Mortgage and Home Equity Loan Interest Deductions Under the Tax Cuts and Jobs Act

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Presented by Kris Maksimovich

With its passage in December 2017, the Tax Cuts and Jobs Act (TCJA) changed the deductions for interest on mortgage and home equity loans. What is not clear, however, is how to apply those changes to residential debt.

The source of this ambiguity is twofold: (1) definitions from the 1986 “old” tax law and (2) the multiple ways to use home equity. The possible result? The interest on some refinanced mortgages and home equity loans and lines of credit may be deductible under the TCJA. Here, we’ll provide some clarity on this issue, starting with a definition of residential debt.

How does the Internal Revenue Code define residential debt?

The mortgage interest deduction began under the Tax Reform Act of 1986 (a.k.a. the old tax law). This law allowed a deduction for qualified residence interest in two separate categories: acquisition indebtedness and home equity indebtedness. It defined “acquisition debt” as new or refinanced secured debt used to acquire, construct, or substantially improve a residence. It defined “home equity debt” as secured debt that could, but did not have to, be used to acquire, construct, or improve a house.

The TCJA did not change or modify either definition.

What interest can be deducted?

Prior to 2018, you could deduct interest on mortgage debt up to $1,000,000. The $1,000,000 could be either a single mortgage or a total combined mortgage debt on a primary residence and a vacation home.

You could also deduct up to $100,000 of the interest paid on home equity loans and lines of credit. This interest was deductible irrespective of how you used the loan proceeds. Debt consolidation? Deductible. College tuition? Deductible.

Under the TCJA, however, only acquisition debt qualifies for the interest deduction. Obviously, mortgages are loans for the acquisition or construction of a home. The TCJA caps the interest deduction for mortgages obtained after January 1, 2018, at $750,000. All mortgage debt secured before December 31, 2017, is grandfathered under the old rules. This means that the $1,000,000 limit still applies to mortgages that existed before the end of last year.

The TCJA also eliminates the interest deduction for home equity loans and lines of credit. Here, it contains no grandfather provisions. Even if a home equity loan or line of credit was taken before December 31, 2017, an interest deduction on its remaining balance may depend entirely on whether the debt is acquisition debt.

Will interest on a home equity loan or line of credit used for home improvement be deductible?

Maybe. This is one of the ambiguities that the Internal Revenue Service (IRS) must clarify. The TCJA kept the old tax law’s definitions of acquisition debt and home equity debt; however, the TCJA looks only at the use of the debt. That is, interest is deductible if the loan is acquisition debt used to build, acquire, or improve a home. The fact that a primary residence secures a new home equity loan or line of credit is irrelevant.

Home equity loans and lines of credit are often, but not always, used to improve a residence. For example, a home equity loan used for debt consolidation or college tuition does not qualify as acquisition debt because it does not enhance the home’s value. On the other hand, the same home equity loan used to build an addition that increases the home’s cost basis and improves its market value appears to meet the definition of acquisition debt.

Will a refinanced mortgage qualify as acquisition debt?

Again, maybe. This is another aspect of the TCJA that lacks clarity. The original mortgage was acquisition debt. But what if part of the refinancing is used to pay off credit cards? The interest on that portion of the refinanced loan is not acquisition debt.

Is there general agreement that interest on a refinanced mortgage or home equity loan may be deducted if it meets the definition of acquisition debt?

No. Some tax preparers take a literal approach. They read the TCJA as barring a deduction for all home equity debt, irrespective of its use. Others take a more practical view. They interpret the TCJA in conjunction with the old tax law’s definition of acquisition debt.

You can help prepare for this uncertainty by documenting and tracking the use of home equity debt.

Unknown territory

As you can see from this discussion, until the IRS provides guidance on the implementation of the TCJA, we are in unknown territory. Specifically, clarification is needed regarding what home equity and refinanced mortgage debt qualifies for an interest deduction. While we await further details, however, focus on what we do know and prepare for the potential possibilities.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. 

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Kris Maksimovich is a financial advisor located at Global Wealth Advisors 18170 Dallas Parkway, Suite 103, Dallas, TX 75287. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (972) 931-3818 or at info@gwadvisors.net.

© 2018 Commonwealth Financial Network®

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