Question

Javier and Anita Sanchez purchased a home on January 1, 2019, for $744,000 by paying $248,000 down and borrowing the remaining $496,000 with a 7 percent loan secured by the home. The loan requires interest-only payments for the first five years. The Sanchezes would itemize deductions even if they did not have any deductible interest. The Sanchezes' marginal tax rate is 32 percent. (Round your intermediate calculations to the nearest whole dollar amount) a. What is the after-tax cost of the interest expense to the Sanchezes in 2019? Ahort cost of the interest expense b. Assume the original facts, except that the Sanchezes rent a home and pay $34720 in rent during the year. What is the after-tax cost of their rental payments in 2019? Attertax cost of the rental payments c. Assuming the interest expense is their only itemized deduction for the year and that Javier and Anita file a joint return, have great eyesight and are under 60 years of age, what is the after tax cost of the 2019 interest expense? After tax cost of the interest expense

Answer 1

The after-tax cost of the interest expense for the Sanchezes in 2019 is $23,610. Rental payments have an after-tax cost of $34,720 as there is no tax deduction for rent. The after-tax cost does not change if the interest expense is their only itemized deduction.

Step-by-step explanation:

The student has asked about the after-tax cost of home interest expenses and rental payments. To calculate the after-tax cost of the interest expense for Javier and Anita Sanchez in 2019, you need to first determine the amount of interest they would pay in that year on their interest-only loan. The interest for one year on a $496,000 loan at 7% is $34,720. Since they are in the 32% marginal tax bracket, the after-tax cost is calculated by taking the total interest and subtracting the tax savings from being able to deduct this expense. The tax savings is $34,720 times 32%, which is $11,110. The after-tax cost of the interest expense is therefore $34,720 - $11,110, equaling $23,610.

If instead they were renting a home and paid $34,720 in rent during the year, the after-tax cost would be exactly $34,720, since there is no tax deduction for rental payments.

Assuming the interest expense is the only itemized deduction, the after-tax cost of the 2019 interest expense would remain the same, because their itemization status does not alter the fact that they can deduct the interest expense, hence the after-tax cost would still be $23,610.

Answer 2

a. The after-tax cost of the interest expense to the Sanchezes in 2019 is $23,654.40. b. The after-tax cost of their rental payments in 2019 is also $23,654.40. c. The after-tax cost of the 2019 interest expense is $23,654.40.

Step-by-step explanation:

a. To calculate the after-tax cost of the interest expense in 2019, we need to find the deductible interest. Since the Sanchezes itemize deductions, we can include the deductible interest. The deductible interest for the first five years is the annual interest expense, which is 7% of the loan amount. So, the deductible interest is $496,000 × 7% = $34,720.

Therefore, the after-tax cost of the interest expense is the deductible interest minus the tax savings. The tax savings are the deductible interest multiplied by the marginal tax rate. So, the after-tax cost of the interest expense is $34,720 - ($34,720 × 32%) = $23,654.40.

b. To calculate the after-tax cost of the rental payments in 2019, we can consider the rental payments as an expense. The after-tax cost of the rental payments is the rental payments minus the tax savings. The tax savings are the rental payments multiplied by the marginal tax rate. So, the after-tax cost of the rental payments is $34,720 - ($34,720 × 32%) = $23,654.40.

c. Assuming the interest expense is the only itemized deduction for the year, the after-tax cost of the 2019 interest expense can be calculated using the same formula as in part a. The deductible interest is $34,720 and the marginal tax rate is 32%. So, the after-tax cost of the interest expense is $34,720 - ($34,720 × 32%) = $23,654.40.