If you own a home, the interest you pay on your home mortgage provides a tax break.  Many taxpayers believe that any interest paid on their home mortgage loan is deductible, but this is incorrect.  With the passage of the Tax Cuts and Jobs Act, now is a good time to revisit the interest deduction rules for home equity loans.

Let’s Define Debt

Acquisition Debt.   Acquisition debt means debt that is: (1) secured by the taxpayer’s principal home and/or a second home, and (2) incurred in acquiring, constructing, or substantially improving the home.  The debt must be secured by the same home on which the construction/improvement is being made.  You can deduct interest on acquisition debt on up to two qualified residences: your primary home, and one other vacation home or similar property, subject to some limitations. You cannot deduct mortgage interest on a third residence.

Home Equity Debt.   Home equity debt means debt that: (1) is secured by the taxpayer’s home, and (2) isn’t “acquisition indebtedness” (that is, wasn’t incurred to acquire, construct, or substantially improve the home). From 2018 through 2025, there’s no deduction for the interest on home equity debt.

When is Interest Deductible?

Note that interest may be deductible on what a lender may call a “home equity loan,” “home equity line of credit,” etc., where that loan actually fits the tax law’s definition of “acquisition debt” because the proceeds are used to substantially improve or construct the home. The 2018 – 2025 denial of the deduction for interest on “home equity debt” applies regardless of when the home equity debt was incurred.

If the home equity loan proceeds are used for a trade or business, the interest may be deductible by that entity.  Thus, it is important that anyone with a home equity loan be able to trace how the funds were used.

Taxpayers considering taking out a “home equity loan”-i.e., a loan that’s not incurred to acquire, construct, or substantially improve the home-should take into consideration the fact that interest on the loan won’t be deductible. Further, taxpayers with outstanding home equity debt – again, meaning debt that’s not incurred to acquire, construct, or substantially improve the home – will lose the interest deduction for interest on that debt, starting in 2018.

There may be other exceptions for deducting interest.  If you have a specific situation in mind, please contact us at 480-424-7855 to discuss.

Adapted from © 2019 Thomson Reuters/Tax & Accounting. All Rights Reserved.