Tax Code Changes You Should Know: What's New for Homeowners

Tax Code Changes You Should Know: What's New for Homeowners
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This is the second entry in a five-part series about changes to the U.S. tax code from the Tax Cuts and Jobs Act. Topics of the other articles include itemized deductions, exemptions, and child/dependent credits; miscellaneous itemized deductions; the Alternative Minimum Tax; and qualified business income.

The Tax Cuts and Jobs Act (TCJA) significantly changed the amount of principal on which interest can be deducted and changed the tax treatment of home equity interest.

Principal Limits

Under the “old” tax law, you could deduct home acquisition interest on mortgages secured by a qualified residence, which is defined as a principal residence and a second home, as long as the combined mortgage amount did not exceed $1 million. Under certain circumstances, it was possible to qualify an additional $100,000 of acquisition debt as home equity debt and be able to deduct the interest on a total of $1.1 million of debt.

Under the TCJA, the limit is reduced to $750,000. Fortunately, if you took out the mortgage prior to Dec. 15, 2017, you are grandfathered in under the old laws. This won't apply if you refinance a loan, though, so be careful if you are looking to refinance a loan in the $750,000 to $1 million range, as you could lose significant deductions.

Home Equity Interest

Under the TCJA, home equity interest is not deductible and, unlike the principal limits, existing home equity debt is not grandfathered. This means if you have home equity interest, you no longer can deduct it. Only home acquisition debt remains deductible. This could cause a lot of problems for taxpayers, because your first mortgage isn't always totally home acquisition debt and your home equity loan is not always home equity debt.

Home acquisition debt is debt obtained for the purchase or improvement of a qualified residence. Conversely, home equity debt is not used for purchase or improvement. Let's look at a couple of examples.

  • Mortgage refinance. Suppose you purchased your home in the '90s and took out a mortgage to pay for it. That would be home acquisition debt. When interest rates went down in 2009, you refinanced it. When you refinanced you took out $50,000 in equity for a really nice family vacation. You have a new first mortgage, so it is all acquisition debt, right? I'd say “no.” The $50,000 you took out for a trip is definitely home equity debt. You (your bank probably won't do it for you) will have to determine the percentage of your interest paid that is actually home acquisition debt.
  • Home equity loans. Deductibility of your interest on loans secured by real estate isn't determined by what it is called, as we saw above. So, if you take out a home equity loan and use the proceeds to improve your home, the interest is deductible regardless of the name.

While a “rose by any other name …” might be true, you won't want to rely on that logic when calculating your deductible mortgage interest.