It’s official: Despite widespread fears to the contrary, the IRS has clarified that last year’s big tax bill did not kill all interest deductions on home equity lines of credit (HELOCs) and equity loans.
In a policy statement, the IRS said that it has received “many questions … from taxpayers and tax professionals” about HELOCs and equity loans in the wake of the Tax Cut and Jobs Act of 2017, which passed in December. That legislation eliminated a section of the federal tax code authorizing interest write-offs on “home equity indebtedness” from 2018 through 2025. But as noted in this column in January, the law did not curtail deductions on all HELOC and equity loan interest payments. It depends on how you use the money you borrow.
Taxpayers can “often still deduct interest on a home equity loan, home equity line of credit or second mortgage, regardless of how the loan is labeled,” said the IRS, provided the borrowed funds are used to “buy, build or substantially improve the taxpayer’s home that secures the loan” and the total debt on the house does not exceed statutory limits. The amount of the first mortgage on the property, combined with the home equity or HELOC debt, cannot exceed $750,000, the newly revised limit for mortgage interest deductions by taxpayers filing joint returns; married owners filing separately have a new ceiling of $375,000. Previously, the limits were $1 million and $500,000.
So what does all this mean in practical terms? Here’s a quick example. Say you and your spouse own a $500,000 house and have a $250,000 first mortgage with an interest rate in the mid-3-percent range. You want to put on a family room addition estimated to cost $100,000 and do bathroom upgrades estimated to run another $50,000. However, you’d prefer not to give up your super low interest rate by refinancing into a new, larger first mortgage. Another option, now fully sanctioned by the IRS: Take out a $150,000 HELOC that will permit you to draw down periodic amounts to pay contractors as they complete scheduled construction benchmarks, leaving your first mortgage intact.
