Why is this distinction important?
d. Would Jane (and John) realize better tax benefits if she had a separate business for her jewelry making activities?
e. What tax benefits would John realize if he invested $15,000 in Jane's jewelry making?
f. Can Jane depreciate her vehicle or jewelry making equipment? How?

Solution Preview

a. What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for Federal income tax purposes?

The differences only relate to the amount of deductible mortgage interest paid during a year. Since both are deductible and both are the same type of debt, there is only a calculation of the amount of interest times the tax rate of the taxpayers. There is one exception: mortgage interest is limited to $1,000,000 of deduction.

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

No, Section 1031 exchanges are only used for business assets, not personal residences. The money for a new house is not a taxable event in itself, but it will have been taxed at the ...

Solution Summary

In 549 words, each question is answered with a few sentences including explanations for application of the Internal Revenue Code.

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