1. On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.4
ID: 2559783 • Letter: 1
Question
1. On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.4 million by paying $230,000 down and borrowing the remaining $1.17 million with a 15 percent loan secured by the home. (Enter your answers in dollars and not in millions of dollars. Do not round intermediate calculations.)
a. What is the amount of the interest expense the Franklins may deduct in year 1?
Deductible interest expense: $_________________
b. Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $312,000 secured by the home at a 15 percent rate. They make interest-only payments on the loan during the year. What amount of interest expense may the Franklins deduct in year 3 on this loan? (Assume the Franklins do not use the loan proceeds to improve the home)?
Deductible interest expense: $_________________
Explanation / Answer
a) Deductable interest expense = $165,000 (164,999.9999 approximately)
the acquisition indebtedness limit ($1,000,000)and the home equity limit indebtedness limit ($100,000)are two separate limits ,
the maximum amount of debt on which a tax payer can deduct qualified residence interest is $1,100,000,as the value of tax payer residence is at least $1,100,000.
Franklin home worth =$1.4 millions
Deductions applicable is up to $ 1,100,000
Calculation of Deductable interest on loan :
Total interest expense =total loan principal*interest rate
1.17millions*15% = $175,500
Deductible interest expense =(qualified debt/total debt )*total interest expense
($1.1millions/1.17millions)*175,500=$164,999.999 approximately
=$165,000
Deductable interest expense = $165,000 (164,999.9999 approximately)
b) Deductible interest expense =$15,000
once acquisition indebtedness is established , only payments on principle can deduct the indebtedness and only additional indebtedness secured by the residence and incurred to substantially improve the residence can increase it .
in this case the franklins reduced their original acquisition indebtedness to zero .
because the franklins do not use the additional loan in year 3 to substantially improve their home, the loan cannot be classified as acquisition indebtedness.
Thus ,the interest on the loan can only be deducted to the extent that it qualifies as home equity indebtedness .
$100,000 of the loan qualifies as home equity indebtedness and the franklins may deduct $15,000 of interest paid on the loan = $100,000*15%
Deductible interest expense =$15,000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.