The tax treatment of up-front financing costs calls for these expenses to be amortized over the life of the loan. However, if the loan is prepaid prior to the term of the loan (perhaps because the property is sold), the tax treatment of these costs changes. If up-front financing costs on a 30-year loan total $6,000, and the loan is prepaid in full at the end of year 5, what is the maximum amount that the investor can deduct when calculating taxable income from rental operations in year 5?

Question

Quizplus · Accepted Answer

The maximum amount that the investor can deduct when calculating taxable income in year 5 is equal to the portion of the up-front financing costs that has not been amortized as of the end of year 5.

Using the straight-line method of amortization, the annual amortization of the financing costs would be $6,000/30 = $200. Therefore, after five years, the total amortization of the financing costs would be $200 x 5 = $1,000.

Since the loan was prepaid at the end of year 5, the remaining unamortized financing costs would be $6,000 - $1,000 = $5,000.

Therefore, the maximum amount that the investor can deduct in year 5 is $5,000. Choice B is the correct answer.

The Tax Treatment of Up-Front Financing Costs Calls for These