Tax Cuts and Jobs Act of 2017: How Will it Impact Your Deduction of Mortgage and Home Equity Loan Interest for 2018?

The Tax Cuts and Jobs Act of 2017 (“TCJA”) has changed how itemized deductions are calculated for 2018 until 2026. One of these changes is in how interest is allowed to be deducted on mortgage and home equity loans.

For tax years prior to 2018, mortgage interest on principal mortgage balances up to $1M for married filing joint (“MFJ”) taxpayers ($500,000 single or married filing separate (“MFS”)) and interest on home equity loan principal balances of up to $100,000, for all legal uses of the funds, were deductible.

The TCJA has changed this.  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).    Qualified residence loans that are incurred to buy, build, or improve your qualified residence.  A qualified residence is normally defined as your primary home and one other vacation home or similar property.      If a taxpayer has entered into a binding written contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and actually purchases the residence before April 1, 2018, the taxpayer will be subject to the pre-2018 interest rules using $1M (MFJ) and $500,000 (MFS) loan limitations.   

The TCJA suspends from 2018 until 2026 the deduction for interest paid on home equity loans, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.    Keep in mind: Total acquisition debt and home equity loans must adhere to the $750,000/$375,000 limit above.    Interest on home equity loans used for personal expenses (credit card payments, vacations, etc.) will no longer be deductible.  Qualified residence loans cannot exceed the cost of the qualified residence securing the loan. Interest on these loans are limited to purchase of the residence, additions and home improvements on the residence securing the loan only.

Below illustrates the points above:

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. Why? The additional $250,000 is secured by the main home.  In order to be deductible, the vacation home must secure the additional loan.

Be sure to consult your tax advisor regarding how the Tax Cuts and Jobs Act of 2017 will affect your 2018 tax filings.