Question

In: Finance

Hazel Nutt plans on living in NYC. Hazel is considering whether she should buy or rent....

Hazel Nutt plans on living in NYC. Hazel is considering whether she should buy or rent.

If Ms. Nutt buys the Co-Op apartment it will cost $550,000.  This price includes all closing costs.

Annual home ownership information:

  • Property taxes:  1.5% of the property price
  • Insurance:  1% of the property price
  • Maintenance:  1.5% of the property price
  • Mortgage loan:  Assume Hazel will get a $450,000, 4%, 30-year interest only (IO) loan. There are no closing costs or points for the mortgage.

Hazel’s marginal income tax rate is 30%. Her effective tax rate is 25%. She files her income tax returns as a single filer

If she rents the same place, it will cost $3,000 per month in rent.

Assume the apartment value is projected to grow 4% each year that Hazel owns the Co-Op.

When Hazel decides to sell, the closing costs associated with selling is 4%

  1. If Hazel buys, what is her total cost of ownership for the first year?  (Include all the annual home ownership costs and expenses, but DO NOT include the purchase price, i.e. acquisition costs).

  1. If Hazel buys, what are the tax-deductible expenses (assume no SALT limits apply) AND what is her tax savings (i.e. the tax shield) from ownership in the first year?  

  1. If Hazel buys, what is her net cash savings (including the tax benefit) from owning vs renting in the first year?  

Hazel Nutt plans on living in NYC. Hazel is considering whether she should buy or rent.

If Ms. Nutt buys the Co-Op apartment it will cost $550,000.  This price includes all closing costs.

Annual home ownership information:

  • Property taxes:  1.5% of the property price
  • Insurance:  1% of the property price
  • Maintenance:  1.5% of the property price
  • Mortgage loan:  Assume Hazel will get a $450,000, 4%, 30-year interest only (IO) loan. There are no closing costs or points for the mortgage.

Hazel’s marginal income tax rate is 30%. Her effective tax rate is 25%. She files her income tax returns as a single filer

If she rents the same place, it will cost $3,000 per month in rent.

Assume the apartment value is projected to grow 4% each year that Hazel owns the Co-Op.

When Hazel decides to sell, the closing costs associated with selling is 4%

  1. If Hazel buys, what is her total cost of ownership for the first year?  (Include all the annual home ownership costs and expenses, but DO NOT include the purchase price, i.e. acquisition costs).

  1. If Hazel buys, what are the tax-deductible expenses (assume no SALT limits apply) AND what is her tax savings (i.e. the tax shield) from ownership in the first year?  

  1. If Hazel buys, what is her net cash savings (including the tax benefit) from owning vs renting in the first year?  

Solutions

Expert Solution

1st Part :

Hazelnut's cost if it owns the property and buying cost is not to be included (for first year)

Annual expenses p.a. Amount(in $)

Property tax (1.5%*550000) = 8250

Insurance expenses(1%*550000) = 5500

Maintenance exoenses(1.5%*550000) = 8250

Interest cost p.a (refer note below)    = 600

Total Expense Cost 22600

Note:

Since we have to calculate the cost in case Hazel buys the property, we need to consider the interest on loan which she needs for financing the cost of the property. Since the loan is available for $4,50,000 only, we assume that for the balance payment for buying the property,she has her own funds.

Secondly, since the loan is an interest only loan, it does not include monthly principal repayment in the first year.It will include only interest payment.

Calculatuion of interest on loan:

Loan amount $4,50,000 Interest rate =4%p.a. Time period= 30 years

Interest amount = 4,50,000*4%*1/30= $600

2nd Part

Tax deductible expenses if she buys the property would include Property tax and interest cost as maintenace cost and insurance expenses are not allowed to be deducted for the computation of tax.

Tax shield from ownership in the first year

=$(8250+600)*25%

= $ 2212.50

3rd Part

Net cash savings from owning vs renting in the first year:

Cost of rent = $ 3000*12= $36,000

Tax sheild for rent payments = 36000*25%=$9000

Cost of renting after tax sheild = $(36000-9000) = $ 27,000(a)

In case she owns the property , total cost as calculated in first part =$22,600

Less: tax shield = $2212.50

Cost after taking effect of tax shield = $(22600-2212)

= $ 20,388 (b)

Net cash savings = (a)-(b)

=27000-20388

= $ 6612


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