Whether you’re waiting on a call from your C.P.A. to discuss your prepared return or you’re desperately digging up receipts before your appointment, you’re probably very aware that we’re in the thick of tax season. While there is nothing you can do to improve your tax situation for 2017, you should take a few minutes from your meeting to discuss how the changes enacted with the Tax Cuts and Jobs Act will affect your 2018 taxes.
One of the areas you should look at is your total amount of mortgage interest, home equity loans and home equity lines of credit. For tax years beginning after Dec. 31, 2017, the Tax Cuts and Jobs Act repealed the deduction for interest on home equity indebtedness.
With so many questions surrounding this change, the IRS released guidance advising taxpayers that in some circumstances, they may be able to continue to deduct interest paid on home equity loans. Under the new law, 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, is not. The loan must be secured by the taxpayer’s qualified residence and not exceed the cost of the home. That means the improvements must be for the home that is collateral for the home equity loan.
We believe this change makes good financial sense. Leading into the subprime mortgage crisis, some homeowners were taking home equity loans at 120% of the value of their home to pay off credit card debt, buy a car or vacation home, or pay for school, for example. They would pay off purchases that carried a higher interest rate with a low interest rate home equity loan and then deduct the interest on their federal tax return. However, when real estate prices dropped, many of these homeowners found themselves upside down in their mortgages.
Homeowners can still use a home equity loan for personal living expenses, but the interest for that portion of the loan will not be tax deductible. For example, if you have a home equity loan and use the money to renovate your kitchen and build a deck, but then take $5,000 to pay off your Visa card, then only the interest on the portion of the loan used for the kitchen remodel and the deck will be deductible.
Keep in mind, the burden of proof lands squarely on the taxpayer’s shoulders. So, if you have a home equity loan or home equity line of credit, keeping records and receipts for your home renovation projects are of the upmost importance. The IRS has not given any guidance as to how taxpayers will need to document the use of equity loan funds.
Another point to keep in mind is that the deduction for mortgage interest is limited to an aggregate of $750,000. If you have a mortgage written into contract before Dec. 15, 2017, you are not subject to the lower acquisition indebtedness amount, but you may lose your deduction on any existing home equity loans, depending on how the loan proceeds were used. However, let’s say you have an existing home mortgage of $600,000, and in 2018, you take out a home equity loan of $350,000 and use the loan solely for renovations to the home. Because the total amount of the loans exceeds $750,000, only a percentage of the total interest paid will be deductible.
While these changes won’t affect what you do or do not owe April 17, 2018, it is best to discuss your situation with your C.P.A. or tax consultant today. If you have questions regarding your tax situation, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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