The Tax Cuts and Jobs Act (TCJA) has made it more difficult to deduct mortgage interest from home loans.
New rules limit mortgage interest deductions up to $750,000 for debt used in the acquisition of a home. The new rules allow you to deduct interest on home equity loans that are used in common transactions.
Don't worry if you have a mortgage that was acquired in the past year. If the transaction was completed before April 1, 2018, these new limits won't apply to home acquisition debt exceeding $1 million. This grandfather rule will not affect homeowners who have existing mortgages or home equity loans.
However, if you're looking to refinance a mortgage, purchase a new home, or take out a home equity loan to fund your down payment, it is important to understand how these changes may affect you.
Let's look at some examples.
First, homebuyers need to be aware that mortgage interest deductions are now limited at $750,000 in home acquisition debt. This can increase the cost of purchasing homes in high-priced housing markets with higher home prices.
It is interesting to note the $750,000 limit does not apply to married couples but single taxpayers. A prior Ninth Circuit Appeals Court ruling states that if two married people purchase a home together they can combine their limits to deduct mortgage interest up to $1.5million.
The interest on a home equity loan that you don't use to buy or improve your home, such as buying a car or paying off debts, is not deductible.
However, if you used the home equity loan to renovate your home or improve it, then interest can be deducted as long as the total loan limit of $750,000 is not exceeded.
This may cause some questions for homeowners who are considering a home equity loan.
Consider a homeowner who has a $800,000.00 mortgage that was paid several years ago. A homeowner is looking to get a $100,000 home equity loan to help improve their house. Is the loan interest and mortgage deductible?
Because the interest on the $800,000.00 mortgage is grandfathered under the old rules that allow deductibility of interest for mortgages up to $1,000,000, it would still be eligible.
However, the interest on the new home Equity loan will not be deductible because it would be taken out in 2018, when the TCJA caps deductions to $750,000 for total acquisition debt.
If the homeowner has a $650,000 mortgage and takes out a $100,000 loan to improve their home in 2018, all interest should be deductible as the combined loans are below $750,000.
If the home equity loan is used to purchase a vacation home, it cannot be deducted from interest. The vacation home is not the collateral for this new loan. A mortgage secured by your second home would be a better option to finance a vacation house than a loan on your main residence.
Refinanced homeowners who have a mortgage must also consider the impact of these new rules. A second grandfather rule is included in the TCJA for home acquisition debt up to $1,000,000 that was taken out prior to December 16, 2017.
Refinance of a grandfathered mortgage will not affect your deductible if the principal amount of the new loan does not exceed the principal balance.
Consider a homeowner who has a mortgage with a balance of $950,000 but a loan that was $1 million last year. Refinance mortgage interest should be deductible, provided that the balance of the mortgage loan does not exceed $950,000.
Let's say that your current mortgage balance is $300,000. You want to replace it with a $400,000 loan. This is commonly known as a cash-out refinance. Only the interest on the $300,000 refinanced mortgage will qualify as deductible mortgage interest in this case. You cannot deduct the interest on any additional debt.