Question

Javier and Anita Sanchez purchased a home on January 1, 2019, for $804,000 by paying $268,000 down and borrowing the remaining $536,000 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. The Sanchezes’ marginal tax rate is 32 percent.

a. What is the after-tax cost of the interest expense to the Sanchezes in 2019?

B. Assume the original facts, except that the Sanchezes rent a home and pay $37,520 in rent during the year. What is the after-tax cost of their rental payments in 2019?

C.Assume the original facts, except that the Sanchezes rent a home and pay $37,520 in rent during the year. What is the after-tax cost of their rental payments in 2019? 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 2019 interest expense?

Answer 1

Part A

After-tax cost of interest expense

$25514

Description	Amount	Explanation
(1) Before-tax interest expense	37520	$536,000 × 7%. All deductible.
(2) Marginal tax rate	32%
(3) Tax savings from interest expense	12006	(1) × (2)
After-tax cost of interest expense	$25514	(1) – (3)

Interest on acquisition indebtedness up to $1,000,000 is allowed for deduction as an itemized deduction.

Part B

After-tax cost of rental payments

$37520

Rental payments gives no tax savings as deduction is not allowed for rental payments.

Part C

After-tax cost of interest expense

$33322

Description	Amount	Explanation
(1) Before-tax interest expense	37520	$536,000 × 7%. All deductible.
(2) Standard deduction	24400
(3) Interest in excess of standard deduction	13120	(1) – (2)
(4) Marginal tax rate	32%
(5) Tax savings from interest expense	4198	(3) × (4)
After-tax cost of interest expense	$33322	(1) – (5)

Benefits produced is the amount of interest expense that exceeds standard deduction, in case of no other deductions other than interest expense.