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 $36,000 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 $2,450. They also found a three-bedroom home that would cost $136,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $100,000 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 $36,000 if they don’t purchase a home. Also, consider the following information:

The couple’s marginal tax rate is 24 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 $3,800.

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 5 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)? (Round your intermediate calculations to the nearest whole dollar amount.)

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 $36,000 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 $2,450. They also found a three-bedroom home that would cost $136,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $100,000 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 $36,000 if they don’t purchase a home. Also, consider the following information:

The couple’s marginal tax rate is 24 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 $3,800.

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 5 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.)

rev: 12_18_2018_QC_CS-151658

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)? (Round your intermediate calculations to the nearest whole dollar amount.)

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 $36,000 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 $2,450. They also found a three-bedroom home that would cost $136,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $100,000 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 $36,000 if they don’t purchase a home. Also, consider the following information:

The couple’s marginal tax rate is 24 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 $3,800.

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 5 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.)

rev: 12_18_2018_QC_CS-151658

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)? (Round your intermediate calculations to the nearest whole dollar amount.)

          

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 $36,000 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 $2,450. They also found a three-bedroom home that would cost $136,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $100,000 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 $36,000 if they don’t purchase a home. Also, consider the following information:

The couple’s marginal tax rate is 24 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 $3,800.

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 5 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)? (Round your intermediate calculations to the nearest whole dollar amount.)

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.)

          

d. Assume that on March 1, 2018, the Jacobys sold their home for $159,000, so that Derek and Meagan could accept job opportunities in a different state. The Jacobys used the sale proceeds to (1) pay off the $100,000 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 $75,000. 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?

e. Assume the same facts as in part (d), except that the Jacobys sell their home for $124,500 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 24 percent and assume that they do not have any other transactions involving capital assets in 2018.

Answer 1

a	Rent the home	$28,050
		Amount-$	Calculation
1	Monthly Rent	-2450
2	Total Rent Payments for the year	-29400	1*12 months
3	Interest Earned on inheritance	1800	36000*5%
4	Taxes on Earnings	-450	3*25%
5	After tax interest earnings	1350	3+4
	Total after tax cost of renting for first year	-28050	2+5
b	Break Even point in yrs	1.67 yrs
1	Initial Cash Outflow from paying points	-2000	$100000*2%
2	Tax Benefit from deducting points	500	1*25%
3	After tax cost of points	-1500	1+2
4	Before tax savings per yr from 4.5% V/S 5.7% int rate	1200	100000*(5.7-4.5)
5	Foregone Tax Benefit per yr of higher interest rate	-300	4*25%
6	After tax savings per yr of 4.5% VS 5.7% int rate	900	4+5
	Break Even in yrs	1.67	3/6
c	After tax cost	$7,125
1	Marginal Tax Rate	25%
2	Mortgage Principal	100000
3	Mortgage interest rate	5.70%
4	First yr interest payment	-5700	2*3
5	Tax savings from interest payments	1425	1*4
6	After tax cost if interest payments	-4275	4+5
7	Deductible property taxes for yr	-3800
8	Tax savings from property tax deduction	950	1*7
9	After tax cost of real property taxes	-2850	7+8
	After tax cost of buying home for 2018	-7125	6+9
d
1	Sales Proceeds	159000
2	Sales commission	-10000
3	Amount Realized	149000	1+2
4	Basis in Home	-136000	Initial purchase price assume interest only payments on mortgage
5	Gain Realized	13000	3+4
6	Exclusion for sale of home	13000	Because after two months the jacobs moved for work reasons they qualify for a max exclusion on their home
7	Gain Realized and taxes payable on gain	-
d 1	Realized Gain /(loss)	13000
	Recognized gain /(loss)	-
d 2	Taxes Payable on gain	-
e
1	Sales Proceeds	124500
2	Sales Commission	7500
3	Amount Realised	132000	1+2
4	Basis in home	-136000	initial purchase price assume interest only payments on mortgage
5	Loss Realized	-4000	3+4
	Effect of loss on Jacobs tax liability	-	Loss not deductible because it is a personal loss no effect on tax liability
	Effect of loss on Jacobs tax liability	-