Using a home equity loan or home equity line of credit (HELOC) are popular ways for individuals to borrow, often at lower interest rates than would be available on unsecured loans. This month we wanted to take time to highlight a change in the tax treatment of home equity interest that was included as part of the Tax Cuts and Jobs Act of 2017 (last year’s income tax changes).
In 2017 and prior, the interest paid on home equity borrowing was tax deductible on loan balances of up to $100,000 regardless of how the funds were used. Due to this tax provision, many were able to borrow on a tax-advantaged basis against their home to pay for large expenses such as a new car, college tuition, business startup costs, medical expenses or even to consolidate high-interest loans such as credit card debt. Beginning in 2018, and through 2026, this is not the case.
The new tax rules state that the interest deduction is only available if the equity loan funds were used to “buy, build or substantially improve the taxpayer’s home that secures the loan”.1 This also resulted in the removal of the $100,000 equity loan interest deduction limitation. Instead, the new $750,000 qualified residence loan deduction threshold applies in aggregate to all lines of debt. For example, if a primary residence has a mortgage balance of $500,000 and an individual uses a $200,000 equity loan to build an addition, all interest on the $700,000 of debt qualifies as a deductible expenses because it is less than the $750,000 limit. Importantly, if the $200,000 home equity loan was used to build an addition on a 2nd home or buy a vacation property it would not qualify for the deduction because the funds were not used on the “home that secures the loan”.
Andrew Hoffarth, CFP®
1 Source: www.IRS.gov