This time it’s clarification of the home equity mortgage deduction, and as with the business meals issue, it’s not as bad as it had first seemed! The more the details from the broad rules last February have come out, the more we are liking the news! When business meals were first named as no longer deductible, we thought it would be changing the landscape of the power lunch. But, details released later softened the blow and it came to light that what the IRS was actually after was a much more targeted class of meals inside entertainment and around employee cafeterias and the like. Now, the details have come out on another headline item that made people groan when first announced: The home equity loan was initially reported to be gone…but wait. It’s not gone, but it appears that the deduction on the interest of the funds that had been widely used for almost anything from paying off student loans to credit card debt is what the service was after. They will still allow up to a limit of $750,000 of mortgage and home equity interest to be deductible, as long as the equity removed is used for the home itself. After reading the rules it seems the sentiment is that if you spent it correctly then the house will retain the mortgaged value or more when paid down. They just don’t want to make it easy to borrow the value to spend on almost anything, as it was before.
For the nerds who want exact wording to back this up, the new law, at Section 11043, says:
“(i) IN GENERAL. In the case of taxable years beginning after December 31, 2017, and before January 1, 2026
(I) DISALLOWANCE OF HOME EQUITY INDEBTEDNESS INTEREST. Subparagraph (A)(ii) shall not apply.
(II) LIMITATION ON ACQUISITION INDEBTEDNESS. Subparagraph (B)(ii) shall be applied by substituting $750,000…
The wording around this (II) means that “despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labeled.” Specifically, the new law eliminates the deduction for interest paid on home equity loans and lines of credit (through 2026) “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
Example : 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.
This is all much better than we had thought. Want to spend your home equity to pay off student loans? You still can. You just need to refi your house as a primary mortgage. Or, if it’s a good time for you to downsize anyway, sell it and buy something smaller, and pay off the other debt with the difference. The art room can be in the garage instead.