Question

Derek and Meagan Jacoby recently graduated from State University and Derek accepted a job in business consulting while Meagan accepted a job in computer programming. Meagan inherited $42,000 from her grandfather who recently passed away. The couple is debating whether they should buy or rent a home. They located a rental home that meets their needs. The monthly rent is $2,600. They also found a three-bedroom home that would cost $172,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $130,000 to acquire the home. They have the option of paying two discount points to receive a fixed interest rate of 4.50 percent on the loan or paying no points and receiving a fixed interest rate of 5.70 percent for a 30-year fixed loan. Though anything could happen, the couple expects to live in the home for no more than five years before relocating to a different region of the country. Derek and Meagan don’t have any school-related debt, so they will save the $42,000 if they don’t purchase a home. Also, consider the following information: The couple’s marginal tax rate is 20 percent. Regardless of whether they buy or rent, the couple will itemize their deductions. If they buy, the Jacobys would purchase and move into the home on January 1, 2018. If they buy the home, the property taxes for the year are $3,950. Disregard loan-related fees not mentioned above. If the couple does not buy a home, they will put their money into their savings account where they earn 4.95 percent annual interest. Assume that all unstated costs are equal between the buy and rent option. Required: Help the Jacobys with their decisions by answering the following questions: (Leave no answer blank. Enter zero if applicable.) a. If the Jacobys decide to rent the home, what is their after-tax cost of the rental for the first year (include income from the savings account in your analysis)? b. What is the approximate break-even point in years for paying the points to receive a reduced interest rate? (To simplify this computation, assume the Jacobys will make interest-only payments, and ignore the time value of money.) (Do not round intermediate calculations. Round your final answer to 1 decimal place.) c. What is the after-tax cost (in interest and property taxes) of living in the home for 2018? Assume that the Jacobys' interest rate is 5.70 percent, they do not pay discount points, they make interest-only payments for the first year, and the value of the home does not change during the year. (Round your intermediate calculations to the nearest whole dollar amount.) . Assume that on March 1, 2018, the Jacobys sold their home for $198,000, so that Derek and Meagan could accept job opportunities in a different state. The Jacobys used the sale proceeds to (1) pay off the $130,000 principal of the mortgage, (2) pay a $10,000 commission to their real estate broker, and (3) make a down payment on a new home in the different state. However, the new home cost only $97,500. Assume they make interest-only payments on the loan. Required: d1. What gain or loss do the Jacobys realize and recognize on the sale of their home? d2. What amount of taxes must they pay on the gain, if any? Assume the same facts as in part (d), except that the Jacobys sell their home for $159,000 and they pay a $7,500 commission. What effect does the sale have on their 2018 income tax liability? Recall that the Jacobys are subject to an ordinary marginal tax rate of 20 percent and assume that they do not have any other transactions involving capital assets in 2018.

Answer 1

a. The Jacobys' after-tax cost of renting the home for the first year is $29,121. b. The approximate break-even point in years for paying the points to receive a reduced interest rate is 18. c. The after-tax cost of living in the home for 2018 is $11,441.

Step-by-step explanation:

a.

To calculate the Jacobys' after-tax cost of renting the home for the first year, we need to consider the monthly rent and the income from their savings account. The monthly rent is $2,600, so the total cost for the year is $2,600 multiplied by 12, which equals $31,200. They also have $42,000 in their savings account, which earns 4.95 percent annual interest. Therefore, the income from their savings account for the year is $42,000 multiplied by 4.95 percent, which equals $2,079.

Subtracting the income from their savings account from the total cost of renting, their after-tax cost of renting the home for the first year is $31,200 minus $2,079, which equals $29,121.

b.

The break-even point in years for paying the points to receive a reduced interest rate can be calculated by comparing the total cost of the loan with and without the points. Let's assume the loan amount is $130,000, the interest rate is 5.70 percent, and the loan term is 30 years.

First, calculate the monthly payment without paying points using the formula: Loan amount multiplied by monthly interest rate.

Next, calculate the monthly payment with paying points by reducing the interest rate to 4.50 percent and using the same formula. Subtract the monthly payment with points from the monthly payment without points to get the monthly savings resulting from paying points.

Divide the points paid by the monthly savings to determine the number of months it would take to recoup the cost of paying the points. Finally, divide the number of months by 12 to get the break-even point in years.

c.

The after-tax cost of living in the home for 2018 includes the interest paid on the loan and the property taxes. The interest rate is 5.70 percent, the loan amount is $130,000, and the property taxes are $3,950.

First, calculate the annual interest paid on the loan by multiplying the loan amount by the interest rate. Next, calculate the annual after-tax interest paid by subtracting the tax savings from the tax deduction using the formula: Annual interest paid multiplied by the marginal tax rate.

Add the annual after-tax interest paid to the property taxes to get the total after-tax cost of living in the home for 2018.

d.

To determine the gain or loss on the sale of their home, subtract the adjusted basis from the selling price. The selling price is $198,000, and the adjusted basis is the original purchase price plus any improvements minus any depreciation or casualty losses. In this case, the adjusted basis is $172,000 (purchase price) plus any improvements.

d2. To calculate the taxes they must pay on the gain, if any, subtract the adjusted basis from the selling price. Multiply the result by the tax rate to get the amount of taxes they must pay on the gain.

If they sell the home for $159,000 and pay a $7,500 commission, the selling price would be adjusted to $151,500. Subtracting the adjusted basis of $172,000, their realized and recognized loss on the sale of their home is $20,500.

Since they incurred a loss, they do not have any gain to be taxed, so they don't have to pay any taxes on the sale.

Answer 2

The Jacobys have several financial decisions to make regarding renting or buying a home, paying points for a reduced interest rate, and the after-tax cost of living in the home. The gain or loss on the sale of their home and the taxes they may need to pay on the gain are also important considerations.

Step-by-step explanation:

To calculate the after-tax cost of renting the home for the first year, we need to consider the monthly rent, income from the savings account, and the couple's marginal tax rate. The after-tax cost of renting is equal to the monthly rent minus the income from the savings account, multiplied by (1 - the marginal tax rate).

For the break-even point in years for paying the points, we need to compare the monthly savings in interest from paying the points to the initial cost of the points. The break-even point is the time it takes for the savings in interest to equal the initial cost of the points.

The after-tax cost of living in the home for 2018 includes the interest paid on the loan and the property taxes. We can calculate it by adding the interest paid and the property taxes, multiplied by (1 - the marginal tax rate).

For the gain or loss realized on the sale of the home, subtract the total cost of the sale (principal of the mortgage, real estate broker commission) from the sale proceeds. If the result is positive, it's a gain. If it's negative, it's a loss. The amount of taxes paid on the gain is determined based on the tax rate and the gain amount. If the sale price is different, the income tax liability is affected based on the gain or loss and the tax rate.