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Tuesday, February 27, 2018
IRS says interest on home equity loans can still be deducted
The Internal Revenue Service said Wednesday that taxpayers can continue to deduct the interest they pay on home equity loans “in many cases,” despite the new tax law's limitations on the mortgage interest deduction.
The IRS is getting blitzed by questions from taxpayers and tax professionals alike, asking if the restrictions in the Tax Cuts and Jobs Act on the mortgage deduction also apply to home equity loans. The IRS said Wednesday that despite the newly enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, a home equity line of credit or a second mortgage, no matter how the loan is labeled. The new tax law that was passed in December suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, the IRS pointed out, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
For instance, under the new tax law, the interest on a home equity loan for building an addition to an existing house is usually deductible, although interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan needs to be secured by the taxpayer’s main home or by a second home, known as a qualified residence. But it can’t exceed the cost of the home, and the loan also needs to meet other requirements.
While the new tax law was being negotiated last year, the mortgage industry and home builders were worried that lawmakers might eliminate the mortgage interest deduction entirely. However, in the end, lawmakers decided to scale back the upper limitations on the deduction instead of getting rid of it completely.
For taxpayers who are trying to decide whether to get a mortgage, the IRS noted that the new tax law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Starting this year, taxpayers can only deduct interest on $750,000 of qualified residence loans, or $375,000 for a married taxpayer filing a separate return. That’s down from the previous limits of $1 million, or $500,000 for a married taxpayer filing a separate return. The limits apply to the total amount of loans used to purchase, build or substantially improve a taxpayer’s main home and a second home.
The IRS provided a few examples to show how the new law works:
Example 1: In January 2018, a taxpayer gets a $500,000 mortgage to buy a main home with a fair market value of $800,000. The following month, 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 doesn’t exceed the home’s cost. Because the total amount of both loans doesn’t exceed $750,000, all the interest paid on the loans is deductible. But 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 wouldn’t be deductible.
Example 2: In January 2018, a taxpayer gets a $500,000 mortgage to buy a main home. The loan is secured by the main home. The following month, the taxpayer takes out a $250,000 loan to buy a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages doesn’t exceed $750,000, all the interest paid on both mortgages is deductible. But if the taxpayer got a $250,000 home equity loan on the main home to buy the vacation home, then the interest on the home equity loan wouldn’t be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to buy a main home. The loan is secured by the main home. In February 2018, the taxpayer gets a $500,000 loan to buy a vacation home. That loan is secured by the vacation home. Because the total amount of both mortgages is more than $750,000, not all the interest paid on the mortgages is deductible, but a percentage of the total interest paid would be deductible.