Yes, you can still deduct interest on home equity loans under the new tax law
While the new Tax Cuts and Jobs Act (TCJA) negatively changes the rules of the game for mortgage interest deductions, all is not necessarily lost. Fortunately, many homeowners will not be affected because the “grandfather” provisions keep the rules of the previous law in place for them.
That said, many homeowners will be adversely affected by the TCJA provision which, for 2018-2025, generally prohibits interest deductions for home equity loans. Again, however, all is not necessarily lost. The little-known fact is that you always deduct interest from a home equity loan under certain circumstances. I will explain when after I cover the necessary background information for the first time.
Earlier law: the “good old days” for mortgage interest deductions
Before the TCJA, you could claim itemized deductions from qualifying residential interest on up to $ 1 million of home acquisition debt (that is, mortgage debt incurred to buy or improve your first or second residence and which is guaranteed by that residence), or $ 500,000 if you were married filing a separate status.
Under previous law, you could also claim itemized deductions on qualifying residential interest up to $ 100,000 of home equity debt for regular tax purposes, or $ 50,000 if you had used the status of. married person to report separately, regardless of how you used the loan proceeds. However, for alternative minimum tax purposes, you could only deduct interest if the home equity loan proceeds were used to purchase or improve your first or second home.
Modification of the TCJA for the home acquisition debt
For 2018-2025, the TCJA generally allows you to treat interest on a home acquisition debt of up to $ 750,000 (incurred to purchase or improve your first or second home and secured by that home) as interest on eligible residence deductible. If you use the separate married filing status, the debt limit is reduced to $ 375,000.
TCJA Change for Home Equity Debt
For 2018-2025, the TCJA generally eliminates the prior law provision that allowed you to claim itemized allowable residential interest deductions on up to $ 100,000 of home equity debt ($ 50,000 for those using the statute declaration of separate marriage).
Grandpa’s Rules for Up to $ 1 Million in Home Acquisition Debt
By grandfather rule, TCJA changes do not affect up to $ 1 million in home acquisition debt written: (1) before December 16, 2017 or (2) under ” a binding contract that was in effect before December 16. 2017, as long as your home purchase was closed before April 1, 2018.
Under a second grandfather rule, the TCJA changes do not affect up to $ 1 million in home acquisition debt written before December 16, 2017 and then refinanced later, as long as the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of refinancing.
Home equity loan faqs
With all of this basic information in mind, let’s now focus on when you can and cannot claim an itemized qualifying residential interest deduction on home equity loans for 2018-2025 under the new rules of the TCJA. Here are some questions and answers. Some of the answers may surprise you, in a good way.
Question: I took a $ 100,000 HELOC this year. I spent the proceeds to pay off credit card balances, car loans, and student loans. Can I deduct interest on my 2018 return?
A: This is a situation where the answer is clearly no because you did not spend the loan proceeds to purchase or improve your first or second home. Thus, your HELOC is classified for tax purposes as home equity debt. For 2018-2025, you cannot treat interest on home equity as qualifying deductible residential interest. Sorry.
Question: Can I still deduct the interest on my $ 100,000 home loan that I took out before the new tax law?
A: May be. If you haven’t spent the proceeds to buy or improve your primary or secondary residence, the answer is no, because you can no longer deduct interest on a mortgage loan that is tax-classified as real estate debt.
But if you spent the $ 100,000 of home equity loan proceeds to buy or improve your first or second home, that could be another story. If you have less than $ 900,000 in first mortgage acquisition debt, you can treat the $ 100,000 home equity loan as additional home acquisition debt that does not exceed the $ 1 million limit for. the debt for the acquisition of pre-TCJA houses benefiting from acquired rights. If this is your case, you can consider the interest on both loans to be eligible residence interest deductible.
Question: I took out a first mortgage of $ 500,000 to buy my primary residence this year. Later, I took out a home equity loan of $ 250,000 to pay for an addition to my primary residence. Can I deduct the interest from both loans?
A: Yes. You can treat the two loans as acquisition debt with a combined balance that does not exceed the TCJA limit of $ 750,000. Thus, you can treat the interest on both loans as eligible residence interest deductible.
Question: I took out a first mortgage of $ 500,000 to buy my primary residence this year. This loan is secured by my primary residence. I later took out a loan of $ 250,000 to buy a vacation home. This loan is secured by the vacation home. Can I deduct the interest from both loans?
A: Yes, because the combined balances of the two loans do not exceed the $ 750,000 TCJA limit for home acquisition debt.
Variation: If you instead took out a $ 250,000 home equity loan against your primary residence to purchase the vacation home, the IRS says the interest on the home equity loan is not considered acquisition debt. , as they are not guaranteed by the vacation home. Therefore, according to the IRS, the home equity loan is classified as such for tax purposes, and you cannot treat the interest on this loan as qualifying residential interest deductible, according to the. IRS Information Release IR2018-32.
Question: I took out an $ 800,000 loan to buy my primary residence last year. This year, I opened a HELOC and borrowed $ 80,000 to renovate my bathrooms. How much interest can I deduct for 2018-2025?
A: You can treat the interest on the first mortgage as qualifying residential interest deductible under the grandfather rule up to a maximum of $ 1 million of pre-TCJA acquisition debt. However, given that your $ 80,000 HELOC was purchased in 2018, the TCJA’s $ 750,000 limit on acquisition debt apparently excludes any deduction for HELOC interest. This is because the entire TCJA limit of $ 750,000 on acquisition debt has been absorbed (and more) by your first acquired mortgage of $ 800,000. Thus, the HELOC is apparently to be treated as home equity debt, and interest on home equity debt cannot be treated as qualifying residential interest deductible for 2018-2025.
Question: I took out a $ 650,000 loan to buy my primary residence last year. This year, I opened a HELOC and borrowed $ 80,000 to renovate my kitchen. How much interest can I deduct for 2018-2025?
A: You can treat all interest on the first mortgage as qualifying residential interest deductible under the grandfather rule up to $ 1 million in acquisition debt. The HELOC balance of $ 80,000 can also be treated as acquisition debt, as the combined balance of the first mortgage and HELOC is only $ 730,000, which is below the limit of $ 750,000. of the TCJA. Thus, you can treat the interest on both loans as qualifying residential interest deductible for 2018-2025.
The bottom line
These FAQs illustrate how the TCJA rules for mortgage interest deduction apply in only a few situations. As you can see, it can get complicated. Sorry about that.