The recent tax law changes have many homeowners and home buyers more than a little nervous about real estate purchasing and borrowing decisions and how they will affect your taxes. It is a reasonable concern, but one that is unnecessary for many who already have home loans and quite a few others interested in obtaining them.
Like most laws, there is a great deal of confusion about what it will mean for you. Below are a few essential details you need to know.
Impact of Tax Cut and Jobs Act of 2017
First, the legislation grandfathered in existing home mortgages, so the new law does not affect the mortgage interest deduction on these loans. Many homeowners are wiping more than a little sweat from their brows over this news. There are changes in store for new mortgage loans, though, some of which might be unpleasant for home buyers in high-demand markets.
Second, while these deductions for existing mortgages remain unchanged, new home loans come with limits to the allowable home mortgage deduction to loan values of $750,000 or less.
New Rules for Home Equity Loan and Line of Credit Interest
In the past, many homeowners have taken advantage of the tax deductibility of home equity loan or line of credit interest by using the proceeds from those loans for a variety of purposes. Before the new tax law, how you used the loan proceeds did not matter. The interest on the loan was tax deductible. Under the new law, taxpayers can still deduct interest paid on home equity loans, but with stipulations.
If you use the funds from your home equity loan or line of credit to upgrade or improve the property that secures that loan, for instance, you can continue to deduct mortgage interest from the loan.
However, if you used the loan funds for such things as paying for a vacation, consolidating credit card debt, paying for college expenses or as alternative funds for the purchase of a new car, the interest is no longer deductible.
Previously, you had been allowed to deduct the interest you paid on up to $100,000 in loans and lines of credit, regardless of how you used the money. That has changed and is true for both loans that preceded the new legislation and those that come after.
What it Means to You
Of course, homeowners who are interested in knowing how they might use the equity in their home moving forward, have a few new things to keep in mind.
- The new ceiling, or limit, for combined mortgage and home equity or second mortgage deductions sits at $750,000. That sum that is reduced considerably from the previous limit of $1.1 million.
- How you use the money matters. If you are getting a home equity loan or second mortgage to make improvements to your home, then it is acceptable to deduct those interest payments. However, if you are using them to fund vacations, purchase cars, pay for your kids to go to college, or even to pay off medical bills or credit cards, then you receive no deductions for mortgage interest paid.
The bottom line for you, as a consumer and homeowner, is that you are only able to use the funds from the home equity to reinvest in the home. That can include a variety of actions, such as:
- Remodel your kitchen.
- Update your wiring.
- Add an addition.
- Enclose a garage.
- Finish a basement.
- Add a bathroom.
- Build an outdoor kitchen.
- Create the mancave of your dreams.
- Give her the master bath that will make her heart melt.
You can choose to do any of these things that will add value to your home as long as it falls within IRS rules defining capital improvements to the home and does not exceed a combined total indebtedness that is greater than $750,000.
You should also know that the new rules concerning home equity lines of credit may be beneficial to you. Under the old law, there was a $100,000 cap for home improvements. You could deduct no more than the mortgage interest on this amount, regardless of how much you paid for your updates and renovations.
Under the new law, it can be any amount up to the limit for the combined total, which is $750,000. That means if your mortgage is $500,000 and you completed $250,000 in renovations, you can deduct the interest on the full amount of your mortgage and your home equity loan.
One final note: As IRS regulations and guidance for the Tax Cut and Jobs Act are still being reviewed and issued as of March 2018; taxpayers should monitor the IRS’s Tax Reform page and work with their tax accountant as needed.