Overview of the New Mortgage Interest Deduction Rules

The new Tax Cuts and Jobs Act (TCJA) scales back or eliminates several itemized deductions, including deductions for qualified mortgage interest. Notably, interest paid on home equity debt is no longer deductible at all, effective in 2018. However, under a little-known “exception” to the rules, deductions may still be allowed for certain home equity loans used for home improvement purposes.

Prior to the TCJA, a taxpayer could deduct mortgage interest for a qualified residence on the first $1 million of acquisition debt and the first $100,000 of home equity debt. “Acquisition debt” is defined as a loan used to buy, build or substantially improve a qualified residence. Any other mortgage debt is “home equity debt.” For these purposes, a qualified residence is your principal residence and one other home, such as a vacation home.

The TCJA lowered the threshold for acquisition debt from $1 million to $750,000 for debts incurred after December 15, 2017. (Interest payments under prior loans are grandfathered.) It also repeals the deduction for home equity debt, beginning in 2018. These changes are scheduled to sunset after 2025.

In other words, in the past you could deduct mortgage interest on the first $100,000 of home equity debt, regardless of the purpose. Now you can’t deduct interest on any home equity debt, unless the proceeds are used to substantially improve the residence. In that case, the debt is treated as an acquisition debt, subject to the rules discussed above.

Example: Say that you incurred an initial mortgage of $500,000 when you bought your home. Any interest you pay on this acquisition debt continues to be deductible after 2017. Then you take out a home equity loan of $50,000 in 2018. This is where the TCJA changes things.

If you use the home equity loan proceeds for personal reasons – for instance, to pay off credit card debt – none of the interest can be deducted. Conversely, if the money is used to remodel your basement or add a deck to your principal residence, all of the interest is deductible, because the debt qualifies as acquisition debt.

Keep in mind the new TCJA rules on mortgage interest generally don’t affect 2017 returns being filed in 2018. You may deduct interest on up to $100,000 of home equity debt even if the proceeds were used for personal reasons.

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