The Tax Cuts and Jobs Act of 2017 has introduced many changes to the U.S. tax code which stand to impact millions of taxpayers in 2018 and onward. One significant change for homeowners pertains to modifications in the deductibility of mortgage and home equity interest payments. For many Americans, the mortgage interest deduction is one of the largest single deductions taken on their tax return.
The new mortgage interest deduction rules apply only to new buyers purchasing after December 15, 2017. Under these rules, taxpayers may deduct the interest paid on debt incurred to buy or improve a first or second home on up to $750,000 of debt. For taxpayers with the filing status married filing separately, the limit is $375,000.
Taxpayers who purchased a home before December 15, 2017 will still be able to deduct mortgage interest paid on up to $1,000,000 in debt (inclusive of mortgage and HELOC) until the year 2025. Additionally, taxpayers who refinance are grandfathered into the prior limitations if their debt originated prior to December 15, 2017. Note that this holds true if the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of refinancing.
Under the previous tax law, taxpayers could deduct interest on the now grandfathered $1,000,000 in debt, as mentioned above, along with home equity line of credit (HELOC) interest deduction on $100,000 of debt.
With respect to HELOCs going forward, the new tax law suspends the deduction from 2018 to 2026 unless the loan was or is used to “buy, build, or substantially improve” the home that secures the loan. Using your HELOC to take a vacation, buy a car, pay student loans, or pay off credit cards for example, will no longer be deductible. If you have an existing HELOC (approved before Dec. 15, 2017) and the proceeds were used to substantially improve your home, the interest will remain deductible, so long as you don’t exceed the total cap.
To clarify, the IRS provided the following example:
Assume that in January 2018, a taxpayer took out a $600,000 mortgage to buy a home valued at $900,000. Then, the next month, the taxpayer took out a $150,000 home equity line of credit to build an addition on the home. “Because the total amount of both loans does not exceed $750,000,” the IRS noted, “all of the interest paid on the loans is deductible.” But if the taxpayer used the loan for “personal” expenses, like paying off student loans or credit cards, the interest would not be deductible.
Taxpayers should also be aware that in addition to the changes made to the mortgage interest deduction, the standard deduction for taxpayers married filing jointly has increased to $24,000 for 2018 ($12,000 if single and $18,000 head of household). For many taxpayers, the new standard deduction amounts may prevent the need to itemize their mortgage interest on Schedule A. Keep in mind that your total mortgage interest plus a maximum of $10,000 for real estate taxes/state taxes would be added together when comparing to the standard deduction thresholds.
For example, using first-year interest costs on a 30-year mortgage at the national average rate of 4.32%, a married couple filing a joint return would need mortgage debt of $324,000 (assuming they maximized the $10,000 deduction for RE tax/State tax available) to exceed the $24,000 standard deduction.
A point of note or planning tip for those who expect to be significantly impacted by the mortgage interest deduction rule change is that just because the interest on a home equity loan or acquisition of indebtedness is not allowed to be itemized does not necessarily mean that it cannot be deducted elsewhere on your personal tax return. For example, if a home-equity loan is used to fund an active business or investment, then it may be deductible on other sections of your return. Additionally, mortgage debt and home-equity loans used to purchase rental properties are not subject to the new limitations.
Please do not hesitate to contact us should you have any questions regarding the deductibility of your mortgage or HELOC debt.
Newburg & Company, LLP