Last year’s Tax Cuts and Jobs Act removed the itemized deduction for home equity interest for 2018 onward. At first blush this would appear a straightforward prohibition of the deduction for interest on any loan not used for the original purchase of a home. As with many things in tax, a laymen’s reading of the rules produces a misleading result. The interest on many of these second loans and lines of credit are still deductible. The difficult part is determining which ones and how much.
The confusion stems from a tax term of art, “home equity interest”. In tax parlance this means something more specific than interest on a second loan secured by a personal residence. When used as a tax term of art the definition narrows to debt secured by a personal residence, not used to buy, build, or improve a home. As such, the use of the funds matters as much as what secures the debt. For example, if a HELOC is used to pay for a new car, a child’s college tuition, or consolidate debt, the interest thereon will count as home equity debt and the interest will not be deductible. However, if used to pay for a bathroom renovation or to build a deck it will not count as home equity debt and the interest thereon will be deductible. If the line of credit is used for both purposes, the interest paid will need to be prorated between the non-deducible and deductible portions. A similar result is had when a home’s primary mortgage is refinanced for more than the remaining debt and the additional proceeds are not used to improve the home.
With less filers itemizing their personal deductions under the new tax regime, it’s unclear how much impact this restriction will have, or how the IRS will move to enforce this change. While a similar rule existed for taxpayers subject to the alternative minimum tax, it has rarely been scrutinized. Alternately, the IRS may take an aggressive position, challenging most second mortgage interest deductions and leaving taxpayers to defend them. Whichever way the IRS jumps on enforcing this change, it’s important for taxpayers to get it right without forfeiting any deductions they’re entitled to. If you would like to discuss how the new home equity interest restriction applies to your situation, please feel free to reach out to us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director