Wondering how the new tax plan will change your situation as a homeowner or prospective buyer? You’re not alone. After a tumultuous course of revisions as a bill, the Tax Cut and Jobs Act has brought forward several key changes to the rules that dictate your deduction, including changes to property taxes, interest deductibility, and home equity line rules. Let’s take a look at the new changes piece by piece.
The new plan keeps the mortgage interest deduction on acquisition indebtedness (i.e. borrowed funds used to buy a home) and the direct refinance of it, but lowers the cap on how much interest you can deduct from $1 million to $750,000. This change only applies to mortgages originated after Dec. 15th, 2017, so if you’ve bought a home before then, you may be in luck! Mortgages created before this date are “grandfathered in,” meaning that homeowners who bought before that time can still deduct interest on up to $1 million.
One noteworthy mention here is that the $750,000 cap refers to your mortgage amount, not the home price. So, if you’re purchasing a $825,000 home with a 10% down payment ($82,500), interest for your whole mortgage amount ($742,500) will be deductible.
State and local property taxes under the new law are now subject to a $10,000 cap on the amount you can deduct. In states with high property taxes, or for wealthier homeowners, this change may have an impact, but lower rates in five of the seven tax brackets may offset any diminished deduction.
A common misconception in the new tax law is that all interest on home equity lines of credit, home equity loans, or second mortgages is no longer tax deductible. In reality, what determines the deductibility of your mortgage interest is how the funds will be used rather than lien position (whether it’s a first or second mortgage). To illustrate this, let’s take a look at the types of home loan debt as categorized by the IRS:
Acquisition Indebtedness is defined as any borrowed funds that are used to build, buy, or improve a property.
Home Equity Indebtedness refers to any debt borrowed against your mortgage that is used for anything other than building, buying, or improving a property – paying for a car or education, or consolidating consumer debt for example.
Under the new tax law, all mortgage interest on a loan under the $750,000 loan amount cap that is categorized as acquisition indebtedness – i.e. the funds were used to buy, build, or improve your home – remains tax deductible. On the other hand, all mortgage interest categorized as home equity indebtedness – i.e. a home equity line of credit was used to pay for vacation, consolidate consumer debt or finance education expenses – is no longer tax deductible.
Let’s say you purchase a $500,000 primary residence using a $400,000 mortgage. You could then deduct the interest on the $400,000 loan because that amount is below the $750,000 cap and the funds were used to buy a qualified residence and are therefore categorized as acquisition indebtedness.
On the other hand, let’s say you buy a $500,000 house using all cash. Two years later, you decide to refinance and take cash out, putting a $400,000 mortgage on the home. If the funds are not used for home improvements, the interest on the loan would not be tax deductible because it would be categorized as home equity indebtedness.
If you’ve already rolled your home equity debt into your first mortgage, it is important to consult with your CPA or Tax Adviser, as all previous interest you were deducting may no longer qualify under the new rules.
Weighing your options for purchasing a home in a specific area, or have questions about your existing loan? Contact us for an overview of potential tax implications and answers to your questions, or even to get you connected with great local tax preparers.
Disclaimer: Always consult a tax preparer when it comes deductibility – homeowners should not use this blog for tax advice solely.
Topics: Tax plan mortgage deduction, tax plan mortgage interest cap, tax plan interest deduction second home, tax plan homeowners, tax plan home interest deduction, Buying a Home, Homeownership, Refinancing