Home Equity Loan Interest Deduction

When the new tax law was passed in December 2017, many taxpayers feared they would no longer be able to deduct the interest on their home equity loan. While this may still be true, the IRS recently released guidance regarding interest on home equity loans that seems more favorable than previously thought.

One specific change to the law remains and that is taxpayers may only deduct loan interest on up to $750,000 of qualified residence loans. This limit is down from the previous limit of $1,000,000 and it applies to “loans used to buy, build, or substantially improve the taxpayer’s main home and second home.”

The IRS provided the following examples to help bring clarity to this discussion:

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.

While this guidance certainly seems more favorable than previously thought by many advisers, taxpayers should consult their tax professional to confirm the deductibility of home equity interest.