In 2012, 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, at 6 percent. In 2014, Gabby made interest-only payments of $18,000 on the $300,000 loan. On January 1, 2014, 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 was for $40,000 at an interest rate of 9 percent. In 2014, 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 can deduct on these loans as home related interest expense?

Question

Quizplus · Accepted Answer

To determine the maximum amount of interest expense that Gabby can deduct as home related interest expense, we need to apply the rules of the tax code.

First, we need to determine the balance of the original mortgage at the end of the year. Gabby's original mortgage was $300,000 with an interest rate of 6 percent, so the interest expense for the year would be:

$300,000 x 6% = $18,000

Next, we need to determine the balance of the home equity loans at the end of the year.

For the first home equity loan of $80,000 at 7 percent interest, Gabby paid $5,600 in interest expense. Therefore, the balance at the end of the year would be:

$80,000 - $5,600 = $74,400

For the second home equity loan of $40,000 at 9 percent interest, Gabby paid $3,600 in interest expense. Therefore, the balance at the end of the year would be:

$40,000 - $3,600 = $36,400

Now we need to determine the total balance of the mortgage and home equity loans.

$300,000 + $74,400 + $36,400 = $410,800

Gabby can deduct interest expense on the original mortgage and up to $100,000 of home equity debt. Therefore, the maximum amount of interest expense that is considered home related is:

$18,000 + $5,600 + $3,600 = $27,200

However, since Gabby used the proceeds of the home equity loans for purposes unrelated to the home, only the interest expense on the original mortgage and the first home equity loan ($80,000) is considered home related. Therefore, the maximum amount of interest expense that Gabby can deduct as home related interest expense is:

$18,000 + $5,600 = $23,600

Additionally, Gabby can deduct the remaining $4,600 of interest expense as investment interest expense, subject to certain limitations.

In 2012, Gabby Purchased a New Home for $500,000 by Making