Tax Reform Series Part 3-Mortgage and Home Equity Loan Interest Deduction
MORTGAGE AND HOME EQUITY LOAN INTEREST DEDUCTION
With the new Tax Cuts and Jobs Act (TCJA) of 2017 in effect for 2018, many people are asking, “Will I be able to deduct a Home Equity Line of Credit (HELOC) this year?” “Am I still able to deduct my mortgage interest?” I will answer these questions about mortgage interest and home equity loan interest deductions in this blog post.
Mortgage Interest Deduction
Old Law: Prior to the TCJA, you could claim interest deductions of up to $1 million on your primary and a second home or $500,000 if you used married filing separate status.
New Law: The TCJA lowers the limit on the deduction for home mortgage interest from $1 million to $750,000. For 2018–2025, it generally allows a taxpayer to deduct interest on mortgage debt of up to $750,000. If you use married filing separate status, the debt limit is cut to $375,000. The limit remains at $1 million for mortgage debt incurred before December 15, 2017.
Home Equity Loan Interest Deduction
Old Law: Prior to the TCJA, you could claim interest deductions on up to $100,000 of home equity loans, home equity lines of credit (HELOCs), and second mortgages, or $50,000 if you used married filing separate status, regardless of how you used the loan proceeds. Previously, you could also use the funds to pay personal expenses like credit card bills and student loans.
New Law: Interest on home equity loans, HELOCs, and second mortgages is still deductible as long as the loan is used to “buy, build or substantially improve the taxpayer’s home that secures the loan.” These changes are due to expire after 2025.
Under both laws, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence).
When claiming the home equity interest deduction, there are a few things to remember.
1. The money must be used for substantial home improvements or renovations. In Publication 936, the IRS has only defined a “substantial” improvement to a home as one that adds value, adapts a home to a new use, or prolongs its useful life. Some cosmetic adjustments to your house may not qualify for a deduction.
2. You cannot take the deduction if you are using home equity to pay for personal expenses.
3. Renovations must be made to the property on which you are taking out the home equity loan. For example, you cannot take out a loan on your primary residence and use the money to renovate or remodel your beach house.
4. Keep records of your expenses. If you are planning to use a home equity loan or HELOC to pay for home repairs or upgrades, be sure to keep receipts for everything that you purchase and bank statements showing where the money went.
5. Keep in mind that the total amount of mortgage-related debt interest that can be deducted beginning in 2018 is $750,000. The old $1 million cap continues to apply to homeowners who obtained their mortgages on or before December 15, 2017. The cap also applies to refinancing on mortgages taken out on or before December 15, 2017, as long as the new mortgage amount does not exceed the amount of debt being refinanced. For example, say a couple currently has a mortgage of $500,000 and a 4% interest rate on their primary residence. They refinance and get a $600,000 mortgage at an interest rate of 3%. Only the interest on the $500,000 portion of the mortgage is deductible.
Home Equity Loan Interest Deduction Examples
To illustrate, the IRS provided the three following examples:
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home, and the total loan amount does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses—such as paying off student loans or credit cards—the interest on the home equity loan would not be deductible.
Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. However, a percentage of the total interest paid is deductible.