As most taxpayers know by now, the TCJA reduced the available mortgage interest deduction from $1,000,000, to $750,000.[1] Essentially, if one bought a home today and financed $1,000,000 of the purchase price[2] interest on only $750,000 of the loan would be deductible. That’s pretty straightforward. This applies to interest secured by a primary or secondary residence, so long as the combined loan amount – commencing in 2018 – does not exceed $750,000.
Where confusion sets in, is how Home Equity Lines of Credit (“HELOCs”) play into the interest deductibility scheme. It isn’t really that different from before – i.e. interest is still deductible, EXCEPT that:
(a) It is subject to the total $750,000 cap; and
(b) The loan funds from the HELOC must be used to build, buy, or substantially improve the taxpayer’s home. (While the funds can still be used for any purpose, e.g. student loans, debt consolidation, college expenses, those uses do not permit the taxpayer to deduct the interest.)
And it makes no difference whether the loan is secured by the taxpayer’s primary or secondary residence – so long as the combined amount of the loans do not exceed the new $750,000 cap. It makes no difference whether the loan is in the form of a HELOC or a straight amortizing second mortgage.[3]
Here are three examples found in a recent IRS Bulletin:
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).
For more information about the new tax law, visit the Tax Reform page on IRS.gov.
One final note; these rules are temporary. They start in 2018 and end in 2026. After that, much depends upon the economy, and whether we have a red or blue administration and/or congress. However, from a practical standpoint, loans already in place at the end of 2025, when the law sunsets, are unlikely to be retroactively affected. ~Phil
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[1] This assumes married taxpayers filing jointly. Otherwise, the maximum amount of the loan drops from the former $500,000 cap, to $375,000 for single filers.
[2] If the loan was secured before January 1, 2018, the interest deductibility continues going forward under the $1M cap.
[3] HELOCs are typically lump sum loans that sit in a second position behind the first loan, but do not become repayable until they are drawn upon. They are a “second mortgage” in that they sit behind the first mortgage in terms of priority – i.e. the holder of the first mortgage has the “first” right to the proceeds upon foreclosure – and, if anything is left, the holder of the second mortgage can recover from the remainder of the foreclosure proceeds. But a standard second mortgage – versus a HELOC – is normally fully amortizing over a fixed term and requires monthly principal and interest payments paid over time. The moment the loan is made, e.g. for $50,000, interest accrues and the borrower is required to repay it, even if the money from the loan sits in the borrower’s bank account and is not used. HELOCs do not have to be repaid until they are drawn upon, and frequently only at an interest-only rate, with a 10-year “call” or balloon.
