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All right, this might be a difficult one, but I have found that the people on this board are often quite knowledgeable about unusual tax situtations.

I have a friend from a foreign country who has been working in the USA for three years. For the first two years of his stay, which ended June 30, 1997, he was paid from a foreign independent (nongovernment) grant. Because of an international tax treaty between the US and his country, he is exempt from any tax liability during these first two years. Thus, the $18,000 he received from Jan 1-Jun 30 is not present on any W-2 as taxable income.

Starting July 1, he was paid by a US company and earned W-2 wages, in the amount of $20,000. This much is clear.

Upon arriving to the US, he bought a house, and for the full 1997 year he paid $8500 in mortgage interest and property taxes. He also has a wife and two children, and thus theoretically can take 4*$2650 in personal exemptions, totalling $10,600.

With this scenario, and also taking into account state income taxes paid during the 6 months that he earned W-2 wages, his taxable income is $16, and his tax liability is $3.

Now (finally!), my question. Is it permitted for him to take the full $8500 deduction and the full $10,600 exemption, even though his tax liability only started at the end of the treaty period (July 1)? Or, can he only deduct half of the mortgage and interest, and only take half of the personal exemption? And if the latter is true, how does this get reported on a 1040 or some other schedule?

He meets the substantial presence test, and plans to file a 1040, not a 1040NR. That is, he is filing with resident alien status.

He is going to consult a CPA about this, but I thought I would throw this out to anyone who might enjoy an challenge.

Thanks and best wishes,
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