Taxing Definitions

Definition — Interesting changes

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The home mortgage interest deduction was one of the itemized deductions changed by the December 2017 tax law that takes effect for 2018 federal income tax returns.

Because the rule was modified and not entirely gutted, some of the old rules still apply. For example, for interest to be deductible, you have to apply the mortgage proceeds to buy, build, or substantially improve your main or second home.

Another rule that hasn’t changed: the loan must be secured by your main home or second home and be no more than the cost of the home. Note that in order to deduct the interest on home equity loans under the new rules, the loan must be secured by the home that is being bought, built, or substantially improved.

What has changed? Under the former rules, you could deduct interest on up to $1 million of qualifying mortgage or home equity debt. The new rules reduce that amount for loans taken out after December 31, 2017. For those loans, you can deduct interest on up to $750,000 of your total qualifying debt. Be aware that special rules apply to maintain the limits when you refinance the debt.

1

In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000.

In February 2018, the taxpayer takes out a $250,000 home equity loan to build an addition on the main home.

Both loans are secured by the main home and the total does not exceed the cost of the home.

Can the taxpayer deduct all of the interest paid on the loans on her 2018 federal income tax return?

or

 

2

In January 2017, a taxpayer takes out a mortgage to purchase a main home with a fair market value of $1.2 million. The loan is secured by the main home.

In January 2018, the taxpayer takes out a $100,000 home equity loan when the balance of the first mortgage was $900,000.

Can the taxpayer deduct all of the interest paid on the loans on her 2018 federal income tax return?

or

 

3

In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home.

In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home.

Can the taxpayer deduct all of the interest paid on the loans on her 2018 federal income tax return?

or

 

4

In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home.

In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home.

Can the taxpayer deduct all of the interest paid on the loans on her 2018 federal income tax return?

or

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions and internal revenue service documents. The full documentation may include facts and issues not presented here. Please use the link provided in the post to read the entire document.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Right answer!

Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible.

Note that if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, the interest on the home equity loan would not be deductible.

Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

The taxpayer may deduct all of the interest from the first loan because the first loan was originated on or before Dec. 15, 2017.

The taxpayer can deduct none of the interest on the home equity loan because the $750,000 limitation applicable to the home equity loan must be reduced (but not below zero) by the amount of the indebtedness incurred on or before December 15, 2017.

Right answer!

Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible.

Note that if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, the interest on the home equity loan would not be deductible.

Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible.

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2 thoughts on “Definition — Interesting changes

  1. I love Taxing Lessons! On Question #2, I’m assuming that the mortgage for the 1.2 million FMV home is 1 million or less. The answer is correct, assuming that the mortgage is 1 million or less, but if the mortgage secured by the 1.2 million FMV home were more than 1 million the interest deduction would be limited, correct?

  2. Thanks for the comment, Phyllis!

    You’re right, the date of the mortgage or HELOC is important. If the loan was taken out on or before December 15, 2017, interest is generally deductible on up to $1 million (MFJ). For loans after that, the limit drops $750,000. Note that refinancing pre-new-law existing home acquisition debt can continue the $1 million ceiling.

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