Question

Javier and Anita Sanchez purchased a home on January 1, 2014, for $525,000 by paying $210,000 down and borrowing the remaining $315,000 with a 9 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. The Sanchezes' marginal tax rate is 30 percent. a. What is the after-tax cost of the interest expense to the Sanchezes in 2014? (Do not round intermediate calculations. Round your answer to 2 decimal places.) After-tax cost of the interest expense b. Assume the original facts, except that the Sanchezes rent a home and pay $28,350 in rent during the year. What is the after-tax cost of their rental payments in 2014? After-tax cost of the rental payments c. Assuming the interest expense is their only itemized deduction for the year and that Javier and Anita file a joint return, have great eyesight, and are under 60 years of age, what is the after-tax cost of their 2014 interest expense? (Do not round intermediate calculations. Round your answer to 2 decimal places.) After-tax cost of the interest expense

Answer 1

a) $ 19845

The $315000 loan is treated as acquisition indebtness , since it was to initially acquire the home.Interest on up to $1000000 of acquisition indebtness is deductible as an itemized deduction.Since the $315000 loan principal is less than the limit all of the interest associated press with the loan is deductible.the after tax cost of the interest expense is calculated as follows:

Before tax interest expense: $ 315000× 9%= $28350

Marginal Tax rate = × 30%

Tax savings from interest expense = $8505

After tax cost of interest expense = $19845

b) $ 28350

Because rental payments are not deductible , they do not generate any tax savings , so the before and after tax cost of the rental payments is the same.

c)$ 23,505

Because the Sanchezes had no other itemized deductions,their interest expense only produces a benefit to them to the extent that it exceeds the standard deduction , calculated as follows:

Before tax interest expense = $ 315000 × 9% = $28350

Standard deduction = $12200(MFJ)

Interest in excess of standard deduction =$ 16150  

Marginal Tax rate =   × 30%  

Tax savings from interest expense = $4845

After tax cost of interest expense = $28350- $ 4845

= $23,505