Question

Kimberly purchased a home on January 1, 2014 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 2014 and 2015 Kimberly made interest-only payments on the loan in the amount of $18,000 each year. On July 1, 2014, 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 2014, she made interest-only payments on this loan in the amount of $5,000 and during 2015 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 Kimberly paid during 2015 that she may deduct as an itemized deduction, if she used the proceeds of the second loan to pay off student loans from law school?

A. $0
B. $5,000
C. $18,000
D. $26,000
E. $26,353

Answer 1

The deductible interest expense on Kimberly's tax return for the year 2015 is $18,000, representing the interest on the initial loan used for home acquisition.

Step-by-step explanation:

The question deals with the maximum amount of interest expense Kimberly paid during 2015 that she may deduct as an itemized deduction, if she used the proceeds of the second loan to pay off student loans from law school. According to the tax laws, interest on a loan used to pay off personal debt, such as student loans, is not deductible as mortgage interest because it is not considered acquisition indebtedness or home equity debt used to buy, build, or substantially improve the borrower's home.

Therefore, the interest Kimberly paid in 2015 on the original loan of $300,000 at 6 percent, which amounts to $18,000, can be deducted, since it's qualified residence interest. However, the interest paid on the second loan of $125,000 at 8 percent, amounting to $10,000 for the year 2015, cannot be deducted because the loan was not used for home acquisition or improvement.

Hence, the answer to the question, which is D. $18,000, represents the deductible interest of the original loan for the year 2015.