Can someone please check my answer for the following problem.
The Smiths wish to refinance their home worth $250,000. They originally paid $130,000 for the home and made $25,000 in improvements. The bank is willing to let the Smith refinance $200,000 with no further improvements to be made to the property. On how much of the loan can the Smiths deduct the interest?
My answer: Can deduct the full interest expense.
Yes.
To calculate how much of the loan the Smiths can deduct the interest on, we need to consider a few factors.
First, let's determine the cost basis of their home. The cost basis is the initial purchase price of the home plus any improvements made. In this case, the Smiths originally paid $130,000 for the home and made $25,000 in improvements. Therefore, their cost basis is $130,000 + $25,000 = $155,000.
Next, we need to find the amount of the loan that exceeds the cost basis. In this scenario, the Smiths are refinancing $200,000. Since their cost basis is $155,000, the amount of the loan that exceeds the cost basis is $200,000 - $155,000 = $45,000.
The IRS allows homeowners to deduct the interest on the portion of the loan that exceeds their cost basis, subject to certain limitations. However, in this case, the entire loan amount of $200,000 exceeds their cost basis of $155,000. As a result, the Smiths can deduct the full interest expense on their loan.
So, your answer is correct. They can deduct the full interest expense.