In year 1, Gabby purchased a new home for $500,000 by making a down payment of$200,000 and financing the remaining $300,000 with a loan, secured by the residence, at6 percent. In year 3, Gabby made interest-only payments of $18,000 on the $300,000loan. On January 1, year 3, Gabby executed two home equity loans (both secured by the home). The first was for $80,000 at an interest rate of 7 percent. The second home equity loan from a different bank (later in the day) was for $40,000 at an interest rate of 9 percent. In year 3, Gabby paid $5,600 of interest payments on the first home equity loan and $3,600 interest expense on the second. Gabby used the loan proceeds for purposes unrelated to the home. What is the maximum amount of interest expense Gabby candeduct on these loans as home related interest expense?

Question

Quizplus · Accepted Answer

The maximum amount of interest expense Gabby can deduct on these loans as home related interest expense is $25,905. This is because the total amount of interest expense incurred on the loans in year 3 is $27,200 ($18,000 + $5,600 + $3,600). However, the maximum amount of home related interest expense that Gabby can deduct is limited to the interest expense on the first $750,000 of acquisition indebtedness. Since Gabby's acquisition indebtedness is $300,000, the maximum amount of home related interest expense that she can deduct is $25,905 ($300,000 x 6% x 3).

In Year 1, Gabby Purchased a New Home for $500,000