B.A. Harris Blog

Home Equity Interest - Deductible?

For many taxpayers, Home Equity Loans and HELOCs, are useful financial tools for easily accessible cash at interest rates that are typically lower than most commercially available credit cards.  Due to their low interest rates, Home Equity Loans have been an enticing option for taxpayers looking to consolidate debt into a single, low cost payment, while also reaping additional beneficial tax treatment.

In previous years, similar to a home mortgage, any interest paid on a Home Equity Loan/HELOC during the current tax year was deductible up to a government-imposed limit. In 2017, interest paid on up to $100,000 of indebtedness could be deducted on Schedule A as an itemized deduction regardless of what those funds were used for. Many taxpayers used these loans for home improvements, educational expenses, or emergency funds. With the passing of the Tax Cuts and Jobs Act of 2017, many of our clients faced concern over whether or not interest paid on their Home Equity Loans/HELOC’s would continue to enjoy tax deductible treatment, and rightfully so. As the end of the year approached, there were articles claiming The Home Equity Loan Interest Deduction is Dead, and according to forbes.com Borrowers Lose Home Equity Tax Deduction.

However, on February 21st the IRS clarified that, in many cases, taxpayers can continue to deduct interest on their home equity loans. In order for the interest paid to qualify to be itemized, you must meet ALL of the following criteria:

1)      The loan must be secured by the taxpayer’s main or second home

2)      The loan MUST be used to buy, build, or substantially improve the home that secures the loan

3)      The deductible interest is limited to amounts paid on indebtedness of $750,000, between the mortgage on the home, plus the Home Equity Loan/HELOC,

4)      The sum of both loans may not exceed the cost of the home, plus substantial improvements

With this clarification we see that as long as the funds derived from a Home Equity Loan/HELOC are used for home improvements, the interest deduction remains. Unfortunately, if those funds were used for any other purpose, such as education or emergency funds, the interest is no longer deductible. Also, the loan limitation amount has changed as well. While in 2017, only the interest paid on $100,000 was deductible, the rule now states that the limitation includes any amount of the Home Equity Loan/HELOC plus the initial mortgage of the home, up to $750,000. This means that potentially the amount of a loan a taxpayer could pay deductible interest on could either increase or decrease, depending on the amount of the original mortgage. The IRS provides the following example:

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. Because the total amount of both loans does not exceed $750,000, ALL of the interest paid on the loans is deductible.

This ruling provides an interesting opportunity for potential tax savings, provided the taxpayer plans accordingly. If you have any questions as to how this change may affect you, give us a call and we will help you through the process.

Aaron Lavarias

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