Are Home Equity Loans Tax-Deductible in 2018?

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When the Tax Cuts and Jobs Act of 2017 was signed into law, there was an immediate uproar. Some people railed about how it would affect their paychecks, others about their child care credits. Another group was howling about their formerly tax-deductible interest from their home equity loans. We’re here to get to the bottom of this situation and clear up any misinformation you may have heard about deducting home equity loan interest in 2018 and after.

Home Equity Tax Deductions: The Basics

Many people panic when they hear that they can’t do a particular thing on their taxes -- or really anywhere. We’ve all been there. Being told you can’t do a thing immediately makes you want to do it.

When it comes to tax deductions, people tend to worry much more than they should. This particular deduction only applies to a small group of people.

For a home equity loan tax deduction to apply to you, you have to be able to itemize. If you’re itemizing, you’ll know it because you’ll file a 1040 Schedule A form with your taxes. Some people itemize because it gets them a bigger break on their taxes, but others -- many others -- don’t, because the standard deduction is larger than what they’d get from an itemized deduction.

The bottom line: if you don’t itemize, you don’t have to worry about this at all.

Now, for the rest of the class, there are two types of debt that are important to this discussion. One, “home equity indebtedness,” is the total opposite of what it sounds like. This is debt that you’ve created by borrowing against your home equity and not using it to upgrade or repair your home. If you took a vacation to the Bahamas with your home equity, that’s home equity indebtedness. Same applies if you used that equity to consolidate other debts.

The other type of debt we care about today is called “acquisition debt.” This is equity you’ve borrowed against to make your home better in some way. It’s a pretty simple concept, really. Fix your house, put in a pool, buy a new set of cabinets for the kitchen -- all acquisition debt. It’s important to differentiate these two types of debt before we move on, since that’s the crux of the home equity tax deduction issue.

What the Tax Cuts and Jobs Act of 2018 Actually Does

There was a lot of confusion over what the Tax Cuts and Jobs Act of 2018 actually did and how it would apply to homeowners, causing the IRS to issue a bulletin to clarify things. The changes are relatively basic and mainly apply to homeowners who might be using a jumbo loan together with a home equity or HELOC or those that have a second home.

Instead of allowing holders of existing qualifying loans to deduct the interest on up to one million dollars of their mortgage debt, as in prior years, the cap has been dropped down to $750,000 for a married couple.

Yes, that is a lot of interest, there’s no doubt, but you can’t argue that it’s all that complicated. Where things get hairy is what a qualified loan actually is. When it comes to home equity loans, HELOCs or second mortgages, you’re now going to be punished for using the proceeds for anything other than improving your home. Anything.

The bottom line is that if the interest was paid on acquisition debt, you’re gold. If not, too bad. The Act didn’t allow for grandfathering existing loans under this tax law, so there will be people who lose their deduction completely until 2026.

IRS-Provided Examples

The IRS was kind enough to write up some examples to help you get a better grip on where these new rules apply and where they don’t. Here we go. (Thank you, IRS! -- probably the first time that phrase has ever been put in print….)

Examples from IRS.gov

“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.

Example 3: 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 $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).
— https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law

We’re Here to Answer Your Mortgage Questions, Big and Small

If you’re still not sure how the Tax Cuts and Jobs Act of 2017 will affect your home equity loan tax deduction, we’re more than happy to help you out. Contact us here! After all, we’re just sharpening all the pencils in the office in anticipation of a hostile cubicle take-over of Kevin’s workspace.