7.Charlie owns one house that he lives in. He bought the house in 2002 for $530,

Question

7.Charlie owns one house that he lives in. He bought the house in 2002 for $530,000, using a $390,000 loan. In 2007 when the loan balance was $190.000 (he had paid off $200,000 of the $390,000 loan) and the house was worth $600,000, he refinanced the loan with a new loan of $410,000. He used $150,000 of the extra cash (he obtained $220.000 in cash) to remodel the kitchen, bathrooms and build a pool. The rest of the money he used to pay for a vacation. In 2012 he obtained a "second" additional loan secured by the house of $60,000 (the house was still worth $600,000) and he used all the money for a new car. If during the year Charli in interest on the $60,000 loan, how much of the $6,000 interest expense would you expect to be deductible? Assume none of the bala nce of the either outstanding loan was paid down. Show your work.

Explanation / Answer

$6,000 interest is fully deductible, the loan taken i.e., $60,000 is to be considered as a home equity loan. According to publicatoin no 936 or IRS, the amount that can be treated as home equity debt is $50,000 if married filing separately or the balance of the fair market value - Home acquisition debt. which ever is lower.

In the mentioned case, the fair market value over the home acquisition debt would be definitely more than the $50,000.

Hence, the amount that can be treated as home equity loan is $50,000. Also the interest paid on $60,000 loan is $6,000, proportionately interest attributable to the $50,000 loan is ($6,000/$60,000)*$50,000 = $5,000.

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