Does the New Tax Law Allow for a Qualified Residence Mortgage Interest Deduction?

The tax reforms pushed by the Trump Administration and enacted by Congress in 2017 impacted several deductions that U.S. taxpayers have routinely claimed on their returns each year. Despite confusion regarding the scope of the Tax Cuts & Jobs Act (TCJA), the IRS has confirmed that mortgage and home equity loan interest is still deductible – with some changes.

What Is a Qualified Residence?

A “qualified residence” is your main home, the place you live most of the time. It can be a house, condo, or cooperative apartment – as well as a house trailer, mobile home, or houseboat – as long as the home has toilet, cooking, and sleeping facilities.

A second home (no more than one) also qualifies, even if you rent it to others, as long as you use it “more than 14 days or more than 10 percent of the number of days during the year that the home is rented at a fair rental, whichever is longer.”

The TCJA maintains the rule that taxpayers can deduct interest on mortgage debt that is considered “acquisition indebtedness,” which according to the Internal Revenue Code is both secured by the taxpayer’s principal home or a second home and incurred in acquiring, constructing, or substantially improving the home.

New Limits for Mortgage and Home Equity Debt

Prior to the TCJA, $1 million was the maximum amount that could be treated as acquisition debt for purposes of deducting interest, or $500,000 for married persons filing separately. The new law reduces the maximum to $750,000, or $275,000 for a married person filing separately.

Previously, these limits applied to interest on both mortgage and home equity line of credit (HELOC), or second mortgage debt. It looked as if the TCJA would eliminate the home equity interest deduction. However, an IRS News Release clarified matters, indicating that as long as the home equity debt is secured by the qualified home and incurred to acquire, construct, or substantially improve the home, the interest remains deductible. If the home equity loan is used to pay off credit cards, student loans, or personal items, the home equity interest is not deductible.

An Example of How the Mortgage and Home Equity Interest Deduction Works

Here’s a scenario (based on an IRS example) to help taxpayers understand, navigate, and comply with the new tax laws.

Assume that in January 2018, you take out a $500,000 first mortgage to purchase a new home that you will use as your primary residence. The home has a fair market value of $800,000. In February 2018, you take out a $250,000 home equity loan that you use exclusively to build an addition to your new residence.

For tax purposes, you’ve met the requirements that both loans are secured by the main home, and that the total amount of debt does not exceed the fair market value of the home. Because the total amount of both loans does not exceed the $750,000 limit, all of the interest paid on both loans is deductible.