5 Required information Pert 1 of 3 The following information applies to the ques

Question

5 Required information Pert 1 of 3 The following information applies to the questions displayed below Javier and Anita Sanchez purchased a home on January 1 of year 1 for $500,000 by paying $200,000 down and borrowing the remaining $300,000 with a 7 percent loan secured by the home The loan requires interest-only payments for the first five years. The Sanchezes would itemize deductions even if they did not have any deductible interest. On January 1, the Sanchezes also borrowed money on a second loan secured by the home for $75.000 The interest rate on the loan is 8 percent and the Sanchezes make interest-only payments in year 1 on the second loan. (Do not round intermediate celculations. Round your finel answers to the nearest whole doller amount.) 10 ponss eBook a. Assuming the Sanchezes use the second loan to landscape the yard to their home, what is the maximum amount of interest expense (on both loans combined) they are allowed to deduct in year 1? References

Explanation / Answer

SOLUTION

(A) $6,000 ($75,000 * 8%)

The first loan of $300,000 is classified as acquisition indebtedness. The second loan of $75,000 would likely also be classified as acquisition indebtedness because it was used to substantially improve the home. Because the Sanchezes’ acquisition indebtedness of $375,000 ($300,000 + $75,000) does not exceed the $1,000,000 acquisition debt limit, they may deduct all of the $21,000 interest on the first loan ($300,000 * 7%) and the entire $6,000 of interest on the second loan ($75,000 * 8%).

(B) $6,000 ($75,000 * 8%)

The Sanchezes can deduct the $21,000 interest on the first loan which is acquisition debt ($300,000 * 7%). The second loan qualifies as a home-equity loan because it was not used to substantially improve the home. The amount of home-equity indebtedness is limited to the lesser of (1) the fair market value of the qualified residence in excess of the acquisition debt related to that residence and (2) $100,000 ($50,000 for married filing separately). The Sanchezes’ home is worth $500,000 ($200,000 down payment plus the $300,000 acquisition indebtedness). Hence the home-equity indebtedness is limited to $75,000 which is the lesser of-

(1) FMV of residence less acquisition debt ($500,000 - $300,000) = $200,000, or

(2) the amount of home-equity indebtedness or $100,000.

Thus the Sanchezes can deduct interest on up to $100,000 of home-equity indebtedness. Because their second loan of $75,000 is below this limit, they can deduct the full $6,000 of interest paid on the second loan ($75,000 * 8%).

(C) $29,143

In this case, the Sanchezes have $420,000 of debt but only $400,000 of qualifying debt ($300,000 acquisition debt + $100,000 qualifying home equity debt). The second loan qualifies as a home-equity loan because it was not used to substantially improve the home. The amount of home-equity indebtedness is limited to the lesser of (1) the fair market value of the qualified residence in excess of the acquisition debt related to that residence and (2) $100,000 ($50,000 for married filing separately).

J and A paid total interest of $30,600 ($21,000 on acquisition and $9,600 for second debt).

= 30,600 * (400,000/420,000) = $29,143

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