Home Mortgage Interest Under The New Tax Law
Under the Tax Cuts and Jobs Act (TCJA), you are generally allowed to deduct interest on up to $750,000 of new mortgage debt incurred to buy or improve a first or second residence (so-called home acquisition debt). Initially, there was a lot confusion on whether these limits included home equity debt, until the IRS issued guidance on this subject.
Before the TCJA was enacted, if you itemized your deductions, you could deduct qualifying mortgage interest for purchases of a home up to $1,000,000 plus an additional $100,000 for equity debt. The new law appeared to eliminate the deduction for interest on a home equity loan, home equity line of credit (HELOC) or second mortgage (sometimes called a “re-fi”).
New Law
In the guidance issued by the IRS it states that “despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labelled.” But the IRS made it clear that the deduction on home equity loans and lines of credit depended on how those funds are used. The new law eliminates the deduction for interest paid on home equity loans and lines of credit, “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan”.
The best way to illustrate all of this is to go through several examples. Listed below are three examples courtesy of the IRS:
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 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 and credit cards, then 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. Only a percentage of the total interest paid is deductible.
Refinancing
Interest on a re-fi which is secured by your home (qualified residence) and which does not exceed the cost of your home and which is used to substantially improve your home will continue to be deductible so long as it meets the other criteria – like the new dollar limit discussed at the beginning of this article.
So, interest on that re-fi you were planning on using to build an addition is deductible so long as you otherwise meet the criteria. The same thing goes for interest on a re-fi to build a roof.
However, if you were going to use the re-fi to pay off credit cards, the interest would not deductible. Similarly, there’s no deduction for re-fi interest you were planning on using to pay for college, or take a vacation.
