On January 1 of year 1, Jason and Jill Marsh acquired a home for $500,000 by paying $400,000 down and borrowing $100,000 with a 7 percent loan secured by the home. On January 1 of year 2, the Marshes needed cash so they refinanced the original loan by taking out a new $250,000 7 percent loan. With the $250,000 proceeds from the new loan, the Marshes paid off the original $100,000 loan and used the remaining $150,000 to fund their son’s college education.

a) What amount of interest expense on the refinanced loan may the Marshes deduct in year 2?

b) Assume the original facts, except that the Marshes use the $150,000 cash from the refinancing to add two rooms and a garage to their home. What amount of interest expense on the refinanced loan may the Marshes deduct in year 2?