The country’s new tax laws, ushered in by President Donald Trump and his Republican counterparts late last year, will bring many changes to the mortgage industry.
Namely, the Tax Cuts and Jobs Act reduces the available mortgage interest deduction from $1 million to $750,000.
But what’s the impact of the tax plan on home equity loans, home equity lines of credit, and second mortgages?
Citing the “many” questions it’s received from taxpayers and tax professionals, the Internal Revenue Service issued a bulletin this week that sheds some light on how home equity loans, HELOCs, and second mortgages will be treated under the new tax plan.
The headline news: The interest paid by borrowers on home equity loans, HELOCs, and second mortgages will still be deductible moving forward, but not in every case.
According to the IRS, the Tax Cuts and Jobs Act states that interest paid on home equity loans and lines of credit is still deductible, as long as they money is used to “buy, build or substantially improve” the taxpayer’s home that secures the loan in question.
But if the money is used to pay other expenses, the interest is not deductible.
The IRS explains further: “Under the new law, for example, 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 expenses, such as credit card debts, is not,” the IRS stated. “As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.”
Besides being required to use the money for home improvements and the like, there are other limits on the home equity loan interest deduction
As stated above, beginning this year, taxpayers are only allowed to deduct interest on $750,000 of “qualified residence loans. Additionally, the mortgage interest deduction limit for a married taxpayer filing a separate return is $375,000.
As the IRS notes, these figures are down from the previous limits of $1 million, or $500,000 for a married taxpayer filing a separate return.
The limits apply to the combined amount of loans used to buy, build or improve the taxpayer’s main home and second home, meaning a borrower may only deduct the mortgage interest on a total of $750,000 in loans, whether the loans are first mortgages, second mortgages, or home equity loans.
The IRS bulletin provides three examples to further demonstrate how the mortgage interest deduction works now:
- 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.
