Tuesday, February 27, 2018
News Release 2018-32, 02/21/2018
Interest deduction on Home Equity Loans Still Exists Under New Law
With IRS Information Release 2018-32 the IRS provided some illustrations that address certain situations where taxpayers can still continue to deduct interest paid on home equity loans.
We still anticipate that more guidance may be necessary to address the interest tracing rules relating to home equity interest.
New Tax law
The Tax Cuts and Jobs Act of 2017 suspended from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit. There was much discussion whether this was a bright line test that applied to all home equity loans or whether the taxpayer could still deduct the interest if the home equity loan proceeds were used to buy, build or substantially improve the taxpayer's home that secures the loan (following the rules/definition of Qualified Indebtedness).
Effective December 15, 2017 (and binding contracts) anyone considering taking out a mortgage may only deduct interest on loans up to $750,000 ($375,000 for married filing separate) of qualified residence loans. The prior limit was $1 million ($500,000 married taxpayer filing separate).
The IRS outlined the following illustrations:
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 Publication 936).
With the above illustrations, it becomes clear that interest incurred on home equity loans are still deductible if the home equity loan is secured by the residence and the proceeds are used for that same residence. Outside of a direct relationship between the home equity loan and the secured property home equity loan interest is not deductible. Taking this one step further and how this relationship relates to the tracing rules (for example if home equity loans are used for investment property) remains unclear. Using example 2 where tracing was not allowed in purchasing the vacation home; this would imply that using a home equity loan that is secured by your principal residence for investment property purchase the interest would also not be deductible.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT
Olsen Thielen, CPAs
Greg Nelson, Olsen - Thielen CPA's
Adam Hartung, Financial Planner
Steve Stalock, Win Home Inspections
Minnnesota Investment Property
Minnesota First Time Home Buyers
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