New Rules for Home Mortgage Interest Deduction

Are you aware of the new rules for the home mortgage interest deduction under the Tax Cuts and Jobs Act of 2017? The new tax bill was passed in December of 2017, and there are some fundamental changes in how we deduct our mortgage interest. For the first time, it’s not focused upon the nature of the loan, it’s focused on what the loan was used for. Whether you obtained a primary mortgage, second mortgage, home equity line of credit… that doesn’t really matter. It matters what the funds used for.

Before getting into that, however, there is a change in how much interest you can deduct. If you owned your home before December 14, 2017, and you still own that home, you can deduct interest on a principal value of up to $1 million. If you acquired the house after December 14 and it was not closed prior to January 1, 2018, you are only able deduct the interest on a principal value of $750,000.

Now, for the larger change. If the proceeds of the equity loan are used to buy, build, or substantially improve your home, the interest continues to qualify as mortgage interest that you can deduct on your tax return. On the other hand, if the loan proceeds were used to purchase a car, pay for college, or consolidate other loans, the interest is true home equity interest, and in that case, is no longer tax deductible.

This doesn’t just apply to the home equity line! If you pulled out extra cash out of a second mortgage to consolidate other debt, that portion of the debt the interest is not tax deductible. You need to remain watchful for creative lending terms. Things like cash out refinance and second mortgages may sound like traditional mortgage loans, but to the extent that the new loan isn’t used to pay off an original loan or to improve the home, the excess is an equity loan, regardless of what the lender calls it. In that case, the new rules will apply, meaning that there’s possibly no tax deduction.

How will the IRS know how your home equity line was used? They won’t. At this time, there’s no way for them to automatically know how your loan was used. However, if the deduction is ever questioned, they will expect you to know and to prove it. You need to have your receipts and need to know what the monies were used for. You need to be more careful than ever to keep good records.

There have been a lot of things in this new tax bill that haven’t been talked about in great detail. Back in January, I published a report “A Review of the Tax Cuts & Jobs Act of 2017,” discussing the main things you need to be aware of. Click this link to download a complimentary copy of the report.