Fund: Before the TCA, you could deduct interest paid on acquisition debt or home equity debt, or both, within generous limits.
- Acquisition debt: This is debt where you use the mortgage proceeds to buy, build, or significantly improve the house. Typically, acquisition debt represents the major portion of a mortgage interest deduction. To be eligible for write-off, the loan must be secured by a qualifying residence, such as your primary residence or a secondary residence such as a vacation home. Interest is deductible on loans up to a threshold of $ 1 million.
- Home equity debt: Where state law allows, you could previously deduct interest on home equity loans secured by a qualifying residence, regardless of how the proceeds were used. With home equity debt, deductions were limited to interest paid on the first $ 100,000 of debt. Also, the loan amount could not exceed your equity in the house.
Along with other itemized deductions, mortgage interest deductions are claimed on Schedule A of Form 1040. They were subject to the “Pease rule” reducing itemized deductions for high income taxpayers.
But the TCJA toughened the rules, from 2018. It notably imposed these three changes.
- The threshold for deducting interest paid on acquisition debt is lowered from $ 1 million to $ 750,000. This applies to loans originating after December 15, 2017 (or April 1, 2018 if there was an enforceable contract in place before December 16, 2017). In other words, the existing owners benefit from acquired rights under the previous rules relating to acquisition debts. If you qualify, you can continue to deduct all eligible mortgage interest up to the $ 1 million threshold.
- The deduction of interest paid on real estate debt is suspended from 2018 to 2025. It does not matter when you acquired the residence. The law is currently scheduled to revert to the previous provision in 2026.
- In line with other TCJA changes for itemized deductions, the Pease rule is suspended from 2018 to 2025. It is expected to return in 2026, in the absence of new legislation.
Overall, the changes to the TCJA may reduce mortgage interest deductions for some taxpayers. Be aware, however, that you can take advantage of a “loophole” in the tax legislation.
How it works: If you take out a new home equity loan or line of credit and use the proceeds for major home improvements, the debt can be treated as acquisition debt rather than value debt domiciliary. Reason: This is debt incurred to “significantly improve” a qualifying residence. Therefore, you can add this mortgage interest to your deductible total if you still itemize the deductions.
Be sure to maximize the mortgage interest deductions allowed under current law. Your tax advisor can provide you with the necessary advice.