IRS Clarifies New Tax Law Did Not Kill Home Equity Loan Interest Deduction

By Mary Lundstedt

Frost & Associates

 

According to the February 21, 2018, IRS news release, IR-2018-32, there are still circumstances for which interest on home equity loans is still deductible under the Tax Cuts and Jobs Act of 2017. The IRS has now clarified that "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 [emphasis added]."

Before the Tax Cuts and Jobs Act of 2017, a taxpayer who itemized deductions, could deduct mortgage interest for the acquisition of a qualified residence in an amount up to $1,000,000, plus an additional $100,000 of home equity debt. "Acquisition debt" is considered a loan used to buy, build or substantially improve the home, leaving any other mortgage debt as "home equity debt."

Under the Tax Cuts and Jobs Act of 2017, the deduction for interest on home equity indebtedness is suspended for tax years beginning after December 31, 2017, and before January 1, 2026. The language of the new tax law left many tax professionals and taxpayers concerned that interest paid on "home equity debt" might no longer be deductible under any circumstances.

The IRS advised that, pursuant to the Tax Cuts and Jobs Act of 2017, the deduction for interest paid on home equity loans and lines of credit is suspended from 2018 until 2026, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. For instance, the new law typically allows an interest deduction when a home equity loan is used to build an addition to an existing home; however, interest on the same loan used to pay a credit card debt for personal expenses is not deductible.

Furthermore, beginning in 2018, taxpayers are only allowed to deduct interest on $750,000 of qualified residence loans. The new lower dollar limit, stated the IRS, applies to "the combined amount used to buy, build or substantially improve the taxpayer’s main home and second home."

The IRS provided the following examples to further illustrate the new law’s impact on the deduction:

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. A percentage of the total interest paid is deductible (see Publication 936).

If you have questions regarding a home equity loan and tax implications, please contact Frost & Associates, LLC at 410-497-5947.