What the new tax law will do to your mortgage interest deduction


The Tax Cuts and Jobs Act (TCJA) trimmed two important tax breaks for homeowners and left another big one completely untouched. In my last column, I covered how the new law can limit itemized deductions for real property taxes and how it left the valuable home sale gain exclusion break untouched.

In this column, I’ll cover how the new law limits itemized deductions for mortgage interest.

New limits on home mortgage interest deductions

For 2018-2025, the TCJA generally allows you to deduct interest on up to $750,000 of mortgage debt incurred to buy or improve a first or second residence (so-called home acquisition debt). For those who use married filing separate status, the home acquisition debt limit is $375,000.

For 2018-2025, the TCJA also generally eliminates the prior-law provision that allowed interest deductions on up to $100,000 of home equity debt, or $50,000 for those who use married filing separate status.

Before the TCJA, you could deduct interest on up to $1 million of home acquisition debt or $500,000 for those who use married filing separate status. Before the TCJA, you could also treat another $100,000 of mortgage debt as home acquisition debt if the loan proceeds were used to buy or improve a first or second residence, or $50,000 for those who use married filing separate status. The additional $100,000/$50,000 of debt could be in the form of a bigger first mortgage or a home equity loan. So the limit on home acquisition debt under prior law was really $1.1 million, or $550,000 for those who use married filing separate status.

Exceptions for grandfathered debts

Under a grandfather rule, the TCJA changes do not affect home acquisition debt of up to $1 million/$500,000 that was taken out: (1) before 12/16/17 or (2) under a binding contract that was in effect before 12/16/17, as long as the home purchase closes before 4/1/18. Under another grandfather rule, the $1 million/$500,000 home acquisition debt limits continue to apply to home acquisition debt that was taken out before the TCJA and then later — to the extent the initial principal balance of the new loan does not exceed the principal balance of the old loan at the time of the refinancing.

Non-itemizers can ignore all this

None of this home mortgage interest stuff matters unless you have enough 2018 itemized deductions to exceed your standard deduction. That will be the case for fewer folks than under prior law, because the TCJA almost doubled the standard deductions for 2018 compared to 2017. The 2018 standard deduction for married joint-filing couples is $24,000 (compared to $12,700 for 2017). The 2018 standard deduction for heads of households is $18,000 (versus $9,350 for 2017), and the 2018 standard deduction for singles and those who use married filing separate status is $12,000 (versus $6,350 for 2017).

Some examples

If this mortgage interest stuff does matter to you, here are some examples of how the new TCJA mortgage interest deduction limits work.

Example 1: Billy Joe and Bobby Sue are a married joint-filing couple with a $1.5 million mortgage that was taken out to buy their principal residence in 2016. In 2017, the couple paid $60,000 of mortgage interest, and they could deduct $44,000 [($1.1 million/$1.5 million) x $60,000 = $44,000].

For 2018-2025, they can apparently treat no more than $1 million as acquisition debt. So if they pay $55,000 of mortgage interest in 2018, they can apparently deduct only $36,667 [($1 million/$1.5 million) x $55,000 = $36,667].

Example 2: Same basic facts as above, except this time assume that Billy Joe and Bobby Sue refinance their mortgage on 7/1/18, when it has a balance of $1.35 million, by taking out a new first mortgage for the same amount.

Under the grandfather rule for up to $1 million of refinanced home acquisition debt, the couple can continue to deduct the interest on up to $1 million of the new mortgage for 2018-2025.

Example 3: Orlando is an unmarried individual with an $800,000 first mortgage that he took out to buy his principal residence in 2012. In 2016, he opened up a home equity line of credit (HELOC), and borrowed $80,000 to pay off his car loan, credit card balances, and various other personal debts.

On his 2017 return, Orlando can deduct all the interest on the first mortgage under the rules for home acquisition debt. For regular tax purposes, he can also deduct all the HELOC interest under the rules for home equity debt (but the interest is disallowed under the alternative minimum tax (AMT) rules because the HELOC proceeds were not used to buy or improve a first or second residence).

For 2018-2025, Orlando can continue to deduct all the interest on the first mortgage under the grandfather rule for up to $1 million of home acquisition debt, but he cannot treat any of the HELOC interest as deductible home mortgage interest.

Example 4: Same basic facts as above, except this time assume that Orlando used the $80,000 from the HELOC to remodel his principal residence.

On his 2017 return, Orlando can deduct the interest on the first mortgage and the HELOC, because he can treat the combined balance of the loans as home acquisition debt that does not exceed $1.1 million.

For 2018-2025, Orlando can continue to deduct the interest on both loans under the grandfather rule for up to $1 million of home acquisition debt.

Example 5: Paulina is an unmarried individual with an $800,000 first mortgage that was taken out on 12/1/17 to buy her principal residence. In 2018, she opens up a HELOC and borrows $80,000 to remodel her kitchen and bathrooms.

For 2018-2025, Paulina can deduct all the interest on the first mortgage under the grandfather rule for up to $1 million of home acquisition debt. However, because the $80,000 HELOC was taken out in 2018, the new-law $750,000 limit on home acquisition debt apparently precludes any deductions for the HELOC interest. Reason: the entire $750,000 post-TCJA limit on home acquisition debt was absorbed (and then some) by the grandfathered $800,000 first mortgage. So the HELOC balance apparently cannot be treated as home acquisition debt, even though all of the loan proceeds were used to improve Paulina’s principal residence. Instead the HELOC balance must be treated as home equity debt, and interest on home equity debt is disallowed for 2018-2025.

Example 6: Same basic facts as above, except this time assume that the first mortgage taken out by Paulina was only $650,000.

For 2018-2025, she can deduct all the interest on the first mortgage under the grandfather rule for up to $1 million of home acquisition debt. The $80,000 HELOC balance can be treated as home acquisition debt, because the combined balance of the first mortgage and the HELOC is only $730,000, which is under the post-TCJA limit of $750,000 for home acquisition debt. So Paulina can deduct all the interest on both loans under the rules for home acquisition debt.

The bottom line

Many homeowners will be blissfully unaffected by the TCJA’s new limits on deducting home mortgage interest. But folks with larger mortgages and home equity loans must take heed. I hope the examples included here help clarify whether you will be affected and if so, how much. That said, please understand that what you see here is based purely on my analysis of the applicable provisions in our beloved Internal Revenue Code. Subsequent IRS guidance could differ. So please stay tuned. I’ll keep you informed of developments on this important tax-law front.



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