The Home Mortgage Interest Deduction - Changes Under the TCJA

The Tax Cuts and Jobs Act of 2017 (“TCJA”), enacted Dec. 22, makes modifications to the deductibility of home mortgage interest for tax years from January 1, 2018 through December 31, 2025. Previously a taxpayer could deduct acquisition indebtedness of $1 million ($500,000 in the case of a married person filing a separate return) and home equity indebtedness of $100,000 ($50,000 in the case of a married individual filing a separate return), regardless of the use of the proceeds of the home equity indebtedness. As sanctioned by the IRS, a taxpayer could deduct mortgage interest on acquisition indebtedness of $1,100,000, if there was no home equity indebtedness.

For acquisition indebtedness incurred before December 15, 2017 the limitation will continue to stay at $1,000,000 ($500,000 in the case of married taxpayers filing separately). New acquisition indebtedness incurred after December 15, 2017 is limited to $750,000 ($375,000 in the case of married taxpayers filing separately). The TCJA suspends for 8 years the deduction for interest on home equity indebtedness.
On February 21, 2018 the Internal Revenue Service issued a statement through Notice-2018-32 on the deductibility of home mortgage interest with several examples as noted below.

The deduction is suspended for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. Subject to limitations, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.

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).

These examples do not encompass all possibilities for deducting interest on home equity indebtedness. For example, if one were to incur home equity indebtedness and strictly trace the proceeds of the loan to the purchase of securities, the interest may be deductible as investment interest. Be aware that tracing has its own set of rules and taxpayers may need to irrevocably elect to treat debt as not secured by a qualified residence to take advantage of this benefit.

If you wish to work through the mechanics of the deduction, with particular attention to the impact it can have on your specific situation, please contact your HM&M tax advisor.