Deduction for Qualified Residence Interest under 2017 Tax Cuts and Jobs Act

Taxpayers may deduct interest on mortgage debt that is “acquisition debt”. Acquisition debt means debt that is: (i) secured by the taxpayer’s principal home or a second home, and (ii) incurred in acquiring, constructing, or substantially improving the home. This basic rule has not been changed by Tax Cuts and Jobs Act (the “Act”). (Internal Revenue Code Section 163(h)(3)(F)]. 

Prior to the new Act, the maximum amount that could be treated as acquisition debt for purposes of deducting interest was $1 million (or $500,000 for married persons filing debt interest could also be deducted if the debt (2) was secured by the taxpayer’s home, and (2) was not acquisition indebtedness (to wit; not incurred to acquire, construct, or substantially improve the home). 

Under the 2017 Act: 

Under the new Act, the limit of acquisition debt is reduced to $750,000 (and $275,000 for a married person filing separately). The $1 million pre-Act figure still applies to acquisition debt incurred before December 15, 2017. 

Originally it looked as if the 2017 Act eliminated the interest deduction for home equity debt. However, the Internal Revenue Service, in IRS News Release 2018-32 (dated 2/21/18), clarifies situations in which a home equity loan may still generate deductible interest. 

If within the new limit of $750,000, in addition to the deductible first mortgage interest, the home equity interest can be deductible if it is used to buy, build, or substantially improve the taxpayer’s home that secures the loan. 

However, if the home equity loan is used to pay off credit cards, pay off student loans, or pay other personal items, the home equity interest would not be deductible. 

New Release 2018-32 provides, among other examples, the following: 

Example:

In January 2018, a taxpayer takes out a $500,000 first mortgage, to purchase a main home, which home has a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put 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. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off credit cards, the interest on the home equity loan would not be deductible.