Recent Tax Developments – 2018 August

We continue with our series on tax law changes under the Tax Cuts and Jobs Act. This newsletter examines the changes made to the deductibility of home mortgage and equity loan interest. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Taxpayers may deduct interest on mortgage debt that is “acquisition debt.” Acquisition debt means debt that is: (1) secured by the taxpayer's principal home and/or a second home, and (2) incurred in acquiring, constructing, or substantially improving the home. This rule isn't changed by the Act.

Under pre-Act rules, the maximum amount that was treated as acquisition debt for the purpose of deducting interest was $1 million ($500,000 for marrieds filing separately). This meant that a taxpayer could deduct interest on no more than $1 million of acquisition debt. Under pre-Act rules, taxpayers could also deduct interest on “home equity debt.” Home equity debt, as specially defined for purposes of the mortgage interest deduction, meant debt that: (1) was secured by the taxpayer's home, and (2) wasn't “acquisition indebtedness” (that is, wasn't incurred to acquire, construct, or substantially improve the home). Thus, the rule allowing deduction of interest on home equity debt enabled taxpayers to deduct interest on debt that was not incurred to acquire, construct, or substantially improve a home—on debt that could be used for any purpose. As with acquisition debt, pre-Act rules limited the maximum amount of “home equity debt” on which interest could be deducted to the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer's equity in the home.

Under the Act, the limit on acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). The $1 million, pre-Act limit applies to acquisition debt incurred before Dec. 15, 2017, and to debt arising from refinancing pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. Thus, taxpayers can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt, and that refinanced debt amount won't be subject to the reduced limitation.

Also, starting in 2018, the Act eliminates the deduction for interest on “home equity debt.” The elimination of the deduction for interest on home equity debt applies regardless of when the home equity debt was incurred.

Taxpayers considering taking out a home equity loan—i.e., a loan that's not incurred to acquire, construct, or substantially improve the home—should take into consideration the fact that interest on the loan won't be deductible. Further, taxpayers with outstanding home equity debt—again, meaning debt that's not incurred to acquire, construct, or substantially improve the home—will lose the prior-law interest deduction for interest on that debt, starting in 2018. (Interest on home equity debt is deductible for the 2017 tax year, the return for which is filed in early 2018.)

Finally, it's important to note that both of these changes—the lowered maximum for acquisition debt, and the elimination of the deduction for home equity debt—last for eight years, through 2025. In the absence of intervening legislation, the pre-Act rules will come back into effect in 2026. So beginning in 2026, interest on “home equity” loans will be deductible again, and the limit on qualifying acquisition debt will be raised back to $1 million ($500,000 for married separate filers).