Under the new tax law, clients will face new restrictions that may stop them from using home equity to pay off student loans, buy second homes or start businesses.
The Tax Cuts and Jobs Act suspends until 2026 the deduction for interest paid on home equity loans and lines of credit unless the money is used to buy, build or substantially improve the taxpayer’s home that secures the loan.
“It is confusing that it’s still deductible for some things but not everything,” said Judith Herron, CPA with Markovitz Dugan & Associates CPAs and Business Consultants in Pittsburgh.
“In the past with HNW clients, the calculation for taking a home-equity loan was more one of benefit or opportunity than necessity,” said Jeff Fosselman, senior wealth advisor with Relative Value Partners in Northbrook, Ill. “Now, that analysis changes.”
Added Lynn Conover, CPA and tax partner with The Curchin Group in Red Bank, N.J., “I’ll say to a client, ‘I see you have a home-equity loan.’ From there I ask, ‘What did you use it for?’”
Interest on a loan called a “home equity loan” that was used to substantially improve the qualified residence is still deductible in 2018 if debt falls within limitations: The amount of acquisition debt that produces deductible interest is $1 million if the loan was in place on Dec. 14, 2017. Loans acquired after that date have a $750,000 limit.
For example, suppose in January of this year your client secured a $500,000 mortgage to buy a main home with a fair market value of $800,000. The following month, your client took 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 doesn’t exceed the home’s cost. Because the total amount of both loans doesn’t exceed $750,000, all the interest paid on the loans is deductible.
But if your client used the loan for personal expenses, such as paying off student loans and credit cards, the interest on the loan is not deductible.
“Definitions are of high importance,” said Mary Kay Foss, CPA in Walnut Creek, Calif. “I advise individuals to look into the history of their mortgage indebtedness to verify how much actually qualifies as acquisition indebtedness.”