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Taxpayer asks:

In September 2017 we refinanced our house to pay off crushing credit card debt we incurred during the recession and could not hope to get out from under. 

My question — Is the 2018 refinance law stating that we can only use home equity to pay for work on our dwelling/property retroactive or can we still claim that since it was before that took effect in December 2017? 

I appreciate your time and your blog with so much confusing tax information. 

Taxgirl says:

I agree that this is one of the more confusing pieces of the Tax Cuts and Jobs Act (TCJA) because there are so many working parts. On the one hand, the new law limits the deduction but also allows for some grandfathered bits and tweaks some definitions. With that, a quick recap is probably in order.

Under prior law, if you itemized your deductions, you could deduct qualifying mortgage interest for purchases of a home up to $1,000,000 ($500,000 for married couples filing separately) plus an additional $100,000 for home equity debt. The interest on the home equity debt was deductible no matter how you used the debt, so long as the total of the mortgage and the home equity debt didn’t exceed the fair market value of your home. With those rules, the loan you took out before the TCJA took effect would have been deductible.

The new law limits the amount of debt that qualifies for the home mortgage interest deduction. Beginning in 2018, taxpayers can only deduct interest on $750,000 of new qualified residence loans ($375,000 for a married taxpayer filing separately). The limits apply to the combined total of loans used to buy, build, or substantially improve your home (and a second home, if you have one). 

Congress recognized that some taxpayers bought homes in reliance on the old law, so they grandfathered some of those provisions. Specifically, if you took out a home mortgage before December 15, 2017, you can still deduct the interest payable of up to $1,000,000 of home acquisition debt.

That, of course, left a lot of taxpayers confused: What about home equity loans?

To help, the IRS issued guidance in 2018 which made clear that home equity loans may still be deductible – no matter what they are called – so long as they are used to buy, build or substantially improve your home. However, the TCJA otherwise suspends the deduction from 2018 through 2025. In other words, if the home equity loan is used for a purpose other than to buy, build, or improve your home, it is no longer deductible.

So, is that rule grandfathered, too? Unfortunately, no. Even if the home equity loan was taken out before the law was changed, if it was used for a purpose other than to buy, build or improve your home, it is not deductible. That would include using the loan to pay down other debt.

Here’s a quick example.

  • Let’s say that you bought a home in 2015 worth $900,000 and took out a mortgage worth $800,000. And let’s say that you took out a home equity loan in 2016 worth $75,000 that you wanted to use to pay off your credit card balances.
  • In 2015, you could deduct the interest on the mortgage. In 2016 and 2017, you could deduct the interest on the mortgage and the interest on the home equity debt. But beginning in 2018, you could only deduct the interest on the mortgage on the first home – even though it’s over the $750,000 limit. The rule which grandfathered up to $1 million of home acquisition debt would apply, but the home equity loan interest would not be deductible.
  • If, however, you had taken out a home equity loan in 2016 worth $75,000 to pay for a new kitchen and bath, the interest on the loan would still be deductible because it was used to improve your home.

It’s no wonder that you’re confused: the rules are anything but simple. I hope, however, that clears it up for you. For more info on home mortgage interest, check out IRS Pub 936 (downloads as a PDF).

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
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