Taxpayers can continue to deduct the interest they pay on home equity loans when the funds are used for home improvements, the IRS confirmed in a statement on Wednesday. The status of home equity deductions has been in question following the limits on the mortgage interest deduction included in recent tax reform legislation. The IRS says it has been fielding more questions from taxpayers and tax professionals on whether the interest on home equity loans, home equity lines of credit, or second mortgages can still be deducted.
In its statement, the IRS said despite the restrictions on mortgages, taxpayers can, in most cases, still deduct interest on home equity loans, a home equity line of credit, or a second mortgage.
The tax law, passed in December, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit unless the funds are used to buy, build, or substantially improve the taxpayer’s home, the IRS notes. As such, the interest on a home equity loan used for building an addition to an existing home would generally be deductible, Accounting Today explains. But interest on the same loan used to pay personal living expenses, like credit card debt, would not be.
Under the new tax reform, a limit has been placed on mortgages qualifying for the home mortgage interest deduction. Starting in 2018, taxpayers can only deduct interest on $750,000 of qualified residence loans, or $375,000 for a married taxpayer filing a separate return—down from $1 million or $500,000 for a married taxpayer, respectively.
The IRS offered the following scenario in describing how the new tax law works when it comes to home equity loans:
“In January 2018, a taxpayer gets a $500,000 mortgage to buy a main home with a fair market value of $800,000. The following month, 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 doesn’t exceed the home’s cost. Because the total amount of both loans doesn’t exceed $750,000, all the interest paid on the loans is deductible. But if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan wouldn’t be deductible.”
The National Association of REALTORS® welcomed the IRS announcement Wednesday to clarify that tax deductions for home equity loans or home equity lines of credit can still be taken if used on home improvements.
“The National Association of REALTORS® is pleased with the IRS announcement clarifying and confirming that under the new tax law owners can continue to deduct the interest on a home equity loan, line of credit or second mortgage when the proceeds are used to substantially improve their residence,” said NAR President Elizabeth Mendenhall. “There has been much confusion on this issue, and the continued deductibility will bring real benefits to those who choose to take on remodeling projects to bring more resale value to their home or gain equity that may have been lost during the downturn.”