After the Tax Cuts and Jobs Act (TCJA) was passed, there was concern that the beloved mortgage interest deduction for home equity loans had met its demise. While, on its face, that is what the law says, there is a loophole that taxpayers can use if they meet certain criteria.
As long as the loan is secured by a qualified residence (primary home or vacation home) and not for an investment property then you can begin evaluating whether the loan qualifies for the technique we are discussing that was approved by the IRS on February 21, 2018.
• The proceeds from the loan must be used for home improvements.• The loan must be characterized as an acquisition debt. The law states that the debt was incurred to “buy, build or substantially improve” a qualified residence.
THE BENEFIT OF ACQUISITION DEBT
Under the previous law, taxpayers could deduct mortgage interest paid up to $1million of debt categorized as acquisition debt. If the debt was categorized as a home equity loan or line of credit, the deduction on interest paid was capped at $100,000.The TCJA law has made some interesting changes and provided for some grandfathering which tends to complicate matters a bit. All loans made after December 15, 2017, are subject to the new tax law which reduces the cap on acquisition debt to $750,000 for those looking to claim a deduction on interest and the home equity and line of credit deduction is eliminated completely. However, for loans that were acquired prior to the deadline, the deduction caps under the previous law remain in place and those same interest deductions continue to apply even if you refinance your remaining mortgage debt.
THE HOME EQUITY LOOPHOLE
While the TCJA completely wipes out the deduction for interest paid on home equity loans and lines of credit and that law will remain in place until the sunset date of 2025, there is a way to get around it. As long as you are using your home equity loan or line of credit for home improvements or the purchase of a qualified residence, the debt is automatically considered to be acquisition debt and taxpayers are then eligible for the deduction as long as they stay under the $750,000 threshold.If your existing mortgage on your vacation home is $300,000 and you borrow $150,000 to update the kitchen and bathrooms and install an outdoor shower and jacuzzi, then the interest that you pay on your existing mortgage, as well as your acquisition debt, is deductible - if you itemize your tax deductions.
As always, it is important to execute tax deductions properly and that you have a keen understanding of what the best tax strategy is for your individual circumstances. For help with this and other planning and tax management questions, do not hesitate to reach out to us.