Think Twice Before Taking Out a Home Equity Loan
February 7, 2018
Last year’s Tax Cut and Jobs Act (the “Act”) introduced many tax changes on the individual return front. One rule that has seen important changes is the home interest deduction.
Under the prior rule, a taxpayer could deduct interest on up to $1 million ($500,000 for a married person filing a separate return) in debt incurred to acquire or substantially improve his or her residence. The Act largely left this rule in place, although the limit has been reduced from $1 million to $750,000 ($375,000 for a married person filing a separate return). This limitation change does not apply to indebtedness in place prior to December 15, 2017, or the subsequent refinancing of such indebtedness.
While the change in the limitation has gotten significant publicity, a second change is not as widely known even though it will impact many taxpayers. The home interest deduction used to be available for up to $100,000 in home equity loans. It did not matter what the loan proceeds were used for, the interest was deductible. For example, an individual could take out a home equity loan to purchase a car, take a trip, or finance a child’s college tuition, and the individual could claim a deduction for the interest expense. Unfortunately, the Act no longer allows a deduction on home equity loans except where the loan was part of the acquisition indebtedness for the home. So if you are considering using a home equity loan to finance expenditures unrelated to the acquisition or substantial improvement of your property, you may want to reconsider whether this is your best financing option given that the interest will no longer be deductible. Also, if you already took out a home equity loan for this type of expenditure, be aware that your loan is subject to this new rule and the interest is no longer deductible.
The good news is that these changes to the home interest deduction are for taxable years 2018 through 2025, and absent legislative action, the old rule will go back into effect in 2026.