Research Problem 1
1. Discuss the different types of interests and the IRS rule related to the deductibility of each type for tax purposes.
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. There are different types of interests, including investment interest, qualified residence interest, student loan interest, and personal interest, which are either deductible or nondeductible. Personal interests are interests on car loans, credit cards, loans for appliances and furniture and interest on loans made by one person to another. Personal interest is nondeductible. If interest is paid on a qualified student loan, taxpayers may be able to deduct the interest as deduction for AGI. Generally, the allowable amount for student loan is lesser of $2,500 or the amount of interest taxpayer actually paid. Investment interest is interest paid on money borrowed to purchase or hold investment property. It is tax deductible on income tax return up to the amount of the net investment income. However, if the interest is incurred to produce tax exempt income, it cannot be deducted. Investment interest is not any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. The qualified residence interest is interest taxpayer pays on a loan secured by one’s main home or a second home. The loan may be a mortgage to buy primary home, a second mortgage, a home equity loan, or line of credit. The main home is where taxpayer lives most of the time. A second home is other residence taxpayer owns and treats as a second home. If the second home is rented, taxpayer must also use it as a home during the year for more than the greater of 14 days or 10% of the number of days it’s rented, for the interest to qualify as qualified residence interest. Home equity loan interest usually is nondeductible unless the loan is used to buy,...