Q:
I read that with the new tax law, interest on home equity lines of credit was no longer deductible. Is this true?
A:
Good question, and it's one that's stumped CPAs and tax professionals since the new tax law was passed. Finally, the IRS has cleared things up. And it's good news for homeowners considering financing a remodel using a home equity line of credit (HELOC). While we can't offer tax advice, I am happy to report that the IRS has just confirmed in a recent advisory that interest paid on a HELOC is still tax deductible . . . in certain circumstances.
With the passage of the Tax Cuts and Jobs Act of 2017 in December, the fate of HELOC tax deductions was uncertain. While the interest deduction is indeed suspended until 2026, there is one substantial loophole: you can still deduct if you use borrowed HELOC funds to "buy, build, or substantially improve" the home securing the loan.
Here are examples of expenses that would likely render interest on the loan deductible or not:
Deductible
- Building an addition
- A kitchen renovation
Not Deductible
- Personal living expenses
- Paying off credit card debt
An example of a HELOC interest deduction
Here's what it might look like in practice. Say you own a Seattle home, worth $800,000, and you have a mortgage balance of $350,000 at a low 3.25% interest rate. Perhaps your kitchen is in need of a $150,000 renovation, and you would like to tap the substantial equity you have in your home. You could do a "cash-out" refinance and use the funds to pay for the improvement, but then your entire balance would be subject to today's higher interest rates.
Another option would be to apply for a $150,000 HELOC. This would allow you to keep your low rate on your original mortgage. You would then draw on your line of credit periodically to pay for your remodeling expenses. The interest on both your HELOC and your original mortgage would be deductible, up to the limits listed below.
Mortgage Interest Deductibility Limits
You may have heard that the new tax law has lowered the limit on mortgages that qualify for the interest deduction, and this is true. Here's what the IRS states:
Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return.
Keep in mind that the limits above are for total qualifying mortgage debt. So if you have a mortgage with a $500,000 balance and you take out a $250,000 HELOC to finance a remodel, you will have reached the limit and cannot deduct interest on additional mortgage debt.
See also: Interest on Home Equity Loans Often Still Deductible Under New Law [IRS.gov]
The IRS provides the following examples:
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 (see Publication 936).
While everyone's unique situation is different and we cannot offer tax advice, I hope this article provides some insight into your options after the recent tax law changes. For more information about whether the interest you pay on mortgage debt is deductible, visit the IRS website and consult a tax expert.
See also: Can I Deduct a Remodel on My Taxes?
