Gresham|Savage Tax Update: When is the Interest Payment on a Home Equity Loan Deductible?

Apr 26, 2020

The Tax Cuts and Jobs Act of 2017 (the “Tax Act”) is said to have eliminated the deduction for interest paid on home equity loans and lines of credit.  The IRS, on February 21, 2018, clarified that despite the newly-enacted restrictions on interest deductions, many taxpayers will still be able to deduct interest on a home equity loan, home equity line of credit or second mortgage.  The dispositive fact in determining deductibility is not how the loan is labeled; but rather, how the loan was secured and how the funds were used.  If the loan or line of credit was used to buy, build or substantially improve a Qualified Home that secures the loan, then the interest thereon remains deductible as a home mortgage interest deduction under IRC Section 163.  A Qualified Home is a main home or second home and the term encompasses a variety of dwellings, including houses, condos, coops, mobile homes, house trailers & boats, or any similar property that has sleeping, cooking, and toilet facilities.

For those considering a loan or mortgage, be aware that the Tax Act imposes a lower dollar limit on loans qualifying for the home mortgage interest deduction.  Beginning in 2018, married taxpayers filing jointly may only deduct interest on $750,000 of Qualified Home loans and single individuals/ married taxpayers filing separately are limited to $375,000.

The following example illustrates these points for an average married couple filing jointly.

Example:  In February 2018, taxpayers borrow $500,000 to purchase a main home. This loan is secured by a mortgage on their main home and is 100% deductible.

In March of 2018, taxpayers take out a $50,000 home equity loan to put an addition on to their main home. Both loans are secured by their main home and do not exceed the $750,000 limit, so the interest is 100% deductible.

In April 2018, taxpayers borrow $200,000 to purchase a vacation home.  The loan is secured by their vacation home.  Because the total amount of all three loans does not exceed $750,000, 100% of the interest paid on these loans is deductible.  If, however, taxpayers had taken a home equity loan on their main home to purchase the vacation home, the interest on the home equity loan would not be deductible.

In May 2018, taxpayers take out a $25,000 home equity loan on their vacation home to make substantial improvements to their vacation home.  Because the total amount of all 4 loans now exceeds $750,000, some but not all of their interest payments are deductible.  To calculate the deductible portion: (i) divide $750,000 by the total amount of Qualified Home debt, and (ii) multiply the resulting percentage (rounded to three places) by the total amount of interest paid.

David E. Foate works within the Business practice group of Gresham|Savage. His practice focuses on the state and federal tax complexities inherent in the lives of business owners and their families. He can be contacted at 909.890.4499 or [email protected]

This Tax Update is for educational purposes only and is not intended to provide legal counsel or serve as legal advice.  Any tax advice contained in this Tax Update is not intended or written to be used, and cannot be used, by you or any other recipient for the purpose of (a) avoiding penalties that may otherwise be imposed by the IRS, or (b) supporting, promoting, marketing, or recommending any transaction or matter to any third party.  If you have a legal matter, it is best to consult the advice of an attorney. You can talk with David Foate or another experienced attorney at Gresham|Savage by calling (909) 890-4499 (Inland Empire) or (619) 794-0050 (San Diego).

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