Tax Loophole Found for Home-Equity Loan Interest

The 2017 Tax Cuts and Jobs Act introduced a slew of new tax breaks while doing away with others, one of which was supposed to be home equity loan interest. Much of that deduction has effectively been eliminated, at least through the end of 2025. The Internal Revenue Service (IRS), however, has allowed for a loophole in the tax law that would allow some homeowners to continue benefiting from the home equity loan interest deduction. (For more, see How the GOP Tax Bill Affects You.)

Several other tax changes directly affect taxpayers who own a home or plan to purchase one, including a reduction of the limit on deductible mortgage debt to $750,000 for loans taken out after Dec. 14, 2017. The previous limit was $1 million. In addition, going forward, there’s a cap of $10,000 on itemized deductions for state and local taxes (SALT), including property taxes. (For more, see Trump’s Tax Reform Plan.) 

In February 2018 the IRS issued an advisory for taxpayers regarding the status of the home equity loan interest deduction. The advisory specified that interest on home equity loans, home equity lines of credit (HELOCs) and second mortgages is still deductible, regardless of how the loan is labeled, as long as the loan is for an IRS-approved use. Specifically, home equity loans, HELOCs or second mortgages must be used to “buy, build or substantially improve the taxpayer’s home that secures the loan” for interest to be deductible. 

While the IRS didn’t include a list of expenses that would be covered under the law’s provisions, the advisory did include some examples of allowable home-improvement expenses. For instance, you may still qualify for the deduction if you’re using a home equity loan or HELOC to:

• Build an addition to expand your home
• Put a new roof on the property
• Replace your HVAC system
• Complete an extensive kitchen or bathroom remodeling project
• Resurface your driveway

The preservation of the deduction for eligible taxpayers is good news for homeowners. A TransUnion report estimates that over two-thirds of homeowners could be eligible for a HELOC, and HELOC originations are expected to reach up to 11 million in the next five years. The report also estimates that the number of consumers who open a home equity line of credit between 2018 and 2022 will be more than double the rate of those who did so between 2012 and 2016. 

Keeping the home equity loan deduction, even in limited form, may also have positive implications in encouraging home ownership. Other provisions of the tax bill could have the opposite effect. In addition to the severe cut in the state and local taxes deduction, this includes the almost doubling of the standard deduction to $12,000 for single filers and $24,000 for married couples filing a joint return. According to a report from the National Association of Realtors, the higher standard deduction may shrink the number of taxpayers eligible to claim mortgage interest and property tax deductions by itemizing. That would mean there’d be no tax differential between renting and owning for more than 90% of taxpayers. Retaining the home equity loan deduction may be viewed as an added incentive to buy instead of rent. (For more, see To Rent or Buy? There’s More to It Than Money.) 

If you a own a home and are planning to claim the home equity loan interest deduction, there are a few things to remember. First, the money must be used for home improvements or renovations. You can’t take the deduction if you’re using home equity to pay for personal expenses or consolidate credit card debts. The same goes if you’re taking out a loan and letting the money sit in the bank as your just-in-case fund for emergencies.

What's more, the renovations have to be made on the property on which you are taking out the home equity loan. You can't, for example, take out a loan on your primary residence and use the money to renovate your cottage at the lake.

Next, keep proper records of your expenses. The odds of being audited by the IRS are generally low, but you don’t want to take any chances. If you’re planning to use a home equity loan or HELOC to pay for home repairs or upgrades, be sure to keep receipts for everything you spend and bank statements showing where the money went. 

Finally, remember that the deduction is not unlimited. The total amount of mortgage-related debt interest that can be deducted beginning in 2018 is $750,000. If you have a large amount of equity and a large first mortgage loan, you may not be able to deduct all the combined interest paid. Since interest on older mortgages is grandfathered to $1 million loans, check carefully with your accountant about what you can deduct if you have both an older mortgage and a home equity loan that qualifies for deductions.

A home equity loan or line of credit can be a convenient source of funding when you want to spruce up your home. Snagging a tax deduction for the interest you pay is an added perk. As with any other loan, however, take time to compare interest rates and loan terms from different lenders to find the best deal possible.