Question

9. Tom paid $17,000 in mortgage interest and $8,000 in property taxes last year. His average tax rate is 21.5%, his marginal tax rate is 28%. Compute Tom's tax shield from the mortgage interest and property tax deduction. 10. Jill buys a house for $800k, lives there for exactly 10 years and sells it. Suppose Jill's annual cost of ownership is exactly equal to the annual rent she would have paid to live in the same house. Suppose the price of Jill's house grows 3.4% annually. Compute Jill's annual IRR from owning net of renting. (hint: look at the buy vs rent slides, assume no mortgage or buying/selling expenses.)

Answer 1

Soln:

Say the Earning Before Interest and Tax (EBIT) is X

we know that, EBIT (-) Interest = Earning Before Tax(EBT)

EBT (-) Tax = Net Profit

Property Tax is not your personal Tax. So it is already shown as an expense before reaching EBIT. The Interest of $17,000 is deducted from EBIT to reach EBT.

So, now think carefully. If both the expenses (Mortgage Interest and Property Tax would have not been deducted, then we would have charged Tax on EBIT, that is X and Tax amount would have obviously been high.

Now, as we are deducting (17,000 + 8,000) = 25,000, so we are saving tax of 28% of 25,000. That is 7,000.