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Tax Forms 1040ez

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Tax Forms 1040ez

Tax forms 1040ez 4. Tax forms 1040ez   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Tax forms 1040ez Payments from checking accounts. Tax forms 1040ez Amounts paid within 30 days. Tax forms 1040ez Optional method for determining date of reallocation. Tax forms 1040ez Interest on a segregated account. Tax forms 1040ez How to report. Tax forms 1040ez Interest You Can DeductStatement. Tax forms 1040ez Expenses paid to obtain a mortgage. Tax forms 1040ez Prepayment penalty. Tax forms 1040ez De minimis OID. Tax forms 1040ez Constant-yield method. Tax forms 1040ez Loan or mortgage ends. Tax forms 1040ez Interest You Cannot DeductPenalties. Tax forms 1040ez Who is a key person? Exceptions for pre-June 1997 contracts. Tax forms 1040ez Interest allocated to unborrowed policy cash value. Tax forms 1040ez Capitalization of Interest When To Deduct InterestPrepaid interest. Tax forms 1040ez Discounted loan. Tax forms 1040ez Refunds of interest. Tax forms 1040ez Prepaid interest. Tax forms 1040ez Discounted loan. Tax forms 1040ez Tax deficiency. Tax forms 1040ez Related person. Tax forms 1040ez Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Tax forms 1040ez Introduction This chapter discusses the tax treatment of business interest expense. Tax forms 1040ez Business interest expense is an amount charged for the use of money you borrowed for business activities. Tax forms 1040ez Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Tax forms 1040ez Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Tax forms 1040ez 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Tax forms 1040ez Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Tax forms 1040ez If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Tax forms 1040ez Allocate your interest expense to the following categories. Tax forms 1040ez Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Tax forms 1040ez You allocate loan proceeds by tracing disbursements to specific uses. Tax forms 1040ez The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Tax forms 1040ez Secured loan. Tax forms 1040ez   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Tax forms 1040ez Example. Tax forms 1040ez You secure a loan with property used in your business. Tax forms 1040ez You use the loan proceeds to buy an automobile for personal use. Tax forms 1040ez You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Tax forms 1040ez    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Tax forms 1040ez The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Tax forms 1040ez For more information, see Publication 936. Tax forms 1040ez Allocation period. Tax forms 1040ez   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Tax forms 1040ez The date the loan is repaid. Tax forms 1040ez The date the loan is reallocated to another use. Tax forms 1040ez Proceeds not disbursed to borrower. Tax forms 1040ez   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Tax forms 1040ez This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Tax forms 1040ez Proceeds deposited in borrower's account. Tax forms 1040ez   Treat loan proceeds deposited in an account as property held for investment. Tax forms 1040ez It does not matter whether the account pays interest. Tax forms 1040ez Any interest you pay on the loan is investment interest expense. Tax forms 1040ez If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Tax forms 1040ez Example. Tax forms 1040ez Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Tax forms 1040ez No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Tax forms 1040ez On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Tax forms 1040ez On September 4, Celina uses an additional $40,000 from the account for personal purposes. Tax forms 1040ez Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Tax forms 1040ez From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Tax forms 1040ez From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Tax forms 1040ez Order of funds spent. Tax forms 1040ez   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Tax forms 1040ez Any unborrowed amounts held in the same account. Tax forms 1040ez Any amounts deposited after these loan proceeds. Tax forms 1040ez Example. Tax forms 1040ez On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Tax forms 1040ez The following table shows the transactions in her account during the tax year. Tax forms 1040ez Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Tax forms 1040ez She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Tax forms 1040ez She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Tax forms 1040ez She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Tax forms 1040ez For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Tax forms 1040ez Payments from checking accounts. Tax forms 1040ez   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Tax forms 1040ez You can treat checks written on the same day as written in any order. Tax forms 1040ez Amounts paid within 30 days. Tax forms 1040ez   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Tax forms 1040ez This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Tax forms 1040ez   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Tax forms 1040ez If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Tax forms 1040ez   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Tax forms 1040ez Example. Tax forms 1040ez Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Tax forms 1040ez Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Tax forms 1040ez Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Tax forms 1040ez Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Tax forms 1040ez In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Tax forms 1040ez Optional method for determining date of reallocation. Tax forms 1040ez   You can use the following method to determine the date loan proceeds are reallocated to another use. Tax forms 1040ez You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Tax forms 1040ez The first day of that month. Tax forms 1040ez The date the loan proceeds are deposited in the account. Tax forms 1040ez However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Tax forms 1040ez Interest on a segregated account. Tax forms 1040ez   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Tax forms 1040ez When the interest earned is used up, any remaining payments are from loan proceeds. Tax forms 1040ez Example. Tax forms 1040ez You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Tax forms 1040ez When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Tax forms 1040ez You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Tax forms 1040ez All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Tax forms 1040ez The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Tax forms 1040ez The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Tax forms 1040ez Loan repayment. Tax forms 1040ez   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Tax forms 1040ez Personal use. Tax forms 1040ez Investments and passive activities (other than those included in (3)). Tax forms 1040ez Passive activities in connection with a rental real estate activity in which you actively participate. Tax forms 1040ez Former passive activities. Tax forms 1040ez Trade or business use and expenses for certain low-income housing projects. Tax forms 1040ez Line of credit (continuous borrowings). Tax forms 1040ez   The following rules apply if you have a line of credit or similar arrangement. Tax forms 1040ez Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Tax forms 1040ez Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Tax forms 1040ez Treat these loans as repaid in the order shown on the loan agreement. Tax forms 1040ez Loan refinancing. Tax forms 1040ez   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Tax forms 1040ez Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Tax forms 1040ez Debt-financed distribution. Tax forms 1040ez   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Tax forms 1040ez The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Tax forms 1040ez How to report. Tax forms 1040ez   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Tax forms 1040ez If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Tax forms 1040ez If the proceeds were used in an investment activity, enter the interest on Form 4952. Tax forms 1040ez If the proceeds are used for personal purposes, the interest is generally not deductible. Tax forms 1040ez Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Tax forms 1040ez Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Tax forms 1040ez It does not matter what type of property secures the loan. Tax forms 1040ez You can deduct interest on a debt only if you meet all the following requirements. Tax forms 1040ez You are legally liable for that debt. Tax forms 1040ez Both you and the lender intend that the debt be repaid. Tax forms 1040ez You and the lender have a true debtor-creditor relationship. Tax forms 1040ez Partial liability. Tax forms 1040ez   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Tax forms 1040ez Example. Tax forms 1040ez You and your brother borrow money. Tax forms 1040ez You are liable for 50% of the note. Tax forms 1040ez You use your half of the loan in your business, and you make one-half of the loan payments. Tax forms 1040ez You can deduct your half of the total interest payments as a business deduction. Tax forms 1040ez Mortgage. Tax forms 1040ez   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Tax forms 1040ez However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Tax forms 1040ez Statement. Tax forms 1040ez   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Tax forms 1040ez You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Tax forms 1040ez A governmental unit is a person for purposes of furnishing the statement. Tax forms 1040ez   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Tax forms 1040ez You cannot deduct this amount. Tax forms 1040ez For information on how to report this refund, see Refunds of interest, later in this chapter. Tax forms 1040ez Expenses paid to obtain a mortgage. Tax forms 1040ez   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Tax forms 1040ez These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Tax forms 1040ez If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Tax forms 1040ez Prepayment penalty. Tax forms 1040ez   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Tax forms 1040ez Interest on employment tax deficiency. Tax forms 1040ez   Interest charged on employment taxes assessed on your business is deductible. Tax forms 1040ez Original issue discount (OID). Tax forms 1040ez   OID is a form of interest. Tax forms 1040ez A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Tax forms 1040ez The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Tax forms 1040ez   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Tax forms 1040ez Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Tax forms 1040ez You generally deduct OID over the term of the loan. Tax forms 1040ez Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Tax forms 1040ez De minimis OID. Tax forms 1040ez   The OID is de minimis if it is less than one-fourth of 1% (. Tax forms 1040ez 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Tax forms 1040ez   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Tax forms 1040ez On a constant-yield basis over the term of the loan. Tax forms 1040ez On a straight-line basis over the term of the loan. Tax forms 1040ez In proportion to stated interest payments. Tax forms 1040ez In its entirety at maturity of the loan. Tax forms 1040ez You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Tax forms 1040ez Example. Tax forms 1040ez On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Tax forms 1040ez The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Tax forms 1040ez Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Tax forms 1040ez The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Tax forms 1040ez 0025 × 10). Tax forms 1040ez You choose to deduct the OID on a straight-line basis over the term of the loan. Tax forms 1040ez Beginning in 2013, you can deduct $150 each year for 10 years. Tax forms 1040ez Constant-yield method. Tax forms 1040ez   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Tax forms 1040ez You figure your deduction for the first year using the following steps. Tax forms 1040ez Determine the issue price of the loan. Tax forms 1040ez Generally, this equals the proceeds of the loan. Tax forms 1040ez If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Tax forms 1040ez Multiply the result in (1) by the yield to maturity. Tax forms 1040ez Subtract any qualified stated interest payments from the result in (2). Tax forms 1040ez This is the OID you can deduct in the first year. Tax forms 1040ez   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Tax forms 1040ez To get the adjusted issue price, add to the issue price any OID previously deducted. Tax forms 1040ez Then follow steps (2) and (3) above. Tax forms 1040ez   The yield to maturity is generally shown in the literature you receive from your lender. Tax forms 1040ez If you do not have this information, consult your lender or tax advisor. Tax forms 1040ez In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Tax forms 1040ez Example. Tax forms 1040ez The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Tax forms 1040ez The yield to maturity on your loan is 10. Tax forms 1040ez 2467%, compounded annually. Tax forms 1040ez For 2013, you can deduct $93 [($98,500 × . Tax forms 1040ez 102467) − $10,000]. Tax forms 1040ez For 2014, you can deduct $103 [($98,593 × . Tax forms 1040ez 102467) − $10,000]. Tax forms 1040ez Loan or mortgage ends. Tax forms 1040ez   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Tax forms 1040ez A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Tax forms 1040ez If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Tax forms 1040ez See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Tax forms 1040ez Points. Tax forms 1040ez   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Tax forms 1040ez These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Tax forms 1040ez If any of these charges (points) are solely for the use of money, they are interest. Tax forms 1040ez   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Tax forms 1040ez However, you can choose to fully deduct points in the year paid if you meet certain tests. Tax forms 1040ez For exceptions to the general rule, see Publication 936. Tax forms 1040ez The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Tax forms 1040ez Partial payments on a nontax debt. Tax forms 1040ez   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Tax forms 1040ez You can deduct only the interest. Tax forms 1040ez This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Tax forms 1040ez Installment purchase. Tax forms 1040ez   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Tax forms 1040ez If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Tax forms 1040ez The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Tax forms 1040ez For more information on installment sales and unstated interest, see Publication 537. Tax forms 1040ez Interest You Cannot Deduct Certain interest payments cannot be deducted. Tax forms 1040ez In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Tax forms 1040ez You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Tax forms 1040ez Interest paid with funds borrowed from original lender. Tax forms 1040ez   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Tax forms 1040ez You can deduct the interest expense once you start making payments on the new loan. Tax forms 1040ez   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Tax forms 1040ez All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Tax forms 1040ez Capitalized interest. Tax forms 1040ez   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Tax forms 1040ez See Capitalization of Interest, later. Tax forms 1040ez In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Tax forms 1040ez Add this interest to the basis of the property. Tax forms 1040ez Commitment fees or standby charges. Tax forms 1040ez   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Tax forms 1040ez You may be able to deduct them as business expenses. Tax forms 1040ez   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Tax forms 1040ez See Capitalization of Interest, later. Tax forms 1040ez Interest on income tax. Tax forms 1040ez   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Tax forms 1040ez Treat this interest as a business deduction only in figuring a net operating loss deduction. Tax forms 1040ez Penalties. Tax forms 1040ez   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Tax forms 1040ez You cannot deduct them. Tax forms 1040ez Generally, you cannot deduct any fines or penalties. Tax forms 1040ez Interest on loans with respect to life insurance policies. Tax forms 1040ez   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Tax forms 1040ez   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Tax forms 1040ez However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Tax forms 1040ez Who is a key person?   A key person is an officer or 20% owner. Tax forms 1040ez However, the number of individuals you can treat as key persons is limited to the greater of the following. Tax forms 1040ez Five individuals. Tax forms 1040ez The lesser of 5% of the total officers and employees of the company or 20 individuals. Tax forms 1040ez Exceptions for pre-June 1997 contracts. Tax forms 1040ez   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Tax forms 1040ez If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Tax forms 1040ez Interest allocated to unborrowed policy cash value. Tax forms 1040ez   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Tax forms 1040ez This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Tax forms 1040ez For more information, see section 264(f) of the Internal Revenue Code. Tax forms 1040ez Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Tax forms 1040ez The property must be produced by you for use in your trade or business or for sale to customers. Tax forms 1040ez You cannot capitalize interest related to property that you acquire in any other manner. Tax forms 1040ez Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Tax forms 1040ez Designated property is any of the following. Tax forms 1040ez Real property. Tax forms 1040ez Tangible personal property with a class life of 20 years or more. Tax forms 1040ez Tangible personal property with an estimated production period of more than 2 years. Tax forms 1040ez Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Tax forms 1040ez Property you produce. Tax forms 1040ez   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Tax forms 1040ez Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Tax forms 1040ez Carrying charges. Tax forms 1040ez   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Tax forms 1040ez You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Tax forms 1040ez For more information, see chapter 7. Tax forms 1040ez Capitalized interest. Tax forms 1040ez   Treat capitalized interest as a cost of the property produced. Tax forms 1040ez You recover your interest when you sell or use the property. Tax forms 1040ez If the property is inventory, recover capitalized interest through cost of goods sold. Tax forms 1040ez If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Tax forms 1040ez Partnerships and S corporations. Tax forms 1040ez   The interest capitalization rules are applied first at the partnership or S corporation level. Tax forms 1040ez The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Tax forms 1040ez   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Tax forms 1040ez You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Tax forms 1040ez To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Tax forms 1040ez Additional information. Tax forms 1040ez   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Tax forms 1040ez For more information, see sections 1. Tax forms 1040ez 263A-8 through 1. Tax forms 1040ez 263A-15 of the regulations and Notice 88-99. Tax forms 1040ez Notice 88-99 is in Cumulative Bulletin 1988-2. Tax forms 1040ez When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Tax forms 1040ez Cash method. Tax forms 1040ez   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Tax forms 1040ez You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Tax forms 1040ez Prepaid interest. Tax forms 1040ez   You generally cannot deduct any interest paid before the year it is due. Tax forms 1040ez Interest paid in advance can be deducted only in the tax year in which it is due. Tax forms 1040ez Discounted loan. Tax forms 1040ez   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Tax forms 1040ez For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Tax forms 1040ez Refunds of interest. Tax forms 1040ez   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Tax forms 1040ez If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Tax forms 1040ez Accrual method. Tax forms 1040ez   Under an accrual method, you can deduct only interest that has accrued during the tax year. Tax forms 1040ez Prepaid interest. Tax forms 1040ez   See Prepaid interest, earlier. Tax forms 1040ez Discounted loan. Tax forms 1040ez   See Discounted loan, earlier. Tax forms 1040ez Tax deficiency. Tax forms 1040ez   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Tax forms 1040ez If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Tax forms 1040ez   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Tax forms 1040ez Related person. Tax forms 1040ez   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Tax forms 1040ez The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Tax forms 1040ez See section 267 of the Internal Revenue Code for more information. Tax forms 1040ez Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Tax forms 1040ez See Treatment of gift and demand loans, later, in this discussion. Tax forms 1040ez A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Tax forms 1040ez A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Tax forms 1040ez A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Tax forms 1040ez An additional payment in an amount equal to the forgone interest. Tax forms 1040ez The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Tax forms 1040ez Forgone interest. Tax forms 1040ez   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. Tax forms 1040ez Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Tax forms 1040ez Internal Revenue Bulletins are available on the IRS web site at www. Tax forms 1040ez irs. Tax forms 1040ez gov/irb. Tax forms 1040ez You can also contact an IRS office to get these rates. Tax forms 1040ez Loans subject to the rules. Tax forms 1040ez   The rules for below-market loans apply to the following. Tax forms 1040ez Gift loans (below-market loans where the forgone interest is in the nature of a gift). Tax forms 1040ez Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Tax forms 1040ez Corporation-shareholder loans. Tax forms 1040ez Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Tax forms 1040ez Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Tax forms 1040ez   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Tax forms 1040ez Treatment of gift and demand loans. Tax forms 1040ez   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Tax forms 1040ez ) equal to the forgone interest on the loan. Tax forms 1040ez You are then treated as transferring this amount back to the lender as interest. Tax forms 1040ez These transfers are considered to occur annually, generally on December 31. Tax forms 1040ez If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Tax forms 1040ez The lender must report it as interest income. Tax forms 1040ez Limit on forgone interest for gift loans of $100,000 or less. Tax forms 1040ez   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Tax forms 1040ez This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Tax forms 1040ez If the borrower's net investment income is $1,000 or less, it is treated as zero. Tax forms 1040ez This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Tax forms 1040ez Treatment of term loans. Tax forms 1040ez   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Tax forms 1040ez ) on the date the loan is made. Tax forms 1040ez This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Tax forms 1040ez The same amount is treated as original issue discount on the loan. Tax forms 1040ez See Original issue discount (OID) under Interest You Can Deduct, earlier. Tax forms 1040ez Exceptions for loans of $10,000 or less. Tax forms 1040ez   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Tax forms 1040ez This exception applies only to the following. Tax forms 1040ez Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Tax forms 1040ez Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Tax forms 1040ez This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Tax forms 1040ez Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Tax forms 1040ez Exceptions for loans without significant tax effect. Tax forms 1040ez   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Tax forms 1040ez Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Tax forms 1040ez Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Tax forms 1040ez Certain employee-relocation loans. Tax forms 1040ez Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Tax forms 1040ez S. Tax forms 1040ez trade or business and not exempt from U. Tax forms 1040ez S. Tax forms 1040ez tax under an income tax treaty. Tax forms 1040ez Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Tax forms 1040ez Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Tax forms 1040ez Consider all the following factors. Tax forms 1040ez Whether items of income and deduction generated by the loan offset each other. Tax forms 1040ez The amount of the items. Tax forms 1040ez The cost of complying with the below-market loan provisions if they were to apply. Tax forms 1040ez Any reasons, other than taxes, for structuring the transaction as a below-market loan. Tax forms 1040ez Exception for loans to qualified continuing care facilities. Tax forms 1040ez   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Tax forms 1040ez A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Tax forms 1040ez Designed to provide services under continuing care contracts (defined below). Tax forms 1040ez Includes an independent living unit, and either an assisted living or nursing facility, or both. Tax forms 1040ez Substantially all of the independent living unit residents are covered by continuing care contracts. Tax forms 1040ez A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Tax forms 1040ez The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Tax forms 1040ez The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Tax forms 1040ez The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Tax forms 1040ez For more information, see section 7872(h) of the Internal Revenue Code. Tax forms 1040ez Sale or exchange of property. Tax forms 1040ez   Different rules generally apply to a loan connected with the sale or exchange of property. Tax forms 1040ez If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Tax forms 1040ez However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Tax forms 1040ez See Unstated Interest and Original Issue Discount (OID) in Publication 537. Tax forms 1040ez More information. Tax forms 1040ez   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Tax forms 1040ez 7872-5 of the regulations. Tax forms 1040ez Prev  Up  Next   Home   More Online Publications
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The Tax Forms 1040ez

Tax forms 1040ez 2. Tax forms 1040ez   Possession Source Income Table of Contents Types of IncomeCompensation for Labor or Personal Services Investment Income Sales or Other Dispositions of Property Scholarships, Fellowships, Grants, Prizes, and Awards Effectively Connected Income In order to determine where to file your return and which form(s) you need to complete, you must determine the source of each item of income you received during the tax year. Tax forms 1040ez Income you received from sources within, or that was effectively connected with the conduct of a trade or business within, the relevant possession must be identified separately from U. Tax forms 1040ez S. Tax forms 1040ez or foreign source income. Tax forms 1040ez This chapter discusses the rules for determining if the source of your income is from: American Samoa, The Commonwealth of the Northern Mariana Islands (CNMI), The Commonwealth of Puerto Rico (Puerto Rico), Guam, or The U. Tax forms 1040ez S. Tax forms 1040ez Virgin Islands (USVI). Tax forms 1040ez Generally, the same rules that apply for determining U. Tax forms 1040ez S. Tax forms 1040ez source income also apply for determining possession source income. Tax forms 1040ez However, there are some important exceptions to these rules. Tax forms 1040ez Both the general rules and the exceptions are discussed in this chapter. Tax forms 1040ez U. Tax forms 1040ez S. Tax forms 1040ez income rule. Tax forms 1040ez   This rule states that income is not possession source income if, under the rules of Internal Revenue Code sections 861–865, it is treated as income: From sources within the United States, or Effectively connected with the conduct of a trade or business within the United States. Tax forms 1040ez Table 2-1 shows the general rules for determining whether income is from sources within the United States. Tax forms 1040ez Table 2-1. Tax forms 1040ez General Rules for Determining U. Tax forms 1040ez S. Tax forms 1040ez Source of Income Item of Income Factor Determining Source Salaries, wages, and other compensation for labor or personal services Where labor or services performed Pensions Contributions: Where services were performed that earned the pension Investment earnings: Where pension trust is located Interest Residence of payer Dividends Where corporation created or organized Rents Location of property Royalties:   Natural resources Location of property Patents, copyrights, etc. Tax forms 1040ez Where property is used Sale of business inventory—purchased Where sold Sale of business inventory—produced Allocation if produced and sold in different locations Sale of real property Location of property Sale of personal property Seller's tax home (but see Special Rules for Gains From Dispositions of Certain Property , later, for exceptions) Sale of natural resources Allocation based on fair market value of product at export terminal. Tax forms 1040ez For more information, see Regulations section 1. Tax forms 1040ez 863-1(b). Tax forms 1040ez Types of Income This section looks at the most common types of income received by individuals, and the rules for determining the source of the income. Tax forms 1040ez Generally, the same rules shown in Table 2-1 are used to determine if you have possession source income. Tax forms 1040ez Compensation for Labor or Personal Services Income from labor or personal services includes wages, salaries, commissions, fees, per diem allowances, employee allowances and bonuses, and fringe benefits. Tax forms 1040ez It also includes income earned by sole proprietors and general partners from providing personal services in the course of their trade or business. Tax forms 1040ez Services performed wholly within a relevant possession. Tax forms 1040ez   Generally, all pay you receive for services performed in a relevant possession is considered to be from sources within that possession. Tax forms 1040ez However, there is an exception for income earned as a member of the U. Tax forms 1040ez S. Tax forms 1040ez Armed Forces or a civilian spouse. Tax forms 1040ez U. Tax forms 1040ez S. Tax forms 1040ez Armed Forces. Tax forms 1040ez   If you are a bona fide resident of a relevant possession, your military service pay will be sourced in that possession even if you perform the services in the United States or another possession. Tax forms 1040ez However, if you are not a bona fide resident of a possession, your military service pay will be income from the  United States even if you perform services in a possession. Tax forms 1040ez Civilian spouse of active duty member of the U. Tax forms 1040ez S. Tax forms 1040ez Armed Forces. Tax forms 1040ez   If you are a bona fide resident of a U. Tax forms 1040ez S. Tax forms 1040ez possession and choose to keep that possession as your tax residence under MSRRA when relocating with your servicemember spouse under military orders, the source of income for your labor or personal services is considered to be that possession. Tax forms 1040ez Likewise, if your tax residence is in one of the 50 states or the District of Columbia before relocating and you choose to keep it as your tax residence, the source of income for services performed in any of the U. Tax forms 1040ez S. Tax forms 1040ez possessions is considered to be the United States and, specifically, your state of residence or the District of Columbia. Tax forms 1040ez Services performed partly inside and partly outside a relevant possession. Tax forms 1040ez   If you are an employee and receive compensation for labor or personal services performed both inside and outside the relevant possession, special rules apply in determining the source of the compensation. Tax forms 1040ez Compensation (other than certain fringe benefits) is sourced on a time basis. Tax forms 1040ez Certain fringe benefits (such as housing and education) are sourced on a geographical basis. Tax forms 1040ez   Or, you may be permitted to use an alternative basis to determine the source of compensation. Tax forms 1040ez See Alternative basis , later. Tax forms 1040ez   If you are self-employed, determine the source of your income for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. Tax forms 1040ez In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next. Tax forms 1040ez Time basis. Tax forms 1040ez   Use a time basis to figure your compensation for labor or personal services from the relevant possession (other than the fringe benefits discussed later). Tax forms 1040ez Do this by multiplying your total compensation (other than the fringe benefits discussed later) by the following fraction:   Number of days you performed  services in the relevant  possession during the year     Total number of days you  performed services during the year           You can use a unit of time less than a day in the above fraction, if appropriate. Tax forms 1040ez The time period for which the income is made does not have to be a year. Tax forms 1040ez Instead, you can use another distinct, separate, and continuous time period if you can establish to the satisfaction of the IRS that this other period is more appropriate. Tax forms 1040ez Example. Tax forms 1040ez In 2013, you worked in your employer's office in the United States for 60 days and in the Puerto Rico office for 180 days, earning a total of $80,000 for the year. Tax forms 1040ez Your Puerto Rico source income is $60,000, figured as follows. Tax forms 1040ez       180 days 240 days × $80,000 = $60,000                 Multi-year compensation. Tax forms 1040ez   The source of multi-year compensation is generally determined on a time basis over the period to which the compensation is attributable. Tax forms 1040ez Multi-year compensation is compensation that is included in your income in 1 tax year but is attributable to a period that includes 2 or more tax years. Tax forms 1040ez You determine the period to which the income is attributable based on the facts and circumstances of your case. Tax forms 1040ez For more information on multi-year compensation, see Treasury Decision (T. Tax forms 1040ez D. Tax forms 1040ez ) 9212 and Regulations section 1. Tax forms 1040ez 861-4, 2005-35 I. Tax forms 1040ez R. Tax forms 1040ez B. Tax forms 1040ez 429, available at www. Tax forms 1040ez irs. Tax forms 1040ez gov/irb/2005-35_IRB/ar14. Tax forms 1040ez html. Tax forms 1040ez Certain fringe benefits sourced on a geographical basis. Tax forms 1040ez   If you received any of the following fringe benefits as compensation for labor or services performed as an employee partly inside and partly outside a relevant possession, you must source that income on a geographical basis. Tax forms 1040ez Housing. Tax forms 1040ez Education. Tax forms 1040ez Local transportation. Tax forms 1040ez Tax reimbursement. Tax forms 1040ez Hazardous or hardship duty pay. Tax forms 1040ez Moving expense reimbursement. Tax forms 1040ez For information on determining the source of the fringe benefits listed above, see Regulations section 1. Tax forms 1040ez 861-4. Tax forms 1040ez Alternative basis. Tax forms 1040ez   You can determine the source of your compensation under an alternative basis if you establish to the satisfaction of the IRS that, under the facts and circumstances of your case, the alternative basis more properly determines the source of your income than the time or geographical basis. Tax forms 1040ez If you use an alternative basis, you must keep (and have available for inspection) records to document why the alternative basis more properly determines the source of your income. Tax forms 1040ez De minimis exception. Tax forms 1040ez   There is an exception to the rule for determining the source of income earned in a possession. Tax forms 1040ez Generally, you will not have income from a possession if during a tax year you: Are a U. Tax forms 1040ez S. Tax forms 1040ez citizen or resident, Are not a bona fide resident of that possession, Are not employed by or under contract with an individual, partnership, or corporation that is engaged in a trade or business in that possession, Temporarily perform services in that possession for 90 days or less, and Earned $3,000 or less from such services. Tax forms 1040ez This exception began with income earned during your 2008 tax year. Tax forms 1040ez Pensions. Tax forms 1040ez   Generally, pension income has two components: contributions to the pension plan and the earnings accrued from investing those contributions. Tax forms 1040ez The contribution portion is sourced according to where services were performed that earned the pension. Tax forms 1040ez The investment earnings portion is sourced according to the location of the pension trust. Tax forms 1040ez Example. Tax forms 1040ez You are a U. Tax forms 1040ez S. Tax forms 1040ez citizen who worked in Puerto Rico for a U. Tax forms 1040ez S. Tax forms 1040ez company. Tax forms 1040ez All services were performed in Puerto Rico. Tax forms 1040ez Upon retirement you remained in Puerto Rico and began receiving your pension from the U. Tax forms 1040ez S. Tax forms 1040ez pension trust of your employer. Tax forms 1040ez Distributions from the U. Tax forms 1040ez S. Tax forms 1040ez pension trust must be allocated between (1) contributions, which are Puerto Rico source income, and (2) investment earnings, which are U. Tax forms 1040ez S. Tax forms 1040ez source income. Tax forms 1040ez Investment Income This category includes such income as interest, dividends, rents, and royalties. Tax forms 1040ez Interest income. Tax forms 1040ez   The source of interest income is generally determined by the residence of the payer. Tax forms 1040ez Interest paid by corporations created or organized in a relevant possession (possession corporation) or by individuals who are bona fide residents of a relevant possession is considered income from sources within that possession. Tax forms 1040ez   However, there is an exception to this rule if you are a bona fide resident of a relevant possession, receive interest from a corporation created or organized in that possession, and are a shareholder of that corporation who owns, directly or indirectly, at least 10% of the total voting stock of the corporation. Tax forms 1040ez See Regulations section 1. Tax forms 1040ez 937-2(i) for more information. Tax forms 1040ez Dividends. Tax forms 1040ez   Generally, dividends paid by a corporation created or organized in a relevant possession will be considered income from sources within that possession. Tax forms 1040ez There are additional rules for bona fide residents of a relevant possession who receive dividend income from possession corporations, and who own, directly or indirectly, at least 10% of the voting stock of the corporation. Tax forms 1040ez For more information, see Regulations section 1. Tax forms 1040ez 937-2(g). Tax forms 1040ez Rental income. Tax forms 1040ez   Rents from property located in a relevant possession are treated as income from sources within that possession. Tax forms 1040ez Royalties. Tax forms 1040ez   Royalties from natural resources located in a relevant possession are considered income from sources within that possession. Tax forms 1040ez   Also considered possession source income are royalties received for the use of, or for the privilege of using, in a relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property. Tax forms 1040ez Sales or Other Dispositions of Property The source rules for sales or other dispositions of property are varied. Tax forms 1040ez The most common situations are discussed below. Tax forms 1040ez Real property. Tax forms 1040ez   Real property includes land and buildings, and generally anything built on, growing on, or attached to land. Tax forms 1040ez The location of the property generally determines the source of income from the sale. Tax forms 1040ez For example, if you are a bona fide resident of Guam and sell your home that is located in Guam, the gain on the sale is sourced in Guam. Tax forms 1040ez If, however, the home you sold was located in the United States, the gain is U. Tax forms 1040ez S. Tax forms 1040ez source income. Tax forms 1040ez Personal property. Tax forms 1040ez   The term “personal property” refers to property (such as machinery, equipment, or furniture) that is not real property. Tax forms 1040ez Generally, gain (or loss) from the sale or other disposition is sourced according to the seller's tax home. Tax forms 1040ez If personal property is sold by a bona fide resident of a relevant possession, the gain (or loss) from the sale is treated as sourced within that possession. Tax forms 1040ez   This rule does not apply to the sale of inventory, intangible property, depreciable personal property, or property sold through a foreign office or fixed place of business. Tax forms 1040ez The rules applying to sales of inventory are discussed below. Tax forms 1040ez For information on sales of the other types of property mentioned, see Internal Revenue Code section 865. Tax forms 1040ez Inventory. Tax forms 1040ez   Your inventory is personal property that is stock in trade or that is held primarily for sale to customers in the ordinary course of your trade or business. Tax forms 1040ez The source of income from the sale of inventory depends on whether the inventory was purchased or produced. Tax forms 1040ez Purchased. Tax forms 1040ez   Income from the sale of inventory that you purchased is sourced where you sell the property. Tax forms 1040ez Generally, this is where title to the property passes to the buyer. Tax forms 1040ez Produced. Tax forms 1040ez   Income from the sale of inventory that you produced in a relevant possession and sold outside that possession (or vice versa) is sourced based on an allocation. Tax forms 1040ez For information on making the allocation, see Regulations section 1. Tax forms 1040ez 863-3(f). Tax forms 1040ez Special Rules for Gains From Dispositions of Certain Property There are special rules for gains from dispositions of certain investment property (for example, stocks, bonds, debt instruments, diamonds, and gold) owned by a U. Tax forms 1040ez S. Tax forms 1040ez citizen or resident alien prior to becoming a bona fide resident of a possession. Tax forms 1040ez You are subject to these special rules if you meet both of the following conditions. Tax forms 1040ez For the tax year for which the source of the gain must be determined, you are a bona fide resident of the relevant possession. Tax forms 1040ez For any of the 10 years preceding that year, you were a citizen or resident alien of the United States (other than a bona fide resident of the relevant possession). Tax forms 1040ez If you meet these conditions, gains from the disposition of this property will not be treated as income from sources within the relevant possession for purposes of the Internal Revenue Code. Tax forms 1040ez Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U. Tax forms 1040ez S. Tax forms 1040ez tax return. Tax forms 1040ez (See chapter 3 for additional filing information. Tax forms 1040ez ) With respect to the CNMI, Guam, and the USVI, the gain from the disposition of this property will not meet the requirements for certain tax rules that may allow bona fide residents of those possessions to reduce or obtain a rebate of taxes on income from sources within the relevant possessions. Tax forms 1040ez These rules apply to dispositions after April 11, 2005. Tax forms 1040ez For details, see Regulations section 1. Tax forms 1040ez 937-2(f)(1) and Examples 1 and 2 of section 1. Tax forms 1040ez 937-2(k). Tax forms 1040ez Example 1. Tax forms 1040ez In 2007, Cheryl Jones, a U. Tax forms 1040ez S. Tax forms 1040ez citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U. Tax forms 1040ez S. Tax forms 1040ez corporation listed on the New York Stock Exchange. Tax forms 1040ez On March 1, 2010, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Tax forms 1040ez Cheryl satisfied the presence test in 2010 and, under the year-of-move exception, she was considered a bona fide resident of Puerto Rico for the rest of 2010. Tax forms 1040ez On March 1, 2010, the closing value of Cheryl's stock in the Rose Corporation was $2,000. Tax forms 1040ez On January 5, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Tax forms 1040ez Under the earlier rules, none of Cheryl's $6,000 gain will be treated as income from sources within Puerto Rico. Tax forms 1040ez The source rules discussed in the preceding paragraphs supplement, and may apply in conjunction with, an existing special rule. Tax forms 1040ez This existing special rule applies if you are a U. Tax forms 1040ez S. Tax forms 1040ez citizen or resident alien who becomes a bona fide resident of American Samoa, the CNMI, or Guam, and who has gain from the disposition of certain U. Tax forms 1040ez S. Tax forms 1040ez assets during the 10-year period beginning when you became a bona fide resident. Tax forms 1040ez The gain is U. Tax forms 1040ez S. Tax forms 1040ez source income that generally is subject to U. Tax forms 1040ez S. Tax forms 1040ez tax if the property is either (1) located in the United States; (2) stock issued by a U. Tax forms 1040ez S. Tax forms 1040ez corporation or a debt obligation of a U. Tax forms 1040ez S. Tax forms 1040ez person or of the United States, a state (or political subdivision), or the District of Columbia; or (3) property that has a basis in whole or in part by reference to property described in (1) or (2). Tax forms 1040ez See chapter 3 for filing information. Tax forms 1040ez Special election. Tax forms 1040ez   For dispositions after April 11, 2005, you can choose to treat the part of gain (or loss) attributable to the time you held the property while a bona fide resident of the relevant possession (the possession holding period) as gain (or loss) from sources within that possession. Tax forms 1040ez Make the election by reporting the gain attributable to the possession holding period on your income tax return for the year of disposition. Tax forms 1040ez This election overrides both of the special rules discussed earlier. Tax forms 1040ez   There are two methods for figuring the gain for the possession holding period, one for marketable securities and another for other types of investment property. Tax forms 1040ez Marketable securities. Tax forms 1040ez   Marketable securities are those actively traded on an established financial market, such as stock in a publicly held corporation. Tax forms 1040ez Under the special election, allocate the gain (or loss) by figuring the appreciation separately for your possession and U. Tax forms 1040ez S. Tax forms 1040ez holding periods. Tax forms 1040ez   Your possession holding period begins on the first day you do not have a tax home outside the relevant possession. Tax forms 1040ez The gain (or loss) attributable to the possession holding period is the difference in fair market value of the security at the close of the market on the first and last days of this holding period. Tax forms 1040ez This is your gain (or loss) that is treated as being from sources within the relevant possession. Tax forms 1040ez If you were a bona fide resident of the relevant possession for more than one continuous period, combine the gains (or losses) from each possession holding period. Tax forms 1040ez Example 2. Tax forms 1040ez Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U. Tax forms 1040ez S. Tax forms 1040ez and possession holding periods. Tax forms 1040ez Cheryl's possession holding period began March 1, 2010, the date her tax home changed to Puerto Rico. Tax forms 1040ez Therefore, the portion of gain attributable to her possession holding period is $5,000 ($7,000 sale price – $2,000 closing value on first day of the possession holding period). Tax forms 1040ez By reporting $5,000 of her $6,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Tax forms 1040ez Other personal property. Tax forms 1040ez   For personal property other than marketable securities, use a time-based allocation. Tax forms 1040ez Figure the gain (or loss) attributable to the possession holding period by multiplying your total gain (or loss) by the following fraction. Tax forms 1040ez      Number of days in the  possession holding period     Total number of days  in your holding period         The result is your gain (or loss) that is treated as being from sources within the relevant possession. Tax forms 1040ez Example 3. Tax forms 1040ez In addition to the stock in Rose Corporation, Cheryl acquired a 5% interest in the Alder Partnership on January 1, 2009. Tax forms 1040ez On March 1, 2010, when she established bona fide residency in Puerto Rico, her partnership interest was not considered a marketable security. Tax forms 1040ez On September 16, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold her interest in Alder Partnership for a $100,000 gain. Tax forms 1040ez She had owned the interest for a total of 1,720 days. Tax forms 1040ez Cheryl's possession holding period (from March 1, 2010, through September 16, 2013) is 1,296 days. Tax forms 1040ez The portion of her gain attributable to Puerto Rico is $75,349 ($100,000 x (1,296 Puerto Rico days ÷ 1,720 total days)). Tax forms 1040ez By reporting $75,349 of her $100,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Tax forms 1040ez Scholarships, Fellowships, Grants, Prizes, and Awards The source of these types of income is generally the residence of the payer, regardless of who actually disburses the funds. Tax forms 1040ez Therefore, in order to be possession source income, the payer must be a resident of the relevant possession, such as an individual who is a bona fide resident or a corporation created or organized in that possession. Tax forms 1040ez These rules do not apply to amounts paid as salary or other compensation for services. Tax forms 1040ez See Compensation for Labor or Personal Services, earlier in this chapter, for the source rules that apply. Tax forms 1040ez Effectively Connected Income In limited circumstances, some kinds of income from sources outside the relevant possession must be treated as effectively connected with a trade or business in that possession. Tax forms 1040ez These circumstances are listed below. Tax forms 1040ez You have an office or other fixed place of business in the relevant possession to which the income can be attributed. Tax forms 1040ez That office or place of business is a material factor in producing the income. Tax forms 1040ez The income is produced in the ordinary course of the trade or business carried on through that office or other fixed place of business. Tax forms 1040ez An office or other fixed place of business is a material factor if it significantly contributes to, and is an essential economic element in, the earning of the income. Tax forms 1040ez The three kinds of income from sources outside the relevant possession to which these rules apply are the following. Tax forms 1040ez Rents and royalties for the use of, or for the privilege of using, intangible personal property located outside the relevant possession or from any interest in such property. Tax forms 1040ez Included are rents or royalties for the use of, or for the privilege of using, outside the relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and similar properties if the rents or royalties are from the active conduct of a trade or business in the relevant possession. Tax forms 1040ez Dividends or interest from the active conduct of a banking, financing, or similar business in the relevant possession. Tax forms 1040ez Income, gain, or loss from the sale or exchange outside the relevant possession, through the office or other fixed place of business in the relevant possession, of: Stock in trade, Property that would be included in inventory if on hand at the end of the tax year, or Property held primarily for sale to customers in the ordinary course of business. Tax forms 1040ez Item (3) will not apply if you sold the property for use, consumption, or disposition outside the relevant possession and an office or other fixed place of business in a foreign country was a material factor in the sale. Tax forms 1040ez Example. Tax forms 1040ez Marcy Jackson is a bona fide resident of American Samoa. Tax forms 1040ez Her business, which she conducts from an office in American Samoa, is developing and selling specialized computer software. Tax forms 1040ez A software purchaser will frequently pay Marcy an additional amount to install the software on the purchaser's operating system and to ensure that the software is functioning properly. Tax forms 1040ez Marcy installs the software at the purchaser's place of business, which may be in American Samoa, in the United States, or in another country. Tax forms 1040ez The income from selling the software is effectively connected with the conduct of Marcy's business in American Samoa, even though the product's destination may be outside the possession. Tax forms 1040ez However, the compensation she receives for installing the software (personal services) outside of American Samoa is not effectively connected with the conduct of her business in the possession—the income is sourced where she performs the services. Tax forms 1040ez Prev  Up  Next   Home   More Online Publications