Your tax clients, Jack and Diane a married couple filing a joint return, fell in love with a new construction house for sale in their small Illinois hometown. The builder offers two options on the home: purchase with 20% down or rent the home. Assume the following facts and projections when considering the analysis: Jack and Diane both have steady jobs with a current AGI of $120,000. They anticipate annual AGI growth of 3%. The home has a purchase price of $200,000 and is located in an area with an expected annual property value growth rate of 5%. If Jack and Diane purchase the home, they will put 20% down and finance the remainder on a 30 year mortgage at 5.25%. Annual property taxes on the home are 2.6% of the homes value. If Jack and Diane rent the home, they will invest what would have been their 20% down payment into municipal bonds paying an annual interest rate of 4%. The home rents for 1% of the assessed property value per month. Jack and Diane will use the home as their principal residence for all 10 years. Regardless of their decision, Jack and Diane intend to contribute 10% of their AGI each year to their favorite qualified charitable organizations. Jack and Diane intend to move out of the area (but in the same State) in 10 years to support their parents in retirement. Their parents live in an area with substantially similar home costs. Jack and Diane live in a State which imposes a tax on Federal AGI at 4.95%. The model uses 2021 income tax brackets and assumes the inflation adjustments to tax brackets and standard deduction continue as trended from 2019 to 2021.

PLEASE SHOW YOUR WORK

1. What is the effective tax rate in year 4 if Jack and Diane rent? What if they own?