Mortgage Interest Deductibility Maze

By: AnnaMarie Mock, CFP®

On December 22nd, the Tax Cuts and Jobs Act of 2017 signed into law changed the tax landscape for individuals and corporations. Although there are many modifications to the tax code that will affect all Americans, the mortgage interest itemized deduction directly affects current and future homeowners.  This article explores how the mortgage interest deduction may impact deductibility going forward.

Tax Treatment Is Based On Use Not Loan Terms

With the Tax Cuts and Jobs Act of 2017, new mortgage debt created after December 15, 2017 is deductible up to $750,000, and interest from home equity loans may still be deductible. Home equity debt used to acquire, build, or substantially improve a primary residence that increases the cost basis may still be deductible up to the $750,000 ceiling. The tax treatment of interest is based on how it is used not how the loan is structured.

Example 1) Jack and Jill purchased a primary home valued at $800,000 with a $500,000 mortgage. The following month, they take out a $250,000 home equity loan to add an addition. The home equity loan interest will be deductible because the proceeds from the loan were used to substantially improve the home and does not exceed $750,000. However, if the loan were used to pay off personal expenses like credit card debt, the loan interest would not qualify for a deduction.

Example 2) If Jack and Jill instead took out a home equity loan of $250,000 to purchase a vacation home, the home equity loan interest would still be deductible because the loan is used to acquire a new property and is secured by the vacation home.

Example 3) If they take out a larger loan of $500,000 to buy the vacation home, only $250,000 of the loan would be deductible because the aggregation of the primary home mortgage and home equity loan is greater than $750,000.

There may, also, be multiple loans that are treated differently based on how the proceeds were used.

Example 4) Jack and Jill lived in their home for 5 years and the mortgage decreased to $455,000. They decide to refinance their mortgage back to $500,000 and use $45,000 cash refinance to purchase a car. The original $455,000 mortgage is still deductible. However, the $45,000 cash out refinance portion will not be deductible as it was not used to acquire, build, or substantially improve the home. A single loan can be treated differently based on how the proceeds were used.

Thoughts Going Forward

IRS Form 1098 reports payments made and interest paid during the tax year. However, the existing form does not distinguish between deductible and non-deductible debt. This causes a wrinkle now that taxpayers are still expected to differentiate the debt type even within one loan! As the year progresses, we would expect the form to be updated to support these recent changes or some additional clarity about how deductibility will be handled going forward.   

If you have any questions about the effects of the new tax laws, please contact a member of the HIGHLAND team.