On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $2.25 million by paying $540,000 down and borrowing the remaining $1.71 million with a 10 percent loan secured by the home.

a.

What is the amount of the interest expense the Franklins may deduct in year 1?

b.

Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $334,000 secured by the home at a 10 percent rate. They make interest-only payments on the loan during the year. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)? C. Assume the same facts as in (b), except that the Franklins borrow $87,500 secured by their home. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?