Alex, who is single, conducts an activity in 2019 that is appropriately classified as a hobby. The activity produces the following revenues and expenses: Revenue $18,000 Property taxes 3,000 Materials and supplies 4,500 Utilities 2,000 Advertising 5,000 Insurance 750 Depreciation 4,000 Without regard to this activity, Alex's AGI is $42,000. Determine the amount of income Alex must report and the amount of the expenses he is permitted to deduct. Assume Alex itemizes his deductions.

The solution to the given problem is done below.

Explanation:

Alex must report the $18,000 as revenues. All of the property taxes of $3,000 can be deducted. Because the remaining expenses of $16,250 exceed the balance of $15,000 ($18,000 revenues - $3,000 property taxes), the $15,000 is deductible as follows:

Materials and supplies $ 4,500

Utilities 2,000

Advertising 5,000

Insurance 750

Depreciation (because depreciation is sequenced

last, only $2,750 of the $4,000 is eligible) 2,750

Total deductible expenses $15,000

These expenses of $15,000 are classified as miscellaneous itemized deductions and will be subject to the 2%-of-AGI floor. Hence, $1,200 [ ($42,000 + $18,000) * 2%] of these expenses is disallowed.

Other AGI $42,000

Revenues from hobby $18,000

Less: Expenses

Property taxes (3,000)

Miscellaneous itemized

deduction ($15,000 - $1,200) (13,800)

Less: Personal exemption (4,050)

Taxable income $39,150