Plan for New Rules on Home-Related Tax Deductions

SEPTEMBER 19, 2018
David Robinson, CFP
When preparing their 2018 tax returns next year, taxpayers will have to deal with changes in rules for deductions involving their homes. home owner 2018 tax rules

Stemming from the federal Tax Cuts and Jobs Act of 2017, these changes involve mortgage interest, home equity debt interest and local property tax. They have potentially significant financial implications for medical professionals buying or borrowing against equity on expensive homes.

Mortgage Debt

Initially, Congress had the home mortgage interest deduction on the chopping block. But Congress ended up preserving this deduction—within limits. The new law limits the amount of mortgage debt for this deduction to $750,000 for new mortgages and $1 million for existing mortgages secured before Dec. 15, 2017.

Home Equity Debt

Until this year, if you had a home equity loan or a home equity line of credit (HELOC), you could spend the full amount on whatever you pleased and deduct the interest on it. As a result, people who had run up large amounts of credit card debt obtained loans at lower interest rates to pay credit card companies---and got to deduct this as well. They also bought new cars, went on vacations and generally lived it up—all with a handy tax deduction on the debt interest.

Because of the new tax law, these days are over. Now, the IRS allows deductions only on interest on the amounts of home equity debt proceeds that you spend to improve the home used to secure the debt, with a limit of $100,000.

As this limit can be an aggregate figure applied to total debt on two homes, you can get one home equity loan or HELOC on your primary residence and one on your vacation home, and the limit would apply to the two loans together. However, you can’t use a HELOC on one home to improve a second one. When this practice was permissible, it happened a lot during the real estate run-up of the mid-2000s. And people would get a HELOC on one home to get money to pay a down payment a second, which they would flip in a rising market for quick profits.

Initially, the new legislation passed in the fall appeared to eliminate deductions on home equity debt entirely. But the IRS subsequently clarified this, stating: "Despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on home equity loans, [HELOCs and] second mortgages, regardless of how the loan is labelled."

The new law eliminates the deduction for interest paid on home equity loans and HELOCs "unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan."

Accordingly, the new rules liminate blanket deduction on interest on debt from cash-outs—second mortgage loans for amounts greater than their existing mortgage that homeowners use to get cash. Now, only the interest on money from loans that they spend to improve that particular home is deductible.

The same goes for interest on reverse mortgages. Homeowners can no longer deduct the interest on loan proceeds they use for any purpose except improving the property.

Thus, comes an end to spending the proceeds from mortgage debt any way borrowers may like with the comfort of knowing they can deduct the interest.

If you’re planning to deduct home equity debt interest, you must make sure all improvement expenses qualify and keep records of these expenses. The need to do this isn’t clear from the pertinent tax form, IRS Form 1098, as the current form doesn’t ask how you spent the money from the loan or even mention home-improvement expenses. That’s because it’s the same form that was used when the blanket deduction was allowed.

Taxpayers need to be aware that they must nevertheless keep good records of expenditures in case of an audit.

Itemizing Deductions

Even if you have mortgage debt interest that qualifies as deductible, you’ll only be able to deduct it if you meet the new threshold for itemizing deductions.

To itemize this tax year, total deductions must exceed the new standard deduction, which has nearly doubled—to $12,000 for singles, $18,000 for heads of household and $24,000 for married couples filing jointly. Single individuals 65 and older get an additional standard deduction of $1,600 and married couples where both individuals are 65 and filing jointly, $2,600.

Having deductions that exceeding these amounts can mean incrementally greater total deductions.

State and Local Taxes

The new rules put a limit of $10,000 on the federal deduction of state and local taxes. These taxes include property tax, which on upscale homes can be well over the new deduction limit, especially in higher taxation areas of the country such as the Northeast and the West Coast.

Losing this deduction is a big hit for these homeowners. If your property tax is $20,000--which isn’t unusual on homes in in the greater New York metro area—and your effective tax rate is 20 percent, the new deduction limit means you’ll pay $2,000 more in federal tax than you did previously, all other factors being equal.

As the saying goes, forewarned is forearmed, so becoming aware of these changes will enable you to be proactive. By not waiting until tax time to deal with these issues, you’ll have more time to plan so you can get a better tax outcome or, at least, avoid errors that may bring an audit.

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David Robinson, a Certified Financial Planner, is founder/CEO of RTS Private Wealth Management, an SEC-registered firm in Phoenix that provides fiduciary services to help clients achieve their financial goals. His practice focuses on helping wealthy individuals with custom financial plans, using a holistic approach to grow/protect wealth, manage taxes, identify insurance solutions, prepare for retirement and manage estate plans.

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