Current Law (2017 tax year)
Qualified residence interest means interest paid or accrued during the taxable year on either acquisition indebtedness or home equity interest. A qualified residence means the taxpayers principal residence and one other residence of the taxpayer selected to be a qualified residence. A qualified residence can be a house, condominium, cooperative, mobile home, house trailer or boat.
Acquisition indebtedness is indebtedness that is incurred in acquiring, constructing, or substantially improving a qualified residence of the taxpayer and which secures the residence. The maximum amount of acquisition indebtedness is $1 million ($500,000 for a married taxpayer filing a separate return).
Home equity indebtedness is indebtedness (other than acquisition indebtedness) secured by a qualified residence. The amount of home equity indebtedness for which an interest deduction is allowed may not exceed $100,000 ($50,000 in the case of married filing separately).
New Law
In the case of taxable years beginning after December 31, 2017, and beginning before January 1, 2026, a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 in the case of married taxpayers filing separately). This applies to indebtedness acquired after December 15, 2017. In the case of acquisition indebtedness incurred before December 15, 2017, this limitation is $1,000,000 ($500,000 in the case of married taxpayers filing separately). That means the $1,000,000 limit on acquisition indebtedness incurred before December 15, 2017 is grandfathered. For taxable years beginning after December 31, 2025, a taxpayer may treat up to $1,000,000 ($500,000 in the case of married taxpayers filing separately) of indebtedness as acquisition indebtedness, regardless of when the indebtedness was incurred.
A taxpayer who has a mortgage in place at December 15, 2017 may refinance that debt. The interest will remain deductible even if the debt in refinanced after December 15, 2017 and exceeds $750,000 (but not in excess of $1,000,000) provided the amount of the indebtedness resulting from the refinancing does not exceed the amount of the refinanced indebtedness. Therefore, the maximum dollar amount that may be treated as principle acquisition indebtedness will not decrease by reason of the refinancing.
The TCJA suspends the $100,000 home equity interest deduction after December 31, 2017 and before January 1, 2025, as defined in the prior law but will allow certain types of home equity interest as a deduction in the future (see below).
New Guidance
Update IRS News Release 2018-32
On February 21, 2018, the IRS released a news release providing additional guidance on home equity loans. The news release adds new information regarding home equity loans. Under the new law, 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 expense is not deductible. As under prior law, the loan must be secured by the taxpayer’s main home or second home, not exceed the cost of the home and meet other requirements.
The IRS provided three examples to illustrate these points which are included below. As we have stated, there will be a continuous flow of information from the IRS which will direct how the TCJA is ultimately implemented.
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 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.
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. A percentage of the total interest paid is deductible.
The new interpretation by the IRS in News Release 2018-32 is taxpayer friendly. There was the potential under the new law for all home equity loan interest to be disallowed. The $100,000 home equity interest deduction allowed under the old law is still not allowed during the suspension period.
Caution: This explanation is general in nature and should not be used for specific planning. Contact a tax professional for your specific planning needs.