Home Equity Interest – Deductible or Not?

The new federal tax law created a lot of confusion over whether mortgage interest on home equity loans and lines of credit are still deductible, and the Internal Revenue Service is getting a lot of questions from taxpayers and tax professionals alike. The IRS finally came out with additional guidance, confirming that the majority of taxpayers will still be able to deduct mortgage interest paid on home equity loans and lines of credit, subject to a few restrictions.

The Tax Cuts and Jobs Act of 2017, enacted December 22, 2017, specifically suspended interest paid on home equity lines of credit and home equity loans until 2026… UNLESS the proceeds are used to buy, build or substantially improve the taxpayer’s home that secures the loan. Under the new law, interest on a home equity loan used to build an addition or to improve the home is typically deductible, while interest on the same loan used to pay personal living expenses, such as student loans and credit card debt, is not. As under the new law, the loan must be secured by the taxpayer’s main home or second home, not to exceed the cost of the home and meet other requirements

 

There are also other limitations, such as a combined loan balance limit. Beginning in 2018, only interest paid on $750,000 of qualified residence loans (for taxpayers filing jointly) may be deductible. This limit is reduced to $375,000 for taxpayers filing a single return, and is in place for home acquisition indebtedness obtained after December 16, 2017.

The IRS even provided clarifying guidance and some 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 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 deducible. 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. A percentage of the total interest paid is deductible (see Publication 936).

Posted by JitLeeBillings

Leave a Reply