Tax deductions

Home Equity Loans and the Limit on Tax Deductions for Home Loans

The Tax Cuts and Jobs Act (TCJA), enacted on December 22, 2017, made significant changes to the deductibility of interest on home loans. More importantly, the amount of interest you can deduct on qualifying home loans is now limited to $750,000 for single filers and married couples filing jointly (or $375,000 if married filing separately), up from $1 million (or $500,000 for newlyweds filing separately) previously.

Key points to remember

  • The Tax Cuts and Jobs Act (TCJA) lowered the dollar limit of home loans eligible for the mortgage interest deduction.
  • The limit was increased from $1 million to $750,000 for single filers and married couples filing jointly (or $375,000 for married filers separately, from $500,000 previously).
  • A qualifying loan must be for a taxpayer’s primary or secondary residence.
  • In addition to mortgages, home equity loans, home equity lines of credit (HELOCs), and second mortgages also qualify for the deduction if the total of all loans does not exceed the $750,000 limit.
  • Home equity loans and HELOC interest deductions are only allowed under the new TCJA rules if the loan is used to purchase, build or substantially improve the home that is secured by that loan.

The ceiling for mortgage tax deductions

The amount of interest you can deduct on your tax return depends on when you loaned it, how much you loaned, and how you use the loan proceeds.

Tax Cuts and After-Tax Jobs Act

For home loans taken on or after December 16, 2017, interest is fully deductible if your loan balance totals $750,000 or less for singles and married couples filing jointly (or $375,000 or less if married separately). If your home loan balances exceed this amount, interest is only deductible up to the limit. Additionally, for a home equity loan or HELOC, the loan proceeds must be used to purchase, build, or substantially improve the home securing the loan for the interest to be deductible. This law applies to taxes from 2018 to 2026.

Tax Cuts and Jobs Act

For home loans taken out before December 16, 2017 but after October 13, 1987, interest is fully deductible if your loan balance totals $1 million or less for single and married couples filing jointly (or $500,000 or less if married declaring separately). If your home loan balances exceed this amount, interest is only deductible up to the limit. However, beginning with the 2018 through 2026 tax years, interest on home equity loans or HELOCs is only deductible if the loan proceeds are used to purchase, build, or substantially improve the home securing the loan, even if the loan was contracted before the entry into force of the law. past.

There is one exception: if you entered into “a binding written contract before December 15, 2017 to complete the purchase of a principal residence before January 1, 2018” and you actually entered into the residence before April 1, 2018, you are “considered to have incurred home purchase debt before December 16, 2017”.

Inherited debt

If your mortgage loan was taken out on or before October 13, 1987, there is no limit to the interest deduction on your mortgage loan. This inherited debt (the IRS still uses the old term “grandfather”, despite its racist roots) is fully deductible if it was secured by your qualifying home at any time after that date. There are also no restrictions on the use of proceeds for inherited debt to qualify for the home loan interest deduction.

If you refinanced a qualifying home-secured loan after October 13, 1987, for an amount not exceeding the remaining mortgage principal on the debt, the refinance is also considered inherited debt.

Qualified Residential Loans

Loans secured by your principal or secondary residence (also called qualified residence) that do not exceed the applicable ceiling depending on the date of acquisition may give rise to the mortgage interest tax deduction. Eligible loan types include your primary mortgage, secondary mortgage, home equity loan, or home equity line of credit (HELOC).

Since the passage of the TCJA, home equity loans and HELOCs are only eligible for the mortgage interest deduction to the extent that the proceeds are used to purchase, build or improve the home secured by the loan and the total value of all loans does not exceed the corresponding ceiling. The interest deduction for home equity loans or HELOCs is suspended from 2018 to 2026 if you use the proceeds for other purposes.

Examples of tax deductions for home loans

Here are some examples of situations where the mortgage interest deduction is authorized or not.

Fully deductible home equity loan

In January 2022, Sarah took out a $400,000 mortgage to purchase a primary residence. In April 2022, she took out a $200,000 home equity loan to build an addition on her house. In this example, the total value of Sarah’s loans does not exceed the $750,000 limit, the use of the home equity loan qualifies for the interest deduction, and both loans are secured by the principal residence. All interest is deductible.

Two fully deductible mortgages

In January 2022, Tom took out a $300,000 mortgage to purchase his primary residence. In May 2022, he took out a $250,000 mortgage to buy a vacation home. Both loans are secured by the houses purchased with the funds, respectively the principal residence and the secondary residence. In this example, the total value of Tom’s loans does not exceed the $750,000 limit, the loans are secured by the appropriate qualified residence, and all interest is deductible.

Non-deductible home equity loan

In January 2022, Jose took out a $300,000 mortgage to purchase his primary residence, valued at $800,000. In March 2022, he took out a $250,000 home equity loan on the principal residence to buy a vacation home. In this example, the total loan value is below the $750,000 limit. However, the use of home equity loan proceeds does not qualify for the tax deduction. The loan is secured by the main residence and was used to purchase the vacation home. Therefore, interest on the home loan is not tax deductible.

Partially deductible mortgage loan

In January 2022, Kat took out a $500,000 mortgage to purchase her primary residence. In May 2022, she took out a $400,000 mortgage to buy a vacation home. Both loans are secured by the houses purchased with the funds, respectively the principal residence and the secondary residence. In this example, the loans are secured by the appropriate qualified residence. However, the total loan value exceeds the $750,000 limit. Only a percentage of the total interest paid by Kat is deductible.

Is interest on a home equity loan deductible as a second mortgage?

It depends. Interest on a home equity loan, or HELOC, is only deductible if the proceeds are used to buy, build or improve the home that is securing the loan. This means that interest cannot be deducted if you used the proceeds to pay your personal living expenses.

In addition, you cannot deduct the interest on a mortgage that you took out on your main residence to buy a secondary residence. For the deduction, the proceeds of the home equity loan must be used on the qualifying residence that is secured by the loan.

I took out a home equity loan to pay off credit card debt. Is interest deductible?

No, interest on your loan is not deductible if used for personal debt. A home equity loan qualifies for the interest deduction only if the proceeds were used to purchase, build or improve the home securing the loan.

How can I find my mortgage interest for the year?

Your mortgage lender will show the annual amount of mortgage interest you paid on Form 1098. When you receive Form 1098, you can use this amount to record your mortgage interest deduction on Schedule A, line 8a, of Form 1040. .

The essential

Some home equity loans and HELOCs are eligible for the mortgage interest deduction, but only if you meet both loan limit requirements and use the home equity loan or HELOC for the permitted purpose. Carefully review your deductions to make sure you meet the requirements.