Question

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6. The tax effect of interest payments on loans to make real estate investments

Eileen invested in residential real estate for $100,000 ($85,000 for the building and $15,000 for the land). She financed her purchase with a 30-year mortgage for $75,000 at an interest rate of 7%. A year has passed since her purchase. Eileen is now curious about how her taxes, cash flow, after-tax return, and after-tax yield would have been different if she had paid cash for the property. Eileen’s files indicate the following information regarding her investment:

•	Rental revenues were $15,000
•	The depreciation deduction was $3,091
•	Eileen paid $5,226 interest on the mortgage
•	Eileen is in a 25% tax bracket

Complete the following table. Assume that all factors except those described above remain constant. For the after-tax yields, round your answers to the nearest decimal and round all other answers to the nearest whole number. Enter all figures as positive numbers, and follow the guidance in the tables to perform the appropriate mathematical operations.

	Paid cash	Used leverage
Gross rental income	$_______	$_______
Less: Annual depreciation deduction	$_______	$_______
Subtotal	$_______	$_______
Less: Interest expense for the year	$_______	$_______
Taxable income	$_______	$_______
Cash flow after paying interest	$_______	$_______
Less: Income tax liability	$_______	$_______
After-tax return	$_______	$_______
After-tax yield	%______	%______

Because Eileen took out a mortgage to finance her investment, she was able to___________her overall rate of return, compared to making the investment solely with cash.
A. Increase
B. Decrease

In the first year of ownership, it appears to have been a__________strategy.
A. Failed
B. Successful

Answer 1

Answer for above questions;

• Because Eileen took out a mortgage to finance her investment, she was able to___Decrease________her overall rate of return, compared to making the investment solely with cash.
• In the first year of ownership, it appears to have been a_Successful_ strategy.