Post-tax reform, some high-net-worth clients remain confused over how to deduct mortgage interest.
For mortgages taken out after the middle of last December, only the interest on the first $750,000 of the mortgage is deductible, $250,000 less than previous allowed. Interest on home-equity loans can generally no longer be deducted at all. And advisors must educate wealthy clients, especially in states where residential real estate values are high and that deduction is also now limited.
“When clients are looking at buying a new home, they’re disappointed with the reduction in tax breaks,” said Larry Pon, CPA/PFS/CFP at Pon & Associates, Redwood City, Calif. One of his clients, for instance, is buying a new house for $2.5 million and has a new mortgage of $1.2 million.
“He’ll be paying about $48,000 in mortgage interest, but he will only be able to deduct $30,000 of that interest,” Pon said -- adding that pain came “when I told him he could only deduct $10,000 of the $31,000 he will be paying in property taxes on the new house.”
“When we start to prepare the 2018 returns for our HNW clients, it’ll also now be necessary to ask them what they used their loans and lines of credit for,” said Jim McGrory, CPA and shareholder at Drucker & Scaccetti in Philadelphia. “No deduction is allowed for interest on home equity loans and lines of credit that were used for other non-acquisition purposes such as paying off auto loans, vacation trips or college tuition.”
Borrowing against a main home to improve a vacation home no longer produces an interest deduction either. Christopher Fundora, a CFP at Traphagen Investment Advisors in Oradell, N.J., said this change impacts clients buying a second home, particularly if they have a mortgage on their primary residence. The new $10,000 limit on state and local and property taxes (SALT) also especially impacts carrying multiple properties, Fundora said.
“As the [deduction’s] sunset isn’t until Dec. 31, 2025, we’re not advising clients to wait eight years or potentially longer,” added Anish Kansara, a CPA and tax manager at Traphagen. “Clients interested in real estate [investments] instead of looking for personal use property may be now focused on purchasing rental properties” which still allow for deductions.
Confusing matters: Indebtedness for home equity loans may be deductible if your client used the money to acquire, build or substantially improve a qualified residence and secured the loan with that qualified residence, added Tommy Blackburn, CPA/PFS/CFP and senior financial planner with Verus Financial Partners in Richmond, Va. “We haven’t really experienced our clients being alarmed,” he said. “While they’d prefer a higher deduction, there’s more focus on how the entire new tax law affects their plans.” Still, he added, for a resident of Blackburn’s state in the highest tax bracket and married filing jointly, “an interest rate of 5 percent on $250,000 of qualified debt would’ve created a deduction of $12,500.”
How are HNW clients responding? “With the recent increases in interest rates and with expectations that they’ll be even higher in the future, some clients are thinking about refinancing their adjustable rate mortgages and are concerned whether the reduction in mortgage-debt limit will apply to them,” McGrory said.
But, he added, with debt incurred to refinance acquisition indebtedness that was incurred on or prior to Dec. 15, 2017, the new loan is treated as having been incurred on the date the original debt was incurred. If an HNW client has an interest-only ARM with a principal balance outstanding of $1 million, he or she can refinance a mortgage and still deduct all of the interest as long as they do not borrow more than $1 million.
Restrictive new rules or not, some HNW clients will likely have a lower tax bill for 2018 due to elimination of the alternative minimum tax. “There’s a lot of noise in the media about the SALT and mortgage-interest deductions. What’s missing is the AMT discussion, probably because it’s too complex,” Pon said. “Review the overall tax calculation.”