As you might imagine, the Tax Cuts and Jobs Act of 2017 created a bit of confusion around the tax-deductibility of mortgage interest in general and home equity lines of credit (HELOCs) in particular.
Under the old tax rules, you could deduct the interest expense on up to $1 million (if you were single or married filing jointly, or $500,000 for married filing separately) of home-secured debt used to purchase or make capital improvements on your qualified principal and/or second residence. You could also deduct the interest expense on up to $100,000 ($50,000 for married filing separately) of home equity debt secured by your home, whether in the form of a regular loan or revolving line of credit.
The two were related—but separate—circumstances, and once you understood the limits, the rules were pretty clear. Not so much now. Here’s why.
Tax-deductibility limits on mortgage interest depend on the date of your mortgage
Let’s start with the simplest. If you took out your mortgage before December 15, 2017, home-secured debt up to $1 million is grandfathered in. So you could still deduct the interest expense on up to that amount. After that date, the limit goes down to $750,000 if you are single or married filing a joint return ($375,000 for married filing separately).
Since your mortgage is $500,000, you’re fine no matter when you took out your mortgage. You can deduct the interest expense on the entire amount.
HELOCs are now wrapped into the total limit on tax-deductibility—with a caveat
A HELOC is another story, and here’s where it gets more complicated. In the past, a HELOC was treated separately and the interest expense on up to $100,000 (single or married filing jointly) was tax-deductible no matter how the money was spent.
Under the new law, home equity loans and lines of credit are no longer tax-deductible. However, the interest on HELOC money used for capital improvements to a home is still tax-deductible, as long as it falls within the home loan debt limit. Dates are important here, too. If you used a HELOC for home improvement before December 15, 2017, it would be grandfathered in to the $1 million limit. However, if you spent the money on December 15, 2017 or later, you’d be subject to the $750,000 limit.
In your case, with a $500,000 mortgage, you could deduct the interest expense on up to a $250,000 HELOC, as long as you spend that money on home improvements like your kitchen remodel. Your $500,000 mortgage plus a $250,000 HELOC would put you at the current limit.
For the record, second homes count, too
Fortunately, the new laws and limits do still apply to the purchase and improvement of second homes. However, the total home-secured debt limit for tax-deductibility is still $750,000 for both homes. But this, too, can get complicated depending on the timing.
For instance, let’s say you had two homes prior to December 15, 2017: a principal residence with an $800,000 mortgage and a vacation condo with a $200,000 mortgage. The interest expense on both would be tax-deductible under the old limit. Now let’s say you sold the condo. If you subsequently decide to purchase a new condo, the mortgage interest would no longer be tax-deductible because, while your old mortgage would be grandfathered in, any new purchase would make you subject to the new, lower debt limit.
Keeping track of your HELOC expenditures
With the new tax-deductibility laws regarding the use of HELOC money, it’s more important than ever to keep track of your home improvement expenses. Be sure to keep good records and have all receipts available come tax time to assure that you get the available tax deductions. This is something you should discuss with your accountant or tax advisor.
One more thought: Don’t necessarily be deterred from using your HELOC to pay off credit card debt as you suggested just because the interest won’t be tax-deductible. HELOC interest rates are still significantly lower than rates on consumer debt. Just be aware of the potential effect of rising interest rates, and make certain you don’t rack up any more consumer debt. Good debt management is an important part of overall financial planning and can work to your advantage in the right circumstances.