The Tax Cuts and Jobs Act passed in December 2017 no longer permits an individual to deduct the interest paid on home equity loans. This is a major change in the tax laws and very unfavorable to all US taxpayers who have these loans/lines of credit (or may have in the future). But like many new (and old) tax laws, when we don’t like the answer to a tax question we search for the loophole. And fortunately, such a loophole exists in this tax arena.
The new tax law permits an exception to this harsh rule if the loan/line of credit was used to buy, build or substantially improve the taxpayer’s qualified residence (main home/primary residence or second home) that secures the loan. The IRS provides some examples of how this will work (and I have modified them)- if you want to read the IRS version here is the link: https://www.irs.gov/newsroom/tax-reform
January 2018: Jose buys his primary residence for $800,000. To make this purchase he obtains a $500,000 mortgage. In February 2018, Jose takes out a $250,000 home equity loan to put an addition on his main home. Both loans are secured by the main home and the total ($750,000) doesn’t exceed the home’s value ($800,000). Because the total amount of both loans doesn’t exceed $750,000 (the maximum permitted under the new tax laws), all the interest paid on the loans (including the home equity loan) is tax deductible.
Same facts as in Example 1 except that Jose used the proceeds from the $250,000 home equity loan for personal expenses (paying off credit cards, buying a new car, vacation expenses, etc.). The interest on the home equity loan is NOT tax deductible.
January 2018: Stacy obtains a $500,000 mortgage to buy her primary residence. This loan is secured by her main home. In February 2018, she takes out a $250,000 loan to buy a vacation home. This loan is secured by the vacation home. Because the total amount of both mortgages doesn’t exceed $750,000, all interest paid on both loans is tax deductible.
Same facts as in Example 3 except that Stacy obtained the $250,000 home equity loan secured on her main home to buy the vacation home. In this case, the interest on the $250,000 loan would not be tax deductible because the loan was not secured on the vacation home.
January 2018: Christine obtains a $500,000 mortgage to buy her main home. The loan is secured by her main home. In February 2018, she gets another $500,000 loan to buy a vacation home. That loan is secured by the vacation home. Because the total amount of both mortgages is more than $750,000, she is not permitted to deduct all interest paid on the mortgages. Instead, she is permitted to deduct the interest on up to $750,000 of loans and thus a large percentage (but not all) of the total interest paid would be tax deductible.