Question

1. For the last eight years, Bob Hartley and his family have lived in a large Victorian house in Vermont. At the beginning of the current year, Bob and his wife decided to convert the house into a bed and breakfast. The family, including the two children and the dog, move into the basement which accounts for 30% of the square footage of the house. The basement has two bedrooms, two bathrooms, a den and a small kitchen. The upper two floors are used for the bed and breakfast, which is run as a sole proprietorship.

Bob hires two employees to help run the business. Their expenses for the house and the business include:

   Mortgage interest on the house                           $18,000

   Property taxes on the house                                 $3,000

   Salaries for two employees                                 $40,000

   Groceries for breakfast and snacks                     $7,000

Depreciation                                              $10,000

      

For breakfast, all of the family members eat the same food that is prepared for the guests. They usually also share the cookies and cakes in the evening.

On Bob’s schedule C for the business, he deducts $78,000 of expenses for the current year. Discuss whether these deductions are appropriate and why or why not. If this is not correct please indicate what Bob should have done.

Answer 1