Home Equity Loans: Tax Deductions and Decor

Tax deductions on home equity loans and mortgages have long benefited homeowners. These deductions allow homeowners to reduce their taxable income by the amount of interest paid on these qualified loans. But tax laws have changed!

What you need to know before getting a home equity loan!

New tax laws lowered deductible limits, redefined loan use, and could leave you revising your plans. Before taking out a home loan, make sure you understand how the new laws could affect your decision.

Note: If you’ve been deducting interest on debt over $750,000 and your loan(s) originated before December 15, 2017, ‘grandfathering’ rules may apply. But, you DO need to pay attention, or you could lose your Grandpa status!

What changed, and when?

The Tax Cuts and Jobs Act of 2017 made sweeping changes in business and individual tax laws. Included are changes about Mortgage Interest Deduction laws, including home equity loans and home equity line of credit loans (HELOC).

Note: A home equity loan and a HELOC are different, but similar type loans and the same laws apply to both.

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Three essential questions get us started:

• What is ‘home equity’? Simply put, it’s the difference between the amount your house is worth and any debts against the home.
• Why is mortgage interest deduction included here? The new tax laws apply to the combined amount of loans used to buy, build, or substantially improve the taxpayer’s main and second home. Taxpayers may only deduct interest on $750,000 (down from previous limits of $1 million) of qualified residence loans, or $375,000 for a married taxpayer filing a separate return.
• How is the tax deduction taken?  You must itemize deductions on Schedule A of IRS Form 1040 if your deductible expenses add up to more than the amount of the standard deduction. Expect to receive an IRS Form 1098, the Mortgage Interest Statement, from your lender or lenders. It shows the interest you paid on your primary mortgage, home equity loan, or line of credit in the previous year.

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Three main categories under new tax laws require that new home equity loans must:

1. Be secured by a qualified residence(s),
2. Not exceed the value of the residence(s) and
3. Be used to acquire or substantially improve the residence(s)

Details of home equity loan category requirements

The Mortgage Interest Deduction allows homeowners to reduce their taxable income by deducting interest on qualifying loans.

Loans must be secured by a qualified residence(s) 

Your loan must be secured by a qualified residence or residences. Qualified residences include the taxpayer’s main home and second home.

What about multiple owners? Dad and Junior purchase a vacation cabin together. As owners, each can deduct the amount of interest they pay, only if they itemize allowed deductions. It doesn’t matter whose name or Social Security number is on the IRS 1098, as long as they are a legal owner of the property.

What about interest on someone else’s mortgage? Perhaps Junior purchases the property and holds the mortgage himself, becomes unemployed, and Dad makes the mortgage payments. Dad cannot claim the interest deduction unless he is a legal owner of the property.

Loans must not exceed the value of the residence(s) 

Combined amounts of your home mortgage, home equity loan, or HELOC are used to determine this figure. Beginning in 2018, taxpayers may only deduct interest on $750,000 of new qualified residence loans ($375,000 for a married taxpayer filing separately).

The IRS explains:  In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by that main home. In February 2018, the taxpayer takes out a $500,000 loan to buy a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, only a percentage of the interest paid on the mortgages is deductible.

Loans must be used to acquire or substantially improve the residence(s) 

The TCJA of 2017, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.

What does the IRS consider to be qualified, substantial improvements to your home? You might get different opinions from your decorator and architect, so do your homework! Structural changes or adding that mother-in-law wing may qualify. However, don’t count those easily exchangeable items of decor as being qualified deductions.

“Repairs that maintain your home in good condition, such as repainting your home, aren’t substantial improvements,” the IRS states.

Keep and provide the IRS with receipts for work done!

Home equity loans for business

It’s your choice, but should you? By using money outside legal tax-advantaged boundaries, you allow the IRS to benefit from your choices. You can protect yourself and your business against legal taxes.

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What really makes a difference?

Common sense always makes a difference. Remember, the new $750,000 cap on deductible interest applies to the combined amount of loans used to buy, build, or substantially improve your main and second home. According to Dave Ramsey, as of May 2019, the U.S. median home price was $315,000. Make that a new home, add the vacation home, and an equity loan for renovation, and tipping the scales at $750,000 could happen.

What’s the bottom line?

You want control of your future. As your CPA financial and tax specialist, I help you manage and control your overall economic life goals. It’s that simple.

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