Question

Javier and Anita Sanchez purchased a home on January 1, 2023, for $600,000 by paying $200,000 down and borrowing the remaining $400,000 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.

a. What is the after-tax cost of the interest expense to the Sanchezes in 2023?
B. Assume the original facts, except that the Sanchezes rent a home and pay $21,000 in rent during the year. What is the after-tax cost of their rental payments in 2023?
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 their 2023 interest expense?

Answer 1

The after-tax cost of the interest expense to the Sanchezes in 2023 is $19,040. The after-tax cost of their rental payments is 21,000, as rental expenses are not tax-deductible. Assuming the interest expense is their only deduction, the after-tax cost remains 19,040.

Step-by-step explanation:

To calculate the after-tax cost of the interest expense for the Sanchezes in 2023, we need to consider the amount of interest they will pay on their loan and their marginal tax rate.

1. Calculate the annual interest: 400,000 loan × 7% = 28,000.
2. Calculate the tax shield: 28,000 × 32% = 8,960.
3. Subtract the tax shield from the annual interest: 28,000 - 8,960 = 19,040, which is the after-tax cost of interest for 2023.

For the rental payment situation: Since personal rental expenses are not typically tax-deductible, the after-tax cost remains at 21,000 for 2023.

When considering the after-tax cost with interest expense as their only itemized deduction and given their demographic details, the calculation remains the same as in step one. Their after-tax cost of interest for 2023 is still 19,040.

Answer 2

a. The after-tax cost of the interest expense to the Sanchezes in 2023 is $19,040. b. The after-tax cost of their rental payments in 2023 is $21,000. c. The after-tax cost of their 2023 interest expense is $28,000.

Step-by-step explanation:

a. What is the after-tax cost of the interest expense to the Sanchezes in 2023?

To calculate the after-tax cost of the interest expense, we need to determine the deductible interest and apply the Sanchezes' marginal tax rate. The deductible interest is the interest expense on the loan for the first five years, which is $400,000 x 7% = $28,000 per year. Since they would itemize deductions, the after-tax cost of the interest expense is calculated as follows:

After-tax cost = Deductible interest x (1 - Marginal tax rate)

= $28,000 x (1 - 0.32)

= $19,040

b. What is the after-tax cost of their rental payments in 2023?

The after-tax cost of the rental payments is calculated by subtracting the tax savings from the rental payments. Since they would not have any deductible interest, the tax savings would be zero. Therefore, the after-tax cost of their rental payments is equal to the total rental payments:

After-tax cost = Rental payment

= $21,000

c. What is the after-tax cost of their 2023 interest expense?

Since the interest expense is their only itemized deduction, the after-tax cost is the same as the deductible interest. The deductible interest is $28,000 per year for the first five years, so the after-tax cost of their 2023 interest expense is $28,000.