Tax Reform for Individuals: Mortgage and Home Equity Loan Interest Changes

With the passage of the Tax Cuts and Jobs Act, there are new limits on the amount of mortgage interest homeowners can deduct for primary and secondary residences. Below are the previous limitations, the new limitations, and impacts homeowners should be aware of.

Previous Law

Previously, taxpayers could deduct mortgage interest on loans of up to $1 million of acquisition indebtedness secured by a qualified residence ($500,000 if married filing separately).  Acquisition indebtedness includes debt that is incurred in buying, constructing or substantially improving the taxpayer’s primary or secondary residence. The prior law also allowed taxpayers to deduct interest paid on home equity loans up to $100,000 ($50,000 if married filing separately).  The home equity debt could not exceed the fair market value of the home less the acquisition debt.

New Law

Mortgage Interest

The new tax law limits the mortgage interest deduction for taxpayers who itemize through 2025.   The new limits cap mortgage interest deductions at $750,000 of acquisition indebtedness ($375,000 if married filing separately).  Mortgage interest pertaining to second residences will still be allowed as a deduction, but will also subject to the new limitation.

Taxpayers who purchased their home or refinanced before December 15, 2017, will be grandfathered into the old law and are allowed to keep the previous $1 million limitation, while homes purchased after that deadline will be required to use the new $750,000 limitation.

Starting January 1, 2026, the $750,000 limitation will revert back to the $1 million limitation for all taxpayers, regardless of when the home was purchased.

Home Equity Loan Interest

There was some uncertainty on how the IRS intended to treat interest paid on home equity loans, and on February 21, 2018, the IRS released IR 2018-32 advising taxpayers that in many cases they can continue to deduct interest paid on home equity loans, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labeled.

The notice indicates that interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by a qualified residence, such as the taxpayer’s main home or second home, and not exceed the cost of the home, among other requirements.

The $750,000 deduction limits apply to the combined amount of mortgage and home equity loans used to buy, build or improve the taxpayer’s main home and second home. Home equity debt is no longer capped at $100,000 for deduction purposes.

Impact on Individuals

For individuals whose homes are valued at less than $750,000 or were purchased before December 15, 2017, the new limits will not affect your mortgage interest deduction. If you have bought or are considering buying a home or second residence over $750,000, you will be limited on the amount of mortgage interest you can deduct.  The amount that will be limited depends on the fair market value of the qualified residence. Homeowners can refinance mortgage debts that existed before December 15, 2017 up to $1 million and still deduct the interest, as long as the new loan does not exceed the amount refinanced.

Contact an Anders advisor with questions on how these tax law changes will affect you.