Question

On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.74 million by paying 240,000 down and borrowing the remaining $1.50 million with a 4.6 percent loan secured by the home. The Franklins paid interest only on the loan for year 1 and year 2 (unless stated otherwise). (Enter your answers in dollars and not in millions of dollars. Do not round intermediate calculations. Leave no answer blank. Enter zero if applicable.)

a. What is the amount of interest expense the Franklins may deduct in year 2 assuming year 1 is 2017?

b. What is the amount of interest expense the Franklins may deduct in year 2 assuming year 1 is 2018?

c. Assume that year 1 is 2018 and that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $320,000 secured by the home at a 5 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.)

Answer 1

Part 1

Answer is $50600

Total interest expense = total loan principal * interest rate = 1500000*4.6% = 69000

Deductible interest expense = Qualified debt/Total debt * total interest expense = (1100000/1500000)*69000 = 50600

Qualified debt = home acquisition indebtedness limit + home-equity indebtedness limit =$1,000,000 + $100,000 = $1,100,000

Part 2

Answer is $4600 or $23000

(100000*4.6%) = $4600 (they do not use the loan proceeds to substantially improve the home)

((1500000-1000000)*4.6%) = $23000 (they do not use the loan proceeds to substantially improve the home)

Part 3

Answer is $16000

(320,000 * 5%) = $14720 because it is less than 100,000