Javier and Anita Sanchez purchased a home on January 1 of year 1 for $500,000 by

Question

Javier and Anita Sanchez purchased a home on January 1 of year 1 for $500,000 by paying $50,000 down and borrowing the remaining $450,000 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. (Round your answers to the nearest whole dollar amount.)

b.

Assume the original facts and that the Sanchezes take out a second loan (on the same day as the first loan) secured by the home in the amount of $50,000 to fund expenses unrelated to the home. The interest rate on the second loan is 8 percent. The Sanchezes make interest-only payments during the year. What is the maximum amount of their deductible interest expense in year 1 on both loans combined?

Explanation / Answer

Answer:

The first loan of $450,000 is classified as acquisition in debtedness. The second loan of$80,000 is classified as home-equity indebtedness. 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 ($50,000 down payment plus the $450,000 acquisition indebtedness).Hence the home-equity indebtedness is limited to $50,000 which is the lesser of(1) FMV of residence less acquisition debt ($500,000 - $450,000) = $50,000 or(2) the amount of home-equity indebtedness or $100,000Because the total debt secured by the home exceeds the total qualifying debt, the Sanchezes can use the chronological order method or the average interest method to determine the total deductible interest.

Under the chronological method, the Sanchezes could deduct $4,000 on the second loan ($50,000 × 8%) and $31,500 on the first loan for a total of $35,500 interest expense.

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