Emeril borrows $340,000 to finance taxable and tax-exempt investments.He incurs $18,000 investment interest expense,allocated equally between the taxable and tax-exempt investments.Ignore any possible investment interest expense limitation.How much of the interest expense is deductible,and where is it deductible?

Question

Quizplus · Accepted Answer

Since Emeril borrowed money to invest in both taxable and tax-exempt investments, the investment interest expense must be allocated between the two based on the proportion of the borrowed funds used for each investment.

Let's say Emeril invested X dollars in taxable investments and Y dollars in tax-exempt investments, where X+Y = $340,000 (total amount borrowed).

Since the investment interest expense of $18,000 is equally allocated between the two investments, we can set up the following equation:

0.5 * $18,000 = (X/$340,000) * $18,000 + (Y/$340,000) * $18,000

Simplifying the equation, we get:

$9,000 = X/(X+Y) * $18,000

Solving for X, we get:

X = $170,000

Therefore, Emeril invested $170,000 in taxable investments and $170,000 in tax-exempt investments.

Since the investment interest expense allocated to the taxable investments is $9,000 ($18,000 * $170,000/$340,000) and the investment interest expense allocated to the tax-exempt investments is also $9,000 ($18,000 * $170,000/$340,000), only one-half of the investment interest expense ($9,000) is deductible, and it is deductible from AGI.

Therefore, the answer is D: $9,000 from AGI.

Emeril Borrows $340,000 to Finance Taxable and Tax-Exempt Investments