The tax laws are engineered in many ways to favor or address certain industries. One of these engineered efforts is to favor home ownership by individuals over renting, benefiting the residential construction, real estate, and mortgage industries, all of which directly affects the vast majority of individual taxpayers. The largest single deduction is to itemize the interest paid on a mortgage on a principal residence. If you own a home, the interest paid on a home mortgage provides a tax break. The amount of mortgage interest that may be deducted, however, is limited. With home prices increasing over the last few years nationwide, many home buyers will find that their ability to deduct mortgage interest is limited.
Mortgage debt that is "acquisition debt" is deductible. 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. Interest can be deducted on up to two qualified residences, so a primary home and one other vacation home or similar property can qualify. Mortgage interest on a third residence is not deductible.
There is a limitation, however, on the ability to deduct interest. From 2018 through 2025, mortgage interest for acquisition debt greater than $750,000 ($375,000 for a married taxpayer filing separately) is not deductible. For example, if a taxpayer bought a $2 million house with a $1.5 million mortgage, only the interest that paid on the first $750,000 in debt is deductible. The rest is considered personal interest, and not deductible.
For mortgages taken out after 2025 and before 2018, different limits apply. Beginning in 2026 interest is not deductible on acquisition debt greater than $1 million ($500,000 for married individuals filing separately). This is also the limit that applied before 2018. The $1 million ceiling applies to acquisition debt incurred before Dec. 15, 2017, and to refinancings of pre-Dec. 15, 2017 debt. The higher $1 million limit applies to acquisition debt incurred before Dec. 15, 2017, and to debt arising from the refinancing of pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. Thus, taxpayers can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt, and that refinanced debt amount won't be subject to $750,000 limitation, but instead will be subject to the $1 million limitation.
Note that the limit (ceiling) on home mortgage debt for which interest is deductible includes both your primary residence and your second home, combined. Many taxpayers assume that they can deduct the interest on $750,000 for each mortgage. But if a taxpayer has a $700,000 mortgage on a primary home and a $500,000 mortgage on a beach house or ski lodge, the interest on $450,000 of the total debt as nondeductible personal interest.
Interest on " home equity loans" isn't deductible, from tax years 2018 to 2025. "Home equity debt," as specially defined for purposes of the mortgage interest deduction, 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. 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 to 2025 denial of the deduction for interest on "home equity debt" applies regardless of when the home equity debt was incurred.
After 2025 and before 2018, home equity interest is deductible, within limits. Beginning with 2026, home equity debt will be deductible. However, the interest that can be deducted is limited to loan amounts of the lesser of $100,000 ($50,000 if your filing status is married filing separately) or your equity in the home. This is also the limit that applied before 2018, when interest on home equity debt was deductible. The interest on a "home equity loan" will be deductible regardless of how you use the loan proceeds, except when the proceeds are used to purchase tax-exempt obligations.
Thus, taxpayers considering taking out a "home equity loan", which is 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 will lose the interest deduction for interest on that debt, starting in 2018. For the post-2025 and pre-2018 tax year, home equity interest is not deductible for alternative minimum tax (AMT) purposes, unless the loan is used to improve the home.
Home buying and ownership receives favorable treatment under the US tax code. Bear in mind, however, that as home values increase and mortgages increase, some complications come into play. It may seem that it is easy enough to say that home mortgage is deductible but, as made clear by the above, a taxpayer needs to bear all of the rules and limitations in mind.
Dowell Group, LLP | All Rights Reserved |
Created by Olive + Ash. Managed by Olive Street Design.