In September of this year, Rudolph refinanced his home. Prior to refinancing, hi

Question

In September of this year, Rudolph refinanced his home. Prior to refinancing, his only outstanding debt

was the balance due on his original mortgage of $110,000. Rudolph needed some additional money to
pay for his child’s college education and to take advantage of an investment opportunity, so upon
refinancing, Rudolph took out a 30-year mortgage for $250,000. To reduce the interest rate on the
mortgage, down to 5%, Rudolph paid $2,500 in points on refinance. Which of the following statements
is correct?

Rudolph can deduct all of the mortgage interest paid on the note.

Rudolph can deduct the mortgage interest incurred on $110,000. The remaining interest is
      not deductible.

Rudolph can only deduct the mortgage interest incurred on $210,000.

Rudolph can only deduct the mortgage interest paid on $210,000 plus a pro rata portion of
      the points paid on refinancing (ratably over the life of the loan).

Rudolph can deduct all of the mortgage interest paid on the note.

Rudolph can deduct the mortgage interest incurred on $110,000. The remaining interest is
      not deductible.

Rudolph can only deduct the mortgage interest incurred on $210,000.

Rudolph can only deduct the mortgage interest paid on $210,000 plus a pro rata portion of
      the points paid on refinancing (ratably over the life of the loan).

Explanation / Answer

Solution: Rudolph can only deduct the mortgage interest paid on 210,000 plus a pro rata portion of the points paid on refinancing.

Explanation: The refinanced amount of 110,000 continues to be treated as acquisition in indebtedness because that was the previous balance on Rudolph's mortgage. The additional amount of 100,000 will be considered allowed for deductions as equity indebtedness. Because the interest amount of 40,000 (=250,000 - 210,000) will not be allowed for deductions because it exceeds the permissible interest expense deduction. Furthermore, since not the entire new mortgage is categorised as acquisition indebtedness, and only a portion of the points paid on the refinance will be allowed for deduction

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