Even though the tax reform package was passed six months ago, we are still figuring out exactly what these changes will look like on our tax returns. One of these changes is now a bit easier to understand thanks to the IRS. You heard that right – the IRS recently released helpful information on the deductibility of home equity loans and mortgages. The Tax Cuts and Jobs Act changed the eligibility for receiving these deductions, which will affect many borrowers who have historically relied upon them to make their loans affordable.
First Things First – What about my Mortgage?
Taxpayers with mortgages to secure their primary home and their vacation home can rest easy; the mortgage interest deduction was not taken away. If you purchased your home before December 16th, 2017, nothing will change for you. However, if you bought your home after that time period, you have a new set of rules to contend with.
Both married and single taxpayers can take a deduction for the interest on up to $750,000 of home acquisition debt, or $375,000 for married taxpayers filing separately. In years past, these numbers had been $1 million and $500,000, respectively.
In the IRS’s informational article, they pointed out that these loans cannot exceed the cost of the home that is securing the debt. This is not a new rule, but it’s one that many people did not fully understand.
Here is an example to illustrate how these rules work in tandem:
In March of 2018, Amy took out a $500,000 mortgage to purchase her main home, and the home itself was used as collateral for the loan. Two months later, Amy took out a $200,000 mortgage to purchase her first vacation home, and the vacation home was used as collateral for the loan. The interest she pays on both of these mortgages is deductible because (1) her total acquisition debt did not exceed $750,000, and (2) her mortgages did not exceed the cost of the homes that were securing them.
In March of 2018, John purchased a home valued at $500,000. He took out a loan for $575,000 and used the excess $75,000 on kitchen renovations. Only the interest on $500,000 of his mortgage will be deductible.
Ok, Now What about Home Equity Loans?
Home equity loans and HELOCs are a type of second mortgage that is secured by the equity you have in your home. Taxpayers often view home equity loans more favorably than other types of debt because (1) they are easier to qualify for, (2) they have lower interest rates than other forms of debt, and (3) they can provide the taxpayer with a very a large sum of money at once. And, until this year, the interest on these loans had been deductible, so there was also a potential tax benefit that drew taxpayers to this type of debt.
Unfortunately, the tax reform package removed this deduction… mostly. Beginning this year, taxpayers can only deduct the interest on home equity loans if they use that money to buy, build, or substantially improve the home that secures the loan. No longer can taxpayers take a deduction if they use the loan proceeds to pay off credit card debt or finance their education. They can certainly choose to use their HELOC for these purposes, but they cannot expect a tax deduction if they do so. Luckily, the rules for this deduction revert back to normal in 2026, so this change is only a temporary inconvenience. And remember, as in years past, only the interest on up to $100,000 of HELOCs are deductible.
What Else Should I Be Thinking About?
Here are just a few more things we’d like you to keep in mind:
- If you refinance your home this year, you will be subject to the newly modified rules that we discussed above if the new loan exceeds the amount of the refinanced indebtedness. Even if your deduction is limited, this may still be a smart move; the rate reduction you receive from refinancing may outweigh the tax savings you will be forfeiting.
- If your mortgage exceeds $750,000, only a portion of your interest will be deductible. Let’s say you paid $36,000 of interest on your $900,000 mortgage this year. When you file your return, you would only be able to deduct $30,000 of that interest ($750,000 ÷ $900,000 x $36,000 = $30,000).
- Even if you have to forfeit the deduction, it may still be a smart financial decision to use your HELOC to pay off higher-interest debt like credit cards or student loans. It will all come down to the math.
- If you choose to use your HELOC to renovate your home, keep track of your receipts in case the IRS requires proof that you spent that money on qualified home improvement expenses.
Our Spire Group professionals are here to help you navigate these new rules. Please contact us if you have any questions.