Contrary to early reports, the Tax Cuts and Jobs Act of 2017 allows taxpayers who buy, build or substantially improve their homes using either a home equity loan, home equity lines of credit (HELOC) or second mortgages to deduct interest on the loans. That’s the good news. But if you take out the loan to pay for personal living expenses—credit card debt, for instance—you can’t deduct the interest from your taxes.
The IRS gave this guidance in response to many questions from taxpayers like you, as well as tax professionals. The agency explained that, just as older rules had specified, the loan must be secured by your main home or second home—known in IRS parlance as qualified residences—and must not exceed the cost of the home.
There is, though, a lower dollar limit on mortgages qualifying for the home mortgage deduction: You may deduct interest on only $750,000 of qualified residence loans. The maximum is $375,000 if you’re married and filing a separate return, which is also down from prior limits. These limits apply to the combined amount of loans used to buy, build or substantially improve your main or second home.
The IRS gave three examples to help clarify its thinking:
- If you buy a home with a fair market value of $800,000 with a $500,000 mortgage in January and then, the very next month, you decide to take out a $250,000 home equity loan to put an addition onto that home, all the interest on the loans are deductible. Why? The loans are secured by the main home and don’t exceed the cost of the home. At the same time, the amount of both loans doesn’t exceed $750,000.
- You buy a main home with a $500,000 mortgage and then, the next month, you take out a $250,000 loan for a vacation home. The amount of both mortgages doesn’t exceed $750,000, so all the interest is deductible. However, if you take the $250,000 home equity loan on the main home to buy a vacation home, you are out of luck. No deducting the interest.
- Similar game: You take out a $500,000 mortgage to purchase a main home. Your loan is secured by the main home. The next month, you take out a $500,000 loan to purchase a vacation home. This loan is secured by the vacation home, but, as you have figured out, the mortgages exceed the $750,000 limit, and so not all the interest paid on the mortgages is deductible. You get to deduct just a percentage of the total interest paid.
The key takeaway here is that the rules are subtle but complicated, and an error can cost you thousands of dollars. Before making assumptions about the tax implications of any mortgage product, give us a call and we’ll see how the rules apply to your situation.