Homeowners may see less of a tax break this year, thanks to the Tax Cuts and Jobs Act (TCJA). Beginning with homes purchased after December 16, 2017, you can only deduct the interest incurred on $750,000 of mortgage debt on qualifying residences (primary homes and one second residence). Under prior law, the limit was $1 million in mortgage loan debt with an extra $100,000 in home equity debt.
Can you still deduct interest on a home equity loan or a home equity line of credit (HELOC) under the new law? Yes – but only in certain circumstances.
To be deductible, a home equity loan or HELOC must be used to "buy, build, or substantially improve" the home that secures the loan. In addition, the total mortgage debt incurred after the new law took effect – including the home equity debt – must be at or below the cost of the home and below the new mortgage deduction limit ($750,000 for married couples filing jointly or single taxpayers, $375,000 for married filing separately).
You can use a HELOC for any purpose you want, because the loan/line of credit is secured against the equity in your home. The new law only affects whether you can deduct the interest payments.
The IRS issued a few examples to illustrate the point. We'll expand on those examples.
Let's assume you and your spouse take out a $500,000 mortgage on a home with a market value of $800,000 in January 2018. You then take out a $250,000 HELOC to improve your home. You are using the HELOC for home improvement, the total mortgage debt is at the $750,000 limit, and the total mortgage debt is below the $800,000 value of your home. You may deduct all of your mortgage interest debt.
If only half of your HELOC was used for home improvement purposes, you could only claim an interest deduction on $125,000 of the HELOC. (That may still be prudent from a debt-paying perspective, but you won't get the tax advantage.)
If your home value was only $600,000, you would only be able to deduct the interest on the $500,000 mortgage loan plus $100,000 of the HELOC.
Now let's assume a January 2018 mortgage on the same $500,000 home and a second loan in November 2018 to purchase a $250,000 vacation home. If the $250,000 loan is secured against the second home, everything's still deductible – but if you took out a HELOC on the first home to buy the second home, the interest on the second home's debt wouldn't be deductible because the loan was secured by a different home.
If the second home was also $500,000, your total mortgage debt would be $1 million, and you could only deduct interest on up to $750,000 of that debt.
What if you had a $900,000 mortgage that was purchased in 2016 and you want to take out a $100,000 HELOC on that home in 2018? You could deduct interest on the full $900,000 of original mortgage debt under the old rules, but you couldn't deduct any interest on the HELOC because it was incurred under the new rules and your total mortgage debt is above $750,000.
Remember that the interest rates you are charged on your mortgage and HELOC may be influenced by your credit score. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
The rules can be confusing, so if you aren't sure what applies, contact a trusted financial advisor and/or your local IRS office. You'll be ready for your 2018 tax filing and will have clear direction for the future – at least until the next round of legislation or 2026, when these changes are set to expire.
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