With the new GOP Tax Plan now in effect for 2018 many people are wondering, “Can I still deduct my home equity line of credit? Should I refinance to make it tax-deductible again?” Or just “How do I know if I can deduct the Home Equity Line of Credit (HELOC) interest?” We will answer your questions and more below.
The basics of home equity lines of credit and new tax plan
This issue tends to confuse many homeowners. There are quite a few cases where the interest on a HELOC can be deductible but there are also many times the interest will not be deductible. To add to the confusion, there will also likely be cases when only a certain portion of the home equity loan is deductible. It all depends on your specific situation.
I live in Los Angeles, and many of my clients live in locales with high property values. Californians feared the new tax law (The Tax Cuts and Jobs Act of 2017) – enacted last December- would completely screw those counting on deducting interest from Home Equity Loans and Lines of Credit. Earlier proposals of the tax plan would have completely eliminated this deduction. Thankfully, that didn’t happen but the final plan did put quite a few limitations on this deduction for property owners.
To help reduce the confusion, the IRS issued an advisory which you can read here. From the advisory we get some of the details of what will be deductible and what will not. For the tax years 2018 through 2025, you will not be able to deduct HELOCs. There are, however, a few exceptions. If you plan on taking this deduction, your loan must be used to “buy, build or substantially improve” the residence that secures the underlying loan.
What does or does not qualify for the deduction?
If you are using the loan to do work on your home, you can still deduct the interest. Think of things like replacing the roof, adding solar panels or remodeling a kitchen or bathroom. I am sorry to let you know that furniture and artwork do not count.
On the other hand, if you are trying to use your home like a piggy bank to fund your lifestyle, you will not be able to deduct the interest. Your plan to pay for Junior’s college with home equity might also be out the window. Likewise, you can no longer use the money to pay off credit cards or use it to buy that new car you’ve been eyeing. In the end, what you use the money for is up to you. Whether or not that use is deductible is up to the IRS.
Limits to home equity line amounts
Generally, homeowners may deduct interest paid on HELOC debt up to $100,000. But here is some fun, fine print you probably weren’t aware of. The HELOC deduction is limited to the purchase price of the home. This may trip up some of you who’ve owned your home for decades or perhaps bought a real fixer upper. For example, let’s say you purchased a home for $50,000 and plan to put a ton of work into. In this case, you would only be able to deduct interest paid up to $50,000 if using a HELOC.
Also, worth noting is the new tax plan lowers the dollar limits on traditional mortgages. Beginning in 2018, taxpayers may deduct interest on just $750,000 in home loans. This only applies to homes purchased as of December 16th, 2017. Homeowners who purchased their homes before that date can still deduct up to $1 million in principal mortgage debt.
Another thing to be aware of is the fact that the $750,000 limit applies to the combined total of all debt, on all properties, owned. For example, if you have a $500,000 mortgage on your primary residence and owe $250,000 on a home in Palm Springs the entire amount gets a tax break. But if your primary residence is $750,000 and your secondary home is $250,000, you would only get a tax break on $750,000 and none of your paid interest on the second home would be deductible.
For my single readers, there is a bit of good news here. Two singles could potentially deduct a combined $1.5 million in mortgage debt ($750,000 each) if they went in together on the purchase of a home. A married couple, however, would be limited to $750,000.
Changes to the Home Equity Loans deduction is more likely to hit the average American family. As of writing this post, the median price of a home in the U.S. is $207,000 according to Zillow. That’s a far cry from exceeding the mortgage deduction limits. I love L.A., but my down payment back in 2007 was more than that.
The following are a few of the most common mortgage deduction questions we have been fielding recently:
I was able to deduct my home equity loan on my 2017 taxes I just filed, when does this change kick-in?
These changes begin with tax year 2018. This mean the new rules will affect the taxes you file in 2019. You still have time to figure out if your loan will or won’t be deductible and make the appropriate adjustments to your budget or loans.
You can use your HELOC however you want. For example, if you wanted to buy a boat, a plane or go on a shopping spree, your HELOC could be used for those things. But I don’t recommend using it for any of those purchases. The new tax law will only change what will be tax-deductible and what will not. Paying off your credit card or student loans with a HELOC may still be a smart financial move, but it won’t give you a tax break.
How am I supposed to prove that the borrowed money was for eligible purchases?
I am currently in the middle of some major home repairs and I’m taking extra care to track my spending and save invoices from my contractor. How exactly the IRS will track or confirm eligibility has yet to be determined. Where you typically need to keep tax records for three-seven years, you will likely need to keep HELOC home improvement records as long as you want to take a deduction on the loan’s interest.
Hopefully the IRS will come out with some type of form or statement to show how much, if any, of the loan is eligible for a deduction. Many homeowners may have a HELOC where only a portion ends up being deductible.
For example, let’s pretend that you owe a total of $100,000 but just $60,000 was used to for home improvement. Just for fun, let’s say you used it to put in a pool. The rest was used to consolidate other debt. Using this scenario, only the portion used to improve the home (the pool) would help you lower your tax bill.
Should I refinance?
This will depend on your overall situation. The costs of refinancing into a single, first mortgage will likely kill most of the tax savings for many homeowners. You’ll also want to check the math as interest rates are creeping up. Even a small increase on your large principal mortgage rate could also reduce or eliminate the tax savings from deducting interest on the HELOC portion of your debt.
If you find that your head is spinning, you’re not alone. This topic and many other parts of the GOP tax plan are confusing. The main takeaway is to be proactive so you don’t get whacked with a sky-high tax bill when filing in 2019. It’s also important to note that while an estimated 90%+ of Americans will see their tax bill drop for 2018, the remaining 10% will see their taxes go up. These individuals, most likely homeowners in high-tax states, will need to plan accordingly.
Source: forbes.com ~ By: ,