Unlocking the HELOC Interest Deductions: Clarifications from the IRS

The IRS published an Information Release on February 21, 2018 clarifying that certain home loan mortgage interest deductions many thought were lost under the new tax act may still be deductible. 1 The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was enacted on December 22, 2017, suspends from 2018 until 2026, any deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build, or substantially improve the home of the taxpayer which secures the loan (acquisition indebtedness).

As a result of the TCJA, taxpayers should know that:

(1) deductibility is capped at the lesser of:

(a) the fair market value of the qualified residence, and

(b) $750,000, if married filing joint or $375,000 otherwise, and

(2) notwithstanding that the TCJA disallows home equity indebtedness by its very definition, some home equity indebtedness is still deductible (due to redefinition in the statute). 2

So, taxpayers must make sure they consider (1) the purpose of the loan, (2) the property which will secure the loan, and (3) the total amount of indebtedness secured by the property.

The IRScontinued by providing a few examples:

Example 1 – A Deductible Home Improvement Loan Under the Value Cap and a Non-Home Improvement Loan Non-Deductible Scenario

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 – A Deductible Loan to Purchase a Second Home Secured by the Second Home and a Non-Deductible Loan Improperly Secured

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 – Working Past the Limit – Beyond the Cap 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 $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. 3

Our clients have historically used home refinancing indebtedness in the past for down payments for investment projects or other debts.  While the landscape may have changed under the TCJA, opportunities are still available.

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Footnotes

  1. IR 2018-32
  2. See IRC 163(h)(3)(C)(1) Here, the term “home equity indebtedness” excludes “acquisition indebtedness”
  3. Examples provided in IR 2018-32