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IRS: Interest on many home equity loans remains deductible

IRS: Interest on many home equity loans remains deductible

By Ron Trujillo/ron@calhomenews.com

Interest on a home equity loan is deductible in many cases under the new tax plan, according to the Internal Revenue Service.

The federal agency recently detailed that taxpayers can often continue to deduct interest on a home equity loan, home equity line of credit — also known as a HELOC — or second mortgages, regardless of how the loan is labeled.

There are definitely some changes under the new tax law. For example, interest on money from a home equity loan used to build an addition to an existing home is generally deductible, while interest on the same loan used to pay personal living expenses — as credit cards or purchase a vehicle — is not, according to the IRS.

The new tax law still requires the loan must be secured by the taxpayer’s main home or second home, not exceed the cost of the home and meet other requirements.

Now, there are some big changes when it comes to how many of the dollars qualify for an interest deduction. The new law has a lower dollar limit: $750,000 or $375,000 for a married taxpayer filing a separate return. These new limits are down from the previous cap of $1 million or $500,000 for a married taxpayer filing a separate return.

Of course, the lower limit affects Californians and those living in other high-cost housing states, such as New York, New Jersey and Illinois. California’s median-home price is about $550,000, but many home equity loans in the state do not exceed the $500,000 threshold.

The new limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and/or second home. In an effort to assist homeowners, the IRS has provided some examples if a home-equity loan, HELOC or second mortgage would be tax deductible. The following three examples appear unedited from the IRS website:

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. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.

Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home.  Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.

Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home.  Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).

For more information, visit the IRS website for more information about the new tax reform law.

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