After much confusion and a flood of inquiries following passage of new tax reform legislation, the Internal Revenue Service on Feb. 21 advised taxpayers that, in many instances, they can continue to deduct interest paid on home equity loans.
Responding to many questions received from taxpayers and tax professionals, the IRS said that despite newly-enacted restrictions on home mortgages, taxpayers often can still deduct interest on a home equity loan, home equity line of credit or second mortgage, regardless of how the loan is labelled. The Tax Cuts & Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
As under prior law, the loan must be secured by the taxpayer’s main home or second home — known as a qualified residence — not exceed the cost of the home, and meet other requirements.
Realtors were pleased with the IRS announcement clarifying and confirming that under the new tax law owners can continue to deduct the interest on a home equity loan, line of credit or second mortgage when the proceeds are used to substantially improve their residence.
“There has been much confusion on this issue,” said Elizabeth Mendenhall, president of the National Association of Realtors. “The continued deductibility will bring real benefits to those who choose to take on remodeling projects to bring more resale value to their home or gain equity that may have been lost during the downturn.”
For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans.
The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return.
The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.
M. Dean Vincent is the 2018 chairman of the Santa Clarita Valley Division of the 9,800-member Southland Regional Association of Realtors. David Walker, of Walker Associates, co-authors articles for SRAR. The column represents SRAR’s views and not necessarily those of The Signal. The column contains general information about the real estate market and is not intended to replace advice from your Realtor or other realty related professionals.
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 IRS Publication 936)
