The following article was featured on the Patriot Ledger. You can view the original article by clicking here.
Interest on home equity debt is no longer tax-deductible. While this seems like a simple concept, it has caused a fair amount of confusion among taxpayers. The confusion stems from differences between how Congress defines “home equity debt” and how the general public defines that term. But first we must review the rules regarding the deductibility of mortgage interest.
The Tax Code allows a taxpayer to deduct interest on debt that is used to buy, build or substantially improve a principal residence and one other residence. In addition, the loan must be secured by the residence. The law refers to this type of debt as “acquisition indebtedness.” The interest on such debt is still deductible under the new tax law, albeit with a reduced debt limit of $750,000 for loans incurred after December 15, 2017. Loans existing before December 15, 2017, are grandfathered and subject to the old $1,000,000 loan limit.
So, what is home equity debt? Congress defines “home equity debt” as debt that is secured by a residence but the proceeds of which are not used to buy, build or substantially improve the residence (in other words, not acquisition indebtedness). As is the case with acquisition indebtedness, it is the use of the proceeds that is the important factor. Under the old tax law, interest on up to $100,000 of home equity debt was deductible. Now, interest on home equity debt is no longer deductible.
Now for the confusion. Financial institutions offer “home equity loans” and “home equity lines of credit” as financing products. These terms are used regardless of the use of the proceeds. Therefore, taxpayers with home equity loans cannot simply assume that the interest on such debt is non-deductible. An example may help.
If an individual takes out a home equity line of credit and uses that money to build an in-law addition on their house, that loan is considered acquisition indebtedness and the interest is deductible. If that same individual pulls out the same amount of money through a home equity line of credit and uses those funds to pay for college, or a new car, or a European vacation, that is considered home equity indebtedness. None of the interest on the loan is tax-deductible.
Many people might also have debt that is bifurcated, meaning that some of the proceeds are deductible and some are not. (In the example above, someone could take money from a line of credit and use some of those funds for a kitchen renovation and some to pay off credit card debt.) Each year individuals will need to calculate and keep track of the amount of loan proceeds that were used to buy, build or substantially improve a residence and the amount that was used for other purposes.
Although we’ve been talking about these changes for the past year, the idea of “home equity” is so ingrained in people’s minds that the income tax definition of “home equity indebtedness” may come as a surprise to many people. Still, there is hope that some interest from your home equity line could be deducted – as long as it’s actually acquisition indebtedness.