Will the New Tax Law Affect My Mortgage Interest Deduction?

Mortgage Interest Deduction

One of the staples of owning a home and having a mortgage is the benefit of being able to write off the interest from that mortgage on your taxes and lowering your taxable income. There has been a lot of confusion on how the new tax law, The Tax Cuts and Jobs Act or TCJA for short, impacts these itemized deductions and you as a homeowner.

I hope to bring some clarity to this issue and show that most homeowners will not be greatly affected by these new changes. To start though, let me say that I am not a CPA or tax attorney. I am a mortgage lender in San Diego who wants to help educate his clients on the great benefits that still exist with homeownership. Please verify your specific situation with your CPA.

What Has Changed?

The TCJA has implemented new limits on home mortgage interest deductions for 2018-2025. A homeowner can now generally deduct interest on up to $750,000 of mortgage debt which was incurred to buy or improve a primary or second residence (this is called home acquisition debt). For homeowners who file their taxes using married filing separate status, the home acquisition debt limit is $375,000.

In addition, for the same time period, the new tax law also eliminates the prior provision in the tax law that allowed interest deductions on up to $100,000 of home equity debt, or $50,000 for homeowners who use married filing separate status.
Before the TCJA, you could deduct interest on up to a $1 million mortgage or $500,000 for those who use married filing separate status. A homeowner could also write off the interest on another $100,000 of mortgage debt if the loan proceeds were used to buy or improve a first or second residence, or $50,000 for those who use married filing separate status.

The additional $100,000/$50,000 of mortgage debt could be in the form of a bigger first mortgage or a home equity loan. Due to the additional mortgage debt that could be added, the limit on home acquisition debt prior to the new tax law was really $1.1 million, or $550,000 for those who use a married filing separate status.

Good News for Homeowners with Existing Mortgages

The new tax law does have some exemptions that help current homeowners with mortgages that were in place prior to the new law being implemented. Under a grandfather rule, the TCJA changes do not affect the write offs of mortgages up to $1 million that were already in place prior to specific dates.

If you refinanced prior to 12/16/17 and have a mortgage of $1 million, you will continue to be able to write off the interest on the full $1million loan. Secondly, if you were under a binding contract to purchase a home that was in effect before 12/16/17, as long as the home purchase closes before 4/1/18, you will be able to write off the entire amount of interest on a $1 million loan.

Under another grandfather rule, the $1 million/$500,000 home acquisition mortgage debt limits continue to apply to future refinances up to those loan amounts if the initial mortgage that was taken out before the new tax laws went into effect. To fall under this grandfather clause the new principal loan balance of the refinance cannot exceed the principal balance of the old loan at the time of refinancing.

Non-Itemizers Will Not Be Affected by Any of This

None of these changes to home mortgage interest deductions and the confusion it can bring, matters unless you have enough 2018 itemized deductions to exceed your standard deduction.

That will be the case for fewer homeowners now than in the past. That is due to the fact that the TCJA almost doubled the standard deductions for 2018 compared to 2017. The 2018 standard deduction for married joint-filing couples is $24,000 (compared to $12,700 for 2017).

The 2018 standard deduction for heads of households is $18,000 (versus $9,350 for 2017), and the 2018 standard deduction for singles and those who use married filing separate status is $12,000 (versus $6,350 for 2017).

Let’s Look at Some Examples

If you are still reading, the mortgage interest deductions do matter to you. So let’s look at some examples of how the new TCJA mortgage interest deduction limits work.

Example 1: Before & After

Todd and Beth are married and file their taxes joint. They have a $1.2 million mortgage that was used to buy their principal residence in 2016. In 2017, the couple paid $60,000 of mortgage interest and they could deduct $55,000.

($1.1 million/$1.2 million) x $60,000 = $55,000

For the tax years of 2018-2025, they will only be able to write off the interest on $1 million of their loan. So if they pay $53,000 of mortgage interest in 2018, they can deduct only $44,166

($1 million/$1.2 million) x $53,000 = $44,166

Example 2: Refinance After 2018

Here is a scenario where the information is the same as above, but this time Todd and Beth refinance their mortgage on 8/15/18, when it has a balance of $1.15 million. They do a rate and term refinance keeping their new loan balance at $1.15 million.

Under the grandfather rule we talked about above, the couple will be able to continue to deduct the interest on up to $1 million of the new mortgage amount for 2018-2025.

Example 3: Purchase First Mortgage and Equity Line

Louis is an unmarried man with an $875,000 first mortgage that he took out to buy his primary residence in 2014. In 2016, he opened up a home equity line of credit, and borrowed $60,000 to pay off his student loans, credit card balances, and various other personal debts.

On his 2017 return, Louis can deduct all the interest on the first mortgage. For regular tax purposes, he can also deduct all the line of credit interest under the rules for home equity debt.

For tax years 2018-2025, Louis can continue to deduct all the interest on the first mortgage under the grandfather rule for up to $1 million, but he can no longer treat any of the line of credit interest as deductible home mortgage interest. That is because it was not used to purchase the home or improve it.

Example 4: Purchase First Mortgage and Home Improvements

Let’s take the same scenario as above, except this time let’s say Louis used the $60,000 from the equity line to remodel his primary residence.

On his 2017 return, Louis can deduct the interest on the first mortgage and the line of credit, because he can treat the combined balances as home acquisition debt that does not exceed $1.1 million.

For tax years 2018-2025, Louis can continue to deduct the interest on both loans under the grandfather rule because they fall under the new limit of $1 million of mortgage debt used to buy or improve the home.

Example 5: When the Limit Has Been Met

Samantha is an unmarried individual with an $850,000 first mortgage that was taken out on 11/30/17 to buy her primary residence. In 2018, she opens up an equity line of credit and borrows $75,000 to remodel her kitchen and bathrooms.

For the tax years 2018-2025, Samantha can deduct all the interest on the first mortgage under the grandfather rule for up to $1 million because it was used to buy the home. However, because the $75,000 equity line was taken out in 2018, it falls under the new tax law with the $750,000 limit on mortgage debt that can be written off.

You ask why? The entire $750,000 that could be used toward a tax deduction was absorbed by the grandfathered $850,000 first mortgage. So the equity line balance cannot be treated as a tax deduction, even though the entire loan was used to improve Samantha’s primary residence. Instead the equity line balance will be treated as home equity debt, and interest on home equity debt is not allowed to be used as an interest write off for 2018-2025.

Example 6: Writing Off Both First Mortgage and Equity Line

Let’s change a few facts from the scenario above. This time let’s say that the first mortgage taken out by Samantha was only $625,000.

For tax years 2018-2025, she will be able to deduct all the interest on the first mortgage under the grandfather rule because her purchase loan was below the $1 million mortgage cap.

The $75,000 equity line can also be used as a tax write off. This is because it was used to improve the home and the combined balance of the first mortgage and the equity line is only $700,000, which is under the new mortgage limit of $750,000. So Samantha can deduct all the interest on both loans under the new tax rules.

Example 7: Buying a New Home and Vacation Home After 2018

In this example, Mark and Gina buy a home in January 2018. They obtain a $500,000 mortgage to purchase their primary home. In February 2019, they decide to buy a vacation home. They obtain a $500,000 mortgage on that property as well. Due to the fact that the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. Mark and Gina will only be able to deduct the interest on the loan amounts up to $750,000 for the 2 homes combined.

Do I Need to be Concerned

The good news is, most homeowners will be unaffected by the TCJA’s new limits on deducting home mortgage interest. If you are a homeowner with a larger mortgage and home equity loans, you should definitely look into this more deeply and talk with your CPA.

Hopefully, the several examples I gave above will help clarify whether you will be affected or not. But as I said before, please do not take my information as the final word. Please contact a tax professional to see how your specific scenario may be affected.  If you would like advice on a home loan for a purchase or refinance, please feel free to reach out to me.

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