Under prior law, if you were itemizing your deductions, you could deduct qualifying mortgage interest for purchases of a home up to $1,000,000 plus an additional $100,000 for equity debt. The new tax reform appeared to eliminate the deduction for interest on a home equity line of credit (HELOC). There was much confusion amongst taxpayers and accountants alike.

Can Interest on the Home Equity Line of Credit (HELOC) Still Be Deducted?

On February 21st the IRS issued bulletin IR-2018-32  stating the following:

“Despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labelled. The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.

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Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.

The above means that, interest on a re-finance which is secured by your home (qualified residence) and which does not exceed the cost of your home and which is used to substantially improve your home will continue to be deductible so long as it meets the other criteria – like the new dollar limit, which is now set at $750,000. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.

The IRS shared a few examples:

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).

In conclusion, if you are using the refinance funds to make any home improvements such as a room addition, new roof or new kitchen, you could deduct the interest if you meet the required criteria. If you are using the funds for other reasons such as paying off credit card debt, the interest is not deductible.

Last Word. Given that the new standard deduction for married filing joint is $24,000, many Americans may not even itemize their deductions. If this is your projected scenario you may want to consider paying off your HELOC or perhaps replacing it with a loan against your 401K. There are many financial considerations so be sure to consult with your tax advisor on all your options.

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