Question

You are a new tax staff at H CPA Firm. You have been asked to draft a tax memorandum for one of the firm’s new clients, Ms. Rachel Ross. Ms. Ross has a number of unique tax issues this year. The partner at H CPA, your boss, has requested a detailed memorandum outlining the relevant facts, proper tax treatment and applicable tax law.

Ms. Ross is unavailable to answer any clarifying questions regarding the facts described below. If assumptions are required in reaching your conclusion, please highlight those in the memorandum to the partner.

Facts

In late 2018, Ms. Ross found herself unemployed and pondering her purpose. With the encouragement of a few friends, Ms. Ross decided to celebrate the start of 2019 in Las Vegas (perhaps a short vacation would help her sort out next steps). While she had never been a gambler, Ms. Ross did quite well at the poker table, accumulating winnings of $5,500 over a three-day weekend. Perhaps she should be a professional poker player! Ms. Ross decided to stay in Las Vegas, she said goodbye to her friends and found a short-term apartment rental ($300 per week) just down the street from the casinos. Ms. Ross spent $1,000 on books, videos, and on-line courses on how to “play poker to win.” Ms. Ross also hired a Vegas street mime to help her perfect her poker face (cost $1,000). She started entering poker tournaments and went to the casinos daily to refine her poker skills.

Ms. Ross views herself as a professional poker player; she would like to treat her poker activities as a business for tax purposes, although she has no idea of the ramifications of that choice. She tracked her net winnings/losses on a daily basis and in the 45 days that she was living in Las Vegas (excluding her initial $5,500 of winnings from the New Year’s weekend gambling with her friends) she had the following winnings/losses:

# of Days	Net Winnings/(Losses) per day	Total
5	(1,000)	(5,000)
3	(5,000)	(15,000)
4	(600)	(2,400)
4	Broke even (0)	(0)
10	2,000	20,000
12	500	6,000
6	1,000	6,000
1	700,000	700,000
45 days total		709,600

In addition, she paid $12,000 in entry fees for a few major poker tournaments. Having won a major poker tournament (the $700,000 of winnings in one day, noted above), Ms. Ross decided it was time to return to Illinois.

Back in Illinois, Ms. Ross wanted to invest her poker winnings. In early March 2019, she purchased two duplexes (i.e. 4 residential rental units) for $400,000. She also purchased $200,000 in bitcoin.

For the duplexes, Ms. Ross spent a month preparing the units for rent (i.e., cleaning, painting, maintenance, improvements). She incurred $1,000 in supply costs (paint, cleaning supplies, etc.) and $5,000 in costs related to fixtures (lighting, doors, window treatments, etc.). On April 1st she rented the first two units. Each tenant signed a one-year lease (April 1, 2019 – March 31, 2020) with monthly rent payments of $1,000. On May 1st she rented the second two units. Each tenant signed a one-year lease (May 1, 2019 – April 30, 2020) with monthly rent payments of $1,500. After the units were rented, Ms. Ross logged 80 hours and $4,000 in supplies for routine maintenance on the units. Ms. Ross also paid $15,000 in 2019 for insurance on the rental units.

Ms. Ross’ bitcoin has doubled in value to $400,000. However, she did not trade or sell any of her bitcoin during 2019.

Questions you should address:

1. How should Ms. Ross’ gambling activity be taxed? As a business or a recreational activity?

2. How much taxable income does Ms. Ross have related to her rental real estate business? And is that business eligible for a QBI deduction?

3. How much, if any, taxable income does Ms. Ross have related to her ownership of bitcoin?

Answer 1

1- Determining whether an individual is engaged in the trade or business of gambling is based on the facts and circumstances. If one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business. As in this case Ms. Ross has spent considerable time and money in refining her skills in order to become a professional Gambler, her Income from Gambling should be treated as a Business Income.

(Note:- Here we are not calculating the income, as we have been asked only to answer whether it would be considered as business or a recreational activity, and question hasn't specifically mentioned to calculate the income)

2- Rental Income- F/Y 2019-20 (Assuming Financial year starts from 1st January 19 till December 2020)

Rent from 1st 2 units (April 19 to December 20) = (1000*9)*2 = $18000

Rent from 2nd 2 units (May 19 to December 20) = (1500*8)*2= $24000

    Total Rental Income= $42000

Yes, Ms. Ross will be eleigible for Qualified Business Income (QBI) deduction of 20% as her Income during the year 2019 is less then $160700.

3- Income from Bitcoin is taxable only when Bitcoin are sold. As Ms. Rosy has not yet sold the Bitcoin, there will be no taxablity. The year in which she sells the bitcoin, the income from it will be taxable as Long term Capital gain if it is held for more then 12 months, and Short term Capital gain if held for less then 12 months.