The home mortgage interest deduction under the TCJA

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The Tax Cuts & Jobs Act (TCJA) altered the tax code to a degree not seen before in decades. The TCJA eliminated 1031 exchanges of personal property, for instance. Prior to the TCJA, personal property 1031 exchanges were performed very frequently; it was common for car rental companies, as an example, to regularly exchange their old rental vehicles for new ones. The TCJA also made a major change to the deductibility of mortgage debt interest and home equity debt interest. The deduction for mortgage interest and home equity debt interest has been a very significant tax break for homeowners. Prior to the TCJA, this break had been untouched since the 1980s.

Given the emphasis our society places on homeownership, you’ll likely encounter many clients who want to understand how the updated version of this deduction works. Explaining the changes made in the TCJA to laypeople won’t be easy, but with a bit of work you should be able to give your clients a basic understanding of the mortgage interest deduction.

Deductibility of Mortgage Interest Prior to TCJA

Under the old rules prior to the TCJA, itemizers could deduct the interest on the first $1 million ($500,000 for married person filing separately) of their home mortgage debt. In addition, they could deduct the interest on the first $100,000 of their home equity debt (i.e. HELOC); this was true regardless of whether the home equity loan proceeds were used for home building purposes. So, if a person acquired a mortgage loan of $900,000 to purchase a new primary residence, that person would be able to deduct the entire amount of interest paid on this principal. If the mortgage loan were $1.2 million, only the amount of interest paid on the initial $1 million of this mortgage loan would be deductible.

Deductibility of Mortgage Interest After the TCJA

The TCJA altered the principal amount on which mortgage interest may be deducted. Now, instead of $1 million, the limit is the first $750,000 of mortgage principal ($375,000 for married filing separately). The mortgage loan proceeds must be used for the acquisition or improvement of a personal residence, and the loan must be secured by the home being acquired or improved. In other words, a person cannot obtain loan one a first residence and then use the proceeds to acquire or improve a second residence; in that case, the interest would not be deductible. If a person acquires a mortgage loan of $1.2 million, and pays $65,000 in mortgage interest, that person would now need to calculate the amount of deductible interest as a percentage of the total interest.

The TCJA Eliminated Home Equity Debt Used for Unrelated Purposes

Formerly, a person could deduct the interest arising from a home equity loan (such as a HELOC), regardless of whether that loan were used to finance improvements. So, a person could take out a HELOC loan of $100,000, use the loan to pay off credit card debt or auto loan debt, and still take the deduction for the HELOC interest. Now, this provision has been eliminated entirely, and so the interest deriving from home equity debt is no longer deductible at all. However, the interest stemming from a home equity loan may still be deductible, but the proceeds from the loan must go toward improving the underlying property. The reason for this is that the TCJA determines deductibility based on the use of the loan, rather than its type or other classification. So, if the home equity loan goes toward improving the underlying residence, then it’s considered an “acquisition loan” for tax purposes, and the interest may be deducted. But, the $750,000 limit remains in place, and so the home equity loan interest would not be deductible if the loan pushed a given taxpayer beyond the $750,000 limit (which may happen if there’s a sizable preexisting mortgage loan).

This a broad overview of the current state of the mortgage interest deduction. But this is where the conversation has to start when you’re giving clients an explanation. The deduction includes other rules and exceptions. For instance, there’s the “grandfather rule,” which means that the current loan limit doesn’t apply to loans already acquired past a certain date. For those loans, the old limit still applies. In other words, the TCJA limit only applies to new mortgage loans acquired after December 15, 2017.

Even though younger Americans have a somewhat different attitude toward homeownership when compared with earlier generations, homeownership still remains a major goal for many, many people in our country today. The tax code has historically furthered the goal of ownership for Americans. In some ways, we can interpret this revision to the current law as a step backwards. However, the new law did dramatically increase the standard deduction, and so perhaps many who would’ve been affected by the change to the mortgage interest deduction won’t be affected.
This article was written by Jorgen R. Olson, an independent writer based in Seattle, WA. He writes on behalf of Sammamish Mortgage, a family-owned mortgage company serving clients in the Pacific Northwest region for over 25 years.

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