Home Equity Loan Interest Still Deductible, According to IRS
Following a surplus of questions from taxpayers and tax professionals alike, the IRS announced last week that taxpayers still have opportunities to deduct interest paid on home equity loans under the Tax Cuts and Jobs Act. Not every circumstance will allow for the home equity interest deduction, however – only those in which the money is used to “buy, build or substantially improve” the taxpayer’s home for which the loan was secured.
These new criteria apply to traditional home equity loans, home equity lines of credit (HELOC) and second mortgages, regardless of how the loan is labeled. To meet the new parameters of the tax reform law, taxpayers will not be able to deduct interest on debt used to pay personal living expenses, such as credit card debt.
Questions initially arose as a result of the tax reform provision which limits the mortgage interest deduction to $750,000 of qualified residence loans ($375,000 for a married taxpayer filing separately) for years 2018 through 2026. The limit had previously been $1 million ($500,000 for separate filers).
These limits now apply to the combined amount of loans used by taxpayers to buy, build or improve their homes – whether first mortgages, second mortgages or home equity loans.
To further illustrate how taxpayers can and cannot deduct mortgage interest under the new tax law, the IRS provided the following three 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 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.
For more information on how mortgage interest and home equity loan interest deductions are impacted by the Tax Cuts and Jobs Act above, please contact MFA’s Tax Team.
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