Client Alerts Home Equity Interest Still Deductible for Many


The language of the new tax law led some to believe that interest on all home equity loans, home equity lines of credit and second mortgages was not deductible from 2018 through 2025. In response, the IRS issued a statement clarifying that the interest will remain deductible based on how the proceeds were used and not how the loan is labeled.

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Previous Provisions

Under prior tax law, taxpayers could deduct qualified residence interest on a loan of up to $1 million secured by a qualified residence, plus interest on a home equity loan (other than debt used to acquire a home) up to $100,000.

For tax purposes, a qualified residence is the taxpayer’s principal residence and a second residence, which can be a house, condominium, cooperative, mobile home, house trailer or boat.  The principal residence is where the taxpayer resides most of the time, and the second residence is any other residence the taxpayer owns and treats as a second home.

Taxpayers are not required to use the second home during the year to claim the deduction. However, if the second home is rented to others, the taxpayer must also use it as a home during the year for the greater of 14 days or 10% of the number of days it’s rented.

In the past, interest on qualifying home equity debt was deductible regardless of how the loan proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles and other personal expenses and still claim the itemized interest deduction. 

The New Rules for 2018 Through 2025

The new rules apply from 2018 through 2025. For new mortgages, the new rules limit the amount of debt on which a taxpayer can deduct interest to $750,000. Mortgages that were used to buy, build, or improve a home and that were in place prior to the new law are grandfathered and subject to the old $1 million total debt limit.

Comments by the congressional conference committee suggested the interest on all home equity loans would not be deductible under the new rules. The new law even included a section captioned “DISALLOWANCE OF HOME EQUITY INDEBTEDNESS INTEREST.”  This led many people to believe interest on all home equity loans was eliminated through 2025. However, on February 21, 2018 the IRS issued a release (IR 2018-32) to clarify.

The IRS stated that interest is deductible on any loans (up to the applicable debt limit) if the proceeds are used to buy, build or substantially improve the home that secures the loan. In other words, the interest is not deductible if the loan proceeds are used for other types of expenses.

In addition, the IRS confirmed that the deduction limits apply to the combined amount of mortgage and home equity loans. That means home equity debt is not capped at $100,000 for purposes of the deduction.

Some examples from the IRS help show how the new rules work:

Example 1
A taxpayer took out a $500,000 mortgage to buy a principal residence with a FMV of $800,000 in January 2018.  The loan is secured by the residence. In February, they take out a $250,000 home equity loan to pay for an addition to the home. Both loans are secured by the principal residence, and the total does not exceed the value of the home.

The taxpayer can deduct all of the interest on both loans because the total loan amount does not exceed $750,000. However, if they used the home equity loan proceeds to pay off student loans and credit card bills, then the interest on that loan would not be deductible.

Example 2
The taxpayer from the previous example takes out the same mortgage in January. In February, they also take out a $250,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages does not exceed $750,000, they can deduct all of the interest paid on both mortgages. However, if they took out a $250,000 home equity loan on the principal home to buy the second home, the interest on the home equity loan would not be deductible.

Example 3
In January 2018, a taxpayer took out a $500,000 mortgage to buy a principal home, secured by the home. In February, they take out a $500,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages exceeds $750,000, they can deduct only a percentage of the total interest that is paid on them.

For further information, contact Thomas R. Vance or your ORBA advisor at 312.670.7444.

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