I had a client call me last week that was concerned about a home loan he was taking out. “My loan broker told me interest on home equity loans is no longer tax deductible. Is that true?”
Well, the broker was partially accurate. For 2018, taxpayers may only deduct mortgage interest paid on $750,000 on new qualified residence loans. The limit is $375,000 for taxpayers filing separately. These amounts are down from the $1,000,000/$500,000 limit for qualified residence loans obtained prior to 12/15/2017, which are grandfathered under the Tax Cuts & Jobs Act.
Home equity loans are usually defined as loans taken out after the initial purchase of a home. They are sometimes in the form of a line of credit that can be borrowed as needed.
The answer to my client’s question is that in some cases, interest on home equity loans is still tax deductible. If all of the following conditions are met, the interest on the home equity is still tax deductible:
• The loan must be secured by the taxpayer’s residence.
• The proceeds of the loan must be used to buy, build or improve the home.
• The total qualified indebtedness of loans obtained after 12/15/17 must not exceed the $750,000/$375,000 limit above.
My client was using the loan proceeds for a room addition to his home, so the mortgage interest paid on the home equity loan was tax deductible.
Here are some examples of deductibility of interest paid on home equity loans:
Example 1: In April 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In July 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 tax 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 February 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In June 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. This 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 tax 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. Only a percentage of the total interest paid is tax deductible.
Interest paid on home equity loans that are used for personal purposes is no longer tax deductible. However, interest used for other purposes, such as in a trade or business, may be tax deductible as a business expense. Thus, the use of the proceeds of the home equity loan is important in determining tax deductibility.
Always beware of misinformation regarding income tax deductions. Ask your tax advisor to be sure.
© Daniel J. Domancich, CPA, CFP®