On Feb. 21, 2018, the IRS released IR-2018-31, Interest on Home Equity Loans Often Still Deductible Under New Law, explaining that in many cases, taxpayers will be able to continue to deduct interest paid on home equity loans, home equity lines of credit (HELOC) or second mortgages under Sec. 163.
Recently enacted federal tax reform suspended the deduction for interest paid on home equity loans and lines of credit unless used to buy, build or substantially improve the taxpayer’s home that secures the loan. Interest on a home equity loan used to pay personal living expenses, such as credit card debts would not be deductible. The suspension is effective for tax years 2018 through 2025.
Additionally, the prior law capped the total “acquisition indebtedness,” essentially the amount secured by the residence, to a total of $1 million. For the period of the suspension, the total cap has been reduced to $750,000 for indebtedness incurred on or after Dec. 15, 2017. The cap applies to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.
The guidance provides three examples to help illustrate the new rules. Two of the examples are especially noteworthy and are reproduced in their entirety below:
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 1 emphasizes that in order for the interest to be deductible, the proceeds from the loans must be used to buy, build or substantially improve the home.
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.
Similar to Example 1, not only must the loans be used to buy, build or substantially improve the home, the home that secured the loan must be the home where the work occurs.
The IRS also reminds taxpayers that, as was the case under the prior law, there are a number of eligibility requirements to deduct the interest including that the loan must be secured by a taxpayer’s main or second home and not exceed the cost of the home. Certain taxpayers under contract by Dec. 15, 2017, who close on the purchase of a principal residence before Jan. 1, 2018 and who purchase such residence by April, 1, 2018, may still qualify for the higher $1 million cap. Additional information about the home mortgage interest deduction can be found in Publication 936.
Taxpayers with questions about the new interest deduction provisions should speak to their tax advisers with questions. For more information on federal tax reform, please visit RSM’s Tax Reform Resource Center.