Kimberly purchased a home on January 1,year 1 for $500,000 by making a down payment of $200,000 and financing the remaining $300,000 with a 30-year loan,secured by the residence,at 6 percent.During year 1 and year 2 Kimberly made interest-only payments on this loan in the amount of $18,000 each year.On July 1,year 1,when her home was worth $500,000,Kimberly borrowed an additional $125,000 secured by the home at an interest rate of 8 percent.During year 1,she made interest-only payments on this loan in the amount of $5,000 and,during year 2,she made interest only payments on the loan in the amount of $10,000.What is the maximum amount of the $28,000 interest expense ($18,000 + $10,000)that Kimberly paid during year 2 may she deduct as an itemized deduction,if she used the proceeds of the second loan to pay off student loans from law school?

Question

Quizplus · Accepted Answer

Out of the total interest expenses paid during year 2, Kimberly can only deduct the interest paid on the loan that was used to buy, build, or improve her home, as well as the interest paid on up to $100,000 of the second loan that was used for these purposes. Since Kimberly used $125,000 of the second loan to pay off student loans, she can only deduct the interest on $100,000 of that loan.

The interest expenses that qualify for deduction during year 2 would be:
- $18,000 of interest paid on the first loan
- $5,000 of interest paid on the second loan that was used for home improvements or buying/building the home 
- $10,000 of interest paid on the second loan that can be deducted due to the $100,000 limit

This adds up to $33,000, but since the maximum amount of interest expense she can deduct is $28,000, the answer is E, $26,353.

Kimberly Purchased a Home on January 1,year 1 for $500,000