Problem:
On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.8 million by paying $465,000 down and borrowing the remaining $1.335 million with a 11 percent loan secured by the home.
Required:
Question 1: What is the amount of the interest expense the Franklins may deduct in year 1?
Question 2: Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $358,000 secured by the home at a 11 percent rate. They make interest-only payments on the loan during the year. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?
Question 3: Assume the same facts as in (b), except that the Franklins borrow $80,500 secured by their home. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?
Note: Solve the problem and show all work.