0. Assignment Problem Seven - 1

   (Interest Deductibility - 4 Cases)

   Each of the following independent Cases involves the payment of interest and the issue of whether the interest will be deductible for tax purposes.

   Case A Monica Lewis acquires a $700,000 mortgage on her Toronto condo and immediately transfers the entire amount to her brokerage account. The full amount is invested in high tech stocks that she anticipates will double in value during the coming year.

   Unfortunately, instead of doubling, the stocks lose 60 percent of their value. They are sold dur- ing the year for $280,000, with the proceeds being used to pay off a portion of the mortgage. The balance of $420,000 ($700,000 - $280,000) is still outstanding at the end of the year. She is uncertain as to when she will be able to pay off this remaining amount. Can she continue to deduct the interest on the amount of the outstanding balance? Explain your conclusion.

   Case B Garner Blake borrows $850,000 in order to purchase a a duplex that he intends to rent to arms length tenants. After not being able to rent either property for a period of 18 months, he sells the property for $600,000. Recognizing that the market for duplex rentals is weak, he acquires two single family rental properties, the first for $250,000 and the second for $350,000. Explain how the original $850,000 proceeds from the loan can be allocated to the two properties.

   Case C Perry Carson acquires a rental property for $575,000, with 100 percent of this value being financed by a bank loan. Several years later, when the bank loan has been paid down to $500,000, he sells the property for $825,000. He uses the proceeds to acquire two other rental properties, the first for $375,000, the second for $450,000. The bank loan is maintained with the balance remaining at $500,000. Explain how the $500,000 balance of the loan can be allocated to the two properties.

   Case D On his first sighting of the vehicle, Thomson Fraser immediately falls in love with the $525,000 Rolls Royce SUV. His bank would be happy to finance this purchase with a loan that bears interest at 7.5 percent.

   However, he can borrow the same amount using a margin loan against the securities in his substantial trading account. As the rate here is only 4 percent, he chooses this alternative for financing his dream vehicle. As the loan is using income-producing securities as collateral, he assumes that he will be able to deduct this interest. Is he correct? Explain your conclusion.